# FIRST NATIONAL CORP /VA/ (FXNC) FY 2021 MD&A Verbatim Item 7 Management's Discussion and Analysis from FIRST NATIONAL CORP /VA/'s 10-K for fiscal year 2021. SEC filing source: https://www.sec.gov/Archives/edgar/data/719402/000143774922007721/fxnc20211231_10k.htm Accession: 0001437749-22-007721 Filing date: 2022-03-30 Report date: 2021-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Confidence: high Company profile: /company/FXNC/ All MD&A years: /company/FXNC/mda/ Next year: /company/FXNC/mda/fy2022/ (FY 2022) Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation The following discussion and analysis of the financial condition and results of operations of the Company for the years ended December 31, 2021 and 2020 should be read in conjunction with the consolidated financial statements and related notes to the consolidated financial statements included in Item 8 of this Form 10-K. Executive Overview The Company First National Corporation (the Company) is the bank holding company of: [[GREPCENT_TABLE]] [["","\u2022","First Bank (the Bank). The Bank owns:"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","First Bank Financial Services, Inc."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","Shen-Valley Land Holdings, LLC"],["","\u2022","Bank of Fincastle Services, Inc."],["","\u2022","ESF, LLC"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","First National (VA) Statutory Trust II (Trust II)"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","First National (VA) Statutory Trust III (Trust III and, together with Trust II, the Trusts)"]] [[/GREPCENT_TABLE]] First Bank Financial Services, Inc. invests in entities that provide title insurance and investment services. Shen-Valley Land Holdings, LLC and ESF, LLC were formed to hold other real estate owned and future office sites. Bank of Fincastle Services, Inc. owns an entity that provides mortgage services.  The Trusts were formed for the purpose of issuing redeemable capital securities, commonly known as trust preferred securities, and are not included in the Company’s consolidated financial statements in accordance with authoritative accounting guidance because management has determined that the Trusts qualify as variable interest entities. Products, Services, Customers and Locations The Bank offers loan, deposit, and wealth management products and services. Loan products and services include consumer loans, residential mortgages, home equity loans, and commercial loans. Deposit products and services include checking accounts, treasury management solutions, savings accounts, money market accounts, certificates of deposit, and individual retirement accounts. Wealth management services include estate planning, investment management of assets, trustee under an agreement, trustee under a will, individual retirement accounts, and estate settlement. Customers include small and medium-sized businesses, individuals, estates, local governmental entities, and non-profit organizations. The Bank’s office locations are well-positioned in attractive markets along the Interstate 81, Interstate 66, and Interstate 64 corridors in the Shenandoah Valley, Roanoke Valley, central regions of Virginia, and the Richmond market areas. Within these market areas, there are diverse types of industry including medical and professional services, manufacturing, retail, warehousing, Federal government, hospitality, and higher education.  The Bank’s products and services are delivered through 20 bank branch offices, a loan production office, and a customer service center in a retirement village.  For the location and general character of each of these offices, see Item 2 of this Form 10-K. Many of the Bank’s services are also delivered through the Bank’s mobile banking platform, its website, www.fbvirginia.com, and a network of ATMs located throughout its market area. Revenue Sources and Expense Factors The primary source of revenue is from net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense and typically represents between 70% and 80% of the Company’s total revenue. Interest income is determined by the amount of interest-earning assets outstanding during the period and the interest rates earned on those assets. The Bank’s interest expense is a function of the amount of interest-bearing liabilities outstanding during the period and the interest rates paid. In addition to net interest income, noninterest income is the other source of revenue for the Company. Noninterest income is derived primarily from service charges on deposits, fee income from wealth management services, ATM and check card fees, and brokered mortgage fees. Primary expense categories are salaries and employee benefits, which comprised 54% of noninterest expenses during 2021, followed by occupancy and equipment expense, which comprised 12% of noninterest expenses. Although the Company recorded a recovery of loan losses in 2021, the provision for loan losses is also typically a primary expense of the Bank. The provision is determined by factors that include net charge-offs, asset quality, economic conditions, and loan growth. Changing economic conditions caused by inflation, recession, unemployment, or other factors beyond the Company’s control have a direct correlation with asset quality, net charge-offs, and ultimately the required provision for loan losses. Overview of Financial Performance and Condition Net income increased by $1.5 million to $10.4 million, or $1.86 per diluted share, for the year ended December 31, 2021, compared to $8.9 million, or $1.82 per diluted share, for the same period in 2020. Return on average assets was 0.88% and return on average equity was 10.30% for the year ended December 31, 2021, compared to 0.98% and 10.92%, respectively, for the year ended December 31, 2020. The $1.5 million increase in net income for the year ended December 31, 2021 resulted primarily from a $5.4 million increase in net interest income, a $3.7 million decrease in provision for loan losses and a $1.9 million, or 24%, increase in noninterest income, compared to the same period of 2020. These favorable variances were partially offset by an $8.9 million, or 38%, increase in noninterest expense and a $537 thousand increase in income tax expense. 26 Table of Contents Net interest income increased $5.4 million for the year ended December 31, 2021 from a $4.3 million increase in total interest income and a $1.1 million decrease in total interest expense, compared to the same period of 2020. Although the net interest margin decreased by 37-basis points to 3.13%, net interest income increased as the impact of the lower net interest margin was offset by a $274.0 million, or 32%, increase in average earning assets, a $1.3 million increase in accretion of deferred PPP loan income, net of origination costs, and $408 thousand of accretion of loan discounts, net of premium amortization, on acquired loans.  Total interest expense decreased by $1.1 million, or 32%, primarily from a decrease in interest expense on deposits as the Bank lowered interest rates paid on deposit accounts. The merger of The Bank of Fincastle with and into First Bank on July 1, 2021 contributed to the increase in average earning assets.  The provision for loan losses decreased $3.7 million, which resulted from $650 thousand of recovery of loan losses in 2021 and provision for loan losses of $3.0 million in 2020. The allowance for loan losses totaled $5.7 million, or 0.69% of total loans at December 31, 2021, compared to $7.5 million, or 1.19% of total loans at December 31, 2020. The specific reserve decreased $2.2 million, which was partially offset by a $392 thousand increase in the general reserve. Net charge-offs totaled $1.1 million in 2021 and $449 thousand in 2020. Noninterest income increased $1.9 million, primarily from increases in ATM and check card fees, wealth management fees, fees for other customer services and other operating income.  The merger with Fincastle contributed to increases in all noninterest income categories, except for wealth management fees.   Noninterest expense increased $8.9 million, primarily from the addition of employees, customers and branch offices through the merger of The Bank of Fincastle with and into First Bank on July 1, 2021, and from merger related expenses that totaled $3.5 million during the year. Several noninterest expense categories increased as a result of the merger. The $3.5 million of merger related expenses contributed to the increases in salaries and employee benefits, marketing, supplies, legal and professional fees, data processing, and other operating expense. The following is selected financial data for the Company for the years ended December 31, 2021 and 2020. This information has been derived from audited financial information included in Item 8 of this Form 10-K (in thousands, except ratios and per share amounts). [[GREPCENT_TABLE]] [["As of and for the years ended December 31,"],["","","2021","","","2020"],["Results of Operations"],["Interest and dividend income","","$","37,144","","","$","32,851"],["Interest expense","","","2,304","","","","3,383"],["Net interest income","","","34,840","","","","29,468"],["Provision for loan losses","","","(650",")","","","3,000"],["Net interest income after provision for loan losses","","","35,490","","","","26,468"],["Noninterest income","","","10,172","","","","8,225"],["Noninterest expense","","","32,717","","","","23,786"],["Income before income taxes","","","12,945","","","","10,907"],["Income tax expense","","","2,586","","","","2,049"],["Net income","","$","10,359","","","$","8,858"],["Key Performance Ratios"],["Return on average assets","","","0.88","%","","","0.98","%"],["Return on average equity","","","10.30","%","","","10.92","%"],["Net interest margin (1)","","","3.13","%","","","3.50","%"],["Efficiency ratio (1)","","","64.44","%","","","62.52","%"],["Dividend payout","","","25.69","%","","","24.23","%"],["Equity to assets","","","8.42","%","","","8.93","%"],["Per Common Share Data"],["Net income, basic","","$","1.87","","","$","1.82"],["Net income, diluted","","","1.86","","","","1.82"],["Cash dividends","","","0.48","","","","0.44"],["Book value at period end","","","18.28","","","","17.47"],["Financial Condition"],["Assets","","$","1,389,437","","","$","950,932"],["Loans, net","","","819,408","","","","622,429"],["Securities","","","324,749","","","","156,334"],["Deposits","","","1,248,752","","","","842,461"],["Shareholders\u2019 equity","","","117,039","","","","84,916"],["Average shares outstanding, diluted","","","5,559","","","","4,880"],["Capital Ratios (2)"],["Leverage","","","8.82","%","","","8.80","%"],["Risk-based capital ratios:"],["Common equity Tier 1 capital","","","14.09","%","","","14.57","%"],["Tier 1 capital","","","14.09","%","","","14.57","%"],["Total capital","","","14.76","%","","","15.82","%"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(1)","This performance ratio is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational performance. Such information is not prepared in accordance with U.S. generally accepted accounting principles (GAAP) and should not be construed as such. Management believes such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. See \u201cNon-GAAP Financial Measures\u201d included in Item 7 of this Form 10-K."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(2)","All capital ratios reported are for the Bank."]] [[/GREPCENT_TABLE]] For a more detailed discussion of the Company's annual performance, see "Net Interest Income,” “Provision for Loan Losses,” "Noninterest Income," "Noninterest Expense" and "Income Taxes" below. 27 Table of Contents Acquisition of The Bank of Fincastle On July 1, 2021, the Company completed the acquisition of The Bank of Fincastle for an aggregate purchase price of $33.8 million of cash and stock. The Company paid cash consideration of $6.8 million and issued 1,348,065 shares of its common stock to the shareholders of Fincastle. Upon completion of the transaction, Fincastle was merged with and into First Bank. At the time of closing of the acquisition, The Bank of Fincastle had six bank branch offices operating in the Roanoke Valley region of Virginia and reported total assets of $267.9 million, total loans of $194.5 million and total deposits of $236.3 million.  For the year ended December 31, 2021, the Company recorded merger related expenses of $3.4 million in connection with the acquisition of Fincastle. The Company estimates that it will incur an additional $20 thousand of merger related expenses in the first and second quarters of 2022.  After the merger, the former Fincastle branches continued to operate as The Bank of Fincastle, a division of First Bank, until the systems were converted on October 16, 2021. All branch offices were operating as First Bank as of December 31, 2021.  Purchased performing loans were recorded at fair value, including a credit discount. The fair value discount will be accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan losses on the purchased loans is expected in future periods as the accretion decreases the fair value discount amount.  A provision may also be required for any deterioration in these loans in future periods. The Company expects cost savings to be realized as Fincastle's operations are fully integrated during 2022. Acquisition of SmartBank Loan Portfolio On September 30, 2021, the Bank acquired $82.0 million of loans and certain fixed assets from SmartBank related to its Richmond area branch, located in Glen Allen, Virginia. First Bank paid cash consideration of $83.7 million for the loans and fixed assets.  Additionally, an experienced team of bankers based out of the SmartBank location have transitioned to become employees of First Bank.  First Bank did not assume any deposit liabilities from SmartBank in connection with the transaction, and SmartBank closed their branch operation on December 31, 2021. First Bank assumed the facility lease at the branch on December 31, 2021 and now operates a loan production office in the location of the former SmartBank branch. First Bank’s assumption of the lease and acquisition of the remaining branch assets was completed in the fourth quarter of 2021. The Company incurred expenses totaling $101 thousand related to the acquisition of loans and fixed assets of SmartBank in the fourth quarter of 2021.  Purchased performing loans were recorded at fair value, including a credit discount. The fair value discount will be accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan losses may be required as fair value discounts accrete to lower amounts than the required reserves for purchased loans and for any deterioration in these loans in future periods. Non-GAAP Financial Measures This report refers to the efficiency ratio, which is computed by dividing noninterest expense, excluding OREO expense, amortization of intangibles, merger expenses, and gains/(losses) on disposal of premises and equipment, by the sum of net interest income on a tax-equivalent basis and noninterest income, excluding securities gains. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be construed as such. Management believes, however, such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The Company, in referring to its net income, is referring to income under GAAP. The components of the efficiency ratio calculation are summarized in the following table (dollars in thousands). [[GREPCENT_TABLE]] [["","","Efficiency Ratio"],["","","2021","","","2020"],["Noninterest expense","","$","32,732","","","$","23,815"],["Subtract: other real estate owned expense, net","","","(26",")","","","\u2014"],["Subtract: amortization of intangibles","","","(28",")","","","(151",")"],["Subtract: merger related expenses","","","(3,514",")","","","\u2014"],["","","$","29,164","","","$","23,664"],["Tax-equivalent net interest income","","$","35,120","","","$","29,666"],["Noninterest income","","","10,172","","","","8,225"],["Subtract: securities gains, net","","","(37",")","","","(40",")"],["","","$","45,255","","","$","37,851"],["Efficiency ratio","","","64.44","%","","","62.52","%"]] [[/GREPCENT_TABLE]] 28 Table of Contents This report also refers to net interest margin, which is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for both 2021 and 2020 is 21%.  The reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below (in thousands). [[GREPCENT_TABLE]] [["","","Reconciliation of Net Interest Income to Tax-Equivalent Net Interest Income"],["","","2021","","","2020"],["GAAP measures:"],["Interest income - loans","","$","32,797","","","$","29,497"],["Interest income - investments and other","","","4,347","","","","3,354"],["Interest expense - deposits","","","(1,415",")","","","(2,589",")"],["Interest expense \u2013 subordinated debt","","","(619",")","","","(501",")"],["Interest expense \u2013 junior subordinated debt","","","(270",")","","","(293",")"],["Total net interest income","","$","34,840","","","$","29,468"],["Non-GAAP measures:"],["Tax benefit realized on non-taxable interest income - loans","","$","32","","","$","34"],["Tax benefit realized on non-taxable interest income - municipal securities","","","248","","","","164"],["Total tax benefit realized on non-taxable interest income","","$","280","","","$","198"],["Total tax-equivalent net interest income","","$","35,120","","","$","29,666"]] [[/GREPCENT_TABLE]] Critical Accounting Policies General The Company’s consolidated financial statements and related notes are prepared in accordance with GAAP. The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, or relieving a liability. The Bank uses historical losses as one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another. Although the economics of transactions would be the same, the timing of events that would impact transactions could change. Presented below is a discussion of those accounting policies that management believes are the most important (Critical Accounting Policies) to the portrayal and understanding of the Company’s financial condition and results of operations. The Critical Accounting Policies require management’s most difficult, subjective, and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. Allowance for Loan Losses The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management determines that the loan balance is uncollectible. Subsequent recoveries, if any, are credited to the allowance. For further information about the Company’s loans and the allowance for loan losses, see Notes 1, 3, and 4 to the Consolidated Financial Statements included in this Form 10-K. The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The Company performs regular credit reviews of the loan portfolio to review credit quality and adherence to underwriting standards. The credit reviews consist of reviews by its internal credit administration department and reviews performed by an independent third party. Upon origination, each loan is assigned a risk rating ranging from one to nine, with loans closer to one having less risk. This risk rating scale is the Company's primary credit quality indicator. The Company has various committees that review and ensure that the allowance for loans losses methodology is in accordance with GAAP and loss factors used appropriately reflect the risk characteristics of the loan portfolio. 29 Table of Contents The allowance represents an amount that, in management’s judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of the collateral, overall portfolio quality, and review of specific potential losses. The evaluation also considers the following risk characteristics of each loan portfolio class: [[GREPCENT_TABLE]] [["","\u2022","1-4 family residential mortgage loans carry risks associated with the continued creditworthiness of the borrower and changes in the value of the collateral."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","Real estate construction and land development loans carry risks that the project may not be finished according to schedule, the project may not be finished according to budget, and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure or other factors unrelated to the project."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","Other real estate loans carry risks associated with the successful operation of a business or a real estate project, in addition to other risks associated with the ownership of real estate, because repayment of these loans may be dependent upon the profitability and cash flows of the business or project."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","Commercial and industrial loans carry risks associated with the successful operation of a business because repayment of these loans may be dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much reliability."]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["","\u2022","Consumer and other loans carry risk associated with the continued creditworthiness of the borrower and the value of the collateral, if any. Consumer loans are typically either unsecured or secured by rapidly depreciating assets such as automobiles. These loans are also likely to be immediately and adversely affected by job loss, divorce, illness, personal bankruptcy, or other changes in circumstances. Other loans included in this category include loans to states and political subdivisions."]] [[/GREPCENT_TABLE]] The allowance for loan losses consists of specific and general components. The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows, fair value of collateral less estimated costs to sell, or observable market price of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal is ordered if a current one is not on file. Appraisals are typically performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions among other considerations. The general component covers loans that are not considered impaired and is based on historical loss experience adjusted for qualitative factors. The historical loss experience is calculated by loan type and uses an average loss rate during the preceding twelve quarters. The qualitative factors are assigned by management based on delinquencies and asset quality, national and local economic trends, effects of the changes in the value of underlying collateral, trends in volume and nature of loans, effects of changes in the lending policy, the experience and depth of management, concentrations of credit, quality of the loan review system, and the effect of external factors such as competition and regulatory requirements. The factors assigned differ by loan type. The general allowance estimates losses whose impact on the portfolio has yet to be recognized by a specific allowance. Allowance factors and the overall size of the allowance may change from period to period based on management’s assessment of the above described factors and the relative weights given to each factor. For further information regarding the allowance for loan losses, see Notes 1 and 4 to the Consolidated Financial Statements included in this Form 10-K. Loans Acquired in a Business Combination Acquired loans are classified as either (i) purchased credit-impaired (PCI) loans or (ii) purchased performing loans and are recorded at fair value on the date of acquisition. PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Corporation will not collect all contractually required principal and interest payments. When determining fair value, PCI loans may be evaluated individually or may be aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. There were no acquired loans classified as PCI in the acquisition of Fincastle and the SmartBank loan portfolio acquisition during the third quarter of 2021. Purchased performing loans are those for which there is no evidence of credit deterioration.  When determining fair value for purchased performing loans acquired from the Bank of Fincastle and SmartBank during 2021, First Bank evaluated the loans individually and they were initially recorded at fair value on the date of the acquisitions.  Overall, there were net discounts recorded for the acquired loans, which are being accreted into income over the life of the loans through interest and fees on loans.  The Bank calculates a required allowance for loan loss for each purchased performing loan on a quarterly basis.  Provision for loan losses are recorded for purchased performing loans for the amount of the required allowance for loan losses that exceeds the unaccreted discount. Goodwill The Company's goodwill was recognized in connection with business combinations that occurred in the third quarter of 2021. The Company will review the carrying value of goodwill at least annually or more frequently if certain impairment indicators exist. In testing goodwill for impairment, the Company may first consider qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then no further testing would be required and the goodwill of the reporting unit would not be impaired. If the Company elects to bypass the qualitative assessment or if we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit will be compared with its carrying value to determine whether an impairment exists. 30 Table of Contents Lending Policies General In an effort to manage risk, the Bank’s loan policy gives loan amount approval limits to individual loan officers based on their position within the Bank and level of experience. The Management Loan Committee can approve new loans up to the Bank's legal lending limit. The Board Loan Committee reviews all loans greater than $1.0 million. The Board Loan Committee currently consists of six directors, five of which are non-management directors. The Board Loan Committee approves the Bank’s Loan Policy and reviews risk management reports, including watch list reports, concentrations of credit, policy exceptions, and risk grade migration. The Board Loan Committee meets at least two times per quarter and the Chairman of the Committee then reports to the Board of Directors. Residential loan originations are primarily generated by mortgage loan officer solicitations and referrals by employees, real estate professionals, and customers. Commercial real estate loan originations and commercial and industrial loan originations are primarily obtained through direct solicitation and additional business from existing customers. All completed loan applications are reviewed by the Bank’s loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment, and credit history of the applicant. The Bank also participates in commercial real estate loans and commercial and industrial loans originated by other financial institutions that are typically outside its market area. In addition, the Bank has purchased consumer loans originated by other financial institutions that are typically outside its market area. Loan quality is analyzed based on the Bank’s experience and credit underwriting guidelines depending on the type of loan involved. Except for loan participations with other financial institutions, real estate collateral is valued by independent appraisers who have been pre-approved by the Board Loan Committee. As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, certain appraisals are analyzed by management or by an outsourced appraisal review specialist throughout the year in order to ensure standards of quality are met. The Company also obtains an independent review of loans within the portfolio on an annual basis to analyze loan risk ratings and validate specific reserves on impaired loans. In the normal course of business, the Bank makes various commitments and incurs certain contingent liabilities which are disclosed but not reflected in its financial statements, including commitments to extend credit. At December 31, 2021, commitments to extend credit, stand-by letters of credit, and rate lock commitments totaled $185.0 million. Construction and Land Development Lending The Bank makes local construction loans, including residential and land acquisition and development loans. These loans are secured by the property under construction and the underlying land for which the loan was obtained. The majority of these loans mature in one year. Construction lending entails significant additional risks, compared with residential mortgage lending. Construction and land development loans sometimes involve larger loan balances concentrated with single borrowers or groups of related borrowers. Another risk involved in construction and land development lending is the fact that loan funds are advanced upon the security of the land or property under construction, which value is estimated based on the completion of construction. Thus, there is risk associated with failure to complete construction and potential cost overruns. To mitigate the risks associated with this type of lending, the Bank generally limits loan amounts relative to the appraised value and/or cost of the collateral, analyzes the cost of the project and the creditworthiness of its borrowers, and monitors construction progress. The Bank typically obtains a first lien on the property as security for its construction loans, typically requires personal guarantees from the borrower’s principal owners, and typically monitors the progress of the construction project during the draw period. 31 Table of Contents 1-4 Family Residential Real Estate Lending 1-4 family residential lending activity may be generated by Bank loan officer solicitations and referrals by real estate professionals and existing or new bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment, and credit history of the applicant. Residential mortgage loans generally are made on the basis of the borrower’s ability to make payments from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In addition to the Bank’s underwriting standards, loan quality may be analyzed based on guidelines issued by a secondary market investor. The valuation of residential collateral is generally provided by independent fee appraisers who have been approved by the Board Loan Committee. In addition to originating mortgage loans with the intent to sell to correspondent lenders or broker to wholesale lenders, the Bank also originates and retains certain mortgage loans in its loan portfolio. Commercial Real Estate Lending Commercial real estate loans are secured by various types of commercial real estate typically in the Bank’s market area, including multi-family residential buildings, office and retail buildings, hotels, industrial buildings, and religious facilities. Commercial real estate loan originations are primarily obtained through direct solicitation of customers and potential customers. The valuation of commercial real estate collateral is provided by independent appraisers who have been approved by the Board Loan Committee. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy in general. The Bank’s commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower’s creditworthiness, prior credit history, and reputation. The Bank typically requires personal guarantees of the borrowers’ principal owners and considers the valuation of the real estate collateral. Commercial and Industrial Lending Commercial and industrial loans generally have a higher degree of risk than loans secured by real estate, but typically have higher yields. Commercial and industrial loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business. The loans may be unsecured or secured by business assets, such as accounts receivable, equipment, and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, any collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much reliability as real estate. Also included in this category are loans originated under the SBA's PPP. PPP loans are fully guaranteed by the SBA, and in some cases borrowers may be eligible to obtain forgiveness of the loans, in which case loans would be repaid by the SBA. Consumer Lending Loans to individual borrowers may be secured or unsecured, and include unsecured consumer loans and lines of credit, automobile loans, deposit account loans, and installment and demand loans. These consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss, or depreciation. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. The underwriting standards employed by the Bank for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on a proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income. Also included in this category are loans purchased through a third-party lending program. These portfolios include consumer loans and carry risks associated with the borrower, changes in the economic environment, and the vendor itself. The Company manages these risks through policies that require minimum credit scores and other underwriting requirements, robust analysis of actual performance versus expected performance, as well as ensuring compliance with the Company's vendor management program. 32 Table of Contents Results of Operations General Net interest income represents the primary source of earnings for the Company. Net interest income equals the amount by which interest income on interest-earning assets, predominantly loans and securities, exceeds interest expense on interest-bearing liabilities, including deposits, other borrowings, subordinated debt, and junior subordinated debt. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, are the components that impact the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets. The provision for loan losses, noninterest income, noninterest expense and income tax expense are the other components that determine net income. Noninterest income and expense primarily consists of income from service charges on deposit accounts, ATM and check card income, revenue from wealth management services, revenue from other customer services, income from bank owned life insurance, general and administrative expenses and amortization expense. Net Interest Income For the year ended December 31, 2021, net interest income increased $5.4 million, or 18%, to $34.8 million for the year ended December 31, 2021, compared to net interest income of $29.5 million for the prior year. The increase in net interest income was primarily attributable to a $274.0 million, or 32%, increase in average earnings assets, which was partially offset by a 37-basis point decrease in the net interest margin to 3.13%. The acquisition of The Bank of Fincastle on July 1, 2021 and an increase in average deposit balances resulted in growth of average earning assets. The decrease in the net interest margin was attributable to decreases in earning asset yields and a change in the composition of average earning assets. Average loans, which was the highest yielding category, decreased to 64% of average earning assets for the year ended December 31, 2021, compared to 69% for the same period of 2020. Although average loans increased $88.8 million, increases in lower yielding asset categories also experienced growth, as average securities increased $81.3 million and Federal funds sold and interest-bearing deposits in other banks combined increased $103.9 million. Interest income increased $4.3 million during 2021. The higher amount of total interest and dividend income resulted from increases in both interest and fees on loans and interest on securities. Interest and fees on loans increased $3.3 million, or 11%, from a 14% increase in average loan balances, which was partially offset by a 12-basis point decrease in the yield on total loans to 4.61%. Accretion on deferred PPP fee income, net of costs, was included in interest and fees on loans, which totaled $2.0 million for the year ended December 31, 2021, compared to $824 thousand in the prior year. The total amount of deferred PPP income, net of origination costs, not yet recognized through interest and fees on loans totaled $367 thousand at December 31, 2021.  As a result, the Bank expects accretion of deferred PPP income, net of origination costs, to decrease significantly in future periods, when compared to income recognized in 2021 and 2020.  Accretion of loan discounts, net of premium amortization, on acquired loans was also included in interest and fees on loans and totaled $408 thousand for the year ended December 31, 2021. There was no accretion or amortization of discounts or premiums on acquired loans during 2020. Interest and dividends on securities increased $960 thousand, or 30%, during 2021 from a 57% increase in average securities balances, which was partially offset by a 39-basis point decrease in the yield on total securities to 1.96%. Total interest expense decreased by $1.1 million, or 32%, to $2.3 million, primarily from interest expense on deposits, which decreased $1.2 million, or 45%, from a 26-basis point decrease in the cost of interest-bearing deposits.  The decrease in the cost of interest-bearing deposits was partially offset by the impact of a $145.6 million, or 26%, increase in average interest-bearing deposit balances. The decrease in the cost of interest-bearing deposits was attributable to a reduction in interest rates paid on checking, money market and time deposits.  The Bank lowered interest rates paid on deposits in 2020 and 2021, after the Federal Reserve lowered the Federal Funds rate by 150 basis points in March 2020 in response to the COVID-19 pandemic. 33 Table of Contents The following table provides information on average interest-earning assets and interest-bearing liabilities for the years ended December 31, 2021 and 2020 as well as amounts and rates of tax equivalent interest earned and interest paid (dollars in thousands). The volume and rate analysis table analyzes the changes in net interest income for the periods broken down by their rate and volume components (in thousands). [[GREPCENT_TABLE]] [["Average Balances, Income and Expense, Yields and Rates (Taxable Equivalent Basis)"],["","","Years Ending December 31,"],["","","2021","","","2020"],["","","Average Balance","","","Interest Income/Expense","","","Yield/Rate","","","Average Balance","","","Interest Income/Expense","","","Yield/Rate"],["Assets"],["Interest-bearing deposits in other banks","","$","164,118","","","$","213","","","","0.13","%","","$","81,193","","","$","190","","","","0.23","%"],["Securities:"],["Taxable","","","173,363","","","","3,100","","","","1.79","%","","","112,146","","","","2,448","","","","2.18","%"],["Tax-exempt (1)","","","47,570","","","","1,184","","","","2.49","%","","","27,557","","","","781","","","","2.83","%"],["Restricted","","","1,926","","","","88","","","","4.56","%","","","1,844","","","","99","","","","5.36","%"],["Total securities","","","222,859","","","","4,372","","","","1.96","%","","","141,547","","","","3,328","","","","2.35","%"],["Loans: (2)"],["Taxable","","","709,347","","","","32,677","","","","4.61","%","","","620,250","","","","29,367","","","","4.73","%"],["Tax-exempt (1)","","","3,389","","","","152","","","","4.49","%","","","3,664","","","","164","","","","4.49","%"],["Total loans","","","712,736","","","","32,829","","","","4.61","%","","","623,914","","","","29,531","","","","4.73","%"],["Federal funds sold","","","20,934","","","","10","","","","0.05","%","","","9","","","","\u2014","","","","0.10","%"],["Total earning assets","","","1,120,647","","","","37,424","","","","3.34","%","","","846,663","","","","33,049","","","","3.90","%"],["Less: allowance for loan losses","","","(6,316",")","","","","","","","","","","","(6,137",")"],["Total nonearning assets","","","68,105","","","","","","","","","","","","60,690"],["Total assets","","$","1,182,436","","","","","","","","","","","$","901,216"],["Liabilities and Shareholders\u2019 Equity"],["Interest-bearing deposits:"],["Checking","","$","254,077","","","$","424","","","","0.17","%","","$","193,870","","","$","690","","","","0.36","%"],["Money market accounts","","","168,932","","","","187","","","","0.11","%","","","149,029","","","","701","","","","0.47","%"],["Savings accounts","","","164,768","","","","107","","","","0.07","%","","","111,693","","","","67","","","","0.06","%"],["Certificates of deposit:"],["Less than $100","","","69,904","","","","310","","","","0.44","%","","","59,726","","","","453","","","","0.76","%"],["Greater than $100","","","52,304","","","","385","","","","0.74","%","","","50,176","","","","677","","","","1.35","%"],["Brokered deposits","","","650","","","","2","","","","0.34","%","","","579","","","","1","","","","0.26","%"],["Total interest-bearing deposits","","","710,635","","","","1,415","","","","0.20","%","","","565,073","","","","2,589","","","","0.46","%"],["Federal funds purchased","","","1","","","","\u2014","","","","0.47","%","","","1","","","","\u2014","","","","1.58","%"],["Subordinated debt","","","9,992","","","","619","","","","6.20","%","","","7,527","","","","501","","","","6.65","%"],["Junior subordinated debt","","","9,279","","","","270","","","","2.91","%","","","9,279","","","","293","","","","3.16","%"],["Other borrowings","","","\u2014","","","","\u2014","","","","\u2014","%","","","0","","","","\u2014","","","","0.00","%"],["Total interest-bearing liabilities","","","729,907","","","","2,304","","","","0.32","%","","","581,880","","","","3,383","","","","0.58","%"],["Noninterest-bearing liabilities"],["Demand deposits","","","348,829","","","","","","","","","","","","236,061"],["Other liabilities","","","3,104","","","","","","","","","","","","2,182"],["Total liabilities","","","1,081,840","","","","","","","","","","","","820,123"],["Shareholders\u2019 equity","","","100,596","","","","","","","","","","","","81,093"],["Total liabilities and shareholders\u2019 equity","","$","1,182,436","","","","","","","","","","","$","901,216"],["Net interest income","","","","","","$","35,120","","","","","","","","","","","$","29,666"],["Interest rate spread","","","","","","","","","","","3.02","%","","","","","","","","","","","3.32","%"],["Cost of funds","","","","","","","","","","","0.21","%","","","","","","","","","","","0.41","%"],["Interest expense as a percent of average earning assets","","","","","","","","","","","0.21","%","","","","","","","","","","","0.40","%"],["Net interest margin","","","","","","","","","","","3.13","%","","","","","","","","","","","3.50","%"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(1)","Income and yields are reported on a taxable-equivalent basis assuming a federal tax rate of 21%. The tax-equivalent adjustment was $280 thousand for 2021, and $198 thousand for 2020"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(2)","Loans placed on a non-accrual status are reflected in the balances."]] [[/GREPCENT_TABLE]] 34 Table of Contents [[GREPCENT_TABLE]] [["","","Volume and Rate"],["","","Years Ending December 31,"],["","","2021"],["","","Volume Effect","","","Rate Effect","","","Change in Income/Expense"],["Interest-bearing deposits in other banks","","$","22","","","$","\u2014","","","$","22"],["Loans, taxable","","","4,019","","","","(709",")","","","3,310"],["Loans, tax-exempt","","","(12",")","","","\u2014","","","","(12",")"],["Securities, taxable","","","971","","","","(318",")","","","653"],["Securities, tax-exempt","","","484","","","","(80",")","","","404"],["Securities, restricted","","","5","","","","(15",")","","","(10",")"],["Federal funds sold","","","10","","","","(2",")","","","8"],["Total earning assets","","$","5,499","","","$","(1,124",")","","$","4,375"],["Checking","","$","380","","","$","(646",")","","$","(266",")"],["Money market accounts","","","109","","","","(622",")","","","(513",")"],["Savings accounts","","","30","","","","10","","","","40"],["Certificates of deposits:"],["Less than $100","","","97","","","","(240",")","","","(143",")"],["Greater than $100","","","30","","","","(323",")","","","(293",")"],["Brokered deposits","","","\u2014","","","","\u2014","","","","\u2014"],["Federal funds purchased","","","\u2014","","","","\u2014","","","","\u2014"],["Subordinated debt","","","149","","","","(31",")","","","118"],["Junior subordinated debt","","","\u2014","","","","(23",")","","","(23",")"],["Other borrowings","","","\u2014","","","","\u2014","","","","\u2014"],["Total interest-bearing liabilities","","$","795","","","$","(1,875",")","","$","(1,080",")"],["Change in net interest income","","$","4,704","","","$","751","","","$","5,455"]] [[/GREPCENT_TABLE]] Provision for Loan Losses Recovery of loan losses totaled $650 thousand for the year ended December 31, 2021 and resulted in an allowance for loan losses that totaled $5.7 million, or 0.69% of total loans. This compared to a provision for loan losses of $3.0 million for the year ended December 31, 2020 and an allowance for loan losses of $7.5 million, or 1.19% of total loans at December 31, 2020. The allowance for loan losses decreased primarily as a result of purchased loan accounting related to the Bank of Fincastle and SmartBank acquisitions. Recovery of loan losses of $650 thousand and net charge offs of $1.1 million resulted in a $1.8 million decrease in the allowance for loan losses during 2021. The specific reserve component of the allowance for loan losses decreased $2.2 million, while the general reserve component of the allowance for loan losses increased $392 thousand.  The decrease in the specific reserve was primarily attributable to the resolution of a previously impaired loan. The increase in the general reserve was attributable to loan growth, an increase in historical losses, and reserves on purchased loans. These increases were partially offset by improvements to the asset quality and economic qualitative factors that had been increased during the pandemic. The Bank recorded provision for loan losses of $3.0 million for prior year ended December 31, 2020, which was attributable to net charge-offs totaling $449 thousand and increases in both the general and specific reserve components of the allowance for loan losses. The general reserve component of the allowance for loan losses increased primarily from adjustments to qualitative factors, which resulted from the Bank’s observation of unfavorable changes in economic indicators impacted by the pandemic, consideration of risks associated with loans modified for interest-only payments in accordance with the CARES Act, and an increase in substandard loan amounts. The increase in the specific reserve component of the allowance for loan losses included reserves placed on newly identified impaired loans during the year. 35 Table of Contents Noninterest Income Noninterest income increased $1.9 million, or 24%, to $10.2 million for the year ending December 31, 2021, compared to the prior year. The increase was primarily attributable to a $616 thousand, or 27%, increase in ATM and check card fees, a $504 thousand, or 23%, increase in wealth management fees, a $343 thousand, or 35%, increase in fees for other customer services, and a $442 thousand increase in other operating income. The increase in ATM and check card fees was attributable to the addition of new customer deposit accounts through the Merger with Fincastle and an increase in customer check card transactions. Wealth management revenue increased from a higher amount of assets under management. The increase in brokered mortgage fee income was attributable to an increase in customer refinance activity. Other operating income increased primarily from income from investments in partnerships that provide title insurance and finance small businesses. Noninterest Expense Noninterest expense increased $8.9 million, or 38%, to $32.7 million for the year ending December 31, 2021, compared to the prior year. Merger and acquisition expenses totaled $3.5 million for the year and were comprised of $1.2 million of salaries and employee benefits, $69 thousand of marketing expense, $75 thousand of supplies, $1.8 million of legal and professional fees, $81 thousand data processing fees, and $290 thousand of other operating expense. In addition, several noninterest expense categories increased during the year as a result of adding employees, customers and branch offices from the merger of The Bank of Fincastle with and into First Bank on July 1, 2021, and also from the acquisition of SmartBank’s loan portfolio, employees and loan production office located in the Richmond, Virginia market on September 30, 2021. Expenses that increased during the year as a result of the growth of the Company after the Merger included salaries and employee benefits, occupancy, equipment, marketing, supplies, ATM and check card expense, FDIC assessment, data processing, and other operating expense. Expenses that increased as a result of the acquisition of the SmartBank loan portfolio, Richmond-area office, and employees included salaries and employee benefits, occupancy, equipment, marketing, supplies, data processing, and other operating expense.  Merger and acquisition expenses totaled $1.3 million for the three month period ending December 31, 2021.  Income Taxes Income tax expense increased $537 thousand during the year ended December 31, 2021 compared to the prior year. The Company’s income tax expense differed from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the year ended December 31, 2021 and 2020. The difference was a result of net permanent tax deductions, primarily comprised of tax-exempt interest income and income from bank owned life insurance. A more detailed discussion of the Company’s tax calculation is contained in Note 11 to the Consolidated Financial Statements included in this Form 10-K. 36 Table of Contents Financial Condition General Total assets increased $438.5 million to $1.4 billion at December 31, 2021, compared to $950.9 million at December 31, 2020. The increase was primarily attributable to a $197.0 million increase in net loans, a $168.4 million increase in securities, and a $43.1 million increase in interest-bearing deposits in banks. The increase in the loan portfolio was impacted by $194.5 million of loans acquired on July 1, 2021 through the acquisition of Fincastle, an $82.0 million loan portfolio acquisition from SmartBank on September 30, 2021, and an $82.5 million decrease in PPP loan balances during the year ended December 31, 2021. At December 31, 2021, total liabilities increased $406.4 million to $1.3 billion compared to $866.0 million at December 31, 2020. The increase was attributable to the acquisition of Fincastle, on July 1, 2021, which added total liabilities of $238.0 million, and growth of the Bank's deposit portfolio.  Total deposits increased by $406.3 million, which included $236.3 million in total deposits acquired from Fincastle.  Proceeds from PPP loan originations and the receipt of government stimulus checks by customers during the year contributed to the increase in deposits. Noninterest-bearing demand deposits and savings and interest-bearing deposits increased $150.0 million and $211.0 million, respectively, while time deposits decreased $45.4 million.  Total shareholders' equity increased $32.1 million to $117.0 million at December 31, 2021, compared to $84.9 million at December 31, 2020.  The increase was primarily attributable to the issuance of common stock in the amount of $1.7 million and surplus of $25.4 million in the acquisition of Fincastle. Other notable increases include a $7.7 million increase in retained earnings. This increase was partially offset by a $3.1 million decrease in accumulated other comprehensive income.   Loans The Bank is an active lender with a loan portfolio that includes commercial and residential real estate loans, commercial loans, consumer loans, construction and land development loans, and home equity loans. The Bank’s lending activity is concentrated on individuals, small and medium-sized businesses, and local governmental entities primarily in its market areas. As a provider of community-oriented financial services, the Bank does not attempt to further geographically diversify its loan portfolio by undertaking significant lending activity outside its market areas.  The Bank actively participated as a lender in the U.S. Small Business Administration’s (SBA) Paycheck Protection Program (PPP) to support local small businesses and non-profit organizations by providing forgivable loans. Loan fees received from the SBA are accreted by the Bank into income evenly over the life of the loans, net of loan origination costs, through interest and fees on loans. PPP loans totaled $12.4 million and $64.7 million at December 31, 2021 and 2020, respectively; with $159 thousand scheduled to mature in the second and third quarters of 2022, and $12.2 million scheduled to mature in the first and second quarters of 2026. The Company believes the majority of these loans will ultimately be forgiven and repaid by the SBA in accordance with the terms of the program. It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan losses through additional provision for loan losses charged to earnings. The Bank recognized $2.0 million and $824 thousand of accretion on deferred PPP income, net of origination costs, through interest and fees on loans for year ended December 31, 2021 and 2020, respectively. The total amount of deferred PPP income, net of origination costs, not yet recognized through interest and fees on loans totaled $367 thousand at December 31, 2021. Loans, net of allowance for loan losses, increased $197.0 million to $819.4 million at December 31, 2021, compared to $622.4 million at December 31, 2020.  The increase was attributable to the acquisition of Fincastle and the SmartBank loan portfolio, which added loans totaling $194.5 million and $82.0 million, respectively.  The increase in loans from the acquisitions was partially offset by a $52.2 million decrease in PPP loan balances during 2021. Commercial real estate loans increased by $118.0 million, residential real estate loans increased by $56.2 million, construction loans and other loans increased by $28.4 million and $4.1 million, respectively.  These increases were partially offset by commercial and industrial and consumer loans that decreased by $10.0 million and $1.5 million, respectively.  The decrease in commercial and industrial loans was a result of $82.5 million decrease in PPP loans during 2021. 37 Table of Contents The following table sets forth the maturities of the loan portfolio at December 31, 2021 (in thousands): [[GREPCENT_TABLE]] [["","","Maturity/Repricing Schedule of Loans Held for Investment"],["","","December 31, 2021"],["","","Construction and Land Development","","","Secured by 1-4 Family Residential","","","Other Real Estate","","","Commercial and Industrial","","","Consumer and Other Loans","","","Total"],["Variable Rate:"],["Within 1 year","","$","11,802","","","$","7,254","","","$","13,065","","","$","13,104","","","$","489","","","$","45,714"],["1 to 5 years","","","4,435","","","","7,715","","","","811","","","","873","","","","32","","","","13,866"],["5 to 15 years","","","9,690","","","","94,604","","","","111,809","","","","8,252","","","","4,019","","","","228,374"],["After 15 years","","","1,091","","","","46,748","","","","68,853","","","","882","","","","\u2014","","","","117,574"],["Fixed Rate:"],["Within 1 year","","","12,160","","","","3,675","","","","17,157","","","","9,434","","","","770","","","","43,196"],["1 to 5 years","","","6,418","","","","14,297","","","","55,947","","","","41,913","","","","7,175","","","","125,750"],["5 to 15 years","","","10,125","","","","72,881","","","","85,333","","","","22,672","","","","196","","","","191,207"],["After 15 years","","","\u2014","","","","44,816","","","","11,946","","","","2,675","","","","\u2014","","","","59,437"],["","","$","55,721","","","$","291,990","","","$","364,921","","","$","99,805","","","$","12,681","","","$","825,118"]] [[/GREPCENT_TABLE]] Asset Quality Management classifies non-performing assets as non-accrual loans and OREO. OREO represents real property taken by the Bank when its customers do not meet the contractual obligation of their loans, either through foreclosure or through a deed in lieu thereof from the borrower and properties originally acquired for branch operations or expansion but no longer intended to be used for that purpose. OREO is recorded at the lower of cost or fair value, less estimated selling costs, and is marketed by the Bank through brokerage channels. The Bank had $1.8 million in assets classified as OREO at December 31, 2021.  The Bank did not have any assets classified as OREO at December 31, 2020. Non-performing assets totaled $4.2 million and $6.7 million at December 31, 2021 and 2020, representing approximately 0.30% and 0.71% of total assets, respectively.  Non-performing assets consisted of $1.8 million of OREO and $2.3 million of non-accrual loans at December 31, 2021.  Non-performing assets consisted only of non-accrual loans at December 31, 2020.  The decrease in non-accrual loans was primarily attributable to the resolution of a $4.3 million loan that was partially charged-off.  This decrease was partially offset by $2.0 million of nonperforming assets acquired from the Bank of Fincastle, including $1.8 million in properties formerly classified as bank premises by the Bank of Fincastle, which were classified as OREO at December 31, 2021. At December 31, 2021, 78.1% of non-performing assets were commercial and industrial loans, 18.5% were residential real estate loans, and 3.4% were other real estate loans. Non-performing assets could increase due to the deterioration of other loans identified by management as potential problem loans. Other potential problem loans are defined as performing loans that possess certain risks, including the borrower’s ability to pay and the collateral value securing the loan, that management has identified that may result in the loans not being repaid in accordance with their terms. Other potential problem loans totaled $1.1 million and $1.4 million at December 31, 2021 and December 31, 2020, respectively. The amount of other potential problem loans in future periods may be dependent on economic conditions and other factors influencing a customers’ ability to meet their debt requirements. 38 Table of Contents.  There were no loans greater than 90 days past due and still accruing at December 31, 2021.  There were $302 thousand of loans greater than 90 days past due and still accruing at December 31, 2020. In response to the unknown impact of the pandemic on the economy and its customers, the Bank created and implemented a loan payment deferral program for individual and business customers beginning in the first quarter of 2020, which provided them the opportunity to defer monthly payments for 90 days. By June 30,  2020, loans participating in the program reached $182.6 million. The majority of these loans resumed regular payments during the second half of 2020 after their deferral periods ended. There were no loans remaining in the program at December 31, 2021. These loans were not considered troubled debt restructurings (TDRs) because they were modified in accordance with relief provisions of the CARES Act and interagency regulatory guidance. During the fourth quarter of 2020 and the first half of 2021, the Bank modified terms of certain loans for customers that continued to be negatively impacted by the pandemic by lowering borrower’s loan payments with interest only payments for periods ranging between 6 and 24 months. Modified loans totaled $11.5 million at December 31, 2021, which were all in the Bank’s commercial real estate loan portfolio.  All modified loans were either performing under their modified terms or resumed regular loan payments as of December 31, 2021. The allowance for loan losses represents management’s analysis of the existing loan portfolio and related credit risks. The provision for loan losses is based upon management’s current estimate of the amount required to maintain an adequate allowance for loan losses reflective of the risks in the loan portfolio. The allowance for loan losses totaled $5.7 million at December 31, 2021 and $7.5 million at December 31, 2020, representing 0.69% and 1.19% of total loans, respectively. After analyzing the composition of the loan portfolio, related credit risks, and changes in asset quality during recent years, the Company determined that the three year loss period and the qualitative adjustment factors that established the general reserve component of the allowance for loan losses were appropriate at December 31, 2021. The allowance for loan losses as a percentage of total loans decreased to 0.69% at December 31, 2021 compared to 1.19% at December 31, 220 primarily as a result of purchased loan accounting related to the Bank of Fincastle and SmartBank acquisitions. For further discussion regarding the allowance for loan losses, see “Provision for Loan Losses” above. Recoveries of loan losses of $737 thousand and $67 thousand were recorded in the other real estate loan and commercial and industrial loan classes, respectively, during the year ended December 31, 2021. The recovery of loan losses in the other real estate loan class resulted primarily from a decrease in the specific reserve. The decrease in the specific reserve for the other real estate loan class resulted from the resolution of a previously impaired loan. The recovery of loan losses in the commercial and industrial loan class resulted from a decrease in the specific reserve. These recoveries were offset by provision for loan losses totaling $154 thousand in the construction and land development, 1-4 family residential, and consumer and other loan classes. For more detailed information regarding the provision for loan losses, see Note 4 to the Consolidated Financial Statements included in this Form 10-K. Impaired loans totaled $2.3 million and $6.7 million at December 31, 2021 and 2020, respectively. The related allowance for loan losses required for these loans totaled $55 thousand and $2.2 million at December 31, 2021 and December 31, 2020, respectively. The average recorded investment in impaired loans during 2021 and 2020 was $4.5 million and $3.9 million, respectively. Included in the impaired loans total are loans classified as TDRs totaling $1.6 million and $6.0 million at December 31, 2021 and 2020, respectively. Loans classified as TDRs represent situations in which a modification to the contractual interest rate or repayment structure has been granted to address a financial hardship. As of December 31, 2021, none of these TDRs were performing under the restructured terms and all were considered non-performing assets. 39 Table of Contents Management believes, based upon its review and analysis, that the Bank has sufficient reserves to cover losses inherent within the loan portfolio. For each period presented, the provision for loan losses charged to expense was based on management’s judgment after taking into consideration all factors connected with the collectability of the existing portfolio. Management considers economic conditions, historical loss factors, past due percentages, internally generated loan quality reports, and other relevant factors when evaluating the loan portfolio. There can be no assurance, however, that an additional provision for loan losses will not be required in the future, including as a result of changes in the qualitative factors underlying management’s estimates and judgments, changes in accounting standards, adverse developments in the economy, on a national basis or in the Company’s market area, loan growth, or changes in the circumstances of particular borrowers. For further discussion regarding the allowance for loan losses, see “Critical Accounting Policies” above. The following table shows a detail of loans charged-off, recovered, and the changes in the allowance for loan losses (dollars in thousands). [[GREPCENT_TABLE]] [["","","Allowance for loan losses"],["","","Construction and Land Development","","","Secured by 1-4 Family Residential","","","Other Real Estate","","","Commercial and Industrial","","","Consumer and Other Loans","","","Total"],["For the year ended December 31, 2020:"],["Balance at beginning of year","","$","464","","","$","776","","","$","2,296","","","$","562","","","$","836","","","$","4,934"],["Charge-offs","","","\u2014","","","","\u2014","","","","\u2014","","","","(69",")","","","(715",")","","","(784",")"],["Recoveries","","","2","","","","8","","","","2","","","","18","","","","305","","","","335"],["Provision for (recovery of) loan losses","","","(160",")","","","238","","","","2,658","","","","273","","","","(9",")","","","3,000"],["Balance at end of year","","$","306","","","$","1,022","","","$","4,956","","","$","784","","","$","417","","","$","7,485"],["Average loans","","$","32,528","","","$","235,275","","","$","247,527","","","$","100,095","","","$","8,489","","","$","623,914"],["Ratio of net (recoveries) charge-offs to average loans","","","-0.01","%","","","0.00","%","","","0.00","%","","","0.05","%","","","4.83","%","","","0.07","%"],["For the year ended December 31, 2021:"],["Balance at beginning of year","","","306","","","","1,022","","","","4,956","","","","784","","","","417","","","","7,485"],["Charge-offs","","","\u2014","","","","(15",")","","","(992",")","","","(6",")","","","(434",")","","","(1,447",")"],["Recoveries","","","6","","","","65","","","","3","","","","7","","","","241","","","","322"],["Provision for (recovery of) loan losses","","","33","","","","5","","","","(737",")","","","(67",")","","","116","","","","(650",")"],["Balance at end of year","","","345","","","","1,077","","","","3,230","","","","718","","","","340","","","","5,710"],["Average loans","","$","32,233","","","$","265,900","","","$","296,382","","","$","107,964","","","$","10,258","","","$","712,737"],["Ratio of net (recoveries) charge-offs to average loans","","","-0.02","%","","","-0.02","%","","","0.33","%","","","0.00","%","","","1.88","%","","","0.16","%"]] [[/GREPCENT_TABLE]] The following table shows the balance of the Bank’s allowance for loan losses allocated to each major category of loans and the ratio of related outstanding loan balances to total loans (dollars in thousands).     [[GREPCENT_TABLE]] [["Allocation of Allowance for Loan Losses"],["","","At December 31,"],["","","2021","","","2020"],["Allocation of Allowance for Loan Losses:"],["Real estate loans:"],["Construction and land development","","$","345","","","$","306"],["Secured by 1-4 family","","","1,077","","","","1,022"],["Other real estate loans","","","3,230","","","","4,956"],["Commercial and industrial","","","718","","","","784"],["Consumer and other loans","","","340","","","","417"],["Total allowance for loan losses","","$","5,710","","","$","7,485"],["Ratios of loans to total period-end loans:"],["Real estate loans:"],["Construction and land development","","","6.8","%","","","4.3","%"],["Secured by 1-4 family","","","35.4","%","","","37.4","%"],["Other real estate loans","","","44.2","%","","","39.3","%"],["Commercial and industrial","","","12.1","%","","","17.4","%"],["Consumer and other loans","","","1.5","%","","","1.6","%"],["","","","100.0","%","","","100.0","%"]] [[/GREPCENT_TABLE]] 40 Table of Contents The following table provides information on the Bank’s non-performing assets at the dates indicated (dollars in thousands). [[GREPCENT_TABLE]] [["","","Non-performing Assets"],["","","At December 31,"],["","","2021","","","2020"],["Non-accrual loans","","$","2,304","","","$","6,714"],["Other real estate owned","","","1,848","","","","\u2014"],["Total non-performing assets","","$","4,152","","","$","6,714"],["Loans past due 90 days accruing interest","","","\u2014","","","","302"],["Total non-performing assets and past due loans","","$","4,152","","","$","7,016"],["Troubled debt restructurings","","$","1,638","","","$","5,976"],["Non-performing assets to period end loans","","","0.50","%","","","1.07","%"]] [[/GREPCENT_TABLE]] The following table summarizes the Company's credit ratios on a consolidated basis as of December 31, 2021 and 2020. [[GREPCENT_TABLE]] [["","","Consolidated Credit Ratios"],["","","December 31, 2021"],["","","2021","","","2020"],["Total Loans","","$","825,118","","","$","629,914"],["Nonaccrual loans","","$","2,304","","","$","6,714"],["Allowance for loan losses (ALL)","","$","5,710","","","$","7,485"],["Nonaccrual loans to total loans","","","0.28","%","","","1.07","%"],["ALL to total loans","","","0.69","%","","","1.19","%"],["ALL to nonaccrual loans","","","247.83","%","","","111.48","%"]] [[/GREPCENT_TABLE]] Securities Securities totaled $324.8 million at December 31, 2021, an increase of $168.5 million, or 108%, from $156.3 million at the end of 2020. Investment securities are comprised of U.S. agency and mortgage-backed securities, obligations of state and political subdivisions, corporate debt securities, and restricted securities. As of December 31, 2021, neither the Company nor the Bank held any derivative financial instruments in their respective investment security portfolios. Gross unrealized gains in the available for sale portfolio totaled $2.0 million and $4.0 million at December 31, 2021 and 2020, respectively. Gross unrealized losses in the available for sale portfolio totaled $2.6 million and $82 thousand at December 31, 2021 and 2020, respectively. Gross unrealized gains in the held to maturity portfolio totaled $242 thousand and $509 thousand at December 31, 2021 and 2020, respectively.  Gross unrealized losses in the held to maturity portfolio totaled $66 thousand at December 31, 2021.  There were no gross unrealized losses in the held to maturity portfolio at December 31, 2020.  Investments in an unrealized loss position were considered temporarily impaired at December 31, 2021 and 2020. The change in the unrealized gains and losses of investment securities from December 31, 2020 to December 31, 2021 was related to changes in market interest rates and was not related to credit concerns of the issuers. 41 Table of Contents The following table shows the maturities of debt and restricted securities at amortized cost and market value at December 31, 2021 and approximate weighted average yields of such securities (dollars in thousands). Yields on state and political subdivision securities are shown on a tax equivalent basis, assuming a 21% federal income tax rate. The Company attempts to maintain diversity in its portfolio and maintain credit quality and re-pricing terms that are consistent with its asset/liability management and investment practices and policies. For further information on securities, see Note 2 to the Consolidated Financial Statements included in this Form 10-K. [[GREPCENT_TABLE]] [["","","Securities Portfolio Maturity Distribution/Yield Analysis"],["","","At December 31, 2021"],["","","Less than One Year","","","One to Five Years","","","Five to Ten Years","","","Greater than Ten Years and Equity Securities","","","Total"],["U.S. Treasury securities"],["Amortized cost","","$","\u2014","","","$","29,891","","","$","9,980","","","$","\u2014","","","$","39,871"],["Market value","","$","\u2014","","","$","29,745","","","$","9,913","","","$","\u2014","","","$","39,658"],["Weighted average yield","","","\u2014","%","","","1.02","%","","","1.28","%","","","\u2014","%","","","1.09","%"],["U.S. agency and mortgage-backed securities"],["Amortized cost","","$","2,000","","","$","3,212","","","$","38,312","","","$","159,999","","","$","203,523"],["Market value","","$","2,000","","","$","3,271","","","$","38,578","","","$","158,993","","","$","202,842"],["Weighted average yield","","","2.36","%","","","2.40","%","","","1.76","%","","","1.51","%","","","1.58","%"],["Obligations of state and political subdivisions"],["Amortized cost","","$","1,175","","","$","6,356","","","$","21,880","","","$","48,675","","","$","78,086"],["Market value","","$","1,178","","","$","6,519","","","$","22,003","","","$","48,892","","","$","78,592"],["Weighted average yield","","","2.41","%","","","2.89","%","","","2.37","%","","","2.27","%","","","2.35","%"],["Corporate debt securities"],["Amortized cost","","$","\u2014","","","$","\u2014","","","$","2,019","","","$","\u2014","","","$","2,019"],["Market value","","$","\u2014","","","$","\u2014","","","$","2,020","","","$","\u2014","","","$","2,020"],["Weighted average yield","","","\u2014","%","","","\u2014","%","","","2.84","","","","\u2014","%","","","2.84","%"],["Restricted securities"],["Amortized cost","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","1,813","","","$","1,813"],["Market value","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","1,813","","","$","1,813"],["Weighted average yield","","","\u2014","%","","","\u2014","%","","","\u2014","%","","","4.99","%","","","4.99","%"],["Total portfolio"],["Amortized cost","","$","3,175","","","$","39,459","","","$","72,191","","","$","210,487","","","$","325,312"],["Market value","","$","3,178","","","$","39,535","","","$","72,514","","","$","209,698","","","$","324,925"],["Weighted average yield (1)","","","2.38","%","","","1.43","%","","","1.91","%","","","1.72","%","","","1.73","%"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(1)","Yields on tax-exempt securities have been calculated on a tax-equivalent basis using the federal corporate income tax rate of 21 percent. The weighted average yield is calculated based on the relative amortized costs of the securities."]] [[/GREPCENT_TABLE]] The above table was prepared using the contractual maturities for all securities with the exception of mortgage-backed securities (MBS) and collateralized mortgage obligations (CMO). Both MBS and CMO securities were recorded using the yield book prepayment model that incorporates four causes of prepayments including home sales, refinancing, defaults, and curtailments/full payoffs. As of December 31, 2021, the Company did not own securities of any issuer for which the aggregate book value of the securities of such issuer exceeded ten percent of shareholders’ equity. 42 Table of Contents Deposits At December 31, 2021, deposits totaled $1.2 billion, an increase of $406.3 million, from $842.5 million at December 31, 2020. The increase was attributable to the acquisition of Fincastle on July 1, 2021, which included $236.3 million of deposits, as well as growth in the Bank's deposit portfolio. There was a slight change in the deposit mix when comparing the periods. At December 31, 2021, noninterest-bearing demand deposits, savings and interest-bearing demand deposits, and time deposits composed 33%, 55%, and 12% of total deposits, respectively, compared to 31%, 57%, and 12% at December 31, 2020. The following tables include a summary of average deposits and average rates paid (dollars in thousands). [[GREPCENT_TABLE]] [["","","Average Deposits and Rates Paid"],["","","Year Ended December 31,"],["","","2021","","","2020"],["","","Amount","","","Rate","","","Amount","","","Rate"],["Noninterest-bearing deposits","","$","348,829","","","","\u2014","%","","$","236,061","","","","\u2014","%"],["Interest-bearing deposits:"],["Interest checking","","$","254,077","","","","0.17","%","","$","193,870","","","","0.36","%"],["Money market","","","168,932","","","","0.11","%","","","149,029","","","","0.47","%"],["Savings","","","164,768","","","","0.07","%","","","111,693","","","","0.06","%"],["Time deposits:"],["Less than $100","","","69,904","","","","0.44","%","","","59,726","","","","0.76","%"],["Greater than $100","","","52,304","","","","0.74","%","","","50,176","","","","1.35","%"],["Brokered deposits","","","650","","","","0.34","%","","","579","","","","0.26","%"],["Total interest-bearing deposits","","$","710,635","","","","0.20","%","","$","565,073","","","","0.46","%"],["Total deposits","","$","1,059,464","","","","","","","$","801,134"]] [[/GREPCENT_TABLE]] The table above includes brokered deposits greater than $100 thousand. As of December 31, 2021 the estimated amount of total uninsured deposits was $246.0 million.  Maturities of the estimated amount of uninsured time deposits at December 31, 2021 are presented in the table below.  The estimate of uninsured deposits generally represents the portion of deposit accounts that exceed the FDIC insurance limit of $250,000 and is calculated based on the same methodologies and assumptions used for purposes of the Bank’s regulatory reporting requirements. [[GREPCENT_TABLE]] [["Maturities of Uninsured Time Deposits"],["","","December 31, 2021"],["3 months or less","","$","1,504"],["3-6 months","","","847"],["6-12 months","","","444"],["Over 12 months","","","2,169"],["","","$","4,964"]] [[/GREPCENT_TABLE]] Liquidity Liquidity represents the ability to meet present and future financial obligations through either the sale or maturity of existing assets or with borrowings from correspondent banks or other deposit markets. The Company classifies cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, investment securities, and loans maturing within one year as liquid assets. As part of the Bank’s liquidity risk management, stress tests and cash flow modeling are performed quarterly. As a result of the Bank’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Bank maintains overall liquidity sufficient to satisfy its depositors’ requirements and to meet its customers’ borrowing needs. At December 31, 2021, cash, interest-bearing and noninterest-bearing deposits with banks, securities, and loans maturing within one year totaled $268.1 million. At December 31, 2021, 11% or $88.9 million of the loan portfolio is scheduled to mature within one year. Non-deposit sources of available funds totaled $240.4 million at December 31, 2021, which included $155.7 million of secured funds available from Federal Home Loan Bank of Atlanta (FHLB), $51.0 million of unsecured federal funds lines of credit with other correspondent banks, and $33.7 million available through the Federal Reserve Discount Window. Subordinated Debt See Note 9 to the Consolidated Financial Statements included in this Form 10-K, for discussion of subordinated debt. Junior Subordinated Debt See Note 10 to the Consolidated Financial Statements included in this Form 10-K, for discussion of junior subordinated debt. 43 Table of Contents Off-Balance Sheet Arrangements The Company, through the Bank, is a party to credit related financial instruments with risk not reflected in the consolidated financial statements in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance sheet instruments. At December 31, 2021 and 2020, the following financial instruments were outstanding whose contract amounts represent credit risk (in thousands): [[GREPCENT_TABLE]] [["","","2021","","","2020"],["Commitments to extend credit and unfunded commitments under lines of credit","","$","161,428","","","$","114,892"],["Stand-by letters of credit","","","18,904","","","","10,675"]] [[/GREPCENT_TABLE]] Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Bank, is based on management’s credit evaluation of the customer. Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized as deemed necessary and may or may not be drawn upon to the total extent to which the Bank is committed. Commercial and standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments if deemed necessary. At December 31, 2021, the Bank had $4.6 million in locked-rate commitments to originate mortgage loans. Risks arise from the possible inability of counterparties to meet the terms of their contracts. The Bank does not expect any counterparty to fail to meet its obligations. On April 21, 2020, the Company entered into interest rate swap agreements related to its outstanding junior subordinated debt. The Company uses derivatives to manage exposure to interest rate risk through the use of interest rate swaps. Interest rate swaps involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date with no exchange of underlying principal amounts. The interest rate swaps qualified and are designated as cash flow hedges. The Company’s cash flow hedges effectively modify the Company’s exposure to interest rate risk by converting variable rates of interest on $9.0 million of the Company’s junior subordinated debt to fixed rates of interest for periods that end between June 2034 and October 2036. The cash flow hedges’ total notional amount is $9.0 million. At December 31, 2021, the cash flow hedges had a fair value of $941 thousand, which is recorded in other assets. The net gain/loss on the cash flow hedges is recognized as a component of other comprehensive income and reclassified into earnings in the same period(s) during which the hedged transactions affect earnings. The Company’s derivative financial instruments are described more fully in Note 24 to the Consolidated Financial Statements included in this Form 10-K. Capital Resources The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Company’s asset and liability levels and consistent with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses. The Company meets eligibility criteria of a small bank holding company in accordance with the Federal Reserve Board’s Small Bank Holding Company Policy Statement issued in February 2015 and is no longer obligated to report consolidated regulatory capital. Effective January 1, 2015, the Bank became subject to capital rules adopted by federal bank regulators implementing the Basel III regulatory capital reforms adopted by the Basel Committee on Banking Supervision (the Basel Committee), and certain changes required by the Dodd-Frank Act. The minimum capital level requirements applicable to the Bank under the final rules are as follows: a new common equity Tier 1 capital ratio of 4.5%; a Tier 1 capital ratio of 6%; a total capital ratio of 8%; and a Tier 1 leverage ratio of 4% for all institutions. The final rules also established a “capital conservation buffer” above the new regulatory minimum capital requirements. The capital conservation buffer was phased-in over four years and, as fully implemented effective January 1, 2019, requires a buffer of 2.5% of risk-weighted assets. This results in the following minimum capital ratios beginning in 2019: a common equity Tier 1 capital ratio of 7.0%, a Tier 1 capital ratio of 8.5%, and a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions. Management believes, as of December 31, 2021 and December 31, 2020, that the Bank met all capital adequacy requirements to which it is subject, including the capital conservation buffer. 44 Table of Contents The following table summarizes the Bank’s regulatory capital and related ratios at December 31, 2021, 2020, and 2019 (dollars in thousands). [[GREPCENT_TABLE]] [["","","Analysis of Capital"],["","","At December 31,"],["","","2021","","","2020"],["Common equity Tier 1 capital","","$","120,224","","","$","84,032"],["Tier 1 capital","","","120,224","","","","84,032"],["Tier 2 capital","","","5,710","","","","7,211"],["Total risk-based capital","","","125,934","","","","91,243"],["Risk-weighted assets","","","852,959","","","","576,612"],["Capital ratios:"],["Common equity Tier 1 capital ratio","","","14.09","%","","","14.57","%"],["Tier 1 capital ratio","","","14.09","%","","","14.57","%"],["Total capital ratio","","","14.76","%","","","15.82","%"],["Leverage ratio (Tier 1 capital to average assets)","","","8.82","%","","","8.80","%"],["Capital conservation buffer ratio(1)","","","6.76","%","","","7.82","%"]] [[/GREPCENT_TABLE]] [[GREPCENT_TABLE]] [["(1)","Calculated by subtracting the regulatory minimum capital ratio requirements from the Company\u2019s actual ratio for Common equity Tier 1, Tier 1, and Total risk based capital. The lowest of the three measures represents the Bank\u2019s capital conservation buffer ratio."]] [[/GREPCENT_TABLE]] The prompt corrective action framework is designed to place restrictions on insured depository institutions if their capital levels begin to show signs of weakness. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following capital level requirements in order to qualify as “well capitalized:” a common equity Tier 1 capital ratio of 6.5%; a Tier 1 capital ratio of 8%; a total capital ratio of 10%; and a Tier 1 leverage ratio of 5%. The Bank met the requirements to qualify as "well capitalized" as of December 31, 2021 and 2020. On September 17, 2019 the FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the Economic Growth Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities. The CARES Act temporarily lowered the tier 1 leverage ratio requirement to 8% until December 31, 2020. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the "well-capitalized" ratio requirements under the prompt corrective action regulations and would not be required to report or calculate risk-based capital. Although the Bank did not opt into the CBLR framework at December 31, 2021, it may opt into the CBLR framework in a future quarterly period. For further discussion regarding the CARES Act, see "Supervision and Regulation" included in Item 1 of this Form 10-K. During the fourth quarter of 2019, the Board of Directors of the Company authorized a stock repurchase plan pursuant to which the Company may have repurchased up to $5.0 million of its outstanding common stock through December 31, 2020.  During 2020, the Company repurchased and retired 129,035 shares at an average price paid per share of $16.05, for a total of $2.1 million. The Company’s stock repurchase plan was suspended in the second quarter of 2020, and remained suspended until it ended on December 31, 2020. The Company has not authorized another stock repurchase plan as of December 31, 2021. The Company continues to update its enterprise risk assessment and capital plan as the operating environment develops. As a result of its risk assessments and capital planning, the Company issued $5.0 million of subordinated debt in June 2020. The purpose of the issuance was primarily to further strengthen holding company liquidity and to remain a source of strength for the Bank in the event of a severe economic downturn. The Company was able to use the proceeds of the issuance for general corporate purposes.  The subordinated debt issued consisted of a 5.50% fixed-to-floating rate subordinated note due 2030 issued to an institutional investor and was structured to qualify as Tier 2 capital under bank regulatory guidelines. After considering several factors, including the overall risk profile and capital adequacy of the Company and the Bank, on January 1, 2022, the Company repaid $5.0 million of subordinated debt with a fixed interest rate of 6.75% that was issued in 2015.  The capital planning process also included consideration of whether to continue the Company’s cash dividend payments to common shareholders. The Company continued to pay quarterly cash dividends on its common stock throughout the pandemic.  The Company acquired Fincastle on July 1, 2021 and their shareholders received aggregate merger consideration of $6.8 million in cash and 1,348,065 shares of the Company’s common stock. The acquisition of Fincastle resulted in goodwill and other intangible assets that were excluded from the regulatory capital of First Bank. For the three-month and twelve-month periods ended December 31, 2021, the Company recorded merger and acquisition related expenses of $1.2 million and $3.4 million, respectively, in connection with the acquisition of Fincastle. The Company estimates that it will incur aggregate Fincastle merger related costs of $3.4 million, which includes $20 thousand of additional merger related costs expected to be incurred during the first and second quarters of 2022. First Bank acquired SmartBank’s Richmond, Virginia office and hired a team of their employees on September 30, 2021, which included the office’s loan portfolio and certain fixed assets. First Bank also assumed SmartBank’s office lease during the fourth quarter of 2021. The acquisition of the SmartBank loans resulted in goodwill that was excluded from the regulatory capital of First Bank. For the three-month and twelve-month periods ended December 31, 2021, the Company recorded merger and acquisition related expenses of $101 thousand in connection with the acquisition of the SmartBank loans. The Company does not anticipate incurring any additional SmartBank acquisition related costs in future periods. First Bank remained well-capitalized at December 31, 2021. Recent Accounting Pronouncements See Note 1 to the Consolidated Financial Statements included in this Form 10-K, for discussion of recent accounting pronouncements. 45 Table of Contents