FCAP · Read the filing

ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

General

As the holding company for the Bank, the Company conducts its business primarily through the Bank. The Bank’s results of operations depend primarily on net interest income, which is the difference between the income earned on its interest-earning assets, such as loans and investments, and the cost of its interest-bearing liabilities, consisting primarily of deposits, retail repurchase agreements and borrowings from the FHLB. The Bank’s net income is also affected by, among other things, fee income, provisions for loan losses, operating expenses and income tax provisions. The Bank’s results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government legislation and policies concerning monetary and fiscal affairs, housing and financial institutions and the intended actions of the regulatory authorities.

Management uses various indicators to evaluate the Company’s financial condition and results of operations. Indicators include the following:

Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of the Company and the Bank. The information contained in this section should be read in conjunction with the consolidated financial statements and the accompanying Notes to Consolidated Financial Statements included in this report.

Operating Strategy

The Company is the parent company of an independent community-oriented financial institution that delivers quality customer service and offers a wide range of deposit, loan and investment products to its customers. The commitment to customer needs, the focus on providing consistent customer service, and community service and support are the keys to the Bank’s past and future success. The Company has no other material income other than that generated by the Bank and its subsidiaries.

The Bank’s primary business strategy is attracting deposits from the general public and using those funds to originate residential mortgage loans, multi-family residential loans, commercial real estate and business loans and consumer loans. The Bank invests excess liquidity primarily in interest-bearing deposits with the FHLB and other financial institutions, federal funds sold, U.S. government and agency securities, local municipal obligations and mortgage-backed securities.

In recent years, the Company’s operating strategy has also included strategies designed to enhance profitability by increasing sources of noninterest income and improving operating efficiency while managing its capital and limiting its credit risk and interest rate risk exposures. To accomplish these objectives, the Company has focused on the following:

Critical Accounting Policies and Estimates

The accounting and reporting policies of the Company comply with U.S. GAAP and conform to general practices within the banking industry. The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding reported results. Critical accounting policies are those policies that require management to make assumptions about matters that are highly uncertain at the time an accounting estimate is made; and different estimates that the Company reasonably could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the Company’s financial condition, changes in financial condition or results of operations. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized under U.S. GAAP.

Significant accounting policies, including the impact of recent accounting pronouncements, are discussed in Note 1 of the accompanying Notes to Consolidated Financial Statements. Those policies considered to be critical accounting policies are described below.

Allowances for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impacted loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the IDFI and FDIC, as an integral part of their examination process, periodically reviews our allowance for loan losses and may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. Note 1 and Note 4 of the accompanying Notes to Consolidated Financial Statements describe the methodology used to determine the allowance for loan losses. The Company has not made any substantive changes to its methodology for determining the allowance for loan losses during the year ended December 31, 2020, but management does review (and modify as necessary) the qualitative factors used in the estimate of the allowance for loan losses on a quarterly basis.

Valuation Methodologies. In the ordinary course of business, management applies various valuation methodologies to assets and liabilities that often involve a significant degree of judgment, particularly when active markets do not exist for the items being valued. Generally, in evaluating various assets for potential impairment, management compares the fair value to the carrying value. Quoted market prices are referred to when estimating fair values for certain assets, such as certain investment securities. For investment securities for which quoted market prices are not available, the Company obtains fair value measurements from an independent pricing service. However, for those items for which market-based prices do not exist and an independent pricing service is not readily available, management utilizes significant estimates and assumptions to value such items. Examples of these items include goodwill and other intangible assets, acquired loans and deposits, foreclosed and other repossessed assets, impaired loans, stock-based compensation and certain other financial investments. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Company’s results of operations. Note 19 of the accompanying Notes to Consolidated Financial Statements describes the methodologies used to determine the fair value of investment securities, impaired loans, loans held for sale and foreclosed real estate. There were no changes in the valuation techniques and related inputs used during the year ended December 31, 2020.

Results of Operations for the Year Ended December 31, 2020 Compared to the Year Ended December 31, 2019

Net Income.Net income attributable to the Company was $10.1 million ($3.02 per share diluted; weighted average common shares outstanding of 3,349,277, as adjusted) for the year ended December 31, 2020 compared to $10.3 million ($3.09 per share diluted; weighted average common shares outstanding of 3,344,072, as adjusted) for the year ended December 31, 2019.

Net Interest Income.Net interest income decreased$2.0 million, or 6.7%, from $30.1 million for 2019 to $28.1 million for 2020 primarily due to a decrease in the interest rate spread, the difference between the average tax-equivalent yield on interest-earning assets and the average cost of interest-bearing liabilities, partially offset by an increase in the average balance of interest-earning assets.

Total interest income decreased$2.4 million for 2020 as compared to 2019. This decrease was primarily due to a decrease in the tax-equivalent yield on interest-earning assets from 4.28% for 2019 to 3.57% for 2020, partially offset by an increase in the average balance of interest-earning assets from $760.8 million for 2019 to $846.3 million for 2020. The decrease in the tax-equivalent yield was due to the Federal Open Market Committee (FOMC) lowering rates due to the COVID-19 pandemic and the Bank originating $45.9 million in PPP loans which carry a fixed rate of 1.00%. The increase in the average balance of interest-earning assets in 2020 was primarily attributable to growth in other interest-earning assets and in loans. Interest on loans decreased $1.2 million as a result of the average tax-equivalent yield on loans decreasingfrom 5.54% for 2019 to 4.93% for 2020 partially offset by an increase in the average balance of loans from $465.4 million for 2019 to $498.2 million for 2020. Interest and dividends on investment securities (including FHLB stock) decreased $695,000 for 2020 compared to 2019 due to a decrease in the tax equivalent yield on investment securities from 2.29% in 2019 to 2.08% in 2020. Other interest income decreased $489,000 for 2020 as compared to 2019 primarily due to the tax equivalent yield of federal funds sold and interest-bearing deposits with banks decreasing from 2.29% to 0.40% when comparing the two periods, partially offset by an increase in the average balance of other interest-earning assets from $37.4 million for 2019 to $92.0 million for 2020.

Total interest expense decreased $399,000, from $2.0 million for 2019 to $1.6 million for 2020, due to a decrease in the average cost of interest-bearing liabilities from 0.35% for 2019 to 0.25% for 2020, partially offset by an increase in the average balance of interest-bearing liabilities from $567.6 million for 2019 to $615.8 million for 2020. As a result of the changes in interest-earning assets and interest-bearing liabilities, the interest rate spread (tax equivalent basis) decreased from 3.93% for 2019 to 3.32% for 2020. For further information, see “Average Balances and Yields” below. The changes in interest income and interest expense resulting from changes in volume and changes in rates for 2020 and 2019 are shown in the schedule captioned “Rate/Volume Analysis” included herein.

Provision for Loan Losses. The provision for loan losses was $1.8 million for 2020 compared to $1.4 million for 2019. The increase in provision for loan losses primarily reflects changes to qualitative factors within the Bank’s allowance for loan losses calculation related to uncertainties surrounding COVID-19 and loan growth. Total outstanding loans increased by $36.2 million during 2020 as compared to an increase of $33.2 million during 2019. Net charge-offs decreased from $429,000 for 2019 to $237,000 for 2020, and nonperforming loans decreased from $1.8 million at December 31, 2019 to $1.5 million at December 31, 2020. The provisions were recorded to bring the allowance to the level determined in applying the allowance methodology after reduction for net charge-offs during the year.

Provisions for loan losses are charges to earnings to maintain the total allowance for loan losses at a level considered reasonable by management to provide for probable known and inherent loan losses based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specified impaired loans and economic conditions. Although management uses the best information available, future adjustments to the allowance may be necessary due to changes in economic, operating, regulatory and other conditions that may be beyond the Bank’s control. While the Bank maintains the allowance for loan losses at a level that it considers adequate to provide for estimated losses, there can be no assurance that further additions will not be made to the allowance for loan losses and that actual losses will not exceed the estimated amounts.

Noninterest income. Noninterest income increased $1.7 million to $8.6 million for 2020 primarily due to increases in gains on loans sold and ATM and debit card fees of $1.5 million and $676,000, respectively. Included in gains on the sale of loans during 2020 was a $214,000 gain on the sale of the Bank’s $1.5 million credit card portfolio. The Bank originated $143.9 million of loans for sale in the secondary market during 2020, compared to $70.8 million in originations during 2019. The increase in ATM and debit card fees is primarily attributable to increased transaction volume. Those increases were partially offset by a $300,000 decrease in service charges on deposit accounts primarily attributable to decreased overdraft fees as a result of the pandemic. In addition, noninterest income during 2020 included a $194,000 unrealized loss on equity securities compared to a $32,000 unrealized gain on equity securities during 2019.

Noninterest expense. Noninterest expense decreased $222,000, to $23.0 million for 2020 primarily due to decreases data processing expense, net loss on foreclosed real estate and advertising expense of $435,000, $286,000 and $200,000, respectively. This was partially offset by an increase in compensation and benefits expense of $689,000 when comparing the two periods. A significant factor in the decrease in data processing and advertising expenses during 2020 was the rollout of the Bank’s new digital platform in the fourth quarter of 2019 and the associated costs, including termination fees from the previous platform provider. Compensation and benefits increased for 2020 primarily due to normal salary and wage increases and increased incentive compensation related to loan sales.

Income tax expense.Tax expense decreased $295,000 for 2020 to $1.7 million primarily due to an increase in nontaxable income and a decrease in taxable income when comparing the two years. As a result, the effective tax rate decreased from 16.1% for 2019 to 14.3% for 2019. See Note 12 of the accompanying Notes to Consolidated Financial Statements for additional details on the Company’s income tax expense.

Results of Operations for the Year Ended December 31, 2019 Compared to the Year Ended December 31, 2018

Net Income.Net income attributable to the Company was $10.3 million ($3.09 per share diluted; weighted average common shares outstanding of 3,344,072, as adjusted) for the year ended December 31, 2019 compared to $9.3 million ($2.77 per share diluted; weighted average common shares outstanding of 3,335,394, as adjusted) for the year ended December 31, 2018.

Net Interest Income.Net interest income increased$2.8 million, or 10.3%, from $27.3 million for 2018 to $30.1 million for 2019 primarily due to increases in the average balance of interest-earning assets and the interest rate spread, the difference between the average tax-equivalent yield on interest-earning assets and the average cost of interest-bearing liabilities.

Total interest income increased$3.2 million for 2019 as compared to 2018. This increase was primarily a result of increases in the tax-equivalent yield on interest-earning assets from 4.01% for 2018 to 4.28% for 2019 and in the average balance of interest-earning assets from $730.5 million for 2018 to $760.8 million for 2019. The increase in the average balance of interest-earning assets in 2019 was primarily attributable to continued growth in loans and partially offset by continued declining balances in investment securities. Interest on loans increased $2.9 million as a result of the average balance of loans increasingfrom $423.6 million for 2018 to $465.4 million for 2019 and the average tax-equivalent yield on loans increasingfrom 5.39% for 2018 to 5.54% for 2019. Interest and dividends on investment securities (including FHLB stock) increased $144,000 for 2019 compared to 2018 due to an increase in the tax equivalent yield on investment securities from 2.13% in 2018 to 2.29% in 2019, partially offset by a decrease in the average balance of investment securities from $267.4 million for 2018 to $258.0 million for 2019. Other interest income increased $96,000 for 2019 as compared to 2018 primarily due to the tax equivalent yield of federal funds sold and interest-bearing deposits with banks increasing from 1.92% to 2.29% when comparing the two periods.

Total interest expense increased $349,000, from $1.6 million for 2018 to $2.0 million for 2019, due to increases in the average balance of interest-bearing liabilities from $552.2 million for 2018 to $567.6 million for 2019 and in the average cost of interest-bearing liabilities from 0.29% for 2018 to 0.35% for 2019. Included in the interest-bearing liabilities were borrowed funds with an average balance of $1.2 million for 2018 and an average cost of 1.78%. There were no borrowed funds during 2019. For further information, see “Average Balances and Yields” below. The changes in interest income and interest expense resulting from changes in volume and changes in rates for 2019 and 2018 are shown in the schedule captioned “Rate/Volume Analysis” included herein.

Provision for Loan Losses. The provision for loan losses was $1.4 million for 2019 compared to $1.2 million for 2018. The consistent application of management’s allowance methodology resulted in an increasein the provision for loan losses for 2019, primarily due to the loan portfolio growth during the year. Total outstanding loans increased by $33.2 million during 2019 as compared to an increase of $25.0 million during 2018. Net charge-offs decreased from $737,000 for 2018 to $429,000 for 2019, and nonperforming loans decreased from $3.1 million at December 31, 2018 to $1.8 million at December 31, 2019. The provisions were recorded to bring the allowance to the level determined in applying the allowance methodology after reduction for net charge-offs during the year.

Noninterest income. Noninterest income increased $758,000 to $6.9 million for 2019 due to increases in ATM and debit card fees and unrealized gains on equity securities of $248,000 and $239,000, respectively. There was also a loss on a tax credit investment of $270,000 recorded in 2018. Those changes were partially offset by an $89,000 decrease in service charges on customer accounts during 2019.

Noninterest expense. Noninterest expense increased $1.7 million, to $23.3 million for 2019 primarily due to increases in compensation and benefits expense of $1.4 million and data processing expense of $458,000 when comparing the two periods. Compensation and benefits expense increased primarily due to normal salaries and benefits increases and an increase in stock compensation expense. A significant factor in the increase in data processing expense during 2019 was the rollout of the Bank’s new digital platform in the fourth quarter of 2019 and the associated costs, including termination fees from the previous platform provider.

Income tax expense.Tax expense increased $593,000 for 2019 to $2.0 million primarily due to an increase in taxable income and a reduction in benefits from a tax credit entity. As a result, the effective tax rate increased from 13.1% for 2018 to 16.1% for 2019. See Note 12 of the accompanying Notes to Consolidated Financial Statements for additional details on the Company’s income tax expense.

Average Balances and Yields. The following table sets forth certain information for the periods indicated regarding average balances of assets and liabilities, as well as the total dollar amounts of interest income from average interest-earnings assets and interest expense on average interest-bearing liabilities and average yields and costs. Such yields and costs for the periods indicated are derived by dividing income or expense by the average historical cost balances of assets or liabilities, respectively, for the periods presented and do not give effect to changes in fair value that are included as a separate component of stockholders’ equity. Average balances are derived from daily balances. Tax-exempt income on loans and investment securities has been adjusted to a tax equivalent basis using the federal marginal tax rate of 21%.

Year Ended December 31,

Average Average Average

(Dollars in thousands) Average Yield/ Average Yield/ Average Yield/

Balance Interest Cost Balance Interest Cost Balance Interest Cost

Interest-earning assets:

Loans (1) (2) (3):

Investment securities:

Interest-bearing liabilities:

Noninterest-bearing liabilities:

Less: tax equivalent adjustment (606 ) (483 ) (419 )

_________________________

(1) Interest income on loans includes fee income of $1,772,000, $1,027,000 and $984,000 for the years ended December 31, 2020, 2019 and 2018, respectively.

(2) Average loan balances include loans held for sale and nonperforming loans.

(3) Interest income on loans includes net accretion on acquired loans of $36,000, $44,000 and $149,000 for the years ended December 31, 2020, 2019 and 2018, respectively.

(4) Includes taxable debt and equity securities and FHLB stock.

(5) Includes interest-bearing deposits with banks, federal funds sold and interest-bearing time deposits.

(6) Stockholders' equity attributable to First Capital, Inc.

Rate/Volume Analysis. The following table sets forth the effects of changing rates and volumes on net interest income and interest expense computed on a tax-equivalent basis. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate); (ii) effects attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) effects attributable to changes in rate and volume (change in rate multiplied by changes in volume). Tax exempt income on loans and investment securities has been adjusted to a tax-equivalent basis using the federal marginal tax rate of 21%.

Increase (Decrease) Due to Increase (Decrease) Due to

Rate/ Rate/

Rate Volume Volume Net Rate Volume Volume Net

(In thousands)

Interest-earning assets:

Loans:

Investment securities:

Interest-bearing liabilities:

Borrowed funds - - - - (21 ) (21 ) 21 (21 )

Comparison of Financial Condition at December 31, 2020 and 2019

Total assets increasedfrom $827.5 million at December 31, 2019 to $1.02 billion at December 31, 2020 primarily due to increases in cash and cash equivalents, net loans receivable and securities available for sale.

Net loans increasedfrom $466.5 million at December 31, 2019 to $500.3 million at December 31, 2020. The primary contributing factor to the increase in net loans was an increaseof $37.0 million in commercial business loans, including PPP loans. During 2020, the Bank originated $45.9 million of PPP loans and the remaining balance as of December 31, 2020 was $37.3 million. The Bank also increased commercial real estate loans by $13.6 million during 2020 and construction loans decreased $7.6 million during the year primarily due to a decrease in commercial real estate construction loans. The Bank continued to sell the majority of newly originated fixed-rate residential mortgage loans in the secondary market. The Bank originated $143.9 million in new residential mortgages for sale in the secondary market during 2020 compared to $70.8 million in 2019. These loans were originated and funded by the Bank for sale in the secondary market. Of the total originations for 2020, $23.7 million paid off existing loans in the Bank’s portfolio, the majority of which were construction loans. Originating mortgage loans for sale in the secondary market allows the Bank to better manage its interest rate risk, while offering a full line of mortgage products to prospective customers.

Securities available for sale, at fair value, consisting primarily of U.S. agency mortgage-backed securities and collateralized mortgage obligations, U.S. agency notes and bonds, and municipal obligations, increasedfrom $254.6 million at December 31, 2019 to $283.5 million at December 31, 2020. Purchases of securities available for sale totaled $104.4 million in 2020. These purchases were partially offset by principal repayments of $46.7 million and maturities of $32.6 million in 2020. No securities were sold during 2020. The Bank invests excess cash in securities that provide safety, liquidity and yield. Accordingly, we purchase mortgage-backed securities to provide cash flow for loan demand and deposit changes, we purchase federal agency notes for short-term yield and low risk, and municipals are purchased to improve our tax equivalent yield focusing on longer term profitability.

Cash and cash equivalents increasedfrom $51.4 million at December 31, 2019 to $175.9 million at December 31, 2020. The increaseis due primarily to excess funds generated from deposits.

Total deposits increased $178.3 millionto $900.5 million at December 31, 2020. During 2020, noninterest-bearing, interest-bearing demand deposit accounts and savings accounts increased $79.5 million, $66.5 million and $36.7 million, respectively.

There were no outstanding borrowings at December 31, 2020 or 2019.

Total stockholders’ equity attributable to the Company increased $11.8 million from $98.8 million at December 31, 2019 to $110.6 million at December 31, 2020. This increaseis primarily the result of retained net income of $6.9 million and a net unrealized gain on available for sale securities of $4.7 million due to changes in the yield curve and long-term rate forecasts. As of December 31, 2020, the Company had repurchased 101,239 shares of the 240,467 shares authorized by the Board of Directors under the current stock repurchase program which was announced in August 2008 and 429,773 shares since the original repurchase program began in 2001.

Off-Balance-Sheet Arrangements

The Company is a party to financial instruments with off-balance-sheet risk including commitments to extend credit under existing lines of credit and commitments to originate loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements.

Off-balance-sheet financial instruments whose contract amounts represent credit and interest rate risk are summarized as follows:

At December 31,

(In thousands)

Commitments to originate new loans $ 11,254 $ 14,246

Undisbursed portion of construction loans 19,179 23,081

Standby letters of credit 346 473

The Company does not have any special purpose entities, derivative financial instruments or other forms of off-balance-sheet financing arrangements.

Commitments to originate new loans or to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Most equity line commitments are for a term of five to 10 years and commercial lines of credit are generally renewable on an annual basis. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amounts of collateral obtained, if deemed necessary by the Company upon extension of credit, are based on management’s credit evaluation of the borrower.

Contractual Obligations

The following table summarizes information regarding the Company’s contractual obligations as of December 31, 2020:

Payments due by period

Total Less than 1 Year 1 – 3 Years 3 – 5 Years More than 5 Years

(In thousands)

Operating lease obligations 81 19 38 24 -

Liquidity and Capital Resources

Liquidity refers to the ability of a financial institution to generate sufficient cash flow to fund current loan demand, meet deposit withdrawals and pay operating expenses. The Bank’s primary sources of funds are new deposits, proceeds from loan repayments and prepayments and proceeds from the maturity of securities. The Bank may also borrow from the FHLB. While loan repayments and maturities of securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, general economic conditions and competition. At December 31, 2020, the Bank had cash and interest-bearing deposits with banks (including interest-bearing time deposits) of $179.5 million and securities available for sale with a fair value of $283.5 million. If the Bank requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB, collateral eligible for repurchase agreements and unsecured federal funds purchased lines of credit with other financial institutions.

The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to support loan growth and deposit withdrawals, to satisfy financial commitments and to take advantage of investment opportunities. At December 31, 2020, the Bank had total commitments to extend credit of $118.2 million. See Note 16 in the accompanying Notes to Consolidated Financial Statements. At December 31, 2020, the Bank had certificates of deposit scheduled to mature within one year of $34.2 million. Historically, the Bank has been able to retain a significant amount of its deposits as they mature.

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company requires funds to pay any dividends to its shareholders and to repurchase any shares of its common stock. The Company’s primary source of income is dividends received from the Bank and the Captive. The amount of dividends the Bank may declare and pay to the Company in any calendar year, without the receipt of prior approval from the banking regulators, cannot exceed net income for that year to date plus retained net income (as defined) for the preceding two calendar years. At December 31, 2020, the Company (on an unconsolidated basis) had liquid assets of $3.0 million.

The Bank is required to maintain specific amounts of capital pursuant to regulations. As previously mentioned in this report, in 2020 the Bank elected to opt in to the CBLR framework. As of December 31, 2020 the Bank was in compliance with all regulatory capital requirements which were effective as of such date with a CBLR of 9.37%. See Note 18 in the accompanying Notes to Consolidated Financial Statements.

On September 24, 2020, the Company filed an automatic shelf registration statement with the SEC. The shelf registration permits the Company to issue up to $35 million of debt and equity securities, of which $35 million remains available, subject to Board authorization and market conditions. While we seek to preserve flexibility with respect to cash requirements, there can be no assurance that market conditions would permit us to sell securities on acceptable terms at any given time or at all.

Effect of Inflation and Changing Prices

The consolidated financial statements and related financial data presented in this report have been prepared in accordance with U.S. GAAP, which generally require the measurement of financial position and operating results in terms of historical dollars, without considering the changes in relative purchasing power of money over time due to inflation. The primary impact of inflation is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of the financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Market Risk Analysis

Qualitative Aspects of Market Risk. Market risk is the risk that the estimated fair value of our assets and liabilities will decline as a result of changes in interest rates or financial market volatility, or that our net income will be significantly reduced by interest rate changes.

The Company’s principal financial objective is to achieve long-term profitability while reducing its exposure to fluctuating market interest rates by operating within acceptable limits established for interest rate risk and maintaining adequate levels of funding and liquidity. The Company has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between asset and liability maturities and interest rates. In order to reduce the exposure to interest rate fluctuations, the Company has developed strategies to manage its liquidity, shorten its effective maturities of certain interest-earning assets and decrease the interest rate sensitivity of its asset base. Management has sought to decrease the average maturity of its assets by emphasizing the origination of short-term commercial and consumer loans, all of which are retained by the Company for its portfolio. The Company relies on retail deposits as its primary source of funds. Management believes the use of retail deposits, compared to brokered deposits, reduces the effects of interest rate fluctuations because they generally represent a more stable source of funds.

Quantitative Aspects of Market Risk. The Company does not maintain a trading account for any class of financial instrument nor does the Company engage in hedging activities or purchase high-risk derivative instruments. Furthermore, the Company is not subject to foreign currency exchange rate risk or commodity price risk.

Potential cash flows, sales, or replacement value of many of our assets and liabilities, especially those that earn or pay interest, are sensitive to changes in the general level of interest rates. This interest rate risk arises primarily from our normal business activities of gathering deposits, extending loans and investing in investment securities. Many factors affect the Company’s exposure to changes in interest rates, such as general economic and financial conditions, customer preferences, historical pricing relationships, and re-pricing characteristics of financial instruments. The Company’s earnings can also be affected by the monetary and fiscal policies of the U.S. Government and its agencies, particularly the FRB.

An element in the Company’s ongoing process is to measure and monitor interest rate risk using a Net Interest Income at Risk simulation to model the interest rate sensitivity of the balance sheet and to quantify the impact of changing interest rates on the Company. The model quantifies the effects of various possible interest rate scenarios on projected net interest income over a one-year horizon. The model assumes a semi-static balance sheet and measures the impact on net interest income relative to a base case scenario of hypothetical changes in interest rates over twelve months and provides no effect given to any steps that management might take to counter the effect of the interest rate movements. The scenarios include prepayment assumptions, changes in the level of interest rates, the shape of the yield curve, and spreads between market interest rates in order to capture the impact from re-pricing, yield curve, option, and basis risks.

Results of the Company’s simulation modeling, which assumes an immediate and sustained parallel shift in market interest rates, project that the Company’s net interest income could change as follows over a one-year horizon, relative to our base case scenario, based on December 31, 2020 and 2019 financial information.

Immediate Change One Year Horizon One Year Horizon

in the Level Dollar Percent Dollar Percent

of Interest Rates Change Change Change Change

(Dollars in thousands)

Static - - - -

At December 31, 2020 and December 31, 2019, the Company’s simulated exposure to an increase in interest rates shows that an immediate and sustained increase in rates of 1.00%, 2.00% or 3.00% would increase the Company’s net interest income over a one year horizon compared to a flat interest rate scenario. Alternatively, at December 31, 2020 and December 31, 2019, an immediate and sustained decrease in rates of 1.00% or 2.00% would decrease the Company’s net interest income over a one year horizon compared to a flat interest rate scenario. During the year ended December 31, 2020, the Company updated the discount rates and betas on loans used in its interest rate risk model for loans and deposits to better reflect the market, and also updated the deposit decay rates to levels indicated in a third-party study of customer accounts.

The Company also has longer term interest rate risk exposure, which may not be appropriately measured by Net Interest Income at Risk modeling. Therefore, the Company also uses an Economic Value of Equity (“EVE”) interest rate sensitivity analysis in order to evaluate the impact of its interest rate risk on earnings and capital. This is measured by computing the changes in net EVE for its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. EVE modeling involves discounting present values of all cash flows for on and off balance sheet items under different interest rate scenarios and provides no effect given to any steps that management might take to counter the effect of the interest rate movements. The discounted present value of all cash flows represents the Company’s EVE and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. The amount of base case EVE and its sensitivity to shifts in interest rates provide a measure of the longer term re-pricing and option risk in the balance sheet.

Results of the Company’s simulation modeling, which assumes an immediate and sustained parallel shift in market interest rates, project that the Company’s EVE could change as follows, relative to the Company’s base case scenario, based on December 31, 2020 and 2019 financial information.

Immediate Change Economic Value of Equity Economic Value of Equity as a

in the Level Dollar Dollar Percent Percent of Present Value of Assets

of Interest Rates Amount Change Change EVE Ratio Change

(Dollars in thousands)

Immediate Change Economic Value of Equity Economic Value of Equity as a

in the Level Dollar Dollar Percent Percent of Present Value of Assets

of Interest Rates Amount Change Change EVE Ratio Change

(Dollars in thousands)

The previous tables indicate that at December 31, 2020 and 2019 the Company would expect an increase in its EVE in the event of a sudden and sustained 100, 200 or 300 basis point increase in prevailing interest rates and a decrease in its EVE in the event of a sudden and sustained 100 or 200 basis point decrease in prevailing interest rates. As previously mentioned in this report, during the year ended December 31, 2020, the Company updated the discount rates and betas on loans used in its interest rate risk model for loans and deposits to better reflect the market, and also updated the deposit decay rates to levels indicated in a third-party study of customer accounts.

The models are driven by expected behavior in various interest rate scenarios and many factors besides market interest rates affect the Company’s net interest income and EVE. For this reason, the Company models many different combinations of interest rates and balance sheet assumptions to understand its overall sensitivity to market interest rate changes. Therefore, as with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing tables and it is recognized that the model outputs are not guarantees of actual results. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates of deposit could deviate significantly from those assumed in the modeling scenarios.

Impact of Recent Accounting Pronouncements

For a discussion of the impact of recent accounting pronouncements, see Note 1 of the accompanying Notes to Consolidated Financial Statements.

ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information required by this item is incorporated herein by reference to the section captioned “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Market Risk Analysis” in this Annual Report on Form 10-K.

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements required by this item are listed in Part IV, Item 15(a)(1) and are filed as part of this Annual Report on Form 10-K and incorporated herein by reference.

ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A.CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”): (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

Changes to Internal Control over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting during the quarter ended December 31, 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B.OTHER INFORMATION

Not applicable.

PART III

ITEM 10.DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

The information required in response to this item will be contained in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders and is incorporated herein by reference.

Executive Officers Who Are Not Directors

Name Age(1) Position

Dennis L. Thomas 64 Executive Vice President- Lending

Jill Keinsley 53 Executive Vice President, Human Resources Director

_________________________

(1) As of December 31, 2020.

Biographical Information

Dennis L. Thomas has been affiliated with the Bank since January 2000. He was employed by Harrison County Bank from 1981 until its merger with the Bank and has served in his present position since 2018. Prior to that time, Mr. Thomas served as Senior Vice President – Lending.

Jill Keinsley has been affiliated with the Bank since August 2006 and has served in her present position since 2018. Prior to that time, Ms. Keinsley served as Senior Vice President and Human Resources Director since August 2006.

Code of Ethics

The Company maintains a Code of Ethics and Business Conduct that applies to all directors, officers and employees of the Company and its subsidiaries. The Code of Ethics and Business Conduct is posted on the Company’s Internet website, www.firstharrison.com.

ITEM 11.EXECUTIVE COMPENSATION

The information required in response to this item will be contained in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders and is incorporated herein by reference.

ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required in response to this item will be contained in the Company’s Proxy Statement for the 2021 Annual Meeting of Shareholders to be filed within 120 days after December 31, 2020 and is incorporated herein by reference.

(a) Security Ownership of Certain Beneficial Owners.

(b) Security Ownership of Management

Management of the Company knows of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant.

(d) Equity Compensation Plan Information

See Part II, Item 5 for information about securities authorized for issuance under the Company’s equity compensation plan.

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTORS INDEPENDENCE

ITEM 14.PRINCIPAL ACCOUNTING FEES AND SERVICES

PART IV

ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) Financial Statements.

The following consolidated financial statements of the Company and its subsidiaries are included in this Annual Report on Form 10-K:

Page Reference

Report of Independent Registered Public Accounting Firm F- 1

Consolidated Balance Sheets at December 31, 2020 and 2019 F- 3

Notes to Consolidated Financial Statements F- 8

(a)(2) Financial Statement Schedules. All financial statement schedules are omitted as the required information either is not required or applicable, or the required information is contained in the consolidated financial statements or related notes.

(a)(3) Exhibits

3.1 Articles of Incorporation of First Capital, Inc. (1)

3.2 Fifth Amended and Restated Bylaws of First Capital, Inc. (2)

4.1 Description of First Capital, Inc. common stock

10.4 *First Capital, Inc. 2009 Equity Incentive Plan (5)

10.12 *First Capital, Inc. 2019 Equity Incentive Plan (7)

21.0 List of Subsidiaries of First Capital, Inc.

23.0 Consent of Monroe Shine and Co., Inc.

31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

101.SCH Inline XBRL Taxonomy Extension Schema Document

101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF Inline XBRL Taxonomy Extension Definition Linkbase Document

101.LAB Inline XBRL Taxonomy Extension Label Linkbase Document

101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase Document

* Management contract or compensatory plan, contract or arrangement.

ITEM 16.FORM 10-K SUMMARY

Not applicable.

Report of Independent Registered Public Accounting Firm

To the Shareholders and Board of Directors of

First Capital, Inc.

Corydon, Indiana

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of First Capital, Inc. (the “Company”) as of December 31, 2020 and 2019, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Companyas of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

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

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

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

Critical Audit Matter

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

F-1

Allowance for Loan Losses – Qualitative Factors

The primary procedures we performed to address this critical audit matter included:

We have served as the Company’s, or its predecessors’, auditor consecutively since at least 1968.

New Albany, Indiana

March 15, 2021

F-2

FIRST CAPITAL, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data) 2020 2019

ASSETS

Interest-bearing deposits with banks 6,232 3,412

Interest-bearing time deposits 6,396 6,490

Federal Home Loan Bank and other restricted stock, at cost 1,988 1,988

Foreclosed real estate - 170

Core deposit intangible 672 819

LIABILITIES

Deposits:

Accrued interest payable 153 210

Accrued expenses and other liabilities 6,186 6,161

Commitments and Contingencies

EQUITY

Retained earnings-substantially restricted 72,155 65,266

Unearned stock compensation (1,520 ) (940 )

Accumulated other comprehensive income 6,822 2,142

Total First Capital, Inc. stockholders' equity 110,639 98,836

Noncontrolling interest in subsidiary 112 112

See notes to consolidated financial statements.

F-3

FIRST CAPITAL, INC.

CONSOLIDATED STATEMENTS OF INCOME

INTEREST INCOME

Securities:

INTEREST EXPENSE

Advances from Federal Home Loan Bank - - 21

NONINTEREST INCOME

Service charges and fees on deposit accounts 1,788 2,088 2,177

Loss on sale of available for sale securities and time deposits - (147 ) (95 )

Unrealized gain (loss) on equity securities (194 ) 32 (207 )

Impairment loss on tax credit investment - - (270 )

Increase in cash value of life insurance 210 211 227

NONINTEREST EXPENSE

Net loss on foreclosed real estate 13 299 476

Net Income Attributable to First Capital, Inc. $ 10,131 $ 10,325 $ 9,253

Earnings per common share attributable to First Capital, Inc.:

Dividends per share on common shares $ 0.96 $ 0.95 $ 0.92

See notes to consolidated financial statements.

F-4

FIRST CAPITAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

OTHER COMPREHENSIVE INCOME (LOSS)

Unrealized gains (losses) on securities available for sale:

Unrealized holding gains (losses) arising during the period 6,050 7,163 (1,943 )

Income tax benefit - (29 ) (23 )

Net of tax amount - 105 72

Other Comprehensive Income (Loss), net of tax 4,680 5,619 (1,417 )

See notes to consolidated financial statements.

F-5

FIRST CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

Accumulated

Additional Other Unearned

Common Paid-in Retained Comprehensive Stock Treasury Noncontrolling

Other comprehensive loss - - - (1,417 ) - - - (1,417 )

Restricted stock grants, net of forfeitures - 700 - - (700 ) - - -

Stock compensation expense - - - - 192 - - 192

Purchase of 820 treasury shares - - - - - (34 ) - (34 )

Other comprehensive income - - - 5,619 - - - 5,619

Restricted stock grants - 508 - - (508 ) - - -

Stock compensation expense - - - - 288 - - 288

Purchase of 862 treasury shares - - - - - (44 ) - (44 )

Other comprehensive incomes - - - 4,680 - - - 4,680

Restricted stock grants - 961 - - (961 ) - - -

Stock compensation expense - - - - 381 - - 381

Purchase of 2,122 treasury shares - - - - - (147 ) - (147 )

See notes to consolidated financial statements.

F-6

FIRST CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

CASH FLOWS FROM OPERATING ACTIVITIES

Increase in cash value of life insurance (210 ) (211 ) (227 )

Gain on life insurance - - (94 )

Loss on sale of available for sale securities and time deposits - 147 95

Amortization of tax credit investment 338 361 329

Impairment loss on tax credit investment - - 270

Unrealized (gain) loss on equity securities 194 (32 ) 207

Net realized and unrealized loss on foreclosed real estate 4 170 442

Net unrealized loss on premises and equipment 13 - -

Increase in accrued interest receivable (358 ) (248 ) (134 )

Increase (decrease) in accrued interest payable (57 ) 60 43

Net change in other assets/liabilities 291 (210 ) (499 )

CASH FLOWS FROM INVESTING ACTIVITIES

Net decrease in interest-bearing time deposits 94 1,207 1,548

Proceeds from maturities of securities available for sale 32,647 30,575 3,325

Proceeds from sales of securities available for sale - 21,725 14,345

Investment in cash value of life insurance - - (1,000 )

Purchase of Federal Home Loan Bank stock - - (9 )

Proceeds from sale of foreclosed real estate 233 3,116 483

Purchase of premises and equipment (602 ) (2,973 ) (402 )

Purchase of equity investment - - (1,922 )

Proceeds from settlement of bank-owned life insurance policies - - 545

CASH FLOWS FROM FINANCING ACTIVITIES

Net decrease in advances from Federal Home Loan Bank - - (10,000 )

Purchase of treasury stock (13 ) (2 ) (32 )

Taxes paid on stock award shares for employees (134 ) (42 ) (2 )

See notes to consolidated financial statements.

F-7

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

First Capital, Inc. (the “Company”) is the financial holding company of First Harrison Bank (the “Bank”), a wholly-owned subsidiary. The Bank is an Indiana chartered commercial bank which provides a variety of banking services to individuals and business customers through 18 locations in Indiana and Kentucky. The Bank’s primary source of revenue is real estate mortgage loans. The Bank originates mortgage loans for sale in the secondary market and also sells non-deposit investment products through a financial services division. First Harrison Investments, Inc. and First Harrison Holdings, Inc. are wholly-owned Nevada corporate subsidiaries of the Bank that jointly own First Harrison, LLC, a Nevada limited liability company that holds and manages an investment securities portfolio. First Harrison REIT, Inc. is a wholly-owned subsidiary of First Harrison Holdings, Inc. which holds a portion of the Bank’s real estate mortgage loan portfolio. Heritage Hill, LLC is a wholly-owned subsidiary of the Bank that holds and operates certain foreclosed real estate properties. FHB Risk Mitigation Services, Inc. (the “Captive”) is a wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company, the Bank and the Bank’s subsidiaries, and reinsurance to eight other third party insurance captives, for which insurance may not be currently available or economically feasible in the insurance marketplace.

Basis of Consolidation and Reclassifications

The consolidated financial statements include the accounts of the Company and its subsidiaries and have been prepared in accordance with generally accepted accounting principles in the United States of America and conform to general practices in the banking industry. Intercompany balances and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to the current year presentation. The reclassifications had no effect on net income or stockholders’ equity.

Statements of Cash Flows

For purposes of the statements of cash flows, the Company has defined cash and cash equivalents as cash on hand, amounts due from banks (including cash items in process of clearing), interest-bearing deposits with other banks with an original maturity of 90 days or less, money market funds and federal funds sold.

Use of Estimates

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

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

A majority of the Company’s loan portfolio consists of single-family residential and commercial real estate loans in the Louisville, Kentucky metropolitan area. Accordingly, the ultimate collectability of a substantial portion of the Company’s loan portfolio and the recovery of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Use of Estimates – continued

While management uses available information to recognize losses on loans and foreclosed real estate, further reductions in the carrying amounts of loans and foreclosed real estate may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans and foreclosed real estate. Such agencies may require the Company to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans and foreclosed real estate may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.

Investment Securities

Securities Available for Sale: Securities available for sale consist primarily of mortgage-backed and other debt securities and are stated at fair value. The Company holds mortgage-backed securities and other debt securities issued by the Government National Mortgage Association (“GNMA”), a U.S. government agency, and the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”), and the Federal Home Loan Bank (“FHLB”), government-sponsored enterprises (collectively referred to as government agencies), as well as collateralized mortgage obligations (“CMOs”) and other mortgage-backed securities. Mortgage-backed securities represent participating interests in pools of long-term first mortgage loans originated and serviced by the issuers of the securities. CMOs are complex mortgage-backed securities that restructure the cash flows and risks of the underlying mortgage collateral. The Company also holds debt securities issued by municipalities and political subdivisions of state and local governments.

Amortization of premiums and accretion of discounts are recognized in interest income using methods approximating the interest method over the period to maturity, adjusted for anticipated prepayments. Unrealized gains and losses, net of tax, on securities available for sale are included in other comprehensive income and the accumulated unrealized holding gains and losses are reported as a separate component of equity until realized. Realized gains and losses on the sale of securities available for sale are determined using the specific identification method and are included in other noninterest income and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income.

Declines in the fair value of individual available for sale securities below their amortized cost that are other than temporary result in write-downs of the individual securities to their fair value. The related write-downs are included in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in fair value.

Equity Securities: Equity securities, other than restricted securities such as FHLB stock, are carried at fair value, with changes in fair value included in earnings. Equity securities without readily determinable fair values are carried at cost, minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer. Dividends received from equity securities, other than restricted securities such as FHLB stock, are included in other noninterest income.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Investment Securities - continued

FHLB Stock: The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. Investments in non-marketable equity securities such as FHLB stock are carried at cost and are classified as restricted securities. Dividends received from these investments are included in dividend income. Impairment testing on these investments is based on applicable accounting guidance and the cost basis is reduced when impairment is deemed to be other-than-temporary.

Loans and Allowance for Loan Losses

Loans Held for Investment

Loans are stated at unpaid principal balances, less net deferred loan fees and the allowance for loan losses. The Company grants real estate mortgage, commercial business and consumer loans. Loan origination and commitment fees, as well as certain direct costs of underwriting and closing loans, are deferred and amortized as a yield adjustment to interest income over the lives of the related loans using the interest method. Amortization of net deferred loan fees is discontinued when a loan is placed on nonaccrual status.

Nonaccrual Loans

The recognition of income on a loan is discontinued and previously accrued interest is reversed when interest or principal payments become 90 days past due unless, in the opinion of management, the outstanding interest remains collectible. Past due status is determined based on contractual terms. Generally, by applying the cash receipts method, interest income is subsequently recognized only as received until the loan is returned to accrual status. The cash receipts method is used when the likelihood of further loss on the loan is remote. Otherwise, the Company applies the cost recovery method and applies all payments as a reduction of the unpaid principal balance until the loan qualifies for return to accrual status. Interest income on impaired loans is recognized using the cost recovery method, unless the likelihood of further loss on the loan is remote.

A loan is restored to accrual status when all principal and interest payments are brought current and the borrower has demonstrated the ability to make future payments of principal and interest as scheduled, which generally requires that the borrower demonstrate a period of performance of at least six consecutive months.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Loans and Allowance for Loan Losses – continued

Impaired Loans

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

Values for collateral dependent loans are generally based on appraisals obtained from independent licensed real estate appraisers, with adjustments applied for estimated costs to sell the property, costs to complete unfinished or repair damaged property and other factors. New appraisals are generally obtained for all significant properties when a loan is identified as impaired, and a property is considered significant if the value of the property is estimated to exceed $200,000. Subsequent appraisals are obtained as needed or if management believes there has been a significant change in the market value of a collateral property securing a collateral dependent impaired loan. In instances where it is not deemed necessary to obtain a new appraisal, management bases its impairment and allowance for loan loss analysis on the original appraisal with adjustments for current conditions based on management’s assessment of market factors and management’s inspection of the property.

Troubled Debt Restructurings

The modification of a loan is considered to be a troubled debt restructuring (“TDR”) if the debtor is experiencing financial difficulties and the Company grants a concession to the debtor that it would not otherwise consider. By granting the concession, the Company expects to obtain more cash or other value from the debtor, or to increase the probability of receipt, than would be expected by not granting the concession. The concession may include, but is not limited to, reduction of the stated interest rate of the loan, reduction of accrued interest, extension of the maturity date or reduction of the face amount of the debt. A concession will be granted when, as a result of the restructuring, the Company does not expect to collect all amounts due, including interest at the original stated rate. A concession may also be granted if the debtor is not able to access funds elsewhere at a market rate for debt with similar risk characteristics as the restructured debt. The Company’s determination of whether a loan modification is a TDR considers the individual facts and circumstances surrounding each modification.

A TDR can involve loans remaining on nonaccrual, moving to nonaccrual, or continuing on accrual status, depending on the individual facts and circumstances of the borrower. A TDR on nonaccrual status is restored to accrual status when the borrower has demonstrated the ability to make future payments in accordance with the restructured terms, including consistent and timely payments of at least six consecutive months according to the restructured terms.

Allowance for Loan Losses

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

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Loans and Allowance for Loan Losses – continued

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

The allowance consists of specific and general components. The specific component relates to loans that are individually evaluated for impairment. For such loans that are classified as impaired, an allowance is established when the underlying discounted collateral value (or present value of estimated future cash flows) of the impaired loan is lower than the carrying value of that loan.

The general component covers loans not considered to be impaired. Such loans are pooled by segment and losses are modeled using annualized historical loss experience adjusted for qualitative factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the prior five years. The Company’s historical loss experience is then adjusted for qualitative factors that are reviewed on a quarterly basis based on the risks present for each portfolio segment. Management considers changes and trends in the following qualitative loss factors: underwriting standards, national and local economic conditions, past due loan trends, collateral valuations, loan concentrations and other internal and external factors as determined by management. Each qualitative factor is evaluated and a qualitative factor adjustment is applied to the actual historical loss factors in determining the adjusted loss factors used in management’s allowance for loan losses adequacy calculation.

Management also applies additional loss factor multiples to loans classified as watch, special mention and substandard that are not individually evaluated for impairment. The loss factor multiples for classified loans are based on management’s assessment of historical trends regarding losses experienced on classified loans in prior periods. See Note 4 for additional discussion of the qualitative factors utilized in management’s allowance for loan losses methodology at December 31, 2020 and 2019.

Management exercises significant judgment in evaluating the relevant historical loss experience and the qualitative factors. Management also monitors the differences between estimated and actual incurred loan losses for loans considered impaired in order to evaluate the effectiveness of the estimation process and make any changes in the methodology as necessary.

The following portfolio segments are considered in the allowance for loan loss analysis: residential real estate, land, construction, commercial real estate, commercial business, home equity and second mortgage, and other consumer loans.

Residential real estate loans primarily consist of loans to individuals for the purchase or refinance of their primary residence, with a smaller portion of the segment secured by non-owner-occupied residential investment properties and multi-family residential investment properties. The risks associated with residential real estate loans are closely correlated to the local housing market and general economic conditions, as repayment of the loans is primarily dependent on the borrowers’ or tenants’ personal cash flow and employment status.

Land loans primarily consist of loans secured by farmland and vacant land held for investment purposes. The risks associated with land loans are related to the market value of the property taken as collateral and the underlying cash flows for loans secured by farmland, and general economic conditions.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Loans and Allowance for Loan Losses – continued

Construction loans primarily consist of loans secured by single-family residential properties, multi-family properties and commercial projects, and include both owner-occupied and speculative investment properties. Risks inherent in construction lending are related to the market value of the property held as collateral, the cost and timing of constructing or improving a property, the borrower’s ability to use funds generated by a project to service a loan until a project is completed, movements in interest rates and the real estate market during the construction phase, and the ability of the borrower to obtain permanent financing.

Commercial real estate loans are comprised of loans secured by various types of collateral including office buildings, warehouses, retail space and mixed use buildings located in the Company’s primary lending area. Risks related to commercial real estate lending are related to the market value of the property taken as collateral, the underlying cash flows and general economic condition of the local real estate market. Repayment of these loans is generally dependent on the ability of the borrower to attract tenants at lease rates that provide for adequate debt service and can be impacted by local economic conditions which impact vacancy rates. The Company generally obtains loan guarantees from financially capable parties for commercial real estate loans.

Commercial business loans includes lines of credit to businesses, term loans and letters of credit secured by business assets such as equipment, accounts receivable, inventory, or other assets excluding real estate and are generally made to finance capital expenditures or fund operations. Commercial loans contain risks related to the value of the collateral securing the loan and the repayment is primarily dependent upon the financial success and viability of the borrower. As with commercial real estate loans, the Company generally obtains loan guarantees from financially capable parties for commercial business loans. Commercial business loans also include loans originated under the SBA’s Paycheck Protection Program (“PPP”).

Home equity and second mortgage loans and other consumer loans consist primarily of home equity lines of credit and other loans secured by junior liens on the borrower’s personal residence, home improvement loans, automobile and truck loans, boat loans, mobile home loans, loans secured by savings deposits, credit cards and other personal loans. The risk associated with these loans is related to the local housing market and local economic conditions including the unemployment level.

There were no significant changes to the Company’s accounting policies or methodology used to estimate the allowance for loan losses during the years ended December 31, 2020, 2019 and 2018.

Loan Charge-Offs

For portfolio segments other than consumer loans, the Company’s practice is to charge-off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower’s failure to meet repayment terms, the borrower’s deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loan’s classification as a loss by regulatory examiners, or for other reasons. A partial charge-off is recorded on a loan when the uncollectibility of a portion of the loan has been confirmed, such as when a loan is discharged in bankruptcy, the collateral is liquidated, a loan is restructured at a reduced principal balance, or other identifiable events that lead management to determine the full principal balance of the loan will not be repaid. A specific reserve is recognized as a component of the allowance for estimated losses on loans individually evaluated for impairment. Partial charge-offs on nonperforming and impaired loans are included in the Company’s historical loss experience used to estimate the general component of the allowance for loan losses as discussed above. Specific reserves are not considered charge-offs in management’s evaluation of the general component of the allowance for loan losses because they are estimates and the outcome of the loan relationship is undetermined.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Loans and Allowance for Loan Losses – continued

Consumer loans not secured by real estate are typically charged off at 90 days past due, or earlier if deemed uncollectible, unless the loans are in the process of collection. Overdrafts are charged off after 45 days past due. Charge-offs are typically recorded on loans secured by real estate when the property is foreclosed upon if the carrying value of the loan exceeds the property’s fair value less the estimated costs to sell.

Loans Held for Sale

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market value. Aggregate market value is determined based on the quoted prices under a “best efforts” sales agreement with a third party. Net unrealized losses are recognized through a valuation allowance by charges to income. Realized gains on sales of mortgage loans are determined using the specific identification method and are included in noninterest income. Mortgage loans are sold with servicing released.

Commitments to originate mortgage loans held for sale are considered derivative financial instruments to be accounted for at fair value. The Bank’s mortgage loan commitments subject to derivative accounting are fixed-rate mortgage loan commitments at market rates when initiated. At December 31, 2020, the Bank had no commitments required to be accounted for at fair value as all mortgage loan commitments were best efforts commitments where specific loans were committed to be delivered if and when the loan closed. Fair value is estimated based on fees that would be charged on commitments with similar terms.

Transfers of Financial Assets

The Company accounts for transfers and servicing of financial assets in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 860,Transfers and Servicing. Transfers of financial assets are accounted for as sales only when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free from conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Transfers of a portion of a loan must meet the criteria of a participating interest. If it does not meet the criteria of a participating interest, the transfer must be accounted for as a secured borrowing. In order to meet the criteria for a participating interest, all cash flows from the loan must be divided proportionately, the rights of each loan holder must have the same priority, and the loan holders must have no recourse to the transferor other than standard representations and warranties and no loan holder has the right to pledge or exchange the entire loan.

The Company sells financial assets in the normal course of business, the majority of which are related to residential mortgage loan sales through established programs and commercial loan sales through participation agreements. In accordance with accounting guidance for asset transfers, the Company considers any ongoing involvement with transferred assets in determining whether the assets can be derecognized from the balance sheet. With the exception of servicing and certain performance-based guarantees, the Company's continuing involvement with financial assets sold is minimal and generally limited to market customary representation and warranty clauses.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Foreclosed Real Estate

Foreclosed real estate includes formally foreclosed property and property obtained via a deed in lieu of foreclosure that is currently held for sale. At the time of acquisition, foreclosed real estate is recorded at fair value less estimated costs to sell, which becomes the property’s new basis. Any write-downs based on the property’s fair value at the date of acquisition are charged to the allowance for loan losses. After acquisition, valuations are periodically performed by management and property held for sale is carried at the lower of the new cost basis or fair value less cost to sell. Costs incurred in maintaining foreclosed real estate and subsequent impairment adjustments to the carrying amount of a property, if any, are included in net loss on foreclosed real estate.

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. The Company uses the straight line method of computing depreciation at rates adequate to amortize the cost of the applicable assets over their estimated useful lives. Maintenance and repairs are expensed as incurred. The cost and related accumulated depreciation of assets sold, or otherwise disposed of, are removed from the related accounts and any gain or loss is included in earnings.

Cash Value of Life Insurance

The Bank has purchased life insurance policies on certain directors, officers and key employees to offset costs associated with the Bank’s compensation and benefit programs. The Bank is the owner and is a joint or sole beneficiary of the policies. Bank-owned life insurance is recorded at the amount that can be realized under the insurance contracts at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. Income from the increase in cash surrender value of the policies and income from the realization of death benefits is reported in noninterest income.

Goodwill and Other Intangibles

Goodwill recognized in a business combination represents the excess of the cost of the acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed. Goodwill is evaluated for possible impairment at least annually or more frequently upon the occurrence of an event or change in circumstances that would more likely than not reduce the fair value of the reporting unit below its carrying amount. Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or in business climate, (2) unanticipated competition, or (3) an adverse action or assessment by a regulator. If the carrying amount of the goodwill exceeds the fair value of the reporting unit, an impairment loss is recognized in earnings equal to that excess amount. The loss recognized cannot exceed the carrying amount of goodwill. After a goodwill impairment loss is recognized, the adjusted carrying amount of goodwill is its new accounting basis.

Other intangible assets consist of acquired core deposit intangibles. Core deposit intangibles are amortized over the estimated economic lives of the acquired core deposits. The carrying amount of core deposit intangibles and the remaining estimated economic life are evaluated annually or whenever events or circumstances indicate the carrying amount may not be recoverable or the remaining period of amortization requires revision. After an impairment loss is recognized, the adjusted carrying amount of the intangible asset is its new accounting basis.

Securities Lending and Financing Arrangements

Securities purchased under agreements to resell (reverse repurchase agreements) and securities sold under agreements to repurchase (repurchase agreements) are treated as collateralized lending and borrowing transactions, respectively, and are carried at the amounts at which the securities were initially acquired or sold.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Stock-Based Compensation

The Company has adopted the fair value based method of accounting for stock-based compensation prescribed in FASB ASC Topic 718 for its stock compensation plans.

Advertising Costs

Advertising costs are charged to operations when incurred.

Income Taxes

When income tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while other positions are subject to some degree of uncertainty regarding the merits of the position taken or the amount of the position that would be sustained. The Company recognizes the benefits of a tax position in the consolidated financial statements of the period during which, based on all available evidence, management believes it is more-likely-than-not (more than 50 percent probable) that the tax position would be sustained upon examination. Income tax positions that meet the more-likely-than-not threshold are measured as the largest amount of income tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with the income tax positions claimed on income tax returns that exceeds the amount measured as described above is reflected as a liability for unrecognized income tax benefits in the consolidated balance sheets, along with any associated interest and penalties that would be payable to the taxing authorities, if there were an examination. Interest and penalties associated with unrecognized income tax benefits are classified as additional income taxes in the consolidated statements of income.

Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred income taxes. Income tax reporting and financial statement reporting rules differ in many respects. As a result, there will often be a difference between the carrying amount of an asset or liability as presented in the accompanying consolidated balance sheets and the amount that would be recognized as the tax basis of the same asset or liability computed based on the effects of tax positions recognized, as described in the preceding paragraph. These differences are referred to as temporary differences because they are expected to reverse in future years. Deferred income tax assets are recognized for temporary differences where their future reversal will result in future tax benefits. Deferred income tax assets are also recognized for the future tax benefits expected to be realized from net operating loss or tax credit carryforwards. Deferred income tax liabilities are recognized for temporary differences where their future reversal will result in the payment of future income taxes. Deferred income tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Comprehensive Income

Comprehensive income consists of reported net income and other comprehensive income. Other comprehensive income refers to revenue, expenses, gains and losses that are recorded as an element of equity but are excluded from reported net income. Other comprehensive income includes changes in the unrealized gains and losses on securities available for sale.

Amounts reclassified out of unrealized gains or losses on securities available for sale included in accumulated other comprehensive income or loss (“AOCI”) are included in the net gain (loss) on sale of available for sale securities line item in the consolidated statements of income.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Loss Contingencies

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.

Concentration of Credit Risk

The Company and its subsidiaries maintain cash balances at various financial institutions. At times, these cash balances may be in excess of federally insured limits.

Recent Accounting Pronouncements

The following are summaries of recently issued or adopted accounting pronouncements that impact the accounting and reporting practices of the Company:

In June 2016, the FASB issued Accounting Standards Update (“ASU”) No.2016-13,Financial Instruments – Credit Losses (Topic 326). The update commonly referred to as the current expected credit loss methodology (“CECL”), replaces the incurred loss methodology for recognizing credit losses under current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Under the new guidance, an entity will measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. The expected loss model will apply to loans and leases, unfunded lending commitments, held-to-maturity debt securities and other debt instruments measured at amortized cost. The impairment model for available-for-sale debt securities will require the recognition of credit losses through a valuation allowance when fair value is less than amortized cost, regardless of whether the impairment is considered to be other-than-temporary. For the Company, the amendments in the update were originally effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently assessing the impact the guidance will have upon adoption, but management expects its allowance for loan losses to increase through a one-time adjustment to retained earnings as of the beginning of the first reporting period in which the new standard is effective. However, until the evaluation is complete, the magnitude of the increase will be unknown. In planning for the implementation of ASU 2016-13, the Company has formed a CECL implementation team consisting of members of senior management that meets on a periodic basis and is currently evaluating software solutions, data requirements and loss methodologies.

In November 2019, the FASB issued ASU No.2019-10 which delayed the effective date of ASU 2016-13 for smaller reporting companies (as defined by the Securities and Exchange Commission (“SEC”)) and other non-SEC reporting entities to fiscal years beginning after December 15, 2022, including interim periods within those fiscal periods. Early adoption is permitted as of fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is a smaller reporting company as defined by the SEC, and currently does not intend to early adopt CECL.

In August 2018, the FASB issued ASU No.2018-13,Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The update removes, modifies and adds certain disclosure requirements for fair value measurements. Among other changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels and the valuation processes for Level 3 fair value measurements, but will be required to disclose the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in the update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted upon issuance of the update. The adoption of this update effective January 1, 2020 did not have a material impact on the Company’s consolidated financial position or results of operations.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(1 - continued)

Recent Accounting Pronouncements – continued

In October 2020, the FASB issued ASU No.2020-08, Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs. The ASU amends the guidance under Subtopic 310-20 to provide that for each reporting period, to the extent that the amortized cost basis of an individual callable debt security exceeds the amount repayable by the issuer at the next call date, the excess (that is, the premium) shall be amortized to the next call date unless the premium of the individual callable debt security is amortized based on consideration of estimated prepayments. The amendments in the update are effective for public entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. Early application is not permitted for public entities. All entities should apply the amendments in the update on a prospective basis as of the beginning of the period of adoption for existing or newly purchased callable debt securities. The adoption of this update is not expected to have a material impact on the Company's consolidated financial position or results of operations.

The Company has determined that all other recently issued accounting pronouncements will not have a material impact on the Company’s consolidated financial statements or do not apply to its operations.

(2) RESTRICTION ON CASH AND DUE FROM BANKS

Previously, the Bank was required to maintain reserve balances on hand and with the Federal Reserve Bank (“FRB”). However, the FRB Board set the reserve requirement to 0% effective March 26, 2020. The average amount of required reserve balances for the years ended December 31, 2020, 2019 and 2018 was approximately $492,000, $1.9 million and $1.8 million, respectively.

(3) INVESTMENT SECURITIES

Investment securities have been classified in the consolidated balance sheets according to management’s intent. Investment securities at December 31, 2020 and 2019 are summarized as follows:

Gross Gross

Amortized Unrealized Unrealized Fair

(In thousands) Cost Gains Losses Value

Securities available for sale:

Other debt securities:

Securities available for sale:

Other debt securities:

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(3 - continued)

The amortized cost and fair value of debt securities as of December 31, 2020, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities and CMO may differ from contractual maturities because the mortgages underlying the obligations may be prepaid without penalty.

Securities Available for Sale

Amortized Fair

Cost Value

(In thousands)

Due after one year through five years 68,776 70,110

Due after five years through ten years 37,626 39,864

Mortgage-backed securities and

At December 31, 2020, certain securities available for sale with an amortized cost of $54.0 million and fair value of $55.1 million were pledged to secure public fund deposits.

At December 31, 2020 and 2019, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, with an aggregate book value greater that 10% of stockholders’ equity.

Information pertaining to investment securities with gross unrealized losses at December 31, 2020 and 2019, aggregated by investment category and the length of time that individual investment securities have been in a continuous loss position, follows.

Number of Gross

Investment Fair Unrealized

(Dollars in thousands) Positions Value Losses

Continuous loss position less than twelve months:

Agency notes and bonds 2 5,997 3

Municipal obligations 2 1,303 4

Continuous loss position more than twelve months:

Total more than twelve months 4 1,589 12

Total securities available for sale 20 $ 15,078 $ 37

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(3 - continued)

Number of Gross

Investment Fair Unrealized

(Dollars in thousands) Positions Value Losses

Continuous loss position less than twelve months:

Agency mortgage-backed securities 5 $ 723 $ 2

Continuous loss position more than twelve months:

Management evaluates securities for other-than-temporary impairment at least quarterly, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

At December 31, 2020, the municipal obligations and U.S. government agency debt securities, including agency mortgage-backed securities, agency CMOs, and agency notes and bonds, in a loss position had depreciated approximately 0.2% from the amortized cost basis. All of the U.S. government agency securities and municipal securities are issued by U.S. government agencies, government-sponsored enterprises, or municipal governments, and are secured by first mortgage loans or municipal project revenues. These unrealized losses related principally to current interest rates for similar types of securities. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government, its agencies or other governments, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. As the Company has the ability to hold the U.S. government agency debt securities and municipal securities in an unrealized loss position until maturity, no declines are deemed to be other-than-temporary.

While management does not anticipate any credit-related impairment losses at December 31, 2020, additional deterioration in market and economic conditions may have an adverse impact on the credit quality in the future.

During the year ended December 31, 2020, the Company sold no available for sale securities or interest-bearing time deposits. During the year ended December 31, 2019, the Company realized gross gains of $22,000 and gross losses of $156,000 on sales of available for sale securities. During the year ended December 31, 2018, the Company realized gross gains of $218,000 and gross losses of $313,000 on the sale of available for sale securities.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED

(3 - continued)

Equity Securities

In September 2018, the Company acquired 90,000 shares of common stock in another bank holding company, representing approximately 5% of the outstanding common stock of the entity, for a total investment of $1.9 million. During the years ended December 31, 2020, 2019 and 2018, the Company recognized an unrealized loss of $194,000, an unrealized gain of $32,000 and an unrealized loss of $207,000, respectively, on this equity investment. At December 31, 2020 and 2019, the equity investment had a fair value of $1.6 million and $1.7 million, respectively, and is included in other assets on the consolidated balance sheets.

(4) LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans at December 31, 2020 and 2019 consisted of the following:

Real estate mortgage loans:

Commercial real estate construction 4,988 20,086

Consumer loans:

Home equity and second mortgage loans 52,001 54,677

Less undisbursed portion of loans in process (19,179 ) (23,081 )

Deferred loan origination fees and costs, net 317 1,137

Allowance for loan losses (6,625 ) (5,061 )

The Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) was passed by Congress on March 27, 2020. The CARES Act included a total allocation of $659 billion for PPP loans to be issued by financial institutions through the SBA. PPP loans are forgivable, in whole or in part, if the proceeds are used for eligible payroll costs and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and are 100% guaranteed by the SBA. PPP loans originated prior to June 5, 2020 have a term of two years, while PPP loans originated on or after June 5, 2020 have a term of five years. In accordance with the Paycheck Protection Flexibility Act of 2020, payments on PPP loans are deferred until the SBA remits the borrower’s loan forgiveness amount to the lender or, if the borrower does not apply for loan forgiveness, 10 months after the end of the borrower’s loan forgiveness covered period. The SBA paid the originating bank a processing fee ranging from 1% to 5%, based on the size of the loan. Through December 31, 2020, the Bank had originated $45.9 million in PPP loans and had received gross fees of $1.8 million from the SBA. At December 31, 2020, PPP loans totaling $37.3 million were included in commercial business loans and net deferred loan fees related to PPP loans was $842,000, which will be recognized over the life of the loans and as borrowers are granted forgiveness.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(4 - continued)

The Consolidated Appropriations Act of 2021 signed into law on December 27, 2020 included the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act, which renewed the PPP by allocating additional funds for both new first time PPP borrowers and “second round” PPP loans for qualifying existing PPP borrowers. The Bank is actively pursuing additional PPP loans under the program, which currently is extended through March 31, 2021.

At December 31, 2020 and 2019, the net unamortized premium on loans acquired from other financial institutions, excluding purchased credit impaired (“PCI”) loans, was $61,000 and $67,000, respectively.

At December 31, 2020 and 2019, residential mortgage loans secured by residential properties without private mortgage insurance or government guarantee and with loan-to-value ratios exceeding 90% amounted to approximately $1.6 million and $2.3 million, respectively.

The Bank has entered into loan transactions with certain directors, officers and their affiliates (i.e., related parties). In the opinion of management, such indebtedness was incurred in the ordinary course of business on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with unrelated persons and does not involve more than normal risk of collectability or present other unfavorable features.

The following table represents the aggregate activity for related party loans during the years ended December 31, 2020 and 2019. Adjustments are made to reflect new directors and officers added during the year, as well as directors and officers that left the Company during the year.

Adjustments due to officer and director changes (1,051 ) -

Off-balance-sheet commitments (including commitments to make loans, unused lines of credit and letters of credit) to related parties at December 31, 2020 and 2019 were $2.0 million and $7.5 million, respectively.

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(4 - continued)

The following table provides the components of the Company’s recorded investment in loans at December 31, 2020 and 2019:

(In thousands)

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(4 - continued)

An analysis of the allowance for loan losses and recorded investment in loans as of and for the year ended December 31, 2020 is as follows:

(In thousands)

Allowance for Loan Losses:

Ending allowance balance attributable to loans:

Individually evaluated for impairment $ - $ - $ - $ - $ - $ - $ - $ -

Acquired with deteriorated credit quality 31 - - - - - - 31

Recorded Investment in Loans:

Acquired with deteriorated credit quality 271 - - 26 - - - 297

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(4 - continued)

An analysis of the allowance for loan losses and recorded investment in loans as of and for the year ended December 31, 2019 is as follows:

(In thousands)

Allowance for Loan Losses:

Ending allowance balance attributable to loans:

Individually evaluated for impairment $ 16 $ - $ - $ - $ - $ - $ - $ 16

Acquired with deteriorated credit quality 12 - - - - - - 12

Recorded Investment in Loans:

Acquired with deteriorated credit quality 285 - - 39 - - - 324

F-

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED

(4 - continued)

An analysis of the allowance for loan losses for the year ended December 31, 2018 is as follows:

(In thousands)

Allowance for Loan Losses:

December 31, 2020 and 2019, management applied qualitative factor adjustments to each portfolio segment as they determined that the historical loss experience was not indicative of the level of risk in the remaining balance of those portfolio segments. As part of their analysis of qualitative factors, management considers changes in underwriting standards, economic conditions, past due loan trends, collateral valuations, loan concentrations and other internal and external factors. During the year ended December 31, 2020, management adjusted the qualitative factors due to economic uncertainties related to the novel coronavirus ("COVID-19"). At December 31, 2020, there was still considerable uncertainty about how severely the COVID-19 pandemic has impacted the loan portfolio. As a result, management has increased the allowance qualitative factor adjustments for each portfolio segment while considering the potential length of the pandemic, continued elevated unemployment rates, the impact of further state and local restrictions, the impact of government stimulus activities and the timeline for economic recovery.

Management also adjusts the historical loss factors for loans classified as watch, special mention and substandard that are not individually evaluated for impairment. The adjustments consider the increased likelihood of loss on classified loans based on the Company’s separate historical experience for classified loans.

At December 31, 2020, the Company's allowance for loan losses totaled $6.6 million, of which $6.0 million related to qualitative factor adjustments. At December 31, 2019, the Company's allowance for loan losses totaled $5.1 million, of which $3.9 million related to qualitative factor adjustments. These changes were made to reflect management’s estimates of inherent losses in the loan portfolio at December 31, 2020 and 2019.

First Capital Inc FCAP US Equity

FCAP · 10-K · period ended 2020-12-31

ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

ITEM 9A.CONTROLS AND PROCEDURES

ITEM 9B.OTHER INFORMATION

ITEM 10.DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

ITEM 11.EXECUTIVE COMPENSATION

ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTORS INDEPENDENCE

ITEM 14.PRINCIPAL ACCOUNTING FEES AND SERVICES

ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

ITEM 16.FORM 10-K SUMMARY

First Capital Inc FCAP US Equity☆

FCAP · 10-K · period ended 2020-12-31

ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

ITEM 9A.CONTROLS AND PROCEDURES

ITEM 9B.OTHER INFORMATION

ITEM 10.DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

ITEM 11.EXECUTIVE COMPENSATION

ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTORS INDEPENDENCE

ITEM 14.PRINCIPAL ACCOUNTING FEES AND SERVICES

ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

ITEM 16.FORM 10-K SUMMARY

First Capital Inc FCAP US Equity