Item 1A. Risk Factors
CREDIT RISK
Focus on lending to small to mid-sized community-based businesses may increase our credit risk.
Most of the Company’s commercial business and commercial real estate loans are made to small business or middle market customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a heightened vulnerability to economic conditions. If general economic conditions in the market areas in which the Company operates negatively impact this important customer sector, the Company’s results of operations and financial condition may be adversely affected. Moreover, a portion of these loans have been made by the Company in recent years and the borrowers may not have experienced a complete business or economic cycle since becoming borrowers of the Bank. The deterioration of the borrowers’ businesses may hinder their ability to repay their loans with the Company, which could have a material adverse effect on the Company’s financial condition and results of operations.
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The allowance for loan losses may not be adequate to cover actual losses.
In accordance with GAAP, an allowance for loan losses is maintained to provide for probable loan losses. The allowance for loan losses may not be adequate to cover actual credit losses, and future provisions for credit losses could materially and adversely affect operating results. The allowance for loan losses is based on prior experience as well as an evaluation of risks in the current portfolio. The amount of future losses is susceptible to changes in economic, operating, and other outside forces and conditions, including changes in interest rates, all of which are beyond the Company’s control; and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review the Company’s loans and allowance for loan losses. The Company also outsources independent loan review. While management believes that the allowance for loan losses is adequate to cover current probable losses, it cannot make assurances that it will not further increase the allowance for loan losses or that regulators will not require it to increase this allowance. Either occurrence could adversely affect earnings.
The allowance for loan losses requires management to make significant estimates that affect the consolidated financial statements. Due to the inherent nature of this estimate, management cannot provide assurance that it will not significantly increase the allowance for loan losses, which could materially and adversely affect earnings.
A decline in the condition of the local real estate market could negatively affect our business.
The Company offers a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, residential mortgages, home equity loans and lines of credit, consumer and other loans. Many of these loans are secured by real estate (both residential and commercial). As of December 31, 2021, 82.6% of all loans were secured by mortgages on real property. Substantially all of the Company’s real property collateral is located in its market area. If there is a decline in real estate values, especially in the Company’s market area, the collateral for loans would deteriorate and provide significantly less security to the Company. In the event the Company forecloses on a loan that is collateralized with property having reduced market value, the Company may suffer a recovery loss.
The Bank has a moderate concentration of credit exposure in commercial real estate, and loans with this type of collateral are viewed as having more risk of default.
As of December 31, 2021, the Bank had approximately $405,722 in loans secured by commercial real estate, representing approximately 51.5% of total loans outstanding at that date. The real estate consists primarily of multi-family housing, non-owner-operated properties and other commercial properties. These types of loans are generally viewed as having more risk of default than residential real estate loans. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. It may be more difficult for commercial real estate borrowers to repay their loans in a timely manner, as commercial real estate borrowers’ abilities to repay their loans frequently depends on the successful rental of their properties. Cash flows may be affected significantly by general economic conditions, and a downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default. Because the Bank’s loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in the percentage of non-performing loans. An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on the Company’s financial condition.
Nonperforming assets take significant time to resolve and adversely affect the Company’s results of operations and financial condition.
The Company’s nonperforming assets adversely affect its net income in various ways. The Company expects to continue to incur additional losses relating to volatility in nonperforming loans. The Company does not record interest income on nonaccrual loans, which adversely affects its income and increases credit administration costs. When the Company receives collateral through foreclosures and similar proceedings, it is required to mark the related asset to the then fair market value of the collateral less estimated selling costs, which may, and often does, result in a loss. An increase in the level of nonperforming assets also increases the Company’s risk profile and may impact the capital levels regulators believe are appropriate in light of such risks. The Company utilizes various techniques such as workouts and restructurings to manage problem assets. Increases in or negative adjustments in the value of these problem assets, the underlying collateral, or in the borrowers’ performance or financial condition, could adversely affect the Company’s business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and staff, which can be detrimental to the performance of their other responsibilities, including generation of new loans. There can be no assurance that the Company will avoid further increases in nonperforming loans in the future.
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The Company relies upon independent appraisals to determine the value of the real estate which secures a significant portion of its loans, and the values indicated by such appraisals may not be realizable if the Company is forced to foreclose upon such loans.
A significant portion of the Company’s loan portfolio consists of loans secured by real estate. The Company relies upon independent appraisers to estimate the value of such real estate. Appraisals are only estimates of value and the independent appraisers may make mistakes of fact or judgment which adversely affect the reliability of their appraisals. In addition, events occurring after the initial appraisal may cause the value of the real estate to increase or decrease. As a result of any of these factors, the real estate securing some of the Company’s loans may be more or less valuable than anticipated at the time the loans were made. If a default occurs on a loan secured by real estate that is less valuable than originally estimated, the Company may not be able to recover the outstanding balance of the loan and will suffer a loss.
Our loan portfolio’s credit risk and the risk of loan losses may increase if economic conditions worsen due to the ongoing COVID-19 pandemic.
If the COVID-19 pandemic depresses business activity, it is likely to result in a higher rate of business closures and increased job losses in the region in which we do business. If, in response to the COVID-19 pandemic, public colleges and universities in our market area experience reduced enrollment or in-person learning, or reduced attendance at sporting events, employment levels in our area may also be adversely affected. These factors would increase the likelihood that more of our customers would become delinquent or default on their loans. A higher level of loan defaults could result in higher loan losses, which could adversely affect our result of operations and financial condition.
The risk of loss in our investment portfolio may increase if economic conditions worsen due to the ongoing COVID-19 pandemic or if interest rates change rapidly.
The Company holds both corporate and municipal bonds in its investment portfolio. An economic downturn due to the COVID-19 pandemic could increase the actual or perceived risk of default by both corporate and government issuers and, in either case, could adversely affect the value of these investments. In addition, the value of these investments could be adversely affected by a change in interest rates and related factors, including the pricing of securities.
The ongoing COVID-19 pandemic may adversely affect the Company’s current or future impaired loans.
The impact of the COVID-19 pandemic continues to present uncertainty and may lead to additional loans designated as impaired in future quarters. Cash flow assumptions associated with impaired loans measured under the cash flow method may be impacted if borrowers are further distressed by the economic impacts of the COVID-19 pandemic, resulting in lower measurements and higher funding requirements for the allowance for loan losses. Real estate activity in the Company’s market over the most recent 12 months has been robust. However, if the COVID-19 pandemic begins to negatively impact the real estate markets in which the Company’s collateral resides, the fair value of impaired loans measured using the collateral method could decline and may result in charge-offs.
The expiration of federal government aid related to the COVID-19 pandemic to assist borrowers may increase credit risk.
Federal aid from the CARES Act, the CAA and other regulations assisted borrowers during 2020 and 2021 for COVID-19 pandemic-related hardship. With the expiration of the aid, borrowers may face increased difficulty in servicing debt, which could result in loan losses and adversely affect the Company’s financial condition and results of operation.
MARKET RISK
If competition increases, our business could suffer, which could result in loan losses and adversely affect the Company’s financial condition and results of operations.
The financial services industry is highly competitive, with a number of commercial banks, credit unions, insurance companies, stockbrokers, financial technology companies and other nonbank financial service providers seeking to do business with our customers. If there is additional competition from new business or if our existing competitors focus more attention on our market, we could lose customers and our business could suffer.
Consumers may increasingly decide not to use the Bank to process their financial transactions, which would have a material adverse impact on the Company’s financial condition and operations.
Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on the Company’s financial condition and results of operations.
The expected replacement or discontinuation of the London Interbank Offered Rate (“LIBOR”) as a benchmark interest rate and a transition to an alternative reference interest rate could present operational problems and result in market disruption.
The administrator of LIBOR has announced its intention to extend the publication of most tenors of LIBOR for U.S. dollars through June 30, 2023 and ceased publishing other LIBOR tenors on December 31, 2021. Management cannot predict whether or when LIBOR will actually cease to be available, whether the Secured Overnight Funding Rate (“SOFR”), will become the market benchmark in its place or what impact such a transition may have on the Company’s business, financial condition and results of operations.
The Federal Reserve, based on the recommendations of the Federal Reserve Bank of New York’s Alternative Reference Rate Committee, has begun publishing SOFR, which is intended to replace LIBOR, and has encouraged banks to transition away from LIBOR as soon as practicable. Although SOFR appears to be the preferred replacement rate for LIBOR, it is unclear if other benchmarks may emerge or if other rates will be adopted outside of the United States. The replacement of LIBOR also may result in economic mismatches between different categories of instruments that now consistently rely on the LIBOR benchmark. Markets are slowly developing in response to these new rates, and questions around liquidity in these rates and how to appropriately adjust these rates to eliminate any economic value transfer at the time of transition remain a significant concern.
The Company has a small number of loans, purchased through participation with larger banks, with attributes that are either directly or indirectly dependent on LIBOR. Since proposed alternative rates are calculated differently, payments under contracts referencing new rates will differ from those referencing LIBOR. The transition from LIBOR could create additional cost and risk, with potential to adversely impact the Company’s financial condition and results of operations.
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INTEREST RATE RISK
When market interest rates change, our net interest income can be negatively affected in the short term.
The direction and speed of interest rate changes affect our net interest margin and net interest income. In the short term, rising interest rates may negatively affect our net interest income if our interest-bearing liabilities (generally deposits) reprice sooner than our interest-earning assets (generally loans). Falling interest rates may negatively affect our net interest income if our interest-earning assets reprice sooner than our interest-bearing liabilities.
LIQUIDITY RISK
The Company’s liquidity needs could adversely affect results of operations and financial condition.
The Company’s primary sources of funds are deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including, but not limited to, changes in economic conditions, reductions in real estate values or markets, availability of, and/or access to, sources of refinancing, business closings or lay-offs, and natural disasters. Additionally, deposit levels may be affected by a number of factors, including, but not limited to, rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to customers on alternative investments and general economic conditions. Accordingly, the Company may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include Federal Home Loan Bank of Atlanta (“FHLB”) advances, sales of securities and loans, federal funds lines of credit from correspondent banks and borrowings from the Federal Reserve Discount Window, as well as additional out-of-market time deposits and brokered deposits. While the Company believes that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands, particularly if the Company continues to grow and experiences increasing loan demand. The Company may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should such sources not be adequate.
CYBERSECURITY RISK
Our information systems may experience an interruption or security breach.
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions of our internet banking, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the possible failure, interruption or security breach of our information systems, there can be no assurance that any such failure, interruption or security breach will not occur or, if it does occur, that it will be adequately addressed.
In the ordinary course of business, the Company collects and stores sensitive data, including proprietary business information and personally identifiable information of its customers and employees, in systems and on networks. The secure processing, maintenance and use of this information is critical to the Company’s operations and business strategy. The Company has invested in industry-accepted technologies, and annually reviews its processes and practices that are designed to protect its networks, computers and data from damage or unauthorized access. Despite these security measures, the Company’s computer systems experienced two cyber-intrusions, one in May 2016 and one in January 2017 in which certain customer information was compromised, but which did not cause interruption to the Company’s normal operations. The Company has implemented additional security measures since the breaches.
The Company’s computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. A breach of any kind could compromise systems and the information stored there could be accessed, damaged or disclosed. The occurrence of any failure, interruption or security breach of our communications and information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability.
Cybersecurity attacks may disarm and/or bypass system safeguards that are used by us and our vendors and service providers, and allow unauthorized access and misappropriation of financial data and assets.
As a financial institution, we are vulnerable to and are the target of cybersecurity attacks that attempt to access our digital technology systems, disarm and/or bypass system safeguards, access customer data and ultimately increase the risk of economic and reputational loss.
The Company experienced two cyber-intrusions, one in May 2016 and one in January 2017 in which certain customer information was compromised. The Company has strengthened its multi-faceted approach to reduce the exposure of our systems to cyber-intrusions, strengthen our defenses against hackers and protect customer accounts and information relevant to customer accounts from unauthorized access. These tools include digital technology safeguards, internal policies and procedures, and employee training.
The Company believes its cybersecurity risk management program reasonably addresses the risk from cybersecurity attacks. However, it is not possible to fully eliminate exposure. We may experience human error or have unknown susceptibilities that allow our systems to become victim to a highly-sophisticated cyber-attack. If hackers gain entry to our systems, they may disable other safeguards that limit loss, including limits on the number, amount and frequency of ATM withdrawals, as well as other loss-prevention or detection measures.
We also face risks related to cybersecurity attacks and security breaches in connection with the use, transmission and storage of sensitive information regarding us and our customers by various vendors and service providers. Some of these vendors and service providers have been the target of cybersecurity attacks or suffered security breaches, and because they use systems that we do not control or secure, future cyber-attacks or security breaches affecting any of these vendors and service providers could impact us through no fault of our own. In some cases, we may have exposure and suffer losses relating to these companies. Although we assess the security of our higher risk vendors and service providers, we cannot be sure that the information security protocols of all companies we do business with are sufficient to withstand cyber-attacks or other security breaches.
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Cybersecurity attacks are probable and may result in additional costs.
The Company has experienced many attempted cybersecurity attacks, of which two resulted in a breach. The Company estimates that the probability of future attempted cyber-attacks is high. To reduce the risk of loss from cyber-attacks, the Company has incurred costs related to advisory expenses, insurance premiums, system monitoring and testing, and installing new technological infrastructure and defenses. If the Company experiences a cyber-breach, these costs will increase and the Company will also likely incur additional litigation, reputational harm and regulatory costs.
Insurance may not cover losses from cybersecurity attacks.
The Company has invested in insurance related to cybersecurity. Insurance policies are necessary to protect the Company from major losses but may be written in such a way as to limit the protection from certain risks, including cyber risks. If the insurance carrier denies coverage of losses, the Company may litigate. Because of policy technicalities, litigation may not result in a favorable outcome for the Company. Litigation will result in additional legal expense.
OPERATIONAL RISK
The Company is dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect the Company’s operations and prospects.
The Company currently depends on the services of a number of key management personnel. The loss of key personnel could materially and adversely affect the results of operations and financial condition. The Company’s success also depends in part on the ability to attract and retain additional qualified management personnel. Competition for such personnel is strong and the Company may not be successful in attracting or retaining the personnel it requires.
The Company relies on other companies to provide key components of the Company’s business infrastructure.
Third parties provide key components of the Company’s business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, internet connections and network access. While the Company has selected these third party vendors carefully, it does not control their actions. Any problem caused by these third parties, including those resulting from disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher volumes, failures of a vendor to provide services for any reason or poor performance of services, could adversely affect the Company’s ability to deliver products and services to its customers and otherwise conduct its business. Financial or operational difficulties of a third party vendor could also hurt the Company’s operations if those difficulties interface with the vendor’s ability to serve the Company. Replacing these third party vendors could also create significant delay and expense and damage the Company’s ability to service its customers, resulting in a loss of customer goodwill. Accordingly, use of such third parties creates an unavoidable inherent risk to the Company’s business operations.
The Company’s ability to operate profitably may be dependent on its ability to integrate or introduce various technologies into its operations.
The market for financial services, including banking and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, online banking and tele-banking. The Company’s ability to compete successfully in its market may depend on the extent to which it is able to exploit such technological changes. If the Company is not able to afford such technologies, properly or timely anticipate or implement such technologies, or effectively train its staff to use such technologies, its business, financial condition or results of operations could be adversely affected.
COMPLIANCE AND REGULATORY RISK
Additional laws and regulations, or revisions and rescission of existing laws and regulations, could lead to a significant increase in our regulatory burden.
Both federal and state governments could enact new laws and regulations affecting financial institutions that would further increase our regulatory burden and could negatively affect our profits. Likewise, revisions or rescission of existing laws and regulations already implemented may result in additional compliance costs, at least in the short term or, if done imprudently, could ultimately create economic risks negatively affecting our revenues.
Intense oversight by regulators could result in stricter requirements and higher overhead costs.
Regulators for the Company and the Bank are tasked with ensuring compliance with applicable laws and regulations. Laws and regulations are subject to a degree of interpretation. If financial industry regulators take more extreme interpretations, the Company’s earnings could be adversely impacted.
Regulatory capital standards may have an adverse effect on the Company’s profitability, lending, and ability to pay dividends on the Company’s securities.
The Company is subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital that the Company and the Bank must maintain. From time to time, regulators implement changes to these regulatory capital adequacy guidelines. If the Company fails to meet these minimum capital guidelines and/or other regulatory requirements, its financial condition would be materially and adversely affected. The Basel III Capital Rules require bank holding companies and their subsidiaries to maintain significantly more capital as a result of higher required capital levels and more demanding regulatory capital risk weightings and calculations. While the Company is exempt from these capital requirements under the Statement, the Bank is not exempt and must comply. The Bank must also comply with the capital requirements set forth in the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act, as amended. Satisfying capital requirements may require the Company to limit its banking operations, retain net income or reduce dividends to improve regulatory capital levels, which could negatively affect its business, financial condition and results of operations.
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Changes in accounting standards could impact reported earnings.
The authorities who promulgate accounting standards, including the Financial Accounting Standards Board (“FASB”), SEC, and other regulatory authorities, periodically change the financial accounting and reporting standards that govern the preparation of the Company’s consolidated financial statements. These changes are difficult to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of consolidated financial statements for prior periods. Such changes could also require the Company to incur additional personnel or technology costs. Notably, guidance issued in June 2016 requires a change in the calculation of credit reserves from using an incurred loss model to using the current expected credit losses model (“CECL”). During 2019, the standard’s effective date was delayed for the Company and other qualifying institutions until January 1, 2023. The Company formed a management committee to prepare for the new standard. The committee implemented data collection measures, researched forecasting resources, studied applicable loss calculations and has begun running preliminary CECL models concurrent with the incurred loss model. To implement the standard, the Company will incur costs related to documentation, technology, training and increased audit expenses to validate the model. Implementation could significantly impact our required credit reserves. Other impacts to capital levels, profit and loss and various financial metrics will also result.
The Company’s ability to pay dividends depends upon the results of operations of its subsidiaries.
The Company is a financial holding company and a bank holding company that conducts substantially all of its operations through NBB. As a result, the Company’s ability to make dividend payments on its common stock depends primarily on certain federal regulatory considerations and the receipt of dividends and other distributions from NBB. There are various regulatory restrictions on the ability of NBB to pay dividends or make other payments to the Company. Although the Company has historically paid a cash dividend to the holders of its common stock, holders of the common stock are not entitled to receive dividends, and regulatory or economic factors may cause the Company’s Board of Directors to consider, among other things, the reduction of dividends paid on the Company’s common stock.
Climate change and related legislative and regulatory initiatives may result in operational changes and expenditures that could significantly impact the Company’s business.
The current and anticipated effects of climate change are creating an increasing level of concern for the state of the global environment. As a result, political and social attention to the issue of climate change has increased. Federal and state legislatures and regulatory agencies have continued to propose and advance numerous legislative and regulatory initiatives seeking to mitigate the effects of climate change. The federal banking agencies, including the OCC, have emphasized that climate-related risks are faced by banking organizations of all types and sizes and are in the process of enhancing supervisory expectations regarding banks’ risk management practices. In December 2021, the OCC published proposed principles for climate risk management by banking organizations with more than $100 billion in assets. The OCC also has appointed its first ever Climate Change Risk Officer and established an internal climate risk implementation committee in order to assist with these initiatives and to support the agency’s efforts to enhance its supervision of climate change risk management. Similar and even more expansive initiatives are expected, including potentially increasing supervisory expectations with respect to banks’ risk management practices, accounting for the effects of climate change in stress testing scenarios and systemic risk assessments, revising expectations for credit portfolio concentrations based on climate-related factors and encouraging investment by banks in climate-related initiatives and lending to communities disproportionately impacted by the effects of climate change. To the extent that these initiatives lead to the promulgation of new regulations or supervisory guidance applicable to the Company, the Company would likely experience increased compliance costs and other compliance-related risks.
LEGAL RISK
The Company is subject to claims and litigation pertaining to fiduciary responsibility.
From time to time, customers make claims and take legal action pertaining to the performance of the Company’s fiduciary responsibilities. Whether customer claims and legal action related to the performance of the Company’s fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to the Company, they may result in significant financial liability and/or adversely affect the market perception of the Company and its products and services, as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.
GENERAL RISK
Changes in funding for local universities could materially affect our business.
Two major employers in the Company’s market area are Virginia Tech and Radford University, both state-supported institutions. If federal or state support for public colleges and universities wanes, our business may be adversely affected from declines in university programs, capital projects, employment, enrollment, sporting and cultural events, and other related factors.
If the economy suffers a recession, our credit risk will increase and there could be greater loan losses.
If the economy suffers a recession, it is likely to result in a higher rate of business closures and increased job losses in the region in which we do business. These factors would increase the likelihood that more of our customers would become delinquent or default on their loans. A higher level of loan defaults could result in higher loan losses, which could adversely affect our result of operations and financial condition.
Political, economic and social risks in the U.S. and the rest of the world could negatively affect the financial markets.
Political, economic and social risks in the U.S. and the rest of the world could affect financial markets and affect fiscal policy which could negatively affect our investment portfolio and earnings.
While the Company’s common stock is currently traded on the Nasdaq Capital Market, it has less liquidity than stocks for larger companies quoted on a national securities exchange.
The trading volume in the Company’s common stock on the Nasdaq Capital Market has been relatively low when compared with larger companies listed on the Nasdaq Capital Market or other stock exchanges. There is no assurance that a more active and liquid trading market for the common stock will exist in the future. Consequently, stockholders may not be able to sell a substantial number of shares for the same price at which stockholders could sell a smaller number of shares. In addition, the Company cannot predict the effect, if any, that future sales of its common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of the common stock. Sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, could cause the price of the Company’s common stock to decline, or reduce the Company’s ability to raise capital through future sales of common stock.
Natural disasters, acts of war or terrorism, the impact of public health issues and other adverse external events could detrimentally affect our financial condition and results of operations.
Natural disasters, acts of war or terrorism, the impact of public health issues and other adverse external events could have a significant negative impact on our ability to conduct business or upon third parties who perform operational services for us or our customers. Such events also could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in lost revenue or cause us to incur additional expenses.
Although the Company has business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective. In the event of a natural disaster, acts of war or terrorism, the impact of public health issues or other adverse external events, our business, services, asset quality, financial condition and results of operations could be adversely affected.
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The effects of widespread public health emergencies may negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations.
Widespread health emergencies, such as the current COVID-19 pandemic, can disrupt our operations through their impact on our employees, customers and their businesses, and the communities in which we operate. Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, negatively impact regional economic conditions, result in a decline in local loan demand, loan originations and deposit availability and negatively impact the implementation of our growth strategy. Any one or more of these developments could have a material adverse effect on our business, financial condition and results of operations.
The ongoing COVID-19 pandemic may adversely affect the Company’s business, financial condition and operations; the extent of such impacts are highly uncertain and difficult to predict.
Global health and economic concerns relating to the COVID-19 pandemic has had a material adverse impact on the macroeconomic environment and significantly increased economic uncertainty.
The COVID-19 outbreak has adversely impacted and is likely to continue to adversely impact the Company’s workforce and operations and the operations of the Company’s customers and business partners. In particular, the Company may experience adverse effects due to operational factors impacting the Company or its customers or business partners, including but not limited to:
The extent to which the COVID-19 pandemic impacts the Company’s business, liquidity, financial condition and operations will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, its duration and severity, the actions to contain it or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In addition, the rapidly changing and unprecedented nature of COVID-19 heightens the inherent uncertainty of forecasting future economic conditions and their impact on the Company’s loan portfolio, thereby increasing the risk that the assumptions, judgments and estimates used to determine the allowance for loan losses and other estimates are incorrect. Further, the Company’s program providing loan payment extensions and interest only periods could delay or make it difficult to identify the extent of asset quality deterioration during the period of relief. As a result of these and other conditions, the ultimate impact of the COVID-19 pandemic is highly uncertain and subject to change, and the Company cannot predict the full extent of the impacts on its business or operations, or the local and national economy as a whole. To the extent any of the foregoing risks or other factors that develop as a result of COVID-19 materialize, it could exacerbate the risk factors above, or otherwise materially and adversely affect the Company’s business, liquidity, financial condition and results of operations.
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Item 1B. Unresolved Staff Comments
There are no unresolved staff comments.
Item 2. Properties
NBB owns and has a branch bank in NBI’s headquarters building located at 101 Hubbard Street, Blacksburg, Virginia. NBB’s main office is at 100 South Main Street, Blacksburg, Virginia. NBB owns an additional eighteen branch offices and a private office location for support functions and it leases four branch locations and a loan production office. We believe that existing facilities are adequate for current needs and to meet anticipated growth.
Item 3. Legal Proceedings
NBI, NBB, and NBFS are not currently involved in any material pending legal proceedings. There are no legal proceedings against the Company related to cybersecurity.
Item 4. Mine Safety Disclosures
Not applicable.
Part II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock Information and Dividends
NBI’s common stock is traded on the Nasdaq Capital Market under the symbol “NKSH.” As of December 31, 2021, there were 560 record stockholders of NBI common stock.
NBI’s primary source of funds for dividend payments is dividends from its bank subsidiary, NBB. Bank dividend payments are restricted by regulators, as more fully disclosed in “Regulation, Supervision and Government Policy” contained in Part I, Item 1, “Business” and Note 10 of Notes to Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data” of this Form 10-K.
On May 12, 2021, NBI’s Board of Directors approved the repurchase of up to 1,000,000 shares of the Company’s common stock. The authorization extends from June 1, 2021 to May 31, 2022. During 2021, the Company repurchased 368,083 shares, of which 87,400 shares were repurchased under a prior repurchase plan in effect from June 1, 2020 to May 31, 2021 and 106,121 shares were repurchased under the plan that became effective June 1, 2021. The Company may yet repurchase 893,879 shares under the program. The Company’s share repurchase program does not obligate it to acquire any specific number of shares or any shares at all. During 2020, the Company repurchased 57,554 shares under prior repurchase authorizations.
Purchases of Equity Securities by the Issuer
Share repurchase activity during the fourth quarter of 2021 was as follows:
Item 6. [Reserved]
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
$ in thousands, except per share data.
The purpose of this discussion and analysis is to provide information about the results of operations, financial condition, liquidity and capital resources of the Company. The discussion should be read in conjunction with the material presented in Item 8, “Financial Statements and Supplementary Data,” of this Form 10-K.
Subsequent events have been considered through the date of this Form 10-K.
Cautionary Statement Regarding Forward-Looking Statements
We make forward-looking statements in this Form 10-K that are subject to significant risks and uncertainties. These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals, and are based upon our management’s views and assumptions as of the date of this report. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements.
These forward-looking statements are based upon or are affected by factors that could cause our actual results to differ materially from historical results or from any results expressed or implied by such forward-looking statements. These factors include, but are not limited to, effects of or changes in:
● interest rates,
● general and local economic conditions,
● the legislative/regulatory climate,
● unanticipated increases in the level of unemployment in the Company’s market,
● the quality or composition of the loan and/or investment portfolios,
● demand for loan products,
● deposit flows,
● competition,
● demand for financial services in the Company’s market,
● the real estate market in the Company’s market,
● laws, regulations and policies impacting financial institutions,
● technological risks and developments, and cyber-threats, attacks or events,
● the Company’s technology initiatives,
● performance by the Company’s counterparties or vendors,
● applicable accounting principles, policies and guidelines, and
These risks and uncertainties should be considered in evaluating the forward-looking statements contained in this report. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report. This discussion and analysis should be read in conjunction with the description of our “Risk Factors” in Item 1A. of this Form 10-K.
Cybersecurity
The Company considers cybersecurity risk to be one of the greatest risks to its business. We have deployed a multi-faceted approach to limit the risk and impact of unauthorized access to customer accounts and to information relevant to customer accounts. We use digital technology safeguards, internal policies and procedures, and employee training to reduce the exposure of our systems to cyber-intrusions. The Company also requires assurances from key vendors regarding their cybersecurity.
We control functionalities of online and mobile banking to reduce risk. We do not offer online account openings or loan originations. We do not permit customers to submit address changes or wire requests through online banking, and we limit the dollar amount of online banking transfers to other banks. We require a special vetting process for commercial customers who wish to originate ACH transfers.
Further, the Company has a program to identify, mitigate and manage its cybersecurity risks. The program includes penetration testing and vulnerability assessment, technological defenses such as antivirus software, patch management, firewall management, email and web protections, an intrusion prevention system, a cybersecurity insurance policy which covers some but not all losses arising from cybersecurity breaches, as well as ongoing employee training. The cost of these measures was $357 for 2021 and $379 for 2020. These costs are included in various categories of noninterest expense.
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However, it is not possible to fully eliminate exposure. The potential for financial and reputational losses due to cyber-breaches is increased by the possibility of human error, unknown system susceptibilities, and the rising sophistication of cyber-criminals to attack systems, disable safeguards and gain access to accounts and related information. We maintain insurance for these risks but insurance policies are subject to exceptions, exclusions and terms whose applications have not been widely interpreted in litigation. Accordingly, insurance can provide less than complete protection against the losses that result from cybersecurity breaches and pursuing recovery from insurers can result in significant expense. In addition, some risks such as reputational damage and loss of customer goodwill, which can result from cybersecurity breaches, cannot be insured against.
Response to COVID-19 Pandemic
The COVID-19 pandemic has affected the global economy since the first quarter of 2020. The Company has complied with national, state and local guidelines to help reduce the spread of the virus, including implementing social distancing measures for employees and customers. The Company’s business relies on positive relationships with customers. At this time, we feel our customer relationships remain strong and our team remains ready to provide banking services. All forms of customer service are now available without restriction.
The Company has a robust business continuity plan, and partners with vendors whom we believe also have robust business continuity plans. In implementing its business continuity plan to address the COVID-19 pandemic, the Company has not incurred material expenditures and does not anticipate material expenditures. Further, all critical functions are cross-trained as part of our business continuity preparedness. Controls over cash and physical assets have remained in place and internal controls over financial reporting and disclosure have been maintained.
Non-GAAP Financial Measures
The Company prepares financial information in accordance with GAAP, with the exception of certain financial measures which are computed under a basis other than GAAP (“non-GAAP”). These measures include the efficiency ratio, the net interest margin and the noninterest margin. Management believes such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP.
Net Interest Margin
The Company uses the net interest margin to measure profit on interest generating activities, as a percentage of total interest-earning assets. The net interest margin is calculated by dividing taxable equivalent net interest income by total average interest-earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit is 21%. The reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below.
$ in thousands Year ended December 31,
GAAP measures:
Interest on interest-bearing deposits 170 276
Interest and dividends on securities - taxable 7,960 7,383
Interest on securities - nontaxable 1,934 1,826
Non-GAAP measures:
Tax benefit on nontaxable loan income $ 318 $ 444
Tax benefit on nontaxable securities income 643 564
Total tax benefit on nontaxable interest income $ 961 $ 1,008
Total tax-equivalent net interest income $ 42,850 $ 39,179
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Efficiency Ratio
The efficiency ratio is computed by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income, excluding certain items management deems unusual or non-recurring. The tax rate used to calculate the fully taxable equivalent basis is 21%. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. The components of the efficiency ratio calculation are summarized in the following table.
$ in thousands Year ended December 31,
Taxable-equivalent net interest income $ 42,850 $ 39,179
Less: partnership income (1) (467 ) (332 )
Less: realized securities gains (6 ) (108 )
Total income for ratio calculation $ 50,803 $ 46,683
Critical Accounting Policies
General
The Company’s consolidated financial statements are prepared in accordance with GAAP. The financial information contained within our statements is, to a significant extent, financial information based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. Although the economics of the Company’s transactions may not change, the timing of events that would impact the transactions could change.
Presented below is a discussion of accounting policies that are the most important to the portrayal and understanding of the Company’s financial condition and results of operations. Please refer to Note 1 of Notes to Consolidated Financial Statements for additional information on the Company’s accounting policies. Critical accounting policies require management’s most difficult, subjective, and complex judgments about matters that are inherently uncertain. If conditions occur that differ from our assumptions, depending upon the severity of such differences, the Company’s financial condition or results of operations may be materially impacted. The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them as needed.
Allowance for Loan Losses
The Company evaluates the allowance each quarter through a methodology that estimates losses on individual impaired loans and evaluates the effect of numerous factors on the credit risk of groups of homogeneous loans (collectively-evaluated loans).
Impaired loans
Impaired loans are identified through the Company’s credit risk rating process. Generally, impaired loans have risk ratings that indicate higher risk, such as “classified” or “special mention.” Nonaccrual loan relationships that meet the Company’s balance threshold of $250 are designated impaired. Other loan relationships that meet the Company’s balance threshold of $250 and for which a credit review identified a weakness that indicates principal and interest will not be collected according to the loan terms. All TDRs, regardless of size or past due status are designated impaired.
Troubled debt restructurings
Loan modifications are reviewed to determine whether, at the time of the modification, the borrower is experiencing financial difficulty and whether the Company provided a concession that it would not otherwise consider. With the exception of borrowers affected by COVID-19 in 2020 or 2021 who fell under the provisions of the CARES Act and CAA, modified loans that meet this criteria are designated TDRs.
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Individual evaluation
At the reporting date, the fair value of each impaired loan is estimated using either the cash flow method or the collateral method.
Cash flow method
The cash flow method is applied to loans that are not collateral dependent and for which cash flows may be estimated. The cash flow method measures fair value using assumptions specific to each loan, including expected amount and timing of cash flows and discount rate. For TDR loans, the discount rate is the rate immediately prior to the modification that resulted in a TDR. If an impaired loan evaluated under the cash flow method becomes 90 days or more past due, it is examined to determine whether the late payment indicates collateral dependency or cash flows below those that were used in the fair value measurement.
Collateral method
The collateral method is applied to impaired loans that are collateral-dependent, for which foreclosure is imminent or for which non-collateral repayment sources are determined not to be available or reliable. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Fair value is based upon the “as-is” value of independent appraisals or evaluations.
Impaired loans secured by residential 1-4 family properties with outstanding principal balances greater than $250 are valued using an appraisal. Appraisals are also used to value impaired loans secured by commercial real estate with outstanding principal balances greater than $500. Impaired loans secured by residential 1-4 family property with outstanding principal balances of $250 or less, or secured by commercial real estate with outstanding principal balances of $500 or less, are valued using a real estate evaluation prepared by a third party.
Appraisals must conform to the Uniform Standards of Professional Appraisal Practice and are prepared by an independent third-party appraiser who is certified and licensed and who is approved by the Company. Appraisals may incorporate market analysis, comparable sales analysis, cash flow analysis and market data pertinent to the property to determine market value.
Evaluations are prepared by third party providers and reviewed by employees of the Company who are independent of the loan origination, operation, management and collection functions. Evaluations provide a property’s market value based on the property’s current physical condition and characteristics and the economic market conditions that affect the collateral’s market value. Multiple sources of data contribute to the estimate of market value, including physical inspection, independent third-party automated tools, comparable sales analysis and local market information.
Updated appraisals or evaluations are ordered when a loan becomes impaired if the appraisal or evaluation on file is more than 24 months old. Appraisals and evaluations are reviewed for propriety and reasonableness and may be discounted if the Company determines that the value exceeds reasonable levels. If an updated appraisal or evaluation has been ordered but has not been received by a reporting date, the fair value may be based on the most recent available appraisal or evaluation, discounted for age. The appraisal or evaluation value is reduced by selling costs if recovery is expected solely from the sale of collateral.
Nonaccrual status of impaired loans
Nonaccrual status is applied to impaired loans that are not TDRs and for which fair value measurement indicates an impairment loss. Nonaccrual status is applied to TDRs that allow the borrower to discontinue payments of principal or interest for more than 90 days, unless the modification provides reasonable assurance of repayment performance and collateral value supports regular underwriting requirements. TDRs that maintain current status for at least a six-month period, including history prior to restructuring, may accrue interest. Impaired loans with partial charge-offs are maintained as impaired until the remaining balance is satisfied.
Collectively evaluated loans
Non-impaired loans are grouped by portfolio segments. Portfolio segments are further divided into smaller loan classes. Loans within a segment or class have similar risk characteristics. Credit loss on collectively-evaluated loans is estimated by applying to current class balances the class historical charge-off rates and percentages for qualitative factors that affect credit risk.
Qualitative factors include changes in national and local economic and business conditions, the nature and volume of classes within the portfolio, loan quality, loan officers’ experience, lending policies and the Company’s loan review system. The qualitative factor allocations are determined for pass-rated loans. To reflect the increased risk of criticized assets, qualitative factor allocations are multiplied by 150% for special mention loans, and multiplied by 200% for classified loans.
Loss rates
Loss rates are calculated for and applied to individual classes by averaging loss rates over the most recent eight quarters. The loss rate calculation for each class includes losses and recoveries on all loans within the class, including TDRs and other impaired loans. The look-back period of eight quarters is applied consistently among all classes.
Two loss rates for each class are calculated: total net charge-offs for the class as a percentage of average class loan balance (“class loss rate”), and total net charge-offs for the class as a percentage of average classified loans in the class (“classified loss rate”). Net charge-offs in both calculations include charge-offs and recoveries for all loans within the class, including classified and non-classified loans, as well as impaired and TDR loans. Class historical loss rates are applied to collectively evaluated pass-rated loan balances and special mention rated loan balances, and classified historical loss rates are applied to collectively evaluated classified loan balances.
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Qualitative factor allocations
The analysis of certain factors results in standard allocations to all classes. These factors include the risk from changes in lending policies, loan officers’ experience, changes in loan review, and economic factors including local unemployment levels, local bankruptcy rates, interest rate environment, and competition/legal/regulatory environments. Standard allocations for residential vacancy rates and housing inventory are applied to the following classes: all classes within the consumer real estate segment, residential construction, investor-owned residential real estate, multifamily loans, other commercial real estate and state and political subdivision loans.
Qualitative factors incorporate economic data targeted to the Company’s market. If market–specific information is not available on a timely basis, regional or national information that historically shows a high degree of correlation to market data may be used.
Also applied to all segments and classes is an economic factor implemented to address COVID-19 uncertainty: national unemployment filings. Due to continuous developments related to the COVID-19 pandemic, current data is valuable in assessing risk. Local unemployment data lags the reporting date but historical analysis determined that local unemployment filings were closely correlated to national unemployment filings.
Factors analyzed for each class, with resultant allocations based upon the level of risk assessed for each class, include levels of past due loans, levels of nonaccrual loans, current class balance as a percentage of total loans, loans that received COVID-related modifications that are still in the modification period, and the percentage of high risk loans within the class. High risk loans include junior liens, interest only and high loan to value loans. High risk loans within each class are analyzed and allocated additional reserves based on current trends.
Nonaccrual status
The Company reviews loans with certain risk indicators to determine whether the loans should be placed on nonaccrual status, including loans that exceed 90 days past due, loans rated classified, and loans with a non-COVID 19 related modification that provides relief from payments of interest or principle for more than 90 days.
Loans in nonaccrual are reviewed on an individual loan basis to determine whether they may return to accrual status. To return to accrual status, the Company’s analysis must determine that future payments are reasonably assured. To satisfy this criteria, the Company’s evaluation must determine that the underlying cause of the original delinquency or weakness that indicated nonaccrual status has been resolved, such as receipt of new guarantees, increased cash flows that cover the debt service or other resolution. Nonaccrual loans that demonstrate reasonable assurance of future payments and that have made at least six consecutive payments in accordance with repayment terms and timeframes may be returned to accrual status.
Sales, purchases and reclassification of loans
The Company finances consumer real estate mortgages under “best efforts” contracts with mortgage purchasers. The mortgages are designated as held for sale upon initiation. There have been no major reclassifications from portfolio loans to held for sale. Mortgages held for sale are not included in the calculation of the allowance for loan losses.
Occasionally, the Company purchases or sells participations in loans. All participation loans purchased met the Company’s normal underwriting standards at the time the participation was entered. Participation loans are included in the appropriate portfolio balances to which the allowance methodology is applied.
Unallocated surplus
In addition to funding the allowance for loan losses based upon data analysis, the Company has the option to fund an unallocated surplus in excess to the calculated requirement, based upon management judgement. The Company’s policy permits an unallocated surplus of between 0% and 5% of the calculated requirement. At December 31, 2021, management provided an unallocated surplus of 4.9% to reflect the uncertainty presented by the ongoing COVID-19 pandemic.
Estimation of the allowance for loan losses
The estimation of the allowance involves analysis of internal and external variables, methodologies, assumptions and management’s judgment and experience. Key judgments used in determining the allowance for loan losses include internal risk rating determinations, market and collateral values, discount rates, loss rates, and management’s assessment of current economic conditions. These judgments are inherently subjective and actual losses could be greater or less than the estimate. Future estimates of the allowance could increase or decrease based on changes in the financial condition of individual borrowers, concentrations of various types of loans, economic conditions or the markets in which collateral may be sold. The estimate of the allowance accrual determines the amount of provision expense and directly affects our financial results.
The estimate of the allowance for December 31, 2021 considered market conditions as of December 31, 2021 where possible, and the most recent available information when data was not available as of December 31, 2021, portfolio conditions and levels of delinquencies at December 31, 2021, and net charge-offs in the eight quarters prior to the quarter ended December 31, 2021. For additional discussion of the allowance, see Note 5 of the Notes to Consolidated Financial Statements and the subsections “Asset Quality,” and “Provision and Allowance for Loan Losses” below.
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Goodwill
Goodwill is subject to at least an annual assessment for impairment by applying a fair value based test. The Company contracts with a third party valuation expert to perform impairment testing in the fourth quarter of each year. The Company’s most recent impairment test was performed using data from September 30, 2021. Accounting guidance provides the option of performing preliminary assessment of qualitative factors to determine whether impairment testing is necessary. The Company opted not to perform the preliminary assessment. The Company’s goodwill impairment analysis considered three valuation techniques appropriate to the measurement. The first technique uses the Company’s market capitalization as an estimate of fair value; the second technique estimates fair value using current market pricing multiples for companies comparable to the Company; while the third technique uses current market pricing multiples for change-of-control transactions involving companies comparable to the Company. The analysis did not result in an impairment assessment.
Certain key judgments were used in the valuation measurement. Goodwill is held by the Company’s bank subsidiary. The bank subsidiary is 100% owned by the Company, and no market capitalization is available. Because most of the Company’s assets are comprised of the bank subsidiary’s equity, the Company’s market capitalization was used to estimate the Bank’s market capitalization. Other judgments include the assumption that the companies and transactions used as comparables for the second and third technique were appropriate to the estimate of the Company’s fair value, and that the comparable multiples are appropriate indicators of fair value, and compliant with accounting guidance.
Pension Plan
The Company’s actuary determines plan obligations and annual pension expense using a number of key assumptions. Key assumptions may include the discount rate, the estimated return on plan assets and the anticipated rate of compensation increases. Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may impact pension assets, liabilities or expense.
Performance Summary
The COVID-19 pandemic continued to impact the Company in 2021, although in somewhat different respects than the impact in 2020. During 2020, the Company worked with borrowers impacted by the COVID-19 pandemic to provide payment relief, which reduced interest income on certain loans within the portfolio. Adverse economic indicators escalated credit risk, increasing provision for loan loss expense. Positive effects of the COVID-19 pandemic resulted from the low interest rate environment, which fueled refinance activity and gains from the sale of mortgages. The Company also participated in the SBA’s PPP loan program and recognized increased fee income.
During 2021, the Company recognized additional fee income from PPP loans. Pandemic-related modifications slowed significantly and there are currently no loans under modified terms related to the COVID-19 pandemic. Economic indicators improved markedly and the Company was able to recover some of the provision expense recognized in 2020.
Key performance ratios provide a summary of the Company’s results and allow comparison with results from prior years. The following table presents NBI’s key performance ratios for the years indicated:
Year Ended December 31,
Return on average assets 1.26 % 1.15 %
Return on average equity(1) 10.59 % 8.21 %
Basic net earnings per common share $ 3.28 $ 2.48
Fully diluted net earnings per common share $ 3.28 $ 2.48
Net interest margin (2) 2.81 % 2.98 %
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Growth
NBI’s key growth indicators are shown in the following table:
Securities and restricted stock, loans and total assets increased when amounts at December 31, 2021 are compared with amounts at December 31, 2020. Customer deposits increased $197,444 or 15.22% from December 31, 2020, with the most substantial increase in interest-bearing deposits, as well as increases in noninterest-bearing deposits and savings deposits. Time deposits declined. The liquidity provided by the increase of deposits supported growth in loans of $35,256 or 4.64% and growth in securities and restricted stock of $138,904 or 25.35%.
Asset Quality
Key indicators of NBI’s asset quality are presented in the following table:
Loans past due 90 days or more and accruing 90 17
Allowance for loan losses to loans(2) 0.96 % 1.10 %
Net charge-off ratio 0.05 % 0.05 %
(2) Loans are net of unearned income and deferred fees and costs.
The Company monitors asset quality indicators in managing credit risk and in determining the allowance and provision for loan losses. As of December 31, 2021, nonperforming loans and other real estate improved when compared with levels at December 31, 2020, while accruing loans past due 90 days or more increased slightly. The net charge-off ratio remained steady from 2020 to 2021.
The Company’s risk analysis determined an allowance for loan losses of $7,674 at December 31, 2021, resulting in a recovery of previous provision expense of $398. This compares with an allowance for loan losses of $8,481 as of December 31, 2020, and a provision of $1,991 for the year ended December 31, 2020. The ratio of the allowance for loan losses to loans decreased to 0.96% at December 31, 2021, from 1.10% at December 31, 2020. The methodology for determining the allowance for loan losses relies on historical charge-off trends, modified by loan portfolio trends and economic indicators.
More information about the level and calculation methodology of the allowance for loan losses is provided in the sections “Provision and Allowance for Loan Losses”, “Balance Sheet – Loans – Risk Elements” and “Balance Sheet – Loans – Modifications and Troubled Debt Restructurings” below as well as Notes 1 and 5 of the Notes to Consolidated Financial Statements.
Sufficient resources have been dedicated to working out problem assets, and exposure to loss is somewhat mitigated because most of the nonperforming loans are collateralized. More information about nonaccrual and past due loans is provided in the section “Balance Sheet – Loans – Risk Elements” below and Note 5 of the Notes to Consolidated Financial Statements. The Company continues to carefully monitor risk levels within the loan portfolio and the evolving impact of the COVID-19 pandemic.
Net Interest Income
The Company’s primary source of revenue is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and other interest-bearing liabilities. Net interest income is affected by various factors, including the Federal Reserve’s monetary policy, U.S. fiscal policy, competitive pressure, the level and composition of the interest-earning assets and the composition of interest-bearing liabilities. Changes in the Federal Reserve’s target interest rate immediately affect the yield on the Company’s interest-bearing deposits in other banks, and affect other interest-earning assets within a short time. The primary source of funds used to support the Company’s interest-earning assets is deposits. When the interest rate environment changes, the Company can immediately change rates on interest-bearing deposits and change offering rates on new time deposits. Existing time deposits commit the Company to the contractual rate for the length of the term. Time deposits provide a measure of stability in the cost of funds, but partially delay the Company’s ability to respond to downward rate movements.
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The net interest margin for the year ended December 31, 2021 declined when compared with the year ended December 31, 2020. The Federal Reserve cut rates in March 2020 in an effort to counter the COVID-19 pandemic’s economic impact and maintained low interest rates throughout 2021. The low rates spurred high levels of loan refinance activity. Calls on securities surged and reinvestment opportunities for matured and called securities as well as investing excess liquidity from customer deposits resulted in lower yields for taxable and nontaxable securities. Further, uncertainty surrounding the length of time that customer deposits, bolstered by federal stimulus aid, will remain with the Bank resulted in a higher balance in interest-bearing deposits, which provides the lowest yielding investment opportunity. In response, the Company reduced offering rates on deposits in 2020 and 2021.
Fees and interest income from PPP loans helped increase the net interest margin in 2021 and 2020. During 2020 and 2021, the Company generated 1,259 PPP loans with original principal balances totaling $83,023. The loans bear a contractual interest rate of 1%, supplemented by an origination fee which is accreted over the life of the loan. When loans are forgiven or paid off prior to maturity, the Company recognizes the outstanding origination fee at the date of forgiveness or payoff. PPP loans contributed interest and fee income of $2,711 for the year ended December 31, 2021 and $1,753 for the year ended December 31, 2020. As of December 31, 2021, gross PPP loans totaling $1,094 with net deferred fees of $42 remain on the balance sheet.
The frequency and/or magnitude of future changes in market interest rates and legislative changes are difficult to predict and may have a greater short-term impact on net interest income than adjustments by management. Please refer to the section titled “Analysis of Changes In Interest Income and Interest Expense” for further information related to rate and volume changes.
Analysis of Net Interest Earnings
The following table shows the major categories of interest‐earning assets and interest‐bearing liabilities, the interest earned or paid, the average yield or rate on the daily average balance outstanding, net interest income and net yield on average interest‐earning assets for the years indicated.
Interest-earning assets:
Interest-bearing liabilities:
Net yield on average interest‐earning assets 2.81 % 2.98 %
(4) Nonaccrual loans are included in average balances for yield computations.
(5) Daily averages are shown at amortized cost.
(6) Includes restricted stock.
The following table reconciles net interest income on a fully-taxable equivalent basis to net interest income on a GAAP basis for the years indicated.
$ in thousands December 31,
Taxable equivalent adjustment 961 1,008
Net interest income, fully taxable equivalent $ 42,850 $ 39,179
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Analysis of Changes in Interest Income and Interest Expense
The following table sets forth, for the years indicated, a summary of the changes in interest income and interest expense resulting from changes in average asset and liability balances (volume) and changes in average interest rates (rate).
Changes Due To
Rates(2) Volume(2) Net Dollar Change
Interest income: (1)
Interest expense:
Interest-bearing demand deposits $ (1,789 ) $ 687 $ (1,102 )
(1) Taxable equivalent basis using a Federal income tax rate of 21%.
The low interest rate environment reduced interest income when the year ended December 31, 2021 is compared with the year ended December 31, 2020. However, greater volume more than offset the impact of rates, resulting in a net increase in interest income.
The Company’s reduced deposit offering rates saved $3,178 in interest expense, slightly offset by increased expense for higher volume when the year ended December 31, 2021 is compared with the year ended December 31, 2020.
Interest Rate Sensitivity
Interest rate risk is the risk to earnings or capital arising from movements in market interest rates. When interest-earning assets and interest-bearing liabilities reprice at different times or in different degrees or when call options are exercised, in response to change in market interest rates, future net interest income is impacted. When interest-earning assets mature or re-price more quickly than interest-bearing liabilities, the balance sheet is considered “asset sensitive”. An asset sensitive position will produce relatively more net interest income when interest rates rise and less net interest income when rates decline. Conversely, when interest-bearing liabilities mature or re-price more quickly than interest-earning assets in a given period, the balance sheet is considered “liability sensitive”. A liability sensitive position will produce relatively more net interest income when interest rates fall and less net interest income when rates increase.
The Company considers interest rate risk to be a significant risk and manages its exposure through policies approved by its Asset Liability Committee ("ALCO") and Board of Directors. ALCO reviews periodic reports of the Company's interest rate risk position, including results of simulation analysis. Simulation analysis applies interest rate shocks, hypothetical immediate shifts in interest rates, to the Company’s financial instruments and determines the impact to projected one-year net interest income and other key measures.
The following table shows the results of rate shocks on the one-year projected net interest income as of December 31, 2021 and 2020. For purposes of this analysis, noninterest income and expenses are assumed to be flat.
Rate Shift (bp) Change in Projected Net Interest Income
Results of the simulation for net interest income at December 31, 2021 and December 31, 2020 indicate the Company is in an asset sensitive position. As a part of the simulation process, certain estimates and assumptions must be made. These include, but are not limited to, asset growth, the mix of assets and liabilities, the interest rate environment and local and national economic conditions. Asset growth and the mix of assets can, to a degree, be influenced by management. Other areas, such as the interest rate environment and economic factors, cannot be controlled. In addition, competitive pressures can make it difficult to price deposits and loans in a manner that optimally minimizes interest rate risk. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes; changes in market conditions and customer behavior; and changes in management strategies.
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While the asset/liability management program is designed to protect the Company over the long term, it does not provide near-term protection from interest rate shocks, as interest rate sensitive assets and liabilities do not by their nature move up or down in tandem in response to changes in the overall rate environment. The Company’s profitability in the near term may be temporarily negatively affected in a period of rapidly rising or rapidly falling rates, because it takes some time for the Company’s portfolio to reflect changes to offering rates in response to a new interest rate environment.
Noninterest Income
The following table presents the Company’s noninterest income for the years indicated.
$ in thousands Year Ended December 31, Change
An enhanced fee schedule implemented in the latter half of 2020 benefitted income from service charges on deposits in 2021. Service charges on deposit accounts include account maintenance fees, fees for nonsufficient funds, ATM and wire transfer fees. Other service charges and fees include charges for official checks, income from the sale of checks to customers, safe deposit box rent, fees from letters of credit and income from commissions on the sale of credit life, accident and health insurance.
Increased transactions improved credit card fees when the year ended December 31, 2021 is compared with the year ended December 31, 2020. Credit card fees are presented net of certain processing expenses and are dependent on the volume of transactions.
Trust fees increased when the year ended December 31, 2021 is compared with the year ended December 31, 2020. Trust fees are generated from a number of different types of accounts, including estates, personal trusts, employee benefit trusts, investment management accounts, attorney-in-fact accounts and guardianships. Trust income varies depending on the number and type of accounts under management and financial market conditions.
The Company purchased an additional $5,000 in bank-owned life insurance (“BOLI”) during 2021, contributing to increased income compared with 2020.
A robust housing market during 2020 and the Federal Reserve’s rate cuts in March 2020 spurred a high level of consumer real estate purchase activity and refinance activity, increasing the sale of mortgage loans. During the year ended December 31, 2021, activity returned to more conventional levels, decreasing the gain on sale of mortgage loans when the year ended December 31, 2021 is compared with the year ended December 31, 2020.
Other income benefitted in 2021 from increased commissions on sales of securities and insurance, compared with the year ended December 31, 2020. Other income includes dividends and increases in the Company’s equity-method investments, net gains from the sale of fixed assets, and revenue from investment and insurance sales.
During 2021, securities gains resulted solely from the call of securities. During 2020, the Company realized net securities gains of $43 on the sale of securities and $65 on calls of securities. The sale of securities was pursuant to a restructuring plan to manage interest rate risk.
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Noninterest Expense
The following table presents the Company’s noninterest expense for the years indicated.
$ in thousands Year Ended December 31, Change
Net costs of other real estate owned 51 39 12 30.77 %
Salaries and employee benefits expense, which includes salaries, payroll taxes, health insurance, contributions to the employee stock ownership plan and employee 401(k), pension expense, incentives and salary continuation increased when 2021 is compared with 2020, due to normal compensation and staffing decisions as well as increased pension cost.
When the year ended December 31, 2021 is compared with the year ended December 31, 2020, occupancy, furniture and fixtures expense increased slightly, while data processing and ATM expense decreased slightly.
FDIC assessment expense increased from 2020 to 2021. The FDIC assessment is accrued based on a method provided by the FDIC. During the third quarter of 2019, the FDIC notified the Bank that it was eligible to use small bank assessment credits. The credits reduced expense for the first half of 2020, after which FDIC assessment expense returned to normal levels.
Net costs of other real estate owned ("OREO") increased slightly when the years ended December 31, 2021 and 2020 are compared. This expense category varies with the number of foreclosed properties owned by NBB and with the costs associated with each. It includes write-downs on OREO plus other costs associated with carrying these properties, as well as net gains or losses on the sale of other real estate. There were no write downs during 2021 and one write-down in 2020 totaling $9. Other costs for these properties in 2021 were $25, compared with $51 in 2020. The Company recorded a loss of $26 on the sale of OREO in 2021 and a gain of $21 on the sale of OREO in 2020. The Company currently has loans of $62 in process of foreclosure.
Franchise tax expense increased when the years ended December 31, 2021 and 2020 are compared. Franchise taxes are levied by the states in which NBB operates and are based upon NBB’s total equity at the prior year-end, adjusted for real estate taxes and certain other items.
The category of other operating expenses includes noninterest expense items such as professional services, stationery and supplies, telephone costs and charitable donations. Other operating expenses decreased when the years ended December 31, 2021 and 2020 are compared, primarily due to decreased non-service pension cost.
Income Taxes
Income tax expense for 2021 was $4,251 compared to $3,077 in 2020. The Company’s statutory tax rate was 21% for such years. The Company’s effective tax rates for 2021 and 2020 were 17.26% and 16.06%, respectively. The expected income tax expense based on the Company’s statutory tax rate differs from the actual income tax expense due to tax exempt income on municipal securities and loans. See Note 9 of the Notes to Consolidated Financial Statements for information relating to income taxes.
Effects of Inflation
The Company’s consolidated statements of income generally reflect the effects of inflation. Since interest rates, loan demand and deposit levels are related to inflation, the resulting changes are included in net income. The most significant item which does not reflect the effects of inflation is depreciation expense. Historical dollar values used to determine depreciation expense do not reflect the effects of inflation on the market value of depreciable assets after their acquisition.
Provision and Allowance for Loan Losses
The Company’s risk analysis at December 31, 2021 determined an allowance for loan losses of $7,674 or 0.96% of loans net of unearned income and deferred fees and costs. The allowance at December 31, 2020 was $8,481 or 1.10% of loans net of unearned income and deferred fees and costs. The determination of the appropriate level for the allowance for loan losses resulted in a recovery of $398 for the twelve months ended December 31, 2021, compared with a provision of $1,991 for the twelve month period ended December 31, 2020. To determine the appropriate level of the allowance for loan losses, the Company considers credit risk for certain loans designated as impaired and for non-impaired (“collectively evaluated”) loans.
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Individually Evaluated Impaired Loans
Individually evaluated impaired loans at December 30, 2021 were $5,878 gross and $5,880 net of unearned income and deferred fees and costs. There were no specific allocations to the allowance for loan losses as of December 31, 2021. At December 31, 2020, individually evaluated impaired loans totaled $4,903 gross and $4,905 net of unearned income and deferred fees and costs, with specific allocations to the allowance for loan losses totaling $75. The specific allocation is determined based on criteria particular to each impaired loan.
Collectively Evaluated Loans
Collectively evaluated loans totaled $797,851 gross and $797,368 net of unearned income and deferred fees and costs, with an allowance of $7,674 or 0.96% of collectively-evaluated loans net of unearned income and deferred fees and costs at December 31, 2021. At December 31, 2020, collectively evaluated loans totaled $765,124 gross and $763,894 net of unearned income and deferred fees and costs, with an allowance of $8,406 or 1.10%.
Collectively evaluated loans are divided into classes based upon risk characteristics. In order to calculate the allowance for collectively evaluated loans, the Company applies to each loan class a historical net charge-off rate for the class, adjusted for qualitative factors that influence credit risk. Qualitative factors evaluated for impact to credit risk include economic measures, asset quality indicators, loan characteristics, and changes to internal Company policies and changes in management.
Net Charge-Offs
Increases in the net charge-off rate increase the required allowance for collectively-evaluated loans, while decreases in the net charge-off rate decrease the required allowance for collectively-evaluated loans. On a portfolio level, net charge-offs were $409 for the twelve months ended December 31, 2021, or 0.05% of average loans. Net charge-offs for the twelve months ended December 31, 2020 were $373 or 0.05% of average loans. The 8-quarter average historical loss rate was 0.05% as of December 31, 2021 and 0.07% as of December 31, 2020.
Economic Factors
Economic factors influence credit risk and impact the allowance for loan loss. The Company considers economic indicators within its market area, including: unemployment, business and personal bankruptcy filings, the residential vacancy rate and the inventory of new and existing homes.
The Company sources economic data pertinent to its market from the most recently available publications. Most economic indicators lag the report date by one to three months. In periods of low volatility, lagging indicators are accepted as reasonably representative of current conditions. The COVID-19 pandemic introduced significant uncertainty and beginning in 2020, the Company implemented a qualitative factor for national unemployment filings to capture current economic data. Unemployment filings for the Company’s market area are not available on a timely basis, however national data is available on a timely basis and historical analysis shows a strong correlation between national and local unemployment filings.
National unemployment claims escalated sharply beginning in the latter half of March 2020 and the Company reacted by substantially increasing the allowance for loan losses. During 2021, national unemployment claims decreased considerably and average weekly claims over the last six weeks of the year were similar to pre-pandemic levels, allowing the Company to reduce the allocation for this factor.
The Company continues to monitor the most recently available economic indicators for its market and their effect on credit risk. As of December 30, 2021, the unemployment rate for the Company’s market area was measured as of November 30, 2021 and decreased from the measurement available at December 31, 2020, decreasing the allocation to the allowance for loan losses.
Business and personal bankruptcy filing data was available as of September 2021. Higher bankruptcy filings indicate heightened credit risk and increase the allowance for loan losses, while lower bankruptcy filings have a beneficial impact on credit risk. Compared with data available at December 31, 2020, business bankruptcies were at a similar level and received the same allocation and personal bankruptcies were slightly lower and resulted in a slightly lower allocation.
Residential vacancy rates and housing inventory impact the Company’s residential construction customers and the consumer real estate market. Higher levels increase credit risk. The residential vacancy rate at December 31, 2021 was measured as of the third quarter of 2021 and while still lower than normal levels, worsened slightly from the data incorporated into the December 31, 2020 calculation, resulting in a higher allocation. Housing inventory data was available as of December 31, 2021. Levels are historically low and are lower than those at December 31, 2020.
Asset Quality Indicators
Asset quality indicators, including past due levels, nonaccrual levels and internal risk ratings, are evaluated at the class level. Loans past due and loans designated nonaccrual indicate heightened credit risk. Increases in past due and nonaccrual loans increase the required level of the allowance for loan losses and decreases in past due and nonaccrual loans reduce the required level of the allowance for loan losses.
Accruing loans past due 30-89 days were 0.12% of total loans net of unearned income and deferred fees and costs at December 31, 2021, a decrease from 0.19% at December 31, 2020. Accruing loans past due 90 days or more were 0.01% of total loans, net of unearned income and deferred fees and costs at December 31, 2021 compared to 0.00% at December 31, 2020. Nonaccrual loans at December 30, 2021 were 0.36% of total loans net of unearned income and deferred fees and costs, lower than 0.48% at December 31, 2020.
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Loans rated special mention and classified (together, “criticized assets”) indicate heightened credit risk. Higher levels of criticized assets increase the required level of the allowance for collectively-evaluated loans, while lower levels of criticized assets reduce the required level of the allowance for collectively-evaluated loans. Collectively evaluated loans rated special mention were $3,728 at December 31, 2021, lower than $8,035 at December 31, 2020. Collectively evaluated loans rated classified were $1,064 at December 31, 2021 and $473 at December 31, 2020.
Other Factors
The Company considers other factors that impact credit risk, including the interest rate environment, the competitive, legal and regulatory environments, changes in lending policies and loan review, changes in management, high risk loans, as well as a factor to measure the risk from loans that received a COVID-19 modification and then received a subsequent COVID-19 modification.
The interest rate environment impacts variable rate loans. If interest rates increase, the payment on variable rate loans increases, which may increase credit risk. The interest rate environment is at a low level as of December 31, 2021, unchanged from the level at December 31, 2020. The low level of interest rates indicates no additional credit risk.
The competitive, legal and regulatory environments were evaluated for changes that would impact credit risk. Higher competition for loans increases credit risk, while lower competition decreases credit risk. Competition remained at similar levels to those at December 31, 2020. The legal and regulatory environments remain in a similar posture to that at December 31, 2020.
Lending policies, loan review procedures and management’s experience influence credit risk. Since December 31, 2020, there have been no changes that affect credit risk to the Company’s lending policies or loan review procedures. During the fourth quarter, the Company’s Chief Credit Officer resigned. The Company allocated to the allowance for loan losses to reflect the increased risk that results from a change in management.
Levels of high risk loans are considered in the determination of the level of the allowance for loan loss. A decrease in the level of high risk loans within a class decreases the required allocation for the loan class, and an increase in the level of high risk loans within a class increases the required allocation for the loan class. Total high risk loans decreased $23,101 or 20.41% from the level at December 31, 2020, resulting in a decreased allocation.
At December 31, 2020, the Company allocated to the allowance for loan losses for certain COVID-19 related modifications. As of December 31, 2021, there were no loans with COVID-19 related modifications still in the modification period, and no allocation was taken.
Unallocated Surplus
The unallocated surplus at December 30, 2021 is $361 or 4.94% in excess of the calculated requirement. The unallocated surplus at December 31, 2020 was $396 or 4.89% in excess of the calculated requirement. The surplus provides some mitigation of the uncertainty surrounding the impact of COVID-19.
Conclusion
The calculation of the appropriate level for the allowance for loan losses incorporates analysis of multiple factors and requires management’s prudent and informed judgment. The most recently available data showed improvements that decreased the required level of the allowance for loan losses at December 31, 2021 from December 31, 2020 including loans considered high risk, business and personal bankruptcy filings, the unemployment rate, criticized loans and certain loans with COVID-19 related modifications. Other indicators, including accruing loans past due 90 days or more and residential vacancy, showed worsening from levels at December 31, 2020 and increased the required level of the allowance for loan losses.
To reflect the impact of the COVID-19 pandemic, the Company added a qualitative factor for national unemployment filings beginning with the first quarter of 2020. During 2020, national unemployment filings increased dramatically from pre-pandemic levels and was the source of most of the provision taken for 2020. During 2021, unemployment filings declined substantially, which was a key factor in reducing the required level of the allowance for loan losses and resulted in a recovery for the year ended December 31, 2021.
The Company augmented the calculated requirement with an unallocated surplus of 4.94% to mitigate some of the uncertainty caused by the lingering pandemic. Based on analysis of historical indicators, asset quality and economic factors, management believes the level of allowance for loan losses is reasonable for the credit risk in the loan portfolio as of December 31, 2021.
Please refer to Note 5of Notes to Consolidated Financial Statements for further information on collectively evaluated loans, individually evaluated impaired loans and the unallocated portion of the allowance for loan losses.
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Balance Sheet
Total assets at December 31, 2021 were $1,702,175, an increase of $182,502 or 12.01%, from $1,519,673 at December 31, 2020. Growth in assets was fueled by growth in customer deposits, which increased $197,444 or 15.22% from $1,297,143 at December 31, 2020 to $1,494,587 at December 31, 2021.
Loans
The Company’s loan categorization reflects its approach to loan portfolio management and includes six groups. Real estate construction loans include construction loans for residential and commercial properties, as well as land. Consumer real estate loans include conventional and junior lien mortgages, equity lines and investor-owned residential real estate. Commercial real estate loans are comprised of owner-occupied and leased nonfarm, nonresidential properties, multi-family residence loans and farmland. Commercial non-real estate loans include agricultural loans, operating capital lines and loans secured by capital assets, as well as PPP loans. At December 31, 2021, PPP loans were $1,094 with deferred fees of $42. At December 31, 2020, PPP loans were $36,903 with net deferred fees of $911. Public sector and industrial development authority (“IDA”) loans are extended to municipalities. Consumer non-real estate loans include automobile loans, personal loans, credit cards and consumer overdrafts.
A. Maturities and Interest Rate Sensitivities
The following table presents maturities and interest rate sensitivities for loans. Loans are presented on a gross basis.
$ in thousands December 31, 2021
< 1 Year 1 – 5 Years 6-15 Years >15 Years Total
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B. Modifications and Troubled Debt Restructurings
Modifications
In the ordinary course of business the Company modifies loan terms on a case-by-case basis, including consumer and commercial loans, for a variety of reasons. Modifications may include rate reductions, payment extensions of varying lengths of time, a change in amortization term or method or other arrangements. Payment extensions allow borrowers temporary payment relief and result in extending the original contractual maturity by the number of months for which the extension was granted. The Company may grant payment extensions to borrowers who have demonstrated a willingness and ability to repay their loan but who are experiencing consequences of a specific unforeseen temporary hardship. If the temporary event is not expected to impact a borrower’s ability to repay the debt, and if the Company expects to collect all amounts due including interest accrued at the contractual interest rate for the extension period at contractual maturity, the modification is not designated a TDR.
Modifications to consumer loans generally involve short-term payment extensions to accommodate specific, temporary circumstances. Modifications to commercial loans may include, but are not limited to, changes in interest rate, maturity, amortization and financial covenants. If the modified terms are consistent with competitive market conditions and representative of terms the borrower could otherwise obtain in the open market, the modified loan is not categorized as a TDR.
The Company codes modifications to assist in identifying TDRs. When the COVID-19 pandemic began, the Company added coding to identify modifications to borrowers experiencing COVID-19 related hardship.
Modifications Made for Competitive Purposes
During the year ended December 31, 2021, the Company provided 875 modifications for competitive reasons to loans totaling $112,718. The modifications were not TDRs and were not related to COVID-19. For the twelve months ended December 31, 2020, the Company provided non-TDR modifications for competitive reasons to 1,047 loans totaling $152,681.
Modifications Related to COVID-19
The COVID-19 pandemic negatively impacted a significant number of the Company’s borrowers, and may adversely impact some borrowers in the future. Since the COVID-19 pandemic began in March 2020, the Company provided modifications related to COVID-19 financial difficulty, including payment extensions and interest only periods. The CARES Act, the CAA and regulatory guidance specify criteria that, if met, permit an election not to designate the loans as TDRs. The TDRs designated during the year ended December 31, 2021 resulted from COVID-19 related modifications that did not meet the legal and regulatory criteria to avoid designation as TDR. All of the Company’s other COVID-19 related modifications met the criteria and were not designated TDR. The Company followed its normal risk rating and nonaccrual designation procedures and did not automatically downgrade or designate as nonaccrual if the loan was modified for COVID-19 related difficulty.
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The following tables provide information regarding COVID-19 related modifications for the years ended December 31, 2021 and December 31, 2020.
Twelve Months Ended December 31,
Maturity date extension - - 2 729
Rate reductions(1) - - 5 442
A loan that received multiple modifications as part of one request, for instance, a rate reduction and a payment extension, is presented only under one modification category. A loan that was modified pursuant to a first request and then was modified subsequently pursuant to a separate request is included for each of the requests. For example, a loan that received a payment extension under a first request and a rate reduction under a second request is counted in the rate reduction category and again in the payment extension category.
All COVID-19 related modifications for payment extensions and interest-only periods have returned to contractual terms as of December 31, 2021.
TDRs
The Company’s TDRs, by delinquency status, are presented below:
$ in thousands TDR Delinquency Status as of December 31, 2021
Accruing
Total TDR Loans Current 30-89 Days Past Due 90+ Days Past Due Nonaccrual
Consumer real estate $ 191 $ 191 $ - $ - $ -
Commercial non-real estate 301 - - - 301
$ in thousands TDR Delinquency Status as of December 31, 2020
Accruing
Total TDR Loans Current 30-89 Days Past Due 90+ Days Past Due Nonaccrual
Consumer real estate $ 194 $ 194 $ - $ - $ -
Consumer non-real estate 2 1 - 1 -
Please refer to Note 5 of Notes to Consolidated Financial Statements for information on the effect of default on the allowance for loan losses.
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Summary of Loan Loss Experience
A. Loan Loss Data
The following table provides information about the allowance for loan losses, nonperforming assets and accruing loans past due 90 days or more:
December 31,
Allowance for loan losses $ 7,674 $ 8,481
Total loans, net of unearned income and deferred fees 803,248 768,799
Nonaccrual loans $ - $ 846
TDR loans in nonaccrual status 2,873 2,839
Total nonperforming loans $ 2,873 $ 3,685
Other real estate owned, net 957 1,553
Total nonperforming assets $ 3,830 $ 5,238
Allowance for loan losses to nonperforming loans 267.11 % 230.15 %
Allowance for loan losses to nonperforming assets 200.37 % 161.91 %
Accruing loans past due 90 days or more $ 90 $ 17
Management analyzes many factors to determine the appropriate level for the allowance for loan losses and resultant provision expense, including the historical loss rate, the quality of the loan portfolio as determined by management, diversification as to type of loans in the portfolio, internal policies and economic factors. The allowance for loan losses at December 31, 2020 reflected stressed economic data and a high level of uncertainty associated with the COVID-19 pandemic. The percentage of the allowance for loan losses to total loans decreased from December 31, 2020 to December 31, 2021. Improved economic conditions at December 31, 2021, as well as lower loss rates, decreases in the amount of loans considered high risk, criticized loans and certain loans with COVID-19 related modifications, led to the reduction of the percentage of the allowance for loan losses to loans. Nonperforming loans and other real estate owned (“OREO”), together nonperforming assets, improved from December 31, 2020 to December 31, 2021, while accruing loans past due 90 days or more worsened slightly. More information about the level and calculation methodology of the allowance for loan losses is provided in the sections “Provision and Allowance for Loan Losses” as well as Notes 1 and 5 of Notes to Consolidated Financial Statements.
B. Analysis of Net Charge-Offs
The following tables show net charge-offs, average loan balance and the percentage of charge-offs to average loan balance for each of the Company’s loan segments at the end of each period. Average loans are presented net of unearned income and net deferred fees.
$ in thousands December 31, 2021
Real estate construction $ - $ 45,463 - %
Consumer real estate (7 ) 193,159 - %
Public Sector and IDA - 45,829 - %
$ in thousands December 31, 2020
Real estate construction $ - $ 37,258 - %
Public Sector and IDA - 57,760 - %
The Company charges off commercial real estate loans at the time that a loss is confirmed. When delinquency status or other information indicates that the borrower will not repay the loan, the Company considers collateral value based upon a current appraisal or internal evaluation. Any loan amount in excess of collateral value is charged off and the collateral is taken into OREO.
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C.Allocation of the Allowance for Loan Losses
The allowance for loan losses has been allocated according to the amount deemed necessary to provide for anticipated losses within the categories of loans for the years indicated. Loans are presented net of unearned income and net deferred fees.
An analysis of the allowance for loan losses by impairment basis follows. Loans are presented on a gross basis.
$ in thousands December 31,
Allowance related to impaired loans - 75
Allowance to impaired loans - 1.53 %
Allowance related to non-impaired loans 7,674 8,406
Allowance to non-impaired loans 0.95 % 1.10 %
Less: unearned income and deferred fees and costs (481 ) (1,228 )
Loans, net of unearned income and deferred fees and costs 803,248 768,799
Allowance for loan losses, total 7,674 8,481
Please refer to the discussion under “Provision and Allowance for Loan Losses” for additional information on the determination of the allowance for loan loss.
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Securities
The fair value of securities available for sale was $686,080, an increase of $139,338 or 25.49% from December 31, 2020. The securities portfolio is subject to the volatility and risk in the financial markets. The risk in financial markets affects the Company in the same way that it affects other institutional and individual investors. The Company’s investment portfolio includes corporate bonds. If the corporate issuers were to default, there could be a delay in the payment of interest, or there could be a loss of principal and accrued interest. To date, there have been no defaults in any of the corporate bonds held in the portfolio. The Company’s investment portfolio also contains a large percentage of municipal bonds. If economic forces reduce the ability of states and municipalities to make scheduled principal and interest payments on their outstanding indebtedness, or if their income from taxes and other sources declines significantly, states and municipalities could default on their bond obligations. There have been no defaults among the municipal bonds in the Company’s investment portfolio. The fair value of available for sale securities is reflected on the Company's balance sheet.
In making investment decisions, management follows internal policy guidelines that help to limit risk by specifying parameters for both security quality and industry and geographic concentrations. Management regularly monitors the quality of the investment portfolio and tracks changes in financial markets. The value of individual securities will be written down if a decline in fair value is considered to be other than temporary, given the totality of the circumstances.
Additional information about securities available for sale and securities held to maturity can be found in Note 3 of the Notes to Consolidated Financial Statements.
Maturities and Associated Yields
The following table presents the maturities for debt securities available for sale at their carrying values as of December 31, 2021 and weighted average yield for each range of maturities. Weights are based upon the value of each security.
$ in thousands Maturities and Yields
< 1 Year 1-5 Years 5-10 Years > 10 Years None Total
Available for Sale:
Weighted average yield - - 1.61 % 4.00 % - 3.20 %
(1) Rates shown represent weighted average yield on a fully taxable basis.
The majority of mortgage-backed securities and collateralized mortgage obligations held at December 31, 2021 were backed by U.S. government agencies. Certain holdings are required to be periodically subjected to the Federal Financial Institution Examination Council’s (FFIEC) high risk mortgage security test. These tests address possible fluctuations in the average life and variances caused by the change in rate times the change in volume that have been allocated to rate and volume changes proportional to the relationship of the absolute dollar amounts of the change in each. Except for U.S. government agency securities, the Company has no securities with any issuer that exceeds 10% of stockholders’ equity.
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Deposits
The following table presents deposit categories:
Deposits, including noninterest-bearing demand deposits, interest-bearing deposits and interest-bearing time deposits are obtained in the Company’s markets through traditional marketing techniques. The Company’s deposits do not include any brokered deposits. Time deposits decreased due to decreased offering rates. All other categories of deposits increased, due in large part to government stimulus funds received by municipal depositors and other depositors.
A. Average Amounts of Deposits and Average Rates Paid
Average amounts and average rates paid on deposit categories are presented below:
$ in thousands Year Ended December 31,
Average Amounts Average Rates Paid Average Amounts Average Rates Paid
B.Uninsured Deposits
FDIC insurance covers deposits of up to $250 per depositor. As of December 31, 2021, $599,948 of the Bank's deposits were uninsured. The following table sets forth time deposit that exceed $250.
$ in thousands December 31, 2021
Derivatives and Market Risk Exposures
The Company engages in derivative financial instruments associated with its secondary market operation. The derivatives are valued within other assets and other liabilities. Please refer to Note 1 of Notes to Consolidated Financial Statements for information on derivative valuation. The Company is not a party to derivatives with off-balance sheet risks such as futures, forwards, swaps, and options.
The Company is a party to financial instruments with off-balance sheet risks such as commitments to extend credit, standby letters of credit, and recourse obligations in the normal course of business to meet the financing needs of its customers. See Note 13 of Notes to Consolidated Financial Statements for additional information relating to financial instruments with off-balance sheet risk. Management does not plan any future involvement in high risk derivative products.
The Company has investments in mortgage-backed securities, principally through the Government National Mortgage Association and Federal National Mortgage Association, with a fair value of approximately $206,174. See Note 3 of Notes to Consolidated Financial Statements for additional information relating to securities.
The Company’s securities and loans are subject to credit and interest rate risk, and its deposits are subject to interest rate risk. Management considers credit risk when a loan is granted and monitors credit risk after the loan is granted. The Company maintains an allowance for loan losses to absorb losses in the collection of its loans. See Note 5 of Notes to Consolidated Financial Statements for information relating to the allowance for loan losses. See Note 14 of Notes to Consolidated Financial Statements for information relating to concentrations of credit risk.
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The effects of changing interest rates are primarily managed through adjustments to the loan portfolio and deposit base, to the extent competitive factors allow. Adjustments for asset and liability management are made when securities are called or mature and funds are subsequently reinvested. Securities may be sold for reasons related to credit quality, to maintain compliance with regulatory limitations or for interest rate risk management. No trading activity is planned in the foreseeable future.
See Interest Rate Sensitivity for further details on asset liability management and Note 15 of Notes to Consolidated Financial Statements for information relating to fair value of financial instruments.
Liquidity
Liquidity measures the Company’s ability to meet its financial commitments at a reasonable cost. Demands on the Company’s liquidity include funding additional loan demand and accepting withdrawals of existing deposits. The Company has diverse liquidity sources, including customer and purchased deposits, customer repayments of loan principal and interest, sales, calls and maturities of securities, Federal Reserve discount window borrowing, short-term borrowing, and FHLB advances. At December 31, 2021, the Bank did not have purchased deposits, discount window borrowings, short-term borrowings, or FHLB advances. To assure that short-term borrowing is readily available, the Company tests accessibility annually.
The Company considers its security portfolio for typical liquidity needs, within accounting, legal and strategic parameters. Portions of the securities portfolio are pledged to meet state requirements for public funds deposits. Discount window borrowings also require pledged securities. Increased/decreased liquidity from public funds deposits or discount window borrowings results in increased/decreased liquidity from pledging requirements. The Company monitors public funds pledging requirements and unpledged available for sale securities accessible for liquidity needs.
Regulatory capital levels determine the Company’s ability to use purchased deposits and the Federal Reserve discount window. At December 31, 2021, the Company is considered well capitalized and does not have any restrictions on purchased deposits or borrowing ability at the Federal Reserve discount window.
The Company monitors factors that may increase its liquidity needs. Some of these factors include deposit trends, large depositor activity, maturing deposit promotions, interest rate sensitivity, maturity and repricing timing gaps between assets and liabilities, the level of unfunded loan commitments and loan growth. At December 31, 2021, the Company’s liquidity is sufficient to meet projected trends in these areas.
To monitor and estimate liquidity levels, the Company performs stress testing under varying assumptions on credit sensitive liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows. The Company’s Contingency Funding Plan sets forth avenues for rectifying liquidity shortfalls. At December 31, 2021, the analysis indicated adequate liquidity under the tested scenarios.
The Company utilizes several other strategies to maintain sufficient liquidity. Loan and deposit growth are managed to keep the loan to deposit ratio within the Company’s own policy range of 65% to 75%. At December 31, 2021, the loan to deposit ratio was 53.74%. The investment strategy takes into consideration the term of the investment, and securities in the available for sale portfolio are laddered based upon projected funding needs.
In the normal course of business, we enter into certain contractual obligations, including obligations to make future payments on lease arrangements, contractual commitments with depositors, and service contracts. The table below presents our significant contractual obligations as of December 31, 2021, except for pension and other postretirement benefit plans, which are included in Note 8 of Notes to Consolidated Financial Statements in this Form 10-K.
$ in thousands Payments Due by Period
Total Less Than 1 Year 1-3 Years 4-5 Years More Than 5 Years
(1) Includes contracts with a minimum annual payment of $100.
As of December 31, 2021, the Company was not aware of any other known trends, events or uncertainties that have or are reasonably likely to have a material impact on our liquidity. As of December 31, 2021, the Company has no material commitments for long term debt or for capital expenditures.
Recent Accounting Pronouncements
See Note 1 of Notes to Consolidated Financial Statements for information relating to recent accounting pronouncements.
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Capital Resources
Total stockholders’ equity at December 31, 2021 was $191,751, a decrease of $8,856, or 4.41%, from the $200,607 at December 31, 2020. The largest component of stockholders’ equity, retained earnings, decreased from $189,547 at December 31, 2020 to $188,229 at December 31, 2020, due to dividends of $8,806 and repurchase of shares of $12,894, offset by net income of $20,382.
The Company qualifies as a small bank holding company under the Federal Reserve’s Small Bank Holding Company Policy Statement, which exempts bank holding companies with less than $3 billion in assets from reporting consolidated regulatory capital ratios and from minimum regulatory capital requirements. NBB is subject to various capital requirements administered by banking agencies, including an additional capital conservation buffer in order to make capital distributions or discretionary bonus payments. Risk-based capital ratios are calculated in compliance with OCC rules based on the Basel III Capital Rules. The Bank’s ratios are well above the required minimums at December 31, 2021 and December 31, 2020. Risk based capital ratios for the Bank are shown in the following tables.
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements at December 31, 2021 are detailed in the table below.
$ in thousands Payments Due by Period
Total Less Than 1 Year 1-3 Years 4-5 Years More Than 5 Years
Mortgage loans with potential recourse 18,287 18,287 - - -
In the normal course of business the Company’s banking affiliate extends lines of credit to its customers. Amounts drawn upon these lines vary at any given time depending on the business needs of the customers.
Standby letters of credit are also issued to the Bank’s customers. There are two types of standby letters of credit. The first is a guarantee of payment to facilitate customer purchases. The second type is a performance letter of credit that guarantees a payment if the customer fails to perform a specific obligation. Revenue from these letters was approximately $42 in 2021.
While it would be possible for customers to fully draw on approved lines of credit and for beneficiaries to call all letters of credit, historically this has not occurred. In the event of a sudden and substantial draw on these lines, the Company has its own lines of credit from which it can draw funds. A sale of loans or investments would also be an option to meet liquidity demands.
The Company sells mortgages on the secondary market subject to recourse agreements. The mortgages originated must meet strict underwriting and documentation requirements for the sale to be completed. The Company estimates a potential loss reserve for recourse provisions. The amount is not material as of December 31, 2021. To date, no recourse provisions have been invoked.
Operating leases are for buildings used in the Company’s day-to-day operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Information about market risk is set forth above in the “Interest Rate Sensitivity” and “Derivatives and Market Risk Exposure” sections, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Form 10-K.
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Item 8. Financial Statements and Supplementary Data
Consolidated Balance Sheets
December 31,
$ in thousands, except per share data 2021 2020
Assets
Mortgage loans held for sale 615 866
Loans:
Less unearned income and deferred fees and costs (481 ) (1,228 )
Loans, net of unearned income and deferred fees and costs 803,248 768,799
Less allowance for loan losses (7,674 ) (8,481 )
Other real estate owned, net 957 1,553
Liabilities and Stockholders’ Equity
Accrued interest payable 48 56
Commitments and contingencies
Stockholders’ equity:
Accumulated other comprehensive (loss) income, net (4,058 ) 3,020
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Income
Years ended December 31,
$ in thousands, except per share data 2021 2020
Interest Income
Interest on interest-bearing deposits 170 276
Interest and dividends on securities – taxable 7,960 7,383
Interest on securities – nontaxable 1,934 1,826
Interest Expense
Provision for (recovery of) loan losses (398 ) 1,991
Net interest income after provision for (recovery of) loan losses 42,287 36,180
Noninterest Income
Service charges on deposit accounts 2,045 1,966
Other service charges and fees 179 162
Credit and debit card fees, net 1,869 1,400
Gain on sale of mortgage loans 364 676
Realized securities gains, net 6 108
Noninterest Expense
Occupancy, furniture and fixtures 1,842 1,795
Net costs of other real estate owned 51 39
Basic and fully diluted net income per common share $ 3.28 $ 2.48
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Comprehensive Income
Years ended December 31,
Other Comprehensive (Loss) Income, Net of Tax
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Changes in Stockholders’ Equity
Other comprehensive loss, net of tax of ($1,881) - - (7,078 ) (7,078 )
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Cash Flows
Years ended December 31,
Cash Flows from Operating Activities
Adjustment to reconcile net income to net cash provided by operating activities:
(Recovery of) provision for loan losses (398 ) 1,991
Deferred income tax expense 152 282
Depreciation of premises and equipment 636 708
Amortization of premiums and accretion of discounts, net 1,688 1,455
Gain on disposal of fixed assets - (2 )
Gain on calls and sales of securities available for sale, net (6 ) (108 )
Loss (gain) and write-down on other real estate owned 25 (13 )
Loss on sale of repossessed assets - 1
Income on investment in BOLI (910 ) (877 )
Gain on sale of mortgage loans held for sale (364 ) (676 )
Origination of mortgage loans held for sale (17,672 ) (39,647 )
Contribution to defined benefit plan - (5,000 )
Net change in:
Accrued interest receivable (76 ) (743 )
Accrued interest payable (8 ) (88 )
Net cash provided by operating activities 22,882 13,793
Cash Flows from Investing Activities
Net change in interest-bearing deposits (9,296 ) (43,844 )
Proceeds from repayments of mortgage-backed securities 44,881 18,068
Purchases of securities available for sale (219,331 ) (241,164 )
Net change in restricted stock 434 (59 )
Purchases of loan participations (25,167 ) (11,404 )
Collections of loan participations 15,191 207
Loan originations and principal collections, net (25,289 ) (24,875 )
Proceeds from disposal of other real estate owned 621 72
Proceeds from disposal of repossessed assets 11 30
Recoveries on loans charged off 346 347
Purchase of BOLI (5,000 ) -