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,
● 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 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 and for customers who submit wire requests through online banking.
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 $418 for 2022 and $357 for 2021. These costs are included in various categories of noninterest expense.
19
Table of Contents
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.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared in accordance with GAAP. The financial information contained within our statements is, to a significant extent, 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.
Critical accounting policies are most important to the portrayal of the Company’s financial condition or results of operations and 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 has designated three policies as critical, including those governing the allowance for loan losses, goodwill and the pension plan. The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them as needed. Please refer to Note 1 of Notes to Consolidated Financial Statements for information on these and other accounting policies.
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 fully taxable equivalent (“FTE”) net interest income by total average interest-earning assets. FTE net interest income is non-GAAP because it incorporates the tax benefit of interest income on loans and securities that is not subject to federal tax. The tax rate utilized in calculating the tax benefit is 21%. The reconciliation of FTE net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below.
Year ended December 31,
FTE net interest income (non-GAAP) $ 47,945 $ 42,850
Net interest margin (non-GAAP) 2.88 % 2.81 %
20
Table of Contents
Efficiency Ratio
The efficiency ratio is computed by dividing noninterest expense by the sum of FTE net interest income and noninterest income, excluding certain items management deems unusual or non-recurring. 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.
Year ended December 31,
FTE net interest income (non-GAAP) $ 47,945 $ 42,850
Less: partnership income (1) (367 ) (467 )
Less: realized securities gains - (6 )
Less: gain on sale of private equity investment (3,823 ) -
Total income for ratio calculation $ 56,156 $ 50,803
Performance Summary
The following table presents summary income and expenses for the years indicated:
Year ended December 31,
Provision for (recovery of) loan losses 706 (398 )
Net interest income after provision for (recovery of) loan losses 46,320 42,287
Net income in 2022 benefitted from expansion in net interest income and from the sale of a private equity investment, reflected in noninterest income. 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 1.52 % 1.26 %
Basic and fully diluted net earnings per common share $ 4.33 $ 3.28
Net interest margin (3) 2.88 % 2.81 %
21
Table of Contents
Change in Key Balances
Key balances are shown in the following table:
Change
Loans, net of unearned income and deferred fees and costs and the allowance for loan losses, grew when December 31, 2022 is compared with December 31, 2021 due to customer demand in the Company’s primary markets. During 2022, the Company expanded its lending footprint, opening two new loan production offices in Charlottesville and Staunton, Virginia.
Securities available for sale are reported at fair value, which moves inversely to interest rate changes. The Federal Reserve increased interest rates substantially during 2022, causing a decline in securities fair value when December 31, 2022 is compared with December 31, 2021.
Customer deposits increased when December 31, 2022 is compared with December 31, 2021, in all categories except for time deposits. Time deposit offering rates were set strategically low during 2022. During the fourth quarter of 2022, deposits decreased from the third quarter of 2022 due to competitive pressure.
When December 31, 2022 is compared with December 31, 2021, the decrease in total assets and in stockholders’ equity is primarily due to a decline in the market value of securities.
Asset Quality
Key indicators of NBI’s asset quality are presented in the following table:
Loans past due 90 days or more and accruing 8 90
Other real estate owned 662 957
Allowance for loan losses to loans(2) 0.96 % 0.96 %
Net charge-off ratio 0.02 % 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, 2022, nonperforming loans, other real estate owned ("OREO"), and loans past due 90 days or more improved when compared with levels as of December 31, 2021. The net charge-off ratio decreased from 2021 to 2022.
The Company believes that 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 Note 1 and Note 5 of Notes to Consolidated Financial Statements. The Company continues to carefully monitor risk levels within the loan portfolio.
Income Statement
The following provides information on the results of operations for the years ended December 31, 2022 and December 31, 2021.
22
Table of Contents
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 customer 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 correspondent banks and affect other interest-earning assets over 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 assesses competition for deposits in determining changes to its offering rates.
The net interest margin for the year ended December 31, 2022 improved when compared with the year ended December 31, 2021. Federal Reserve rate increases during 2022 improved yields on interest-bearing deposits in correspondent banks and on adjustable-rate mortgage backed securities. The yield on loans decreased during 2022, due to PPP fees received in 2021, however the yield on loans originated or repriced after March of 2022 benefitted from the Federal Reserve rate increases. High levels of customer deposits and low competition during 2022 allowed the Company to maintain low interest expense for the year ended December 31, 2022, compared with the year ended December 31, 2021. During the fourth quarter of 2022, the Company experienced higher competition and pricing pressure on deposits, and expects this will continue into 2023.
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 2.88 % 2.81 %
(5) Nonaccrual loans are included in average balances for yield computations.
(6) Includes restricted stock.
The following table reconciles net interest income on an FTE basis to net interest income on a GAAP basis for the years indicated.
December 31,
23
Table of Contents
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)
Increase in income on interest-earning assets $ 840 $ 4,240 $ 5,080
Interest expense:
Interest-bearing demand deposits $ (175 ) $ 312 $ 137
Savings deposits (47 ) 21 (26 )
(1) FTE basis using a Federal income tax rate of 21%.
Total interest income increased when the year ended December 31, 2022 is compared with the year ended December 30, 2021, primarily due to volume. Rate-related income on loans fell when the year ended December 31, 2022 is compared with the year ended December 31, 2021 due to PPP fees that were received during 2021. However, increased volume offset much of the impact of lower income from rates.
Federal Reserve interest rate increases in 2022 improved yield on interest-bearing deposits and yield on variable-rate and new taxable securities, when the year ended December 31, 2022 is compared with the year ended December 31, 2021. Higher volume in taxable securities also increased interest income. Income on nontaxable securities decreased when the year ended December 31, 2022 is compared with the year ended December 31, 2021, as higher-yielding nontaxable securities matured and were not replaced.
Deposit volume increased interest expense that was mitigated by lower deposit offering rates, when the years ended December 31, 2022 and 2021 are compared.
The following table sets forth 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), when the year ended December 31, 2021 is compared with the year ended December 31, 2020.
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%.
(2) Variances caused by the change in rate multiplied by the change in volume have been allocated to rate and volume changes proportional to the relationship of the absolute dollar amounts of the change in each.
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 net interest income projected for one year from the reporting date. For purposes of this analysis, noninterest income and expenses are assumed to be flat.
24
Table of Contents
Results of the net interest income simulation as of December 31, 2022 indicate that the Company is liability sensitive, a change from the asset sensitive position as of December 31, 2021. The simulation process requires certain estimates and assumptions including, but 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.
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.
Provision for (Recovery of) Loan Loss
Provision for loan loss for the year ended December 31, 2022 was $706, compared with a recovery of $398 for the year ended December 31, 2021. The ratio of the allowance for loan loss to total loans was 0.96% as of December 31, 2022 and December 31, 2021. The provision for the year ended December 31, 2022 reflects loan portfolio growth and changes in factors detailed in “Balance Sheet – Loans – Allowance for Loan Losses” below. The recovery in 2021 reflected improved economic indicators from those in 2020. More information about the level and calculation methodology of the allowance for loan losses is provided in Notes 1 and 5 of Notes to Consolidated Financial Statements.
Noninterest Income
The following table presents the Company’s noninterest income for the years indicated.
Year Ended December 31, Change
Realized securities gains, net - 6 (6 ) (100.00 )%
Service charges on deposit accounts increased when the year ended December 31, 2022 is compared with the year ended December 31, 2021, primarily due to fees generated from increased customer use of the Bank’s overdraft program. Service charges on deposit accounts also include account maintenance fees, ATM fees and wire transfer fees.
Other service charges and fees increased due to higher volume of letters of credit and associated fees, when the year ended December 31, 2022 is compared with the year ended December 31, 2021. Other service charges and fees also include charges for official checks, income from the sale of checks to customers, safe deposit box rent, and income from commissions on the sale of credit life, accident and health insurance.
Increased transaction volume improved credit card fees when the year ended December 31, 2022 is compared with the year ended December 31, 2021. Credit card fees are presented net of certain processing expenses and are dependent on the volume of transactions.
Trust income increased when the year ended December 31, 2022 is compared with the year ended December 31, 2021. 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.
25
Table of Contents
The Company purchased an additional $5,000 in bank-owned life insurance (“BOLI”) during 2021, contributing to increased income compared with 2021.
The Federal Reserve’s rate increases in 2022 slowed the level of consumer real estate purchase and refinance activity, decreasing the sale of mortgage loans when compared to 2021.
The Company held an ownership interest in Infinex Investments, Inc. (“Infinex”), through which NBFS provides investment services. During the fourth quarter of 2022, the Company recognized a gain on the sale of its shares when Infinex was acquired by a larger holding company. Infinex continues as a division of its new parent company and NBFS continues to work through Infinex to provide investment services .
Other income includes dividends and increases in the Company’s equity-method investments, which decreased when the year ended December 31, 2022 is compared with the year ended December 31, 2021. Other income also includes net gains from the sale of fixed assets and revenue from investment and insurance sales.
Noninterest Expense
The following table presents the Company’s noninterest expense for the years indicated.
Year Ended December 31, Change
Salaries and employee benefits expense, which includes payroll taxes, health insurance, contributions to the employee stock ownership plan and employee 401(k), pension expense, incentives and salary continuation increased when 2022 is compared with 2021, due to normal compensation and staffing decisions.
When the year ended December 31, 2022 is compared with the year ended December 31, 2021, occupancy, furniture and fixtures expense and data processing and ATM expense increased slightly, as did FDIC assessment expense. The FDIC assessment is accrued based on a method provided by the FDIC.
Net costs of OREO include write-downs, maintenance costs, and net gains or losses on the sale of OREO property. This expense category varies with the number of foreclosed properties owned by NBB and with the costs associated with each. During 2022, the Company wrote down a property by $295 to reflect reduction in list price taken as part of a marketing strategy. Other costs for these properties in 2022 were $30. In 2021, the Company recorded a loss on sale of $26 and other expenses of $25.
Franchise tax expense increased when the years ended December 31, 2022 and 2021 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, non-service pension cost and charitable donations. Other operating expenses decreased when the years ended December 31, 2022 and 2021 are compared, primarily due to a decrease of $597 in non-service pension cost. Non-service pension cost is determined by actuarial assumptions and projections. During 2022 and 2021, the calculations resulted in a credit to expense, due to the expected return on plan assets. For more information on non-service pension cost, please refer to Note 8 of Notes to Consolidated Financial Statements.
Income Taxes
Income tax expense for 2022 was $5,831 compared to $4,251 in 2021. The Company’s statutory tax rate was 21% for such years. The Company’s effective tax rates for 2022 and 2021 were 18.36% and 17.26%, 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 Notes to Consolidated Financial Statements for information relating to income taxes.
26
Table of Contents
Balance Sheet
The following provides information on the Company’s financial position as of December 31, 2022 and 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. 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 total loans, loans with predetermined interest rates and loans with adjustable interest rates. Predetermined interest rates do not adjust throughout the life of the loan. Loans are presented on a gross basis.
< 1 Year 1 – 5 Years 6-15 Years >15 Years Total
Total loans:
Loans with predetermined interest rates:
Loans with adjustable interest rates:
B. 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.
During the year ended December 31, 2022, the Company provided modifications for competitive reasons to 840 loans totaling $120,241. During the year ended December 31, 2021, the Company provided modifications for competitive reasons to 875 loans totaling $112,718. The modifications were not TDRs and were not related to COVID-19.
During 2021, the Company provided modifications to borrowers experiencing COVID-19 related hardship. The modification met criteria specified by the CARES Act, the CAA and regulatory guidance and were not designated TDR, including 37 payment extensions to loans totaling $16,426 and 8 amortizing loans granted temporary interest-only periods totaling $22,135. 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.
27
Table of Contents
C. TDRs
Modifications are evaluated to determine whether they meet requirements for designation as TDR. Please refer to Notes 1 and 5 of Notes to Consolidated Financial Statements for information on designation of TDRs during the reporting periods and the effect of default on the allowance for loan losses. The Company’s TDRs, by delinquency status, are presented below:
TDR Delinquency Status as of December 31, 2022
Accruing
Total TDR Loans Current 30-89 Days Past Due 90+ Days Past Due Nonaccrual
Consumer real estate $ 186 $ - $ 186 $ - $ -
Commercial non real estate 263 - - - 263
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
D. Summary of Loan Loss Experience
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 $ 8,225 $ 7,674
Total loans, net of unearned income and deferred fees 852,744 803,248
Nonaccrual loans $ 91 $ -
TDR loans in nonaccrual status 2,756 2,873
Total nonperforming loans $ 2,847 $ 2,873
Other real estate owned, net 662 957
Total nonperforming assets $ 3,509 $ 3,830
Allowance for loan losses to nonperforming loans 288.90 % 267.11 %
Allowance for loan losses to nonperforming assets 234.40 % 200.37 %
Accruing loans past due 90 days or more $ 8 $ 90
More information about the level and calculation methodology of the allowance for loan losses is provided in the sections “Allowance for Loan Losses” as well as Notes 1 and 5 of Notes to Consolidated Financial Statements.
28
Table of Contents
E. 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.
Real estate construction $ - $ 67,197 -
Commercial non real estate (9 ) 53,742 (0.02 )%
Public Sector and IDA - 48,112 -
Real estate construction $ - $ 45,463 -
Public Sector and IDA - 45,829 -
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.
F. Allowance for Loan Losses
The Company’s risk analysis as of December 31, 2022 determined an allowance for loan losses of $8,225 or 0.96% of loans net of unearned income and deferred fees and costs. The allowance as of December 31, 2021 was $7,674 or 0.96% of loans net of unearned income and deferred fees and costs. 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.
Individually Evaluated Impaired Loans
Individually evaluated impaired loans decreased from December 31, 2021 to December 31, 2022, due to the payoff of one relationship. As of December 31, 2022 individually evaluated loans were $3,032 on a gross basis and $3,033 net of unearned income and deferred fees and costs. Individually evaluated impaired loans as of December 31, 2021 were $5,878 gross and $5,880 net of unearned income and deferred fees and costs. Measurement as of December 31, 2022 and December 31, 2021 did not result in specific allocations to the allowance for loan losses.
Collectively Evaluated Loans
Collectively evaluated loans totaled $850,161 gross and $849,711 net of unearned income and deferred fees and costs, with an allowance of $8,225 or 0.97% of collectively evaluated loans net of unearned income and deferred fees and costs as of December 31, 2022. As of December 31, 2021, 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.
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 management.
Net Charge-Offs
Increases in the net charge-off rate require the allowance for collectively evaluated loans to be increased, while decreases in the net charge-off rate require the allowance for collectively evaluated loans to be decreased. On a portfolio level, net charge-offs were $155 for the year ended December 31, 2022, or 0.02% of average loans. For the year ended December 31, 2021, net charge-offs were $409 or 0.05% of average loans. The 8-quarter average historical loss rate was 0.03% for the year ended December 31, 2022 and 0.05% for the year ended December 31, 2021.
29
Table of Contents
Economic Factors
Economic factors influence credit risk and impact the allowance for loan loss. The Company sources economic data pertinent to its market from the most recently available publications, including unemployment, business and personal bankruptcy filings, the residential vacancy rate and the inventory of new and existing homes.
As of December 31, 2022, the unemployment rate for the Company’s market area was measured as of November 2022 and increased from the measurement available as of December 31, 2021, leading management to increase the allocation to the allowance for loan losses.
Business and personal bankruptcy filing data was available as of September 2022. 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 as of December 31, 2021, business bankruptcy filings slightly decreased and personal bankruptcy filings slightly increased.
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 as of December 31, 2022 was measured as of the third quarter of 2022 and worsened slightly from the data incorporated into the December 31, 2021 calculation, resulting in a higher allocation. Housing inventory data was available as of December 31, 2022. The level was slightly higher than as of December 31, 2021, resulting in a higher allocation.
Economic factors in 2021 included an allocation for national unemployment filings. This factor was added early in the COVID-19 pandemic to capture risk that may not have been reflected by the Company’s standard economic indicators. By the beginning of 2022, national unemployment filings had returned to pre-pandemic levels for a sustained period and the Company removed the allocation.
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 0.16% of total loans net of unearned income and deferred fees and costs as of December 31, 2022, an increase from 0.12% as of December 31, 2021. As of December 31, 2022, accruing loans past due 90 days were $8, compared with $90 or 0.01% of total loans, net of unearned income and deferred fees and costs as of December 31, 2021. Nonaccrual loans as a percentage of total loans net of unearned income and deferred fees and costs were 0.33% as of December 31, 2022 and 0.36% as of December 31, 2021.
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. There were no collectively evaluated loans rated special mention as of December 31, 2022, compared with $3,728 as of December 31, 2021, due to improvement in credit quality of a large relationship. Collectively evaluated loans rated classified were $1,393 as of December 31, 2022 and $1,064 as of December 31, 2021.
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, and high risk loans.
The interest rate environment impacts variable rate loans. When interest rates increase, the payment on variable rate loans increases, which may increase credit risk. The Federal Reserve increased the target Fed Funds rate seven times, totaling 425 basis points during 2022, resulting in an increased allocation for December 31, 2022 compared with the allocation for December 31, 2021.
The competitive, legal and regulatory environments were evaluated for changes that would impact credit risk. Higher competition for loans may increase credit risk, while lower competition may decrease credit risk. Competition remained at a similar level to that as of December 31, 2021. The legal and regulatory environments remain in a similar posture to that as of December 31, 2021.
Lending policies, loan review procedures and management’s experience influence credit risk. During 2022, appraisal requirements on residential real estate changed, resulting in an increased allocation from December 31, 2021. Loan review procedures remained similar to those as of December 31, 2021 and no allocation was taken. The allocation for management experience declined from December 31, 2021 to December 31, 2022, due to the hiring of a seasoned Chief Credit Officer to replace the former Chief Credit Officer who left at the end of 2021.
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 7.67% from the level as of December 31, 2021.
Unallocated Surplus
The unallocated surplus as of December 31, 2022 was $179 or 2.23% in excess of the calculated requirement. The unallocated surplus as of December 31, 2021 was $361 or 4.94% in excess of the calculated requirement. The surplus provides some mitigation of current economic uncertainty that may impact credit risk.
30
Table of Contents
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 Company augmented the calculated requirement with an unallocated surplus. 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, 2022.
Please refer to Note 5 of 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.
G. 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 as of the dates indicated. Loans are presented net of unearned income and net deferred fees and costs.
An analysis of the allowance for loan losses by impairment basis follows. Loans are presented on a gross basis.
December 31,
Allowance related to impaired loans - -
Allowance to impaired loans - -
Allowance related to non-impaired loans 8,225 7,674
Allowance to non-impaired loans 0.97 % 0.96 %
Less: unearned income and deferred fees and costs (449 ) (481 )
Loans, net of unearned income and deferred fees and costs 852,744 803,248
Allowance for loan losses, total 8,225 7,674
Please refer to the discussion under “Allowance for Loan Losses” for additional information on the determination of the allowance for loan loss.
Securities
The Company's securities are designated as available for sale and as such, are reported at fair value. The following table presents information on securities available for sale as of the dates indicated.
Change
31
Table of Contents
The securities portfolio is subject to the volatility and risk in the financial markets. The risk in financial markets, including interest rate risk and credit risk, affects the Company in the same way that it affects other institutional and individual investors. The fair value of available for sale securities is reflected on the Company's balance sheet. The unrealized loss in the Company’s investment portfolio is due to interest rate risk, the result of increases in the Federal Reserve’s target interest rate during 2022. The Company’s Asset Liability Management Committee is closely monitoring all of the Company’s financial assets and liabilities in order to manage interest rate risk.
Credit risk in the Company’s investment portfolio is evaluated on an individual security basis. 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. As of December 31, 2022, there are no credit risk concerns with any of the Company’s securities.
The majority of mortgage-backed securities and collateralized mortgage obligations 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.
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 can be found in Note 3 of Notes to Consolidated Financial Statements.
Deposits
The following table presents deposits by category:
Change
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.
32
Table of Contents
A. Average Amounts of Deposits and Average Rates Paid
Average amounts and average rates paid on deposit categories are presented below:
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, 2022, $665,002 of the Bank’s deposits were uninsured. The following table sets forth time deposits that exceed $250.
Derivatives and Market Risk Exposures
The Company engages in derivative financial instruments associated with its secondary market operation. The derivatives are recorded 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’s investments in mortgage-backed securities are primarily through the Government National Mortgage Association and Federal National Mortgage Association. 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.
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. As of December 31, 2022, 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.
33
Table of Contents
Regulatory capital levels determine the Company’s ability to use purchased deposits and the Federal Reserve discount window. As of December 31, 2022, 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. As of December 31, 2022, the Company’s liquidity is sufficient to meet projected trends.
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. As of December 31, 2022, 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 internally-set target range. As of December 31, 2022, the loan to deposit ratio was 55.28%. 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, except for pension and other postretirement benefit plans, which are included in Note 8 of Notes to Consolidated Financial Statements.
December 31, 2022 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, 2022, 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, 2022, the Company has no material commitments for long term debt or for capital expenditures.
Capital Resources
Total stockholders’ equity as of December 31, 2022 was $122,687, a decrease of $69,064, or 36.02%, from $191,751 as of December 31, 2021. The decline in stockholders’ equity is due to the change in market value of the securities portfolio, which was in a gain position as of December 31, 2021 and ended December 31, 2022 in a loss position. Unrealized gains and losses in the securities portfolio are reflected in the equity component, accumulated other comprehensive income (loss). The largest component of stockholders’ equity, retained earnings, increased from $188,229 as of December 31, 2021 to $199,091 as of December 31, 2022. The increase stemmed from net income of $25,932, offset by dividends of $8,950 and repurchases of shares of $6,120.
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 as of December 31, 2022 and December 31, 2021. Risk based capital ratios for NBB are shown in the following tables.
34
Table of Contents
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements as of December 31, 2022 are detailed in the table below.
Payments Due by Period
Total Less Than 1 Year 1-3 Years 4-5 Years More Than 5 Years
Mortgage loans with potential recourse 8,654 8,654 - - -
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 $71 in 2022.
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, 2022. To date, no recourse provisions have been invoked.
Operating leases are for buildings used in the Company’s day-to-day operations.
Recent Accounting Pronouncements
See Note 1 of Notes to Consolidated Financial Statements for information relating to recent accounting pronouncements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
35
Table of Contents
Item 8. Financial Statements and Supplementary Data
Consolidated Balance Sheets December 31,
$ in thousands, except per share data 2022 2021
Assets
Restricted stock, at cost 941 845
Mortgage loans held for sale - 615
Loans:
Less unearned income and deferred fees and costs (449 ) (481 )
Loans, net of unearned income and deferred fees and costs 852,744 803,248
Less allowance for loan losses (8,225 ) (7,674 )
Other real estate owned, net 662 957
Liabilities and Stockholders’ Equity
Accrued interest payable 106 48
Commitments and contingencies
Stockholders’ equity:
Accumulated other comprehensive loss, net (83,766 ) (4,058 )
The accompanying notes are an integral part of these consolidated financial statements.
36
Table of Contents
Consolidated Statements of Income Year ended December 31,
$ in thousands, except per share data 2022 2021
Interest Income
Interest on interest-bearing deposits 1,353 170
Interest and dividends on securities – taxable 12,788 7,960
Interest on securities – nontaxable 1,715 1,934
Interest Expense
Provision for (recovery of) loan losses 706 (398 )
Net interest income after provision for (recovery of) loan losses 46,320 42,287
Noninterest Income
Service charges on deposit accounts 2,425 2,045
Other service charges and fees 214 179
Credit and debit card fees, net 1,916 1,869
Gain on sale of mortgage loans 157 364
Gain on sale of private equity investment 3,823 -
Realized securities gains, net - 6
Noninterest Expense
Occupancy, furniture and fixtures 1,934 1,842
Net costs of other real estate owned 325 51
Basic and fully diluted net income per common share $ 4.33 $ 3.28
The accompanying notes are an integral part of these consolidated financial statements.
37
Table of Contents
Consolidated Statements of Comprehensive (Loss) Income Year ended December 31,
Other Comprehensive Loss, Net of Tax
Total Comprehensive (Loss) Income $ (53,776 ) $ 13,304
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.
38
Table of Contents
Consolidated Statements of Cash Flows Year ended December 31,
Cash Flows from Operating Activities
Adjustment to reconcile net income to net cash provided by operating activities:
Provision for (recovery of) loan losses 706 (398 )
Deferred income tax (benefit) expense (109 ) 152
Depreciation of premises and equipment 609 636
Amortization of premiums and accretion of discounts, net 1,257 1,688
Gain on disposal of fixed assets (9 ) -
Gain on calls and sales of securities available for sale, net - (6 )
Loss and write-down on other real estate owned 295 25
Income on investment in BOLI (958 ) (910 )
Gain on sale of mortgage loans held for sale (157 ) (364 )
Origination of mortgage loans held for sale (7,882 ) (17,672 )
Sale of mortgage loans held for sale 8,654 18,287
Net change in:
Accrued interest receivable (897 ) (76 )
Accrued interest payable 58 (8 )
Net cash provided by operating activities 29,500 22,882
Cash Flows from Investing Activities
Proceeds from repayments of mortgage-backed securities 32,664 44,881
Purchases of securities available for sale (117,341 ) (219,331 )
Net change in restricted stock (96 ) 434
Purchases of loan participations (19,051 ) (25,167 )
Loan originations and principal collections, net (52,271 ) (25,289 )
Proceeds from disposal of other real estate owned - 621
Proceeds from disposal of repossessed assets - 11
Recoveries on loans charged off 212 346
Purchase of BOLI - (5,000 )
Additions to premises and equipment (1,258 ) (323 )
Proceeds from sale of premises and equipment 9 -
Cash Flows from Financing Activities
Net cash provided by financing activities 32,850 175,284
Net change in cash and due from banks (67,360 ) 4,917
Cash and due from banks at end of year $ 71,429 $ 138,789
Supplemental Disclosures of Cash Flow Information
Interest paid on deposits and borrowed funds $ 3,025 $ 3,106
Supplemental Disclosures of Noncash Activities
Loans charged against the allowance for loan losses $ 367 $ 755
Loans transferred to other real estate owned - 50
Loans transferred to repossessed assets 7 11
Unrealized loss on securities available for sale (106,678 ) (13,054 )
Minimum pension liability adjustment 5,781 4,095
The accompanying notes are an integral part of these consolidated financial statements.
39
Table of Contents
Notes to Consolidated Financial Statements
$ in thousands, except per share data.
Note 1: Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of National Bankshares, Inc. and its wholly-owned subsidiaries, the National Bank of Blacksburg, and National Bankshares Financial Services, Inc. All intercompany balances and transactions have been eliminated in consolidation.
The accounting and reporting policies of the Company conform to GAAP and to general practices within the banking industry. Subsequent events have been considered through the date of this Form 10-K. The following summarizes significant accounting policies.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and amounts due from banks.
Interest-Bearing Deposits
The Company invests over-night funds in interest-bearing deposits at other banks, including the FHLB, the Federal Reserve and other entities. Interest-bearing deposits are carried at cost.
Securities
Certain debt securities that management has the positive intent and ability to hold to maturity may be classified as “held to maturity” and recorded at amortized cost. Trading securities are recorded at fair value with changes in fair value included in earnings. Securities not classified as held to maturity or trading, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive loss. The Company uses the interest method to recognize purchase premiums and discounts in interest income over the term of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
The Company follows the accounting guidance related to recognition and presentation of other–than-temporary impairment (“OTTI”). The guidance specifies that if (a) an entity does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that the entity will not have to sell the debt security prior to recovery, the security would not be considered OTTI, unless there is a credit loss. When criteria (a) and (b) are met, the entity will recognize the credit component of an OTTI of a debt security in earnings and the remaining portion in other comprehensive loss.
Equity securities with readily-determinable fair values are measured at fair value using the “exit price notion”. Changes in fair value are recognized in net income. Equity securities without readily-determinable fair values are recorded as other assets at cost less impairment, if any, and adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investment of the same issuer.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value on an individual loan basis. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. The Company releases mortgage servicing rights when loans are sold on the secondary market.
Loans
The Company, through its banking subsidiary, provides mortgage, commercial, and consumer loans to customers. Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoff, are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses, any purchase premium or discount, unearned income and deferred fees or costs. Interest income is accrued on the unpaid principal balance. Unearned income on dealer-originated loans and loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. Purchase premium or discount is recognized as an adjustment of the related loan yield using the interest method.
The Bank’s loan policy is updated and approved by the Board of Directors annually and disseminated to lending and loan portfolio management personnel to ensure consistent lending practices. The policy communicates the Company’s risk tolerance by prescribing underwriting guidelines and procedures, including approval limits and hierarchy, documentation standards, requirements for collateral and loan-to-value limits, debt coverage, overall creditworthiness and guarantor support. Of primary consideration is the repayment ability of the borrowers and (if secured) the collateral value in relation to the principal balance. Collateral lowers risk and may be used as a secondary source of repayment. The credit decision must be supported by documentation appropriate to the type of loan, including current financial information, income verification or cash flow analysis, tax returns, credit reports, collateral information, guarantor verification, title reports, appraisals (where appropriate) and other documents.
The Company’s loans are grouped into six segments: real estate construction, consumer real estate, commercial real estate, commercial non real estate, public sector and IDA, and consumer non-real estate. Each segment is subject to certain risks that influence pricing, loan structures, approval requirements, reserves, and ongoing credit management.
40
Table of Contents
Real Estate Construction Loans. Real estate construction loans are subject to general risks from changing commercial building and housing market trends and economic conditions that may impact demand for completed properties and the costs of completion. Completed properties that do not sell or become leased within originally expected timeframes may impact the borrower’s ability to service the debt. Construction loans are underwritten against projected cash flows from rental income, business and/or personal income from an owner-occupant or the sale of the property to an end-user. Associated risks may be mitigated by requiring fixed-price construction contracts, performance and payment bonding, controlled disbursements, and pre-sale contracts or pre-lease agreements. Risks specific to the borrower are also evaluated, including previous repayment history, debt service ability, and current and projected loan-to value ratios for the collateral.
Consumer Real Estate Loans. The Bank offers a variety of first mortgage and junior lien loans secured by primary residences within our markets. The credit quality of consumer real estate is subject to risks associated with the borrower’s repayment ability and collateral value. Credit decisions are primarily based on loan-to-value (“LTV”) ratios, debt-to-income (“DTI”) ratios, liquidity and net worth. Income and financial information is obtained from personal tax returns, personal financial statements and employment documentation. A maximum LTV ratio of 80% is generally required. The DTI ratio is limited to 43% of gross income.
Consumer real estate mortgages may have fixed interest rates for the entire term of the loan or variable interest rates subject to change after the first, third, or fifth year. Variable rates are based on the weekly average yield of United States Treasury Securities and are underwritten at fully-indexed rates.
Home equity loans are secured primarily by second mortgages on residential property. The underwriting policy for home equity loans generally permits aggregate (the total of all liens secured by the collateral property) borrowing availability up to 80% of the appraised value of the collateral. We offer both fixed rate and variable rate home equity loans, with variable rate loans underwritten at fully-indexed rates. Decisions are primarily based on LTV ratios, DTI ratios, liquidity and credit history. We do not offer home equity loan products with reduced documentation.
We do not offer certain high risk loan products such as interest-only consumer mortgage loans, hybrid loans, payment option adjustable rate mortgages (“ARMs”), reverse mortgage loans, loans with initial teaser rates or any product with negative amortization. A hybrid loan begins as a fixed rate mortgage and after a set number of years, automatically adjusts to an ARM. Payment option ARMs usually have adjustable rates, for which borrowers choose their monthly payment of either a full payment, interest only, or a minimum payment which may be lower than the payment required to reduce the balance of the loan in accordance with the originally underwritten amortization.
Commercial Real Estate Loans. Commercial real estate loans generally are secured by first mortgages on real estate, including multifamily residential real estate, commercial real estate occupied by the owner/borrower, and commercial real estate leased to non-owners. Properties financed include retail centers, office space, hotels and motels, apartments, and industrial properties. Loans in the commercial real estate segment are impacted by economic risks from changing commercial real estate markets, rental markets for multi-family housing and commercial buildings, and economic factors that would impact the businesses housed by the commercial real estate. Underwriting decisions are based upon an analysis of the economic viability of the collateral and creditworthiness of the borrower. The Bank obtains appraisals from qualified certified independent appraisers to establish the value of collateral properties. The loan amount is generally limited to 80% of the lower of cost or appraised value and is individually determined based on the property type, quality, location and financial strength of any guarantors. The property’s projected net cash flows compared to the debt service (often referred to as the “debt service coverage ratio”) is required to be 115% or greater and is computed after deduction for a vacancy factor and property expenses, as appropriate. Borrower cash flow may be supplemented by a personal guarantee from the principal(s) of the borrower and guarantees from other parties. The Bank may employ stress testing techniques on higher balance loans to determine repayment ability in a changing rate environment before granting loan approval. The Bank requires title insurance, fire, extended coverage casualty insurance and flood insurance, if appropriate, in order to protect the security interest in the underlying property.
Commercial Non Real Estate Loans. Commercial non real estate loans are secured by collateral other than real estate, or are unsecured. Credit risk for commercial non real estate loans is subject to economic conditions, borrower repayment ability and collateral value (if secured). Commercial and agricultural loans primarily finance equipment acquisition, expansion, working capital, and other general business purposes. Because these loans have a higher degree of risk, the Bank generally obtains collateral such as inventory, accounts receivables or equipment and personal guarantees from the borrowing entity’s principal owners. The Bank’s policy limits lending up to 60% of the appraised value for inventory, up to 90% of the lower of cost of market value of equipment and up to 70% for accounts receivables less than 90 days old. Credit decisions are based upon an assessment of the financial capacity of the applicant, including the primary borrower’s ability to repay within proposed terms, a risk assessment, financial strength of guarantors and adequacy of collateral. Credit agency reports of individual owners’ credit history supplement the analysis.
Public Sector and IDA Loans. Public sector and IDA loans are extended to municipalities and related entities within the Bank’s geographical footprint. Borrowers include general taxing authorities such as a city or county, industrial/economic development authorities or utility authorities. Credit risk stems from the entity’s ability to repay through either a direct obligation or assignment of specific revenues from an enterprise or other economic activity. Repayment sources are derived from taxation, such as property taxes and sales taxes, or revenue from the project financed with the loan. The Company’s underwriting considers economic and population trends of the municipality and the municipality’s reserves, pension liabilities and other liabilities.
41
Table of Contents
Consumer Non-Real Estate Loans. Consumer non-real estate includes credit cards, automobile and other consumer loans. Credit cards and certain other consumer loans are unsecured, while collateral is obtained for automobile loans and other consumer loans. Credit risk stems primarily from the borrower’s ability to repay. Our procedures for underwriting consumer loans include an assessment of an applicant’s overall financial capacity, including credit history and the ability to meet existing obligations and payments on the proposed loan. If the loan is secured by an automobile or other collateral, the underwriting process also includes a comparison of the value of the collateral security to the proposed loan amount. We require borrowers to maintain collision insurance on loans secured by automobiles.
TDRs
Loan modifications are reviewed at the time of modification to determine whether the loan should be designated as TDR. When the Company grants a concession to a borrower for economic or legal reasons related to a borrower’s financial condition, the loan is classified as a TDR. When the Company grants a subsequent modification to a loan that had previously been modified but not designated as a TDR, it considers whether the totality of the accommodations amount to a concession that, along with the evaluation of borrower financial difficulty, indicate TDR status. Concessions may include reduction of the interest rate, extension of the maturity date at an interest rate lower than the current market rate for a new loan with similar risk, forgiveness of principal or accrued interest or other actions intended to minimize the economic loss. TDRs may be removed from TDR status if the restructuring agreement specifies a contractual interest rate that is a market interest rate at the time of restructuring and the loan is in compliance with its modified terms one year after the restructure was completed.
Past due status and nonaccrual designation
A loan is considered past due when a payment of principal and/or interest is due but not paid. Credit card payments not received within 30 days after the statement date, real estate loan payments not received within the payment cycle and all other non-real estate secured loans for which payment is not made within the required payment cycle are considered 30 days past due. Management closely monitors loans past due 30-89 days and loans past due 90 or more days.
The Company considers multiple factors when determining whether to discontinue accrual of interest on individual loans. Generally loans are placed in nonaccrual status when collection of interest and/or full principal is considered doubtful. Interest accrual is discontinued at the time a commercial real estate loan or commercial non real estate loan is 90 days delinquent unless the credit is well secured and in the process of collection. Loans modified to provide relief from payments of interest or principle for more than 90 days are designated nonaccrual. Accrued interest is reversed against income when a loan is placed in nonaccrual status. Any interest payments received during a loan’s nonaccrual period are credited to the principal balance of the loan.
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 evaluation must determine that the underlying cause of the original delinquency or weakness has been resolved, such as receipt of new guarantees and/or increased cash flows that cover the debt service, and that future payments are reasonably assured. Nonaccrual loans that are not TDR are returned to accrual status when all the principal and interest amounts contractually due are current and future payments are reasonably assured. Nonaccrual TDR loans may return to accrual status after six months of timely repayment performance.
Charge-off policy
The Company’s charge-off policy meets or is more stringent than the minimum standards required by regulators. When available information confirms that a specific loan or a portion thereof, within any loan class, is uncollectible the amount is charged off against the allowance for loan losses. Additionally, losses on consumer real estate and consumer non-real estate loans are typically charged off no later than when the loans are 120-180 days past due, and losses on loans secured by residential real estate or by commercial real estate are charged off by the time the loans reach 180 days past due, in compliance with regulatory guidelines. Accordingly, secured loans may be charged down to the estimated value of the collateral, with previously accrued unpaid interest reversed. Subsequent charge-offs may be required as a result of changes in the market value of collateral or other repayment prospects.
Allowance for Loan Losses
The allowance for loan losses is an estimate of probable losses inherent in the loan portfolio. The allowance is funded by the provision for loan losses, reduced by charge-offs of loans and increased by recoveries of previously charged-off loans. The determination of the allowance is based on two accounting principles, Accounting Standards Codification (“ASC”) Topic 450-20 (Contingencies) which requires that losses be accrued when occurrence is probable and the amount of the loss is reasonably estimable, and ASC Topic 310-10 (Receivables) which requires accrual of losses on impaired loans if the recorded investment exceeds fair value.
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").
42
Table of Contents
Impaired loans
Impaired loans are larger non-homogeneous loans for which there is a probability that collection of principal or interest will not occur according to the contractual terms of the loan agreement, as well as loans whose terms have been modified in a TDR. The Company performs ongoing analysis of the loan portfolio to determine credit quality on an individual loan basis and to identify impaired loans. 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.
Impaired loan measurement methods
Impaired loans are individually evaluated to determine appropriate reserves and are measured at the lower of the invested amount or the fair value. Fair value of impaired loans is estimated by either the present value of the loan’s expected future cash flows (“cash flow method”) or the estimated fair value, less selling costs, of the underlying collateral (“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.
Results of fair value measurement
The estimated fair value is compared with the loan’s recorded investment (unpaid principal net of any interest payments made during the nonaccrual period and net of any partial charge-offs, accrued interest and deferred fees and costs). Any amount of recorded investment that exceeds estimated fair value on collateral-dependent loans, as well as any other impairment loss considered uncollectible, is charged against the allowance for loan losses. Fair value shortfalls that are not considered uncollectible for loans that are not collateral-dependent are accrued in the allowance as specific reserves. Impaired loans for which collection of interest or principal is in doubt are placed in nonaccrual status. If fair value of an impaired loan is higher than the book value, no specific reserve is recorded, and the loan remains impaired as long as analysis indicates that collection of the loan will not occur according to the contractual terms of the loan agreement.
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.
43
Table of Contents
Collectively evaluated loans
General allowances are established for collectively evaluated loans. Collectively evaluated loans are grouped into classes based on similar characteristics. Factors considered in determining general allowances include historical loss rates, credit quality indicators, and qualitative factors.
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.
Credit quality indicators
Credit quality indicators, which the Company terms risk grades, are assigned through the Company’s credit review function for larger loans and selective review of loans that fall below credit review thresholds. Credit quality is rated based on the loan’s payment history, the borrower’s current financial situation and value of the underlying collateral.
Loans that do not indicate heightened risk are graded as “pass.” Loans that appear to have elevated credit risk because of frequent or persistent past due status, which is less than 75 days, or that show weakness in the borrower’s financial condition are risk graded “special mention.” Loans with frequent or persistent delinquency exceeding 75 days or that have a higher level of weakness in the borrower’s financial condition are graded “classified.” Classified loans have regulatory risk ratings of “substandard” and “doubtful.”
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 all real-estate secured classes 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. In 2021, the Company applied to all segments and classes an economic factor implemented to address COVID-19 uncertainty: national unemployment filings. Local unemployment filings are closely correlated to national unemployment filings and presented real-time data that was not available with local unemployment data. After a sustained period of pre-pandemic levels of national unemployment filings, the Company removed the factor in 2022.
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, 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.
Allocations for qualitative factors 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.
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.
44
Table of Contents
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. Please see Note 5 for additional information.
Rate Lock Commitments
The Company enters into commitments to originate mortgage loans in which the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 30 to 60 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, by committing to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result, the Company is not exposed to losses nor will it realize significant gains related to its rate lock commitments due to changes in interest rates. The correlation between the rate lock commitments and the best efforts contracts is very high due to their similarity.
The market value of rate lock commitments and best efforts contracts is not readily ascertainable because rate lock commitments and best effort contracts are not actively traded in stand-alone markets. The Company determines the fair value of rate lock commitments and best efforts contracts by measuring the changes in the value of the underlying assets while taking into consideration the probability that the rate lock commitments will close. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss occurs on the rate lock commitments.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is charged to expense over the estimated useful lives of the assets on the straight-line basis. Depreciable lives include 40 years for premises, 3-10 years for furniture and equipment, and 3 years for computer software. Costs of maintenance and repairs are charged to expense as incurred and improvements are capitalized.
Other Real Estate Owned
Real estate acquired through or in lieu of foreclosure is held for sale and is initially recorded at fair value less estimated costs to sell at the date of foreclosure, establishing the cost basis of the asset. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other operating expenses.
Goodwill
The Company records as goodwill the excess of purchase price over the fair value of the identifiable net assets acquired. 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 annual testing as of September 30 of each fiscal year. The impairment test for 2022 incorporated data as of September 30, 2022.
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 NBI, while the third technique uses current market pricing multiples for change-of-control transactions involving companies comparable to NBI.
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 techniques 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. Based upon data at September 30, 2022, each measure indicated that the Company’s fair value exceeded its book value and no impairment was indicated.
Pension Plan
The Company recognizes the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and recognizes changes in that funded status in the year in which the changes occur through other comprehensive loss. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the projected benefit obligation.
45
Table of Contents
The Company’s actuary determines plan obligations and annual pension expense using a number of key assumptions, including 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.
Income Taxes
Income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the asset and liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The Company recognizes interest and penalties on income taxes as a component of income tax expense.
Trust Assets and Income
Assets (other than cash deposits) held by NBB’s Trust Department in a fiduciary or agency capacity for customers are not included in the consolidated financial statements since such items are not assets of the Company. Trust income is recognized on the accrual basis.
Earnings Per Common Share
Basic earnings per common share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. During 2022 and 2021, there were no potential common shares outstanding.
The following shows the weighted average number of shares used in computing earnings per common share for the years indicated.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business are recorded as liabilities when the likelihood of loss is probable and reasonably estimated. Management does not believe there are such matters that will have a material effect on the consolidated financial statements.
Advertising
The Company charges advertising costs to expenses as incurred. Advertising expenses were $163 for the year ended December 31, 2022 and $112 for the year ended December 31, 2021.
Revenue Recognition
The Company accounts for revenue associated with financial instruments, including loans and securities via the accrual method. The Company recognizes noninterest income when it satisfies commitments to customers. Please refer to Note 18: Revenue Recognition.
Use of Estimates
In preparing consolidated financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, evaluation of impairment of goodwill, and pension obligations.
Reclassifications
Certain amounts reported in prior years have been reclassified to conform to the current year’s presentation. These reclassifications had no effect on the Company’s net income or stockholders’ equity.
46
Table of Contents
Recent Accounting Pronouncements
ASU 2016-13
In June 2016, the FASB issued Accounting Standards Update (“ASU”) No.2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The ASU, as amended, requires an entity to measure expected credit losses for financial assets carried at amortized cost based on historical experience, current conditions, and reasonable and supportable forecasts. Among other things, the ASU also amended the impairment model for available for sale securities and addressed purchased financial assets with deterioration.
On January 1, 2023, the Company adopted ASU No.2016-13 and related ASUs, in accordance with the required implementation date, and applied the standard’s provisions as a cumulative-effect adjustment to retained earnings as of January 1, 2023. Subsequent to adoption, the Company will record adjustments to its allowance(s) for credit losses and reserve for unfunded commitments through the provision for credit losses in the consolidated statements of income. In future filings, results for reporting periods beginning after January 1, 2023 will be presented under Topic 326, while periods prior to January 1, 2023 will be reported in accordance with GAAP applicable at the time period.
Upon adoption, the allowance for credit losses on loans increased from $8,225 to $10,567 and the reserve for unfunded commitments increased from $35 to $242. Based upon the nature and characteristics of our securities portfolios (including issuer specific matters) at the adoption date, macroeconomic conditions and forecasts at that date, and other management judgments, adoption did not result in an allowance for credit losses on available for sale securities. The increase to allowance for credit losses and reserve for unfunded commitments, net of tax, decreased retained earnings by $2,014 as of January 1, 2023.
The Company engaged a third-party model to tabulate its estimate of current expected credit losses, applying a probability of default/loss given default driven discounted cashflow methodology, with default defined as full or partial charge-off, nonaccrual status or past due 90 days or more. In accordance with ASC 326, the Company has segmented its loan portfolio based on similar risk characteristics, using call report code and risk rating.
The Company designated national unemployment as its forecast variable. Multiple forecasts from reputable and independent third parties are sourced to inform the Company’s reasonable and supportable forecasting of current expected credit losses. The forecast is applied over a forecast horizon selected by management at each reporting date, typically of one year and not to exceed two years, after which loss rates revert to long term historical loss experience on a straight line basis.
To further adjust the allowance for credit losses for expected losses not already included within the quantitative component of the calculation, the Company considers the following qualitative adjustment factors: changes in lending policies and procedures, changes in economic conditions, changes in the nature and volume of the loan portfolio, changes in lending management’s experience, changes in the volume and severity of past due loans, changes in the loan review system, changes in concentrations of credit, and the effect of competition, legal and regulatory requirements.
The Company’s CECL implementation process was overseen by a management committee which included the CFO, Controller, Chief Credit Officer and SVP of Credit Administration and reported to the Company’s Enterprise Risk Management Committee. The implementation process included an assessment of data availability and gap analysis, data collection, consideration and analysis of multiple loss estimation methodologies, an assessment of relevant qualitative factors and correlation analysis of multiple potential loss drivers and their impact on the Company’s historical loss experience. During 2022, the Company calculated its current expected credit losses model in parallel to its incurred loss model in order to further refine the methodology and model. In addition, the Company engaged a third-party to perform a comprehensive model validation.
SAB 119
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (“SAB”) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.
ASU 2022-03
In June 2022, the FASB issued ASU 2022-03, “Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions”. ASU 2022-03 clarifies that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. The ASU is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2023. Early adoption is permitted. The Company does not expect the adoption of ASU 2022-03 to have a material impact on its consolidated financial statements.
ASU 2022-02
In March 2022, the FASB issued ASU No.2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for TDRs by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require a public business entity to disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The amendments in this ASU should be applied prospectively, except for the transition method related to the recognition and measurement of TDRs, an entity has the option to apply a modified retrospective transition method, resulting in a cumulative-effect adjustment to retained earnings in the period of adoption. For entities that have adopted ASU 2016-13, ASU 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For entities that have not yet adopted ASU 2016-13, the effective dates for ASU 2022-02 are the same as the effective dates in ASU 2016-13. Early adoption is permitted if an entity has adopted ASU 2016-13. An entity may elect to early adopt the amendments about TDRs and related disclosure enhancements separately from the amendments related to vintage disclosures. The Company is currently assessing the impact that ASU 2022-02 will have on its consolidated financial statements.
ASU 2020-04
In March 2020, the FASB issued ASU No.2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No.2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No.2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU No.2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company has a small number of participation loans that reference LIBOR. The Company is working with the primary banks to determine appropriate actions.
47
Table of Contents
Note 2: Restriction on Cash
The Company’s subsidiary bank is a member of the Federal Reserve System. The Federal Reserve does not currently require member banks to hold an average balance in order to purchase services from the Federal Reserve.
Note 3: Securities
The amortized cost and fair value of debt securities available for sale, with gross unrealized gains and losses, as of the dates indicated, follows:
The amortized cost and fair value of single maturity securities available for sale, by contractual maturity, are shown below. Mortgage-backed securities are categorized by final maturity. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Available for sale: Amortized Cost Fair Value
48
Table of Contents
Information pertaining to securities with gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
Less Than 12 Months 12 Months or More
Fair Value Unrealized Loss Fair Value Unrealized Loss
Less Than 12 Months 12 Months or More
Fair Value Unrealized Loss Fair Value Unrealized Loss
Corporate debt securities 966 37 - -
The Company had 614 securities with a fair value of $648,278 that were temporarily impaired as of December 31, 2022. The total unrealized loss on these securities was $103,152. Of the temporarily impaired total, 289 securities with a fair value of $259,070 and an unrealized loss of $64,043 have been in a continuous loss position for 12 months or more. The Company has determined that these securities are temporarily impaired as of December 31, 2022 for the reasons set out below.
U.S. Government agencies. Unrealized losses of $42,303 on 222 securities with a fair value of $190,950 were caused by interest rate and market fluctuations. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the cost basis of the investments. Because the Company does not intend to sell the investments and it is not likely that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company does not consider the securities to be other-than-temporarily impaired.
States and political subdivisions. The Company reviewed financial statements and cash flow information for the 58 securities with a fair value of $52,134 and unrealized losses of $19,645 and determined that the unrealized loss is the result of interest rate and market fluctuations and not associated with impaired financial status. The contractual terms of the investment do not permit the issuer to settle the security at a price less than the cost basis of the investment. Because the Company does not intend to sell the investment and it is not likely that the Company will be required to sell the investment before recovery of its amortized cost basis, which may be at maturity, the Company does not consider the investment to be other-than-temporarily impaired.
Mortgage-backed securities. Unrealized losses of $1,913 on 8 securities with a fair value of $15,165 were caused by interest rate and market fluctuations. Because the Company does not intend to sell the investment and it is not likely that the Company will be required to sell the investment before recovery of its amortized costs basis, which may be at maturity, the Company does not consider this investment to be other-than-temporarily impaired.
Corporate debt securities.One corporate debt security with a fair value of $821 presented an unrealized loss of $182. The Company reviewed the corporation’s financial position and determined that the unrealized loss is primarily the result of interest rate and market fluctuations and not associated with impaired financial status. The contractual terms of the investment do not permit the issuer to settle the security at a price less than the cost basis of the investment. Because the Company does not intend to sell the investment and it is not likely that the Company will be required to sell the investment before recovery of the amortized cost basis, which may be at maturity, the Company does not consider the investment to be other-than-temporarily impaired.
Management regularly monitors the credit quality of the investment portfolio. Changes in ratings are noted and follow-up research on the issuer is undertaken when warranted. Management intends to carefully monitor any changes in bond quality.
Restricted Stock
The Company held restricted stock of $941 as of December 31, 2022 and $845 as of December 31, 2021. Restricted stock is reported separately from available for sale securities. As a member of the Federal Reserve and the FHLB, NBB is required to maintain certain minimum investments in the common stock of those entities. Required levels of investment are based upon NBB’s capital and a percentage of qualifying assets. The Company purchases stock from or sells stock back to the correspondents based on their calculations. The stock is held by member institutions only and is not actively traded.
49
Table of Contents
Redemption of FHLB stock is subject to certain limitations and conditions. At its discretion, the FHLB may declare dividends on the stock. In addition to dividends, NBB also benefits from its membership with FHLB through eligibility to borrow from the FHLB, using as collateral NBB’s capital stock investment in the FHLB and qualifying NBB real estate mortgage loans totaling $645,539 as of December 31, 2022. Management reviews for impairment based upon the ultimate recoverability of the cost basis of the FHLB stock, and as of December 31, 2022, management did not determine any impairment.
Management regularly monitors the credit quality of the investment portfolio. Changes in ratings are noted and follow-up research on the issuer is undertaken when warranted. Management intends to carefully monitor any changes in bond quality.
Pledged Securities
As of December 31, 2022 and 2021, securities with a carrying value of $345,689 and $287,023, respectively, were pledged to secure municipal deposits and for other purposes as required or permitted by law.
Realized Securities Gains and Losses
The Company did not have any realized gains or losses in 2022. During 2021, the Company realized net securities gains of $6, all of which stemmed from calls of securities. Information pertaining to realized gains and losses on called securities follows:
For the year ended December 31, 2021
Proceeds Book Value Gross Gain Gross Loss Net Gain
Note 4: Related Party Transactions
In the ordinary course of business, the Company, through its banking subsidiary, has granted loans to related parties, including executive officers and directors of NBI and its subsidiaries. Total funded credit extended to related parties amounted to $18,187 at December 31, 2022 and $14,822 at December 31, 2021. During 2022, total principal additions were $5,145 and principal payments were $1,780. During 2021, total principal additions totaled $2,570 and principal payments were $3,151.
The Company held $9,509 in deposits for related parties as of December 31, 2022 and $14,460 as of December 31, 2021.
The Company leased to a director a small office space. The lease was terminated during 2022. The lease payments totaled $2 in 2022 and $5 in 2021. The Company has also contracted with a director's firm to prepare architectural plans for a new office in Roanoke, Virginia. The arrangement is at arms-length and the Company paid the director's firm $39 in 2022 and $113 in 2021.
Note 5: Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
Please refer to Note 1: Summary of Significant Accounting Policies for information on evaluation of collectively evaluated loans and impaired loans and associated reserves, and policies regarding nonaccruals, past due status and charge-offs.
Portfolio Segments and Classes
The Company determines major segments of loans and smaller classes within each segment based upon characteristics including collateral type and intended use, repayment sources, and (if applicable) the borrower’s business model. The methodology for calculating reserves for collectively evaluated loans is applied at the class level. The Company’s loan segments and classes within each segment are presented below:
Collectively evaluated loans within each class are further stratified by risk rating: pass-rated loans, loans rated special mention, and loans rated classified. Credit risk for collectively evaluated loans is estimated at the class level, by risk rating, by applying historical net charge-off rates and percentages for qualitative factors that influence credit risk. Please refer to Note 1: Summary of Significant Accounting Policies for a discussion of risk factors pertinent to each class, information on evaluation of impaired loans and associated specific reserves, and policies regarding nonaccruals, past due status and charge-offs.
50
Table of Contents
A detailed analysis showing the allowance roll-forward by portfolio segment follows:
A detailed analysis showing the allowance and loan portfolio by segment and evaluation method follows: