PARKWAY ACQUISITION CORP. Management’s discussion and analysis of financial condition and results of operations. (Form 10-K)

Discussion and analysis of operations by management


Overview



Management's Discussion and Analysis is provided to assist in the understanding
and evaluation of Parkway Acquisition Corp's. financial condition and its
results of operations. The following discussion should be read in conjunction
with the Company's consolidated financial statements.



Parkway Acquisition Corp. ("Parkway" or the "Company") was incorporated as a
Virginia corporation on November 2, 2015. Parkway was formed as a business
combination shell company for the purpose of completing a business combination
transaction between Grayson Bankshares, Inc. ("Grayson") and Cardinal Bankshares
Corporation ("Cardinal"). On November 6, 2015, Grayson, Cardinal and Parkway
entered into an agreement pursuant to which Grayson and Cardinal merged with and
into Parkway, with Parkway as the surviving corporation (the "Cardinal merger").
The merger agreement established exchange ratios under which each share of
Grayson common stock was converted to the right to receive 1.76 shares of common
stock of Parkway, while each share of Cardinal common stock was converted to the
right to receive 1.30 shares of common stock of Parkway. The exchange ratios
resulted in Grayson shareholders receiving approximately 60% of the newly issued
Parkway shares and Cardinal shareholders receiving approximately 40% of the
newly issued Parkway shares. The Cardinal merger was completed on July 1, 2016.
Grayson was considered the acquiror and Cardinal was considered the acquiree in
the transaction for accounting purposes. Upon completion of the Cardinal merger,
the Bank of Floyd, a wholly-owned subsidiary of Cardinal, was merged with and
into Grayson National Bank (the "Bank'), a wholly-owned subsidiary of Grayson.
Effective March 13, 2017, the Bank changed its name to Skyline National Bank.



On March 1, 2018, Parkway entered into a definitive agreement pursuant to which
Parkway acquired Great State Bank ("Great State"), based in Wilkesboro, North
Carolina. The agreement provided for the merger of Great State with and into the
Bank, with the Bank as the surviving bank (the "Great State merger"). The
transaction closed and the merger became effective on July 1, 2018. Each share
of Great State common stock was converted into the right to receive 1.21 shares
of Parkway common stock. The Company issued 1,191,899 shares and recognized
$15.5 million in surplus in the Great State merger. Parkway was considered the
acquiror and Great State was considered the acquiree in the transaction for
accounting purposes.



The Bank was organized under the laws of the United States in 1900 and now
serves the Virginia counties of Grayson, Floyd, Carroll, Wythe, Montgomery and
Roanoke, and the North Carolina counties of Alleghany, Ashe, Burke, Caldwell,
Catawba, Cleveland, Davie, Watauga, Wilkes, and Yadkin, and the surrounding
areas, through twenty-five full-service banking offices. As a Federal Deposit
Insurance Corporation ("FDIC") insured national banking association, the Bank is
subject to regulation by the Comptroller of the Currency and the FDIC.  Parkway
is regulated by the Board of Governors of the Federal Reserve System.



For purposes of this annual report, all information contained herein as of and
for periods prior to July 1, 2018 reflects the operations of Parkway prior to
the Great State merger.  Unless this report otherwise indicates or the context
otherwise requires, all references to "Parkway" or the "Company" as of and for
periods subsequent to July 1, 2018 refer to the combined company and its
subsidiary as a combined entity after the Great State merger, and all references
to "Parkway" or the "Company" as of and for periods prior to July 1, 2018 are
references to Parkway and its subsidiary as a combined entity prior to the
merger.



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Management discussion and analysis

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Parkway had net earnings of $9.5 million for 2021 compared to $5.9 million for
2020. Our strong financial performance in 2021 can be attributed in part to our
team's efforts in the SBA-PPP loan program and solid growth in the bank's core
loan portfolio as well. From its commencement in 2020 through 2021 we originated
over $125 million in SBA-PPP loans providing critical funding to businesses
throughout our market area and in 2021 we grew our core loans (excluding SBA-PPP
balances) at an annualized rate of over 7%. Earnings for the year ended December
31, 2021 represented a return on average assets of 1.01% and a return on average
equity of 10.98%, compared to 0.75% and 7.06%, respectively, for the year ended
December 31, 2020. The net interest margin was 3.74% in 2021, compared to 3.96%
in 2020. The net interest margin continued to decline during 2021 due to
historically low interest rates and increasingly competitive loan pricing. As we
look to 2022, we expect continued pressure on our net interest margin as the
SBA-PPP program winds down and the Federal Reserve maintains its accommodative
monetary policy. Increases in the federal funds rate however, could have a
positive impact on margins as the year 2022 progresses.



Forward Looking Statements



From time to time, the Company and its senior managers have made and will make
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Such statements may be contained in this report
and in other documents that the Company files with the Securities and Exchange
Commission. Such statements may also be made by the Company and its senior
managers in oral or written presentations to analysts, investors, the media and
others. Forward-looking statements can be identified by the fact that they do
not relate strictly to historical or current facts. Also, forward-looking
statements can generally be identified by words such as "may," "could,"
"should," "would," "believe," "anticipate," "estimate," "seek," "expect,"
"intend," "plan" and similar expressions.



Forward-looking statements provide management's expectations or predictions of
future conditions, events or results. They are not guarantees of future
performance. By their nature, forward-looking statements are subject to risks
and uncertainties. These statements speak only as of the date they are made. The
Company does not undertake to update forward-looking statements to reflect the
impact of circumstances or events that arise after the date the forward-looking
statements were made. There are a number of factors, many of which are beyond
the Company's control that could cause actual conditions, events or results to
differ significantly from those described in the forward-looking statements.
These factors, some of which are discussed elsewhere in this report, include:



  ? any required increase in our regulatory capital ratios;


  ? inflation, interest rate levels and market and monetary fluctuations;


  ? the difficult market conditions in our industry;

? Trade, monetary and fiscal policies and laws, including interest rate policies

    of the federal government;


  ? applicable laws and regulations and legislative or regulatory changes;

? the timely development and acceptance of new products and services

Society;

? the willingness of customers to substitute competitive products and services

    for the Company's products and services;


  ? the financial condition of the Company's borrowers and lenders;


  ? the Company's success in gaining regulatory approvals, when required;


  ? technological and management changes;

? the Company’s ability to execute its growth and acquisition strategies;

? the company’s critical accounting policies and their implementation

guidelines;

? lower than expected revenue or cost savings or other related issues

    mergers and acquisitions and branch expansion;


  ? changes in consumer spending and saving habits;

? the strength of The United States economy in general and the strength of the

local economic areas in which the company conducts its business;

? the impact of the COVID-19 pandemic, including the Company’s credit quality

and business operations and their impact on general economic and

financial market conditions;

? geopolitical conditions, including acts of terrorism or threats, internationally

hostilities or actions of US or other governments in response to

Acts or threats of terrorism and/or military conflict that could have repercussions

Business and economic situation in the US and abroad;

? the Company’s potential exposure to fraud, negligence, computer theft and

    cyber-crime; and,


  ? the Company's success at managing the risks involved in the foregoing.




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Management discussion and analysis

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Critical Accounting Policies



The Company's financial statements are prepared in accordance with accounting
principles generally accepted in the United States ("GAAP"). The notes to the
audited consolidated financial statements included in the Annual Report for the
year ended December 31, 2021 contain a summary of its significant accounting
policies. Management believes the Company's policies with respect to the
methodology for the determination of the allowance for loan losses, and asset
impairment judgments, such as the recoverability of intangible assets and
other-than-temporary impairment of investment securities, involve a higher
degree of complexity and require management to make difficult and subjective
judgments that often require assumptions or estimates about highly uncertain
matters. Accordingly, management considers the policies related to those areas
as critical.



The allowance for loan losses is an estimate of the losses that may be sustained
in the loan portfolio. The allowance is based on two basic principles of
accounting: the first of which requires that losses be accrued when they are
probable of occurring and estimable, and the second, which requires that losses
be accrued based on the differences between the value of collateral, present
value of future cash flows or values that are observable in the secondary
market, and the loan balance.



The allowance for loan losses has three basic components: (i) the formula
allowance, (ii) the specific allowance, and (iii) the unallocated allowance.
Each of these components is determined based upon estimates that can and do
change when the actual events occur. The formula allowance uses a historical
loss view as an indicator of future losses and, as a result, could differ from
the loss incurred in the future. However, since this history is updated with the
most recent loss information, the errors that might otherwise occur are
mitigated. The specific allowance uses various techniques to arrive at an
estimate of loss. Historical loss information, expected cash flows and fair
market value of collateral are used to estimate these losses. The use of these
techniques is inherently subjective and our actual losses could be greater or
less than the estimates. The unallocated allowance captures losses that are
attributable to various economic events, industry or geographic sectors whose
impact on the portfolio have occurred but have yet to be recognized in either
the formula or specific allowance.



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Management discussion and analysis

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Table 1. Net Interest Earnings and Average Balances (Dollars in Thousands)

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                                      2021                                      2020                                      2019

                                    Interest                                  Interest                                  Interest
                       Average       Income/       Yield/        Average       Income/       Yield/        Average       Income/       Yield/
                       Balance       Expense        Cost         Balance       Expense        Cost         Balance       Expense        Cost
Interest-earning
assets:
Interest-bearing
deposits              $  44,227     $      88          0.20 %   $  45,758     $     214          0.47 %   $  19,082     $     288          1.51 %
Federal funds sold       37,365            44          0.12 %         639             3          0.47 %       9,413           249          2.65 %
Investment
securities               96,020         1,535          1.60 %      32,976           757          2.30 %      42,915         1,088          2.54 %
Loans 1, 2              687,587        33,089          4.81 %     634,755        30,770          4.85 %     548,611        29,177          5.32 %
Total                   865,199        34,756                     714,128        31,744                     620,021        30,802
Yield on average
interest-earning
assets                                                 4.02 %                                    4.45 %                                    4.97 %
Non
interest-earning
assets:
Cash and due from
banks                    12,634                                    10,211                                     8,364
Premises and
equipment                28,342                                    26,044                                    21,383
Interest receivable
and other                39,299                                    38,130                                    37,310
Allowance for loan
losses                   (5,296 )                                  (4,474 )                                  (3,768 )
Unrealized
gain/(loss) on
securities                 (569 )                                     530                                      (263 )
Total                    74,410                                    70,441                                    63,026
Total assets          $ 939,609                                 $ 784,569                                 $ 683,047

Interest-bearing
liabilities:
Demand deposits       $ 197,835           298          0.15 %   $ 145,068           328          0.23 %   $ 128,645           301          0.23 %
Savings deposits        172,847           198          0.11 %     138,344           415          0.30 %     124,441           389          0.31 %
Time deposits           195,008         1,847          0.95 %     192,519         2,604          1.35 %     184,501         2,162          1.17 %
Borrowings                9,862            86          0.87 %      12,894            93          0.72 %       3,077            17          0.55 %
Total                   575,552         2,429                     488,825         3,440                     440,664         2,869
Cost on average
interest-bearing
liabilities                                            0.42 %                                    0.70 %                                    0.65 %

Non
interest-bearing
liabilities:
Demand deposits         273,393                                   208,530                                   160,858
Interest payable
and other                 4,298                                     4,038                                     2,913
Total                   277,691                                   212,568                                   163,771
Total liabilities       853,243                                   701,393                                   604,435

Stockholder's
equity:                  86,366                                    83,176                                    78,612
Total liabilities
and stockholder's
equity                $ 939,609                                 $ 784,569                                 $ 683,047

Net interest income                 $  32,327                                 $  28,304                                 $  27,933

Net yield on
interest-earning
assets                                                 3.74 %                                    3.96 %                                    4.51 %




1 Includes nonaccural loans

2 Interest income includes loan fees

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Management discussion and analysis

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Table 2. Rate/Volume Analysis of Variance (Dollars in Thousands)

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                                  2021 Compared to 2020                     

2020 compared to 2019

                         Interest               Variance               Interest              Variance
                         Income/           Attributable To(1)          Income/          Attributable To(1)
                         Expense                                       Expense
                         Variance         Rate           Volume        Variance         Rate          Volume
Interest-earning
assets:
Interest bearing
deposits                $     (126 )   $     (119 )     $      (7 )   $      (74 )   $        72     $    (146 )
Federal funds sold              41              -              41           (246 )          (115 )        (131 )
Investment securities          778           (147 )           925           (331 )           (96 )        (235 )
Loans                        2,319           (221 )         2,540          1,593          (2,059 )       3,652
Total                        3,012           (487 )         3,499            942          (2,198 )       3,140

Interest-bearing
liabilities:
Demand deposits                (30 )          334            (364 )           27             (10 )          37
Savings deposits              (217 )         (364 )           147             26             (15 )          41
Time deposits                 (757 )         (791 )            34            442             345            97
Borrowings                      (7 )           56             (63 )           76               7            69
Total                       (1,011 )         (765 )          (246 )          571             327           244
Net interest income     $    4,023     $      278       $   3,745     $      371     $    (2,525 )   $   2,896



(1) The interest rate variance attributed to both volume and rate was

associated with the variance attributed to volume and the variance attributed to price

    proportion to the absolute value of the change in each.



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Net Interest Income



Net interest income, the principal source of the Company's earnings, is the
amount of income generated by earning assets (primarily loans and investment
securities) less the interest expense incurred on interest-bearing liabilities
(primarily deposits used to fund earning assets). Table 1 summarizes the major
components of net interest income for the past three years and also provides
yields and average balances.



For the year ended December 31, 2021 total interest income increased by $3.0
million compared to the year ended December 31, 2020. The increase in interest
income in 2021 was primarily due to organic loan growth in new and existing
markets and the $3.8 million recognized in SBA-PPP related fees during 2021;
however, yields were negatively impacted by the exceptionally low interest rate
environment as well as continual competitive pressure on loan rates. As a
result, interest income on loans increased by $2.3 million in 2021 compared to
$1.6 million in 2020. Accretion of purchased loan discounts increased interest
income by $940 thousand in 2021 compared to $1.2 million in 2020, representing a
decrease of $259 thousand. The increases in interest income on investment
securities was due to the $63.0 million increase in average investment
securities due to investment purchases during 2021. The decrease in interest
income on federal funds sold and interest-bearing deposits in banks were due to
the impact of lower short term interest rates. Interest expense on deposits
decreased by $1.0 million for the year ended December 31, 2021 compared to the
same period last year, reflecting rate reductions in deposit offerings, despite
the $89.8 million increase in average interest-bearing deposits from 2020 to
2021. A significant portion of the growth in interest-bearing deposits
year-over-year is attributed to increased balances held by customers during the
pandemic and government stimulus programs, new relationships developed from the
SBA-PPP program, as well as organic growth in new and existing markets during
2021.



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Management discussion and analysis

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Amortization of premiums on acquired time deposits, which reduces interest
expense, totaled $108 thousand in 2021, compared to $189 thousand in 2020,
representing a decrease of $81 thousand. The effects of changes in volumes and
rates on net interest income in 2021 compared to 2020, and 2020 compared to 2019
are shown in Table 2.



The aforementioned factors led to an increase in net interest income of $4.0
million or 14.21% for 2021 as compared to 2020. The net yield on
interest-earning assets decreased by 22 basis points to 3.74% in 2021 compared
to 3.96% in 2020.



Provision for Credit Losses



The allowance for credit losses is established to provide for expected losses in
the Company's loan portfolio. Management determines the provision for credit
losses required to maintain an allowance adequate to provide for probable
losses. Some of the factors considered in making this decision are the levels
and collectability of past due loans, volume of new loans, composition of the
loan portfolio, and general economic outlook.



The provision for loan losses was $723 thousand for the year ended December 31,
2021, compared to $1.2 million for the year ended December 31, 2020.  The
decrease in loan loss provisions from 2020 to 2021 despite the overall growth in
the loan portfolio was due to the improvement in credit quality on the loan
portfolio and the reduction of past due loans and nonperforming loans from 2020
to 2021, as well as net recoveries of $54 thousand in 2021 compared to net
charge offs of $182 thousand in 2020.



The allowance for loan losses for SBA-PPP loans remaining at December 31, 2021
were separately evaluated given the explicit government guarantee. This
analysis, which incorporated historical experience with similar SBA guarantees
and underwriting, concluded the likelihood of loss was remote and therefore
these loans were assigned a zero expected credit loss in the allowance for loan
losses.



The reserve for loan losses at December 31, 2021 was approximately 0.83% of
total loans, compared to 0.74% at December 31, 2020. Management's estimate of
probable credit losses inherent in the acquired Great State and Cardinal loan
portfolios was reflected as a purchase discount which will continue to be
accreted into income over the remaining life of the acquired loans. As of
December 31, 2021 and 2020, the remaining unaccreted discount on the acquired
loan portfolios totaled $1.0 million and $2.0 million, respectively. Management
believes the provision and the resulting allowance for loan losses are adequate.
Additional information is contained in Tables 12 and 13, and is discussed in
Nonperforming and Problem Assets.



Other Income



Noninterest income increased by $1.3 million in 2021 compared to 2020.  Mortgage
origination fees increased by $341 thousand in 2021 compared to 2020.  The
mortgage department closed approximately $57.0 million of mortgage loans for the
secondary market during 2021 compared to $43.5 million in 2020.  Gains from
sales of available-for-sale securities totaled $265 thousand for the year ended
December 31, 2021 compared to $315 thousand for the year ended December 31,
2020.  ATM, credit and debit card income increased by $460 thousand from 2020 to
2021 due to increased debit card usage.  Other income increased by $392 thousand
from 2020 to 2021 due to the recognition of a one-time lease termination fee of
$200 thousand and the recognition of a one-time $193 thousand incentive bonus on
a contract renegotiation with a service provider.



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Table 3. Sources of Interest Free Income (dollars in thousands)

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                                            2021        2020

Service Fees on Deposit Accounts $1,541 $1,441
Increase in present value of life insurance 446 449 Life insurance returns

                            -           -
Mortgage originations fees                   1,061         720
Safe deposit box rental                         88          90
Gain on securities                             265         315
ATM, credit and debit card income            2,073       1,613
Merchant services income                       182         191
Investment services income                      60          35
Exchange income                                203         186
Other income                                   649         257
Total noninterest income                   $ 6,568     $ 5,297



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Other Expense


The main components of noninterest expenses for the last two years are shown in Table 4.



Total noninterest expenses increased by $1.2 million, or 4.66% for the year
ended December 31, 2021, compared to the year ended December 31, 2020 primarily
due to employee and branch costs associated with branch expansion into new North
Carolina markets. Salary and benefit cost increased by $77 thousand from
December 31, 2020 to December 31, 2021.  Occupancy and equipment expenses
increased by $378 thousand and data processing expenses increased by $261
thousand from 2020 to 2021, due to the branch expansion.  FDIC/OCC assessments
increased by $226 thousand for the year ended December 31, 2021 compared to the
year ended December 31, 2020 due to the deposit growth experience during 2021.
This increase was partially offset by a decrease in amortization of core deposit
intangibles of $116 thousand for the year ended December 31, 2021, compared to
same period in 2020. Professional fees increased by $177 thousand primarily due
to increased fees paid for accounting and consulting services.  Other expenses
increased by $147 thousand in the year over year comparison, which includes a
$44 thousand prepayment fee incurred on the paydown of $5.0 million in FHLB
advances in the fourth quarter of 2021.



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Management discussion and analysis

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Table 4. Sources of noninterest expenses (dollars in thousands)

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                                         2021       2020

Salaries & wages                       $ 11,251     $ 11,347
Share-based compensation                    155            -
Employee benefits                         3,274        3,256
Total personnel expense                  14,680       14,603

Director fees                               368          361
Occupancy expense                         1,676        1,596
Data processing expense                   2,026        1,765
Other equipment expense                   1,175        1,029
FDIC/OCC assessments                        609          383
Insurance                                   156          138
Professional fees                           639          462
Advertising                                 702          683
Postage & freight                           458          429
Supplies                                    196          279
Franchise tax                               499          505
Telephone                                   390          370
Travel, dues & meetings                     435          418
ATM/EFT expense                             767          615
Foreclosure expenses                          -            2
Core deposit intangible amortization        595          711
Other expense                               896          749
Total noninterest expense              $ 26,267     $ 25,098



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The overhead efficiency ratio of noninterest expense to adjusted total revenue
(net interest income plus noninterest income) was 67.53% in 2021 and 74.69% in
2020.



Income Taxes



Income tax expense is based on amounts reported in the statements of income
(after adjustments for non-taxable income and non-deductible expenses) and
consists of taxes currently due plus deferred taxes on temporary differences in
the recognition of income and expense for tax and financial statement purposes.
The deferred tax assets and liabilities represent the future Federal income tax
return consequences of those differences, which will either be taxable or
deductible when the assets and liabilities are recovered or settled.



Income tax expense (substantially all Federal) was $2.4 million in 2021 and $1.4
million in 2020, resulting in effective tax rates of 20.4% and 19.8%,
respectively. The increase in income tax expense of $978 thousand in 2021 was
primarily due to the increase in income before taxes of $4.6 million in 2021
compared to 2020.



Net deferred tax assets of $1.1 million, and $1.0 million existed at December
31, 2021 and 2020 respectively. At December 31, 2021, net deferred tax assets
included $392 thousand of deferred tax assets applicable to unrealized losses on
investment securities available for sale, and $176 thousand of deferred tax
assets applicable to unfunded projected pension benefit obligations.
Accordingly, these amounts were not charged to income but recorded directly to
the related stockholders' equity account.



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Management discussion and analysis

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Analysis of the financial situation



Average earning assets increased 21.15% from 2020 to 2021 due to asset growth
primarily reflected in increased loans and investment securities, and higher
liquid asset balances due to average deposit growth of $154.6 million. Total
earning assets represented 92.08% of total average assets in 2021 and 91.02% in
2020. The mix of average earning assets changed from 2020 to 2021 as average
loans increased by $52.8 million, or 8.32%, and average investment securities
increased by $63.0 million, or 191.18%. Average federal funds sold and average
deposits in banks increased by $35.2 million, or 75.86%, from 2020 to 2021.



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Table 5. Average asset mix (dollars in thousands)

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                                                2021                       2020
                                        Average                    Average
                                        Balance         %          Balance         %

Earning assets:
Loans                                  $ 687,587        73.18 %   $ 634,755        80.91 %
Investment securities                     96,020        10.22 %      32,976         4.20 %
Federal funds sold                        37,365         3.97 %         639         0.08 %
Deposits in other banks                   44,227         4.71 %      45,758         5.83 %
Total earning assets                     865,199        92.08 %     714,128        91.02 %

Non earning assets:
Cash and due from banks                   12,634         1.34 %      10,211         1.30 %
Premises and equipment                    28,342         3.02 %      26,044         3.32 %
Other assets                              39,299         4.18 %      38,130         4.86 %
Allowance for loan losses                 (5,296 )      -0.56 %      (4,474 )      -0.57 %
Unrealized gain (loss) on securities        (569 )      -0.06 %         530         0.07 %
Total nonearning assets                   74,410         7.92 %      70,441         8.98 %
Total assets                           $ 939,609       100.00 %   $ 784,569       100.00 %



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Average loans for 2021 represented 73.18% of total average assets compared to
80.91% in 2020. Average federal funds sold increased from 0.08% to 3.97% of
total average assets while deposits in other banks decreased from 5.83% to 4.71%
of total average assets over the same time period. Average investment securities
increased from 4.20% in 2020 to 10.22% of total average assets in 2021. The
balances of nonearning assets to total average assets decreased from 8.98% to
7.92%.



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Management discussion and analysis

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Loans



Average loans totaled $687.6 million for the year ended December 31, 2021.  This
represents an increase of 8.32% from the average of $634.8 million for 2020.
The increase was primarily due to organic growth in new and existing markets
during as well as continued participation in SBA-PPP lending during 2021.



The loan portfolio consists primarily of real estate and commercial loans,
including SBA-PPP loans. These loans accounted for 96.31% of the total loan
portfolio at December 31, 2021. This is down from the 96.97% that the two
categories maintained at December 31, 2020. The amount of loans outstanding by
type at December 31, 2021 and 2020 and the maturity distribution for variable
and fixed rate loans as of December 31, 2021 are presented in Tables 6 and 7,
respectively.


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Table 6. Loan portfolio summary (dollars in thousands)

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                                    December 31, 2021          December 31, 2020
                                   Amount          %          Amount          %

Construction and development      $  44,252         6.48 %   $  46,053         6.93 %
Residential, 1-4 families           240,359        35.16 %     229,706        34.59 %
Residential, 5 or more families      58,054         8.49 %      50,187         7.56 %
Farm land                            25,026         3.66 %      32,449         4.89 %
Nonfarm, nonresidential             230,071        33.66 %     203,886        30.70 %
Total real estate                   597,762        87.45 %     562,281        84.67 %

Agricultural                          2,420         0.35 %       3,127         0.47 %
Commercial                           36,022         5.27 %      30,536         4.60 %
SBA-PPP                              24,528         3.59 %      51,118         7.70 %
Consumer                              7,292         1.07 %       7,127         1.07 %
Other                                15,508         2.27 %       9,906         1.49 %
Total                             $ 683,532       100.00 %   $ 664,095       100.00 %





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Management discussion and analysis

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Table 7. Loan Maturity List, as of December 31, 2021 (dollars in thousands)

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                                                  Commercial,          Consumer
                                    Real         Agricultural &       Consumer &               Total
                                   Estate           SBA-PPP             Other          Amount           %

Fixed rate loans:
One year or less                  $  15,494     $          2,354     $      6,613     $  24,461          3.58 %
Over one to five years               79,424               41,085            8,853       129,362         18.93 %
Over five years to 15 years          39,337                4,191            2,946        46,474          6.80 %
Over 15 years                         5,095                    2                9         5,106          0.75 %
Total fixed rate loans            $ 139,350     $         47,632     $     18,421     $ 205,403         30.06 %

Variable rate loans:
One year or less                  $  12,391     $          6,495     $        343     $  19,229          2.81 %
Over one to five years               17,894                  903            3,440        22,237          3.25 %
Over five years to 15 years         133,060                7,525              296       140,881         20.61 %
Over 15 years                       295,067                  415              300       295,782         43.27 %
Total variable rate loans         $ 458,412     $         15,338     $      4,379     $ 478,129         69.94 %

Total loans:
One year or less                  $  27,885     $          8,849     $      6,956     $  43,690          6.39 %
Over one to five years               97,318               41,988           12,293       151,599         22.18 %
Over five years to 15 years         172,397               11,716            3,242       187,355         27.41 %
Over 15 years                       300,162                  417              309       300,888         44.02 %
Total loans                       $ 597,762     $         62,970     $     22,800     $ 683,532        100.00 %



--------------------------------------------------------------------------------


Interest rates charged on loans vary with the degree of risk, maturity and
amount of the loan.  Competitive pressures, money market rates, availability of
funds, and government regulations also influence interest rates.  On average,
loans yielded 4.81% in 2021 compared to an average yield of 4.85% in 2020.  The
decrease in loan yields was due to increasing competition in our markets for
loans, in addition to a generally lower interest rate environment and the low
rate on SBA-PPP loans, which was partially offset by the fee income earned on
the SBA-PPP loans, as well as a reduction in the overall impact of purchase
accounting adjustment as the accretion of purchase loan discounts decreased by
$259 thousand during 2021.



Investment Securities


The company uses its investment portfolio to provide liquidity for unexpected deposit declines or lending in order to meet the bank’s interest rate sensitivity goals and to generate income.



Management of the investment portfolio has always been conservative with the
majority of investments taking the form of purchases of U.S. Treasury, U.S.
Government Agencies, U.S. Government Sponsored Enterprises and State and
Municipal bonds, as well as investment grade corporate bond issues. Management
views the investment portfolio as a source of income, and purchases securities
with the intent of retaining them until maturity. However, adjustments are
necessary in the portfolio to provide an adequate source of liquidity which can
be used to meet funding requirements for loan demand and deposit fluctuations
and to control interest rate risk. Therefore, from time to time, management may
sell certain securities prior to their maturity. Table 8 presents the investment
portfolio at the end of 2021 by major types of investments and contractual
maturity ranges. Investment securities in Table 8 may have repricing or call
options that are earlier than the contractual maturity date.



                                       35
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Management discussion and analysis

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The total amortized cost of investment securities increased by approximately
$98.8 million from December 31, 2020 to December 31, 2021, while the average
balance of investment securities carried throughout the year increased by
approximately $63.0 million from 2020 to 2021. The average yield of the
investment portfolio decreased to 1.60% for the year ended December 31, 2021
compared to 2.30% for 2020.


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Table 8. investment securities – Term/Revenue Plan (dollars in thousands)

————————————————– ——————————

                                                      December 31, 2021
                      In One        After One        After Five       After         Book         Market         Book          Book
                      Year or        Through          Through          Ten          Value         Value         Value         Value
                       Less         Five Years       Ten Years        Years       12/31/21      12/31/21      12/31/20      12/31/19
Investment
securities:
U.S. Government
agencies             $       -     $          -     $      6,250     $ 14,083     $  20,333     $  20,149     $       -     $       -
Mortgage-backed
securities                   -            2,004           14,437       47,996        64,437        63,311        15,212        19,540
Corporate
securities                   -            1,500                -            -         1,500         1,500         1,500         1,500
State and
municipal
securities               2,801            1,270            8,935      

32,308 45,314 44,755 16,059 11,777 Total

                $   2,801     $      4,774     $     29,622     $ 

94,387 $131,584 $129,715 $32,771 $32,817

Weighted average
yields (1):
U.S. Government
agencies                  0.00 %           0.00 %           1.39 %       1.81 %        1.68 %
Mortgage-backed
securities                0.00 %           2.00 %           1.36 %       1.36 %        1.38 %
Corporate
securities                0.00 %           1.65 %           0.00 %       0.00 %        1.65 %
State and
municipal
securities                2.42 %           4.00 %           1.49 %       2.24 %        2.16 %
Total                     2.42 %           2.42 %           1.41 %       1.73 %        1.70 %



(1) Weighted average returns on investments are based on amortized

       cost and are calculated on a tax equivalent basis.



--------------------------------------------------------------------------------
Deposits



The Company relies on deposits generated in its market area to provide the
majority of funds needed to support lending activities and for investments in
liquid assets.  More specifically, core deposits (total deposits less
certificates of deposit in denominations of more than $250,000) are the primary
funding source.  The Company's balance sheet growth is largely determined by the
availability of deposits in its markets, the cost of attracting the deposits,
and the prospects of profitably utilizing the available deposits by increasing
the loan or investment portfolios.  The Company's management must continuously
monitor market pricing, competitor's rates, and the internal interest rate
spreads to maintain the Company's growth and profitability.  The Company
attempts to structure rates so as to promote deposit and asset growth while at
the same time increasing overall profitability of the Company.



Average total deposits for the year ended December 31, 2021 amounted to $839.1
million, which was an increase of $154.6 million, or 22.59% from 2020.  A
significant portion of the increase is attributed to increased balances held by
customers during the pandemic, new relationships developed from the SBA-PPP
program, as well as organic growth in new and existing markets.  Average core
deposits totaled $801.0 million in 2021 representing a 23.41% increase over the
$649.0 million in 2020.  The percentage of the Company's average deposits that
are interest-bearing decreased to 67.4% in 2021 compared to 69.5% in 2020.  This
decrease is due to the average demand deposits, which earn no interest,
increasing 31.10% from $208.5 million in 2020 to $273.4 million in 2021.
Average deposits for the periods ended December 31, 2021 and 2020 are summarized
in Table 9.



                                       36
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Management discussion and analysis

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Table 9. Deposit Mix (Dollars in Thousands)

————————————————– ——————————

                                     December 31, 2021                      

December 31, 2020

                          Average       % of Total        Average        

Average % of total average

                          Balance        Deposits        Rate Paid       Balance        Deposits        Rate Paid
Interest-bearing
deposits:
Interest-bearing DDA
accounts                 $ 113,840             13.6 %          0.09 %   $  86,696             12.7 %          0.12 %
Money market                83,995             10.0 %          0.23 %      58,372              8.5 %          0.39 %
Savings                    172,847             20.6 %          0.11 %     138,344             20.2 %          0.30 %
Individual retirement
accounts                    46,088              5.5 %          1.04 %      44,044              6.4 %          1.19 %
CD's $250,000 or less      110,825             13.2 %          0.94 %     113,037             16.5 %          1.34 %
CD's greater than
$250,000                    38,095              4.5 %          0.87 %      35,438              5.2 %          1.60 %
Total interest-bearing
deposits                   565,690             67.4 %          0.41 %     475,931             69.5 %          0.70 %

No interest

deposits                   273,393             32.6 %          0.00 %     208,530             30.5 %          0.00 %
Total deposits           $ 839,083            100.0 %          0.28 %   $ 684,461            100.0 %          0.49 %



--------------------------------------------------------------------------------


The average balance of certificates of deposit issued in denominations of more
than $250,000 increased by $2.7 million, or 7.50%, for the year ended December
31, 2021 compared to December 31, 2020. The strategy of management has been to
support loan and investment growth with core deposits and not to aggressively
solicit the more volatile, large denomination certificates of deposit. Loan and
investment securities growth in 2021 was primarily funded through core deposit
growth, thus reducing management's reliance on large denomination certificates
of deposit for funding purposes.



Estimated uninsured deposits totaled $279.3 million at December 31, 2021. Uninsured amounts are estimated based on the portion of the account balance that is in excess FDIC insurance limits. Table 10 includes maturity information related to uninsured term deposits December 31, 2021.

--------------------------------------------------------------------------------

Table 10. Estimated Maturities of Uninsured Term Deposits (Dollars in Thousands)

————————————————– ——————————

Estimated uninsured term deposits at December 31, 2021:

Remaining maturity of three months or less                 $  7,121

Remaining term of more than three months to six months 11,712 Remaining term of more than six months to twelve months 13,290 Remaining term of more than twelve months

                         9,152
Total estimated uninsured time deposits                    $ 41,275




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                                       37
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Management discussion and analysis

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Equity



Stockholders' equity totaled $85.2 million at December 31, 2021 compared to
$85.1 million at December 31, 2020. The increase of $88 thousand was due to
earnings of $9.5 million, plus share-based compensation of $155 thousand, less
other comprehensive losses of $1.6 million, less common stock repurchases of
$6.3 million, and the payment of dividends of $1.6 million. Book value increased
from $14.08 per share at December 31, 2020 to $15.20 per share at December 31,
2021.



Effective January 1, 2015, the federal banking regulators adopted rules to
implement the Basel III regulatory capital reforms from the Basel Committee on
Banking Supervision and certain provisions of the Dodd-Frank Act. The final
rules required the Bank to comply with the following minimum capital ratios: (i)
a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a
Tier 1 capital ratio of 6% of risk-weighted assets; (iii) a total capital ratio
of 8% of risk-weighted assets; and (iv) a leverage ratio of 4% of total assets.
As fully phased in on January 1, 2019, the rules require the Bank to maintain
(i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least
4.5%, plus a 2.5% "capital conservation buffer" (which is added to the 4.5%
common equity Tier 1 ratio, effectively resulting in a minimum ratio of common
equity Tier 1 to risk-weighted assets of at least 7%), (ii) a minimum ratio of
Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital
conservation buffer (which is added to the 6.0% Tier 1 capital ratio,
effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a
minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus
the 2.5% capital conservation buffer (which is added to the 8.0% total capital
ratio, effectively resulting in a minimum total capital ratio of 10.5%), and
(iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital
to average assets.



Under Basel III Capital requirements, a capital conservation buffer of 0.625%
became effective beginning on January 1, 2016. The capital conservation buffer
was gradually increased through January 1, 2019 to 2.50%. The capital
conservation buffer is designed to absorb losses during periods of economic
stress. Banks are now required to maintain levels that meet the required minimum
plus the capital conservation buffer in order to make distributions, such as
dividends, or discretionary bonus payments. The Banks's capital conservation
buffer is 4.23% as of December 31, 2021.



--------------------------------------------------------------------------------

Table 11. Banks Risk-based capital at year-end (dollars in thousands)

————————————————– ——————————

                                                           2021              2020

Tier 1 Capital                                         $      84,900     $      79,240
Unrealized gains on AFS preferred stock                            -        

Qualifying allowance for loan losses (limited to
1.25% of risk-weighted assets)                                 5,717             4,936
Total regulatory capital                               $      90,617     $      84,176
Total risk-weighted assets                             $     740,706     $     642,612

Tier 1 capital as a percentage of risk-weighted
assets                                                          11.5 %            12.3 %
Common Equity Tier 1 capital as a percentage of
risk-weighted assets                                            11.5 %            12.3 %
Total regulatory capital as a percentage of
risk-weighted assets                                            12.2 %            13.1 %
Leverage ratio*                                                  8.6 %             9.5 %



*Tier 1 capital divided by average total assets for the current quarter December 31 of every year.

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                                       38
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Management discussion and analysis

————————————————– ——————————

Distressed and Distressed Assets



Certain credit risks are inherent in making loans, particularly commercial and
consumer loans. Management prudently assesses these risks and attempts to manage
them effectively. The Bank attempts to use shorter-term loans and, although a
portion of the loans have been made based upon the value of collateral, the
underwriting decision is generally based on the cash flow of the borrower as the
source of repayment rather than the value of the collateral. The Bank also
attempts to reduce repayment risk by adhering to internal credit policies and
procedures. These policies and procedures include officer and customer limits,
periodic loan documentation review and follow up on exceptions to credit
policies.



Table 12 provides information about the allowance for loan losses, nonperforming
assets and loans past due 90 days or more and still accruing as of December 31,
2021 and 2020.


--------------------------------------------------------------------------------

Table 12. Credit loss data (dollars in thousands)

————————————————– ——————————

                                                               2021          2020

Allowance for loan losses                                    $   5,677     $   4,900
Total loans                                                  $ 683,532     $ 664,095
Allowance for loan losses to total loans                          0.83 %        0.74 %

Nonperforming loans:
Nonaccrual loans                                             $   1,320     $   4,803
Restructured loans                                               3,167         3,844
Purchased credit-impaired loans on accrual status                  103      

116

Loans past due 90 days or more and still accruing                    -             -
Total nonperforming loans                                        4,590         8,763
Foreclosed assets                                                    -             -
Total nonperforming assets                                   $   4,590     $   8,763

Total non-performing loans as a percentage of total loans 0.67%

     1.32 %
Total allowance for loan losses to nonperforming loans          123.68 %       55.92 %
Total nonperforming assets as a percentage to total assets        0.46 %        1.02 %
Total nonaccrual loans as a percentage to total loans             0.19 %        0.72 %
Total allowance for loan losses to nonaccrual loans              23.25 %       98.02 %



--------------------------------------------------------------------------------


Total nonperforming loans were 0.67% and 1.32% of total outstanding loans as of
December 31, 2021 and 2020, respectively.  The majority of the decrease in
nonaccrual loans from 2021 to 2020 came in the "farmland" category as a result
of one large credit returning to accrual status in 2021.  Nonaccrual loans in
this category decreased by $3.8 million.  Loans are placed in nonaccrual status
when, in management's opinion, the borrower may be unable to meet payments as
they become due.  When interest accrual is discontinued, all unpaid accrued
interest is reversed.  Loans are removed from nonaccrual status when they are
deemed a loss and charged to the allowance, transferred to foreclosed assets, or
returned to accrual status based upon performance consistent with the original
terms of the loan or a subsequent restructuring thereof.  Management's ability
to ultimately resolve these loans either with or without significant loss will
be determined, to a great extent, by general economic and real estate market
conditions.



For the years ended December 31, 2021 and 2020, interest income recognized on
loans in nonaccrual status was approximately $39 thousand and $46 thousand,
respectively. Had these credits been current in accordance with their original
terms, the gross interest income for these credits would have been approximately
$104 thousand and $210 thousand, respectively for the years ended December 31,
2021 and 2020.



Restructured loans represent troubled debt restructurings ("TDRs") that have
returned to accrual status after a period of performance in accordance with
their modified terms. The decrease in restructured loans from 2020 to 2021 came
primarily in the form of principal reductions. A TDR is considered to be
successful if the borrower maintains adequate payment performance under the
modified terms and is financially stable.



There were no foreclosed assets in 2021 or 2020. For more information on distressed assets and loan modifications in response to COVID-19, please see Note 5 of “Notes to the Consolidated Financial Statements” in the Company’s 2021 Annual Report.



                                       39
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Management discussion and analysis

————————————————– ——————————


As of December 31, 2021 and 2020 we had loans with a current principal balance
of $10.9 million and $15.1 million rated "Watch" or "Special Mention".  The
"Watch" classification is utilized by us when we have an initial concern about
the financial health of a borrower that indicate above average risk.  We then
gather current financial information about the borrower and evaluate our current
risk in the credit.  After this review we will either move the loan to a higher
risk rating category or move it back to its original risk rating.  Loans may be
left rated "Watch" for a longer period of time if, in management's opinion,
there are risks that cannot be fully evaluated without the passage of time, and
we want to review it on a more regular basis.  Assets that do not currently
expose the Bank to sufficient risk to warrant a classification such as
"Substandard" or "Doubtful" but otherwise possess weaknesses are designated
"Special Mention".  Loans rated as "Watch" or "Special Mention" are not
considered "potential problem loans" until they are determined by management to
be classified as "Substandard".  As of December 31, 2021, potential problem
loans classified as substandard totaled $6.0 million compared to $11.9 million
at December 31, 2020.  Past due loans are often regarded as a precursor to
further credit problems which would lead to future increases in nonaccrual loans
or other real estate owned.  As of December 31, 2021 loans past due 30-89 days
and still accruing totaled $346 thousand compared to $622 thousand at December
31, 2020.



Certain types of loans, such as option ARM products, subprime loans and loans
with initial teaser rates, can have a greater risk of non-collection than other
loans. The Bank has not offered these types of loans in the past and does not
offer them currently. Junior-lien mortgages can also be considered higher risk
loans. Our junior-lien portfolio at December 31, 2021 totaled $3.8 million, or
0.55% of total loans. The charge-off rates in this category do not vary
significantly from other real estate secured loans in the current year.



The allowance for loan losses is maintained at a level adequate to absorb
potential losses.  Some of the factors which management considers in determining
the appropriate level of the allowance for loan losses are: past loss
experience, an evaluation of the current loan portfolio, identified loan
problems, the loan volume outstanding, the present and expected economic
conditions in general, and in particular, how such conditions relate to the
market area that the Bank serves.  Bank regulators also periodically review the
Bank's loans and other assets to assess their quality.  Loans deemed
uncollectible are charged to the allowance.  Provisions for loan losses and
recoveries on loans previously charged off are added to the allowance.  The
reserve for loan losses at December 31, 2021 was approximately 0.83% of total
loans, compared to 0.74% at December 31, 2020.  Management's estimate of
probable credit losses inherent in the acquired Cardinal Bankshares Corporation
and Great State loan portfolios was reflected as a purchase discount which will
continue to be accreted into income over the remaining life of the acquired
loans.  As of December 31, 2021 and 2020, the remaining unaccreted discount on
the acquired loan portfolios totaled $1.0 million and $2.0 million,
respectively.  This remaining discount can be used for credit losses if a loss
occurs on individual loans in the purchased portfolios.



To quantify the specific elements of the allowance for loan losses, the Bank
begins by establishing a specific reserve for larger-balance, non-homogeneous
loans, which have been identified as being impaired. This reserve is determined
by comparing the principal balance of the loan with the net present value of the
future anticipated cash flows or the fair market value of the related
collateral. If the impaired loan is collateral dependent, then any excess in the
recorded investment in the loan over the fair value of the collateral that is
identified as uncollectible in the near term is charged off against the
allowance for loan losses at that time. The bank also collectively evaluates for
impairment smaller-balance TDRs. The specific component of the allowance for
smaller-balance TDR loans is calculated on a pooled basis considering historical
experience adjusted for qualitative factors. The bank then reviews certain loans
in the portfolio and assigns grades to loans which have been reviewed. Loans
which are adversely classified are given a specific allowance based on the
historical loss experience of similar type loans in each adverse grade with
further adjustments for external factors. The remaining portfolio is segregated
into loan pools consistent with regulatory guidelines. An allocation is then
made to the reserve for these loan pools based on the bank's historical loss
experience with further adjustments for external factors. The allowance is
allocated according to the amount deemed to be reasonably necessary to provide
for the possibility of losses being incurred within the respective categories of
loans, although the entire allowance is available to absorb any actual
charge-offs that may occur.



                                       40
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Management discussion and analysis

————————————————– ——————————

Table 13 shows net charge-offs, average loan balances, and the percentage of charge-offs to average loan balances. The allocation of the allowance for loan losses is shown in Table 14.

————————————————– ——————————

Table 13. Net charge-off analysis (dollars in thousands)

————————————————– ——————————

                                               December 31, 2021
                                                                Percentage of Net
                                                                  (Charge-Offs)
                                   Net                            Recoveries to
                              (Charge-Offs)       Average            Average
                               Recoveries          Loans              Loans

Construction & development   $             5     $  44,437                    0.01 %
Farmland                                   -        29,766                    0.00 %
Residential                                2       289,445                    0.00 %
Commercial mortgage                       61       220,897                    0.03 %
Commercial & agriculture                  45        34,457                    0.13 %
SBA-PPP                                    -        49,438                    0.00 %
Consumer & other                         (59 )      19,147                   (0.31 %)
Total                        $            54     $ 687,587                    0.01 %




                                               December 31, 2020
                                                                Percentage of Net
                                                                  (Charge-Offs)
                                   Net                            Recoveries to
                              (Charge-Offs)       Average            Average
                               Recoveries          Loans              Loans

Construction & development   $            (4 )   $  42,928                   (0.01 %)
Farmland                                   -        34,168                    0.00 %
Residential                              (37 )     269,646                   (0.01 %)
Commercial mortgage                        4       193,295                    0.00 %
Commercial & agriculture                 (31 )      33,301                   (0.09 %)
SBA-PPP                                    -        41,973                    0.00 %
Consumer & other                        (114 )      19,444                   (0.59 %)
Total                        $          (182 )   $ 634,755                   (0.03 %)





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--------------------------------------------------------------------------------

Table 14. Allocation of allowance for credit losses (dollars in thousands)

————————————————– ——————————


                                    December 31, 2021                              December 31, 2020
Balance at the end of                    % of            % of                           % of            % of
the period applicable                   ALL to         Loans to                        ALL to         Loans to
to:                      Amount         Loans         Total Loans       Amount         Loans         Total Loans

Construction &
development             $     484           1.09 %            6.48 %   $     499           1.08 %            6.93 %
Farmland                      315           1.26 %            3.66 %         406           1.25 %            4.89 %
Residential                 2,521           0.84 %           43.65 %       2,167           0.77 %           42.15 %
Commercial mortgage         1,908           0.83 %           33.66 %       1,421           0.70 %           30.70 %
Commercial &
agriculture                   321           0.84 %            5.62 %         293           0.87 %            5.07 %
SBA-PPP                         -           0.00 %            3.59 %           -           0.00 %            7.70 %
Consumer and other            128           0.56 %            3.34 %         114           0.67 %            2.56 %
Total                   $   5,677           0.83 %          100.00 %   $   4,900           0.74 %          100.00 %



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                                       41
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Management discussion and analysis

————————————————– ——————————

Financial instruments with off-balance sheet risk



The Bank is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. These instruments involve, to varying degrees, credit risk in excess
of the amount recognized in the consolidated balance sheets.



The Bank's exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as for on-balance sheet instruments. A summary of the Bank's
commitments at December 31, 2021 and 2020 is as follows:



                                 2021        2020

Commitments to extend credit   $ 140,526     $ 111,778
Standby letters of credit          1,161         1,260
                               $ 141,687     $ 113,038




Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on management's
credit evaluation of the party. Collateral held varies, but may include accounts
receivable, inventory, property and equipment, residential real estate and
income-producing commercial properties.



Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Collateral held varies
as specified above and is required in instances which the Bank deems necessary.

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