NEW PEOPLES BANKSHARES INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)

Caution Regarding Forward-Looking Statements

We make forward looking statements in this annual report on Form 10-K that are
subject to risks and uncertainties. These forward-looking statements include
statements regarding expectations, intentions, projections and beliefs
concerning our profitability, liquidity, and allowance for loan losses, interest
rate sensitivity, market risk, growth strategy, and financial and other goals.
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. The forward-looking
information is based on various factors and was derived using numerous
assumptions.





                                       17


Important factors that may cause actual results to differ from projections include:

º the success or failure of our efforts to implement our business plan;

º any required increase in our regulatory capital ratios;

º meet other regulatory requirements that may arise from the examinations,

     changes in the law and other similar factors;
   º deterioration of asset quality;
   º changes in the level of our nonperforming assets and charge-offs;
   º fluctuations of real estate values in our markets;
   º our ability to attract and retain talent;

º demographic changes in our markets which have a negative impact

economy;

º the uncertain outcome of current or future legislation or regulation or

the policies of state and federal regulators;

º good management of interest rate risk;

º good liquidity management;

º changes in general economic and business conditions in our market area and

United States in general;

º the credit risks inherent in granting loans such as changes in

ability to repay and our management of those risks;

º competition with other banks and financial institutions, and companies

outside the banking sector, including online lenders and those

businesses that have significantly greater access to capital and other

Resources;

º demand, development and acceptance of new products and services we have

offered or may offer;

º the effects of and changes in trade, monetary and fiscal policies and

laws, including interest rate policies Federal Reserveinflation,

interest rate, market and currency fluctuations;

º the occurrence of major natural disasters, including severe weather events

conditions, floods, health issues (including ongoing novel

coronavirus (COVID-19) outbreak and associated efforts to limit

spread of disease) and other catastrophic events;

º geopolitical conditions, including acts or threats of terrorism,

international hostilities or measures taken by the we Or other

governments in response to terrorist and/or military acts or threats

conflicts, which could have an impact on business and economic conditions we

     and abroad;
   º technology utilized by us;
   º our ability to successfully manage cyber security;
   º our reliance on third-party vendors and correspondent banks;
   º changes in generally accepted accounting principles;

º changes in government regulations, tax rates and other similar matters; and,

º other risks, which may be described, from time to time, in our filings with

     the SEC.



Because of these uncertainties, our actual future results may be materially
different from the results indicated by these forward-looking statements. In
addition, our past results of operations do not necessarily indicate our future
results. We expressly disclaim any obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise, except as required by law.



General



The following commentary discusses major components of our business and presents
an overview of our consolidated financial position at December 31, 2021 and
2020, as well as results of operations for the years ended December 31, 2021 and
2020. This discussion should be reviewed in conjunction with the consolidated
financial statements and accompanying notes and other statistical information
presented elsewhere in this Form 10-K.



New Peoples generates a significant amount of its income from the net interest
income earned by the Bank. Net interest income is the difference between
interest income and interest expense. Interest income depends on the volume of
interest-earning assets outstanding during the period and the interest rates
earned thereon. The Bank's interest expense is a function of the average amount
of interest-bearing deposits and borrowed money outstanding during the period
and the interest rates paid thereon. The quality of the assets further
influences the amount of interest income lost on nonaccruing loans and the
amount of provision expense added to the allowance for loan losses. The Bank
also generates noninterest income from service charges on deposit accounts,
debit and credit card interchange income, and commissions on insurance and
investment products sold.

                                       18





Critical Accounting Policies


Certain critical accounting policies affect the more significant judgments and
estimates used in the preparation of our financial statements. Our most critical
accounting estimates relate to our provision for loan losses and the calculation
of our deferred tax asset and any related valuation allowance.



The provision for loan losses reflects the estimated losses resulting from the
inability of our customers to make required payments. If the financial condition
of our borrowers were to deteriorate, resulting in an impairment of their
ability to make payments, our estimates would be updated, and additional
provisions could be required. For further discussion of the estimates used in
determining the allowance for loan losses, we refer you to the section on
"Allowance for Loan Losses" in this discussion.



Deferred tax assets or liabilities are computed based upon the difference
between financial statement and income tax bases of assets and liabilities using
the enacted marginal tax rate. A valuation allowance on net deferred tax assets
would be provided if it was deemed more likely than not such assets would not be
realized. At December 31, 2021 and 2020, the Company had no valuation allowance
on its net deferred tax assets.



The Company recognizes the tax benefit from an uncertain tax position only if it
is more likely than not the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the position. The tax
benefits recognized in the financial statements from such positions are then
measured based on the largest benefit that has a greater than 50% likelihood of
being realized upon settlement. For further discussion of the deferred tax asset
and valuation allowance, we refer you to the section on "Income Taxes and
Deferred Tax Assets" in this discussion.



For more information about our other critical accounting policies, see Note 2, Summary of Significant Accounting Policies, to our Consolidated Financial Statements, found in Item 8 of this Annual Report on Form 10-K.


Cyber Security



The Company, primarily through the Bank, depends on its ability to continuously
process, record and monitor a large number of customer transactions, and
customer, public and regulatory expectations regarding operational and
information security have increased over time. Accordingly, the Company's and
its subsidiaries' operational systems and infrastructure must continue to be
safeguarded and monitored for potential failures, disruptions and breakdowns.
Although the Company has business continuity plans and other safeguards in
place, disruptions or failures in the physical infrastructure or operating
systems that support its businesses and customers, or cyber-attacks or security
breaches of the networks, systems or devices on which customers' personal
information is stored and that customers use to access the Company's and its
subsidiaries' products and services could result in customer attrition,
regulatory fines, penalties or intervention, reputational damage, reimbursement
or other compensation costs, and/or additional compliance costs, any of which
could materially adversely affect the Company's results of operations or
financial condition.



Although to date the Company has not experienced any material losses relating to
cyber-attacks or other information security breaches, there can be no assurance
that it or its subsidiaries will not suffer such losses in the future. The
Company's risk and exposure to these matters remains heightened because of,
among other things, the evolving nature of these threats, our plans to continue
to implement our e-banking and mobile banking channel strategies and develop
additional remote connectivity solutions to serve our customers when and how
they want to be served. As a result, cyber security and the continued
development and enhancement of the Company's controls, processes and practices,
designed to protect its and its subsidiaries' systems, computers, software, data
and networks from attack, damage or unauthorized access, remain a priority for
the Company. As cyber threats continue to evolve, the Company may be required to
expend significant additional resources to continue to modify or enhance its
protective measures or to investigate and remediate any information security
vulnerabilities.



                                       19


As discussed in the Supervision and Regulation section, the federal banking
agencies have issued a joint rule that requires banking organizations to notify
their primary regulator as soon as possible and no later than 36 hours after any
cyber-security incident has occurred. The new rule takes effect on April 1,
2022, with full compliance extended to May 1, 2022.



To date, we have not experienced a significant compromise, significant data loss
or any material financial losses related to cyber-attacks, but our systems and
those of our customers and third-party service providers are under constant
threat and it is possible that we could experience a significant event in the
future.



Recent Events



Since March 2020, the COVID-19 pandemic has adversely affected our communities
and the way we do business, as well as, economic activity globally, nationally
and locally. Among other things, interest rates declined, unemployment increased
and economic output slowed dramatically during 2020.



Within the last year, as restrictions related to the pandemic eased, employment
increased and pent-up demand was released, creating global supply chain issues
and shortages of goods, which in turn has triggered price inflation we have not
seen in over 30 years. In an effort to address inflation, the Federal Open
Market Committee (the "FOMC") has slowed monetary accommodation and on March 16,
2022 increased the federal funds rate 25 bps, in the first of what is expected
to be a series of rate increases during 2022.



Adding to economic uncertainty and increased inflationary pressures are military
actions taken by Russia against Ukraine commencing in February 2022, which have
added stress to existing supply chain concerns and placed upward pressure on oil
and natural gas prices.



At this time, we cannot reasonably estimate the term or intensity of any
possible adverse impact on our financial position, operations or liquidity,
resulting from economic disruption and uncertainty related to COVID-19 variants,
trade and supply chain disruption, continuing inflationary pressures, ongoing
military actions against Ukraine, and the uncertainty of the timing and extent
of potential actions that might be taken by the FOMC.



Overview



The Company made significant progress during 2021 resulting in a record
consolidated net income for the year ended December 31, 2021, of $7.0 million,
or basic income per share of $0.29, as compared to a net income of $2.9 million,
or basic income per share of $0.12, for the year ended December 31, 2020, an
improvement of $4.1 million, or 142.6%. Retained earnings stood at $2.0 million
at December 31, 2021, the first time it has been positive since 2010.



The improvement is due to an increase of $2.1 million in net interest income, a
decrease of $1.9 million in provision for loan loss expense, and an increase of
$1.8 million in noninterest income, offset by an $870 thousand increase in
noninterest expense. The increase of $2.1 million in net interest income was due
primarily to a decrease of $2.0 million in interest expense on deposits, plus an
increase of $329 thousand in interest income on investments, partially offset by
a $315,000 decrease in interest income on loans, including fees. The reduction
in both interest income and interest expense was driven mainly by lower market
rates, which remained low throughout 2020 and 2021. The decrease of $1.9 million
in provision for loan loss expense is due to improving asset quality, as
exhibited by reductions in past due loans, classified loans and nonaccrual
loans, along with improving employment and non-inflation related economic
conditions. The $1.8 million increase in noninterest income was driven by an
additional $507 thousand in service charges and fees, a $557 thousand increase
in card processing and interchange income, a $313 thousand increase in financial
services fees, plus nonrecurring gains on sales of investment securities of $322
thousand. Noninterest expense grew by $870 thousand primarily due to valuation
adjustments of $1.1 million on three former branch office locations, which were
transferred into other real estate owned, offset by a $566 thousand reduction in
salaries and benefit expense.



During the year ended December 31, 2021, total assets grew $38.3 million, or
5.1%, to $794.6 million. Loan balances increased $18.2 million, or 3.2%.
Excluding the net impact of $25.3 million in PPP loan originations and $53.6
million of PPP loan repayments, the remaining loan portfolio grew $46.6 million,
due largely to our new Boone loan production office, which opened during the
fourth quarter of 2020. Deposits grew $39.5 million, or 5.9%, due to the impact
of stimulus payments and PPP loan funds during the first half of the year,
combined with residual liquidity that remains in the financial markets. This
deposit growth, combined with a decrease of $30.3 million in interest bearing
deposits in other banks, funded a net increase in the investment portfolio
of
$59.0 million.



                                       20


The Company’s key performance indicators are as follows:




                                             Year ended December 31,
                                              2021              2020

Return on average assets                         0.88 %           0.39 %
Return on average equity                        11.52 %           5.18 %
Average equity to average assets ratio           7.62 %           7.51 %

Highlights for 2021 include:

Net profit improved by 142.6% to an all-time high of $7.0 millionWhere

$0.29 per share, in 2021 compared to $2.9 millionWhere $0.12 per share, in 2020;

Total assets increased $38.3 millioni.e. 5.1%, at $794.6 million in December

31 2021 compared to $756.3 million at December 31, 2020;

The book value per share was $2.66 from December 31, 2021 and $2.43 from december

31, 2020;

The net interest income was $27.2 millionan augmentation of $2.1 million compared to

2020, as described above;

Our net interest margin was 3.64%, a reduction of 1 basis point compared to

3.65% for the year ended December 31, 2020;

Total loans increased $18.2 millioni.e. 3.2%, to $593.7 million during the year

ended December 31, 2021;

The titles available for sale have increased $59.0 millioni.e. 121.8%, at $107.4

million during the year ended December 31, 2021;

Total deposits increased $39.5 millioni.e. 5.9%, at $707.5 million during the

year ended December 31, 2021mainly due to PPP loan funds and the federal government

stimulus payments;

Non-interest income was $10.0 millionan augmentation of $1.8 million compared to

2020;

· Salary and benefits expenses have been $12.7 milliona reduction of $566

thousands compared to 2020, which is mainly explained by the announced restructuring

in May 2020 and the overall downsizing;

During the fourth quarter of 2021, we began to implement a plan to grow our

minimum wage at $15.00 per hour.;

Non-performing assets, which include non-accrual loans and other real estate

possessed, totaled $4.3 million at December 31, 2021a decrease of $4.6 million,

i.e. 51.6% during the year ended December 31, 2021;

Non-performing assets as a percentage of total assets were 0.54% at the 31st of December,

2021, compared to 1.17% at December 31, 2020;

Annualized net charges as a percentage of average loans were 0.14% over the course of

2021, compared to 0.08% in 2020; and

The allowance for loan losses as a percentage of total loans was 1.13% at

   December 31, 2021, as compared to 1.25% at December 31, 2020.



For more details on the items highlighted above, see the following related sections.

Net interest income and net interest margin



The Company's primary source of income is net interest income, which increased
$2.1 million, or 8.2% in 2021 compared to 2020, due primarily to a decrease of
$2.0 million in interest expense on deposits, plus an increase of $329,000 in
interest income on investments, partially offset by a $315,000 decrease in
interest income on loans, including fees. The reduction in interest expense on
deposits is due to reduced rates on time deposits and a reduction of $34.7
million in average time deposit balances. The increase in interest income on
investments is due to an increase in average balances of $33.6 million, as we
redeployed excess funds into investment securities, which generally provide
higher yields than federal funds or interest-earning correspondent accounts. The
decrease in interest income on loans, including fees, was driven by a decrease
of $1.4 million in interest on loans, offset by an increase in fees of $1.1
million, resulting from PPP loan forgiveness.



The following table shows the rates paid on earning assets and deposit liabilities for the periods indicated.






                                       21





                                                 Net Interest Margin Analysis
                                  Average Balances, Income and Expense, and Yields and Rates

                                                    (Dollars in thousands)
                                                         For the Year Ended                    For the Year Ended
                                                          December 31, 2021                     December 31, 2020
                                                     Average   Income/   Yields/      Average         Income/        Yields/
                                                     Balance   Expense    Rates       Balance         Expense         Rates
ASSETS
  Loans (1) (2)                                    $ 586,963 $  28,323     4.83%  $      578,979  $      28,638          4.95%
  Federal funds sold                                     212         -     0.10%             244              1          0.36%
  Interest bearing deposits in other banks            78,583        95     0.12%          61,083            208          0.34%
  Taxable investment securities                       81,635     1,494    

1.83% 48,072 1,189 2.47%

  Total earning assets                               747,393    29,912    

4.00% 688,378 30,036 4.37%

  Less: Allowance for loans losses                   (7,034)                             (6,512)
  Non-earning assets                                  58,398                              61,411
      Total Assets                                 $ 798,757                      $      743,277

LIABILITIES AND EQUITY

  Interest-bearing demand deposits                 $  59,154 $      59    

0.10% $45,302 $70 0.15%

  Savings and money market deposits                  181,736       148    
0.08%         148,320            360          0.24%
  Time deposits                                      214,937     2,041     0.95%         252,074          3,854          1.53%
  Short-term borrowings                                2,474        33     1.33%           5,000             68          1.36%
  Trust preferred securities                          16,496       420     2.55%          16,496            541          3.28%
    Total interest-bearing liabilities               474,797     2,701     

0.57% 467,192 4,893 1.05%

  Non-interest-bearing deposits                      254,911         -        -%         210,831              -            - %
    Total deposit liabilities and cost of funds      729,708     2,701     0.37%         678,023          4,893          0.72%
  Other liabilities                                    8,178                               9,431
      Total Liabilities                              737,886                             687,454
  Stockholders' Equity                                60,871                              55,823
      Total Liabilities and Stockholders' Equity   $ 798,757                      $      743,277
  Net Interest Income                                        $  27,211                            $      25,143
  Net Interest Margin                                                      3.64%                                    3.65%
  Net Interest Spread                                                      3.43%                                    3.32%

(1) Unexpected loans have been included in average loan balances. (2) Tax-exempt income is not material and has been treated as fully taxable.

Net interest income is affected by changes in both average interest rates and
average volumes (balances) of interest-earning assets and interest-bearing
liabilities. The following tables set forth the amounts of the total changes in
interest income and interest expense which can be attributed to rates, volume
and a combination of rates and volume, for the periods indicated.



                                       22





                            Volume and Rate Analysis
                              Increase (decrease)




                                    Year 2021 Compared to 2020
                                                                          Rate and Volume       Change in Interest
(Dollars in thousands)               Volume Effect      Rate Effect            Effect            Income/ Expense
Interest Income:
Loans                               $        395       $       (700 )    $         (10 )       $         (315 )
Federal funds sold                            -                  (1 )               -                      (1 )
Interest bearing deposits in
other banks                                   59               (134 )              (38 )                 (113 )
Taxable investment securities                830               (309 )      
      (216 )                  305
Total Earning Assets                       1,284             (1,144 )             (264 )                 (124 )

Interest Expense:
Interest-bearing demand deposits              21                (25 )      
        (7 )                  (11 )
Savings and money market
deposits                                      81               (239 )              (54 )                 (212 )
Time deposits                               (568 )           (1,460 )              215                 (1,813 )
Short-term borrowings                        (34 )               (1 )               -                     (35 )
Trust preferred securities                    -                (121 )               -                    (121 )
Total Interest-bearing
Liabilities                                 (500 )           (1,846 )              154                  (2192 )

Change in net interest income $1,784 $702 $

      (418 )       $        2,068






                                    Year 2020 Compared to 2019
                                                                          Rate and Volume       Change in Interest
(Dollars in thousands)               Volume Effect      Rate Effect            Effect            Income/ Expense
Interest Income:
Loans                               $      1,196       $     (1,113 )    $         (47 )       $           37
Federal funds sold                            -                  (4 )               -                      (4 )
Interest bearing deposits in
other banks                                  456               (672 )             (381 )                 (597 )
Taxable investment securities               (280 )              (91 )      
        17                   (355 )
Total Earning Assets                       1,372             (1,880 )             (411 )                 (919 )

Interest Expense:
Interest-bearing demand deposits              18                (10 )      
        (3 )                    5
Savings and money market
deposits                                     (39 )             (605 )               24                   (620 )
Time deposits                               (131 )              (78 )                3                   (206 )
Short-term borrowings                        (12 )                3                 (1 )                  (10 )
Trust preferred securities                    -                (255 )               -                    (255 )
Total Interest-bearing
Liabilities                                 (164 )             (945 )               23                 (1,086 )

Change in net interest income $1,536 $ (935 ) $

      (434 )       $          167



The reduction in interest income and interest expense during both 2021 and 2020
was driven mainly by lower market rates, which have fallen throughout both
years. Overall, our net interest margin decreased 1 basis point to 3.64%in 2021
compared to 3.65% in 2020. While the yield on average assets decreased 37 basis
points, to 4.00% from 4.37%, the cost of funds decreased 35 basis points, to
0.37% from 0.72%.



The reduction in market rates was a direct result of actions taken by the FMOC,
which, in response to the economic impact of the pandemic, reduced the target
federal funds rate twice in March 2020, by 150 bps. As a result, the target
federal funds rate stood at 0.00% - 0.25% and the prime interest rate stands at
3.25%. In March 2022, the FMOC increased the target federal funds rate 25 bps,
resulting in the prime interest rate increasing to 3.50%. It is the general
consensus that this increase is the first of a series of increases that the
FOMC
will effect in 2022.

                                       23




The decrease in interest income is primarily attributed to reduced yield on
loans, not including fees, which was mainly driven by lower market rates, as
noted above, plus materially lower rates earned on PPP loans. The yield on PPP
loans is 1.00%, excluding the impact of deferred fee income. Although loan fees
earned and recognized on PPP loans has been material during 2021 and 2020, it
does not completely make up for the reduced yield. The increase in loan fee
income is a result of recognition of net deferred fees on PPP loans totaling
$2.0 million in 2021, and $994 thousand in 2020. Total loan fees recognized as
part of the yield calculation on loans was $2.4 million during 2021 and $1.3
million during 2020. Overall, loan interest income, including fees, was lower in
2021 than 2020 by $315 thousand.



The PPP ended in June 2021and the remaining PPP loan balances totaled only $6.4 million at December 31, 2021. Therefore, the remaining PPP loans and net unearned fees are not expected to have a material impact on future earnings.



Interest income was positively impacted by an additional $305 thousand of
interest earned on investment securities, all of which are taxable, due to
additional average balances of $33.6 million, as we redeployed excess funds into
investment securities, which generally provide higher yields than federal funds
sold or interest-bearing deposits in other banks. This improvement in interest
income on investments offset the negative effect of reduced interest income from
loans. The yield on investment securities decreased to 1.83% in 2021 from 2.47%
in 2020, due to lower market rates, as noted above.



Interest expense decreased $2.2 million, which more than offset the decrease of
$124 thousand in interest income, driving a $2.1 million improvement in net
interest income. The primary driver of the improvement in interest expense, and
overall cost of funds, was the reduced cost of time deposits, which decreased to
0.95% in 2021 compared to 1.53% in 2020, along with increased average balances
in all other types of deposit accounts, which generally have lower rates.



This change in the mix of our deposits has supported the reduction in our
average cost of funds to 0.37% during 2021, compared to 0.72% during 2020.
Average balances of time deposits decreased $37.1 million while average balances
of interest-bearing demand deposits grew $13.9 million, average balances of
savings and money market deposits grew $34.4 million, and average balances of
noninterest-bearing deposits grew $44.1 million. Increases in average balances
of both interest-bearing and noninterest-bearing deposits is primarily due to
stimulus payments and PPP funds, which are generally deposited into customer
deposit accounts.


Due to the increased deposit balances, additional borrowings from the FHLB have
not been necessary. The Company paid off the last remaining FHLB advance of $5.0
million in June 2021, when it matured.



Our future interest rate structure has been impacted by the commencement of the
end of the use of LIBOR, which will completely phase-out in 2023. We use LIBOR
in pricing some of our interest earning assets and liabilities, including our
trust preferred securities. Certain loan and investment products ceased using
LIBOR in 2021, for new contracts and commitments. Most of these contracts have
been, or will be, replaced with the secured overnight funding rate (SOFR).

Loans



Our primary source of income is interest earned on loans. Total loan balances
increased $18.2 million during 2021, or 3.2%, to $593.7 million at December 31,
2021 as compared to $575.6 million at December 31, 2020. The primary drivers of
this increase in total loans were $26.8 million of growth in commercial loans
secured by real estate, and $16.5 million of growth in multifamily loans secured
by real estate. Commercial loan balances decreased $31.7 million, due mainly to
a decrease in PPP loan balances of $28.4 million. PPP loans totaled $6.4 million
at December 31, 2021. For more detail on loan balances, refer to Note 6 of the
Consolidated Financial Statements and Notes in Item 8 of this Form 10-K.



Nonaccrual loan balances decreased $2.6 million during 2021 to $2.9 million at
December 31, 2021. Nonaccrual loans negatively affect interest income as these
loans are nonearning assets. When doubt about the collectability of a loan
exists, it is the Bank's policy to stop accruing interest on that loan under the
following circumstances: (a) whenever we are advised by the borrower that
scheduled payment or interest payments cannot be met, (b) when conditions
indicate that payment of principal and interest can no longer be expected, or
(c) when any such loan becomes delinquent for 90 days and is not both well
secured and in the process of collection. All interest accrued but not collected
on loans that are placed on nonaccrual is charged off and reversed against
interest income in the current period. In the case of a nonaccrual loan that is
well secured and in the process of collection, the interest accrued but not
collected is not reversed. Interest received on these loans is accounted for on
the cash basis or cost-recovery method until qualifying for return to accrual.
Generally, loans are returned to accrual status when all the principal and
interest amounts contractually due are brought current, six consecutive timely
payments are made, and prospects for future contractual payments are reasonably
assured. For more detail on nonaccrual loans, refer to Note 6 of the
Consolidated Financial Statements and Notes in Item 8 of this Form 10-K.

                                       24





Impaired loan balances also decreased during 2021, to $2.8 million at December
31, 2021, from $5.1 million at December 31, 2020. Interest income and cash
receipts on impaired loans are handled differently depending on whether or not
the loan is on nonaccrual status. If the impaired loan is not on nonaccrual
status, the interest income on the loan is computed using the effective interest
method. For more detail on impaired loan balances, refer to Note 6 of the
Consolidated Financial Statements and Notes in Item 8 of this Form 10-K.



The following table presents the dollar composition and percentage of our loan
portfolio as of December 31:



                                   Loan Composition
                                               2021                      2020
(Dollars in thousands)                     $            %            $            %
Real estate secured:
  Commercial                          $ 206,162        34.7 %   $ 179,381        31.2 %
  Construction and land development      32,325         5.4 %      25,031         4.3 %
  Residential 1-4 family                224,530        37.8 %     222,980        38.7 %
  Multifamily                            33,048         5.6 %      16,569         2.9 %
  Farmland                               18,735         3.2 %      18,368         3.2 %
   Total real estate loans              514,800        86.7 %     462,329        80.3 %
Commercial                               54,325         9.1 %      86,010        14.9 %
Agriculture                               4,021         0.7 %       4,450         0.8 %
Consumer installment loans               18,756         3.2 %      20,632         3.6 %
All other loans                           1,842         0.3 %       2,145         0.4 %
Total loans                             593,744       100.0 %     575,566       100.0 %
Less: Allowance for loan losses           6,735                     7,191
Total                                 $ 587,009                 $ 568,375




Our loan maturities, and the split between fixed rate and variable rate loans at December 31, 2021 are shown in the following table:




                                       25





                                           Maturities of Loans
                               Less than One   One to Five       Five to      After Fifteen
(Dollars in thousands)             Year           Years       Fifteen Years       Years          Total
Real estate secured:
  Commercial                   $    19,831     $   54,437     $    77,974   

$53,920 $206,162

  Construction and land
development                          6,041          6,177          11,942  
        8,165        32,325
  Residential 1-4 family             6,989         20,928          84,520         112,093       224,530
  Multifamily                          989          4,523          10,749          16,787        33,048
  Farmland                           4,079          2,491           7,631           4,534        18,735
   Total real estate loans          37,929         88,556         192,816         195,499       514,800
Commercial                          10,453         34,483           6,624           2,765        54,325
Agriculture                          1,373          2,292              56             300         4,021
Consumer installment loans           2,219         13,788           2,713  
           36        18,756
All other loans                      1,444            398              -               -          1,842
Total                          $    53,418     $  139,517     $   202,209     $   198,600     $ 593,744




The following table shows the dollar amount of fixed rate and floating rate loans with maturities greater than one year as at December 31, 2021:





(Dollars in thousands)                 Fixed Rate     Variable Rate
Real estate secured:
  Commercial                          $   94,563     $       91,768
  Construction and land development       14,967             11,317
  Residential 1-4 family                  91,450            126,091
  Multifamily                             12,127             19,932
  Farmland                                 3,276             11,380
   Total real estate loans               216,383            260,488
Commercial                                36,088              7,784
Agriculture                                2,340                308
Consumer installment loans                13,832              2,705
All other loans                              398                 -
Total                                 $  269,041     $      271,285




Contractual maturities of loans do not reflect the actual term of our loan
portfolio. The average life of mortgage loans is substantially less than the
contractual life due to prepayments and enforcement of due on sale clauses.
Scheduled principal amortization also reduces the average life of the loan
portfolio. The average life of mortgage loans tends to increase when current
market mortgage rates are substantially above rates on existing loans while the
average life decreases when rates on existing loans are substantially above
current market rates.



Some variable rate loans may not reprice, or fully reprice, at their next reset
date due to instances where the reset rate may not be above the rate floor, or
may be more than the allowable rate increase under the terms of the loan. In
these instances, it may take several reset periods before these loans are fully
adjusted.



                                       26



Allowance for Loan Losses



The methodology we use to calculate the allowance for loan losses is considered
a critical accounting policy. The adequacy of the allowance for loan losses is
based upon management's judgment and analysis. The following factors are
included in our evaluation of determining the adequacy of the allowance: risk
characteristics of the loan portfolio, current and historical loss experience,
concentrations, and internal and external factors such as general economic
conditions.



During 2020, in response to the impact of the pandemic, changes to the allowance
model included reviewing our internal scoring related to loan modifications and
extensions, and external factors, specifically unemployment and other economic
factors. During the fourth quarter of 2021, in response to rising price
inflation, this factor has been added to the economic factors considered in the
model. We continue to adjust the allowance for loan loss model to best reflect
the risks in the portfolio and the improvements made in our internal policies
and procedures; however, future provisions may be deemed necessary.



The allowance is increased by a provision for loan losses, which is charged to
expense and reduced by charge-offs, net of recoveries. Loans are charged against
the allowance for loan losses when management believes that collectability of
all or part of the principal is unlikely. Subsequent to charging off a loan,
management makes best efforts to recover any charged-off balances.



The allowance for loan losses decreased to $6.7 million at December 31, 2021 as
compared to $7.2 million at December 31, 2020. The allowance for loan losses at
the end of 2021 was approximately 1.13% of total loans as compared to 1.25% at
the end of 2020. Provisions for loan losses of $372 thousand and $2.3 million
were recorded during 2021 and 2020, respectively. Loans charged off, net of
recoveries, totaled $828 thousand, or 0.28% of average loans, for the year ended
December 31, 2021, compared to $477 thousand, or 0.08% of average loans, in
2020. The low percentage in 2020 is primarily related to the moratorium on
foreclosures that existed for most of 2020. The allowance for loan losses is
being maintained at a level that management deems appropriate to absorb any
potential future losses and known impairments within the loan portfolio whether
or not the losses are actually ever realized.



Nonaccrual loans present higher risks of default, and we have experienced a
decrease in these loans during 2021. At December 31, 2021, there were 65
nonaccrual loans totaling $2.9 million, or 0.50% of total loans. At December 31,
2020, there were 75 nonaccrual loans totaling $5.5 million, or 0.96% of total
loans. The amount of interest income that would have been recognized on these
loans had they been accruing interest was $223 thousand and $494 thousand in the
years 2021 and 2020, respectively. There were no loans past due 90 days or
greater and still accruing interest at either December 31, 2021 or 2020. There
are no commitments to lend additional funds to non-performing borrowers.



A majority of our loans are collateralized by real estate located in our market
area. It is our policy to sufficiently collateralize loans to help minimize
exposure to losses in cases of default. Increasing real estate values in our
area have reduced this exposure somewhat. However, while we consider our market
area to be somewhat diverse, certain areas are more reliant upon agriculture,
coal mining and natural gas. As a result, increased risk of loan impairments is
possible due to the volatile nature of the coal mining and natural gas
industries. As a result of the economic impact of the COVID-19 pandemic, a
number of industries have been identified as posing increased risk.
Specifically, residential and commercial rentals, hotels, restaurants and
entertainment, and the coal and gas industries have been adversely impacted by
the global and domestic economic slowdown. We are monitoring these industries
and consider these segments to be the primary higher risks in the loan
portfolio.



Commercial and commercial real estate loans are initially risk rated by the
originating loan officer. If deterioration in the financial condition of the
borrower and/or their capacity to repay the debt occurs, the loan may be
downgraded by the loan officer. Guidance for risk rate grading is established by
the regulatory authorities who periodically review the Bank's loan portfolio for
compliance. Classifications used by the Bank are Pass, Special Mention,
Substandard, Doubtful and Loss.



With regard to the Bank's consumer and consumer real estate loan portfolio, we
use the guidance found in the Uniform Retail Credit Classification and Account
Management Policy which affects our estimate of the allowance for loan losses.
Under this approach, a consumer or consumer real estate loan must initially have
a credit risk grade of Pass or better. Subsequently, if the loan becomes
contractually 90 days past due or the borrower files for bankruptcy protection,
the loan is downgraded to Substandard and placed in nonaccrual status. If the
loan is unsecured upon being deemed Substandard, the entire loan amount is
charged-off.



                                       27



For non-1-4 family residential loans that are 90 days or more past due or in
bankruptcy, the collateral value less estimated liquidation costs is compared to
the loan balance to calculate any potential deficiency. If the collateral is
sufficient, then no charge-off is necessary. If a deficiency exists, then upon
the loan becoming contractually 120 days past due, the deficiency is charged-off
against the allowance for loan loss. In the case of 1-4 family residential or
home equity loans, upon the loan becoming 120 days past due, a current value is
obtained and after application of an estimated liquidation discount, a
comparison is made to the loan balance to calculate any deficiency.
Subsequently, any noted deficiency is then charged-off against the allowance for
loan loss when the loan becomes contractually 180 days past due. If the customer
has filed bankruptcy, then within 60 days of the bankruptcy notice, any
calculated deficiency is charged-off against the allowance for loan loss.
Collection efforts continue by means of repossessions or foreclosures, and upon
bank ownership, liquidation ensues.



All loans classified as substandard, doubtful or loss are individually reviewed
for impairment in accordance with Accounting Standards Codification (ASC)
310-10-35. In evaluating impairment, a current appraisal is generally used to
determine if the collateral is sufficient. Appraisals are typically less than a
year old and must be independently reviewed to be relied upon. If the appraisal
is not current, we perform a useful life review of the appraisal to determine if
it is reasonable.  If this review determines that the appraisal is not
reasonable, then a new appraisal is ordered. Loans considered impaired decreased
to $2.8 million with $880 thousand requiring a valuation allowance of $166
thousand at December 31, 2021, as compared to $5.1 million with $2.5 million
requiring a valuation allowance of $1.1 million at December 31, 2020. Management
is aggressively working to reduce the impaired credits at minimal loss.



In determining the component of our allowance in accordance with the
Contingencies topic of the Accounting Standards Codification (ASC 450), we do
not directly consider the potential for outdated appraisals since that portion
of our allowance is based on the analysis of the performance of loans with
similar characteristics, external and internal risk factors. We consider the
overall quality of our underwriting process in our internal risk factors, but
the need to update appraisals is associated with loans identified as impaired
under the Receivables topic of the Accounting Standards Codification (ASC 310).
If an appraisal is older than one year, a new external certified appraisal may
be obtained and used to determine impairment. If an exposure exists, a specific
allowance is directly made in the amount of the potential loss, in addition to
estimated liquidation and disposal costs. The evaluation is inherently
subjective as it requires estimates that are susceptible to significant revision
as more information becomes available.



In addition to impaired loans, the remaining loan portfolio is evaluated based
on net charge-off history, economic conditions, and internal processes. To
calculate the net charge-off history factor, we perform a 12-quarter look-back
and use the average net charge offs as a percentage of the loan balances. To
calculate the economic conditions factor, we use current economic data which
includes national and local regional unemployment information, local housing
price changes, gross domestic product growth, and interest rates. Lastly, we
evaluate our internal processes of underwriting and consider the inherent risks
present in the portfolio due to past and present lending practices. As economic
conditions, performance of our loans, and internal processes change, it is
possible that future increases or decreases may be needed to the allowance
for
loan losses.



                              Selected Credit Ratios
                                                               December 31,
(Dollars in thousands)                                      2021          2020
Allowance for loan losses                                $   6,735     $   7,191
Total loans                                                593,744       575,566
Allowance for loan losses to total loans                      1.13 %        1.25 %
Nonaccrual loans                                         $   2,941     $  

5,548

Nonaccrual loans to total loans                               0.50 %       

0.96%

Ratio of allowance for loan losses to nonaccrual loans        2.29 X        1.30 X

Charge-offs net of recoveries                            $     828     $     477
Average loans                                            $ 586,963     $ 578,979
Net charge-offs to average loans                              0.14 %       
0.08 %





The above table includes $1.1 million and $2.5 million in nonaccrual loans as of
December 31, 2021 and 2020, respectively, which have been classified as troubled
debt restructurings. No troubled debt restructurings were past due 90 days or
more and still accruing interest at December 31, 2021 and 2020. There were $2.5
million in loans classified as troubled debt restructurings as of December 31,
2021, as compared to $4.0 million in loans classified as troubled debt
restructurings as of December 31, 2020. For more detail on nonaccrual, impaired,
past due and restructured loans, refer to Note 6 and Note 8 to the Consolidated
Financial Statements and Notes in Item 8 of this Form 10-K.

                                       28





The following table shows the average balance, net charge-offs or recoveries and
percentage of net charge-offs or recoveries by each major category of loans for
the years ended December 31, 2021 and 2020:





                                                                                                   December 31,
                                                          December 31, 2021                            2020
                                                                                       Net                                                      Net
                                                                                   Charge-offs                                              Charge-offs
                                                                                   (Recoveries)                                             (Recoveries)
                                                                                     as % of                                                  as % of
                                                            Net Charge-offs

Average loan Average net write-offs Average loan (thousands of dollars)

                Average Balance         (Recoveries)             Type          Balance           (Recoveries)             Type

Secure real estate:

 Commercial                          $       194,517     $           913                  0.47 %   $  175,281     $             8                 0.00 %
 Construction and land development            28,820                  (6 ) 
             -0.02 %       27,536                  -                  0.00 %
 Residential 1-4 family                      220,524                 (37 )               -0.02 %      235,289                 127                 0.05 %
 Multifamily                                  23,840                  -                   0.00 %       14,851                  -                  0.00 %
 Farmland                                     19,144                 (29 )               -0.15 %       19,749                   9                 0.05 %
 Total real estate loans                     486,845                 841                  0.17 %      472,706                 144                 0.03 %
 Commercial                                   74,711                 (45 )               -0.06 %       77,874                 289                 0.37 %
 Agriculture                                   4,095                  (1 )               -0.02 %        4,781                  14                 0.29 %
 Consumer and all other loans                 19,441                  33   
              0.17 %       21,819                  30                 0.14 %
 Unallocated                                   1,871                  -                   0.00 %        1,799                  -                  0.00 %
 Total loans                         $       586,963     $           828                  0.14 %   $  578,979     $           477                 0.08 %



The following table shows the balance and percentage of our allowance for loan losses allocated to each major category of loans.


                  Allocation of the Allowance for Loan Losses



                                                 December 31, 2021                          December 31, 2020
(Dollars in thousands)                 Amount      % of ALLL      % of Loans      Amount      % of ALLL     % of Loans
Real estate secured:
  Commercial                            2,134           31.7 %          

34.7% 2,281 31.8% 31.3%

  Construction and land development       189            2.8 %           5.4 %       233           3.2 %           4.4 %
  Residential 1-4 family                2,237           33.2 %          37.8 %     1,951          27.1 %          38.9 %
  Multifamily                             254            3.8 %           5.6 %       151           2.1 %           2.9 %
  Farmland                                149            2.2 %           3.2 %        97           1.3 %           3.2 %
Total real estate loans                 4,963           73.7 %          86.7 %     4,713          65.5 %          80.6 %
Commercial                            $ 1,099           16.3 %           9.1 %   $ 2,275          31.6 %          15.0 %
Agriculture                                28            0.4 %           0.7 %        40           0.6 %           0.8 %
Consumer and all other loans              108            1.6 %           3.5 %       163           2.3 %           3.6 %
Unallocated                               537            8.0 %            -           -             -               -
Total                                 $ 6,735          100.0 %         100.0 %   $ 7,191           100 %         100.0 %





We have allocated the allowance according to the amount deemed to be reasonably
necessary to provide for the possibility of losses being incurred within each of
the categories of loans. The allocation of the allowance as shown in the table
above should not be interpreted as an indication that loan losses in future
years will occur in the same proportions or that the allocation indicates future
loan loss trends. Furthermore, the portion allocated to each loan category is
not the total amount available for future losses that might occur within such
categories since the total allowance is a general allowance applicable to the
entire portfolio.


The allocation of the allowance for loan losses is based on our judgment of the
relative risk associated with each type of loan. We have allocated 31.7% of the
allowance to commercial real estate loans, which constituted 34.7% of our loan
portfolio at December 31, 2021. This allocation is similar to the 31.8% in 2020
due primarily to reduction in problem credits in this category over the past
several years. We have allocated 16.3% of the allowance to commercial loans,
which constituted 9.1% of our loan portfolio at December 31, 2021. This
allocation percentage increased compared to December 31, 2020 due to the
significant reduction in PPP loans, which are included in commercial loans,
which have guarantees provided by the SBA, which resulted in their being
excluded from the allowance assessment of commercial loans.

                                       29





Both residential and commercial real estate loans are secured by real estate
whose value tends to be easily ascertainable. These loans are made consistent
with appraisal policies and real estate lending policies, which detail maximum
loan-to-value ratios and maturities.



We have allocated 2.8% of the allowance to real estate construction loans, which
constituted 5.4% of our loan portfolio at December 31, 2021. Construction loans
are secured by real estate with values that are dependent upon market and
economic conditions. Additionally, these credits are generally shorter-term
projects, of eighteen months or less. These loans are made consistent with
appraisal policies and real estate lending policies which detail maximum
loan-to-value ratios and maturities.



We have allocated 33.2% of the allowance to residential real estate loans, which
constituted 37.8% of our loan portfolio at December 31, 2021. Our allocation
increased as a percentage of the allowance for loan losses due to the $1.6
million increase in residential real estate loans during 2021.



We have allocated 1.6% of the allowance to consumer and all other loans, which
constituted 3.5% of our loan portfolio at December 31, 2021. Our allocation
decreased as a percentage of the allowance for loan losses due to these credits
principally being loans to municipal and other government entities, compared to
the 2.3% allocation we had in 2020. At December 31, 2021, we had an unallocated
portion of the allowance for loan losses totaling $537 thousand. While our
legacy loan loss model calculation did not fully allocate the entire allowance,
we believe that the lingering impact of the pandemic, combined with the recent
impact of inflation warrant the maintenance of the allowance for loan losses.



We have commenced the process of implementing the Current Expected Credit Loss
(CECL) model to replace our legacy loan loss model. We expect to be testing and
running concurrent quarterly calculations of both our legacy and CECL models by
the second quarter of 2022.



Other Real Estate Owned



Other real estate owned decreased $2.0 million, or 59.2%, to $1.4 million at
December 31, 2021 from $3.3 million at December 31, 2020. All properties are
available for sale, primarily, by commercial and residential realtors under the
direction of our Special Assets division. Our aim is to reduce the level of OREO
in order to reduce the level of nonperforming assets at the Bank, while keeping
in mind the impact to earnings and capital. In 2021 and 2020, pricing
adjustments were made to make certain properties more marketable, which, in some
cases, reduced the price below the fair value of the property (which is based on
an appraisal less estimated disposition costs). During 2021, we recorded OREO
write-downs of $466 thousand as compared to $132 thousand during 2020.



During 2021, we added $566 thousand in OREO properties as a result of settlement
of foreclosed loans, offset by sales of $2.6 million with net gains of $76
thousand. During 2020, we added $1.1 million in OREO properties as a result of
settlement of foreclosed loans, which was offset by sales of $687 thousand with
net gains totaling $60 thousand. As noted previously, a moratorium on
foreclosures was initiated in Virginia during the first quarter of 2020 and
remained in effect into the third quarter of 2020. Additionally, during 2021,
three closed branch office facilities were transferred from bank premises to
OREO at a value of $950 thousand. As previously discussed, we continue to take
an aggressive approach toward liquidating properties to reduce our level of OREO
properties by making pricing adjustments and holding auctions on some of our
older properties. We expect to continue these efforts in 2022, which could
result in additional losses, while reducing future carrying costs.



Although the properties remain for sale and are actively marketed, we did have
lease agreements on certain other real estate owned properties which generated
rental income at market rates. Rental income on OREO properties was $24 thousand
and $54 thousand in 2021 and 2020, respectively.



Investment Securities



Total investment securities increased $59.0 million, or 121.8%, to $107.4
million at December 31, 2021, Prior to their sale in 2021, from $48.4 million at
December 31, 2020. All securities are classified as available-for-sale for
liquidity purposes. Sales of securities during 2021 totaled $7.7 million, with
$322 thousand in gains realized, while sales of securities in 2020 totaled $1.1
million, with $4 thousand in gains realized. During 2021, maturities, calls and
paydowns totaled $16.3 million, and purchases of securities totaled $85.1
million. Investment securities with a carrying value of $12.1 million and $6.8
million at December 31, 2021 and 2020, respectively, were pledged to secure
public deposits and for other purposes required by law.

                                       30





Our strategy is to invest excess funds in investment securities, which typically
yield more interest income than other short-term investment options, such as
federal funds sold and overnight deposits with the Federal Reserve Bank of
Richmond, but which still provide liquidity.



The fair value of our investment portfolio is substantially affected by changes
in interest rates, which could result in realized losses if we need to sell the
securities and recognize the loss in a rising interest rate environment due to
Federal Reserve actions, U.S. fiscal policies or other factors affecting market
interest rates. At December 31, 2021, we had a net unrealized loss in our
investment portfolio totaling $1.0 million as compared to a $938 thousand gain
at December 31, 2020. As interest rates increase the level of unrealized losses
could change substantially. However, these changes would have no impact on
earnings or regulatory capital, unless the underlying securities were sold at a
loss. We have reviewed our investment portfolio and no investment security is
deemed to have other than temporary impairment. We monitor our portfolio
regularly and use it to maintain liquidity, manage interest rate risk and
enhance earnings.



The fair value and weighted average yield of investment securities at December
31, 2021 are shown in the following schedule by contractual maturity and do not
reflect principal paydowns for amortizing securities. Expected maturities will
differ from contractual maturities because issuers may have the right to call or
prepay obligations with or without call or prepayment penalties. Weighted
average yields are calculated by dividing the contractual interest for each time
period by the average amortized contractual cost.




                                               Less than One Year                One to Five Years                Five to ten years                  After ten years                        Total
(Dollars in thousands)                    Fair Value      Average Yield    

Fair value Average return Fair value Average return Fair value Average return Fair value Average return
we treasures

                           $       -                 -%      $    6,003              0.79 %   $    1,668              1.04 %   $        -                -%      $      7,671              0.84 %
U.S. Government Agencies                        502               1.82 %          441              2.26 %        1,902              2.57 %         6,244              1.67 %          9,089              1.79 %
Taxable municipals                              558               3.23 %           -                -%           1,900              1.74 %        20,522              2.33 %         22,980              2.30 %
Corporate bonds                                  -                 -%           1,037              4.80 %          982              2.00 %            -                -%             2,019              3.41 %
Mortgage backed securities                       -                 -%      
      323              1.29 %        6,295              1.22 %        58,981              1.36 %         65,599              1.34 %
                                         $    1,060               2.56 %   $    7,804              1.41 %   $   12,747              1.54 %   $    85,747              1.61 %   $    107,358              1.59 %




Bank Owned Life Insurance



Both December 31, 2021 and 2020, we had a total total cash value of $4.7 million on life insurance policies covering former key executives.

Total policy income in 2021 and 2020 was $32,000 and $77,000respectively.


Deposits



Total deposits were $707.5 million at December 31, 2021, an increase of $39.5
million, or 5.9%, from $668.0 million at December 31, 2020. Most of the increase
was driven by savings and money market deposits, which grew $34.6 million, or
21.9%, to $192.0 million during 2021. Noninterest-bearing demand deposits grew
by $27.5 million, or 12.3%, to $251.3 million. Interest-bearing demand deposits
also grew, by $15.6 million, or 31.3%, to $65.2 million. Generally, PPP loan
disbursements and federal stimulus payments received by customers are deposited
into noninterest-bearing or interest-bearing demand deposit accounts, which
primarily explains the increases in those types of accounts. Due to the large
influx of non-interest-bearing balances, we allowed attrition of time deposit
balances, which decreased by $38.1 million and allowed us to reduce our average
cost of funds.


Information detailing average deposit balances and average rates paid on deposits is presented in the Net interest margin analysis table contained in the Net interest income and net interest margin section.

Core deposits are considered to include demand deposits and other types of
transaction accounts, such as commercial relationships and savings products, all
of which saw growth in 2021. Overall, we continue to maintain core deposits
through attractive consumer and commercial deposit products and strong ties with
our customer base and communities.



                                       31


Term deposits of $250,000 or more was equivalent to approximately 4.0% of deposits at the end of 2021 and 5.2% of deposits at the end of 2020.

AT December 31, 2021 and 2020, uninsured deposits are estimated at $93.8 million and $79.4 million, respectively. Estimated uninsured deposits include $13.6 million and $15.8 million of public funds, for these respective periods, considered to be secured by pledged securities or letters of credit that we have with the FHLB.

The following table shows the maturities of all term deposits considered uninsured by the FDIC or otherwise.




      Maturities of Uninsured Time Deposits
              (Dollars in thousands)
                December 31, 2021
Three months or less                    $  2,507
Over three months through six months       3,517
Over six months through twelve months      3,945
Over one year                              6,788
                Total                   $ 16,757





At December 31, 2021 and 2020, $12.1 million and $6.8 million of securities,
respectively, were pledged to collateralize public deposits, including time
deposits, held in our Tennessee offices, and as collateral for credit facilities
available through FRB. Additionally, we held letters of credit from the FHLB for
$12.0 million at both December 31, 2021 and 2020, to secure public deposits,
including time deposits, held in our Virginia offices.



We held no brokered deposits at December 31, 2021 and 2020. Internet accounts
are limited to customers located in our primary market area and the surrounding
geographical area. The average balance of and the average rate paid on deposits
is shown in the net interest margin analysis table in the "Net Interest Income
and Net Interest Margin" section above. Total Certificate of Deposit Registry
Service (CDARS) time deposits were $5.8 million and $9.6 million at December 31,
2021 and 2020, respectively.



Noninterest Income



For the year ended December 31, 2021, noninterest income improved $1.8 million,
or 22.5%, to $10.0 million, or 1.25% of average assets, from $8.1 million, or
1.10% of average assets, for the same period in 2020. The improvement was driven
by an increase of $507 thousand in service charges and fees, a $557 thousand
increase in card processing and interchange income, a $313 thousand increase in
insurance and investment fees, plus non-recurring gains on sales of investment
securities of $322 thousand.


The improvement in service charges and fees resulted from the fee schedule
changes we made in August 2020. The new fee schedule was implemented as part of
the overall assessment of products and processes undertaken in 2020. The
adjustment of the fee schedule was designed to allow customers to avoid or
minimize certain fees by taking advantage of certain services such as combined
and online account statements.



The improvement in card processing and interchange revenue resulted from increased volume and the related increase in interchange fees collected.



Efforts to increase noninterest income revenues from financial services drove
the improvement in insurance and investment fees, as we believe this segment
continues to show potential for continued growth.



Other non-interest income also increased, by $138 thousand, but after
considering the non-recurring net gains on sales of fixed assets of $190
thousand in 2021 and the $220 thousand bonus payment received in 2020 from our
card service provider, the increase in this component would have been $168
thousand. This increase can be explained primarily by an increase of $128
thousand from commissions and gains on originations and sales of mortgage loans
into the secondary market, partially driven by the loan production office we
opened in Boone, North Carolina in the fourth quarter of 2020 and the deployment
of additional loan originators during 2021.



                                       32



Noninterest Expense


Noninterest expenses increased $870 thousand, or 3.2%, to $27.9 million at
December 31, 2021, compared to $27.0 million at December 31, 2020. Although
higher, noninterest expense as a percent of total average assets improved to
3.49% in 2021 from 3.63% in 2020. The increase in noninterest expense was
primarily due to an increase of $1.2 million in occupancy and equipment expense,
offset by a $566 thousand reduction in salaries and benefit expense.



The increase in occupancy and equipment expense was driven nearly entirely by
$1.1 million in non-recurring losses on three former branch office locations,
which were transferred into other real estate owned during the third quarter of
2021. Excluding this loss, occupancy and equipment expense would have increased
$182 thousand, due largely to costs associated with the Kingsport office, which
was opened in the third quarter of 2020.



the $566,000 the reduction in payroll and social charges is due to the restructuring implemented in May 2020, which included a combination of job cuts, retirements or resignations representing 12% of the workforce. Excluding the $358,000 severance pay incurred in 2020, this reduction would have been $924,000.

Other operating expenses were up $240 thousand due to higher loan and other real
estate expenses of $246 thousand and $199 thousand, respectively. These
increases offset decreases in FDIC insurance and consulting, which decreased
$127 thousand and $235 thousand, respectively. FDIC premiums decreased due to
improvements in our risk assessment. Consulting decreased due to costs incurred
in 2020, which were not repeated in 2021. In addition, 2021 includes a $76
thousand increase in bank franchise taxes due to the increased tax base and
added taxes for other states.



Our efficiency ratio, a non-GAAP measure, which is defined as noninterest
expense divided by the sum of net interest income plus noninterest income,
improved to 75.56% in 2021 compared to 81.10% in 2020. The decrease in this
ratio is a result of improvements in both net interest income and noninterest
income, as discussed above and in the Net Interest Income and Net Interest
Margin section earlier in this Item 7. We continue to seek opportunities to
operate more efficiently through the use of technology, improving processes,
reducing nonperforming assets and increasing productivity.



Income taxes and deferred tax assets



Income taxes were $1.9 million in 2021, compared to $1.1 million in 2020. The
effective tax rates were 21.7%, and 27.6% for 2021 and 2020, respectively. The
effective tax rate for the periods differed from the federal statutory rate of
21.0% principally due the impact of the recapture of operating loss
carryforwards and applicable credits. The higher effective tax rate in 2020 is
the result of an increase in pre-tax earnings in relation to the various tax
preference items.



Deferred tax assets represent the future tax benefit of future deductible
differences. If it is more likely than not that a tax asset will not be
realized, a valuation allowance is required to reduce the recorded deferred tax
assets to net realizable value. The Company has evaluated positive and negative
evidence to assess the realizability of its deferred taxes. Based on the
evidence, including taxable income projections, the Company believes it is more
likely than not that its deferred tax assets will be realizable. Accordingly,
the Company did not include a valuation allowance against its deferred tax
assets as of December 31, 2021 or 2020.



Tax positions are evaluated in a two-step process. The Company first determines
whether it is more likely than not that a position will be sustained upon
examination. If a tax position meets the more likely than not recognition
threshold, it is then measured to determine the amount of benefit to recognize
in the financial statements. The tax position is measured as the largest amount
of benefit that is greater than 50% likely of being recognized. The Company
classifies interest and penalties as a component of income tax expense.



As of December 31, 2021, the Company had Federal net operating loss carry
forward amounts of approximately $2.2 million. These amounts are not limited
pursuant to Internal Revenue Code (IRC) Section 382. The Company is subject to
examination in the United States and multiple state jurisdictions. Open tax
years for examination are 2018 - 2021.





Capital Resources



Our total stockholders' equity at the end of 2021 was $63.6 million compared to
$58.2 million at the end of 2020. The increase was $5.4 million, or 9.4%. Book
value per common share was $2.66 at December 31, 2021 compared to $2.43 at
December 31, 2020.

                                       33




The Company meets the eligibility criteria to be considered a small bank holding company in accordance with the of the Federal Reserve Small Portfolio Bank Policy Statement issued in February 2015 and does not report consolidated regulatory capital. The Bank continues to be subject to various capital requirements administered by branch banks.



The Bank is characterized as "well capitalized" under the "prompt corrective
action" regulations pursuant to Section 38 of the FDIA. The capital adequacy
ratios for the Bank, including the minimum ratios to be considered "well
capitalized," are set forth in Note 21, Capital, to the consolidated financial
statements in Item 8 of this Form 10-K.



The Bank is also subject to the rules implementing the Basel III capital
framework and certain related provisions of the Dodd-Frank Act. The final rules
require the Bank to comply with the following minimum capital ratios: (i) a
Common Equity Tier 1 (CET1) ratio of at least 4.5%, plus a 2.5% "capital
conservation buffer" (effectively resulting in a minimum CET1 ratio of 7%), (ii)
a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the
2.5% capital conservation buffer (effectively resulting in a minimum Tier 1
capital ratio of 8.5%), (iii) a ratio of total capital to risk-weighted assets
of at least 8.0%, plus the 2.5% capital conservation buffer (effectively
resulting in a minimum total capital ratio of 10.5%), and (iv) a leverage ratio
of 4%, calculated as the ratio of Tier 1 capital to average assets. The capital
conservation buffer is designed to absorb losses during periods of economic
stress. Banking institutions with a CET1 ratio above the minimum but below the
conservation buffer face constraints on dividends, equity repurchases, and
compensation based on the amount of the shortfall. As of December 31, 2021, the
Bank meets all capital adequacy requirements to which it is subject.



Total assets increased in 2021 and we anticipate asset levels to increase in the
future due to an emphasis on growing the loan portfolio and the core deposit
base of the Bank. Based upon projections, we believe our earnings will be
sufficient to support the Bank's planned asset growth.



No cash dividends have been paid historically due to our past retained deficit.
Earnings have accumulated over the last several years and we attained retained
earnings in 2021. Subsequent to December 31, 2021, the Board of Directors
declared a $0.05 cash dividend per share payable on March 31, 2022 to
stockholders of record on March 15, 2022. This is the first cash dividend paid
in the history of the Company. Future payments of cash dividends, if any, will
depend on a number of factors including but not limited to maintaining positive
retained earnings, compliance with regulatory rules governing the payment of
dividends, strategic plans, and sufficient capital at the Bank to allow payment
of dividends to the parent company.



Liquidity


We closely monitor our liquidity and our liquid assets in the form of cash, due
from banks, federal funds sold and unpledged available-for-sale investments.
Collectively, those balances were $159.3 million at December 31, 2021, down from
$134.0 million at December 31, 2020. As discussed previously in this Form 10-K,
this change is a direct result of redeployment of excess cash into investment
securities, which generally return higher yields, while still providing
liquidity, as discussed below. A surplus of short-term assets is maintained at
levels management deems adequate to meet potential liquidity needs.



At December 31, 2021, all of our investments are classified as
available-for-sale, providing an additional source of liquidity in the amount of
$98.3 million, which is net of the $12.1 million of securities pledged as
collateral. This will serve as a source of liquidity while yielding a higher
return when compared to other short-term investment options, such as federal
funds sold and overnight deposits with the Federal Reserve Bank of Richmond.
Total investment securities increased $59.0 million, or 121.8%, during 2021 from
$48.4 million at December 31, 2020.



Our loan to deposit ratio was 83.92% at December 31, 2021 and 86.16% at December 31, 2020.



Available third-party sources of liquidity remain intact at December 31, 2021
which includes the following: our line of credit with the FHLB totaling $199.9
million, the brokered certificates of deposit markets, internet certificates of
deposit, and the discount window at the Federal Reserve Bank of Richmond. We
also have $30.0 million in unsecured federal funds lines of credit available
from three correspondent banks as of December 31, 2021.



We have used our line of credit with FHLB to issue letters of credit totaling
$12.0 million to the Treasury Board of Virginia for collateral on public funds.
No draws on the letters of credit have been issued. The letters of credit are
considered draws on our FHLB line of credit. An additional $187.9 million was
available on December 31, 2021 on the $199.9 million line of credit, of which
$123.6 million is secured by a blanket lien on our residential real estate
loans.

                                       34




Although we have access to the traded deposit market, we do not hold any traded deposits at December 31, 2021 or 2020. As of December 31, 2021we have had $5.8 million reciprocal CDARS term deposits, against $9.6 million at December 31, 2020.



The Bank has access to additional liquidity through the Federal Reserve Bank of
Richmond's Discount Window for overnight funding needs. We may collateralize
this line with investment securities and loans at our discretion; however, we do
not anticipate using this funding source except as a last resort.



With the on-balance sheet liquidity and other external sources of funding, we
believe the Bank has adequate liquidity and capital resources to meet our
requirements and needs for the foreseeable future. However, liquidity can be
further affected by a number of factors such as, counterparty willingness or
ability to extend credit, regulatory actions and customer preferences, some of
which are beyond our control. With the current economic uncertainty resulting
from the COVID-19 pandemic, inflation and the war in Ukraine, we continue
monitoring of our liquidity position, specifically cash on hand in order to meet
customer demands. Additionally, our contingency funding plan is reviewed
quarterly with our Asset Liability Committee.





Financial instruments presenting an off-balance sheet risk

The Bank is a 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. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
contract or notional amounts of those instruments reflect the extent of
involvement the Bank has in particular classes of financial instruments.



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 it does for on-balance-sheet instruments.



A summary of the contractual amount of the Bank’s off-balance sheet risk exposure at December 31, 2021 and 2020 is as follows:

(Dollars in thousands)                                  2021               

2020

Financial instruments whose contract amounts
represent credit risk:
Commitments to extend credit                        $    69,015          $    57,334
Standby letters of credit                                 3,684                2,031



Commitments to extend credit are agreements to lend to a customer provided 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 credit
worthiness 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 counterparty. Collateral held varies but may include accounts
receivable, inventory, property and equipment, and income-producing commercial
properties.


Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These lines of credit cannot effectively be used to the full extent to which the Bank has committed itself.

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, including
commercial paper, bond financing, and similar transactions. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. The Bank holds certificates of
deposit, deposit accounts, and real estate as collateral supporting those
commitments for which collateral is deemed necessary.





Interest Sensitivity



At December 31, 2021, we had a negative cumulative gap rate sensitivity ratio of
12.97% for the one-year re-pricing period, compared to 21.46% at December 31,
2020. A negative cumulative gap generally indicates that net interest income
would decline in a rising interest rate environment as liabilities re-price more
quickly than assets. Conversely, net interest income would likely increase in
periods during which interest rates are increasing. The below table is based on
contractual maturities and does not take into consideration prepayment speeds of
investment securities and loans, nor does it consider decay rates for
non-maturity deposits. When considering these prepayment speed and decay rate
assumptions, along with our ability to control the repricing of a significant
portion of the deposit portfolio, we are in a position to increase interest
income in a rising interest rate environment. With the FOMC initiating a series
of expected rate increases, we believe our current interest risk profile remains
acceptable. Furthermore, we are implementing strategies to moderate any
potential adverse impact to our current interest rate risk profile, from what
could be a sustained medium- to long-term environment of rising interest rates.

                                       35





                                                           Interest Sensitivity Analysis
                                                                 December 31, 2021
                                                             (In thousands of dollars)
                                   1 - 90 Days     91-365 Days      1 - 3  Years      4-5   Years      6-10 Years     Over 10 years        Total
Uses of funds:
Loans                             $   117,732     $    108,871     $     196,232     $    117,809     $   45,156     $        7,944     $ 593,744
Federal funds sold                        228               -                 -                -              -                  -            228
Deposits with banks                    45,516               -                250                              -                  -         45,766
Investments                             7,525           10,891            21,277           18,367         31,564             18,764       108,388
Bank owned life insurance               4,685               -                 -                -              -                  -          4,685
Total earning assets              $   175,686     $    119,762     $     217,759     $    136,176     $   76,720     $       26,708     $ 752,811

Sources of funds:
Int Bearing DDA                        65,212               -                 -                -              -                  -         65,212
Savings & MMDA                        194,702               -                 -                -              -                  -        194,702
Time Deposits                          34,727           81,983            51,120           28,512             -                  -        196,342
Trust Preferred Securities             16,496               -                 -                -              -                  -         16,496
Federal funds purchased                    -                                                                                                   -
Other Borrowings                           -                -                 -                -              -                  -             -
Total interest bearing
liabilities                       $   311,137     $     81,983     $      51,120     $     28,512     $       -      $           -      $ 472,752

Discrete Gap                      $  (135,451 )   $     37,779     $     166,639     $    107,664     $   76,720     $       26,708     $ 280,059
Cumulative Gap                    $  (135,451 )   $    (97,672 )   $     

68,967 $176,631 $253,351 $280,059
Cumulative gap as % of total productive assets

                         -17.99 %         -12.97 %            9.16 %          23.46 %        33.65 %            37.20 %

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