NEW PEOPLES BANKSHARES INC - Annual Report: 2020 (Form 10-K)

United States

Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2020

or

For the transition period from ___________ to ___________

Commission File Number 000-33411

New Peoples Bankshares, Inc.

(Exact name of registrant as specified in its charter)

 Registrant’s telephone number, including area code: (276) 873-7000

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Common Stock - $2 Par Value

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act. Yes ☐ No ☒

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐                                                                                                     Accelerated filer ☐

Non-accelerated filer ☒                                                                                        Smaller reporting company ☒

                                                                                                                               Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒

The aggregate market value of the common stock held by non-affiliates, based on the last reported sales price of $1.40 per share on the last business day of the second quarter of 2020, was $14,465,501.

The number of shares outstanding of the registrant’s common stock was 23,922,086 as of March 31, 2021.

DOCUMENTS INCORPORATED BY REFERENCE:

Proxy Statement for the 2021 Annual Meeting of Shareholders – Part III

TABLE OF CONTENTS

PART I

Item 1.       Business

General

New Peoples Bankshares, Inc. (New Peoples, the Company, we, us or our) is a Virginia financial holding company headquartered in Honaker, Virginia. Our business is conducted primarily through New Peoples Bank, Inc., a Virginia banking corporation (the Bank). The Bank has a division doing business as New Peoples Financial Services which offers investment services through its broker-dealer relationship with Infinex Investments, Inc. NPB Insurance Services, Inc. (NPB Insurance) is a subsidiary of the Bank and generates revenue through the referral of insurance services.

The Bank, headquartered in Honaker, Virginia, offers a range of banking and related financial services focused primarily on serving individuals, small to medium size businesses, and the professional community. We strive to serve the banking needs of our customers while developing personal, hometown relationships with them. Our board of directors believes that marketing customized banking services enables us to establish a niche in the financial services marketplace where we do business.

We provide professionals and small and medium size businesses in our market area with responsive and technologically enabled banking services. These services include loans that are priced on a deposit relationship basis, easy access to our decision makers, and quick and innovative action necessary to meet a customer’s banking needs. Our capitalization and lending limit enable us to satisfy the credit needs of a large portion of the targeted market segment. When a customer needs a loan that exceeds our lending limit, we try to find other financial institutions to participate in the loan with us.

Our History

The Bank was incorporated under the laws of the Commonwealth of Virginia on December 9, 1997 and began operations on October 28, 1998. On September 27, 2001, the shareholders of the Bank approved a plan of reorganization under which they exchanged their shares of Bank common stock for shares of New Peoples common stock. On November 30, 2001, the reorganization was completed and the Bank became New Peoples’ wholly-owned subsidiary.

In June 2003, New Peoples formed two new wholly-owned subsidiaries, NPB Financial Services, Inc. (renamed NPB Insurance Services, Inc. in June 2012) and NPB Web Services, Inc., an inactive web design and hosting company.

The Bank, through its division New Peoples Financial Services, offers fixed and variable annuities, fee based asset management and other investment products through a broker/dealer relationship with Infinex Investments, Inc.

In July 2004, NPB Capital Trust I was formed by New Peoples to issue $11.3 million in trust preferred securities.

In September 2006, NPB Capital Trust 2 was formed by New Peoples to issue $5.2 million in trust preferred securities.

On June 7, 2017, NPB Insurance Services, Inc. purchased a 39% membership interest in Lonesome Pine Title Agency, LLC, which provides title insurance. Another member of the agency is a related party to the Company.

Branch Locations

After a period of significant branch expansion between 2000 and 2008, we have since consolidated some of our branch operations to improve efficiency. Currently, in addition to our headquarters in Honaker, Virginia we have 18 full-service branches located in three states: Virginia - Abingdon, Big Stone Gap, Bluefield, Bristol, Castlewood, Chilhowie, Clintwood, Gate City, Grundy, Haysi, Lebanon, Pounding Mill, Tazewell, Weber City and Wise; West Virginia - Princeton (2); and Tennessee – Kingsport. Additionally, we have one limited services branch in Pound, Virginia; a loan production office in Boone, North Carolina; and a former loan production office in Jonesborough, Tennessee which is currently being used as a hub to meet prospective loan customers.

On September 14, 2020, we opened the branch office in Kingsport, Tennessee, which is located in a building we purchased in February 2020. On October 30, 2020, we closed a nearby office and transferred accounts to the newly opened branch. We have also moved our loan production office to this location and terminated the lease on the former loan production office when it expired in the fourth quarter of 2020.

Renovations to a building we purchased in Bristol, Virginia in 2019, resumed in January 2021 and we anticipate opening this office during the third quarter of 2021. The impact of COVID-19 had caused us to delay those renovations. Regulatory approval to operate this office as a full-service branch was initially received in October 2019 and has been extended to October 2021. We believe this expansion, along with the newly opened Kingsport, TN location, fits our stated objective of expanding our presence in the Tri-Cities market area. The Bristol location is within the business district and will allow us to provide retail consumer, commercial banking and financial services within Bristol and the surrounding area.

Our Market Areas

Our primary market area consists of southwestern Virginia, southern West Virginia, northeastern Tennessee, and western North Carolina. Specifically, we operate in the southwestern Virginia counties of Russell, Scott, Washington, Tazewell, Buchanan, Dickenson, Wise, and Smyth; Mercer county in southern West Virginia and the northeastern Tennessee counties of Sullivan and Washington (collectively, the “Tri-State Area”). In North Carolina, our loan production office is in the county of Watauga. The close proximity and mobile nature of individuals and businesses in adjoining counties and nearby cities in Virginia, West Virginia, Tennessee and North Carolina place these markets within our Bank’s targeted trade area, as well.

Accessibility to Interstates I-77, I-81, I-26, I-64 and I-75, as well as major state and U.S. highways including US 19, US 23, US 58, US 460 and US 421, make the area an ideal location for businesses to serve markets in the Mid-Atlantic, Southeast and Midwest. The area is strategically located midway between Atlanta-Pittsburgh, Charlotte-Cincinnati, and Richmond-Louisville, and is within a day’s drive of more than half of the U.S. population. A regional airport located in Bristol, Tennessee serves the area with commercial flights to and from major cities in the United States. Commercial rail service providers include CSX Transportation and Norfolk Southern Railways.

The Tri-State Area has a diversified economy supported by natural resources, which include coal, natural gas, limestone, and timber; agriculture; healthcare; education; technology; manufacturing and services industries. Predominantly, the market is comprised of locally owned and operated small businesses. Considerable investments in high-technology communications, high-speed broadband network and infrastructure have been made which has opened the area to large technology companies and future business development potential for new and existing businesses. Industries are taking advantage of the low cost of doing business, training opportunities, available workforce and an exceptional quality of life experience for employers and employees alike.

Internet Site

Our internet banking site can be accessed at www.newpeoples.bank. The site includes a customer service area that contains branch and Interactive Teller Machine (ITM) locations, product descriptions and current interest rates offered on deposit accounts. Customers with internet access can apply for loans, open deposit accounts online, access account balances, make transfers between accounts, enter stop payment orders, order checks, and use an optional bill paying service.

Available Information

We file annual, quarterly, and current reports, proxy statements and other information with the Securities and Exchange Commission (the SEC). The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding issuers, like us, that file electronically with the SEC. Our SEC filings are filed electronically and are available to the public online at the SEC’s web site at www.sec.gov. We also provide a link to our filings on the SEC website, free of charge, through our internet website www.npbankshares.com under “Investor Relations.” Information on the websites of the Company and the Bank is not a part of, and is not incorporated into, this report or any other filings the Company makes with the SEC.

COVID-19 Pandemic

The coronavirus (COVID-19) pandemic has negatively impacted the global economy, disrupted global supply chains and increased unemployment levels. Although the temporary closure of many businesses and shelter-in-place policies have eased, restrictions and social distancing continue to impact many of the Company’s customers. While the full effects of the pandemic still remain unknown, the Company is committed to supporting its customers, employees and communities during this difficult time. The Company has given hardship relief assistance to customers, including the consideration of various loan payment deferral and fee waiver options, and encourages customers to reach out for assistance to support their individual circumstances. The pandemic could result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed, the impact on the global economy worsens, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Similarly, because of changing economic and market conditions, we may be required to recognize impairments on securities, goodwill or other significant estimates. The extent to which the pandemic impacts our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.

Effective March 16, 2020, the Federal Reserve lowered the federal funds target rate to a range of between zero and 0.25%. This action followed a prior reduction of the federal funds target rate to a range of 1.00% to 1.25% effective on March 4, 2020. These actions were taken in an emergency response to stem the economic impact of the pandemic. The Federal Reserve has indicated that it expects to maintain the targeted federal funds rate at current levels until such time that the economic environment has stabilized for a period of time. The Company’s earnings and related cash flows are largely dependent upon net interest income, representing the difference between interest income received on interest-earnings assets, primarily loans and securities, and the interest paid on interest-bearing liabilities, primarily customer deposits and borrowed funds. Since the Company’s balance sheet is asset sensitive, earnings are more adversely affected by falling rates since rate sensitive assets reprice more quickly than rate sensitive liabilities. Should the Federal Reserve take any further action regarding rates in relation to the pandemic, the Company’s margins could be compressed even further, perpetuating the negative effect on net income.

The U.S. government also enacted certain fiscal stimulus measures in several phases to assist in counteracting the economic disruptions caused by the pandemic. On March 6, 2020, the Coronavirus Preparedness and Response Supplemental Appropriations Act was enacted to authorize funding for research and development of vaccines and to allocate money to state and local governments for response and containment measures. On March 18, 2020, the Families First Coronavirus Response Act was put in place to provide for paid sick/medical leave, no-cost coverage for testing, expanded unemployment benefits and additional funding to states for the ongoing economic consequences of the pandemic. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law. Among other measures, the CARES Act provided $349 billion for the Paycheck Protection Program (PPP) administered by the Small Business Administration (SBA) to assist qualified small businesses with certain operational expenses, certain credits for individuals and their dependents against their 2020 personal income tax and expanded eligibility for unemployment benefits. This legislation was later amended on April 24, 2020, by the Paycheck Protection Program and Healthcare Enhancement Act which provided an additional $310 billion of funding for PPP loans.

Certain provisions within the CARES Act encourage financial institutions to practice prudent efforts to work with borrowers impacted by the pandemic. Under these provisions, loan modifications deemed to be COVID-19 related would not be considered a troubled debt restructuring (TDR) if the loan was not more than 30 days past due as of December 31, 2019 and the deferral was executed between March 1, 2020 and the earlier of 60 days after the date of the termination of the COVID-19 national emergency or December 31, 2020. The banking regulators issued a similar guidance, which also clarified that a COVID-19 related modification should not be considered a TDR if the borrower was current on payments at the time the underlying loan modification program was implemented and if the modification is considered to be short-term. The Company implemented a short-term modification program to provide relief to consumer and commercial customers following the guidelines of these provisions. Most modifications fall into the 90 to 180-day range with deferred principal and interest due and payable on the maturity date of the existing loans. Specific detail describing these modifications made in relation to the CARES Act can be found in the Loans and Troubled Debt Restructurings discussions in Notes 6 and 8 to the Consolidated Financial Statements contained in Item 8 of this Form 10-K.

Following the enactment of these provisions, in December 2020, the Consolidated Appropriations Act, 2021 was enacted to provide additional economic stimulus to individuals and businesses in response to the extended economic distress caused by the pandemic. This included additional stimulus payments to individuals and their dependents, and extension of enhanced unemployment benefits, $284 billion of additional funds for a second round of PPP loans and a new simplified forgiveness procedure for PPP loans of $150,000 or less. The Bank was a lender for the initial SBA program and closed 665 PPP loans totaling $44.5 million. As of March 31, 2021, 407 loans totaling $24.7 million were fully repaid through forgiveness by the SBA. The Bank is also participating in the second round of the program and through March 31, 2021 has closed 322 loans totaling $18.8 million.

The Company has responded to the circumstances surrounding the pandemic to support the safety and well-being of the employees, customers and shareholders by enacting the following measures:

Given the dynamic nature of the circumstances surrounding the pandemic, it is difficult to ascertain the full impact the ongoing economic disruption will have on the Company. While this impact cannot be predicted or measured, we expect that our income could be impacted in various ways. It is anticipated that the provision for loan loss expense will remain elevated in expectation of a deterioration in a portion of the loan portfolio. As a result of the significant decline in interest rates, the Company may continue to experience a decline in net income and resulting net interest margin; however, there will be a benefit from the fees arising from the PPP loan program. Also, it is possible that noninterest income could be reduced as customers may use fewer fee-based services due to continuing COVID-19 mitigation efforts, such as stay-at-home orders. The Company will continue to closely monitor situations arising from the pandemic and adjust operations accordingly.

Banking Services

General. We accept deposits, make consumer and commercial loans, issue drafts, and provide other services customarily offered by a commercial bank, such as business and personal checking and savings accounts, walk-up tellers, drive-in windows, and 24-hour interactive teller machines. The Bank is a member of the Federal Reserve System and its deposits are insured under the Federal Deposit Insurance Act (the FDIA) to the maximum limit.

Loans. Generally, we offer a full range of short-to-medium term commercial, 1-4 family residential mortgages and personal loans. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and purchase of equipment and machinery. Consumer loans may include secured and unsecured loans for financing automobiles, home improvements, education, personal investments and other purposes.

Our lending activities are subject to a variety of lending limits imposed by state law. While differing limits may apply in certain circumstances based on the type of loan or the nature of the borrower (including the borrower’s relationship to the Bank), the Bank generally is subject to a loans-to-one-borrower limit of an amount equal to 15% of its capital and surplus plus the allowance for loan losses. The Bank voluntarily may choose to impose a policy limit on loans to a single borrower that is less than the legal lending limit.

We obtain short-to-medium term commercial and personal loans through direct solicitation of business owners and continued business from existing customers. Completed loan applications are reviewed by our loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment and credit history of the applicant. If commercial real estate is involved, information is also obtained concerning cash flow after debt service. Loan quality is analyzed based on the Bank’s experience and its credit underwriting guidelines.

Loans by type as a percentage of total loans are as follows:

Commercial Loans. We make commercial loans to qualified businesses in our market area. Our commercial lending consists primarily of commercial and industrial loans to finance accounts receivable, inventory, property, plant and equipment. Commercial business loans generally have a higher degree of risk than residential mortgage loans, but have commensurately higher yields. Residential mortgage loans are generally made on the basis of the borrower’s ability to make repayment from employment and other income and are secured by real estate whose value tends to be easily ascertainable. In contrast, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself.

In 2020, commercial loans also include PPP loans that were made to assist small businesses and non-profit organizations during the pandemic to cover payroll costs and other permitted expenses. These loans are fully guaranteed by the Small Business Administration.

Further, the collateral for commercial business loans may depreciate over time and cannot be appraised with as much precision as residential real estate. To manage these risks, our underwriting guidelines generally require us to secure commercial loans with both the assets of the borrowing business and other additional collateral and guarantees that may be available. In addition, we actively monitor certain measures of the borrower, including advance rate, cash flow, collateral value and other appropriate credit factors.

Residential Mortgage Loans. Our residential mortgage loans consist of residential first and second mortgage loans, residential construction loans, home equity lines of credit and term loans secured by first and second mortgages on the residences of borrowers for home improvements, education and other personal expenditures. We make mortgage loans with a variety of terms, including fixed and floating or variable rates and a variety of maturities.

Under our underwriting guidelines, residential mortgage loans are generally made on the basis of the borrower’s ability to make repayment from employment and other income and are secured by real estate whose value tends to be easily ascertainable. These loans are made consistent with our appraisal policies and real estate lending policies, which detail maximum loan-to-value ratios and maturities.

Construction Loans. Construction lending entails significant additional risks, compared to residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Construction loans also involve additional risks attributable to the fact that loan funds are advanced upon the security of property under construction, which is of uncertain value prior to the completion of construction. Thus, it is more difficult to evaluate the total loan funds required to complete a project and related loan-to-value ratios accurately. To minimize the risks associated with construction lending, loan-to-value limitations for residential, multi-family and non-residential construction loans are in place. These are in addition to the usual credit analyses of borrowers. Management feels that the loan-to-value ratios help to minimize the risk of loss and to compensate for normal fluctuations in the real estate market. Maturities for construction loans generally range from 4 to 12 months for residential property and from 6 to 18 months for non-residential and multi-family properties.

Consumer Loans. Our consumer loans consist primarily of installment loans to individuals for personal, family and household purposes. The specific types of consumer loans that we make include home improvement loans, debt consolidation loans and general consumer lending. Consumer loans entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured, such as lines of credit, or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance due to the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. A borrower may also be able to assert against the Bank as an assignee any claims and defenses that it has against the seller of the underlying collateral.

Our underwriting policy for consumer loans seeks to limit risk and minimize losses, primarily through a careful analysis of the borrower’s creditworthiness. In evaluating consumer loans, we require our lending officers to review the borrower’s level and stability of income, past credit history and the impact of these factors on the ability of the borrower to repay the loan in a timely manner. In addition, we maintain an appropriate margin between the loan amount and collateral value.

Deposits. We offer a variety of deposit products for both individual and business customers. These include demand deposit, interest-bearing demand deposit, savings deposit, money market, health savings and individual retirement (IRA) deposit accounts. In addition, we offer certificates of deposit with terms ranging from 7 days to 60 months, including IRAs with terms ranging from 12 months to 60 months.

Investment Services. We offer a variety of investment services for both individual and business customers. These services include fixed income products, variable annuities, mutual funds, indexed certificates of deposit, individual retirement accounts, long term care insurance, employee group benefit plans, college savings plans, financial planning, managed money accounts, and estate planning. We offer these services through our broker-dealer relationship with Infinex Investments, Inc.

Other Bank Services. Other bank services include safe deposit boxes, cashier’s checks, certain cash management services, direct deposit of payroll and social security checks and automatic drafts for various accounts. We offer ITM and debit card services that can be used by our customers throughout our service area and other regions. We also offer consumer and commercial VISA credit card services. Electronic banking services include debit cards, internet banking, telephone banking, mobile banking, remote deposit capture; merchant transaction processing and wire transfers.

We do not presently anticipate obtaining trust powers, but we are able to provide similar services through our affiliation with Infinex Investments, Inc. Additionally, we have initiated programs of differentiator presentations focusing on such issues as financial literacy and elder abuse. We believe that these types of programs assist our local communities and highlight the skills of our financial service providers.

Competition

The financial services business is highly competitive. We compete as a financial intermediary with other commercial banks, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions operating in the southwestern Virginia, southern West Virginia, eastern Tennessee, and western North Carolina market areas and elsewhere, including online financial services providers. Our market area is a highly competitive, highly branched banking market.

Competition in the market area for loans to small businesses and professionals, the Bank’s target market, is intense, and pricing is important. Many of our larger competitors have substantially greater resources and lending limits than we have. They offer certain services, such as extensive and established branch networks and trust services that we do not provide or do not expect to provide in the near future. Moreover, larger institutions operating in the market area have access to borrowed funds at lower costs than are available to us. Deposit competition among institutions in the market area also is strong. As a result, it is possible that we may have to pay above-market rates to attract or retain deposits.

While pricing is important, our principal method of countering the competition is service. As a community banking organization, we strive to serve the banking needs of our customers while developing personal, hometown relationships with them. Additionally, we worked to implement and enhance digital banking services prior to the onset of the pandemic. As a result, we provide a significant amount of service and a range of products through multiple channels at reasonable fees.

According to a market share report prepared by the Federal Deposit Insurance Corporation (the FDIC), as of June 30, 2020, the most recent date for which market share information is available, the Bank’s deposits as a percentage of total deposits in its major market areas were as follows:

Employees

As of December 31, 2020, we had 201 total employees, of which 193 were full-time employees. None of our employees is covered by a collective bargaining agreement, and we consider relations with employees to be excellent.

Supervision and Regulation

General. As a financial holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended (BHCA), and the examination and reporting requirements of the Board of Governors of the Federal Reserve System (the Federal Reserve). We are also subject to the provisions of the Code of Virginia governing bank holding companies. As a state-chartered commercial bank, the Bank is subject to regulation, supervision and examination by the Virginia State Corporation Commission’s Bureau of Financial Institutions (BFI). As a member of the Federal Reserve System, the Bank is also subject to regulation, supervision and examination by the Federal Reserve. Other federal and state laws, including various consumer protection and compliance laws, govern the activities of the Bank, such as the investments that it makes and the aggregate amount of loans that it may grant to one borrower.

The following description summarizes the most significant federal and state laws applicable to New Peoples and its subsidiaries. To the extent that statutory or regulatory provisions are described, the description is qualified in its entirety by reference to that particular statutory or regulatory provision.

The Bank Holding Company Act. Under the BHCA, the Federal Reserve examines New Peoples periodically. New Peoples is also required to file periodic reports and provide any additional information that the Federal Reserve may require. Activities at the bank holding company level are generally limited to:

Thus, the activities we can engage in are restricted as a matter of law.

With some limited exceptions, the BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve before:

As a result, our ability to engage in certain strategic activities is conditioned on regulatory approval.

In addition, and subject to some exceptions, the BHCA and the Change in Bank Control Act require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company as defined in the statutes and regulations. These requirements make it more difficult for control of our company to change or for us to acquire substantial investments.

Financial Holding Company. As of March 4, 2016 the Company elected to become qualified as a financial holding company (FHC). The Gramm-Leach-Bliley Act (GLBA) created this category of bank holding companies. FHC’s may directly or indirectly through subsidiaries engage in financial activities and activities “incidental” or “complementary” to financial activities. Generally, a FHC need not give prior notice of such activities, but must notify the Federal Reserve within 30 days after the event.

The BHCA provides a long list of “financial” activities that may be engaged in by FHCs such as underwriting, brokering or selling insurance; providing financial or investment advice or underwriting, dealing in or making a market in securities.

There are other potential “financial” activities in which the Federal Reserve is permitted to designate as permitted financial or incidental to financial activities.

We do not currently undertake activities specifically permitted to us as a FHC that are not otherwise permissible for bank holding companies not qualified as FHCs.

Bureau of Financial Institutions (BFI). As a bank holding company registered with the BFI, we must provide the BFI with information concerning our financial condition, operations and management, among other reports required by the BFI. New Peoples is also examined by the BFI in addition to its Federal Reserve examinations. Similar to the BHCA, the Code of Virginia requires that the BFI approve the acquisition of direct or indirect ownership or control of more than 5% of the voting shares of any Virginia bank or bank holding company like us.

Payment of Dividends. New Peoples is a separate legal entity that derives the majority of its revenues from dividends paid to it by its subsidiaries. The Bank is subject to laws and regulations that limit the amount of dividends it can pay. In addition, both New Peoples and the Bank are subject to various regulatory restrictions relating to the payment of dividends, including requirements to maintain capital at or above regulatory minimums. Banking regulators have indicated that banking organizations should generally pay dividends only if the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. The FDIC has the general authority to limit the dividends paid by FDIC insured banks if the FDIC deems the payment to be an unsafe and unsound practice. The FDIC has indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsound and unsafe banking practice.

Capital Adequacy. The federal banking regulators have issued substantially similar capital requirements applicable to all banks and bank holding companies. In addition, those regulators may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth.

The Company meets the eligibility criteria to be considered a small bank holding company in accordance with the Federal Reserve’s Small Bank Holding Company Policy Statement issued in February 2015, and does not report consolidated regulatory capital. With respect to the Bank, the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act (FDIA) were revised, effective as of January 1, 2015, to incorporate a new Common Equity Tier 1 (CET1) risk-based capital measure. The risk-based capital and leverage capital requirements under the final prompt corrective action regulations are set forth in the following table:

The FDIA requires the federal banking regulators to take “prompt corrective action” if a depository institution does not meet minimum capital requirements as set forth above. Generally, a receiver or conservator for a bank that is “critically undercapitalized” must be appointed within specific time frames. The regulations also provide that a capital restoration plan must be filed within 45 days of the date a bank is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Any holding company for a bank required to submit a capital restoration plan must guarantee the lesser of (i) an amount equal to 5% of the bank’s assets at the time it was notified or deemed to be undercapitalized by a regulator, or (ii) the amount necessary to restore the bank to adequately capitalized status. This guarantee remains in place until the bank is notified that it has maintained adequately capitalized status for specified time periods. Additional measures with respect to undercapitalized institutions include a prohibition on capital distributions, growth limits and restrictions on activities.

The Bank is also subject to the rules implementing the Basel III capital framework and certain related provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act). The final rules established minimum capital ratios plus a “capital conservation buffer” designed to absorb losses during periods of economic stress. The phase-in of the capital conservation buffer requirement began on January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until it was fully implemented at 2.5% on January 1, 2019. The final provisions for banks with $250 billion or less in total assets, such as the Bank, are set forth in the following table:

⁽¹⁾    The capital conservation buffer must be maintained in order for a banking organization to avoid being subject to limitations on capital distributions, including dividend payments, and discretionary bonus payments to executive officers.

The final rules include comprehensive guidance with respect to the measurement of risk-weighted assets. For residential mortgages, Basel III retains the risk-weights contained in the prior capital rules, which assign a risk-weight of 50% to most first-lien exposures and 100% to other residential mortgage exposures. The final rule increased the risk-weights associated with certain on-balance sheet assets, such as high volatility commercial real estate loans, and loans that are more than 90 days past due or in nonaccrual status. Capital requirements also increased for certain off-balance sheet exposures including, for example, loan commitments with an original maturity of one year or less.

Under the final rules, certain banking organizations, including the Company and the Bank, were permitted to make a one-time election to continue the prior treatment of excluding from regulatory capital most accumulated other comprehensive income (AOCI) components, including amounts relating to unrealized gains and losses on available-for-sale debt securities and amounts attributable to defined benefit post-retirement plans. Institutions that elected to exclude most AOCI components from regulatory capital under Basel III will be able to avoid volatility that would otherwise be caused by things such as the impact of fluctuations in interest rates on the fair value of available-for-sale debt securities. The Company and the Bank elected to exclude AOCI components from regulatory capital under Basel III.

Failure to meet capital guidelines could subject a bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on taking brokered deposits and certain other restrictions on its business. As described below, the FDIC can impose substantial additional restrictions upon FDIC-insured depository institutions that fail to meet applicable capital requirements as set forth above.

On September 17, 2019, the federal banking regulators jointly issued a final rule required by the Economic Growth, Regulatory Reform and Consumer Protection Act (EGRRCPA) that permits qualifying banks and bank holding companies that have less than $10 billion in consolidated assets, such as New Peoples and the Bank, to elect to be subject to a 9% leverage ratio that would be applied using less complex leverage calculations (commonly referred to as the community bank leverage ratio or CBLR). Under the rule, which became effective on January 1, 2020, banks and bank holding companies that opt into the CBLR framework and maintain a CBLR of greater than 9% are not subject to other risk-based and leverage capital requirements under the Basel III rules and would be deemed to have met the well capitalized ratio requirements under the “prompt corrective action” framework. The CARES Act directed federal banking agencies to adopt interim final rules to lower the threshold under the CBLR from 9% to 8% and to provide a reasonable grace period for a community bank that falls below the threshold to regain compliance, in each case until the earlier of the termination date of the national emergency or December 31, 2020. In April 2020, the federal bank regulatory agencies issued two interim final rules implementing this directive. One interim final rule provides that, as of the second quarter 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement. We have not adopted the CBLR framework.

For further detail on capital and capital ratios see discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” sections, “Capital Resources” and “Liquidity,” contained in Item 7, and in Note 21, “Capital,” to the accompanying Consolidated Financial Statements contained in Item 8.

Other Safety and Soundness Regulations. There are a number of obligations and restrictions imposed on bank holding companies and their bank subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event that the depository institution is insolvent or is in danger of becoming insolvent. For example, the Federal Reserve requires a bank holding company to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so otherwise. These requirements can restrict the ability of bank holding companies to deploy their capital as they otherwise might.

Interstate Banking and Branching. Banks in Virginia may branch without geographic restriction. Current federal law authorizes interstate acquisitions of banks and bank holding companies without geographic limitation. Bank holding companies may acquire banks in any state without regard to state law except for state laws requiring a minimum time a bank must be in existence to be acquired. The Code of Virginia generally permits out of state bank holding companies or banks to acquire Virginia banks or bank holding companies subject to regulatory approval. These laws have the effect of increasing competition in banking markets.

Monetary Policy. The commercial banking business is affected not only by general economic conditions but also by the monetary policies of the Federal Reserve. The Federal Reserve’s monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. In view of unsettled conditions in the national and international political environment, economy and money markets, as well as governmental fiscal and monetary policies their impact on interest rates, deposit levels, loan demand or the business and earnings of the Bank is unpredictable.

Federal Reserve System. Depository institutions that maintain transaction accounts or nonpersonal time deposits are subject to reserve requirements. These reserve requirements are subject to adjustment by the Federal Reserve. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at, or on behalf of, a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution’s interest-earning assets.

Transactions with Affiliates. Transactions between banks and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. These provisions restrict the amount of, and provide conditions with respect to, loans, investments, transfers of assets and other transactions between New Peoples and the Bank.

Loans to Insiders. The Bank is subject to rules on the amount, terms and risks associated with loans to executive officers, directors, principal shareholders and their related interests.

Community Reinvestment Act. Under the Community Reinvestment Act, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practices. The Community Reinvestment Act emphasizes the delivery of bank products and services through branch locations in a bank’s market areas and requires banks to keep data reflecting their efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance with the Community Reinvestment Act and are assigned ratings in this regard. Banking regulators consider a depository institution’s Community Reinvestment Act rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiaries. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the GLBA (see below) may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a “Satisfactory” rating in its latest Community Reinvestment Act examination. The Bank received a rating of “Satisfactory” at its last Community Reinvestment Act performance evaluation, as of July 22, 2019.

In September 2020, the Federal Reserve issued a proposed rule that would significantly change existing Community Reinvestment Act regulations. The proposed rule is intended to: (i) strengthen Community Reinvestment Act’s core purpose of meeting the wide range of low- to moderate-income banking needs and addressing inequities in financial services and credit access; (ii) update standards to reflect changes in banking over time, including the increased use of mobile and internet delivery channels, (iii) promote financial inclusion by including special provisions for activities in underserved areas, and for investments in minority-owned institutions, (iv) bring greater clarity, consistency, and transparency to performance evaluations that are tailored to local conditions, (v) tailor performance tests and assessments to account for differences in bank sizes and business models, (vi) clarify and expand eligible Community Reinvestment Act activities focused on low- to moderate-income communities, (vii) minimize data burden and tailor data collection and reporting requirements, and (vii) recognize the special circumstances of small banks in rural areas. We are evaluating what impact this proposed rule, if implemented, may have on the Company.

Gramm-Leach-Bliley Act of 1999. The GLBA covers a broad range of issues, including a repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. For example, the GLBA permits unrestricted affiliations between banks and securities firms. It also permits bank holding companies to elect to become FHCs, which can engage in a broad range of financial services as described above. In order to become a FHC, a bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed and have at least a satisfactory Community Reinvestment Act rating. On March 4, 2016 the Federal Reserve Bank of Richmond approved New Peoples’ election to become a FHC.

The GLBA also provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities.

Anti-Money Laundering Legislation. New Peoples is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the Money Laundering Control Act of 1986, the USA PATRIOT Act of 2001, and the Anti-Money Laundering Act of 2020. Among other things, these laws and regulations require New Peoples to take steps to prevent the use of New Peoples for facilitating the flow of illegal or illicit money, to report large currency transactions, and to file suspicious activity reports. The Company is also required to carry out a comprehensive anti-money laundering compliance program. Violations can result in substantial civil and criminal sanctions. In addition, provisions of the USA Patriot Act require the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and bank holding company acquisitions.

Privacy and Fair Credit Reporting. Financial institutions, such as the Bank, are required to disclose their privacy policies to customers and consumers and require that such customers or consumers be given a choice (through an opt-out notice) to forbid the sharing of nonpublic personal information about them with nonaffiliated third persons. The Bank also requires business partners with whom it shares such information to assure the Bank that they have adequate security safeguards and to abide by the redisclosure and reuse provisions of applicable law. In addition to adopting federal requirements regarding privacy, individual states are authorized to enact more stringent laws relating to the use of customer information. To date, Virginia has not done so. These privacy laws create compliance obligations and potential liability for the Bank.

Sarbanes-Oxley Act. The Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act) is intended to increase corporate responsibility, provide enhanced penalties for accounting and auditing improprieties by publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities law. The changes required by the Sarbanes-Oxley Act and its implementing regulations are intended to allow shareholders to monitor the performance of companies and their directors more easily and effectively.

The Sarbanes-Oxley Act generally applies to all domestic companies, such as New Peoples, that file periodic reports with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, as amended. The Sarbanes-Oxley Act includes significant additional disclosure requirements and expanded corporate governance rules and the SEC has adopted extensive additional disclosures, corporate governance provisions and other related rules pursuant to it. New Peoples has expended, and will continue to expend, considerable time and money in complying with the Sarbanes-Oxley Act.

Federal Deposit Insurance Corporation. The Bank’s deposits are insured by the Deposit insurance Fund, as administered by the FDIC, to the maximum amount permitted by law, which is $250,000 per depositor. The FDIC uses a “financial ratios method” based on “CAMELS” composite ratings to determine deposit insurance assessment rates for small established institutions with less than $10 billion in assets, such as the Bank. The CAMELS rating system is a supervisory rating system designed to take into account and reflect all financial and operational risks that a bank may face, including capital adequacy, asset quality, management capability, earnings, liquidity and sensitivity to market risk (CAMELS). CAMELS composite ratings set a maximum assessment for CAMELS 1 and 2 rated banks, and set minimum assessments for lower rated institutions.

Dodd-Frank Wall Street Reform and Consumer Protection Act. The Dodd-Frank Act was signed into law on July 21, 2010. Its wide ranging provisions affect all federal financial regulatory agencies and nearly every aspect of the American financial services industry. Among the provisions of the Dodd-Frank Act that directly impact the Company is the creation of an independent Consumer Financial Protection Bureau (CFPB), which has the ability to write rules for consumer protections governing all financial institutions. All consumer protection responsibility formerly handled by other banking regulators is consolidated in the CFPB. It also oversees the enforcement of all federal laws intended to ensure fair access to credit. For smaller financial institutions, such as the Company and the Bank, the CFPB coordinates its examination activities through their primary regulators.

The Dodd-Frank Act contains provisions designed to reform mortgage lending, which includes the requirement of additional disclosures for consumer mortgages. The EGRRCPA modified a number of these requirements, including, for smaller institutions (under $10 billion in total assets) that qualify, a safe harbor for compliance with the “ability to pay” requirements for consumer mortgage loans. The CFPB has implemented mortgage lending regulations to carry out its mandate. In addition, the Federal Reserve has issued rules limiting the fees charged to merchants by credit card companies for debit card transactions. The result of these rules is to limit the amount of interchange fee income available explicitly to larger banks and indirectly to us. The Dodd-Frank Act also contains provisions that affect corporate governance and executive compensation.

The Dodd-Frank Act has had, and may in the future have, a material impact on New Peoples’ operations, particularly through increased compliance costs resulting from new and possible future consumer and fair lending regulations. The future changes resulting from the Dodd-Frank Act may affect the profitability of business activities, require changes to certain business practices, impose more stringent regulatory requirements or otherwise adversely affect the business and financial condition of New Peoples and the Bank. These changes may also require New Peoples to invest significant management attention and resources to evaluate and make necessary changes to comply with new statutory and regulatory requirements.

The Economic Growth, Regulatory Reform and Consumer Protection Act of 2018. The EGRRCPA, which became effective in May 2018, amended provisions of the Dodd-Frank Act and other statutes administered by banking regulators. Among these amendments are provisions exempting insured depository institutions (and their parent companies) with less than $10 billion in consolidated assets and meeting certain other asset and liabilities trading tests from the Volker Rule, which prohibits banks from conducting certain investment activities with their own accounts. The EGRRCPA required the regulators to promulgate rules establishing the new CBLR, as described above. The Act increased the asset threshold from $1 billion to $3 billion for financial institutions to qualify for a less burdensome 18 month on site examination schedule. The EGRRCPA made numerous other changes in regulatory requirements based on the size and complexity of financial institutions, particularly benefiting smaller institutions like the Company.

Cyber Security. In March 2015, federal regulators issued two related statements regarding cyber security. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If the Company fails to observe the regulatory guidance, it could be subject to various regulatory sanctions, including financial penalties.

Other Laws. Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, the Fair and Accurate Credit Transactions Act of 2003 and the Fair Housing Act, require compliance by depository institutions with various disclosure and consumer information handling requirements. These and other similar laws result in significant costs to financial institutions and create potential liability for financial institutions, including the imposition of regulatory penalties for inadequate compliance.

Future Regulatory Uncertainty. Because federal and state regulation of financial institutions changes regularly and is the subject of constant legislative debate, New Peoples cannot forecast how regulation of financial institutions may change in the future and impact its operations. New Peoples fully expects that the financial institution industry will remain heavily regulated notwithstanding the regulatory relief that has been recently adopted.

Item 1A.    Risk Factors

Not required.

Item 1B.    Unresolved Staff Comments

Not applicable.

Item 2.     Properties

At December 31, 2020, the Company’s net investment in premises and equipment was $22.2 million, which includes construction $1.0 million in progress related to a Bristol, Virginia location. Our main office and operations center is in Honaker, Virginia, which includes a full-service branch, and a separate administration and operations center.

The Bank owns 14 of its full-service branches, including its headquarters office, plus its one limited-service branch. The locations of these branches are described in Item 1. In 2017, the Bank sold its Abingdon, Bristol, Gate City and Castlewood, Virginia properties and in connection with the sale of these four properties, entered into commercial lease agreements for the properties, which allowed the Bank to continue to service customers from these locations. During the third quarter of 2019, the Bank sold its Lebanon, Virginia property, and in connection with this sale, entered into a commercial lease agreement which allows the Bank to continue to service customers from this location. For additional discussion of these leases see Note 17, Leasing Activities, in Notes to the Consolidated Financial Statements contained in Item 8 of this form 10-K. Aside from the retail branch offices, we own a building in Bristol, Virginia that is being renovated as a full-service branch with a planned opening in the third quarter of 2021. Additionally, the bank owns two operations buildings, one housing its network operations and another that serves as our call center and ITM network operations center. In November 2020, we entered into a short-term lease on a building in Boone, North Carolina that serves as a loan production office.

During 2018, we limited activity at the Jonesborough, Tennessee loan production office and in 2019 it was closed and the ITM at this site was relocated. Currently, this location is being used as a hub for meeting with prospective loan customers.

The Bank owns a location in Dungannon, Virginia that is currently being leased out, but was formerly used as a branch until its closure during 2010. Two other closed branches (Bluewell, West Virginia and Jonesville, Virginia) that are vacant may be used for future banking offices again. A third vacant former branch office in Bristol, Virginia had been under consideration as a future banking office, but this is likely to change due to its proximity to the office we are renovating. A fourth former branch office in Norton, Virginia was transferred to other real estate owned in 2019 and is being marketed for sale. With the opening of an office in Kingsport, Tennessee in the third quarter of 2020, we closed a nearby location and transferred customer accounts to the new Kingsport office. As a result of assessing our branch network, as part of the overall efficiency project undertaken in 2019 and 2020, offices in Pound and Weber City, Virginia are scheduled to close in the second quarter of 2021, with those accounts being transferred to nearby offices.

We believe that all of our properties are maintained in good operating condition and are suitable and adequate for our operational needs.

Item 3.     Legal Proceedings

In the normal course of operations, we may become a party to legal proceedings, as discussed in Note 20 Legal Contingencies to the consolidated financial statements contained in Item 8 of this form 10-K

Item 4.     Mine Safety Disclosures

Not applicable.

PART II

Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

(a)        Market Information

Computershare Investor Services is the stock transfer agent for New Peoples Bankshares, Inc. The common stock of New Peoples is quoted on the OTC Market’s Pink Open Market under the symbol “NWPP”. The volume of trading of shares of common stock is very limited. Trades in our common stock occur sporadically on a local basis and typically in small volumes. Over-the-Counter market quotations reflect inter-dealer prices without retail mark up, mark down or commissions and may not necessarily represent actual transactions.

The most recent sales price of which management is aware was $2.00 per share on March 24, 2021.

(b)           Holders

On March 24, 2021, there were approximately 4,321 shareholders of record.

(c)          Dividends

In order to preserve capital we have not paid cash dividends to our shareholders. Any declaration of dividends in the future will depend on our earnings, capital requirements, growth strategies, and compliance with regulatory mandates principally at the Bank level since the Company’s primary source of income is dividends which it would receive from the Bank. We are subject to certain dividend restrictions and capital requirements imposed by the Federal Reserve Bank as well as Virginia banking statutes and regulations. We do not anticipate paying a dividend on our common stock in the near future as the Company continues to have a retained deficit. We expect to retain earnings to build capital and position the Company to pay a dividend to its shareholders as soon as practicable. See Note 16 Dividend Limitation on Subsidiary Bank and Note 21 Capital to the consolidated financial statements contained in Item 8 of this form 10-K.

Item 6.        Selected Financial Data

Not required.

Item 7.        Management’s Discussion and Analysis of Financial Condition and Results of Operations  Caution About Forward Looking Statements

We make forward looking statements in this annual report that are subject to risks and uncertainties. These forward looking statements include statements regarding 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.  Important factors that may cause actual results to differ from projections include:

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, 2020 and 2019 as well as results of operations for the years ended December 31, 2020 and 2019. 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 nonaccrual 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 and commissions on insurance and investment products sold.

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 policies 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 further 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 “Provision 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. In the past, the Company provided a valuation allowance on its net deferred tax assets where it was deemed more likely than not such assets would not be realized. At December 31, 2020 and 2019, 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 further discussion of our other critical accounting policies, see Note 2, Summary of Significant Accounting Policies, to our Consolidated Financial Statements, found in Item 8 to 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.

In December 2020, the federal banking agencies issued a notice of proposed rulemaking that would require banking organizations to notify their primary regulator within 36 hours of becoming aware of a “computer-security incident” or a “notification incident.” The proposed rule also would require specific and immediate notifications by bank service providers that become aware of similar incidents.

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 December 31, 2019 COVID-19 has adversely affected, and will continue to adversely affect, economic activity globally, nationally and locally. Market interest rates have declined significantly. In early 2020, the Federal Open Market Committee reduced the target federal funds rate twice by a total of 150 basis points (bps). As a result of these actions the target federal funds rate now stands at 0.00% - 0.25% and the prime interest rate stands at 3.25%.

State and local governments have issued executive orders and businesses have implemented rules as simple as wearing a mask in public and social distancing to limiting attendance at public and household gatherings. This has had, and will continue to have, a significant adverse impact on the economy as certain industries have been seriously impaired or have been forced to close.

Financial services are considered essential services, and we have continued to meet the needs of our customers. We supplemented our existing procedures for the adoption of workplace safety standards outlined by the Virginia Department of Labor and Industry. Since the first quarter of 2020, we have maintained a committee dedicated to managing our response to the pandemic. This has included marshalling supplies and personal protective equipment, coordinating employee and customer communications, evaluating staffing and maintaining compliance with various mandates and regulations. We have restricted access to our lobbies since the first quarter of 2020. Based on our continuing assessment of the intensity of the pandemic in our market areas, we continue to limit lobby access and expect this limitation to be discontinued in the second quarter of 2021 as local cases decrease and vaccinations increase in our region. Meanwhile, our offices continue to provide customer services principally via drive-thru facilities and ITMs.

As part of the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), the Small Business Administration (SBA) was authorized to guarantee Paycheck Protection Program (PPP) loans used by borrowers for payroll and other permitted purposes. The SBA has provided a 100% guarantee and paid originators a processing fee ranging from 1% to 5%, based on the loan amount. We funded a total of $44.5 million of these loans for our customers through August 2020, when the funding period closed, and received $1.6 million in net fees from the SBA, which is being recognized as income over the terms of these loans. As of December 31, 2020, $994 thousand of these fees had been recognized in income. At December 31, 2020, $34.8 million of PPP loans remain. It is anticipated the SBA will forgive the majority of these loans. Through March 31, 2021, 407 loans have received forgiveness payments from the SBA totaling $24.7 million.

In January 2021, the United States Congress passed additional legislation providing economic relief related to the COVID-19 pandemic. This legislation included a second round of Paycheck Protection Loans. We are participating in this program and have funded 322 loans totaling $18.8 million through March 31, 2021

In response to the economic impact brought on by the COVID-19 pandemic, banking and financial regulators provided guidance to financial institutions regarding borrower requests for forbearance. In general, short-term deferrals or other minor modifications extended to borrowers who were current in their loan obligations at December 31, 2019, were not considered troubled debt restructurings (TDRs) or impairments. These accommodations have been provided in the form of payment deferrals or conversion to interest only for a period of time, generally, three to six months. As of December 31, 2020, 688 loans which have received some form of forbearance in accordance within the applicable legislative and regulatory guidelines totaled $112.0 million, and virtually all of them have progressed through their forbearance period, with 15 accounts totaling $836 thousand in forbearance at year-end. In addition to loans receiving forbearance under the CARES Act, 36 accounts totaling $2.4 million at December 31, 2020, were existing or newly classified as TDRs, that received temporary forbearance. Of all accounts receiving forbearance, 82 accounts totaling $5.6 million were past due 30 days or more, including six loans totaling $332 thousand that were past due 90 days or more at December 31, 2020. No accounts past due 90 days or more are accruing interest.

The majority of the loans which obtained forbearance are within our general market area, with $73.3 million, $16.7 million and $26.9 million in Virginia, Tennessee and West Virginia, respectively. At December 31, 2020, these loans cover a number of industries, such as residential property rental of $21.4 million, commercial and other real estate rental of $16.0 million, hotels and motels of $11.0 million; coal mining and natural gas extraction $6.0 million and amusement and entertainment of $5.0 million. Consumer loans represent $40.5 million, with $39.5 million secured by real estate. Most of these loans have reached the end of their forbearance period and the vast majority of these borrowers have resumed their payments. While we believe that the majority of these borrowers will be able to repay their obligations, we cannot reasonably estimate the risk of loss should the adverse economic impact of the pandemic continue for an extended period of time.

In summary, the adverse economic impact of the COVID-19 pandemic has been extensive and wide ranging, resulting in a steep decline in interest rates, an increase in unemployment and a resulting decline in economic output. At this time, we cannot reasonably estimate the term or intensity of any possible adverse impact on our financial position, operations or liquidity. Given the continuation in COVID-19 cases and hospitalizations, economic recovery may be slow and uneven. However, we are encouraged by the recent vaccination programs and therapeutic treatments that have been developed and are becoming more available to the mass population.

Overview

The Company’s consolidated net income for the year ended December 31, 2020 was $2.9 million, or basic income per share of $0.12 as compared to a net income of $2.1 million, or basic income per share of $0.09, for the year ended December 31, 2019. This is an increase of $831 thousand, or $0.03 per share. This increase was driven primarily by a reduction of $2.0 million in non-interest expense and an increase of $167 thousand in net interest income, offset by a reduction of $505 thousand in non-interest income and an increase of $250 thousand in provision for loan losses. The $2.0 million reduction in non-interest expense is a 6.9% decrease and was driven by an $878 thousand decrease in salaries and benefits and a $1.1 million decrease in other operating expenses. The salaries and benefits reduction is a result of the restructure announced in May of 2020. The other operating expenses reduction is a result of renegotiated contracts and reductions in expenses related to loan collections and foreclosed assets. A moratorium on foreclosures during most of 2020 drove the reductions in loan collections and foreclosed asset expenses. The increase in net interest income resulted from a $919 thousand decline in interest income which was more than mitigated by a $1.1 million reduction in interest expense. Economic conditions during 2020 drove reductions in market interest rates which negatively affected our interest income and allowed us to reduce our deposit rates.

At December 31, 2020, total assets were $756.6 million, total loans were $575.6 million, and total deposits were $668.0 million. We closed $44.5 million in PPP loans in 2020, which, when combined with federal stimulus payments received by our deposit customers, drove increases in deposits.

The Company’s key performance indicators are as follows:

Highlights from the year 2020 include:

The $49.9 million growth in total assets was driven primarily by an increase of $40.2 million in interest bearing deposits in other banks, which in turn was driven by a $46.5 million increase in total deposits. The increase in deposits was primarily due to PPP loans, which were dispersed into each loan customer’s checking account. Deposits also increased through federal stimulus payments received by customers into their checking accounts.

Total equity increased to $58.2 million at December 31, 2020, an increase of $3.6 million, or 6.5%. The Bank’s capital ratios at December 31, 2020 as compared to December 31, 2019, respectively, were as follows: Tier 1 leverage ratio of 9.49% versus 9.43%; Tier 1 risk based capital ratio of 15.16% versus 13.72%; total risk based capital ratio of 16.41% versus 14.83%; and common equity Tier 1 capital ratio of 15.16% versus 13.72%. The Bank is considered well-capitalized under regulatory guidelines.

Expenses related to OREO properties were $307 thousand in 2020 compared to $635 thousand in 2019. During 2020, we recorded write-downs on other real estate owned properties of $132 thousand compared to $214 thousand in 2019. During 2020, we had a net gain on the sale of OREO of $60 thousand compared to a net loss of $123 thousand in 2019.

Total loans increased $13.0 million in 2020, or 2.3%, to $575.6 million at December 31, 2020, as compared to $562.5 million at December 31, 2019. The main driver of this increase in total loans is the $44.5 million of PPP loans originated during 2020. Since PPP loans are generally commercial loans, they have supported our strategy to grow and diversify the loan portfolio. Total loans also increased as result of loan demand in the Tri-Cities market along with our initial efforts in the western North Carolina market. As evidenced in 2020, loan growth in general is subject to economic conditions, customer demand, and competition in our markets.

Nonperforming assets, which include nonaccrual loans, loans past due 90 days or more and still accruing interest and OREO increased $332 thousand, or 3.88%, to $8.9 million at year-end 2020 from $8.5 million at year-end 2019. Other real estate owned declined by $59 thousand during 2020 to $3.3 million. Nonaccrual loans increased $391 thousand to $5.5 million during the year ended December 31, 2020. Total nonperforming assets represented 1.17% and 1.21% of total assets at December 31, 2020 and December 31, 2019, respectively. There were no loans past due 90 days or greater and still accruing interest at December 31, 2020 or 2019. The makeup of these assets is primarily related to commercial and residential real estate. During the fourth quarter of 2019, the largest foreclosed property, with a recorded balance of $1.6 million, was sold. We continue undertaking extensive and aggressive measures to work out problem credits and liquidate foreclosed properties. Our goal is to continue to reduce the nonperforming assets being mindful of the impact to earnings and capital; however, we may recognize some losses and reductions in the allowance for loan loss as we expedite the resolution of these problem assets.

Our allowance for loan losses at December 31, 2020 was $7.2 million, or 1.25%, of total loans, as compared to $5.4 million, or 0.95% of total loans at December 31, 2019. Impaired loans decreased $493 thousand, or 8.8%, to $5.4 million, with an estimated allowance of $1,052 thousand for potential losses, at December 31, 2020; as compared to $8.0 million in impaired loans, with an estimated allowance of $318 thousand, at the end of 2019. A provision for loan losses of $2.3 million was recorded in 2020, up from $2.1 million in 2019. Net loans charged off in 2020 were $477 thousand, or 0.08% of average loans, compared to $2.0 million, or 0.36% of average loans, in 2019. The losses recorded in 2019, were primarily related to some commercial loans extended to a few borrowers who ceased operations during that year. Two of these relationships accounted for $1.5 million of the losses recorded. 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. 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.

Net Interest Income and Net Interest Margin

The Company’s primary source of income is net interest income, which increased $167 thousand, or 0.7% in 2020 compared to 2019. While we had increases in both loans and overnight balances in interest-bearing deposits in other banks, the growth was not sufficient to offset the impact of decreases in interest rates, resulting in a decrease in interest income of $919 thousand. However, total interest expense decreased by $1.1 million, more than mitigating the decrease in interest income, due primarily to the reduction of interest rates paid on money market accounts, time deposits and trust preferred securities.

The decrease in interest income is due primarily to lower interest rates on loan accounts, which accounted for $896 thousand of the $919 thousand total decrease, even though average loan balances increased $23.2 million during 2020. Other contributing items to the decline in interest income was a $597 thousand decrease in interest income from deposits in other banks and a $355 thousand decrease in interest on investments. Although average balances of deposits in other banks grew by $22.1 million, the decline in yield to 0.34% from 2.06% in 2020 compared to 2019 drove the reduction in interest income from these deposits. The decline in interest income received from investments was driven by reductions in both rates and balances. Partially mitigating these decreases was a $933 thousand increase in loan fees, driven primarily by fees earned on PPP loans.

The decrease in interest expense of $1.1 million was driven primarily by a $598 thousand reduction in interest expense paid on money market deposit accounts, with both lower balances and lower rates contributing to the savings. Lower rates paid on trust preferred securities contributed $254 thousand toward reductions in interest expense, as lower market rates reduced the variable rates paid in these securities.

Overall, the net interest margin decreased 16 bps to 3.66% in 2020 compared to 3.82% in 2019. This reduction in interest rates was a direct result of actions taken by the Federal Reserve’s Federal Open Market Committee, in response to the economic impact of the pandemic, which reduced the target federal funds rate twice in March 2020, by 150 bps. As a result of these actions the target federal funds rate now stands at 0.00% - 0.25% and the prime interest rate stands at 3.25%. Although the reduction of the federal funds rate in the first quarter of 2020 was an instantaneous move, it was in line with activity during the latter half of 2019, when the prime interest rate dropped three times by 25 bps each based on actions by the Federal Open Market Committee. During 2019 the prime interest rate fell from 5.50% to 4.75%. This was essentially full circle from the cycle in 2018 when the prime interest rate increased from 4.50% to 5.50%. Additionally, the yield on PPP loans is 1.00% (excluding the impact of deferred fee income), which reduces the overall average yield on loans. Fee revenue from the SBA on PPP loans only partially mitigates the low rate on these loans. Our yield on loans was 4.95% in 2020 compared to 5.15% in 2019. We have responded by lowering rates paid on deposit accounts, as evidenced by our 0.72% cost of funds in 2020 compared to 0.92% in 2019.

Another factor impacting the decrease in interest expense and the cost of funds was a significant deposit by a related party to our tiered premium money market account. Of the approximately $30 million of funds received during the first quarter of 2019 and intended as a temporary deposit, only approximately $5 million remained at December 31, 2020.

Due to the increased deposit balances, additional borrowings from the FHLB were unnecessary during 2020. Hence, interest paid on FHLB advances declined by $10 thousand in 2020 compared to 2019, due to maturities in 2019.

Unless we are able to continue to increase the volume of our interest-earning assets going forward, while controlling our cost of funds, we may continue to experience compression on the net interest margin. New and renewed loans are often being repriced at lower interest rates while we anticipate no increase in interest rates in the foreseeable future, due to the economic impact of the COVID-19 pandemic.

Our future interest rate structure also may be impacted by the pending end of the use of LIBOR as a benchmark interest rate in 2021. We use LIBOR in pricing some of our interest earning assets and liabilities, including our trust preferred securities. At this time it appears that LIBOR will be replaced by the Secured Overnight Financing Rate (SOFR), which is a transparent measure of the cost of borrowing cash overnight collateralized by Treasury securities. Because no there is not yet a consensus as to what rate or rates may become acceptable alternatives to LIBOR, however, we cannot predict the effect of any such alternatives on the value of LIBOR-based variable-rate loans, as well as LIBOR-based securities, trust preferred securities, or other securities or financial arrangements. Regardless of whether SOFR or some other benchmark rate replaces LIBOR, we do not anticipate that the change will have a material impact on our ability to negotiate and price earning assets and liabilities. However, the transition to alternative reference rate for new contracts, or the implementation of a substitute index or indices for the calculation of interest rates under the Company’s existing loan agreements with borrowers or other financial arrangements, could change the Company’s market risk profile, interest margin, interest spread and pricing models, may cause the Company to incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept a substitute index or indices, and may result in disputes or litigation with customers or other counter-parties over the appropriateness or comparability to LIBOR of the substitute index or indices.

Nonaccrual loan balances increased $391 thousand during 2020 to $5.5 million at December 31, 2020, which negatively affect interest income as these loans are nonearning assets. 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. 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.

Net Interest Margin Analysis

Average Balances, Income and Expense, and Yields and Rates

(Dollars in thousands)

(1) Non-accrual loans have been included in the average balance of loans outstanding.

(2) Loan fees have been included in interest income on loans.

(3) Tax exempt income is not significant and has been treated as fully taxable.

Net interest income is affected by changes in both average interest rates and average volumes of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total changes in interest income and expense which can be attributed to rate (change in rate multiplied by old volume) and volume (change in volume multiplied by old rate) for the periods indicated.

Loans

Our primary source of income is interest earned on loans. Total loan balances increased $13.0 million during 2020, or 2.3%, to $575.6 million at December 31, 2020 as compared to $562.5 million at December 31, 2019. The main driver in this increase in total loans was a $32.0 million growth in commercial loans, driven by PPP loans. For the same year over year comparison, commercial loans secured by real estate and Multifamily residential loans grew $8.9 million and $2.9 million, respectively, but residential 1-4 family loans and real estate construction loans decreased $19.9 million and $6.1 million, respectively. Our strategy to grow and diversify the loan portfolio was accelerated by pandemic-related economic conditions, but the overall yield on loans suffered, as discussed above. Loans rated substandard or doubtful increased $276 thousand, or 5.4%, to $5.4 million at December 31, 2020 from $5.1 million at December 31, 2019.

Loans receivable outstanding are summarized as follows:

Our loan maturities as of December 31, 2020 are shown in the following table:

Provision 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. As a result of the severe economic downturn during the first quarter of 2020 related to the pandemic, we reassessed our allowance for loan losses methodology and adjusted qualitative factors for the potential future impact on our loan portfolio, which has resulted in additional provisions to the allowance.

The allowance for loan losses increased to $7.2 million at December 31, 2020 as compared to $5.4 million at December 31, 2019. The allowance for loan losses at the end of 2020 was approximately 1.25% of total loans as compared to 0.95% at the end of 2019. Provisions for loan losses of $2.3 million were recorded during 2020 and $2.1 million in 2019. Loans charged off, net of recoveries, totaled $477 thousand, or 0.08% of average loans, for the year ended December 31, 2020, compared to $2.0 million, or 0.36% of average loans, in 2019. This large reduction in net charge-offs is primarily related to the moratorium on foreclosure 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. 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. 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.

Nonaccrual loans present higher risks of default, and we have experienced an increase in these loans during 2020. At December 31, 2020, there were 75 nonaccruing loans totaling $5.5 million, or 0.96% of total loans. At December 31, 2019, there were 74 nonaccruing loans totaling $5.2 million, or 0.92% of total loans. The amount of interest income that would have been recognized on these loans had they been accruing interest was $494 thousand and $714 thousand in the years 2020 and 2019, respectively. In 2019, 94 nonperforming and under performing loans totaling $4.4 million were sold, resulting in a net recovery to the allowance for loans losses of $56 thousand, after determining that it was more cost effective to dispose of the accounts than to continue pursuing collection efforts. There were no loans past due 90 days or greater and still accruing interest at either December 31, 2020 or 2019. 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.

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 $5.1 million with $2.5 million requiring a valuation allowance of $1.1 million at December 31, 2020 as compared to $5.6 million with $919 thousand requiring a valuation allowance of $323 thousand at December 31, 2019. 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.

Following is a summary of non-accruing loans, loans past due longer than 90 days still accruing interest, and restructured loans:

Non-Accrual, Past Due, and Restructured Loans

(Dollars in thousands)

The above table includes $2.5 million and $570 thousand in nonaccrual loans as of December 31, 2020 and 2019, respectively, which have been classified as troubled debt restructurings. No troubled debt restructurings were past due 90 days or more and still accruing as of December 31, 2020 or 2019. There were $4.0 million in loans classified as troubled debt restructurings as of December 31, 2020, as compared to $4.3 million in loans classified as troubled debt restructurings as of December 31, 2019.

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. The following table provides a summary of the activity in the allowance for loan losses.

Analysis of the Allowance for Loan Losses

(Dollars in thousands)  

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 following table 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 32% of the allowance to commercial real estate loans, which constituted 31.17% of our loan portfolio at December 31, 2020. This allocation increased when compared to the 23% in 2019 due primarily to the risks to businesses associated with the COVID-19 pandemic. We have allocated 34% of the allowance to commercial loans, which constituted 19.28% of our loan portfolio at December 31, 2020. This allocation percentage decreased compared to December 31, 2019 due to guarantees provided by the SBA on PPP loans, which resulted in their being excluded from the allowance assessment of commercial loans.

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 3% of the allowance to real estate construction loans, which constituted 4.35% of our loan portfolio at December 31, 2020. Construction loans are secured by real estate with values that are dependent upon market and economic conditions. Values may not always be easily ascertainable as evidenced by the current market conditions. 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 29% of the allowance to residential real estate loans, which constituted 41.62% of our loan portfolio at December 31, 2020. Our allocation decreased as a percentage of the allowance for loan losses due to the $6.9 million decrease in residential real estate loans during 2020.

We have allocated 2% of the allowance to consumer installment loans, which constituted 3.58% of our loan portfolio at December 31, 2020, which declined $31 thousand compared to the 4% allocation we had in 2019.

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