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Caution About Forward-Looking Statements

We make forward-looking statements in this quarterly report on Form 10-Q that are subject to risks and uncertainties. These forward-looking statements include statements regarding expectations, intentions, projections and beliefs concerning our profitability, liquidity, and allowance for credit 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:

• the success or failure of our efforts to implement our business plan;
• any required increase in our regulatory capital ratios;
• satisfying other regulatory requirements that may arise from examinations, changes in the law and other similar factors;
• deterioration of asset quality;
• changes in the level of our nonperforming assets and charge-offs;
• fluctuations of real estate values in our markets;
• our ability to attract and retain talent;
• demographical changes in our markets which negatively impact the local economy;
• the uncertain outcome of current or future legislation or regulations or policies of state and federal regulators;
• the successful management of interest rate risk;
• the successful management of liquidity;
• changes in general economic and business conditions in our market area and the United States in general;
• credit risks inherent in making loans such as changes in a borrower’s ability to repay and our management of such risks;
• competition with other banks and financial institutions, and companies outside of the banking industry, including online lenders and those companies that have substantially greater access to capital and other resources;
• demand, development and acceptance of new products and services we have offered or may offer;
• deposit flows and competition for deposits;
• the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve, inflation, interest rate, market and monetary fluctuations;
• the occurrence of significant natural disasters, including severe weather conditions, floods, health related issues and other catastrophic events;
• geopolitical conditions, including acts or threats of terrorism, international hostilities, or actions taken by the U.S. or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in the U.S. and abroad;
• technology utilized by us;
• our ability to successfully manage cybersecurity;
• our reliance on third-party vendors and correspondent banks;
• changes in generally accepted accounting principles;
• changes in governmental regulations, tax rates and similar matters; and,
• other risks, which may be described, from time to time, in our filings with the SEC.

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

Critical Accounting Policies

For discussion of our significant accounting policies, see our Annual Report on Form 10-K for the year ended December 31, 2023, and Note 2 Summary of Significant Accounting Policies, in Item 1 of this Form 10-Q. 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 allowance for credit losses.

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

Overview and Highlights

Net income for the three months ended March 31, 2024 was $1.8 million, a decrease of $235,000, or 11.63%, from the same period in 2023. Net interest income declined 1.95%, or $138,000, from $7.1 million for the quarter ended March 31, 2023 to $6.9 million for the quarter ended March 31, 2024. The decrease was primarily due to an increase in the cost of interest-bearing liabilities of 150 basis points (“bps”) to 2.77% during the quarter ended March 31, 2024 compared to 1.27% during the quarter ended March 31, 2023.

The balance sheet grew to $850.5 million in total assets as of March 31, 2024, from $826.3 million as of December 31, 2023. Gross loans increased $483,000 to $638.6 million as of March 31, 2024. Additionally, interest-bearing deposits in other banks increased $22.4 million to $72.8 million as of March 31, 2024. During the first three months of 2024 total deposits increased $24.3 million or 3.39% to $740.8 million.

A dividend of $0.07 per share was paid to shareholders during the first quarter of 2024, a 16.7% increase over the dividend paid in 2023.

During the first quarter of 2024, we extended a previously announced stock repurchase program, to continue through March 31, 2025. Since the inception of the program through March 31, 2024, the Company has repurchased 210,299 shares at an average price of $2.34 per share.

Comparison of the Three Months ended March 31, 2024 and 2023

Quarter-to-date highlights include:

Net interest income for the quarter ended March 31, 2024 was $6.9 million compared to $7.1 million for the quarter ended March 31, 2023. The decrease was primarily due to an increase in the cost of interest-bearing liabilities of 150 bps to 2.77% during the quarter ended March 31, 2024 compared to 1.27% during the quarter ended March 31, 2023. The time deposits portfolio was the primary contributor to the decline in the net interest income, due to an increase of 209 bps in the quarterly cost of time deposits to 3.77% and a $64.1 million increase in the average balance of time deposits due to a combination of new deposits and a shift in the mix from lower cost deposit products. Additionally, while the average cost of borrowed funds decreased 101 bps to 5.82%, the related interest expense increased $190,000 due to the increased average balance related to a Federal Home Loan Bank advance and a Federal Reserve Bank Bank Term Funding Program borrowing, taken in the second and fourth quarters of 2023, respectively, which increased the overall outstanding average balance $18.1 million. The increase in the cost of funds was offset in part by an increase of 70 bps in the yield on earning assets. The yield on loans increased 72 bps to 5.83%, partially assisted by recovery of interest on prior nonperforming loans, combined with an increase in the average balance of $49.5 million and interest rate increases on loan renewals and interest rate reset dates, helping to offset the increased cost of funding during the quarter ended March 31, 2024. These rate and volume activities combined to result in a decrease in net interest income of $138,000, as the net interest margin decreased 35 bps, to 3.48% for the quarter ending March 31, 2024 as compared to the 3.83% margin for the same period in 2023.

The following table shows the rates paid on earning assets and interest-bearing liabilities for the periods indicated:

Net Interest Margin Analysis

Average Balances, Income and Expense, and Yields and Rates

Three Months Ended March 31,

Net interest income is affected by changes in both average interest rates and average volumes (balances) of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total changes in interest income and interest expense which can be attributed to rates and volume for the three months ended March 31, 2024, as compared to the three months ended March 31, 2023.

Volume and Rate Analysis

Increase (decrease)

The recovery of credit losses charged to the income statement for the quarter ended March 31, 2024 was $43,000 compared to a provision of $0 for the three months ended March 31, 2023. The amount of the provision for credit losses was impacted by net loan recoveries of $146,000 during the quarter ended March 31, 2024. For a discussion of the factors affecting the allowance for credit losses, including provision expense, refer to Note 7, Allowance for Credit Losses for Loans, in Item 1 of this Form 10-Q.

Noninterest income decreased $78,000 to $2.3 million for the quarter ended March 31, 2024 from $2.4 million for the comparable quarter in 2023. The decrease is due largely to the sales of bank properties in 2024 and 2023. During the first quarter of 2024, a sales agreement for a former branch office was executed resulting in a loss of $33,000. During the same period of 2023, two former office facilities were sold resulting in a net gain of $130,000. The net year-over-year change of $163,000 resulting from these sales, included in other noninterest income, was partially offset by an increase in financial services revenue of $65,000. Service charge income and revenue from card processing of $915,000 and $895,000, respectively, for the first three months of 2024, remained relatively unchanged from the same period of 2023.

Noninterest expense was $7.0 million for the quarter ended March 31, 2024 compared to $6.9 million for the quarter ended March 31, 2023. The $107,000 increase was impacted by the $97,000 increase in salaries and employee benefits, as well as occupancy expenses, which increased $11,000. The increase in salaries and employee benefits related to performance raises, along with severance costs and other contractual payments associated with the recent retirement of the previous chief executive officer and the elimination of several positions during the first quarter of 2024. The increase in occupancy costs are related to the opening of a branch office in Boone, North Carolina during the first quarter of 2024.

The efficiency ratio, which is defined as noninterest expense divided by the sum of net interest income plus noninterest income, increased to 75.42% during the first quarter of 2024 from 72.56% for the first quarter of 2023. We continue to assess our operational procedures and structure to improve efficiencies and contain costs.

Income tax expense for the first quarter of 2024 totaled $531,000, a decrease of $45,000, or 7.81% from $576,000 recorded during the same period in 2023. The effective tax rate for the three months ended March 31, 2024, was 22.92%, compared to 22.18% for the same period in 2023.

Balance Sheet

Total assets as of March 31, 2024 were $850.5 million, an increase of $24.2 million, or 2.9%, from $826.3 million as of December 31, 2023. Gross loans at March 31, 2024 of $638.6 million were largely unchanged from $638.1 million at December 31, 2023. Liquid assets in the form of interest-bearing deposits with banks increased $22.4 million, or 44.6% during the first quarter of 2024. Investment securities decreased $791,000 during the first quarter of 2024 due to a $1.1 million increase in the unrealized loss on securities available for sale during the quarter, which, combined with payments and amortization of $2.8 million, more than offset purchases of $3.1 million.

Gross loans receivable increased $483,000 to $638.6 million as of March 31, 2024 from $638.1 million as of December 31, 2023. Consumer loans increased $2.4 million or 10.69% which included the purchase of $1.0 million of individual loans during the quarter. Commercial real estate and commercial loans decreased $587,000 and $1.2 million, respectively, during the first quarter of 2024. Residential 1-4 family loans and multifamily loans decreased $808,000 and $77,000, respectively, from December 31, 2023 to March 31, 2024. Loan originations during the first quarter of 2024 were impacted by higher interest rates affecting borrower requests, combined with retrenching from the $11.9 million increase in loans during the fourth quarter of 2023.

Total deposits were $740.8 million as of March 31, 2024 compared to $716.5 million as of December 31, 2023. The increase of $24.3 million, or 3.4%, was due to efforts to attract and retain time deposits and money market account relationships, combined with cyclical funds inflows. As a result of these efforts, total time deposits increased $15.5 million, including $3.0 million of brokered time deposits, and money market accounts increased $4.8 million during the first three months of 2024, respectively. The increase in time and money market deposits contributed to the increase in our cost of funds, as previously discussed, due to the continuing rising interest rate environment combined with ongoing competition for deposits.

Total borrowings consisting of Trust preferred securities of $16.2 million, Federal Home Loan Bank advances of $10.0 million and Federal Reserve Bank Bank Term Funding Program Loan of $10.0 million as of March 31, 2024 remained unchanged in comparison to December 31, 2023.

During the first three months of 2024 total shareholders’ equity decreased $795,000 to $64.0 million as of March 31, 2024, due to earnings of $1.8 million which were offset by dividends paid of $1.7 million, the $835,000 increase in the net unrealized loss on available-for-sale investment securities, and the repurchase of common stock totaling $85,000. Consequently, book value per share decreased to $2.70 as of March 31, 2024 compared to $2.73 at December 31, 2023. The Bank remains well capitalized per regulatory guidance.

As previously announced, the Board extended the repurchase of up to 500,000 shares of the Company’s common stock through March 31, 2025. As of March 31, 2024, the Company had repurchased 34,113 shares during the first three months of 2024 at an average price of $2.48 per share. Since the commencement of the repurchase plan, 210,299 shares have been repurchased at an average price of $2.34.

Asset Quality

The allowance for credit losses as a percentage of total loans was 1.16%, or $7.4 million, as of March 31, 2024, and 1.14%, or $7.3 million, as of December 31, 2023. The allowance for credit losses on unfunded commitments was $238,000 at March 31, 2024 as compared to $285,000 at December 31, 2023.

Annualized net charge-offs (recoveries), as a percentage of average loans, was (0.09)% during the first quarter of 2024, compared 0.01% in the first quarter of 2023.

Nonperforming assets, which include nonaccrual loans and other real estate owned, totaled $5.7 million as of March 31, 2024, an increase of $2.0 million, or 55.6%, since year-end 2023. Nonperforming assets as a percentage of total assets were 0.67% as of March 31, 2024, and 0.45% as of December 31, 2023.

Other real estate owned of $157,000 as of March 31, 2024 is unchanged from December 31, 2023. Expenses associated with other real estate owned were $4,000 for the three months ended March 31, 2024, compared to $6,000 during the three months ended March 31, 2023. Nonaccrual loans increased $2.0 million to $5.5 million as of March 31, 2024 from $3.5 million at December 31, 2023, due largely to a single loan relationship that was downgraded and placed in nonaccrual status during the first quarter of 2024.

For detailed information on nonaccrual loans and other real estate owned as of March 31, 2024 and December 31, 2023, refer to Note 6 Loans and Note 10 Other Real Estate Owned in Item 1 of this Form 10-Q.

Loans rated substandard or below totaled $5.5 million as of March 31, 2024, an increase of $2.0 million from $3.5 million as of December 31, 2023. Total past due loans increased to $6.7 million as of March 31, 2024 from $6.2 million as of December 31, 2023.

The allowance for credit losses is 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.

Through our quarterly assessment, we continue to adjust the CECL model to best reflect the risks in the portfolio. However, future provisions may be deemed necessary. During the first three months of 2024, we maintained the adjustments to our qualitative factors initiated in 2023, to consider risk factors associated with commercial real estate and residential mortgage loans. Those changes, along with recoveries of loans previously charged off and the assessment of the historical and specific risks associated with the loan portfolio, resulted in a recovery of credit losses of $43,000, of which $4,000 was a provision for the loan portfolio; offset by a reduction of the allowance for unfunded commitments of $47,000. The following table summarizes components of the allowance for credit losses and related loans as of March 31, 2024 and December 31, 2023:

¹ - Annualized

Deferred Tax Asset and Income Taxes

Due to timing differences between the book and tax treatments of several income and expense items, a net deferred tax asset, excluding the deferred tax asset on the unrealized loss on securities available-for-sale of $3.3 million and $3.1 million, existed as of March 31, 2024 and December 31, 2023, respectively. Our income tax expense was computed at the corporate income tax rate of 21% of taxable income. We have no significant nontaxable income or nondeductible expenses.

Capital Resources

The Company meets the eligibility criteria to be classified as a small bank holding company in accordance with the Federal Reserve’s Small Bank Holding Company Policy Statement issued in February 2015 and is therefore not obligated to report consolidated regulatory capital. The Bank continues to be subject to various capital requirements administered by banking agencies.

The Bank’s capital ratios along with the minimum regulatory thresholds to be considered well-capitalized are presented in Note 4 in Item 1 of this Form 10-Q.

As of March 31, 2024, the Bank remains well capitalized under the regulatory framework for prompt corrective action. The ratios mentioned above for the Bank comply with the Federal Reserve rules to align with the Basel III Capital requirements.

Book value per common share was $2.70 and $2.73 as of March 31, 2024 and December 31, 2023, respectively. The modest decrease in book value was due to the dividend payment of $0.07 per share paid during the first quarter of 2024, combined with the $835,000 increase in unrealized loss on available for sale investment securities and the $85,000 repurchase of common shares during the quarter.

Other key performance indicators are as follows:

¹ - Annualized

Under current economic conditions, we believe it is prudent to continue to retain capital sufficient to support planned asset growth while being able to absorb potential losses that may occur if asset quality deteriorates, and based upon projections, we believe our current capital levels will be sufficient.

During the first quarter of 2024, the Company paid a cash dividend of $0.07 per common share to our shareholders. Future payments of cash dividends will depend on a number of factors including but not limited to maintaining positive retained earnings, compliance with regulatory rules governing the payment of dividends, strategic plans, and sufficient capital at the Bank to allow payment of dividends to the Company.

On April 28, 2022 the board of directors of the Company authorized the repurchase of up to 500,000 shares of the Company’s outstanding common stock through March 31, 2023. As previously reported, this plan was extended by the Board of Directors through March 31, 2025. The actual means and timing of any purchases, number of shares and prices or range of prices will be determined by the Company in its discretion and will depend on a number of factors, including the market price of the Company’s common stock, general market and economic conditions, and applicable legal and regulatory requirements. As of March 31, 2024, the Company has repurchased 210,299 shares at an average price of $2.34 per share since inception of the plan. During the quarter ended March 31, 2024, the Company repurchased 34,113 shares at an average price of $2.48 per share. There is no assurance that the Company will purchase any additional shares under this program.

Liquidity

We closely monitor our liquidity and our liquid assets in the form of cash, due from banks, federal funds sold, and unpledged available-for-sale securities.

As of March 31, 2024, all of our investment securities were classified as available-for-sale. These investments provide a source of liquidity in the amount of $53.0 million, which is net of the $36.0 million of securities pledged as collateral. Investment securities available-for-sale serve as a source of liquidity and interest rate risk management while generally yielding a higher return versus other short-term investment options, such as federal funds sold and overnight deposits with the Federal Reserve Bank. Due to the unrealized loss on securities available-for-sale, the sale of investments would not be considered a primary source of liquidity due to the immediate impact on regulatory capital; however, the majority of the portfolio is considered high credit quality investments and would be available to pledge against borrowings.

Our loan to deposit ratio was 86.21% and 89.06% as of March 31, 2024 and December 31, 2023, respectively. Generally, our policy has been to manage this ratio at or below 90.00%.

Available third-party sources of liquidity as of March 31, 2024 include the following: a line of credit with the FHLB, access to brokered certificates of deposit markets and the discount window at the Federal Reserve Bank. We also have the ability to borrow $30.0 million in unsecured federal funds through credit facilities extended by correspondent banks.

We have used our line of credit with the FHLB to issue a letter of credit totaling $12.0 million to the Treasury Board of Virginia for collateral on public funds. No draws on these letters of credit have been issued. The letters of credit are considered to be draws on our FHLB line of credit. In May 2023, we borrowed $10.0 million from the FHLB, through a fixed rate 5-year advance, to support loan fundings and other general liquidity needs. In December 2023 we borrowed $10.0 million through the Federal Reserve Bank Bank Term Funding Program for one year, which can be prepaid prior to maturity without penalty. An additional $184.6 million was available as of March 31, 2024 on the $206.6 million line of credit, of which $96.4 million is secured by a blanket lien on our residential real estate loans. Full use of the FHLB borrowing capacity would require the Company to pledge additional assets.

During the first quarter of 2024 we accepted $3.0 million of brokered time deposits to augment our balance sheet liquidity. We held no brokered deposits as of December 31, 2023. Internet accounts are limited to customers located in our primary market area and the surrounding geographical area. The average balance of and the rate paid on deposits is shown in the net interest margin analysis tables. Total reciprocal Certificate of Deposit Registry Services (“CDARS”) time deposits were $6.8 million and $6.3 million as of March 31, 2024 and December 31, 2023, respectively. Aside from the availability of CDARS time deposits, we also offer a similar deposit product for transaction account customers through Intrafi Cash Service (“ICS”). As of March 31, 2024 approximately $24.9 million were placed in this product as compared to $20.5 million at December 31, 2023. Both the CDARS and ICS offerings assist us in maintaining deposit relationships, while assuring the depositors’ funds retain federal deposit insurance coverage.

Additional liquidity is available through the Federal Reserve Bank discount window for overnight funding needs. We may collateralize this line with investment securities and loans at our discretion; however, while we do not anticipate using this as a primary funding source, securities with an estimated market value of $35.3 million were pledged as of March 31, 2024.

Time deposits of $250,000 or more were approximately 6.96% of total deposits at March 31, 2024 and 7.36% of total deposits at December 31, 2023.

With the on-balance sheet liquidity and other external sources of funding, we believe the Bank has adequate liquidity and capital resources to meet our requirements and needs for the foreseeable future. However, liquidity can be further affected by a number of factors such as counterparty willingness or ability to extend credit, regulatory actions and customer preferences, etc., some of which are beyond our control.

The bank holding company has approximately $434,000 in cash on deposit at the Bank at March 31, 2024. The holding company receives periodic dividend payments from the Bank which are used to pay operating expenses, to pay trust preferred interest payments and discretionary principal payments, and to fund dividend payments to shareholders and repurchase shares. The Company makes quarterly interest payments on the trust preferred securities.

As discussed in the Capital Resources section, the Company is authorized to repurchase up to 500,000 shares of the Company’s outstanding common stock through March 31, 2024. Payments for any repurchases will be distributed from available funds, or from dividend payments from the Bank, and are not expected to have a material impact on available liquidity.

Off Balance Sheet Items and Contractual Obligations

There have been no material changes during the three months ended March 31, 2024, to the off-balance sheet items and the contractual obligations disclosed in our 2023 Form 10-K.

Not Applicable.

We have carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer (our CEO) and our Executive Vice President and Chief Financial Officer (our CFO), of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were operating effectively in providing reasonable assurance that (a) the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (b) such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended March 31, 2024, that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

Part II Other Information

In the course of operations, we may become a party to legal proceedings in the normal course of business. At March 31, 2024, we do not anticipate that the aggregate ultimate liability arising out of litigation pending or threatened against the Company or any of its subsidiaries or to which the property of the Company or any of its subsidiaries is subject, in the opinion of management, will materially impact the financial condition or liquidity of the Company.

Not Applicable.

Stock Repurchase Program

The Company has an approved one-year stock repurchase program that authorizes the repurchase of up to 500,000 of the Company’s common shares that was extended through March 31, 2025. Repurchases may be made through open market purchases or in privately negotiated transactions. Shares repurchased will be returned to the status of authorized and unissued shares of common stock. The actual means and timing of any purchases, number of shares and prices or range of prices will be determined by the Company.

Shares of the Company’s common stock were repurchased during the three months ended March 31, 2024, as detailed below. Under the terms of the stock repurchase program, the Company has the remaining authority to repurchase up to 289,701 shares of common stock.

None.

Not Applicable.

None

The following exhibits are filed as part of this report or are incorporated by reference:

The following exhibits are filed as part of this report or are incorporated by reference:

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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