Skyline Bankshares, Inc. - Quarter Report: 2019 June (Form 10-Q)

 

 

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

(Mark One)

 

☑

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2019

 

Or

 

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission File Number: 333- 209052

 

PARKWAY ACQUISITION CORP.

(Exact Name of Registrant as Specified in Its Charter)

 

Virginia		47-5486027
(State or Other Jurisdiction of Incorporation)		(I.R.S. Employer Identification Number)
101 Jacksonville Circle
Floyd, Virginia		24091
(Address of Principal Executive Offices)		(Zip Code)

 

(540) 745-4191

(Registrant’s Telephone Number, Including Area Code)

 

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

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
	None

 

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 checkmark whether the Registrant has submitted electronically any Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 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, 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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

 

The registrant had 6,178,275 shares of Common Stock, no par value per share, outstanding as of August 13, 2019.

 

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PART I FINANCIAL INFORMATION
Item 1.		Financial Statements
		Consolidated Balance Sheets—June 30, 2019 (Unaudited) and December 31, 2018 (Audited)			3
		Unaudited Consolidated Statements of Income—Six Months Ended June 30, 2019 and June 30, 2018			4
		Unaudited Consolidated Statements of Income—Three Months Ended June 30, 2019 and June 30, 2018			5
		Unaudited Consolidated Statements of Comprehensive Income—Six and Three Months Ended June 30, 2019 and June 30, 2018			6
		Unaudited Consolidated Statements of Changes in Stockholders’ Equity—Six and Three Months Ended June 30, 2019 and June 30, 2018			7
		Unaudited Consolidated Statements of Cash Flows—Six Months Ended June 30, 2019 and June 30, 2018			8
		Notes to Consolidated Financial Statements			10
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			43
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			49
Item 4.		Controls and Procedures			50
PART II OTHER INFORMATION
Item 1.		Legal Proceedings			51
Item 1A.		Risk Factors			51
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			51
Item 3.		Defaults Upon Senior Securities			51
Item 4.		Mine Safety Disclosures			51
Item 5.		Other Information			51
Item 6.		Exhibits			51
Signatures					52

 

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(dollars in thousands)		June 30,				December 31,
		2019				2018
		(Unaudited)				(Audited)
Assets
Cash and due from banks		$	7,948			$	8,858
Interest-bearing deposits with banks			11,102				12,159
Federal funds sold			14,012				18,990
Investment securities available for sale			41,096				45,428
Restricted equity securities			2,054				2,053
Loans, net of allowance for loan losses of $3,818 at June 30, 2019 and $3,495 at December 31, 2018			546,002				532,970
Cash value of life insurance			17,629				17,413
Foreclosed assets			-				753
Properties and equipment, net			20,990				20,685
Accrued interest receivable			2,212				2,084
Core deposit intangible			3,455				3,892
Goodwill			3,257				3,198
Deferred tax assets, net			1,091				1,853
Other assets			9,476				9,948
		$	680,324			$	680,284
Liabilities and Stockholders’ Equity
Liabilities
Deposits
Noninterest-bearing		$	161,173			$	160,166
Interest-bearing			437,530				441,702
Total deposits			598,703				601,868
Accrued interest payable			111				89
Other liabilities			2,469				2,705
			601,283				604,662
Commitments and contingencies (Note 8)
Stockholders’ Equity
Preferred stock, no par value; 5,000,000 shares authorized, none issued			-				-
Common stock, no par value; 25,000,000 shares authorized, 6,193,275 and 6,213,275 issued and outstanding at June 30, 2019 and December 31, 2018, respectively			-				-
Surplus			41,425				41,660
Retained earnings			38,583				35,929
Accumulated other comprehensive loss			(967	)			(1,967	)
			79,041				75,622
		$	680,324			$	680,284

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		Six Months Ended
		June 30,
(dollars in thousands except share amounts)		2019				2018
		(Unaudited)				(Unaudited)
Interest income
Loans and fees on loans		$	14,261			$	10,357
Interest-bearing deposits in banks			98				35
Federal funds sold			179				38
Interest on taxable securities			540				597
Dividends			61				39
			15,139				11,066
Interest expense
Deposits			1,270				738
Interest on borrowings			-				27
			1,270				765
Net interest income			13,869				10,301
Provision for loan losses			514				145
Net interest income after provision for loan losses			13,355				10,156
Noninterest income
Service charges on deposit accounts			736				719
Other service charges and fees			1,012				850
Net realized (losses) gains on securities			(4	)			5
Mortgage origination fees			210				144
Increase in cash value of life insurance			216				222
Life insurance income			-				229
Other income			162				55
			2,332				2,224
Noninterest expenses
Salaries and employee benefits			6,419				5,298
Occupancy and equipment			1,439				1,256
Foreclosed asset expense, net			2				(2	)
Data processing expense			731				602
FDIC Assessments			144				138
Advertising			293				276
Bank franchise tax			222				210
Director fees			148				130
Professional fees			362				220
Telephone expense			180				187
Core deposit intangible amortization			437				140
Merger related expenses			-				497
Other expense			1,082				890
			11,459				9,842
Net income before income taxes			4,228				2,538
Income tax expense			828				525
Net income		$	3,400			$	2,013
Net income per share		$	0.55			$	0.40
Weighted average shares outstanding			6,209,629				5,021,376
Dividends declared per share		$	0.12			$	0.10

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		Three Months Ended
		June 30,
(dollars in thousands except share amounts)		2019				2018
		(Unaudited)				(Unaudited)
Interest income
Loans and fees on loans		$	7,140			$	5,271
Interest-bearing deposits in banks			40				16
Federal funds sold			109				7
Interest on taxable securities			264				294
Dividends			47				30
			7,600				5,618
Interest expense
Deposits			680				377
Interest on borrowings			-				27
			680				404
Net interest income			6,920				5,214
Provision for loan losses			276				91
Net interest income after provision for loan losses			6,644				5,123
Noninterest income
Service charges on deposit accounts			376				374
Other service charges and fees			499				438
Net realized gains on securities			10				9
Mortgage origination fees			126				67
Increase in cash value of life insurance			108				111
Life insurance income			-				229
Other income			141				33
			1,260				1,261
Noninterest expenses
Salaries and employee benefits			3,262				2,767
Occupancy and equipment			714				627
Foreclosed asset expense, net			1				1
Data processing expense			362				300
FDIC Assessments			72				69
Advertising			158				160
Bank franchise tax			111				105
Director fees			88				73
Professional fees			180				96
Telephone expense			66				94
Core deposit intangible amortization			218				70
Merger related expenses			-				299
Other expense			526				480
			5,758				5,141
Net income before income taxes			2,146				1,243
Income tax expense			411				244
Net income		$	1,735			$	999
Net income per share		$	0.28			$	0.20
Weighted average shares outstanding			6,206,022				5,021,376
Dividends declared per share		$	0.00			$	0.00

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		Six Months Ended
		June 30,
(dollars in thousands)		2019				2018
		(Unaudited)				(Unaudited)
Net Income		$	3,400			$	2,013
Other comprehensive income (loss)
Unrealized gains (losses) on investment securities available for sale:
Unrealized gains (losses) arising during the period			1,261				(844	)
Tax related to unrealized (gains) losses			(264	)			177
Reclassification of net realized (gains) losses during the period			4				(5	)
Tax related to realized gains (losses)			(1	)			1
Total other comprehensive income (loss)			1,000				(671	)
Total comprehensive income		$	4,400			$	1,342

		Three Months Ended
		June 30,
(dollars in thousands)		2019				2018
		(Unaudited)				(Unaudited)
Net Income		$	1,735			$	999
Other comprehensive income (loss)
Unrealized gains (losses) on investment securities available for sale:
Unrealized gains (losses) arising during the period			558				(242	)
Tax related to unrealized (gains) losses			(117	)			51
Reclassification of net realized gains during the period			(10	)			(9	)
Tax related to realized gains			2				2
Total other comprehensive income (loss)			433				(198	)
Total comprehensive income		$	2,168			$	801

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(dollars in thousands except share amounts)
																		Accumulated
																		Other
		Common Stock												Retained				Comprehensive
		Shares				Amount				Surplus				Earnings				Loss				Total
Balance, December 31, 2018			6,213,275			$	-			$	41,660			$	35,929			$	(1,967	)		$	75,622
Net income			-				-				-				1,665				-				1,665
Other comprehensive income			-				-				-				-				567				567
Dividends paid ($0.12 per share)			-				-				-				(746	)			-				(746	)
Balance, March 31, 2019			6,213,275			$	-			$	41,660			$	36,848			$	(1,400	)		$	77,108
Net income			-				-				-				1,735				-				1,735
Other comprehensive income			-				-				-				-				433				433
Common stock repurchased			(20,000	)			-				(235	)			-				-				(235	)
Balance, June 30, 2019			6,193,275			$	-			$	41,425			$	38,583			$	(967	)		$	79,041
Balance, December 31, 2017			5,021,376			$	-			$	26,166			$	32,526			$	(1,510	)		$	57,182
Net income			-				-				-				1,014				-				1,014
Other comprehensive loss			-				-				-				-				(473	)			(473	)
Dividends paid ($0.10 per share)			-				-				-				(502	)			-				(502	)
Balance, March 31, 2018			5,021,376			$	-			$	26,166			$	33,038			$	(1,983	)		$	57,221
Net income			-				-				-				999				-				999
Other comprehensive loss			-				-				-				-				(198	)			(198	)
Balance, June 30, 2018			5,021,376			$	-			$	26,166			$	34,037			$	(2,181	)		$	58,022

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		Six Months Ended
		June 30,
(dollars in thousands)		2019				2018
		(Unaudited)				(Unaudited)
Cash flows from operating activities
Net income		$	3,400			$	2,013
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization			597				600
Amortization of core deposit intangible			437				140
Accretion of loan discount and deposit premium, net			(1,316	)			(340	)
Provision for loan losses			514				145
Deferred income taxes			442				628
Net realized losses (gains) on securities			4				(5	)
Accretion of discount on securities, net of amortization of premiums			239				269
Deferred compensation			(10	)			18
Gains on sale of properties and equipment			(121	)			-
Life insurance income			-				(229	)
Changes in assets and liabilities:
Cash value of life insurance			(216	)			(222	)
Accrued interest receivable			(128	)			(76	)
Other assets			468				(394	)
Accrued interest payable			22				(1	)
Other liabilities			(226	)			-
Net cash provided by operating activities			4,106				2,546
Cash flows from investing activities
Activity in available for sale securities:
Purchases			(1,037	)			-
Sales			3,950				525
Maturities/calls/paydowns			2,441				2,559
Purchases of restricted equity securities			(1	)			10
Net decrease (increase) in loans			(12,625	)			(8,349	)
Proceeds from life insurance contracts			-				413
Proceeds from sale of foreclosed assets			753				-
Purchases of property and equipment, net of sales			(781	)			(815	)
Net cash used in investing activities			(7,300	)			(5,657	)
Cash flows from financing activities
Net decrease in deposits			(2,770	)			(13,405	)
Net increase in borrowings			-				8,906
Common stock repurchased			(235	)			-
Dividends paid			(746	)			(502	)
Net cash used in financing activities			(3,751	)			(5,001	)
Net decrease in cash and cash equivalents			(6,945	)			(8,112	)
Cash and cash equivalents, beginning			40,007				22,875
Cash and cash equivalents, ending		$	33,062			$	14,763

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Supplemental disclosure of cash flow information
Interest paid		$	1,248			$	766
Taxes paid		$	50			$	10
Supplemental disclosure of noncash investing activities
Effect on equity of change in net unrealized loss on available for sale securities		$	1,000			$	(671	)
Transfers of loans to foreclosed properties		$	-			$	410

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Note 1. Organization and Summary of Significant Accounting Policies

 

Organization

 

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

 

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

 

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

 

For purposes of this quarterly report on Form 10-Q, all information contained herein as of and for periods prior to July 1, 2018 reflects the operations of Parkway prior to the Great State merger. Unless this report otherwise indicates or the context otherwise requires, all references to “Parkway” or the “Company” as of and for periods subsequent to July 1, 2018 refer to the combined company and its subsidiary as a combined entity after the Great State merger, and all references to the “Company” as of and for periods prior to July 1, 2018 are references to Parkway and its subsidiary as a combined entity prior to the Great State merger.

 

The consolidated financial statements as of June 30, 2019 and for the six-month and three-month periods ended June 30, 2019 and 2018 included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the information furnished in the interim consolidated financial statements reflects all adjustments necessary to present fairly the Company’s consolidated financial position, results of operations, changes in stockholders’ equity and cash flows for such interim periods. Management believes that all interim period adjustments are of a normal recurring nature. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto as of December 31, 2018, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018. The results of operations for the six-month and three-month periods ended June 30, 2019 are not necessarily indicative of the results to be expected for the full year.

 

 

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Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Critical Accounting Policies

 

Management believes the policies with respect to the methodology for the determination of the allowance for loan losses, and asset impairment judgments involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and the Board of Directors.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company and the Bank, which is wholly owned. All significant, intercompany transactions and balances have been eliminated in consolidation.

 

Business Segments

 

The Company reports its activities as a single business segment. In determining the appropriateness of segment definition, the Company considers components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment.

 

Business Combinations

 

Generally, acquisitions are accounted for under the acquisition method of accounting in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 805, Business Combinations. A business combination occurs when the Company acquires net assets that constitute a business, or acquires equity interests in one or more other entities that are businesses and obtains control over those entities. Business combinations are effected through the transfer of consideration consisting of cash and/or common stock and are accounted for using the acquisition method. Accordingly, the assets and liabilities of the acquired entity are recorded at their respective fair values as of the closing date of the acquisition. Determining the fair value of assets and liabilities, especially the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate estimated fair values. Fair values are subject to refinement for up to one year after the closing date of the acquisition as information relative to closing date fair values becomes available. The results of operations of an acquired entity are included in our consolidated results from the closing date of the merger, and prior periods are not restated. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding future credit losses. The fair value estimates associated with the acquired loans include estimates related to expected prepayments and the amount and timing of expected principal, interest and other cash flows.

 

Use of Estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and foreclosed real estate losses, management obtains independent appraisals for significant properties.

 

 

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Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Use of Estimates, continued

 

Substantially all of the Bank’s loan portfolio consists of loans in its market area. Accordingly, the ultimate collectability of a substantial portion of the Bank’s loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions. The regional economy is diverse, but influenced to an extent by the manufacturing and agricultural segments.

 

While management uses available information to recognize loan and foreclosed real estate losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process, periodically review the Bank’s allowances for loan and foreclosed real estate losses. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is reasonably possible that the allowances for loan and foreclosed real estate losses may change materially in the near term.

 

The Company seeks strategies that minimize the tax effect of implementing their business strategies. As such, judgments are made regarding the ultimate consequence of long-term tax planning strategies, including the likelihood of future recognition of deferred tax benefits. The Company’s tax returns are subject to examination by both Federal and State authorities. Such examinations may result in the assessment of additional taxes, interest and penalties. As a result, the ultimate outcome, and the corresponding financial statement impact, can be difficult to predict with accuracy.

 

Accounting for pension benefits, costs and related liabilities are developed using actuarial valuations. These valuations include key assumptions determined by management, including the discount rate and expected long-term rate of return on plan assets. Material changes in pension costs may occur in the future due to changes in these assumptions.

 

Cash and Cash Equivalents

 

For purposes of reporting cash flows, cash and cash equivalents includes cash and amounts due from banks (including cash items in process of collection), interest-bearing deposits with banks and federal funds sold.

 

Trading Securities

 

The Company does not hold securities for short-term resale and therefore does not maintain a trading securities portfolio.

 

Securities Held to Maturity

 

Bonds, notes, and debentures for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. The Company does not currently hold any securities classified as held to maturity.

 

Securities Available for Sale

 

Available for sale securities are reported at fair value and consist of bonds, notes, debentures, and certain equity securities not classified as trading securities or as held to maturity securities.

 

Unrealized holding gains and losses, net of tax, on available for sale securities are reported as a net amount in a separate component of accumulated other comprehensive income. Realized gains and losses on the sale of available for sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity.

 

 

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Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Securities Available for Sale, continued

 

Declines in the fair value of individual held to maturity and available for sale securities below cost that are other than temporary are reflected as write-downs of the individual securities to fair value. Related write-downs are included in earnings as realized losses.

 

Loans Receivable

 

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal amount adjusted for any charge-offs and the allowance for loan losses. Loan origination costs are capitalized and recognized as an adjustment to yield over the life of the related loan.

 

Interest is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. Payments received are first applied to principal, and any remaining funds are then applied to interest. When facts and circumstances indicate the borrower has regained the ability to meet the required payments, the loan is returned to accrual status. Past due status of loans is determined based on contractual terms.

 

Purchased Performing Loans – The Company accounts for performing loans acquired in business combinations using the contractual cash flows method of recognizing discount accretion based on the acquired loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing loans. A provision for loan losses is recorded for any further deterioration in these loans subsequent to the acquisition

 

Purchased Credit-Impaired (“PCI”) Loans – Loans purchased with evidence of credit deterioration since origination, and for which it is probable that all contractually required payments will not be collected, are considered credit impaired. Evidence of credit quality deterioration as of the purchase date may include statistics such as internal risk grade and past due and nonaccrual status. Purchased impaired loans generally meet the Company’s definition for nonaccrual status. PCI loans are initially measured at fair value, which reflects estimated future credit losses expected to be incurred over the life of the loan. Accordingly, the associated allowance for credit losses related to these loans is not carried over at the acquisition date. Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference, and is available to absorb credit losses on those loans. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent significant increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or a reclassification of the nonaccretable difference with a positive impact on future interest income.

 

Allowance for Loan Losses

 

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance, or portion thereof, is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Allowance for Loan Losses, continued

 

The allowance consists of specific, general and unallocated components. The specific component is calculated on an individual basis for larger-balance, non-homogeneous loans, which are considered impaired. A specific allowance is established when the discounted cash flows, collateral value (less disposal costs), or observable market price of the impaired loan is lower than its carrying value. The specific component of the allowance for smaller- balance loans whose terms have been modified in a troubled debt restructuring (“TDR”) is calculated on a pooled basis considering historical experience adjusted for qualitative factors. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

 

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for all loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

 

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.

 

Troubled Debt Restructurings

 

Under GAAP, the Bank is required to account for certain loan modifications or restructurings as “troubled debt restructurings” or "troubled debt restructured loans."  In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if the Bank for economic or legal reasons related to the borrower’s financial difficulties grants a concession to the borrower that the Bank would not otherwise consider. Debt restructuring or loan modifications for a borrower do not necessarily always constitute a troubled debt restructuring, however, and troubled debt restructurings do not necessarily result in non-accrual loans.

 

Property and Equipment

 

Land is carried at cost. Bank premises, furniture and equipment are carried at cost, less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives:

 

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Foreclosed Assets

 

Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less anticipated cost to sell at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in foreclosure expense on the consolidated statements of income.

 

Pension Plan

 

Prior to the Cardinal merger, both the Bank and Bank of Floyd (“Floyd”) had qualified noncontributory defined benefit pension plans in place which covered substantially all of each bank’s employees.  The benefits in each plan are primarily based on years of service and earnings.  Both the Bank and Floyd plans were amended to freeze benefit accruals for all eligible employees prior to the effective date of the Cardinal merger. The Bank’s plan is a single-employer plan, the funded status of which is measured as the difference between the fair value of plan assets and the projected benefit obligation.  Floyd’s plan is a multi-employer plan for accounting purposes and is a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code.

 

Transfers of Financial Assets

 

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank; (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets; and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

 

Goodwill and Other Intangible Assets

 

Goodwill arises from business combinations and is generally determined as the excess of fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquire, over the fair value of the nets assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently in events and circumstances exists that indicate that a goodwill impairment test should be performed. The Company has selected July 1, 2019 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on our balance sheet.

 

Other intangible assets consist of core deposit intangibles that represent the value of long-term deposit relationships acquired in a business combination. Core deposit intangibles are amortized over the estimated useful lives of the deposit accounts acquired (generally twenty years on an accelerated basis). For the core deposit intangible as a result of the Great State merger, we used an estimated useful life of seven years.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Revenue Recognition

 

On January 1, 2018, we adopted the requirements of Accounting Standards Update (“ASU”) 2014-9, Revenue from Contracts with Customers (“ASU Topic 606”). The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASU, including deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company also completed its evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e., gross vs. net). Based on its evaluation, the Company determined that ASU 2014-09 did not materially change the method in which the Company currently classifies certain costs associated with the related revenue streams. The Company adopted ASU 2014-09 and its related amendments on its required effective date of January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary.

 

Income Taxes

 

Provision for income taxes is based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

 

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more likely than not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more likely than not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.

 

Advertising Expense

 

The Company expenses advertising costs as they are incurred. Advertising expense for the years presented is not material.

 

Basic Earnings per Share

 

Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period, after giving retroactive effect to stock splits and dividends.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Comprehensive Income

 

Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income includes unrealized gains and losses on securities available for sale and changes in the funded status of the pension plan which are also recognized as separate components of equity. The accumulated balances related to each component of other comprehensive income (loss) are as follows:

 

 

Off-Balance Sheet Credit Related Financial Instruments

 

In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under line of credit arrangements, commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.

 

Fair Value of Financial Instruments

 

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 9. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

 

Reclassification

 

Certain reclassifications have been made to the prior years’ financial statements to place them on a comparable basis with the current presentation. Net income and stockholders’ equity previously reported were not affected by these reclassifications.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Recent Accounting Pronouncements

 

The following accounting standards may affect the future financial reporting by the Company:

 

In February 2016, the FASB amended the Leases topic of the Accounting Standards Codification to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments were effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.

 

Effective January 1, 2019, we adopted the guidance using the modified retrospective method and practical expedients for transition. The practical expedients allow us to largely account for our existing leases consistent with current guidance except for the incremental balance sheet recognition for lessees. We have performed an evaluation of our leasing contracts and activities. We have developed our methodology to estimate the right-of use assets and lease liabilities, which is based on the present value of lease payments. At December 31, 2018 future minimum lease payments were approximately $334 thousand. Based on our evaluation the adoption of the guidance was immaterial to our financial position, results of operations, and cash flows. There will not be a material change to the timing of expense recognition.

 

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted for all organizations for periods beginning after December 15, 2018.

 

The Company will apply the amendments to the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. While early adoption was permitted beginning in first quarter 2019, we did not elect that option. We are currently evaluating the impact of the ASU on our consolidated financial statements. We expect the ASU will result in an increase in the recorded allowance for loan losses given the change to estimated losses over the contractual life of the loans adjusted for expected prepayments. The majority of the increase results from longer duration portfolios.  In addition to our allowance for loan losses, we will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.  In July 2019, the FASB proposed changes to the effective date of ASU No. 2016-13 for smaller reporting companies, as defined by the SEC, and other non-SEC reporting entities. The proposal would delay the effective date to fiscal years beginning after December 31, 2022, including interim periods within those fiscal periods.  As the Company is a smaller reporting company, the proposed delay would be applicable to the Company, if it is approved by the FASB.

 

In January 2017, the FASB updated the Accounting Changes and Error Corrections and the Investments—Equity Method and Joint Ventures Topics of the Accounting Standards Codification. The ASU incorporates into the Accounting Standards Codification recent SEC guidance about disclosing, under SEC SAB Topic 11.M, the effect on financial statements of adopting the revenue, leases, and credit losses standards. The ASU was effective upon issuance. The Company is currently evaluating the impact on additional disclosure requirements as each of the standards is adopted, however it does not expect these amendments to have a material effect on its financial position, results of operations or cash flows.

 

In January 2017, the FASB amended the Goodwill and Other Topic of the Accounting Standards Codification to simplify the accounting for goodwill impairment for public business entities and other entities that have goodwill reported in their financial statements and have not elected the private company alternative for the subsequent measurement of goodwill. The amendment removes Step 2 of the goodwill impairment test. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Recent Accounting Pronouncements, continued

 

In March 2017, the FASB amended the requirements in the Receivables—Nonrefundable Fees and Other Costs Topic of the Accounting Standards Codification related to the amortization period for certain purchased callable debt securities held at a premium. The amendments shorten the amortization period for the premium to the earliest call date. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2018. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In February 2018, the FASB amended the Financial Instruments Topic of the Accounting Standards Codification. The amendments clarify certain aspects of the guidance issued in ASU 2016-01. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. All entities may early adopt these amendments for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, as long as they have adopted ASU 2016-01. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2018, the FASB updated the Debt Securities and the Regulated Operations Topics of the Accounting Standards Codification. The amendments incorporate into the Accounting Standards Codification recent SEC guidance which was issued in order to make the relevant interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The amendments were effective upon issuance. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2018, the FASB updated the Income Taxes Topic of the Accounting Standards Codification. The amendments incorporate into the Accounting Standards Codification recent SEC guidance related to the income tax accounting implications of the Tax Cuts and Jobs Act. The amendments were effective upon issuance. The Company does not expect these amendments to have a material effect on its financial statements.

 

In May 2018, the FASB amended the Financial Services—Depository and Lending Topic of the Accounting Standards Codification to remove outdated guidance related to Circular 202. The amendments were effective upon issuance and did not have a material effect on the financial statements.

 

In July 2018, the FASB amended the Leases Topic of the Accounting Standards Codification to make narrow amendments to clarify how to apply certain aspects of the new leases standard. The amendments are effective for reporting periods beginning after December 15, 2018. The Company does not expect these amendments to have a material effect on its financial statements.

 

In July 2018, the FASB amended the Leases Topic of the Accounting Standards Codification to give entities another option for transition and to provide lessors with a practical expedient. The amendments will be effective for the Company for reporting periods beginning after December 15, 2018. The Company does not expect these amendments to have a material effect on its financial statements.

 

In August 2018, the FASB amended the Fair Value Measurement Topic of the Accounting Standards Codification. The amendments remove, modify, and add certain fair value disclosure requirements based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements. The amendments are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this ASU and delay adoption of the additional disclosures until their effective date. The Company does not expect these amendments to have a material effect on its financial statements.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 1. Organization and Summary of Significant Accounting Policies, continued

 

Recent Accounting Pronouncements, continued

 

In August 2018, the FASB amended the Intangibles—Goodwill and Other Topic of the Accounting Standards Codification to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The amendments will be effective for the Company for fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In December 2018, the FASB issued guidance that providing narrow-scope improvements for lessors, that provides relief in the accounting for sales, use and similar taxes, the accounting for other costs paid by a lessee that may benefit a lessor, and variable payments when contracts have lease and non-lease components. The amendments will be effective for the Company for reporting periods beginning after December 15, 2018. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In March 2019, the FASB issued guidance to address concerns companies had raised about an accounting exception they would lose when assessing the fair value of underlying assets under the leases standard and clarify that lessees and lessors are exempt from a certain interim disclosure requirement associated with adopting the new standard. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

 

In April 2019, the FASB issued guidance that clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement of financial instruments. The amendments related to credit losses will be effective for the Company for reporting periods beginning after December 15, 2019. The amendments related to hedging will be effective for the Company for annual periods beginning after December 15, 2019, and interim periods within annual reporting periods beginning after December 15, 2020. The amendments related to recognition and measurement of financial instruments will be effective for the Company for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.

 

In May 2019, the FASB issued guidance to provide entities with an option to irrevocably elect the fair value option, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company does not expect these amendments to have a material effect on its financial statements.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

 

Note 2. Business Combinations

 

On July 1, 2018, Parkway completed its merger with Great State as discussed above in Note 1. Parkway is considered the acquiring entity in this business combination for accounting purposes. Under the terms of the merger agreement, each share of Great State common stock was converted to 1.21 shares of common stock of Parkway which resulted in the issuance of 1,191,899 shares of Parkway stock in the merger. The Company engaged a third party to calculate fair values of all assets and liabilities acquired in the transaction. These valuations are not final and may be refined for up to one year following the merger date.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 2. Business Combinations, continued

 

The following table presents the Great State assets acquired and liabilities assumed as of July 1, 2018 as well as the related fair value adjustments and determination of goodwill.

 

 

Explanation of fair value adjustments:

 

(a)

Reflects the opening fair value of securities portfolio, which was established as the new book basis of the portfolio.

 

(b)

Reflects the fair value adjustment based on the Company’s third party valuation report.

 

(c)

Existing allowance for loan losses eliminated to reflect accounting guidance.

 

(d)

Estimated adjustment to Great State’s real property based upon third-party appraisals and the Company’s evaluation of equipment and other fixed assets.

 

(e)

Reflects the recording of the estimated core deposit intangible based on the Company’s third party valuation report.

 

(f)

Recording of deferred tax asset generated by the net fair value adjustments (tax rate = 21%).

 

(g)

Estimated fair value adjustment to time deposits based on the Company’s third party valuation report on deposits assumed.

 

(h)

Reflects the fair value adjustment based on the Company’s evaluation of acquired other liabilities.

 

The merger was accounted for under the acquisition method of accounting. The assets and liabilities of Great State have been recorded at their estimated fair values and added to those of Parkway for periods following the merger date. Valuations of acquired Great State assets and liabilities may be refined for up to one year following the merger date.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 2. Business Combinations, continued

 

There are two methods to account for acquired loans as part of a business combination. Acquired loans that contain evidence of credit deterioration on the date of purchase are carried at the net present value of expected future proceeds in accordance with FASB ASC 310-30. All other acquired loans are recorded at their initial fair value, adjusted for subsequent advances, pay downs, amortization or accretion of any premium or discount on purchase, charge-offs and any other adjustment to carrying value in accordance with ASC 310-20.

 

In determining the fair values of acquired loans without evidence of credit deterioration at the date of acquisition, management includes (i) no carryover of any previously recorded allowance for loan losses and (ii) an adjustment of the unpaid principal balance to reflect an appropriate market rate of interest, given the risk profile and grade assigned to each loan. This adjustment is then accreted into earnings as a yield adjustment, using the effective yield method, over the remaining life of each loan.

 

To the extent that current information indicates it is probable that the Company will collect all amounts according to the contractual terms thereof, such loan is not considered impaired and is not considered in the determination of the required allowance for loan losses. To the extent that current information indicates it is probable that the Company will not be able to collect all amounts according to the contractual terms thereon, such loan is considered impaired and is considered in the determination of the required level of allowance for loan and lease losses.

 

Subsequent to the acquisition date, increases in cash flows expected to be received in excess of the Company’s initial estimates are reclassified from nonaccretable difference to accretable yield and are accreted into interest income on a level-yield basis over the remaining life of the loan. Decreases in cash flows expected to be collected are recognized as impairment through the provision for loan losses.

 

 

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Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 2. Business Combinations, continued

 

Supplemental Pro Forma Information (dollars in thousands except per share data)

 

The table below presents supplemental pro forma information as if the Great State acquisition had occurred at the beginning of the earliest period presented, which was January 1, 2018. Pro forma results include adjustments for amortization and accretion of fair value adjustments and do not include any projected cost savings or other anticipated benefits of the merger. Therefore, the pro forma financial information is not indicative of the results of operations that would have occurred had the transactions been effected on the assumed date. Pre-tax merger-related costs of $497 thousand and $299 thousand included in the Company’s consolidated statements of operations for the six months and three months ended June 30, 2018 and are not included in the pro forma statements below.

 

 

 

(a)

Supplemental pro forma net income includes the impact of certain fair value adjustments. Supplemental pro forma net income does not include assumptions on cost savings or the impact of merger-related expenses.

 

(b)

Weighted average shares outstanding includes the full effect of the common stock issued in connection with the Great State acquisition as of the earliest reporting date.

 

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Note 3. Investment Securities

 

Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent. The amortized cost of securities and their approximate fair values at June 30, 2019 and December 31, 2018 follow:

 

 

Restricted equity securities totaled $2.1 million at June 30, 2019 and December 31, 2018, respectively. Restricted equity securities consist of investments in stock of the Federal Home Loan Bank of Atlanta (FHLB), CBB Financial Corp., Pacific Coast Bankers Bank, and the Federal Reserve Bank of Richmond, all of which are carried at cost. All of these entities are upstream correspondents of the Bank. The FHLB requires financial institutions to make equity investments in the FHLB in order to borrow money. The Bank is required to hold that stock so long as it borrows from the FHLB. The Federal Reserve requires Banks to purchase stock as a condition for membership in the Federal Reserve System. The Bank’s stock in CBB Financial Corp. and Pacific Coast Bankers Bank is restricted only in the fact that the stock may only be repurchased by the respective banks.

 

The following tables details unrealized losses and related fair values in the Company’s held to maturity and available for sale investment securities portfolios. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2019 and December 31, 2018.

 

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 3. Investment Securities, continued

 

At June 30, 2019, 17 debt securities with unrealized losses had depreciated 1.13 percent from their total amortized cost basis. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, and the financial condition and near-term prospects of the issuer. The relative significance of these and other factors will vary on a case by case basis. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition and the issuer’s anticipated ability to pay the contractual cash flows of the investments. Since the Company intends to hold all of its investment securities until maturity, and it is more likely than not that the Company will not have to sell any of its investment securities before unrealized losses have been recovered, and the Company expects to recover the entire amount of the amortized cost basis of all its securities, none of the securities are deemed other than temporarily impaired at June 30, 2019. Management continues to monitor all of these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of these securities are other than temporarily impaired, which could require a charge to earnings in such periods.

 

Proceeds from sales of investment securities available for sale were $3.95 million and $525 thousand for the six-month and three-month periods ended June 30, 2019 and 2018, respectively.  There were gross realized losses of $14 thousand and $4 thousand in the six-month periods ended June 30, 2019 and 2018, respectively, that resulted from investment securities being called prior to their scheduled maturity.  Gross proceeds from called securities totaled $735 thousand and $50 thousand for the six-month periods ended June 30, 2019 and 2018, respectively.  Gains and losses on the sale of investment securities are recorded on the trade date and are determined using the specific identification method.  Gross realized gains and losses for the six-month and three-month periods ended June 30, 2019 and 2018 are as follows:

 

 

There were no securities transferred between the available for sale and held to maturity portfolios or other sales of held to maturity securities during the periods presented. In the future management may elect to classify securities as held to maturity based upon such considerations as the nature of the security, the Bank’s ability to hold the security until maturity, and general economic conditions.

 

The scheduled maturities of securities available for sale at June 30, 2019, were as follows:

 

 

Maturities of mortgage backed securities are based on contractual amounts. Actual maturity will vary as loans underlying the securities are prepaid.

 

Investment securities with amortized cost of approximately $13.3 million and $13.9 million at June 30, 2019 and December 31, 2018, were pledged as collateral on public deposits and for other purposes as required or permitted by law.

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Note 4. Loans Receivable

 

The major components of loans in the consolidated balance sheets at June 30, 2019 and December 31, 2018 are as follows:

 

 

As of June 30, 2019 and December 31, 2018, substantially all of the Bank’s residential 1-4 family loans were pledged as collateral for borrowing lines at the Federal Home Loan Bank of Atlanta.

 

Note 5. Allowance for Loan Losses and Impaired Loans

 

Allowance for Loan Losses

 

The allowance for loan losses is maintained at a level believed to be sufficient to provide for estimated loan losses based on evaluating known and inherent risks in the loan portfolio. The allowance is provided based upon management’s comprehensive analysis of the pertinent factors underlying the quality of the loan portfolio. These factors include changes in the amount and composition of the loan portfolio, delinquency levels, actual loss experience, current economic conditions, and detailed analysis of individual loans for which the full collectability may not be assured. The detailed analysis includes methods to estimate the fair value of loan collateral and the existence of potential alternative sources of repayment. The allowance consists of specific and general components. The specific component is calculated on an individual basis for larger-balance, non-homogeneous loans, which are considered impaired.  A specific allowance is established when the discounted cash flows, collateral value (less disposal costs), or observable market price of the impaired loan is lower than its carrying value.  The specific component of the allowance for smaller-balance loans whose terms have been modified in a TDR is calculated on a pooled basis considering historical experience adjusted for qualitative factors.  These smaller-balance TDRs were collectively evaluated for impairment.  The general component covers the remaining loan portfolio, and is based on historical loss experience adjusted for qualitative factors. The appropriateness of the allowance for loan losses on loans is estimated based upon these factors and trends identified by management at the time financial statements are prepared.

 

A provision for loan losses is charged against operations and is added to the allowance for loan losses based on quarterly comprehensive analyses of the loan portfolio. The allowance for loan losses is allocated to certain loan categories based on the relative risk characteristics, asset classifications and actual loss experience of the loan portfolio. While management has allocated the allowance for loan losses to various loan portfolio segments, the allowance is general in nature and is available for the loan portfolio in its entirety.

 

 

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Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 5. Allowance for Loan Losses and Impaired Loans, continued

 

Allowance for Loan Losses, continued

 

The following table presents activity in the allowance by loan category and information on the loans evaluated individually for impairment and collectively evaluated for impairment as of June 30, 2019 and December 31, 2018:

 

Allowance for Loan Losses and Recorded Investment in Loans

 

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 5. Allowance for Loan Losses and Impaired Loans, continued

 

Allowance for Loan Losses, continued

 

Allowance for Loan Losses and Recorded Investment in Loans

 

 

As of June 30, 2019 and December 31, 2018, the Bank had no unallocated reserves included in the allowance for loan losses.

 

Management closely monitors the quality of the loan portfolio and has established a loan review process designed to help grade the quality of the Bank’s loan portfolio. The Bank’s loan ratings coincide with the “Substandard,” “Doubtful” and “Loss” classifications used by federal regulators in their examination of financial institutions. Generally, an asset is considered Substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged. Substandard assets include those characterized by the distinct possibility that the insured financial institution will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all the weaknesses inherent in assets classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable. Assets classified as Loss are those considered uncollectible, and of such little value that its continuance on the books is not warranted. Assets that do not currently expose the insured financial institutions to sufficient risk to warrant classification in one of the aforementioned categories but otherwise possess weaknesses are designated “Special Mention.” Management also maintains a listing of loans designated “Watch”. These loans represent borrowers with declining earnings, strained cash flow, increasing leverage and/or weakening market fundamentals that indicate above average risk. As of June 30, 2019 and December 31, 2018, respectively, the Bank had no loans graded “Doubtful” or “Loss” included in the balance of total loans outstanding.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 5. Allowance for Loan Losses and Impaired Loans, continued

 

Allowance for Loan Losses, continued

 

The following table lists the loan grades utilized by the Bank and the corresponding total of outstanding loans in each category as of June 30, 2019 and December 31, 2018:

 

Credit Risk Profile by Internally Assigned Grades

 

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 5. Allowance for Loan Losses and Impaired Loans, continued

 

Loans may be placed in nonaccrual status when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. Payments received are first applied to principal, and any remaining funds are then applied to interest. Loans are removed from nonaccrual status when they are deemed a loss and charged to the allowance, transferred to foreclosed assets, or returned to accrual status based upon performance consistent with the original terms of the loan or a subsequent restructuring thereof.

 

The following table presents an age analysis of nonaccrual and past due loans by category as of June 30, 2019 and December 31, 2018:

 

Analysis of Past Due and Nonaccrual Loans

 

 

Impaired Loans

 

A loan is considered impaired when it is probable that the Bank will be unable to collect all contractual principal and interest payments due in accordance with the original or modified terms of the loan agreement. Smaller balance homogenous loans may be collectively evaluated for impairment. Non-homogenous impaired loans are either measured based on the estimated fair value of the collateral less estimated cost to sell if the loan is considered collateral dependent, or measured based on the present value of expected future cash flows if not collateral dependent. The valuation of real estate collateral is subjective in nature and may be adjusted in future periods because of changes in economic conditions. Management considers third-party appraisals, as well as independent fair market value assessments in determining the estimated fair value of particular properties. In addition, as certain of these third-party appraisals and independent fair market value assessments are only updated periodically, changes in the values of specific properties may have occurred subsequent to the most recent appraisals. Accordingly, the amounts of any such potential changes and any related adjustments are generally recorded at the time such information is received. When the measurement of the impaired loan is less than the recorded investment in the loan, impairment is recognized by creating or adjusting an allocation of the allowance for loan losses and uncollected accrued interest is reversed against interest income. If ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal balance.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 5. Allowance for Loan Losses and Impaired Loans, continued

 

Impaired Loans, continued

 

As of June 30, 2019 and December 31, 2018, respectively, the recorded investment in impaired loans totaled $9.8 million and $10.3 million. The total amount of collateral-dependent impaired loans at June 30, 2019 and December 31, 2018, respectively, was $2.7 million and $2.8 million. As of June 30, 2019 and December 31, 2018, respectively, $3.0 million and $3.4 million of the recorded investment in impaired loans did not have a related allowance. The Bank had $7.1 million and $7.3 million in TDR loans included in impaired loans at June 30, 2019 and December 31, 2018, respectively.

 

The categories of non-accrual loans and impaired loans overlap, although they are not coextensive. The Bank considers all circumstances regarding the loan and borrower on an individual basis when determining whether an impaired loan should be placed on non-accrual status, such as the financial strength of the borrower, the estimated collateral value, reasons for the delay, payment record, the amount past due and the number of days past due.

 

In 2015, management began collectively evaluating performing TDRs with a loan balance of $250,000 or less for impairment. As of June 30, 2019 and December 31, 2018, respectively, $4.6 million and $4.7 million of TDRs included in the following table were evaluated collectively for impairment and were deemed to have $238 thousand and $259 thousand of related allowance.

 

The following table is a summary of information related to impaired loans as of June 30, 2019 and December 31, 2018:

 

Impaired Loans

 

 

1	Recorded investment is the loan balance, net of any charge-offs

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 5. Allowance for Loan Losses and Impaired Loans, continued

 

Impaired Loans, continued

 

 

1	Recorded investment is the loan balance, net of any charge-offs

 

Troubled Debt Restructuring

 

A TDR loan is a loan for which the Bank, for reasons related to the borrower’s financial difficulties, grants a concession to the borrower that the Bank would not otherwise consider.

 

The loan terms which have been modified or restructured due to a borrower’s financial difficulty, include but are not limited to: a reduction in the stated interest rate; an extension of the maturity at an interest rate below current market; a reduction in the face amount of the debt; a reduction in the accrued interest; or re-aging, extensions, deferrals and renewals.  TDR loans are considered impaired loans.

 

 

---

 

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 5. Allowance for Loan Losses and Impaired Loans, continued

 

Troubled Debt Restructuring, continued

 

The following table sets forth information with respect to the Bank’s TDRs as of June 30, 2019 and June 30, 2018:

 

For the Six Months Ended June 30, 2019

 

⁽¹⁾ Loans past due 30 days or more are considered to be in default.

 

During the six months ended June 30, 2019, two loans were modified that were considered to be a TDRs. Term concessions were granted on both loans and one loan had additional funds advanced for legal expenses and property taxes. No TDRs identified in the last twelve months subsequently defaulted in the six months ended June 30, 2019.

 

For the Three Months Ended June 30, 2019

 

⁽¹⁾ Loans past due 30 days or more are considered to be in default.

 

During the three months ended June 30, 2019, one loan was modified that was considered to be a TDR. Term concessions were granted on this loan. No TDRs identified in the last twelve months subsequently defaulted in the quarter ended June 30, 2019.

 

 

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Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 5. Allowance for Loan Losses and Impaired Loans, continued

 

Troubled Debt Restructuring, continued

 

For the Six Months Ended June 30, 2018

 

⁽¹⁾ Loans past due 30 days or more are considered to be in default.

 

During the six months ended June 30, 2018, two loans were modified that were considered to be TDRs. Term concessions were granted and additional funds were advanced for legal expenses and property taxes. No TDRs identified in the last twelve months subsequently defaulted in the six months ended June 30, 2018.

 

For the Three Months Ended June 30, 2018

 

⁽¹⁾ Loans past due 30 days or more are considered to be in default.

 

During the three months ended June 30, 2018, two loans were modified that were considered to be TDRs. Term concessions were granted and additional funds were advanced for legal expenses and property taxes. No TDRs identified in the last twelve months subsequently defaulted in the quarter ended June 30, 2018.

 

 

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Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

---

 

Note 5. Allowance for Loan Losses and Impaired Loans, continued

 

Purchased Credit Impaired Loans

 

During 2018, the Company acquired loans as a result of the Great State merger, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans at June 30, 2019 and December 31, 2018 are as follows:

 

 

There was no accretable yield on purchased credit impaired loans for the period presented.

 

There were no purchased credit impaired loans acquired during the six months ended June 30, 2019. Purchased credit impaired loans acquired during the year ended December 31, 2018 for which it was probable at acquisition that all contractually required payments would not be collected are as follows:

 

 

Income is not recognized on purchased credit impaired loans if the Company cannot reasonably estimate cash flows expected to be collected. The carrying amounts of such loans as of June 30, 2019 and December 31, 2018 are as follows: