NATIONAL BANKSHARES INC [NKSH] Filings

10-Q 1 nksh20230930_10q.htm FORM 10-Q nksh20230930_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2023

☐	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 0-15204

NATIONAL BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

Virginia	54-1375874
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

101 Hubbard Street

Blacksburg, Virginia 24062-9002

(Address of principal executive offices) (Zip Code)

(540) 951-6300

(Registrant’s telephone number, including area code)

(Not applicable)

(Former name, former address and former fiscal year, if changed since last report)

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

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $1.25 per share	NKSH	Nasdaq Capital Market

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

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

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

Large accelerated filer ☐

Accelerated filer ☐

Non-accelerated filer ☒

Smaller reporting company ☒

Emerging growth company ☐

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Outstanding shares of common stock at November 7, 2023

5,891,739

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NATIONAL BANKSHARES, INC.

Form 10-Q

Index

Part I – Financial Information		Page

Item 1	Financial Statements	3

	Consolidated Balance Sheets, September 30, 2023 (Unaudited) and December 31, 2022	3

	Consolidated Statements of Income for the Three Months Ended September 30, 2023 and 2022 (Unaudited)	4

	Consolidated Statements of Comprehensive Loss for the Three Months Ended September 30, 2023 and 2022 (Unaudited)	5

	Consolidated Statements of Income for the Nine Months Ended September 30, 2023 and 2022 (Unaudited)	6

	Consolidated Statements of Comprehensive Income (Loss) for the Nine Months Ended September 30, 2023 and 2022 (Unaudited)	7

	Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended September 30, 2023 and 2022 (Unaudited)	8

	Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2023 and 2022 (Unaudited)	8

	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2023 and 2022 (Unaudited)	9

	Notes to Consolidated Financial Statements (Unaudited)	11

Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33

Item 3	Quantitative and Qualitative Disclosures About Market Risk	47

Item 4	Controls and Procedures	47

Part II – Other Information

Item 1	Legal Proceedings	48

Item 1A	Risk Factors	48

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	48

Item 3	Defaults Upon Senior Securities	48

Item 4	Mine Safety Disclosures	48

Item 5	Other Information	48

Item 6	Exhibits	48

Signatures		49

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	Part I
Item 1. Financial Statements	Financial Information
	National Bankshares, Inc.
	Consolidated Balance Sheets

	(Unaudited)
	September 30,			December 31,
(in thousands, except share and per share data)	2023			2022
Assets
Cash and due from banks	$	13,089		$	12,403
Interest-bearing deposits		40,353			59,026
Securities available for sale, at fair value		591,552			656,852
Restricted stock, at cost		1,264			941
Mortgage loans held for sale		82			-
Loans:
Loans, net of unearned income and deferred fees and costs		848,975			852,744
Less allowance for credit losses		(10,181	)		(8,225	)
Loans, net		838,794			844,519
Premises and equipment, net		11,091			10,371
Accrued interest receivable		6,180			6,001
Other real estate owned, net		662			662
Goodwill		5,848			5,848
Bank-owned life insurance		43,327			43,312
Other assets		39,660			37,616
Total assets	$	1,591,902		$	1,677,551

Liabilities and Stockholders' Equity
Noninterest-bearing demand deposits	$	303,166		$	327,713
Interest-bearing demand deposits		789,148			933,269
Savings deposits		184,801			214,114
Time deposits		187,885			67,629
Total deposits		1,465,000			1,542,725
Accrued interest payable		551			106
Other liabilities		10,238			12,033
Total liabilities		1,475,789			1,554,864
Commitments and contingencies
Stockholders' Equity
Preferred stock, no par value, 5,000,000 shares authorized; none issued and outstanding		-			-
Common stock of $1.25 par value and additional paid in capital. Authorized 10,000,000 shares; issued and outstanding 5,891,739 (including 2,052 unvested) shares at September 30, 2023 and 5,889,687 at December 31, 2022		7,383			7,362
Retained earnings		198,394			199,091
Accumulated other comprehensive loss, net		(89,664	)		(83,766	)
Total stockholders' equity		116,113			122,687
Total liabilities and stockholders' equity	$	1,591,902		$	1,677,551

See accompanying notes to consolidated financial statements.

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National Bankshares, Inc.

Consolidated Statements of Income

(Unaudited)

	Three Months Ended September 30,
(in thousands, except share and per share data)	2023			2022
Interest Income
Interest and fees on loans	$	9,816		$	8,816
Interest on interest-bearing deposits		439			506
Interest on securities – taxable		4,084			3,425
Interest on securities – nontaxable		340			408
Total interest income		14,679			13,155
Interest Expense
Interest on time deposits		1,452			31
Interest on other deposits		4,584			722
Interest on borrowings		3			-
Total interest expense		6,039			753
Net interest income		8,640			12,402
(Recovery of) provision for credit losses		(401	)		252
Net interest income after (recovery of) provision for credit losses		9,041			12,150

Noninterest Income
Service charges on deposit accounts		642			661
Other service charges and fees		151			51
Credit and debit card fees, net		395			448
Trust income		505			492
BOLI income		253			239
Gain on sale of mortgage loans		22			40
Other income		147			209
Total noninterest income		2,115			2,140

Noninterest Expense
Salaries and employee benefits		4,462			4,144
Occupancy, furniture and fixtures		547			476
Data processing and ATM		978			774
FDIC assessment		190			114
Net costs of other real estate owned		14			68
Franchise taxes		339			375
Professional services		251			254
Other operating expenses		684			531
Total noninterest expense		7,465			6,736
Income before income taxes		3,691			7,554
Income tax expense		617			1,392
Net Income	$	3,074		$	6,162
Basic net income per common share	$	0.52		$	1.03
Diluted net income per common share	$	0.52		$	1.03
Weighted average number of common shares outstanding, basic		5,889,687			5,974,961
Weighted average number of common shares outstanding, diluted		5,889,939			5,974,961
Dividends declared per common share	$	-		$	-

See accompanying notes to consolidated financial statements.

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National Bankshares, Inc.

Consolidated Statements of Comprehensive Loss

Three Months Ended September 30, 2023 and 2022

(Unaudited)

	September 30,
(in thousands)	2023			2022
Net Income	$	3,074		$	6,162

Other Comprehensive Loss, Net of Tax
Unrealized holding loss on available for sale securities net of tax of ($4,099) and ($7,822) for the periods ended September 30, 2023 and September 30, 2022, respectively		(15,421	)		(29,424	)
Other comprehensive loss, net of tax		(15,421	)		(29,424	)
Total Comprehensive Loss	$	(12,347	)	$	(23,262	)

See accompanying notes to consolidated financial statements.

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National Bankshares, Inc.

Consolidated Statements of Income

(Unaudited)

	Nine Months Ended September 30,
(in thousands, except share and per share data)	2023			2022
Interest Income
Interest and fees on loans	$	28,793		$	25,240
Interest on interest-bearing deposits		1,207			757
Interest on securities – taxable		12,268			8,847
Interest on securities – nontaxable		1,052			1,283
Total interest income		43,320			36,127

Interest Expense
Interest on time deposits		2,865			105
Interest on other deposits		11,352			1,950
Interest on borrowings		300			-
Total interest expense		14,517			2,055
Net interest income		28,803			34,072
(Recovery of) provision for credit losses		(389	)		696
Net interest income after (recovery of) provision for credit losses		29,192			33,376

Noninterest Income
Service charges on deposit accounts		1,871			1,826
Other service charges and fees		253			157
Credit and debit card fees, net		1,276			1,423
Trust income		1,431			1,374
BOLI income		1,771			718
Gain on sale of investment		2,971			-
Gain on sale of mortgage loans		93			136
Loss on sale of securities		(3,332	)		-
Other income		771			909
Total noninterest income		7,105			6,543

Noninterest Expense
Salaries and employee benefits		13,361			12,133
Occupancy, furniture and fixtures		1,500			1,432
Data processing and ATM		2,730			2,354
FDIC assessment		561			336
Net costs of other real estate owned		29			78
Franchise taxes		1,072			1,108
Professional services		1,555			693
Other operating expenses		1,878			1,526
Total noninterest expense		22,686			19,660
Income before income taxes		13,611			20,259
Income tax expense		2,105			3,637
Net Income	$	11,506		$	16,622
Basic net income per common share	$	1.95		$	2.77
Fully diluted net income per common share	$	1.95		$	2.77
Weighted average number of common shares outstanding, basic		5,889,687			6,008,607
Weighted average number of common shares outstanding, diluted		5,889,778			6,008,607
Dividends declared per common share	$	1.73		$	0.72

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National Bankshares, Inc.

Consolidated Statements of Comprehensive Income (Loss)

Nine Months Ended September 30, 2023 and 2022

(Unaudited)

	September 30,
(in thousands)	2023			2022
Net Income	$	11,506		$	16,622

Other Comprehensive Loss, Net of Tax
Unrealized holding loss on available for sale securities net of tax of ($2,268) and ($23,431) for the periods ended September 30, 2023 and September 30, 2022, respectively		(8,530	)		(88,143	)
Reclassification adjustment for loss included in net income, net of tax of $700 in 2023		2,632			-
Other comprehensive loss, net of tax		(5,898	)		(88,143	)
Total Comprehensive Income (Loss)	$	5,608		$	(71,521	)

See accompanying notes to consolidated financial statements.

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National Bankshares, Inc.

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)

Three Months Ended September 30, 2023 and 2022

(in thousands except share data)	Common Stock and Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total
Balances at June 30, 2022	$	7,476		$	191,545		$	(62,777	)	$	136,244
Net income		-			6,162			-			6,162
Common stock repurchased, 23,500 shares		(29	)		(766	)		-			(795	)
Other comprehensive loss, net of tax of ($7,822)		-			-			(29,424	)		(29,424	)
Balances at September 30, 2022	$	7,447		$	196,941		$	(92,201	)	$	112,187

Balances at June 30, 2023	$	7,367		$	195,320		$	(74,243	)	$	128,444
Net income		-			3,074			-			3,074
Other comprehensive loss, net of tax of ($4,099)		-			-			(15,421	)		(15,421	)
Stock based compensation		16			-			-			16
Balances at September 30, 2023	$	7,383		$	198,394		$	(89,664	)	$	116,113

See accompanying notes to consolidated financial statements.

Nine Months Ended September 30, 2023 and 2022

(in thousands except share data)	Common Stock and Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Loss			Total
Balances at December 31, 2021	$	7,580		$	188,229		$	(4,058	)	$	191,751
Net income		-			16,622			-			16,622
Common stock repurchased, 106,662 shares		(133	)		(3,591	)		-			(3,724	)
Cash dividends of $0.72 per share		-			(4,319	)		-			(4,319	)
Other comprehensive loss, net of tax of ($23,431)		-			-			(88,143	)		(88,143	)
Balances at September 30, 2022	$	7,447		$	196,941		$	(92,201	)	$	112,187

Balances at December 31, 2022	$	7,362		$	199,091		$	(83,766	)	$	122,687
Adoption of ASU 2016-13		-			(2,014	)		-			(2,014	)
Net income		-			11,506			-			11,506
Cash dividends of $1.73 per share		-			(10,189	)		-			(10,189	)
Other comprehensive loss, net of tax of ($1,568)		-			-			(5,898	)		(5,898	)
Stock based compensation		21			-			-			21
Balances at September 30, 2023	$	7,383		$	198,394		$	(89,664	)	$	116,113

See accompanying notes to the consolidated financial statements.

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National Bankshares, Inc.

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2023 and 2022

(Unaudited)

(in thousands)	September 30, 2023			September 30, 2022
Cash Flows from Operating Activities
Net income	$	11,506		$	16,622
Adjustments to reconcile net income to net cash provided by operating activities:
(Recovery of) provision for credit losses		(389	)		696
Depreciation of bank premises and equipment		544			449
Amortization of premiums and accretion of discounts, net		806			972
Gain on disposal of fixed assets		-			(4	)
Loss on sales of securities available for sale, net		3,332			-
Losses and write-downs on other real estate owned, net		-			50
Loss on sales of repossessed assets		5			-
Increase in cash value of bank-owned life insurance		(734	)		(718	)
Origination of mortgage loans held for sale		(6,689	)		(6,348	)
Proceeds from sale of mortgage loans held for sale		6,700			7,099
Gain on sale of mortgage loans held for sale		(93	)		(136	)
Equity based compensation expense		21			-
Net change in:
Accrued interest receivable		(179	)		(718	)
Other assets		59			33
Accrued interest payable		445			(8	)
Other liabilities		(2,002	)		282
Net cash provided by operating activities		13,332			18,271

Cash Flows from Investing Activities
Proceeds from calls, principal payments, sales and maturities of securities available for sale		53,696			33,465
Purchase of securities available for sale		-			(117,341	)
Net change in restricted stock		(323	)		(96	)
Purchase of loan participations		(5,118	)		(10,965	)
Collection of loan participations		6,686			4,513
Loan originations and principal collections, net		1,958			(43,479	)
Proceeds from sale of repossessed assets		13			-
Recoveries on loans charged off		235			153
Proceeds from sale and purchases of premises and equipment, net		(1,264	)		(906	)
BOLI settlement		712			-
Net cash provided by (used in) investing activities		56,595			(134,656	)

Cash Flows from Financing Activities
Net change in time deposits		120,256			(1,945	)
Net change in other deposits		(197,981	)		78,007
Common stock repurchased		-			(3,724	)
Cash dividends paid		(10,189	)		(4,319	)
Net cash (used in) provided by financing activities		(87,914	)		68,019

(Continued)

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Net change in cash and due from banks		(17,987	)		(48,366	)
Cash and due from banks at beginning of period		71,429			138,789
Cash and due from banks at end of period	$	53,442		$	90,423

Supplemental Disclosures of Cash Flow Information
Interest paid on deposits and borrowings	$	14,072		$	2,063
Income taxes paid		3,997			3,441

Supplemental Disclosure of Noncash Activities
Loans charged against the allowance for credit losses	$	232		$	316
Loans transferred to repossessed assets		11			-
Unrealized holding loss on securities available for sale		(7,466	)		(111,574	)
Lease liabilities arising from obtaining right-of-use assets		-			104

See accompanying notes to consolidated financial statements.

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National Bankshares, Inc.

Notes to Consolidated Financial Statements

September 30, 2023

(Unaudited)

$ in thousands, except per share data

Note 1: General

The consolidated financial statements of National Bankshares, Inc. (“NBI”) and its wholly-owned subsidiaries, The National Bank of Blacksburg (the “Bank” or “NBB”) and National Bankshares Financial Services, Inc. (“NBFS”) (collectively, the “Company”), conform to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices within the banking industry. The accompanying interim period consolidated financial statements are unaudited; however, in the opinion of the Company’s management, all adjustments consisting of normal recurring adjustments, which are necessary for a fair presentation of the consolidated financial statements, have been included. The results of operations for the three and nine month periods ended September 30, 2023 are not necessarily indicative of results of operations for the full year or any other interim period. The interim period consolidated financial statements and financial information included in this Form 10-Q should be read in conjunction with the notes to consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 (“2022 Form 10-K”). The Company posts all reports required to be filed under the Securities Exchange Act of 1934 on its web site at www.nationalbankshares.com.

Risks and Uncertainties

The Company is closely monitoring risks that may impact its business, including high inflation, along with U.S. monetary policy maneuvers to reduce inflation. Inflation and U.S. monetary policy maneuvers to reduce it may impact the Company’s customers’ demand for banking services and ability to qualify for and/or repay loans. These risks could adversely affect the Company’s business, financial condition, results of operations, cash flows, credit risk, asset valuations and capital position.

Recent Accounting Pronouncements

In October 2023, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2023-06, “Disclosure Improvements: Codification Amendments in Response to the SEC’s Disclosure Update and Simplification Initiative”. This ASU incorporates certain U.S. Securities and Exchange Commission (SEC) disclosure requirements into the FASB Accounting Standards Codification. The amendments in the ASU are expected to clarify or improve disclosure and presentation requirements of a variety of Codification Topics, allow users to more easily compare entities subject to the SEC’s existing disclosures with those entities that were not previously subject to the requirements, and align the requirements in the Codification with the SEC’s regulations. For entities subject to the SEC’s existing disclosure requirements and for entities required to file or furnish financial statements with or to the SEC in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer, the effective date for each amendment will be the date on which the SEC removes that related disclosure from its rules. For all other entities, the amendments will be effective two years later. However, if by June 30, 2027, the SEC has not removed the related disclosure from its regulations, the amendments will be removed from the Codification and not become effective for any entity. The Company does not expect the adoption of ASU 2023-06 to have a material impact on its consolidated financial statements.

In July 2023, the FASB issued ASU 2023-03, “Presentation of Financial Statements (Topic 205), Income Statement—Reporting Comprehensive Income (Topic 220), Distinguishing Liabilities from Equity (Topic 480), Equity (Topic 505), and Compensation—Stock Compensation (Topic 718)”. This ASU amends the FASB Accounting Standards Codification for Securities and Exchange Commission (“SEC”) paragraphs pursuant to SEC Staff Accounting Bulletin No. 120, SEC Staff Announcement at the March 24, 2022 EITF Meeting, and Staff Accounting Bulletin Topic 6.B, Accounting Series Release 280—General Revision of Regulation S-X: Income or Loss Applicable to Common Stock. ASU 2023-03 is effective upon addition to the FASB Codification. The Company does not expect the adoption of ASU 2023-03 to have a material impact on its consolidated financial statements.

In March 2020, the FASB issued ASU 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the FASB issued ASU 2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company has a small number of participation loans that reference LIBOR. The Company is working with the primary banks to determine appropriate actions.

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In December 2022, the FASB issued ASU 2022-06, “Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848”. ASU 2022-06 extends the period of time preparers can utilize the reference rate reform relief guidance in Topic 848. The objective of the guidance in Topic 848 is to provide relief during the temporary transition period, so the FASB included a sunset provision within Topic 848 based on expectations of when LIBOR would cease being published. In 2021, the UK Financial Conduct Authority delayed the intended cessation date of certain tenors of LIBOR to June 30, 2023.

To ensure the relief in Topic 848 covers the period of time during which a significant number of modifications may take place, the ASU defers the sunset date of Topic 848 from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply the relief in Topic 848. The ASU is effective for all entities upon issuance. The Company is assessing ASU 2022-06 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

Recently Adopted Accounting Standards

ASU 2016-13

On January 1, 2023, the Company adopted ASU 2016-13 “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” and related ASUs. Prior to adoption, the Company followed applicable GAAP and used an incurred loss model to estimate an allowance for loan losses and a liability for credit risk on unfunded commitments. The Company also used a methodology to determine whether securities in an unrealized loss position were other-than-temporarily impaired and whether credit risk was present.

ASU 2016-13 makes significant changes to the accounting for credit losses on financial instruments presented on an amortized cost basis and disclosures about them. The new current expected credit loss (“CECL”) impairment model requires an estimate of expected credit losses, measured over the contractual life of an instrument, which considers historical experience, current conditions and reasonable and supportable forecasts of future economic conditions. The standard provides significant flexibility and requires a high degree of judgment with regards to pooling financial assets with similar risk characteristics and adjusting the relevant historical loss information in order to develop an estimate of expected lifetime losses. ASU 2016-13 permits the use of estimation techniques that are practical and relevant to the Company’s circumstances, as long as they are applied consistently over time and faithfully estimate expected credit losses in accordance with the standard.

The Company applied the standard’s provisions as a cumulative-effect adjustment of $2,014, net of tax, to retained earnings as of January 1, 2023. On the adoption date, the allowance for credit losses (“ACL”) on loans increased from $8,225 to $10,567 and the ACL for unfunded commitments increased from $35 to $242. Based upon the nature and characteristics of our securities portfolios (including issuer specific matters) at the adoption date, macroeconomic conditions and forecasts at that date, and other management judgments, adoption did not result in an ACL on securities available for sale. Results for reporting periods beginning after January 1, 2023 will be presented under Topic 326, while periods prior to January 1, 2023 will be reported in accordance with GAAP applicable for the time period. The following presents the Company’s policies governing determination of the ACL on its financial instruments.

ACL on Securities Available for Sale

The Company evaluates securities available for sale that are in an unrealized loss position on the reporting date. Securities are analyzed to determine whether the decline in the fair value below the amortized cost basis (impairment) is due to credit-related factors or noncredit-related factors. Any impairment that is not credit-related is recognized in other comprehensive income, net of applicable taxes. Credit-related impairment is recognized as an ACL on the Consolidated Balance Sheets, limited to the amount by which the amortized cost basis exceeds the fair value, with a corresponding adjustment to earnings. Both the ACL and the adjustment to net income may be subsequently reversed if conditions change. If the Company intends to sell an impaired security, or more likely than not will be required to sell such a security, before recovering its amortized cost basis, the entire impairment amount must be recognized in earnings with a corresponding adjustment to the security’s amortized cost basis. Because the security’s amortized cost basis would be adjusted to fair value, there would be no ACL in this situation.

In evaluating impairment, the Company considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuers’ financial condition, among other factors. If the Company determines a credit impairment, the ACL on securities available for sale would be established through a provision for credit losses on securities available for sale in the Consolidated Statements of Income. If the Company’s management believes it has confirmed that the loss on a security is uncollectible, or when either of the criteria regarding intent or requirement to sell is met, the loss is charged against the ACL. Accrued interest receivable is excluded from the estimate of credit losses.

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ACL on Loans (“ACLL”)

The Company estimates the ACLL based on amortized cost basis, which is the amount at which the loan is originated, adjusted for net deferred fees or costs, collection of cash, and charge-offs. In the event that collection of principal becomes uncertain, the Company has policies in place to reverse accrued interest in a timely manner. Therefore, the Company has made a policy election to exclude accrued interest from the measurement of the ACLL. Intrinsic to the Company’s policy on estimating the ACLL are policies regarding loan pools, nonaccruals, past due status, collateral valuation, charge-offs and risk ratings. Please refer to the Company’s 2022 Form 10-K, Note 1: Summary of Significant Accounting Policies for additional information on these policies.

The Company measures expected credit losses on loans on a collective (pool) basis, when the loans share similar risk characteristics, such as collateral type and intended use, repayment source, and (if applicable) the borrower’s business model. The Company has identified the following pools of loans with similar risk characteristics for measuring expected credit losses:

Real Estate Construction

Construction, residential

Construction, other

Consumer Real Estate

Equity lines

Residential closed-end first liens

Residential closed-end junior liens

Investor-owned residential real estate

Commercial Real Estate

Multifamily real estate

Commercial real estate, owner occupied

Commercial real estate, other

Commercial Non Real Estate

Commercial and industrial

Public Sector and IDA

Public sector and IDA

Consumer Non Real Estate

Credit cards

Automobile

Other consumer loans

The Company’s methodologies for estimating the ACLL consider available relevant information about the collectability of cash flows, including historical losses, reasonable and supportable forecasts of economic conditions, and current economic and portfolio conditions. The difference between cash flow estimates and amortized cost is the ACLL.

The Company uses a discounted cash flow (“DCF”) method for all of its pools except for bankcards, which are measured using the historical loss rate adjusted for the forecast. For loans using the DCF method, cash flows are projected at the instrument level and discounted using the loan’s effective interest rate. Cash flows are generated using each loan’s payment attributes, adjusted for pool-level information on the probability of default (“PD”), loss given default and prepayment speeds. Default is defined as full or partial charge-off, nonaccrual status or past due 90 days or more. PDs for each pool are calculated using the Company’s historical data, modified by peer data, to ensure a full economic cycle is reflected in the estimate. PDs are then adjusted for the forecast.

The Company designated national unemployment as its forecast variable. Multiple forecasts from reputable and independent third parties are sourced to inform the Company’s reasonable and supportable forecasting of current expected credit losses. The forecast is applied over a horizon selected by the Company’s management at each reporting date, typically of one year and not to exceed two years, after which loss rates revert to long term historical loss experience on a straight line basis over a period determined by the Company’s management, of up to three years. The forecast horizon and reversion period are applied consistently to the entire portfolio.

The results of DCF calculations are modified by allocations for qualitative factors to account for changes in variables that may affect credit risk. The Company considers and allocates for changes in lending policies, management experience, economic conditions, loans past due, competitive, legal and regulatory environments and other factors. Qualitative factors are benchmarked to historical data and are adjusted based upon quantitative analysis.

Loans that do not share risk characteristics are evaluated on an individual basis. The Company designates loans that have been determined to meet the regulatory definitions of “special mention” or “classified” (together known as “criticized”) as individually evaluated. The fair value of individually evaluated loans is measured using the fair value of collateral (“collateral method”) or the DCF method.

The collateral method is applied to individually evaluated loans for which foreclosure is probable. The collateral method is also applied to individually evaluated loans when borrowers are experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral (“collateral dependent”). The ACLL is measured based on the difference between the fair value of the collateral and the amortized cost basis of the loan as of the measurement date. When repayment is expected to be from the operation of the collateral, the ACLL is calculated as the amount by which the amortized cost basis of the loan exceeds the present value of expected cash flows from the operation of the collateral. When repayment is expected to be from the sale of the collateral, the ACLL is calculated as the amount by which the loan’s amortized cost basis exceeds the fair value of the underlying collateral less estimated cost to sell. The ACLL may be zero if the fair value of the collateral at the measurement date exceeds the amortized cost basis of the loan.

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The DCF method is applied to individually evaluated loans that do not meet the criteria for collateral method measurement. Cash flows are projected and discounted using the same method as for collectively evaluated loans, but the PD is increased to reflect increased risk, up to 100% for nonaccrual loans.

Expected credit losses are reflected in the ACLL through a charge to provision for credit losses on the Consolidated Statements of Income. When the Company deems all or a portion of a loan to be uncollectible the appropriate amount is written off against the ACLL. The Company applies judgment to determine when a financial asset is deemed uncollectible; however, generally speaking, an asset will be considered uncollectible no later than when all efforts at collection have been exhausted. Subsequent recoveries, if any, are credited to the ACLL when received.

ACL on Unfunded Commitments

Financial instruments include off-balance sheet credit instruments such as undrawn portions of revolving lines of credit, commercial letters of credit, and loan commitments that have not yet been funded. The contractual amount of those instruments represents the Company’s exposure to credit loss in the event of nonperformance by the borrower. The Company records an ACL on unfunded commitments, unless the commitments to extend credit are unconditionally cancelable. The estimate includes consideration of the likelihood that funding will occur, which is based on a historical funding study derived from internal information, and an estimate of expected credit losses on commitments expected to be funded over its estimated life, which are the same loss rates that are used in computing the ACLL. The ACL on unfunded commitments is recorded as a liability on the Company’s Consolidated Balance Sheets, included in other liabilities, and is adjusted through the provision for credit loss expense in the Company’s Consolidated Statements of Income.

ASU 2022-02

On January 1, 2023, concurrent with its adoption of ASU 2016-13, the Company adopted ASU 2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures.” The amendments eliminate the accounting guidance for troubled debt restructurings (“TDRs”) by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. Disclosures about periods prior to adoption will be presented under GAAP applicable for that period.

Similar to its policy under previous GAAP, the Company continues to identify modifications to loans and to determine whether the borrower is experiencing financial difficulty. If the Company determines that the borrower is experiencing financial difficulty, the loan is designated for financial reporting purposes. Loans that are modified for borrowers experiencing financial difficulty are evaluated to determine whether the credit risk falls within the regulatory definition of “criticized” and requires individual evaluation. Under previous GAAP, modifications to loans when the borrower was experiencing financial difficulty were designated as TDR and were individually evaluated for the duration of the loan.

Note 2: Loans and Allowance for Credit Losses

Loans

The following table presents the composition of the loan portfolio, excluding mortgage loans held for sale, as of the dates indicated.

	September 30, 2023			December 31, 2022
Real estate construction	$	64,181		$	54,579
Consumer real estate		226,671			221,052
Commercial real estate		424,765			437,888
Commercial non real estate		42,940			57,652
Public sector and IDA		51,591			48,074
Consumer non real estate		39,269			33,948
Gross loans		849,417			853,193
Less unearned income and deferred fees and costs		(442	)		(449	)
Loans, net of unearned income and deferred fees and costs	$	848,975		$	852,744
Allowance for credit losses on loans		(10,181	)		(8,225	)
Total loans, net	$	838,794		$	844,519

Accrued interest receivable on loans, which is excluded from the amortized cost of loans, totaled $2,760 at September 30, 2023 and $2,516 at December 31, 2022.

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Past Due and Nonaccrual Loans

The following tables present the aging of past due loans, by loan pool, as of the dates indicated.

	September 30, 2023
	Accruing Current Loans		Accruing Loans 30 – 89 Days Past Due		Accruing Loans 90 or More Days Past Due		Nonaccrual Loans		Total Loans		Accruing and Nonaccrual 90 or More Days Past Due
Real Estate Construction
Construction, 1-4 family residential	$	16,995	$	-	$	-	$	-	$	16,995	$	-
Construction, other		47,165		21		-		-		47,186		-
Consumer Real Estate
Equity line		16,631		23		-		-		16,654		-
Residential closed-end first liens		122,839		679		7		85		123,610		92
Residential closed-end junior liens		5,009		13		-		-		5,022		-
Investor-owned residential real estate		81,385		-		-		-		81,385		-
Commercial Real Estate
Multifamily residential real estate		133,188		-		-		-		133,188		-
Commercial real estate owner-occupied		116,089		288		-		2,429		118,806		236
Commercial real estate, other		172,771		-		-		-		172,771		-
Commercial Non Real Estate
Commercial and industrial		42,452		4		17		467		42,940		252
Public Sector and IDA
States and political subdivisions		51,591		-		-		-		51,591		-
Consumer Non-Real Estate
Credit cards		4,570		4		-		-		4,574		-
Automobile		11,933		42		2		-		11,977		3
Other consumer loans		22,615		98		5		-		22,718		5
Total	$	845,233	$	1,172	$	31	$	2,981	$	849,417	$	588

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	December 31, 2022
	Accruing Current Loans		Accruing Loans 30 – 89 Days Past Due		Accruing Loans 90 or More Days Past Due		Nonaccrual Loans		Total Loans		Accruing and Nonaccrual 90 or More Days Past Due
Real Estate Construction
Construction, 1-4 family residential	$	12,538	$	-	$	-	$	-	$	12,538	$	-
Construction, other		42,041		-		-		-		42,041		-
Consumer Real Estate
Equity line		15,010		16		-		-		15,026		-
Residential closed-end first liens		121,807		750		-		91		122,648		91
Residential closed-end junior liens		2,446		-		-		-		2,446		-
Investor-owned residential real estate		80,524		408		-		-		80,932		-
Commercial Real Estate
Multifamily residential real estate		127,312		-		-		-		127,312		-
Commercial real estate owner-occupied		126,640		-		-		2,493		129,133		252
Commercial real estate, other		181,443		-		-		-		181,443		-
Commercial Non Real Estate
Commercial and industrial		57,373		16		-		263