PINNACLE BANKSHARES CORP [PPBN] Filings

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 2020

PINNACLE BANKSHARES CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Commission file number 000-23909

(434) 369-3000

(Issuer’s telephone number, including area code)

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act: None

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

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

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

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

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

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

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

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

The aggregate value of the voting common equity held by non-affiliates as of June 30, 2020, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $32,731,902 based on the price at which the common stock last traded on such day. This price reflects inter-dealer prices without retail mark up, mark down, or commissions, and may not represent actual transactions.

The number of shares outstanding of Common Stock, $3.00 par value, as of March 18, 2021 was approximately 2,158,379.

Explanatory Note (amounts in thousands)

On February 12, 2021, Pinnacle Bankshares Corporation (“Pinnacle”) issued a press release announcing its unaudited financial results for the quarter and year ended December 31, 2020.  A copy of the press release was attached to a Form 8-K furnished by Pinnacle to the Securities and Exchange Commission on February 12, 2021.  Following the issuance of that press release, Pinnacle continued to complete its year-end audit processes, including with respect to the acquisition of Virginia Bank Bankshares, Inc. and with respect to income taxes.  As a result of completing these audit processes, Pinnacle identified adjustments to other assets and total assets each  decreasing by $318, other liabilities and total liabilities each increasing by $2,208, surplus and stockholders’ equity each decreasing by $2,346,  and income tax expense increasing by $318.  These adjustments are appropriately reflected in the audited financial statements included in Item 8, and in management’s discussion and analysis included in Item 7, included in this Annual Report on Form 10-K, and Pinnacle’s reported net income and basic and diluted earnings per share have been updated to incorporate these adjustments.

PART I

Item 1.Business General

Pinnacle’s Business

Pinnacle Bankshares Corporation (“Pinnacle” or the “Company”), a Virginia corporation, was organized in 1997 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”). Pinnacle is headquartered in Altavista, Virginia.  Pinnacle conducts all of its business activities through the branch offices of its wholly-owned subsidiary bank, First National Bank (Altavista, Virginia) (“First National Bank”). Pinnacle was primarily established for the purpose of holding the stock of its subsidiary, First National Bank, and of such other subsidiaries as Pinnacle may acquire or establish. Pinnacle’s administrative offices are located at 622 Broad Street, Altavista, Virginia.  Pinnacle’s website is www.1stnatbk.com.  The information on our website is not part of, and is not incorporated into, this Annual Report on Form 10-K.

First National Bank was organized as a national bank in 1908 and commenced general banking operations in December of that year, providing services to commercial and agricultural businesses as well as individuals in the Altavista area.  With an emphasis on personal service, First National Bank today offers a broad range of commercial and retail banking products and services including checking, savings and time deposits, individual retirement accounts, online banking, mobile banking, remote deposit capture, merchant bankcard processing, residential and commercial mortgages, home equity loans, consumer installment loans, agricultural loans, investment loans, small business loans, commercial lines of credit and letters of credit.  First National Bank also offers a full range of investment, insurance and annuity products through its association with LPL, Inc. and Banker’s Insurance, LLC.  

First National Bank serves a trade area consisting primarily of all or portions of the Counties of Amherst, Bedford, Campbell and Pittsylvania, and the Cities of Charlottesville, Danville and Lynchburg. The Company has a total of eighteen branches with one in the Town of Amherst in Amherst County, two in Bedford County, two located in the Town of Altavista in Campbell County, three additional branches in Campbell County, three in Pittsylvania County, four in the City of Danville and three in the City of Lynchburg. The Company also operates a loan production office located in Charlottesville.

First National Bank has two wholly-owned subsidiaries. FNB Property Corp., which is a Virginia corporation, formed to hold title to hold real estate for future bank premises.  First Properties, Inc., also a Virginia corporation, was formed to hold title to other real estate owned.

Pinnacle’s revenues are primarily derived from interest on and fees received in connection with, real estate and other loans, and from interest and dividends from investment securities. The principal sources of funds for Pinnacle’s lending activities are its deposits, repayment of loans, maturity of investment securities, and borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”).  

Pinnacle’s operations are influenced by general economic conditions and by related monetary and fiscal policies of regulatory agencies, including the Board of Governors of the Federal Reserve System (the “Federal Reserve”). As a national banking association, the Bank is supervised and examined by the Office of the Comptroller of the Currency (the “OCC”). Interest rates on competing investments and general market rates of interest influence deposit flows and costs of funds. Lending activities are affected by the demand for financing of real estate and other types of loans, which in turn is affected by the interest rate environment and its impact on local demand and the availability of funds. The Bank faces strong competition in the attraction of deposits, its primary source of lendable funds, and in the origination of loans.

Competition

The banking business in central and southern Virginia is highly competitive with respect to both loans and deposits and has a number of major banks that have offices operating throughout the state and in Pinnacle’s market area.  Pinnacle actively competes for all types of deposits and loans with other banks and with nonbank financial institutions, including savings and loan associations, finance companies, credit unions, mortgage companies, insurance companies and other lending institutions.

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Institutions such as brokerage firms, credit card companies and even retail establishments offer alternative investment vehicles such as money market funds as well as traditional banking services.  Other entities (both public and private) seeking to raise capital through the issuance and sale of debt or equity securities also represent a source of competition for Pinnacle with respect to the acquisition of deposits.  Among the advantages that the major banks have over Pinnacle is their ability to finance extensive advertising campaigns and to allocate their investment assets to regions of highest yield and demand over a more diverse geographic area.  Although major banks have these competitive advantages over small community banks, Pinnacle actively emphasizes its competitive advantage by soliciting customers who prefer the personal service offered by a community bank.

Pinnacle is not dependent upon a single customer or industry, the loss of which would have a material adverse effect on Pinnacle’s financial condition.  Pinnacle is located in a market rich in industrial and retail diversification.

Pinnacle believes that its prompt response to lending requests is a key factor to Pinnacle’s competitive position in its primary service area.  In addition, local decision-making and the accessibility of senior management to customers also distinguish Pinnacle from other area financial institutions.

In order to compete with the other financial institutions in its primary service area, Pinnacle relies principally upon local promotional activities, personal contact by its officers, directors, employees and stockholders and its ability to offer specialized services to customers.  Pinnacle’s promotional activities emphasize the advantages of dealing with a local bank attuned to the particular needs of the community.

Information about the Effects of and Responses to COVID-19

The ongoing COVID-19 pandemic has and continues to impact Pinnacle and its customers, employees, communities and service providers; however the ultimate severity of the COVID-19 pandemic, its duration and the extent of its impact on First National Bank’s business, results of operations, financial condition, liquidity and prospects remains uncertain.

Pandemic Guidelines and Business Continuity.  In response to the COVID-19 pandemic, Pinnacle and First National Bank have placed an emphasis on delivering products and services through online and mobile banking, remote deposit capture, and digital communications with customers.

Pinnacle and First National Bank have implemented a set of pandemic guidelines to protect employees and promote business continuity while providing support to its customers and communities facing challenges due to the impacts of COVID-19. These guidelines include policies and procedures with respect to Phase 1, Phase 2 and Phase 3 responses to the COVID-19 pandemic, additional cleaning and sanitation requirements, and branch-specific response plans for employees and customer service at First National Bank’s branch locations, including remote work and social distancing requirements. Pinnacle has purchased additional laptops, invested in additional technology and software, and purchased personal protective equipment for employee use. Pinnacle’s management meets regularly to review the pandemic guidelines, response priorities, guidance issued by health regulatory agencies, and protective measures and other actions being taken by Pinnacle and First National Bank.

Paycheck Protection Program (“PPP”).  As a further part of Pinnacle’s response to the COVID-19 pandemic, First National Bank has participated in the PPP established pursuant to the Coronavirus Aid, Relief, and Economic Security Act (also known as the “CARES Act”) and implemented by the U.S. Small Business Administration with support from the U.S. Department of the Treasury. First National Bank has provided over $40 million in PPP loans to small businesses in its markets and acquired over $13 million in PPP Loans in its merger with Virginia Bank Bankshares, Inc. (“Virginia Bank”) through March 30, 2021.

Acquisition of Virginia Bank Bankshares, Inc.

On October 30, 2020, Pinnacle completed its merger (the “Merger”) with Virginia Bank Bankshares, Inc. (“Virginia Bank”). The Merger was effected pursuant to the terms and conditions of the Agreement and Plan of Reorganization between Pinnacle and Virginia Bank, signed January 21, 2020 and as amended on June 9, 2020, and the related plan of merger (collectively, the “Merger Agreement”).  Under the Merger Agreement, Virginia Bank shareholders had the opportunity to elect to receive either $16.00 of cash (the “Cash Consideration”) or 0.5400 shares of Pinnacle common stock (the “Stock Consideration”) for each share of Virginia Bank common stock held, subject to the limitation that 60% of the shares would be exchanged for the Stock Consideration and 40% of the shares would be exchanged for the Cash Consideration.  

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For additional information about the Merger, see Note 2 to Pinnacle’s condensed consolidated financial statements included in Part II, Item 8 of this report.  The above description of the Merger Agreement does not purport to be complete and is qualified in its entirety by reference to the Merger Agreement which, is included as Exhibit 2.1 to this report and is incorporated by reference herein.

Employees

As of December 31, 2020, Pinnacle had 187 full-time and 10 part-time employees.  Pinnacle’s management believes that its employee relations are good.

Regulation and Supervision

General.  Bank holding companies, banks and their affiliates are extensively regulated under both federal and state law. The following summary briefly describes significant provisions of currently applicable federal and state laws and certain regulations and the potential impact of such provisions. This summary is not complete and is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals. Because regulation of financial institutions changes regularly and is the subject of constant legislative and regulatory debate, we cannot forecast how federal and state regulation and supervision of financial institutions may change in the future and affect Pinnacle’s and First National Bank’s operations.

During 2020, Pinnacle became subject to periodic reporting requirements under Section 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”), which include the filing of annual, quarterly and current reports with the Securities and Exchange Commission (the “SEC”). Pinnacle is also required to comply with other laws and regulations of the SEC applicable to public companies.

As a national bank, First National Bank is subject to regulation, supervision and regular examination by the OCC. The prior approval of the OCC or other appropriate bank regulatory authority is required for a national bank to merge with another bank or purchase the assets or assume the deposits of another bank. In reviewing applications seeking approval of merger and acquisition transactions, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the constituent organizations and the combined organization, the risks to the stability of the U.S. banking or financial system, the applicant’s performance record under the Community Reinvestment Act (the “CRA”) and fair housing initiatives, the data security and cybersecurity infrastructure of the constituent organizations and the combined organization, and the effectiveness of the subject organizations in combating money laundering activities.

Each depositor’s account with First National Bank is insured by the Federal Deposit Insurance Corporation (the “FDIC”) to the maximum amount permitted by law.

First National Bank is also subject to certain regulations promulgated by the Federal Reserve and applicable provisions of Virginia law, insofar as they do not conflict with or are not preempted by federal banking law.

The regulations of the Federal Reserve, the OCC and the FDIC govern most aspects of Pinnacle’s business, including deposit reserve requirements, investments, loans, certain check clearing activities, issuance of securities, payment of dividends, branching, and numerous other matters.  Further, the federal bank regulatory agencies have adopted guidelines and released interpretive materials that establish operational and managerial standards to promote the safe and sound operation of banks and bank holding companies.  These standards relate to the institution’s key operating functions, including but not limited to internal controls, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings, compensation of management, information systems, data security and cybersecurity, and risk management.  As a consequence of the extensive regulation of commercial banking activities in the United States, Pinnacle’s business is particularly susceptible to changes in state and federal legislation and regulations, which may have the effect of increasing the cost of doing business, limiting permissible activities or increasing competition.

As a bank holding company, Pinnacle is subject to the BHCA, and regulation and supervision by the Federal Reserve. A bank holding company is required to obtain the approval of the Federal Reserve before making certain acquisitions or engaging in certain activities. Bank holding companies and their subsidiaries are also subject to restrictions on transactions with insiders and affiliates.

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A bank holding company is required to obtain the approval of the Federal Reserve before it may acquire all or substantially all of the assets of any bank, and before it may acquire ownership or control of the voting shares of any bank if, after giving effect to the acquisition, the bank holding company would own or control more than 5.0% of the voting shares of such bank. The approval of the Federal Reserve is also required for the merger or consolidation of bank holding companies.

Pursuant to the BHCA, the Federal Reserve has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the Federal Reserve has reasonable grounds to believe that continuation of such activity or ownership constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.

Pinnacle is required to file periodic reports with the Federal Reserve and provide any additional information the Federal Reserve may require. The Federal Reserve also has the authority to examine Pinnacle and its subsidiaries, as well as any arrangements between Pinnacle and its subsidiaries, with the cost of any such examinations to be borne by Pinnacle.  Banking subsidiaries of bank holding companies are also subject to certain restrictions imposed by federal law in dealings with their holding companies and other affiliates.

Regulatory Reform.  The financial crisis of 2008, including the downturn of global economic, financial and money markets and the threat of collapse of numerous financial institutions, and other events led to the adoption of numerous laws and regulations that apply to, and focus on, financial institutions. The most significant of these laws is the Dodd-Frank Act, which was enacted on July 21, 2010 and, in part, was intended to implement significant structural reforms to the financial services industry. The Dodd-Frank Act implemented far-reaching changes across the financial regulatory landscape, including changes that have significantly affected the business of all bank holding companies and banks, including Pinnacle and First National Bank. Some of the rules that have been proposed and, in some cases, adopted to comply with the Dodd-Frank Act’s mandates are discussed further below.

In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”) was enacted to reduce the regulatory burden on certain banking organizations, including community banks, by modifying or eliminating certain federal regulatory requirements. While the EGRRCPA maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion as well as for larger banks with assets above $50 billion. In addition, the EGRRCPA included regulatory relief for community banks regarding regulatory examination cycles, call reports, application of the Volcker Rule (proprietary trading prohibitions), mortgage disclosures, qualified mortgages, and risk weights for certain high-risk commercial real estate loans. However, federal banking regulators retain broad discretion to impose additional regulatory requirements on banking organizations based on safety and soundness and U.S. financial system stability considerations.

Pinnacle continues to experience ongoing regulatory reform. These regulatory changes could have a significant effect on how Pinnacle conducts its business. The specific implications of the Dodd-Frank Act, the EGRRCPA, and other potential regulatory reforms cannot yet be fully predicted and will depend to a large extent on the specific regulations that are to be adopted in the future. Certain aspects of the Dodd-Frank Act and the EGRRCPA are discussed in more detail below.

Capital Requirements and Prompt Corrective Action. The Federal Reserve, the OCC and the FDIC have adopted risk-based capital adequacy guidelines for bank holding companies and banks pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) and the Basel III Capital Accords. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Capital Resources”.

The federal banking agencies have broad powers to take prompt corrective action to resolve problems of insured depository institutions.  Under the FDICIA, there are five capital categories applicable to bank holding companies and insured institutions, each with specific regulatory consequences. The extent of the agencies’ powers depends on whether the institution in question is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.”  These terms are defined under uniform regulations issued by each of the federal banking agencies.  If the appropriate federal banking agency determines that an insured institution is in an unsafe or unsound condition, it may reclassify the institution to a lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.

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Failure to meet statutorily mandated capital guidelines or more restrictive ratios separately established for a financial institution could subject Pinnacle and its subsidiaries to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting or renewing brokered deposits, limitations on the rates of interest that the institution may pay on its deposits, and other restrictions on its business.  In addition, an institution may not make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if the making of such dividend would cause First National Bank to become undercapitalized, it could not pay a dividend to Pinnacle.

Basel III Capital Framework. The federal bank regulatory agencies have adopted rules to implement the Basel III capital framework as outlined by the Basel Committee on Banking Supervision and standards for calculating risk-weighted assets and risk-based capital measurements (collectively, the “Basel III Capital Rules”) that apply to banking institutions they supervise.  For purposes of these capital rules, (i) common equity Tier 1 capital (“CET1”) consists principally of common stock (including surplus) and retained earnings; (ii) Tier 1 capital consists principally of CET1 plus non-cumulative preferred stock and related surplus, and certain grandfathered cumulative preferred stock and trust preferred securities; and (iii) Tier 2 capital consists of other capital instruments, principally qualifying subordinated debt and preferred stock, and limited amounts of an institution’s allowance for loan losses.  Each regulatory capital classification is subject to certain adjustments and limitations, as implemented by the Basel III Capital Rules.  The Basel III Capital Rules also establish risk weightings that are applied to many classes of assets held by community banks, including, importantly, applying higher risk weightings to certain commercial real estate loans.

The Basel III Capital Rules and minimum capital ratios required to be maintained by banks were effective on January 1, 2015. The Basel III Capital Rules also include a requirement that banks maintain additional capital (the “capital conservation buffer”), which was phased in beginning January 1, 2016 and was fully phased in as of January 1, 2019.  As fully phased in, the Basel III Capital Rules require banks to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% capital conservation buffer (which is added to the 4.5% CET1 ratio, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7.0%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5%) and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average total assets, subject to certain adjustments and limitations.

The Basel III Capital Rules provide deductions from and adjustments to regulatory capital measures, primarily to CET1, including deductions and adjustments that were not applied to reduce CET1 under historical regulatory capital rules.  For example, mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities must be deducted from CET1 to the extent that any one such category exceeds 10.0% of CET1 or all such categories in the aggregate exceed 15.0% of CET1.

Small Bank Holding Company. The EGRRCPA also expanded the category of bank holding companies that may rely on the Federal Reserve Board’s Small Bank Holding Company Policy Statement by raising the maximum amount of assets a qualifying bank holding company may have from $1 billion to $3 billion. In addition to meeting the asset threshold, a bank holding company must not engage in significant nonbanking activities, not conduct significant off-balance sheet activities, and not have a material amount of debt or equity securities outstanding and registered with the SEC (subject to certain exceptions). The Federal Reserve Board may, in its discretion, exclude any bank holding company from the application of the Small Bank Holding Company Policy Statement if such action is warranted for supervisory purposes.

In August 2018, the Federal Reserve Board issued an interim final rule to apply the Small Bank Holding Company Policy Statement to bank holding companies with consolidated total assets of less than $3 billion. The policy statement, which, among other things, exempts certain bank holding companies from minimum consolidated regulatory capital ratios that apply to other bank holding companies. As a result of the interim final rule, which was effective August 30, 2018, Pinnacle expects that it will be treated as a small bank holding company and will not be subject to regulatory capital requirements. The comment period on the interim final rule closed on October 29, 2018 and, to date, the Federal Reserve has not issued a final rule to replace the interim final rule. First National Bank remains subject to the regulatory capital requirements described above.

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Limits on Dividends. Pinnacle is a legal entity that is separate and distinct from First National Bank. A significant portion of Pinnacle’s revenues result from dividends paid to it by First National Bank. Both Pinnacle and First National Bank are subject to laws and regulations that limit the payment of dividends, including limits on the sources of dividends and requirements to maintain capital at or above regulatory minimums. Federal Reserve supervisory guidance indicates that the Federal Reserve may have safety and soundness concerns if a bank holding company pays dividends that exceed earnings for the period in which the dividend is being paid. Generally, dividends paid by First National Bank during a year may not exceed the sum of the bank’s net income in that year and the bank’s retained earnings of the immediately preceding two calendar years without prior approval of the OCC.  Further, the Federal Deposit Insurance Act (the “FDIA”) prohibits insured depository institutions such as First National Bank from making capital distributions, including paying dividends, if, after making such distribution, the institution would become undercapitalized as defined in the statute. The OCC may prevent First National Bank from paying a dividend if the OCC concludes such dividend would be an unsafe or unsound banking practice. We do not expect that any of these laws, regulations or policies will materially affect the ability of Pinnacle or First National Bank to pay dividends.

Insurance of Accounts, Assessments and Regulation by the FDIC.  First National Bank’s deposits are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to the standard maximum insurance amount for each deposit insurance ownership category. The basic limit on FDIC deposit insurance coverage is $250,000 per depositor. Under the FDIA, the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations as an insured institution, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC, subject to administrative and potential judicial hearing and review processes.

Deposit Insurance Assessments.  The DIF is funded by assessments on banks and other depository institutions calculated based on average consolidated total assets minus average tangible equity (defined as Tier 1 capital). As required by the Dodd-Frank Act, the FDIC has adopted a large-bank pricing assessment scheme, set a target “designated reserve ratio” (described in more detail below) of 2.0% for the DIF and, in lieu of dividends, provides for a lower assessment rate schedule when the reserve ratio reaches 2.0% and 2.5%. An institution’s assessment rate is based on a statistical analysis of financial ratios that estimates the likelihood of failure over a three-year period, which considers the institution’s weighted average capital adequacy, assets, management capability, earnings, liquidity, and sensitivity (“CAMELS”) component rating, and is subject to further adjustments including those related to levels of unsecured debt and brokered deposits (not applicable to banks with less than $10 billion in assets).  At December 31, 2020, total base assessment rates for institutions that have been insured for at least five years range from 1.5 to 30 basis points applying to banks with less than $10 billion in assets.

The Dodd-Frank Act transferred to the FDIC increased discretion with regard to managing the required amount of reserves for the DIF, or the “designated reserve ratio.” The FDIA requires that the FDIC consider the appropriate level for the designated reserve ratio on at least an annual basis. As of December 31, 2020, the designated reserve ratio was 2.0% and the minimum designated reserve ratio was 1.35%.  At December 31, 2020, the reserve ratio was 1.30%.

Certain Transactions by Insured Banks with their Affiliates. There are statutory restrictions related to the extent bank holding companies and their non-bank subsidiaries may borrow, obtain credit from or otherwise engage in “covered transactions” with their insured depository institution (i.e., banking) subsidiaries. In general, an “affiliate” of a bank includes the bank’s parent holding company and any subsidiary thereof. However, an “affiliate” does not generally include the bank’s operating subsidiaries. A bank (and its subsidiaries) may not lend money to, or engage in other covered transactions with, its non-bank affiliates if the aggregate amount of covered transactions outstanding involving the bank, plus the proposed transaction, exceeds the following limits: (a) in the case of any one such affiliate, the aggregate amount of covered transactions of the bank and its subsidiaries cannot exceed 10.0% of the bank’s capital stock and surplus; and (b) in the case of all affiliates, the aggregate amount of covered transactions of the bank and its subsidiaries cannot exceed 20.0% of the bank’s capital stock and surplus. “Covered transactions” are defined to include a loan or extension of credit to an affiliate, a purchase of or investment in securities issued by an affiliate, a purchase of assets from an affiliate, the acceptance of securities issued by an affiliate as collateral for a loan or extension of credit to any person or company, the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate, securities borrowing or lending transactions with an affiliate that creates a credit exposure to such affiliate, or a derivatives transaction with an affiliate that creates a credit exposure to such affiliate. Certain covered transactions are also subject to collateral security requirements.

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Covered transactions as well as other types of transactions between a bank and a bank holding company must be on market terms, which means that the transaction must be conducted on terms and under circumstances that are substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with or involving non-affiliates or, in the absence of comparable transactions, that in good faith would be offered to or would apply to non-affiliates. Moreover, certain amendments to the BHCA provide that, to further competition, a bank holding company and its subsidiaries are prohibited from engaging in certain tying arrangements in connection with any extension of credit, lease or sale of property of any kind, or furnishing of any service.

Incentive Compensation. The Federal Reserve, the OCC and the FDIC have issued regulatory guidance intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Pinnacle, that are not “large, complex banking organizations.” The findings will be included in reports of examination, and deficiencies will be incorporated into the organization’s supervisory ratings. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

In addition, in 2016, the SEC and the federal banking agencies proposed rules that prohibit covered financial institutions (including bank holding companies and banks) from establishing or maintaining incentive-based compensation arrangements that encourage inappropriate risk taking by providing covered persons (consisting of senior executive officers and significant risk takers, as defined in the rules) with excessive compensation, fees or benefits that could lead to material financial loss to the financial institution.  The proposed rules outline factors to be considered when analyzing whether compensation is excessive and whether an incentive-based compensation arrangement encourages inappropriate risks that could lead to material loss to the covered financial institution, and establishes minimum requirements that incentive-based compensation arrangements must meet to be considered to not encourage inappropriate risks and to appropriately balance risk and reward.  The proposed rules also impose additional corporate governance requirements on the boards of directors of covered financial institutions and impose additional record-keeping requirements.  The comment period for these proposed rules has closed and a final rule has not yet been published.

Federal Home Loan Bank of Atlanta. First National Bank is a member of the Federal Home Loan Bank (the “FHLB”) of Atlanta, which is one of 12 regional FHLBs that provide funding to their members for making housing loans as well as for affordable housing and community development loans. Each FHLB serves as a reserve, or central bank, for the members within its assigned region. Each FHLB makes loans to members in accordance with policies and procedures established by the Board of Directors of the FHLB. As a member, First National Bank must purchase and maintain stock in the FHLB. Additional information related to First National Bank’s FHLB stock can be found in Note 1(d) to Pinnacle’s consolidated financial statements attached hereto.

Community Reinvestment Act. Pinnacle is subject to the requirements of the CRA, which imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. A financial institution’s efforts in meeting community credit needs are assessed based on specified factors.  These factors also are considered in evaluating mergers, acquisitions and applications to open a branch or facility. At its last evaluation in 2020, First National Bank received a “Satisfactory” CRA rating.

Confidentiality and Required Disclosures of Consumer Information. Pinnacle is subject to various laws and regulations that address the privacy of nonpublic personal financial information of consumers. The Gramm-Leach-Bliley Act and certain regulations issued thereunder protect against the transfer and use by financial institutions of consumer nonpublic personal information. A financial institution must provide to its customers, at the beginning of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated third parties unless the institution discloses to the customer that the information may be so provided and the customer is given the opportunity to opt out of such disclosure.

Certain exceptions may apply to the requirement to deliver an annual privacy notice based on how a financial institution limits sharing of nonpublic personal information, and whether the institution’s disclosure practices or policies have changed in certain ways since the last privacy notice that was delivered.

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Pinnacle is also subject to various laws and regulations that attempt to combat money laundering and terrorist financing. The Bank Secrecy Act requires all financial institutions to, among other things, create a system of controls designed to prevent money laundering and the financing of terrorism, and imposes recordkeeping and reporting requirements. The USA Patriot Act facilitates information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering, and requires financial institutions to establish anti-money laundering programs. The Office of Foreign Assets Control (“OFAC”), which is a division of the U.S. Department of the Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. If First National Bank finds a name of an “enemy” of the United States on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account or place transferred funds into a blocked account, file a suspicious activity report with the Treasury and notify the Federal Bureau of Investigation.

Although these laws and programs impose compliance costs and create privacy obligations and, in some cases, reporting obligations, and compliance with all of the laws, programs, and privacy and reporting obligations may require significant resources of Pinnacle and First National Bank, these laws and programs do not materially affect First National Bank’s products, services or other business activities.

Cybersecurity. The federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of a financial institution’s board of directors. These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial products and services. The federal banking agencies expect financial institutions to establish lines of defense and ensure that their risk management processes also address the risk posed by compromised customer credentials, and also expect financial institutions to maintain sufficient business continuity planning processes to ensure rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack. If Pinnacle or First National Bank fails to meet the expectations set forth in this regulatory guidance, Pinnacle or First National Bank could be subject to various regulatory actions and any remediation efforts may require significant resources of Pinnacle or First National Bank. In addition, all federal and state bank regulatory agencies continue to increase focus on cybersecurity programs and risks as part of regular supervisory exams.

In October 2016, the federal banking agencies issued proposed rules on enhanced cybersecurity risk-management and resilience standards that would apply to very large financial institutions and to services provided by third parties to these institutions. The comment period for these proposed rules has closed and a final rule has not been published. Although the proposed rules would apply only to bank holding companies and banks with $50 billion or more in total consolidated assets, these rules could influence the federal banking agencies’ expectations and supervisory requirements for information security standards and cybersecurity programs of smaller financial institutions, such as Pinnacle and First National Bank.

Consumer Laws and Regulations. Pinnacle is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Fair Housing Act, among others. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions transact business with customers. Pinnacle must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations.

The Consumer Financial Protection Bureau (the “CFPB”) is the federal regulatory agency responsible for implementing, examining and enforcing compliance with federal consumer financial laws for institutions with more than $10 billion of assets and, to a lesser extent, smaller institutions. The CFPB supervises and regulates providers of consumer financial products and services and has rulemaking authority in connection with numerous federal consumer financial protection laws (for example, but not limited to, the Truth in Lending Act and the Real Estate Settlement Procedures Act).  As a smaller institution (i.e., with assets of $10 billion or less), most consumer protection aspects of the Dodd-Frank Act will continue to be applied to Pinnacle by the Federal Reserve and to First National Bank by the OCC. However, the CFPB may include its own examiners in regulatory examinations by a smaller institution’s prudential regulators and may require smaller institutions to comply with certain CFPB reporting requirements. In addition, regulatory positions taken by the CFPB and administrative and legal precedents established by CFPB enforcement activities, including in connection with supervision of larger bank holding companies and banks, could influence how the Federal Reserve and the OCC apply consumer protection laws and regulations to financial institutions that are not directly supervised by the CFPB. The precise effect of the CFPB’s consumer protection activities on Pinnacle cannot be forecast.

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Mortgage Banking Regulation.  In connection with making mortgage loans, First National Bank is subject to rules and regulations that, among other things, establish standards for loan origination, prohibit discrimination, provide for inspections and appraisals of property, require credit reports on prospective borrowers, in some cases, restrict certain loan features and fix maximum interest rates and fees, require the disclosure of certain basic information to mortgagors concerning credit and settlement costs, limit payment for settlement services to the reasonable value of the services rendered and require the maintenance and disclosure of information regarding the disposition of mortgage applications based on race, gender, geographical distribution and income level. First National Bank’s mortgage origination activities are subject to the Equal Credit Opportunity Act, Truth in Lending Act, Home Mortgage Disclosure Act, Real Estate Settlement Procedures Act, and Home Ownership Equity Protection Act, and the regulations promulgated under these acts, among other additional state and federal laws, regulations and rules.

First National Bank’s mortgage origination activities are also subject to Regulation Z, which implements the Truth in Lending Act.  Certain provisions of Regulation Z require mortgage lenders to make a reasonable and good faith determination, based on verified and documented information, that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Alternatively, mortgage lenders can originate “qualified mortgages”, which are generally defined as mortgage loans without negative amortization, interest-only payments, balloon payments, terms exceeding 30 years, and points and fees paid by a consumer equal to or less than 3.0% of the total loan amount. Under the EGRRCPA, most residential mortgages loans originated and held in portfolio by a bank with less than $10 billion in assets will be designated as “qualified mortgages.” Higher-priced qualified mortgages (e.g., subprime loans) receive a rebuttable presumption of compliance with ability-to-repay rules, and other qualified mortgages (e.g., prime loans) are deemed to comply with the ability-to-repay rules.

Volcker Rule. The Dodd-Frank Act prohibits bank holding companies and their subsidiary banks from engaging in proprietary trading except in limited circumstances, and places limits on ownership of equity investments in private equity and hedge funds (the Volcker Rule). The EGRRCPA, and final rules adopted to implement the EGRRCPA, exempt all banks with less than $10 billion in assets (including their holding companies and affiliates) from the Volcker Rule, provided that the institution has total trading assets and liabilities of 5.0% or less of total assets, subject to certain limited exceptions. Pinnacle believes that its financial condition and its operations are not and will not be significantly affected by the Volcker Rule, amendments thereto, or its implementing regulations.

Call Reports and Examination Cycle. All institutions, regardless of size, submit a quarterly call report that includes data used by federal banking agencies to monitor the condition, performance, and risk profile of individual institutions and the industry as a whole. The EGRRCPA contained provisions expanding the number of regulated institutions eligible to use streamlined call report forms. In June 2019, the federal banking agencies issued a final rule to permit insured depository institutions with total assets of less than $5 billion that do not engage in certain complex or international activities to file the most streamlined version of the quarterly call report.

In December 2018, consistent with the provisions of the EGRRCPA, the federal banking agencies jointly adopted final rules that permit banks with up to $3 billion in total assets, that received a composite CAMELS rating of “1” or “2,” and that meet certain other criteria (including not having undergone any change in control during the previous 12-month period, and not being subject to a formal enforcement proceeding or order), to qualify for an 18-month on-site examination cycle.

Future Regulation. From time to time, various legislative and regulatory initiatives are introduced in Congress and state legislatures, as well as by regulatory agencies. Such initiatives may include proposals to expand or contract the powers of bank holding companies and depository institutions or proposals to substantially change the financial institution regulatory system. Such legislation could change banking statutes and the operating environment of Pinnacle in substantial and unpredictable ways. If enacted, such legislation could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. Pinnacle cannot predict whether any such legislation will be enacted, and, if enacted, the effect that it, or any implementing regulations, would have on the financial condition or results of operations of Pinnacle. A change in statutes, regulations or regulatory policies applicable to Pinnacle or First National Bank could have a material effect on our business.

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Item 1A.Risk Factors

In addition to the other information included in this Annual Report on Form 10-K, the following risk factors should be carefully considered in connection with evaluating our business and any forward-looking statements contained herein. Our business, financial condition, results of operations and cash flows could be harmed by any of the risk factors described below, or other risks that have not been identified or which we believe are immaterial or unlikely. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our business, financial condition, operating results and cash flows could be materially adversely affected.

Risks Related to COVID-19

The ongoing COVID-19 pandemic and measures intended to prevent or slow its spread may have material adverse effects on each of Pinnacle’s business, results of operation, financial condition, liquidity and prospects, and such effects are highly uncertain and difficult to predict.

Global health concerns regarding the COVID-19 pandemic and related governmental actions taken to reduce the spread of the coronavirus have negatively impacted the macroeconomic environment, and the COVID-19 pandemic has significantly increased economic uncertainty and abruptly reduced economic activity. The COVID-19 pandemic has resulted in governmental authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter-in-place orders and business limitations and shutdowns. Such measures have significantly contributed to rising unemployment and negatively impacted consumer and business spending. The COVID-19 pandemic has adversely impacted and could potentially further adversely impact Pinnacle’s workforce and operations, and the operations of their customers and business partners.

Pinnacle may experience adverse financial consequences due to a number of factors that are related to or exacerbated by the COVID-19 pandemic, including, but not limited to:

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These factors may remain prevalent for a significant period of time and may continue to adversely affect Pinnacle’s business, results of operations, financial condition, liquidity and prospects, including even after the COVID-19 pandemic has subsided.

The extent to which the COVID-19 pandemic impacts Pinnacle’s business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of COVID-19, its severity, the actions taken to contain the coronavirus virus or treat its impact and their respective effectiveness, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 pandemic has subsided, Pinnacle may continue to experience materially adverse impacts to their business as a result of the COVID-19’s global economic impact, including the availability of credit, adverse impacts on liquidity and any recession or depression that has occurred or may occur in the future.

There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of COVID-19 is highly uncertain and subject to change. Pinnacle does not know the full extent of the impacts of the COVID-19 pandemic on its business, operations or the economy as a whole. However, the effects could have a material adverse impact on Pinnacle’s financial condition, results of operations, and business.

Further, the COVID-19 pandemic may also exacerbate many of the risk factors identified in the “Risk Factors” section of this Annual Report, including risks related to credit quality, collateral, capital, liquidity, operations, interest rate risk, strategic risk and technology.

In response to the COVID-19 pandemic, governmental authorities have taken unprecedented measures to stabilize economic markets and support economic growth, and Pinnacle’s participation in and execution of these measures could result in reputational harm or litigation that results in judgments, settlements, penalties or fines levied against Pinnacle.

Federal, state and local governments in the United States have taken unprecedented measures to stabilize economic markets and support economic growth in response to the COVID-19 pandemic. The success of these measures is uncertain, and these measures even if successful may not be sufficient to address the negative economic impacts of the COVID-19 pandemic or avert severe and prolonged reductions in economic activity, including in the markets in which Pinnacle operates.

First National Bank is a participating lender in the PPP, a loan program administered through the U.S. Small Business Administration (the “SBA”), that was created to help eligible businesses, organizations and self-employed persons fund their operational costs (and particularly payroll costs) during the COVID-19 pandemic. Under this program, the SBA guarantees 100% of the amounts loaned under the PPP. The laws, rules and guidance that govern the operation of the PPP contain significant ambiguities, which has exposed lenders under the PPP program, including Pinnacle, to risks relating to noncompliance with the PPP. For example, other financial institutions are defendants in purported class action litigation regarding the procedures used by the lender in processing applications for the PPP. Under the PPP, lending banks are generally entitled to rely on borrower representations and certifications of eligibility to participate in the PPP, and lending banks may also be held harmless by the SBA in certain circumstances for actions taken in reliance on borrower representations and certifications. Notwithstanding the foregoing, First National Bank has been and continues to be exposed to credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded or serviced. If a deficiency is identified, the SBA may deny its liability under its guaranty of amounts owed on the PPP loan, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from First National Bank.

Pinnacle’s participation in and execution of these and other measures taken by governments and regulatory authorities in response to the COVID-19 pandemic could result in reputational harm and may also lead to litigation, including class action claims, or regulator or administrative actions or proceedings. Such litigation, actions or proceedings may result in judgments, settlements, penalties and fines levied against Pinnacle.

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Risks Related to Pinnacle’s Lending Activities

Pinnacle may experience increased delinquencies and credit losses, which could have a material adverse effect on Pinnacle’s capital, financial condition and results of operations.

Like other lenders, Pinnacle faces the risk that our customers will not repay their loans. A customer’s failure to repay us is usually preceded by missed monthly payments. In some instances, however, a customer may declare bankruptcy prior to missing payments, and, following a borrower filing bankruptcy, a lender’s recovery of the credit extended is often limited. Since many of Pinnacle’s loans are secured by collateral, Pinnacle may attempt to seize the collateral if and when a customer defaults on a loan. However, the value of the collateral may not equal the amount of the unpaid loan, and Pinnacle may be unsuccessful in recovering the remaining balance from the customer. The resolution of nonperforming assets, including the initiation of foreclosure proceedings, requires significant commitments of time from management, which can be detrimental to the performance of their other responsibilities, and exposes us to additional legal costs.

Pinnacle’s allowance for loan losses may be insufficient to absorb incurred losses in Pinnacle’s loan portfolio, and any increases in the ALL may have a material adverse effect on Pinnacle’s financial condition and results of operations.

Pinnacle maintains an allowance for loan losses (“ALL”), which is a reserve established through a provision for loan losses charged to expense, that represents Pinnacle’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. Elevated levels of loan delinquencies and bankruptcies in Pinnacle’s market area generally and among its customers specifically, can be precursors of future charge-offs and may require increases to the ALL. Higher charge-off rates, delays in the foreclosure process or in obtaining judgments against defaulting borrowers or an increase in Pinnacle’s ALL may hurt Pinnacle’s overall financial performance if it is unable to increase revenue to compensate for these losses, may increase Pinnacle’s cost of funds, and could materially adversely affect Pinnacle’s business, results of operations and financial condition.

The level of the ALL reflects management’s evaluation of the level of loans outstanding, the level of non-performing loans, historical loan loss experience, delinquency trends, underlying collateral values, the amount of actual losses charged to the reserve in a given period and our assessment of present and anticipated economic conditions. The determination of the appropriate level of the ALL inherently involves a high degree of subjectivity and requires Pinnacle to make significant estimates of current credit risks and future trends, all of which may undergo material changes. The ALL may not be sufficient to cover actual loan losses and future provisions for loan losses could materially and adversely affect Pinnacle’s operating results.

Pinnacle’s banking regulators, as an integral part of their examination process, periodically review the ALL and may require Pinnacle to increase its ALL by recognizing additional provisions for loan losses charged to expense, or to decrease the ALL by recognizing loan charge-offs, net of recoveries. Any such required additional provisions for loan losses or charge-offs could have a material adverse effect on Pinnacle’s financial condition and results of operations.

Additionally, the measure of Pinnacle’s ALL is dependent on the adoption and interpretation of accounting standards. In June 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” Under this ASU, the current incurred loss credit impairment methodology will be replaced with the current expected credit loss, or CECL model, a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Accordingly, the implementation of the CECL model will change Pinnacle’s current method of providing ALL and may result in material changes in Pinnacle’s accounting for credit losses on financial instruments. The CECL model may create more volatility in Pinnacle’s level of ALL. If Pinnacle is required to materially increase its level of ALL for any reason, such increase could adversely affect its business, financial condition, and results of operations. The amendment is effective for fiscal years beginning after 2022.

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Pinnacle’s credit standards and its on-going credit assessment processes might not protect it from significant credit losses.

Pinnacle assumes credit risk by virtue of making loans and extending loan commitments and letters of credit. Pinnacle manages credit risk through a program of underwriting standards, heightened review of certain credit decisions, and a continuous quality assessment process of credit already extended. Pinnacle’s exposure to credit risk is managed through the use of consistent underwriting standards that emphasize local lending while avoiding highly leveraged transactions and excessive industry and other concentrations. Pinnacle’s credit administration function employs risk management techniques to help ensure that problem loans are promptly identified. While these procedures are designed to provide Pinnacle with the information needed to implement policy adjustments where necessary and to take appropriate corrective actions, there can be no assurance that such measures will be effective in avoiding undue credit risk.

Pinnacle’s focus on lending to small and mid-sized community-based businesses may increase its credit risk.

Most of Pinnacle’s commercial business and commercial real estate loans are made to small business or middle market customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a heightened vulnerability to economic conditions. If general economic conditions in the market areas in which Pinnacle operates negatively impact this important customer sector, Pinnacle’s results of operations and financial condition may be adversely affected. Moreover, a portion of these loans have been made by Pinnacle in recent years and the borrowers may not have experienced a complete business or economic cycle. Any deterioration of the borrowers’ businesses may hinder their ability to repay their loans with Pinnacle, which could have a material adverse effect on its financial condition and results of operations.

Pinnacle’s concentration in loans secured by real estate may increase its future credit losses, which would negatively affect Pinnacle’s financial results.

Pinnacle offers a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Credit risk and credit losses can increase if its loans are concentrated to borrowers who, as a group, may be uniquely or disproportionately affected by economic or market conditions. As of December 31, 2020, approximately 60.16% of Pinnacle’s loans are secured by real estate, both residential and commercial, substantially all of which are located in its market area. A major change in the region’s real estate market, resulting in a deterioration in real estate values, or in the local or national economy, including changes caused by rising interest rates, could adversely affect Pinnacle’s customers’ ability to pay these loans, which in turn could adversely impact Pinnacle. Risk of loan defaults and foreclosures are inherent in the banking industry, and Pinnacle tries to limit its exposure to this risk by carefully underwriting and monitoring its extensions of credit. Pinnacle cannot fully eliminate credit risk, and as a result credit losses may occur in the future.

A portion of Pinnacle’s loan portfolio consists of commercial real estate loans, which are viewed as having a higher risk of default.

As of December 30, 2020, approximately 28.35% of Pinnacle’s loans are secured by commercial real estate. The real estate consists primarily of non-owner-operated properties and other commercial properties. These types of loans are generally viewed as having a higher risk of default than residential real estate loans. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. It may be more difficult for commercial real estate borrowers to repay their loans in a timely manner, as commercial real estate borrowers’ abilities to repay their loans frequently depends on the successful rental of their properties. Cash flows may be affected significantly by general economic conditions, and a downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default.

Pinnacle’s banking regulators generally give commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital as a result of commercial real estate lending growth and exposures, which could have a material adverse effect on Pinnacle’s results of operations.

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A portion of Pinnacle’s loan portfolio consists of construction and land development loans, and a decline in real estate values and economic conditions would adversely affect the value of these loans and the collateral securing these loans.

As of December 30, 2020, approximately 3.82% of Pinnacle’s loans were construction and land development loans. Construction financing typically involves a higher degree of credit risk than financing on improved, owner-occupied real estate and improved, income producing real estate. Risk of loss on a construction or land development loan is largely dependent upon the accuracy of the initial estimate of the property’s value at completion of construction or development, the marketability of the property, and the bid price and estimated cost (including interest) of construction or development. If the estimate of construction or development costs proves to be inaccurate, Pinnacle may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of the value proves to be inaccurate, we may be confronted, at or prior to the maturity of the loan, with a project whose value is insufficient to assure full repayment. When lending to builders and developers, the cost breakdown of construction or development is provided by the builder or developer. Although Pinnacle’s underwriting criteria are designed to evaluate and minimize the risks of each construction or land development loan, there can be no guarantee that these practices will have safeguarded against material delinquencies and losses to Pinnacle. In addition, construction and land development loans are dependent on the successful completion of the projects they finance. Loans secured by vacant or unimproved land are generally riskier than loans secured by improved property. These loans are more susceptible to adverse conditions in the real estate market and local economy.

Risks Related to Pinnacle’s Business, Operations and Industry

Pinnacle is subject to interest rate risk and fluctuations in interest rates which may negatively affect Pinnacle’s financial performance.

Pinnacle’s profitability depends in substantial part on its net interest margin, which is the difference between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits and borrowings divided by total interest-earning assets. Changes in interest rates affect Pinnacle’s net interest margin in diverse ways, including the pricing of loans and deposits, the levels of prepayments and asset quality. Interest rates are highly sensitive to many factors beyond Pinnacle’s control, including general economic conditions and the policies of the Federal Reserve and other governmental and regulatory agencies. Pinnacle cannot predict actual fluctuations of market interest rates. Recent actions by the Federal Open Market Committee have maintained an accommodative monetary policy, thereby supporting strong labor market conditions and reducing short-term interest rates. Longer-term market interest rates, including yields on U.S. treasury bonds, remain low.  Therefore, Pinnacle expects continued pressure on its net interest margin due to intense competition for loans and deposits from both local and national financial institutions.  An upward movement in interest rates may result in an unfavorable pricing disparity between Pinnacle’s fixed rate loan portfolio and adjustable-rate funding sources.  Continued pressure on our net interest margin could adversely affect our results of operations.

Changes in monetary policy and changes in interest rates will influence the origination of loans, the prepayment of loans, the fair value of existing assets and liabilities, the purchase of investments, the retention and generation of deposits, the rates received on loans and investment securities, and the rates paid on deposits or other sources of funding. The impact of these changes may be magnified if Pinnacle does not effectively manage the relative sensitivity of its assets and liabilities to changes in market interest rates. In addition, Pinnacle’s ability to reflect such interest rate changes in pricing its products is influenced by competitive pressures.

Pinnacle generally seeks to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period so that it may reasonably maintain its net interest margin; however, interest rate fluctuations, loan prepayments, loan production, deposit flows, and competitive pressures are constantly changing and influence the ability to maintain a neutral position. Generally, Pinnacle’s earnings will be more sensitive to fluctuations in interest rates depending upon the variance in volume of assets and liabilities that mature and re-price in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of changes in interest rates, shape and slope of the yield curve, and whether Pinnacle is more asset sensitive or liability sensitive. Accordingly, Pinnacle may not be successful in maintaining a neutral position and, as a result, Pinnacle’s net interest margin may be affected.

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At December 31, 2020, approximately 11.84% of Pinnacle’s loans held for investment were variable rate loans. While the variable rate structure on these loans reduces interest rate risk for First National Bank, increases in market interest rates may cause the borrower’s required payment to increase which, in turn, may increase the risk of payment default or the risk of early pay-off by refinancing with another financial institution.

Pinnacle’s business is subject to economic risks that could adversely affect Pinnacle’s operations and financial condition, and adverse changes in economic conditions in Pinnacle’s market areas or adverse conditions in an industry on which a local market is dependent could adversely affect Pinnacle’s operations and financial conditions.

Deterioration in economic conditions could adversely affect Pinnacle’s business. Pinnacle’s business is directly affected by general economic and market conditions; broad trends in industry and finance; legislative and regulatory changes; changes in governmental monetary and fiscal policies; and inflation, all of which are beyond Pinnacle’s control. A deterioration in economic conditions, in particular a prolonged economic slowdown within Pinnacle’s geographic region, could result in the following consequences, any of which could materially adversely impact Pinnacle’s financial condition or results of operations: an increase in loan delinquencies; an increase in problem assets and foreclosures; a decline in demand for banking products and services; and a deterioration in the value of collateral for loans.

We provide full-service banking and other financial services in the Lynchburg and Danville, Virginia banking markets. Our loan and deposit activities are directly affected by, and our financial success depends on, economic conditions within these markets, as well as conditions in the industries on which those markets are economically dependent. A deterioration in local economic conditions or in the condition of an industry on which a local market depends, such the healthcare and higher education industries, could adversely affect such factors as unemployment rates, business formations and expansions and housing market conditions. Adverse developments in any of these factors could result in among other things, a decline in loan demand, a reduction in the number of creditworthy borrowers seeking loans, an increase in delinquencies, defaults and foreclosures, an increase in classified and nonaccrual loans, a decrease in the value of loan collateral, and a decline in the financial condition of borrowers and guarantors, any of which could adversely affect Pinnacle’s financial condition or results of operations.

Pinnacle’s future success will depend on its ability to compete effectively in the highly competitive financial services industry.

Pinnacle faces substantial competition in all phases of its operation from a variety of competitors. Pinnacle competes with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, and insurance companies, as well as other community, super-regional, and national financial institutions that operate offices within Pinnacle’s primary market areas. Pinnacle’s future growth and success depends on its ability to compete effectively in this highly competitive financial services environment. Many of Pinnacle’s competitors are well established, larger financial institutions and many offer products and services that Pinnacle does not, and many such competitors have substantially greater resources and name recognition. Some of Pinnacle’s competitors are not subject to the same regulation as imposed on bank holding companies and national banking associations, and therefore have regulatory advantages over Pinnacle in accessing funding and providing various services. Pinnacle may face a competitive disadvantage as a result of its smaller size, smaller asset base, and lack of geographic diversification. If Pinnacle raises interest rates paid on deposits or lowers interest rates charged on loans to compete effectively, Pinnacle’s net interest margin and net income could be negatively affected. Failure to compete effectively to attract new or to retain existing customers may reduce or limit Pinnacle’s market share and growth and may adversely affect Pinnacle’s financial condition and results of operations.

Pinnacle may not be able to effectively integrate the operations of Virginia Bank and Trust into First National Bank.

Integration in connection with a merger is sometimes difficult, and there is a risk that integrating Virginia Bank into Pinnacle may take more time and resources than Pinnacle expects. The future operating performance of Pinnacle and First National Bank will depend, in part, on the success of the merger of Virginia Bank and Trust into First National Bank. Virginia Bank and Trust has been merged with and into First National Bank with First National Bank surviving. The success of the merger of the banks will, in turn, depend on a number of factors, including Pinnacle’s ability to: (i) integrate the operations and branches of Virginia Bank and Trust into First National Bank; (ii) retain the deposits and customers of Virginia Bank and Trust; (iii) control the incremental increase in noninterest expense arising from the merger in a manner that enables the combined company to improve its overall operating efficiencies; and (iv) retain and integrate the appropriate personnel of Virginia Bank and Trust into the operations of First National Bank, as well as reducing overlapping bank personnel. The integration of Virginia Bank and Trust and First National Bank following the bank merger will require the dedication of the time and resources of Pinnacle’s management and may temporarily distract managements’ attention from Pinnacle’s day-to-day business. If Pinnacle is unable to successfully integrate Virginia Bank and Trust into First National Bank, Pinnacle may not be able to realize expected operating efficiencies and eliminate redundant costs.

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Pinnacle continually encounters technological change which could affect its ability to remain competitive.

The financial services industry is continually undergoing technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Pinnacle continues to invest in technology and connectivity to automate functions previously performed manually, to facilitate the ability of customers to engage in financial transactions, and otherwise to enhance the customer experience with respect to its products and services. Pinnacle’s continued success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that satisfy customer demands and create efficiencies in its operations. A failure to maintain or enhance a competitive position with respect to technology, whether because of a failure to anticipate customer expectations, substantially fewer resources to invest in technological improvements than larger competitors, or because Pinnacle’s technological developments fail to perform as desired or are not rolled out in a timely manner, may cause Pinnacle to lose market share or incur additional expense.

Pinnacle’s operations may be adversely affected by cyber security risks and cyber-attacks.

In the ordinary course of business, Pinnacle collects and stores sensitive data, including proprietary business information and personally identifiable information of its customers and employees in systems and on networks. The secure processing, maintenance, and use of this information is critical to Pinnacle’s operations and business strategy. In addition, Pinnacle relies heavily on communications and information systems to conduct its business. Any failure, interruption, or breach in security or operational integrity of these systems, such as “hacking,” “identity theft” or “cyber fraud,” could result in failures or disruptions in Pinnacle’s customer relationship management, the general ledger, deposits, loans, and other systems. Moreover, with some of Pinnacle’s employees working from home during the COVID-19 pandemic, there may be increased opportunities for unauthorized access and cyber-attacks.  Pinnacle has invested in accepted technologies, and continually reviews its controls, processes and practices that are designed to protect its networks, computers, and data, including customer information, from damage or unauthorized access. Despite these security measures, Pinnacle’s computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance, or other disruptions. Because the techniques used to obtain unauthorized access, or to disable or degrade systems change frequently and often are not recognized until launched against a target, Pinnacle may be unable to anticipate these techniques or to implement adequate protective measures.

There can be no assurance that Pinnacle will not suffer cyber-attacks or other information security breaches or be impacted by losses from such events in the future. Pinnacle’s risk and exposure to these matters remain heightened because of, among other things, the evolving nature of these threats, current use of internet banking and mobile banking channels, expanded operations and third-party information systems. Recent instances of attacks specifically targeting financial services businesses indicate that the risk to Pinnacle’s systems remains significant.

A breach of any kind could compromise systems and the information stored there could be accessed, damaged, or disclosed. A breach in security or other failure could result in legal claims, regulatory penalties, disruption in operations, remediation expenses, costs associated with customer notification and credit monitoring services, increased insurance premiums, fines and costs associated with civil litigation, loss of customers and business partners, and damage to Pinnacle’s reputation, which could adversely affect its business and financial condition. Furthermore, as cyber threats continue to evolve and increase, Pinnacle may be required to expend significant additional financial and operational resources to modify or enhance its protective measures, or to investigate and remediate any identified information security vulnerabilities.

Pinnacle relies on other companies to provide key components of its business infrastructure.

Third parties provide key components of Pinnacle’s business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, internet connections and network access. While Pinnacle has selected these third-party vendors carefully, it does not control their actions. Any problem caused by these third parties, including poor performance of services, failure to provide services, disruptions in communication services provided by a vendor and failure to handle current or higher volumes, could adversely affect Pinnacle’s ability to deliver products and services to its customers and otherwise conduct its business, and may harm its reputation. Financial or operational difficulties of a third-party vendor could also hurt Pinnacle’s operations if those difficulties interface with the vendor’s ability to serve Pinnacle. Replacing these third-party vendors could also create significant delay and expense. Accordingly, use of such third-parties creates an unavoidable inherent risk to Pinnacle’s business operations.

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The operational functions of business counterparties over which Pinnacle may have limited or no control may experience disruptions that could adversely impact Pinnacle.

Multiple major U.S. retailers and a major consumer credit reporting agency have experienced data systems incursions in recent years reportedly resulting in the thefts of credit and debit card information, online account information, and other personal and financial data of hundreds of millions of individuals. Retailer incursions affect cards issued and deposit accounts maintained by many banks, including First National Bank. Although neither Pinnacle’s or First National Bank’s systems are breached in retailer incursions, such incursions can still cause customers to be dissatisfied with First National Bank and otherwise adversely affect Pinnacle’s and First National Bank’s reputation. These events can also cause First National Bank to take other costly steps to avoid significant theft loss to First National Bank and its customers. In some cases, First National Bank may be required to reimburse customers for the losses they incur. Credit reporting agency intrusions affect First National Bank’s customers and can require these customers and First National Bank to increase account monitoring and take remedial action to prevent unauthorized account activity or access. Other possible points of intrusion or disruption not within Pinnacle’s or First National Bank’s control include internet service providers, electronic mail portal providers, social media portals, distant-server (“cloud”) service providers, electronic data security providers, telecommunications companies, and smart phone manufacturers.

Pinnacle relies substantially on deposits obtained from customers in its target markets to provide liquidity and support growth, and Pinnacle’s liquidity needs could adversely affect results of operations and financial condition.

Pinnacle’s business strategies are based on access to funding from local customer deposits. Deposit levels may be affected by a number of factors, including interest rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to customers on alternative investments and general economic conditions. If Pinnacle’s deposit levels fall, Pinnacle could lose a relatively low-cost source of funding and its interest expense would likely increase as it obtains alternative funding to replace lost deposits.

Another primary source of funds to Pinnacle is loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including, but not limited to, changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, availability of, and/or access to, sources of refinancing, business closings or lay-offs, inclement weather, natural disasters and international instability.

Pinnacle may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include Federal Home Loan Bank of Atlanta advances, sales of securities and loans, federal funds lines of credit from correspondent banks and borrowings from the Federal Reserve Discount Window, as well as additional out-of-market time deposits and brokered deposits. While Pinnacle believes that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands. Pinnacle may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should such sources not be adequate.

Pinnacle may not be able to successfully manage its long-term growth, which may adversely affect its results of operations and financial condition.

A key aspect of Pinnacle’s long-term business strategy is its continued growth and expansion. Pinnacle’s ability to continue to grow depends, in part, upon its ability to (i) open new branch offices or acquire existing branches or other financial institutions, (ii) attract deposits to its current and future branch locations, and (iii) identify attractive loan and investment opportunities.

Pinnacle may not be able to successfully implement its growth strategy if it is unable to identify attractive markets, locations or opportunities to expand in the future, or if Pinnacle is subject to regulatory restrictions on growth or expansion of its operations. Pinnacle’s ability to manage its growth successfully also will depend on whether it can maintain capital levels adequate to support its growth, maintain cost controls and asset quality and successfully integrate any businesses Pinnacle acquires into its organization. As Pinnacle identifies opportunities to implement its growth strategy, it may incur increased personnel, occupancy and other operating expenses. In the case of new branches, Pinnacle must absorb those higher expenses while it begins to generate new deposits, and there is a further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding assets.

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Pinnacle’s success depends on its management team, and the unexpected loss of any of these personnel could adversely affect operations.

Pinnacle’s success is, and is expected to remain, highly dependent on its management team. This is particularly true because, as a community bank, Pinnacle depends on the management team’s ties to the community and customer relationships to generate business. Pinnacle’s growth will continue to place significant demands on management, and the loss of any such person’s services may have an adverse effect upon growth and profitability. If Pinnacle fails to retain or continue to recruit qualified employees, growth and profitability could be adversely affected.

The success of Pinnacle’s strategy depends on its ability to identify and retain individuals with experience and relationships in its markets.

In order to be successful, Pinnacle must identify and retain experienced key management members and sales staff with local expertise and relationships. Competition for qualified personnel is intense and there is a limited number of qualified persons with knowledge of and experience in the community banking industry in Pinnacle’s geographic markets. Even if Pinnacle identifies individuals that it believes could assist it in building its franchise, it may be unable to recruit these individuals away from their current employers. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out Pinnacle’s strategy is often lengthy. Pinnacle’s inability to identify, recruit and retain talented personnel could limit its growth and could materially adversely affect its business, financial condition and results of operations.

Pinnacle’s risk-management framework may not be effective in mitigating risk and loss.

Pinnacle maintains an enterprise risk management program that is designed to identify, assess, mitigate, monitor, and report the risks that it faces. These risks include: interest-rate, credit, liquidity, operational, reputation, compliance, and legal. While Pinnacle assesses and improves this program on an ongoing basis, there can be no assurance that its approach and framework for risk management and related controls will effectively mitigate all risk and limit losses in its business. If conditions or circumstances arise that expose flaws or gaps in Pinnacle’s risk-management program, or if Pinnacle’s controls break down, Pinnacle’s results of operations and financial condition may be adversely affected.

Pinnacle is subject to a variety of operational, technological and organizational risks.

Similar to other financial institutions, Pinnacle is exposed to many types of operational and technological risk, including reputation, legal, and compliance risk. Pinnacle’s ability to grow and compete is dependent on its ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure while it expands and integrates acquired businesses. Operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, fraud by employees or persons outside of Pinnacle, and exposure to external events. Pinnacle is dependent on its operational infrastructure to help manage these risks. From time to time, Pinnacle may need to change or upgrade its technology infrastructure and it may experience disruption, and it may face additional exposure to these risks during the course of making such changes. As Pinnacle acquires other financial institutions, it faces additional challenges when integrating different operational platforms. Such integration efforts may be more disruptive to Pinnacle’s business and/or more costly or time-intensive than anticipated.

Consumers may increasingly decide not to use banks to complete their financial transactions, which could have a material adverse impact on Pinnacle’s financial condition and operations.

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on Pinnacle’s financial condition and results of operations.

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Pinnacle depends on the accuracy and completeness of information about clients and counterparties and Pinnacle’s financial condition could be adversely affected if it relies on misleading or incorrect information.

In deciding whether to extend credit or to enter into other transactions with clients and counterparties, Pinnacle may rely on information furnished to it by or on behalf of clients and counterparties, including financial statements and other financial information, which it does not independently verify. Pinnacle also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, Pinnacle may assume that a client’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of that client. Pinnacle’s financial condition and results of operations could be negatively impacted to the extent it relies on financial statements that do not comply with GAAP or are materially misleading.

The soundness of other financial institutions could adversely affect Pinnacle.

Pinnacle’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. Pinnacle has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by Pinnacle or by other institutions. Many of these transactions expose Pinnacle to credit risk in the event of default of its counterparty or client. In addition, credit risk may be exacerbated when the collateral held cannot be realized upon or is liquidated at prices insufficient to recover the full amount of the financial instrument exposure due. There is no assurance that any such losses would not materially and adversely affect results of operations.

Pinnacle may be adversely impacted by changes in market conditions.

Pinnacle is directly and indirectly affected by changes in market conditions. Market risk generally represents the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions. As a financial institution, market risk is inherent in the financial instruments associated with Pinnacle’s operations and activities, including loans, deposits, securities, short-term borrowings, long-term debt and trading account assets and liabilities. A few of the market conditions that may shift from time to time, thereby exposing Pinnacle to market risk, include fluctuations in interest rates, equity and futures prices, and price deterioration or changes in value due to changes in market perception or actual credit quality of issuers. Pinnacle’s investment securities portfolio, in particular, may be impacted by market conditions beyond its control, including rating agency downgrades of the securities, defaults of the issuers of the securities, lack of market pricing of the securities, and inactivity or instability in the credit markets. Any changes in these conditions, in current accounting principles or interpretations of these principles could impact Pinnacle’s assessment of fair value and thus the determination of other-than-temporary impairment of the securities in the investment securities portfolio, which could adversely affect Pinnacle’s earnings and capital ratios.

Risks Related to Regulation and Supervision of Pinnacle

Pinnacle operates in a highly regulated industry and the laws and regulations that govern Pinnacle’s operations, corporate governance, executive compensation and financial accounting, and reporting, including changes in them or Pinnacle’s failure to comply with them, may adversely affect Pinnacle.

Pinnacle is subject to extensive regulation and supervision that govern almost all aspects of its operations. These laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on Pinnacle’s business activities, limit the dividends or distributions that it can pay, restrict the ability of institutions to guarantee its debt and impose certain specific accounting requirements that may be more restrictive and may result in greater or earlier charges to earnings or reductions in its capital than GAAP. Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional compliance costs.

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Pinnacle is facing increased regulation and supervision of its industry as a result of the financial crisis in the banking and financial markets. The Dodd-Frank Act instituted major changes to the banking and financial institutions regulatory regimes. Other changes to statutes, regulations or regulatory policies or supervisory guidance, including changes in interpretation or implementation of statutes, regulations, policies or supervisory guidance, could affect Pinnacle in substantial and unpredictable ways. Such additional regulation and supervision has increased, and may continue to increase, Pinnacle’s costs and limit its ability to pursue business opportunities. Further, Pinnacle’s failure to comply with these laws and regulations, even if the failure was inadvertent or reflects a difference in interpretation, could subject it to restrictions on its business activities, fines and other penalties, any of which could adversely affect Pinnacle’s results of operations, capital base and the price of its securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect Pinnacle’s business and financial condition.

Applicable regulatory capital standards, including the rules implementing the Basel III capital framework and certain provisions of the Dodd-Frank Act (the “Basel III Capital Rules”), may require Pinnacle and First National Bank to maintain higher levels of capital and liquid assets, which could adversely affect Pinnacle’s profitability and return on equity.

Pinnacle is subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital that Pinnacle and First National Bank must maintain. If Pinnacle or First National Bank fails to meet these minimum capital guidelines and/or other regulatory requirements, its financial condition would be materially and adversely affected. The Basel III Capital Rules require bank holding companies and their subsidiaries to maintain significantly more capital as a result of higher required capital levels and more demanding regulatory capital risk weightings and calculations. While Pinnacle is exempt from these capital requirements under the Federal Reserve’s Small Bank Holding Company Policy Statement (the “SBHC Policy Statement”), First National Bank is not exempt and must comply. First National Bank must also comply with the capital requirements set forth in the “prompt corrective action” regulations pursuant to Section 38 of the FDIA. Satisfying capital requirements may require Pinnacle or First National Bank to limit its banking operations, retain net income or reduce dividends to improve regulatory capital levels, which could negatively affect its business, financial condition and results of operations. The EGRRCPA, which became effective May 24, 2018, provides relief from certain of these requirements, but Pinnacle does not expect the EGRRCPA and the related regulations to materially reduce the impact of regulatory capital requirements on its business.

Regulations issued by the CFPB could adversely impact earnings due to, among other things, increased compliance costs or costs due to noncompliance.

The CFPB has broad rulemaking authority to administer and carry out the provisions of the Dodd-Frank Act with respect to financial institutions that offer covered financial products and services to consumers. The CFPB has also been directed to write rules identifying practices or acts that are unfair, deceptive or abusive in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. For example, the CFPB issued a final rule, effective January 10, 2014, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms, or to originate “qualified mortgages” that meet specific requirements with respect to terms, pricing and fees. The rule also contains additional disclosure requirements at mortgage loan origination and in monthly statements. The requirements under the CFPB’s regulations and policies could limit Pinnacle’s ability to make certain types of loans or loans to certain borrowers, or could make it more expensive and/or time consuming to make these loans, which could adversely impact Pinnacle’s profitability.

Pinnacle is subject to laws regarding the privacy, information security and protection of personal information and any violation of these laws or another incident involving personal, confidential or proprietary information of individuals could damage Pinnacle’s reputation and otherwise adversely affect its business.

Pinnacle’s business requires the collection and retention of large volumes of customer data, including personally identifiable information (“PII”) in various information systems that Pinnacle maintains and in those maintained by third party service providers. Pinnacle also maintains important internal company data such as PII about its employees and information relating to its operations. Pinnacle is subject to complex and evolving laws and regulations governing the privacy and protection of PII of individuals (including customers, employees and other third-parties). For example, Pinnacle’s business is subject to the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) and related regulations and regulatory guidance, which, among other things: (i) impose certain limitations on Pinnacle’s ability to share nonpublic PII about its customers with nonaffiliated third parties; (ii) require that Pinnacle provides certain disclosures to customers about its information collection, sharing and security practices and afford customers the

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right to “opt out” of any information sharing by it with nonaffiliated third parties (with certain exceptions); and (iii) require that Pinnacle develops, implements and maintains a written comprehensive information security program containing appropriate safeguards based on Pinnacle’s size and complexity, the nature and scope of its activities, and the sensitivity of customer information it processes, as well as plans for responding to data security breaches. Various federal and state banking regulators and states have also enacted data breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in the event of a security breach. Ensuring that Pinnacle’s collection, use, transfer and storage of PII complies with all applicable laws and regulations can increase Pinnacle’s costs.

Furthermore, Pinnacle may not be able to ensure that customers and other third parties have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidential or proprietary information of customers or others were to be mishandled or misused, Pinnacle could be exposed to litigation or regulatory sanctions under privacy and data protection laws and regulations. Concerns regarding the effectiveness of Pinnacle’s measures to safeguard PII, or even the perception that such measures are inadequate, could cause Pinnacle to lose customers or potential customers and thereby reduce its revenues. Any failure, or perceived failure, to comply with applicable privacy or data protection laws and regulations may subject Pinnacle to inquiries, examinations and investigations that could result in requirements to modify or cease certain operations or practices or in significant liabilities, fines or penalties, and could damage Pinnacle’s reputation and otherwise adversely affect its operations, financial condition and results of operations.

The federal banking agencies have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards. The federal banking agencies expect financial institutions to establish lines of defense and ensure that their risk management processes also address the risk posed by compromised customer credentials, and also expect financial institutions to maintain sufficient business continuity planning processes to ensure rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack. If Pinnacle or First National Bank fails to meet the expectations set forth in this regulatory guidance, Pinnacle or First National Bank could be subject to various regulatory actions and any remediation efforts may require significant resources.

Pinnacle’s earnings are significantly affected by the fiscal and monetary policies of the U.S. federal government and its agencies.

The policies of the Federal Reserve affect Pinnacle significantly. The Federal Reserve regulates the supply of money and credit in the United States and its policies determine in large part Pinnacle’s cost of funds for lending, investing and capital raising activities and the return it earns on those loans and investments, both of which affect Pinnacle’s net interest margin. The actions of the Federal Reserve also can materially affect the value of financial instruments that Pinnacle holds, such as loans and debt securities, and also can affect Pinnacle’s borrowers, potentially increasing the risk that they may fail to repay their loans. Pinnacle’s business and earnings also are affected by the fiscal or other policies that are adopted by various regulatory authorities of the United States. Changes in fiscal or monetary policy are beyond Pinnacle’s control and hard to predict.

Risks Related to Pinnacle’s Common Stock

Pinnacle is not obligated to pay dividends and its ability to pay dividends is limited.

Pinnacle’s ability to make dividend payments on its common stock depends primarily on certain regulatory considerations and the receipt of dividends and other distributions from First National Bank. There are various regulatory restrictions on the ability of banks, such as First National Bank, to pay dividends or make other payments to their holding companies. Pinnacle is currently paying a quarterly cash dividend to holders of its common stock at a rate of $0.14 per share. Although Pinnacle has historically paid a cash dividend to the holders of its common stock, holders of its common stock are not entitled to receive dividends, and Pinnacle is not obligated to pay dividends in any particular amounts or at any particular times. Regulatory, economic and other factors may cause the Pinnacle board of directors to consider, among other things, reducing dividends paid on its common stock.  

Pinnacle relies on dividends from First National Bank for substantially all of its revenue.

Pinnacle is a bank holding company that conducts substantially all of its operations through First National Bank. As a result, Pinnacle relies on dividends from First National Bank for substantially all of its revenues. In the event First National Bank is unable to pay dividends to Pinnacle, including pursuant to regulatory restrictions on the ability of First National Bank to pay dividends or make other payments to Pinnacle, Pinnacle may not be able to service debt, pay obligations, or pay a cash dividend to the holders of Pinnacle common stock and Pinnacle’s business, financial condition and results of operations may be materially adversely affected.

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Pinnacle common stock currently has a limited trading market and is thinly traded which may limit the ability of shareholders to sell their shares and may increase price volatility.

Pinnacle common stock is quoted on the OTC Markets Group’s OTCQX marketplace under the symbol “PPBN.” Pinnacle common stock is thinly traded and has substantially less liquidity than the common stocks of many other bank holding companies. There can be no assurance that an active trading market for shares of Pinnacle common stock will develop or, if one develops, that it can be sustained. The development of a liquid public market depends on the existence of willing buyers and sellers, the presence of which is not within Pinnacle’s control. Therefore, Pinnacle’s shareholders may not be able to sell their shares at the volume, prices, or times that they desire. Shareholders should be financially prepared and able to hold their shares of Pinnacle common stock for an indefinite period.

In addition, thinly traded stocks can be more volatile than more widely traded stocks. The price of Pinnacle common stock has been volatile in the past and several factors could cause the price to fluctuate substantially in the future. These factors include, but are not limited to, developments related to Pinnacle’s business and operations, stock performance of other companies deemed to be peers, news reports of trends, concerns, irrational exuberance on the part of investors, and other issues related to the financial services industry. The value of publicly traded stocks in the financial services sector can be volatile generally, including due to declining or sustained weak economic conditions and other external factors. The price of Pinnacle common stock may fluctuate significantly in the future, and these fluctuations may be unrelated to its performance. General market declines or market volatility in the future, especially in the financial institutions sector, could adversely affect the price of Pinnacle common stock and the current market price may not be indicative of future market prices.

General Risk Factors

Failure to maintain effective systems of internal control and disclosure controls could have a material adverse effect on Pinnacle’s results of operation and financial condition.

Effective internal and disclosure controls are necessary for Pinnacle to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. First National Bank is already required to establish and maintain an adequate internal control structure over financial reporting pursuant to FDIC regulations.  If Pinnacle cannot provide reliable financial reports or prevent fraud, its reputation and operating results would be harmed. As part of Pinnacle’s ongoing monitoring of its controls, it may discover material weaknesses or significant deficiencies that require remediation.

Pinnacle’s inability to maintain the operating effectiveness of the controls described above could result in a material misstatement of Pinnacle’s financial statements or other disclosures, which could have an adverse effect on its business, financial condition or results of operations. In addition, any failure to maintain effective controls in accordance with Section 404 of the Sarbanes-Oxley Act and FDIC regulations or to timely effect any necessary improvement of Pinnacle’s internal and disclosure controls could, among other things, result in losses from fraud or error, harm Pinnacle’s reputation or cause investors to lose confidence in its reported financial information, all of which could have a material adverse effect on its results of operation and financial condition.

Pinnacle may need to raise additional capital in the future and may not be able to do so on acceptable terms, or at all.

Access to sufficient capital is critical in order to enable Pinnacle to implement its business plan, support its business, expand its operations and meet applicable capital requirements. The inability to have sufficient capital, whether internally generated through earnings or raised in the capital markets, could adversely impact Pinnacle’s ability to support and to grow its operations. If Pinnacle grows its operations faster than it generates capital internally, or if Pinnacle’s existing capital is impaired for any reason, it will need to access the capital markets. Pinnacle may not be able to raise additional capital in the form of additional debt or equity on acceptable terms, or at all. Pinnacle’s ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, Pinnacle’s financial condition and its results of operations. Economic conditions and a loss of confidence in financial institutions may increase Pinnacle’s cost of capital and limit access to some sources of capital. Further, if Pinnacle needs to raise capital in the future, it may have to do so when many other financial institutions are also seeking to raise capital and would then have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse impact on Pinnacle’s business, financial condition and results of operations.

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Changes in accounting standards and management’s selection of accounting methods, including assumptions and estimates, could materially affect Pinnacle’s financial statements.

From time to time, the SEC and the FASB change the financial accounting and reporting standards that govern the preparation of a public bank holding company’s financial statements. These changes can be hard to predict and can materially affect how Pinnacle records and reports its financial condition and results of operations. In some cases, Pinnacle could be required to apply a new or revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained earnings. In addition, management is required to use certain assumptions and estimates in preparing Pinnacle’s financial statements, including determining the fair value of assets and liabilities, among other items. If the assumptions or estimates are incorrect, Pinnacle may experience unexpected material consequences.

Negative perception of Pinnacle or First National Bank through social media may adversely affect their reputation and business.

Pinnacle’s and First National Bank’s reputations are critical to the success of their businesses. Pinnacle believes that its brand image and the brand image of First National Bank have been well received by customers, reflecting the fact that the brand images, like Pinnacle’s and First National Bank’s businesses, are based in part on trust and confidence. Pinnacle’s and First National Bank’s reputation and brand image could be negatively affected by rapid and widespread distribution of publicity through social media channels. Pinnacle’s and First National Bank’s reputation could also be affected by Pinnacle’s association with clients affected negatively through social media distribution, or other third parties, or by circumstances outside of Pinnacle’s control. Negative publicity, whether true or untrue, could affect Pinnacle’s and First National Bank’s ability to attract or retain customers, or cause Pinnacle and First National Bank to incur additional liabilities or costs, or result in additional regulatory scrutiny.

Future issuances of Pinnacle common stock could adversely affect the market price of Pinnacle common stock and could be dilutive.

The Pinnacle board of directors, without the approval of shareholders, could from time to time decide to issue additional shares of Pinnacle common stock or shares of preferred stock, which may adversely affect the market price of the shares of Pinnacle common stock and could be dilutive to Pinnacle shareholders. In addition, new investors may have rights, preferences and privileges that are senior to, and that could adversely affect, Pinnacle’s existing shareholders. For example, preferred stock would be senior to common stock in right of dividends and as to distributions in liquidation. Because Pinnacle’s decision to issue common stock or preferred stock in the future will depend on market conditions and other factors, Pinnacle cannot predict or estimate the amount, timing, or nature of its future offerings of equity securities. Thus, Pinnacle shareholders bear the risk of future offerings diluting their stock holdings, adversely affecting their rights as shareholders, and/or reducing the market price of Pinnacle common stock.

Common stock is equity and Pinnacle common stock is subordinate to any indebtedness or preferred stock of Pinnacle and effectively subordinated to all the indebtedness and other non-common equity claims against First National Bank.

Shares of the Pinnacle common stock are equity interests and do not constitute indebtedness. As such, shares of Pinnacle common stock will rank junior to all of Pinnacle’s indebtedness and to other non-equity claims against Pinnacle and its assets available to satisfy claims against it, including in the event of Pinnacle’s liquidation. Additionally, holders of Pinnacle common stock are subject to prior dividend and liquidation rights of holders of outstanding preferred stock, if any. Pinnacle’s board of directors is authorized to issue classes or series of preferred stock without any action on the part of the holders of Pinnacle common stock, and Pinnacle is permitted to incur additional debt. Upon liquidation, lenders and holders of Pinnacle’s debt securities and preferred stock would receive distributions of Pinnacle’s available assets prior to holders of Pinnacle common stock. Furthermore, Pinnacle’s right to participate in a distribution of assets upon First National Bank’s liquidation or reorganization is subject to the prior claims of First National Bank’s creditors.

Item 1B.Unresolved Staff Comments

Not applicable.

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Item 2.Properties

Current Locations and Property

As of March 30, 2021, Pinnacle, through its subsidiaries, owned or leased the following buildings and office space:

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All of the foregoing properties are used by Pinnacle in the normal course of its business. Pinnacle believes all of these properties are in good operating condition and are adequate for Pinnacle’s present and anticipated future needs. Pinnacle maintains comprehensive general liability and casualty loss insurance covering its properties and activities conducted in or about its properties. Pinnacle believes this insurance provides adequate protection for liabilities or losses that might arise out of the ownership and use of such properties.

Item 3.Legal Proceedings

In the ordinary course of its operations, Pinnacle and its subsidiaries are parties from time to time to various legal proceedings. Based on the information presently available, and after consultation with legal counsel, management believes that there are no pending or threatened legal proceedings against Pinnacle that, if determined adversely, would, in the aggregate, have a material adverse effect on the business, the financial condition or the results of operations of Pinnacle.

Item 4.Mine Safety Disclosures

Not applicable.

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PART II

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

Market Prices and Dividends

Common Stock of Pinnacle is traded on the OTCQX under the symbol “PPBN.” As of March 30, 2021, there were approximately 2,158,379 shares of Common Stock outstanding, which shares are held by approximately 532 active shareholders of record.

Substantially all of Pinnacle’s retained earnings consist of undistributed earnings of its subsidiary Bank, which are restricted by various regulations administered by federal banking regulatory agencies. Under applicable federal laws, the Comptroller of the Currency restricts, without prior approval, the total dividend payments of First National Bank in any calendar year to the net profits of that year, as defined, combined with the retained net profits for the two preceding years.

Pinnacle and First National Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Pinnacle’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Pinnacle and First National Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off‑balance‑sheet items as calculated under regulatory accounting practices. Pinnacle and First National Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Item 6.Selected Financial Data

Not Applicable

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Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with Pinnacle’s consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties, assumptions and other factors that could cause actual results to differ materially from Pinnacle’s expectations expressed in or implied by such forward-looking statements. For additional information about such risks, uncertainties, assumptions and other factors, please refer to “Cautionary Statement Regarding Forward-Looking Statements” and “Risk Factors” included elsewhere in this Annual Report on Form 10-K.

Dollar amounts in the following discussion are in thousands, except ratios, share and per share data.

Information about the Effects of and Responses to COVID-19

The ongoing COVID-19 pandemic has and continues to impact Pinnacle and its customers, employees, communities and service providers, but the ultimate severity of the COVID-19 pandemic, its duration and the extent of its impact on First National Bank’s business, results of operations, financial condition, liquidity and prospects remains uncertain.

Pandemic Guidelines and Business Continuity.  In response to the COVID-19 pandemic, Pinnacle and First National Bank have placed an emphasis on delivering products and services through online and mobile banking, remote deposit capture, and digital communications with customers.

Pinnacle and First National Bank have implemented a set of pandemic guidelines to protect employees and promote business continuity while providing support to its customers and communities facing challenges due to the impacts of COVID-19. These guidelines include policies and procedures with respect to Phase 1, Phase 2 and Phase 3 responses to COVID-19 pandemic, additional cleaning and sanitation requirements, and branch-specific response plans for employees and customer service at First National Bank’s branch locations, including remote work and social distancing requirements. Pinnacle has purchased additional laptops, invested in additional technology and software, and purchased personal protective equipment for employee use. Pinnacle management meets regularly to review the pandemic guidelines, response priorities, guidance issued by health regulatory agencies, and protective measures and other actions being taken by Pinnacle and First National Bank.

Paycheck Protection Program (“PPP”).  As a further part of Pinnacle’s response to the COVID-19 pandemic, First National Bank has participated in the PPP established pursuant to the Coronavirus Aid, Relief, and Economic Security Act (also known as the “CARES Act”), as amended by the Consolidated Appropriations Act, 2021 (the “CAA”), and implemented by the U.S. Small Business Administration with support from the U.S. Department of the Treasury. First National Bank has provided over $42,000 of PPP loans to small businesses in its markets.

Acquisition of Virginia Bank Bankshares, Inc.

On October 30, 2020, Pinnacle completed its merger (the “Merger”) with Virginia Bank Bankshares, Inc. (or “Virginia Bank).  The Merger was effected pursuant to the terms and conditions of the Agreement and Plan of Reorganization between Pinnacle and Virginia Bank, effective January 21, 2020 and as amended on June 9, 2020, and the related plan of merger (collectively, the “Merger Agreement”).  Under the Merger Agreement, Virginia Bank shareholders had the opportunity to elect to receive either $16.00 of cash (the “Cash Consideration”) or 0.5400 shares of Pinnacle common stock (the “Stock Consideration”) for each share of Virginia Bank common stock held, subject to the limitation that 60% of the shares will be exchanged for the Stock Consideration and 40% of the shares will be exchanged for the Cash Consideration.  

For additional information about the Merger, see Note 2 to Pinnacle’s consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.  The above description of the Merger Agreement does not purport to be complete and is qualified in its entirety by reference to the Merger Agreement which is included as Exhibit 2.1 to this report and is incorporated by reference herein.

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Executive Summary

Year Ended December 31, 2020 and 2019.  Pinnacle generated net income of $3,062 for 2020 which represents a $1,334 or 30.35% decrease as compared to net income of $4,396 for 2019.  The decrease as compared to the prior year, which was mainly driven by higher noninterest expense.  The increase in noninterest expense was primarily due to $2,889 in expenses associated with Pinnacle’s merger with Virginia Bank, which closed on October 30, 2020, as well as higher salaries and employee benefits related to strategic growth initiatives to include the Bank’s Downtown Lynchburg Branch and its Charlottesville Loan Production Office.

Profitability as measured by Pinnacle’s return on average assets (“ROA”) was 0.52% for 2020, which is a 40 basis points decrease from the 0.92% produced in 2019.  Correspondingly, return on average equity (“ROE”) also decreased in 2020 to 6.99%, compared to 9.86% for the prior year.      

Total assets as of December 31, 2020 were $860,514, up 71.92% from $500,530 as of December 31, 2019.  The principal components of Pinnacle’s assets as of December 31, 2020 were $564,316 in total gross loans, $46,741 in securities and $210,814 in cash and cash equivalents. During 2020, total loans increased 43.40%, or $170,796 from $393,520 as of December 31, 2019, while securities increased 3.97% or $1,783 from $44,958. Consequently, cash and cash equivalents increased 540.71% or $177,911 from $32,903 as of December 31, 2019 due mainly to an influx of deposits, the liquidation of Virginia Bank’s securities portfolio, which is in the process of being reinvested, and additional liquidity resulting from the merger.   Loans increased primarily due to the addition of approximately $154,000 in loans purchased in the merger which included $13,503 in PPP loans.  Additionally, First National Bank originated $28,208 in PPP loans in 2020.  These increases in loans were partially offset by a few large payoffs of commercial loans and a lower volume of consumer and residential loan originations made in 2020.  

Total liabilities as of December 31, 2020 were $802,184, up $345,071, or 76.27%, from $455,085 as of December 31, 2019.  Higher levels of deposits drove the increase in liabilities.  Approximately $211,000 of the deposit growth resulted from new accounts acquired through the merger with Virginia Bank.  Additional deposit growth was the result of federal government stimulus in response to the pandemic, an overall “flight to safety” by depositors and relationships that moved to the Bank as a result of branch closures in the Bank’s markets served by larger national financial institutions.

Total stockholders’ equity as of December 31, 2020 was $58,330 and consisted primarily of $44,509 in retained earnings.  In comparison, as of December 31, 2019, total stockholders’ equity was $45,445.  Both Pinnacle and First National Bank remain “well capitalized” per all regulatory definitions.

Overview of 2020

Total assets as of December 31, 2020 were $860,514, up 71.92% from $500,530 as of December 31, 2019. The principal components of Pinnacle’s assets at the end of 2020 were $210,814 in cash and cash equivalents, $46,741 in securities and $560,078 in net loans.  During 2020, net loans increased 43.67% or $170,230.  Pinnacle’s lending activities are a principal source of income. Loans increased primarily due to the addition of approximately $154,000 in loans purchased in the merger, which included $13,503 in PPP loans.  Additionally, First National Bank originated $28,208 in PPP loans in 2020.  These increases in loans were partially offset by a few large payoffs of commercial loans and a lower volume of consumer and residential loan originations made in 2020.  

Total liabilities as of December 31, 2020 were $802,184, up 76.27% from $455,085 as of December 31, 2019, primarily due to higher levels of deposits.  Total deposits increased $331,053, or 73.52%, to $781,336 as of December 31, 2020 from $450,283 at December 31, 2019.  Approximately $211,000 of the deposit growth resulted from new accounts acquired through the merger with Virginia Bank.  Noninterest-bearing demand deposits increased $139,608, or 126.43%, and represented 32.03% of total deposits as of December 31, 2020, compared to 24.52% as of December 31, 2019. Savings and NOW accounts increased $166,307, or 67.90%, and represented 52.63% of total deposits as of December 31, 2020, compared to 54.40% as of December 31, 2019.  Time deposits increased $25,138 or 26.48% and represented 15.37% of total deposits as of December 31, 2020, compared to 21.08% as of December 31, 2019.  Pinnacle had no brokered deposits as of December 31, 2020 and December 31, 2019.

Total stockholders’ equity as of December 31, 2020 was $58,330, including $44,509 in retained earnings. At December 31, 2019, stockholders’ equity totaled $45,445, including $42,404 in retained earnings.  The increase in stockholders’ equity resulted largely from $11,447 in in common stock issued in conjunctions with the merger with Virginia Bank and by net income of $3,062 less dividends paid to shareholders of $957.  Dividends paid to shareholders were $0.56 per share paid in 2020 as compared to $0.545 per share paid in 2019.

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Pinnacle had net income of $3,062 in 2020, compared to net income of $4,396 in 2019, a decrease of 30.35%, which was mainly driven by higher noninterest expense. The increase in noninterest expense was primarily due to $2,889 in expenses associated with Pinnacle’s merger with Virginia Bank as well as higher salaries and employee benefits related to strategic growth initiatives to include the Bank’s Downtown Lynchburg Branch and its Charlottesville Loan Production Office.  The increase in noninterest expense was partially offset by an increase in noninterest income which was primarily due to a $2,694 bargain purchase gain related to the merger with Virginia Bank.

For the year ended December 31, 2020, Pinnacle produced $18,269 in net interest income, which represents a $593, or 3.35%, increase as compared to the $17,676 generated in 2019.  Interest income increased $549, or 2.71%, due to higher loan volume in the fourth quarter of 2020 as a result of the merger with Virginia Bank, while interest expense decreased $43,000, or 1.68%, due mainly to a decrease in the cost of deposits caused by lower interest rates.  

Pinnacle’s provision for loan losses was $252 for 2020 representing an $89, or 54.60%, increase as compared to $163 for 2019.  Pinnacle’s provision for loan losses for 2020 included the impact of qualitative adjustments to Pinnacle’s allowance for loan losses required due to the COVID-19 pandemic.  

Noninterest income increased $4,049, or 87.58%, in 2020 to $8,672 from $4,623 in 2019. This improvement was mainly driven by the $2,694 bargain purchase gain related to the merger with Virginia Bank recorded in the fourth quarter of 2020 and a $386 increase in fees generated from sales of mortgage loans.  Revenue from Bank Owned Life Insurance (BOLI) increased $253 in 2020.  Pinnacle also experienced a $249 increase in loan fees primarily associated with the origination of $28,208 in PPP loans.  Other increases in net income included a $148 increase in debit card interchange income, a $90 increase in income derived from the Bank’s investment in Bankers Insurance, LLC, and a $90 increase in commissions on sales of investments and insurance.  

Noninterest expense increased $5,741, or 34.23%, in 2020 to $22,513 from $16,772 in 2019.  The increase is primarily attributed to $2,889 in merger expenses primarily consisting of legal, accounting, investment banking and contract termination fees.  Pinnacle also experienced a $1,167 increase in salaries and benefits and a $496,000 increase in furniture, equipment and occupancy expenses due to growth of Pinnacle during 2020.

Profitability as measured by Pinnacle’s return on average assets (“ROA”) was 0.52% in 2020, which is a 40 basis points decrease from the 0.92% produced in 2019.  Correspondingly, return on average equity (“ROE”) also decreased in 2020 to 6.36%, compared to 9.86% for the prior year.      

Results of Operations, 2020

Net Interest Income.  Net interest income represents the principal source of earnings for Pinnacle.  Net interest income is the amount by which interest and fees generated from loans, securities and other interest-bearing assets exceed the interest expense associated with funding those assets.  Changes in the amounts and mix of interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income.  Changes in the interest rate environment and Pinnacle’s cost of funds also effect net interest income.

The net interest spread decreased to 3.15% in 2020 from 3.82% in 2019. Net interest income was $18,269 in 2020, compared to $17,676 in 2019.  In 2020, Pinnacle’s asset yields decreased greater than its deposit rates causing Pinnacle’s interest rate spread to decrease.  Pinnacle’s yield on interest‑earning assets in 2020 was 78 basis points lower than in 2019 due to higher yielding assets being replaced by lower yielding assets in the second half of 2019 and in 2020 and repricing of existing assets in the lower interest rate environment.  Pinnacle’s cost of funds rate on interest-bearing liabilities in 2020 was 11 basis points lower compared to 2019.  

Pinnacle’s net interest margin also decreased to 3.34% in 2020 from 4.00% in 2019.  Pinnacle’s lower net interest margin in 2020 was due to lower yields from new loans and investments as a result of a lower interest rate environment in the second half of 2019 and in 2020.  Pinnacle attempts to conserve net interest margin by product pricing strategies, such as attracting deposits with longer maturities when rates are relatively low and attracting deposits with shorter maturities when rates are relatively high, all depending on our funding needs.  While there is no guarantee of how rates may change in 2021, Pinnacle will price products that are competitive in the market, allow for growth and strive to maintain the net interest margin as much as possible.  Pinnacle also continues to seek new sources of noninterest income to combat the effects of volatility in the interest rate environment.

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The following table presents the major categories of interest-earning assets, interest-bearing liabilities and stockholders’ equity with corresponding average balances, related interest income or interest expense and resulting yield and rates for the periods indicated.

ANALYSIS OF NET INTEREST INCOME

As discussed above, Pinnacle’s net interest income is affected by the change in the amounts and mix of interest-earning assets and interest-bearing liabilities, referred to as “volume change,” as well as by changes in yields earned on interest-earning assets and rates paid on deposits and other borrowed funds, referred to as “rate change.” The following table presents, for the periods indicated, a summary of changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities and the amounts of change attributable to variations in volumes and rates. Changes attributable to both volume and rate have been allocated proportionately.

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RATE/VOLUME ANALYSIS

Provision for Loan Losses. The provision for loan losses is based upon Pinnacle’s evaluation of the quality of the loan portfolio, total outstanding and committed loans, Pinnacle’s previous loan loss experience and current and anticipated economic conditions. The amount of the provision for loan losses is a charge against earnings. Actual loan losses are charges against the allowance for loan losses.

Pinnacle’s allowance for loan losses is maintained at a level deemed by management to be adequate to provide for known and inherent losses in the loan portfolio. No assurance can be given that unforeseen adverse economic conditions or other circumstances will not result in increased provisions in the future, or that the allowance for loan losses will be adequate for actual losses. Additionally, regulatory examiners may require Pinnacle to recognize additions to the allowance based upon their judgment about information available to them at the time of their examinations.

The provisions for loan losses for year ended December 31, 2020 and 2019 were $252 and $163, respectively.  The provision for loan losses increased $89 during 2020 when compared to 2019 due to a change in qualitative factors adjusted for the COVID-19 Pandemic and deferred loans as the economy deteriorated in 2020.  Pinnacle saw a decrease in its nonperforming loans to total loans from 0.29% on December 31, 2019 to 0.17% on December 31, 2020.  Nonperforming loans were $1,135 as of December 31, 2019 and $950 as of December 31, 2020.  Pinnacle expects credit quality in its loan portfolio to moderately decrease in 2021 due to the ongoing Pandemic and continues to work to minimize its losses from nonaccrual and past due loans.  See “Allowance for Loan Losses” for further discussion.

Noninterest Income.  Total noninterest income for 2020 increased $4,049, or 87.58%, to $8,672 from $4,623 in 2019. This improvement was mainly driven by the $2,694 bargain purchase gain related to the merger and a $386 increase in fees generated from sales of mortgage loans. Revenue from Bank Owned Life Insurance (BOLI) increased $253 in 2020.  Pinnacle also experienced a $249 increase in loan fees primarily associated with the origination of $28,208 in PPP loans.  Other increases in net income included a $148 increase in debit card interchange income, a $90 increase in income derived from the Bank’s investment in Bankers Insurance, LLC, and a $90 increase in commissions on sales of investments and insurance

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Noninterest Expense.  Total noninterest expense for 2020 increased $5,741, or 34.23%, to $22,513 from $16,772 in 2019.  The increase is primarily attributed to $2,889 in merger expenses primarily consisting of legal, accounting, investment banking and contract termination fees.  Pinnacle also experienced a $1,167 increase in salaries and benefits and a $496,000 increase in furniture, equipment and occupancy expenses due to growth of Pinnacle during 2020.

Income Tax Expense. Income taxes on 2020 earnings amounted to $1,114, resulting in an effective tax rate of 26.67%, compared to $968, and an effective tax rate of 18.05% in 2019. The income tax rate increased in 2020 due mainly to capitalized merger transaction costs from the merger with Virginia Bank.

Liquidity. Effective asset/liability management includes maintaining adequate liquidity and minimizing the impact of future interest rate changes on net interest income. The responsibility for monitoring Pinnacle’s liquidity and the sensitivity of its interest-earning assets and interest-bearing liabilities lies with the Investment Committee of First National Bank, which meets at least quarterly to review liquidity and the adequacy of funding sources.

Liquidity measures the ability of Pinnacle to meet its maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund its operations, and to provide for customers’ credit needs. Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds from alternative funding sources.  Pinnacle’s liquidity is provided by cash and due from banks, federal funds sold, investments available-for-sale, managing investment maturities, interest-earning deposits in other financial institutions and loan repayments.

Pinnacle’s ratio of liquid assets to deposits and short‑term borrowings was 34.12% as of December 31, 2020 as compared to 15.77% as of December 31, 2019. Pinnacle sells excess funds as overnight federal funds sold to provide an immediate source of liquidity. Federal funds sold at December 31, 2020 were $479 as most funds were kept in Pinnacle’s Federal Reserve account, which is interest-bearing. Cash and due from banks of $210,814, which includes funds in Pinnacle’s Federal Reserve account, as of December 31, 2020 was $177,911 higher when compared to December 31, 2019. Pinnacle expects to deploy some of this cash into securities and loans in 2021.  

The level of deposits may fluctuate significantly due to seasonal business cycles of depository customers.  Levels of deposits are also affected by convenience of branch locations and ATMs to the customer, the rates offered on interest-bearing deposits and the attractiveness of noninterest-bearing deposit offerings compared with the competition. Some main factors that have increased Pinnacle’s 2020 deposit levels include PPP loan proceeds, government stimulus checks and our customers’ “flight to safety” strategy during the ongoing pandemic.  Similarly, the level of demand for loans may vary significantly and at any given time may increase or decrease substantially. However, unlike the level of deposits, management has more direct control over lending activities and maintains the level of those activities according to the amounts of available funds.  Loan demand may be affected by the overall health of the local economy, loan rates compared with the competition and other loan features offered by Pinnacle.

As a result of Pinnacle’s management of liquid assets and its ability to generate liquidity through alternative funding sources, management believes that Pinnacle maintains overall liquidity that is sufficient to satisfy its depositors’ requirements and to meet customers’ credit needs. Additional sources of liquidity available to Pinnacle include its capacity to borrow funds through correspondent banks and the Federal Home Loan Bank.  The total amount available for borrowing to Pinnacle for liquidity purposes was $143,080 on December 31, 2020 and $135,622 on December 31, 2019.  

Pinnacle obtains sources of funds through growth in deposits, scheduled payments and prepayments from the loan and investment portfolios and retained earnings growth, and may purchase or borrow funds from the Federal Home Loan Bank or through the Federal Reserve’s discount window.  Pinnacle also has sources of liquidity through two correspondent banking relationships.  Pinnacle uses its funds to fund loan and investment growth.  Excess funds are sold daily to other institutions.  Pinnacle also has a $5,000 holding company line of credit with a correspondent bank for bank capital purposes with no outstanding balance as of December 31, 2020 and December 31, 2019.

Pinnacle completed a private placement of $8,000 in fixed-to-floating rate subordinated notes due 2030 (the “Notes”) in the third quarter of 2020. The Notes have been structured to qualify as Tier 2 capital under bank regulatory guidelines in the future, and the proceeds from the sale of the Notes were utilized to pay a portion of the cash consideration paid by Pinnacle in connection with its merger with Virginia Bank on October 30, 2020, and to provide optionality for various growth opportunities and for general corporate purposes. The Notes bear interest at 5.25% per annum, beginning September 18, 2020 to, but excluding September 30, 2025, payable quarterly in arrears. From September 30, 2025 to, but excluding, September 30, 2030, or up to an early redemption date, the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month Secured Overnight Financing Rate (“SOFR”) plus 513 basis points, payable quarterly in arrears. Beginning on September 30, 2025 through maturity, the Notes may be redeemed, at Pinnacle’s option and subject to any required regulatory approval, on any scheduled interest payment date. The Notes will mature on September 30, 2030.

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Pinnacle also completed a $2,000 fixed-to-floating rate promissory note due 2030 (the “Promissory Note”) in the fourth quarter of 2020. The Promissory Note bears interest at 5.25% per annum, beginning December 18, 2020 to, but excluding December 31, 2025, payable quarterly in arrears. From December 31, 2025 to, but excluding December 31, 2030, or up to an early redemption date, the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month Secured Overnight Financing Rate (“SOFR”) plus 515 basis points, payable quarterly in arrears. The Promissory Note will mature on December 31, 2030.

Interest Rates

While no single measure can completely identify the impact of changes in interest rates on net interest income, one gauge of interest rate sensitivity is to measure, over a variety of time periods, the differences in the amounts of Pinnacle’s rate-sensitive assets and rate-sensitive liabilities. These differences or “gaps” provide an indication of the extent to which net interest income may be affected by future changes in interest rates. A “positive gap” exists when rate-sensitive assets exceed rate-sensitive liabilities and indicates that a greater volume of assets than liabilities will reprice during a given period. This mismatch may enhance earnings in a rising interest rate environment and may inhibit earnings in a declining interest rate environment. Conversely, when rate-sensitive liabilities exceed rate-sensitive assets, referred to as a “negative gap,” it indicates that a greater volume of liabilities than assets will reprice during the period. In this case, a rising interest rate environment may inhibit earnings and a declining interest rate environment may enhance earnings.

The cumulative three-year gap as of December 31, 2020 was $143,963, representing 16.72% of total assets, which was within First National Bank’s interest rate risk parameters.  

The following table illustrates Pinnacle’s interest rate sensitivity gap position at December 31, 2020.

REPRICING GAP POSITION

As of December 31, 2020, Pinnacle was asset-sensitive in all periods up to 15 years.  The foregoing table does not necessarily indicate the impact of general interest rate movements on Pinnacle’s net interest yield, because the repricing of various categories of assets and liabilities is discretionary and is subject to competition and other pressures. As a result, various assets and liabilities indicated as repricing within the same period may reprice at different times and at different rate levels. Management attempts to mitigate the impact of changing interest rates in several ways, one of which is to manage its interest rate-sensitivity gap. In addition to managing its asset/liability position, Pinnacle has taken steps to mitigate the impact of changing interest rates by generating noninterest income through service charges, and offering products that are not interest rate‑sensitive.

Effects of Inflation

The effect of changing prices on financial institutions is typically different from other industries as Pinnacle’s assets and liabilities are monetary in nature. Interest rates are significantly impacted by inflation, but neither the timing nor the magnitude of the changes is directly related to price level indices. Impacts of inflation on interest rates, loan demand and deposits are not reflected in the consolidated financial statements.

Investment Portfolio

Pinnacle’s investment portfolio is used primarily for investment income and secondarily for liquidity purposes. Pinnacle invests funds not used for capital expenditures or lending purposes in securities of the U.S. Government and its agencies, mortgage-backed securities, taxable and tax-exempt municipal bonds, and certificates of deposit. Obligations of the U.S. Government and its agencies include treasury notes and callable or noncallable agency bonds. The mortgage-backed securities include mortgage-backed security pools that are diverse as to interest rates. Pinnacle has not invested in derivatives.

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Investment securities as of December 31, 2020 totaled $46,741, an increase of $1,783, or 3.97%, from $44,958 as of December 31, 2019. Held-to-maturity investment securities decreased to $500 as of December 31, 2020 from $1,764 as of December 31, 2019, a decrease of $1,264, or 71.66%.  Available-for-sale investments increased to $46,241 as of December 31, 2020 from $43,194 as of December 31, 2019, an increase of $3,047, or 7.05%.

The following table presents the composition of Pinnacle’s investment portfolios as of the dates indicated.