UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, ~~2022~~2023

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

For the transition period from to

Commission File Number: 1-38874

(Exact name of registrant as specified in its charter)

Virginia	54-1232965
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

112 West King Street, Strasburg, Virginia	22657
(Address of principal executive offices)	(Zip Code)

(540) 465-9121

(Registrant’s telephone number, including area code)

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

Title of each class	Trading symbol(s)	Name of each exchange on which registered
Common stock, par value $1.25 per share	FXNC	The Nasdaq Stock Market LLC

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 (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

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

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
		Emerging growth company	☐

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of November ~~9, 2022, 6,262,381~~3, 2023, 6,260,934 shares of common stock, ppaarr value $1.25 per share, of the registrant were outstanding.

Table of Contents

TABLE OF CONTENTS

		Page
PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets as of September 30, ~~2022~~2023 (unaudited) and December 31, ~~2021~~2022	3

	Consolidated Statements of Income for the three and nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (unaudited)	4

	Consolidated Statements of Comprehensive Income (Loss) ~~Income~~ for the three and nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (unaudited)	6

	Consolidated Statements of Cash Flows for the nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (unaudited)	7

	Consolidated Statements of Changes in Shareholders’ Equity for the three and nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (unaudited)	9

	Notes to Consolidated Financial Statements (unaudited)	10

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	3031

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	4642

Item 4.	Controls and Procedures	4642

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	4743

Item 1A.	Risk Factors	4743

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	4743

Item 3.	Defaults Upon Senior Securities	4743

Item 4.	Mine Safety Disclosures	4743

Item 5.	Other Information	4743

Item 6.	Exhibits	4844

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

FIRST NATIONAL CORPORATION

Consolidated Balance Sheets

(in thousands, except share and per share data)

	(unaudited)					(unaudited)
	September 30,			December 31,		September 30,			December 31,
	2022			2021*		2023			2022*
Assets
Cash and due from banks	$	22,809		$	18,725	$	17,168		$	20,784
Interest-bearing deposits in banks		52,976			157,281		32,931			46,130
Securities available for sale, at fair value		176,403			289,495		148,175			162,907
Securities held to maturity, at amortized cost (fair value, 2022, $142,920; 2021, $33,617)		154,894			33,441
Securities held to maturity, at amortized cost (net of allowance for credit losses of $131 at September 30, 2023)							149,948			153,158
Restricted securities, at cost		1,908			1,813		2,077			1,908
Loans, net of allowance for loan losses, 2022, $6,292; 2021, $5,710		900,222			819,408
Loans, net of allowance for credit losses, 2023, $8,896; 2022, $7,446							943,603			913,077
Other real estate owned, net of valuation allowance		1,578			1,848		—			184
Premises and equipment, net		21,693			22,403		21,363			21,876
Accrued interest receivable		4,247			3,903		4,502			4,543
Bank owned life insurance		24,375			24,294		24,734			24,531
Goodwill		3,030			3,030		3,030			3,030
Core deposit intangibles, net		140			154		122			136
Other assets		19,320			13,642		18,567			17,119
Total assets	$	1,383,595		$	1,389,437	$	1,366,220		$	1,369,383

Liabilities and Shareholders’ Equity

Liabilities
Deposits:
Noninterest-bearing demand deposits	$	438,306		$	413,188	$	403,774		$	427,344
Savings and interest-bearing demand deposits		693,970			689,998		646,980			677,139
Time deposits		133,770			145,566		184,419			136,849
Total deposits	$	1,266,046		$	1,248,752	$	1,235,173		$	1,241,332
Subordinated debt, net of issuance cost		4,995			9,993		4,997			4,995
Junior subordinated debt		9,279			9,279		9,279			9,279
Accrued interest payable and other liabilities		4,198			4,374		4,792			5,417
Total liabilities	$	1,284,518		$	1,272,398	$	1,254,241		$	1,261,023

Commitments and contingencies

Shareholders’ Equity
Preferred stock, par value $1.25 per share; authorized 1,000,000 shares; none issued and outstanding	$	—		$	—	$	—		$	—
Common stock, par value $1.25 per share; authorized 8,000,000 shares; issued and outstanding, 2022, 6,262,381 shares; 2021, 6,228,176 shares		7,828			7,785
Common stock, par value $1.25 per share; authorized 8,000,000 shares; issued and outstanding, 2023, 6,260,934 shares; 2022, 6,264,912 shares							7,826			7,831
Surplus		32,620			31,966		32,840			32,716
Retained earnings		86,382			76,990		95,988			90,284
Accumulated other comprehensive (loss) income, net		(27,753	)		298
Accumulated other comprehensive loss, net							(24,675	)		(22,471	)
Total shareholders’ equity	$	99,077		$	117,039	$	111,979		$	108,360
Total liabilities and shareholders’ equity	$	1,383,595		$	1,389,437	$	1,366,220		$	1,369,383

*Derived from audited consolidated financial statements.

See Notes to Consolidated Financial Statements

Table of Contents

FIRST NATIONAL CORPORATION

Consolidated Statements of Income (Unaudited)

(in thousands, except per share data)

	Three Months Ended				Nine Months Ended					Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,			September 30,		September 30,		September 30,			September 30,
	2022		2021		2022		2021			2023		2022		2023			2022
Interest and Dividend Income
Interest and fees on loans	$	10,759	$	9,215	$	30,218	$	23,432		$	12,640	$	10,759	$	36,038		$	30,218
Interest on deposits in banks		380		79		701		149			338		380		1,441			701
Interest on federal funds sold		—		8		—		8
Interest and dividends on securities:
Taxable interest		1,323		766		3,750		2,180			1,323		1,323		3,968			3,750
Tax-exempt interest		307		242		921		637			304		307		917			921
Dividends		23		21		65		65			26		23		81			65
Total interest and dividend income	$	12,792	$	10,331	$	35,655	$	26,471		$	14,631	$	12,792	$	42,445		$	35,655
Interest Expense
Interest on deposits	$	927	$	369	$	1,680	$	1,060		$	3,810	$	927	$	9,428		$	1,680
Interest on subordinated debt		70		156		208		464			69		70		207			208
Interest on junior subordinated debt		68		68		202		202			69		68		203			202
Interest on other borrowings											—		—		3			—
Total interest expense	$	1,065	$	593	$	2,090	$	1,726		$	3,948	$	1,065	$	9,841		$	2,090
Net interest income	$	11,727	$	9,738	$	33,565	$	24,745		$	10,683	$	11,727	$	32,604		$	33,565
Provision for (recovery of) loan losses		200		—		600		(1,000	)
Net interest income after provision for (recovery of) loan losses	$	11,527	$	9,738	$	32,965	$	25,745
Provision for credit losses											100		200		200			600
Net interest income after provision for credit losses										$	10,583	$	11,527	$	32,404		$	32,965
Noninterest Income
Service charges on deposit accounts	$	708	$	547	$	2,015	$	1,436		$	733	$	708	$	2,062		$	2,015
ATM and check card fees		915		753		2,462		2,036			976		915		2,624			2,462
Wealth management fees		739		696		2,302		1,996			811		739		2,336			2,302
Fees for other customer services		180		279		601		611			122		180		538			601
Brokered mortgage fees		72		155		224		416			38		72		73			224
Income from bank owned life insurance		166		162		441		374			175		166		459			441
Net gains on securities available for sale		—		—		—		37
Net gains on sale of mortgage loans held for sale		—		—		—		25
Other operating income		247		56		473		295			198		247		623			473
Total noninterest income	$	3,027	$	2,648	$	8,518	$	7,226		$	3,053	$	3,027	$	8,715		$	8,518
Noninterest Expense
Salaries and employee benefits	$	5,174	$	5,446	$	15,384	$	12,694		$	5,505	$	5,174	$	16,040		$	15,384
Occupancy		539		500		1,656		1,346			534		539		1,586			1,656
Equipment		546		519		1,725		1,383			598		546		1,756			1,725
Marketing		211		243		585		487			204		211		720			585
Supplies		117		176		384		341			128		117		423			384
Legal and professional fees		361		586		1,075		1,806			439		361		1,204			1,075
ATM and check card expense		332		329		982		828			440		332		1,265			982
FDIC assessment		109		87		393		234			161		109		479			393
Bank franchise tax		238		153		692		493			262		238		778			692
Data processing expense		243		465		700		885			266		243		720			700
Amortization expense		6		5		15		24			5		6		14			15
Other real estate owned expense, net		14		—		83		—
Other real estate owned (income) expense, net											15		14		(201	)		83
Other operating expense		1,193		917		2,971		2,185			1,227		1,193		3,358			2,971
Total noninterest expense	$	9,083	$	9,426	$	26,645	$	22,706		$	9,784	$	9,083	$	28,142		$	26,645

See Notes to Consolidated Financial Statements

Table of Contents

FIRST NATIONAL CORPORATION

Consolidated Statements of Income (Unaudited)

(Continued)

(in thousands, except per share data)

	Three Months Ended				Nine Months Ended				Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,		September 30,		September 30,		September 30,		September 30,
	2022		2021		2022		2021		2023		2022		2023		2022
Income before income taxes	$	5,471	$	2,960	$	14,838	$	10,265	$	3,852	$	5,471	$	12,977	$	14,838
Income tax expense		1,017		562		2,820		2,089		731		1,017		2,502		2,820
Net income	$	4,454	$	2,398	$	12,018	$	8,176	$	3,121	$	4,454	$	10,475	$	12,018
Earnings per common share
Basic	$	0.71	$	0.39	$	1.92	$	1.54	$	0.50	$	0.71	$	1.67	$	1.92
Diluted	$	0.71	$	0.38	$	1.92	$	1.53	$	0.50	$	0.71	$	1.67	$	1.92

See Notes to Consolidated Financial Statements

Table of Contents

FIRST NATIONAL CORPORATION

Consolidated Statements of Comprehensive Income (Loss) ~~Income~~ (Unaudited)

(in thousands)

Three Months Ended

Nine Months Ended

September 30,

September 30,

September 30,

September 30,

2022

2021

2022

2021

Net income
$ 4,454 $ 2,398 $ 12,018 $ 8,176
Other comprehensive (loss), net of tax,

Unrealized holding gains (losses) on available for sale securities, net of tax $155 and ($211) for the three months and ($6,225) and ($565) for the nine months ended September 30, 2022 and 2021, respectively
581 (798 ) (23,424 ) (2,131 )
Unrealized holding losses on securities transferred from available for sale to held to maturity, net of tax $1,605 for the three and nine months ended September 30, 2022. There were no securities transferred for the three and nine months ended September 30, 2021
(6,036 ) — (6,036 ) —
Reclassification adjustment for gains included in net income, net of tax $0 and ($8) for the nine months ended September 30, 2022 and 2021. There were no reclassification adjustments for the three month periods.
— — — (29 )
Change in fair value of cash flow hedges, net of tax $106 and $21 for the three months and $373 and $117 for the nine months ended September 30, 2022 and 2021, respectively
404 80 1,409 442
Total other comprehensive (loss)
(5,051 ) (718 ) (28,051 ) (1,718 )
Total comprehensive (loss) income
$ (597 ) $ 1,680 $ (16,033 ) $ 6,458

	Three Months Ended						Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2023			2022			2023			2022
Net income	$	3,121		$	4,454		$	10,475		$	12,018
Other comprehensive income (loss), net of tax,
Unrealized holding (losses) gains on available for sale securities, net of tax ($1,080) and $155 for the three months and ($925) and ($6,225) for the nine months ended September 30, 2023 and 2022, respectively		(4,063	)		581			(3,480	)		(23,424	)
Unrealized holding losses on securities transferred from available for sale to held to maturity, net of tax ($1,605) for the three months and nine months ended September 31, 2022		—			(6,036	)		—			(6,036	)
Amortization of unrealized holding losses on available-for-sale securities transferred to held to maturity, net of tax of $86 and $0 for the three months and $258 and $0 for the nine months ended September 30, 2023 and 2022, respectively		323			—			972			—
Change in fair value of cash flow hedges, net of tax $113 and $106 for the three months and $82 and $373 for the nine months ended September 30, 2023 and 2022, respectively		424			404			304			1,409
Total other comprehensive (loss)		(3,316	)		(5,051	)		(2,204	)		(28,051	)
Total comprehensive (loss) income	$	(195	)	$	(597	)	$	8,271		$	(16,033	)

See Notes to Consolidated Financial Statements

Table of Contents

FIRST NATIONAL CORPORATION

Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

	Nine Months Ended						Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2022			2021			2023			2022
Cash Flows from Operating Activities
Net income	$	12,018		$	8,176		$	10,475		$	12,018
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of premises and equipment		1,118			1,005			1,195			1,118
Amortization of core deposit intangibles		14			24			14			14
Amortization of debt issuance costs		2			2			2			2
Origination of mortgage loans held for sale		—			(1,586	)
Proceeds from sale of mortgage loans held for sale		—			1,856
Net gains on sales of mortgage loans held for sale		—			(25	)
Provision for (recovery of) loan losses		600			(1,000	)
Fair value adjustments on other real estate owned		—			139
Net gains on securities available for sale		—			(37	)
Net losses (gains) on sale of other real estate owned		33			(8	)
Provision for credit losses on loans								166			600
(Recovery of) credit losses on securities held to maturity								(2	)		—
Provision for credit losses on unfunded commitments								36			—
Net (gain) loss on sale of other real estate owned								(233	)		33
Increase in cash value of bank owned life insurance		(441	)		(374	)		(459	)		(441	)
Accretion of discounts and amortization of premiums on securities, net		891			725			746			891
Accretion of premium on time deposits		(159	)		(101	)		(68	)		(159	)
Accretion of certain acquisition-related loan discounts, net		(1,013	)		—			(510	)		(1,013	)
Stock-based compensation		728			300			681			728
Excess tax benefits on stock-based compensation		3			3			4			3
Losses (gains) on disposal of premises and equipment, net		4			(26	)
Deferred income tax expense (benefit)		46			(1,750	)
(Gain) loss on disposal of premises and equipment, net								(3	)		4
Deferred income tax expense								323			46
Changes in assets and liabilities:
(Increase) decrease in interest receivable		(344	)		453
Decrease in other assets		3,513			2,938
(Decrease) increase in accrued interest payable and other liabilities		(176	)		1,625
Decrease (increase) in interest receivable								41			(344	)
(Increase) decrease in other assets								(284	)		3,513
(Decrease) in accrued interest payable and other liabilities								(814	)		(176	)
Net cash provided by operating activities	$	16,837		$	12,339		$	11,310		$	16,837
Cash Flows from Investing Activities
Proceeds from maturities, calls, principal payments, and sales of securities available for sale	$	21,556		$	43,247
Proceeds from maturities, calls, and principal payments of securities available for sale							$	9,623		$	21,556
Proceeds from maturities, calls, and principal payments of securities held to maturity		7,086			4,120			6,359			7,086
Purchases of securities available for sale		(21,147	)		(160,864	)		—			(21,147	)
Net increase in federal funds sold		—			(80,589	)
Purchases of restricted securities								(274	)		—
Purchases of securities held to maturity		(54,038	)		—			(2,092	)		(54,038	)
Net (purchase) redemption of restricted securities		(95	)		245
Net redemption (purchase) of restricted securities								105			(95	)
Purchase of premises and equipment		(596	)		(622	)		(682	)		(596	)
Cash value of bank owned life insurance released		360			—
Proceeds from sale of premises and equipment		—			32			3			—
Proceeds from sale of other real estate owned		421			288			417			421
Net cash paid in acquisition of Smartbank		—			(1,793	)
Net cash acquired in acquisition of The Bank of Fincastle		—			39,363
Proceeds from cash value of bank owned life insurance								256			360
Net (increase) in loans		(80,401	)		(14	)		(32,368	)		(80,401	)
Net cash used in investing activities	$	(126,854	)	$	(156,587	)
Net cash (used in) investing activities							$	(18,653	)	$	(126,854	)

See Notes to Consolidated Financial Statements

Table of Contents

FIRST NATIONAL CORPORATION

Consolidated Statements of Cash Flows (Unaudited)

(Continued)

(in thousands)

	Nine Months Ended						Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2022			2021			2023			2022
Cash Flows from Financing Activities
Net increase in demand deposits and savings accounts	$	29,090		$	137,352
Net decrease in time deposits		(11,637	)		(3,923	)
Net (decrease) increase in demand deposits and savings accounts							$	(53,729	)	$	29,090
Net increase (decrease) in time deposits								47,638			(11,637	)
Repayment of subordinated debt		(5,000	)		—			—			(5,000	)
Cash dividends paid on common stock, net of reinvestment		(2,474	)		(1,798	)		(2,699	)		(2,474	)
Repurchase of common stock, stock incentive plan		(183	)		(39	)		(114	)		(183	)
Net cash provided by financing activities	$	9,796		$	131,592
(Decrease) in cash and cash equivalents	$	(100,221	)	$	(12,656	)
Repurchase of common stock, stock repurchase plan								(568	)		—
Net cash (used in) provided by financing activities							$	(9,472	)	$	9,796
Decrease in cash and cash equivalents							$	(16,815	)	$	(100,221	)
Cash and Cash Equivalents
Beginning	$	176,006		$	127,297		$	66,914		$	176,006
Ending	$	75,785		$	114,641		$	50,099		$	75,785
Supplemental Disclosures of Cash Flow Information
Cash payments for:
Interest	$	2,285		$	1,728		$	9,405		$	2,285
Income taxes	$	2,265		$	1,674		$	2,726		$	2,265
Supplemental Disclosures of Noncash Investing and Financing Activities
Unrealized (losses) on securities available for sale	$	(29,649	)	$	(2,733	)
Unrealized losses on securities available for sale							$	(4,405	)	$	(29,649	)
Unrealized losses on securities transferred from available for sale to held to maturity	$	(7,641	)	$	—		$	—		$	(7,641	)
Fair value of securities transferred from available for sale to held to maturity	$	74,416		$	—		$	—		$	74,416
Change in fair value of cash flow hedges	$	1,782		$	559		$	386		$	1,782
Transfer from premises and equipment to other real estate owned, net	$	(184	)	$	—		$	—		$	(184	)
Transfer from loans to other real estate owned	$	—		$	130
Issuance of common stock, dividend reinvestment plan	$	152		$	115		$	120		$	152

See Notes to Consolidated Financial Statements

Table of Contents

FIRST NATIONAL CORPORATION

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(in thousands, except share and per share data)

Common Stock

Surplus

Retained Earnings
Accumulated Other Comprehensive Income
Total

Balance, June 30, 2021
$ 6,088 $ 6,295 $ 73,901 $ 2,398 $ 88,682
Net income
— — 2,398 — 2,398
Other comprehensive loss
— — — (718 ) (718 )
Cash dividends on common stock ($0.12 per share)
— — (745 ) — (745 )
Shares issued to shareholders of The Bank of Fincastle
1,685 25,384 — — 27,069
Stock-based compensation
— 181 — — 181
Issuance of 1,894 shares common stock, dividend reinvestment plan
2 37 — — 39
Issuance of 6,000 shares common stock, stock incentive plan
8 (8 ) — — —
Balance, September 30, 2021
$ 7,783 $ 31,889 $ 75,554 $ 1,680 $ 116,906

	Common Stock		Surplus			Retained Earnings			Accumulated Other Comprehensive (Loss)			Total
Balance, June 30, 2022	$	7,815	$	32,398		$	82,804		$	(22,702	)	$	100,315
Net income		—		—			4,454			—			4,454
Other comprehensive loss		—		—			—			(5,051	)		(5,051	)
Cash dividends on common stock ($0.14 per share)		—		—			(876	)		—			(876	)
Stock-based compensation		—		187			—			—			187
Issuance of 2,733 shares common stock, dividend reinvestment plan		4		44			—			—			48
Issuance of 7,500 shares common stock, stock incentive plan		9		(9	)		—			—			—
Balance, September 30, 2022	$	7,828	$	32,620		$	86,382		$	(27,753	)	$	99,077

Common Stock

Surplus

Retained Earnings

Accumulated Other Comprehensive Income

Total

Balance, December 31, 2020
$ 6,075 $ 6,151 $ 69,292 $ 3,398 $ 84,916
Net income
— — 8,176 — 8,176
Other comprehensive loss
— — — (1,718 ) (1,718 )
Cash dividends on common stock ($0.36 per share)
— — (1,914 ) — (1,914 )
Shares issued to shareholders of The Bank of Fincastle
1,685 25,384 — — 27,069
Stock-based compensation
— 300 — — 300
Issuance of 6,102 shares of common stock, dividend reinvestment plan
7 109 — — 116
Issuance of 14,073 shares of common stock, stock incentive plan
18 (18 ) — — —
Repurchase of 2,221 shares of common stock, stock incentive plan
(2 ) (37 ) — — (39 )
Balance, September 30, 2021
$ 7,783 $ 31,889 $ 75,554 $ 1,680 $ 116,906

	Common Stock			Surplus			Retained Earnings			Accumulated Other Comprehensive (Loss)			Total
Balance, June 30, 2023	$	7,813		$	32,601		$	93,805		$	(21,359	)	$	112,860
Net income		—			—			3,121			—			3,121
Other comprehensive loss		—			—			—			(3,316	)		(3,316	)
Cash dividends on common stock ($0.15 per share)		—			—			(938	)		—			(938	)
Stock-based compensation		—			274			—			—			274
Issuance of 2,295 shares of common stock, dividend reinvestment plan		3			37			—			—			40
Repurchase of 6,495 shares of common stock, stock incentive plan		15			(15	)		—			—			—
Repurchase of 3,674 shares of common stock, stock repurchase plan		(5	)		(57	)		—			—			(62	)
Balance, September 30, 2023	$	7,826		$	32,840		$	95,988		$	(24,675	)	$	111,979

	Common Stock			Surplus			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
Balance, December 31, 2021	$	7,785		$	31,966		$	76,990		$	298		$	117,039
Net income		—			—			12,018			—			12,018
Other comprehensive loss		—			—			—			(28,051	)		(28,051	)
Cash dividends on common stock ($0.42 per share)		—			—			(2,626	)		—			(2,626	)
Stock-based compensation		—			728			—			—			728
Issuance of 7,853 shares common stock, dividend reinvestment plan		10			142			—			—			152
Issuance of 34,634 shares common stock, stock incentive plan		43			(43	)		—			—			—
Repurchase of 8,283 shares common stock, stock incentive plan		(10	)		(173	)		—			—			(183	)
Balance, September 30, 2022	$	7,828		$	32,620		$	86,382		$	(27,753	)	$	99,077

	Common Stock			Surplus			Retained Earnings			Accumulated Other Comprehensive (Loss)			Total
Balance, December 31, 2022	$	7,831		$	32,716		$	90,284		$	(22,471	)	$	108,360
Adoption of new accounting standard (ASU 2016-13)		—			—			(1,952	)		—			(1,952	)
Net income		—			—			10,475			—			10,475
Other comprehensive (loss)		—			—			—			(2,204	)		(2,204	)
Cash dividends on common stock ($0.45 per share)		—			—			(2,819	)		—			(2,819	)
Stock-based compensation		—			681			—			—			681
Issuance of 7,047 shares common stock, dividend reinvestment plan		9			111			—			—			120
Issuance of 33,002 shares common stock, stock incentive plan		41			(41	)		—			—			—
Repurchase of 6,495 shares common stock, stock incentive plan		(8	)		(106	)		—			—			(114	)
Repurchase of 37,532 shares common stock, stock repurchase plan		(47	)		(521	)		—			—			(568	)
Balance, September 30, 2023	$	7,826		$	32,840		$	95,988		$	(24,675	)	$	111,979

See Notes to Consolidated Financial Statements

Table of Contents

FIRST NATIONAL CORPORATION

Notes to Consolidated Financial Statements (Unaudited)

Note 1. General

Basis of Presentation

The accompanying unaudited consolidated financial statements of First National Corporation (the Company) and its subsidiary, First Bank (the Bank), have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and in accordance with guidance provided by the ~~SEC.~~Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required by GAAP for annual year-end financial statements. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications of a normal and recurring nature considered necessary to present fairly the financial positions at September 30, ~~2022~~2023 and December 31, ~~2021~~2022, the statements of income and comprehensive income (loss) ~~income~~ for the three and nine months ended September 30, ~~2022~~2023 and ~~2021~~2022, the cash flows for the nine months ended September 30, ~~2022~~2023 and ~~2021~~2022, and the changes in shareholders’ equity for the three and nine months ended September 30, ~~2022~~2023 and ~~2021~~2022. The statements should be read in conjunction with the consolidated financial statements and related notes included in the Annual Report on Form 10-K for the year ended December 31, ~~2021~~2022. Operating results for the three and nine months ended September 30, ~~2022~~2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023. Certain items in the prior period financial statements have been reclassified to conform to the current presentation. These reclassifications had no effect on prior year net income or shareholders' equity.

Significant Accounting Policies and Estimates

Application of the principles of GAAP and practices within the banking industry requires management to make estimates, assumptions, and judgements that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgements are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements may reflect different estimates, assumptions and judgements. Certain policies inherently rely more extensively on the use of estimates, assumptions, and judgements and as such may have a greater possibility of producing results that could be materially different than originally reported. Material estimates that are particularly susceptible to significant changes in the near term include estimates related to the determination of the allowance for credit losses.

The Company’s significant accounting policies followed in the preparation of the unaudited consolidated financial statements are disclosed in Note 1 of the audited financial statements and notes for the year ended December 31, 2022.and are contained in the Company’s 2022 Annual Report on Form 10-K. There have been no significant changes to the application of significant accounting policies since December 31, 2022, except for the following:

Adoption of New Accounting Pronouncements

ASU 2016-13:On January 1, 2023, the Company adopted Accounting Standards Update (ASU) No.2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (Accounting Standards Codification (ASC) 326). This standard replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. CECL requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts and generally applies to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities, and some off-balance sheet credit exposures such as unfunded commitments to extend credit. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses.

In addition, CECL made changes to the accounting for available for sale debt securities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available for sale debt securities if management does not intend to sell and does not believe that it is more likely than not that they will be required to sell.

The Company adopted ASC 326 and all related subsequent amendments thereto effective January 1, 2023 using the modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit exposures. The transition adjustment of the adoption of CECL included an increase in the allowance for credit losses on loans of $2.2 million, which is presented as a reduction to net loans outstanding, and an increase in the allowance for credit losses on unfunded commitments of $153 thousand, which is recorded within other liabilities. The Company recorded an allowance for credit losses for held to maturity securities of $132 thousand, which is presented as a reduction to held to maturity securities outstanding. The Company recorded a net decrease to retained earnings of $2.0 million as of January 1, 2023 for the cumulative effect of adopting CECL, which reflects the transition adjustments noted above, net of the applicable deferred tax assets recorded. Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with previously applicable accounting standards.

The Company adopted ASC 326 using the prospective transition approach for purchase credit deteriorated (PCD) assets that were previously classified as purchase credit impaired (PCI) under ASC 310-30. In accordance with the standard, management did not reassess whether PCI assets met the criteria of PCD assets as of the date of adoption. As of September 30, 2023, the Company had no loans classified as PCD.

The Company adopted ASC 326 using the prospective transition approach for debt securities for which other-than-temporary impairment had been recognized prior to January 1, 2023. As of December 31, 2022, the Company did not have any other-than-temporary impaired investment securities. Therefore, upon adoption of ASC 326, the Company determined that an allowance for credit losses on available for sale securities was not required.

The Company elected not to measure an allowance for credit losses for accrued interest receivable and instead elected to reverse interest income on loans or securities that are placed on nonaccrual status, which is generally when the instrument is 90 days past due, or earlier if the Company believes the collection of interest is doubtful. The Company has concluded that this policy results in the timely reversal of uncollectible interest.

	January 1, 2023		December 31, 2022
	As reported Under		Pre-ASC 326		Impact of ASC
(dollars in thousands)	ASC 326		Adoption		326 Adoption
Assets:
Allowance for credit losses on held to maturity securities:
Corporate securities		132		-		132

Allowance for credit losses on loans:						-
Construction and land development		233		546		(313	)
Secured by 1-4 family residential		2,517		1,108		1,409
Other real estate loans		5,311		3,609		1,702
Commercial and industrial loans		1,487		1,874		(387	)
Consumer and other loans		84		309		(225	)
Allowance for credit losses on loans		9,632		7,446		2,186

Liabilities:
Allowance for credit losses for unfunded commitments		153		-		153

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Allowance for Credit Losses – Held-to-Maturity Securities

The Company estimates expected credit losses on held-to-maturity securities on an individual basis based on a Probability of Default/Loss Given Default (“PD/LGD”) methodology primarily using security-level credit ratings. The primary indicators of credit quality for the Company’s held-to-maturity portfolio are security type and credit ratings, which are influenced by a number of factors including obligor cash flow, geography, seniority, among other factors. The Company’s held-to-maturity securities with credit risk are municipal bonds and corporate debt securities. All other held-to-maturity securities are covered by the explicit or implied guarantee of the United States government or one if its agencies.

Changes in the allowance for credit loss are recorded as provision for (or recovery of) credit losses in the Consolidated Statements of Income. The Company recorded an allowance for credit losses on held-to-maturity securities of $132 thousand upon adoption of ASC 326. During the three months ended September 30, 2023, the Company recorded a recovery of credit losses on held-to-maturity securities of $12 thousand. The allowance for credit losses on held-to-maturity securities was $131 as of September 30, 2023.

Allowance for Credit Losses – Available-for-Sale Securities

Management evaluates all available-for-sale securities in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security, the security is written down to fair value and the entire loss is recorded in earnings.

If either of the above criteria is not met, the Company evaluates whether the decline in fair value is the result of credit losses or other factors. In making the assessment, the Company may consider various factors including the extent to which fair value is less than amortized cost, downgrades in the ratings of the security by a rating agency, the failure of the issuer to make scheduled interest or principal payments and adverse conditions specific to the security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security and any deficiency is recorded as an allowance for credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any amount of unrealized loss that has not been recorded through an allowance for credit loss is recognized in other comprehensive income.

Changes in the allowance for credit loss are recorded as a provision for (or recovery of) credit losses in the Consolidated Statements of Income. Losses are charged against the allowance for credit loss when management believes an available-for-sale security is confirmed to be uncollectible or when either of the criteria regarding intent or requirement to sell is met. At September 30, 2023, there was no allowance for credit loss related to the available-for-sale portfolio.

Accrued interest receivable on available-for-sale securities totaled $786 thousand at September 30, 2023 and was excluded from the estimate of credit losses.

Allowance for Credit Losses – Loans

The allowance for loan credit losses represents an amount which, in management’s judgement, is adequate to absorb the lifetime expected losses that may be sustained on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions, and prepayment experience. The allowance for loan credit losses is measured and recorded upon the initial recognition of a financial asset. The allowance for loan credit losses is reduced by charge-offs, net of recoveries of previous losses, and is increased or decreased by a provision for (or recovery of) credit losses, which is recorded in the Consolidated Statement of Income.

The Company is utilizing a discounted cash flow model to estimate its current expected credit losses. For the purposes of calculating its quantitative reserves, the Company has segmented its loan portfolio based on loans which share similar risk characteristics. Within the quantitative portion of the calculation, the Company utilizes at least one or a combination of loss drivers, which may include unemployment rates, home price indices, and/or gross domestic product (“GDP”), to adjust its loss rates over a reasonable and supportable forecast period of one year. A straight-line reversion technique is used for the following eight quarters, at which time the Company reverts to historical averages. To further adjust the allowance for credit losses for expected losses not already included within the quantitative component of the calculation, the Company may consider qualitative factors, including but not limited to: variability in the economic forecast, changes in volume and severity of adversity classified loans, changes in concentrations of credit, changes in the nature and volume of the loan segments, factors related to credit administration, and other idiosyncratic risks not embedded in the data used in the model.

Loans that do not share risk characteristics are evaluated on an individual basis. The Company designates individually evaluated loans on nonaccrual status as collateral dependent loans, as well as other loans that management of the Company designates as having higher risk and loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral. These loans do not share common risk characteristics and are not included within the collectively evaluated loans for determining the allowance for credit losses. Under CECL, for collateral dependent loans, the Company has adopted the practical expedient to measure the allowance for credit losses based on the fair value of collateral. The allowance for credit losses is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral, which is adjusted for liquidation costs/discounts, and amortized cost. If the fair value of the collateral exceeds the amortized cost, no allowance is required.

The adoption of CECL did not result in a significant change to any other credit risk management and monitoring processes, including identification of past due or delinquent borrowers, nonaccrual practices or charge-off policy.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Allowance for Credit Losses – Unfunded Commitments

Financial Instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company’s exposure to credit losses in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.

The Company records all allowance for credit losses on off-balance sheet credit exposures, unless the commitments to extend credit are unconditionally cancelable, through a charge to provision for (or recovery of) credit losses in the Consolidated Statement of Income. The allowances for credit losses on off-balance sheet credit exposures is estimated by loan segment at each balance sheet date under the current expected credit losses model using the same methodology as the loan portfolio, taking into consideration the likelihood that funding will occur as well as any third-party guarantees. The allowance for unfunded commitments is included in other liabilities on the Company’s consolidated balance sheet.

Accrued Interest Receivable

The Company has elected to exclude the accrued interest from the amortized cost basis in its determination of the allowance for credit losses for both loans and held-to-maturity securities, as well as elected the policy to write-off accrued interest receivable directly through the reversal of interest income. Accrued interest receivable totaled $3.1 million on loans and $593 thousand on held-to-maturity securities at September 30, 2023 and is included in “Accrued Interest Receivable” on the Company’s Consolidated Balance Sheets.

ASU 2022-01:

On January 1, 2023, the Company adopted ASU 2022-01, "Derivatives and Hedging (Topic 815), Fair Value Hedging—Portfolio Layer Method.” ASU 2022-01 clarifies the guidance in ASC 815 on fair value hedge accounting of interest rate risk for portfolios of financial assets and is intended to better align hedge accounting with an organization’s risk management strategies. In 2017, FASB issued ASU 2017-12 to better align the economic results of risk management activities with hedge accounting. One of the major provisions of that standard was the addition of the last-of-layer hedging method. For a closed portfolio of fixed-rate prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, such as mortgages or mortgage-backed securities, the last-of-layer method allows an entity to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows. ASU 2022-01 renames that method the portfolio layer method. The Company adopted ASU 2022-01 prospectively and it did not have a material impact on its consolidated financial statements.

ASU 2022-02:On January 1, 2023, the Company adopted ASU 2022-02, "Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures." ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standards (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings (TDRs) by creditors that have adopted the CECL model and enhance the disclosure requirements for certain loan refinancings by creditors when a borrower is experiencing financial difficulty. In addition, the amendments require that the Company disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. The Company adopted the standard prospectively and it did not have a material impact on the financial statements.

Recent Accounting Pronouncements

In ~~June 2016,~~ ~~the FASB issued ASU~~ ~~No.~~~~2016~~-~~13,~~ ~~“Financial Instruments – Credit Losses (Topic~~ ~~326~~~~): Measurement of Credit Losses on Financial Instruments” (ASU~~ ~~2016~~-13). The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU ~~2016~~-13 ~~as codified in Topic~~ ~~326,~~ ~~including ASU’s~~ ~~2019~~-~~04,~~~~2019~~-~~05,~~~~2019~~-~~10,~~~~2019~~-~~11,~~~~2020~~-~~02,~~ ~~and~~ ~~2020~~-~~03.~~ These ASU’s have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC), such as the Company, and all other entities who do ~~not~~ ~~file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after~~ ~~December 15, 2022.~~ ~~The Company is currently assessing the impact that ASU~~ ~~2016~~-13 will have on its consolidated financial statements. The Company has formed a committee to address the compliance requirements of this ASU, which has analyzed gathered data, defined loan pools and segments, and selected methods for applying the concepts included in this ASU. The Company is in the process of testing selected models, building policy and process documentation, modeling the impact of the ASU on the capital and strategic plans, performing model validation, and finalizing policies and procedures. This guidance ~~may~~ ~~result in material changes in the Company's accounting for credit losses of financial instruments.~~

In ~~March 2022,~~July 2023, the Financial Accounting Standards Board (FASB) issued ASU 2023-03, “Presentation of Financial Statements (Topic 205), Income Statement—Reporting Comprehensive Income (Topic 220), Distinguishing Liabilities from Equity (Topic 480), Equity (Topic 505), and Compensation—Stock Compensation (Topic 718)”. This ASU amends the FASB Accounting Standards ~~Update (ASU)~~Codification for SEC paragraphs pursuant to SEC Staff Accounting Bulletin No. 120, SEC Staff Announcement at the March 24, 2022EITF Meeting, and Staff Accounting Bulletin Topic 6.B, Accounting Series Release 280—General Revision of Regulation S-X: Income or Loss Applicable to Common Stock. ASU 2023-~~01,~~ ~~“Derivatives and Hedging (Topic~~ ~~815~~~~), Fair Value Hedging—Portfolio Layer Method.” ASU~~ ~~2022~~-01 ~~clarifies the guidance in ASC~~ ~~815~~ ~~on fair value hedge accounting of interest rate risk for portfolios of financial assets and is intended to better align hedge accounting with an organization’s risk management strategies. In~~ ~~2017,~~ ~~FASB issued ASU~~ ~~2017~~-12 to better align the economic results of risk management activities with hedge accounting. One of the major provisions of that standard was the addition of the last-of-layer hedging method. For a closed portfolio of fixed-rate prepayable financial assets or ~~one~~ or more beneficial interests secured by a portfolio of prepayable financial instruments, such as mortgages or mortgage-backed securities, the last-of-layer method allows an entity to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that is ~~not~~ ~~expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows. ASU~~ ~~2022~~-01 ~~renames that method the portfolio layer method. For public business entities, ASU~~ ~~2022~~-0103 is effective ~~for fiscal years beginning after~~ ~~December 15, 2022,~~ ~~and interim periods within those fiscal years.~~upon addition to the FASB Codification. The Company does not expect the adoption of ASU ~~2022~~2023-0103 to have a material impact on its consolidated financial statements.

In ~~March 2022,~~ ~~the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU)~~ ~~No.~~~~2022~~-~~02,~~ ~~“Financial Instruments-Credit Losses (Topic~~ ~~326~~~~), Troubled Debt Restructurings and Vintage Disclosures.” ASU~~ ~~2022~~-02 ~~addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU~~ ~~2016~~-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require a public business entity to disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. For entities that have adopted ASU ~~2016~~-~~13,~~ ~~ASU~~ ~~2022~~-02 ~~is effective for fiscal years beginning after~~ ~~December 15, 2022,~~ ~~including interim periods within those fiscal years. For entities that have~~ ~~not~~ ~~yet adopted ASU~~ ~~2016~~-~~13,~~ ~~the effective dates for ASU~~ ~~2022~~-02 ~~are the same as the effective dates in ASU~~ ~~2016~~-~~13.~~ ~~Early adoption is permitted if an entity has adopted ASU~~ ~~2016~~-~~13.~~ ~~The Company is currently assessing the impact that ASU~~ ~~2022~~-02 ~~will have on its consolidated financial statements.~~

~~Table of Contents~~

~~Notes to Consolidated Financial Statements (Unaudited)~~

~~Effective~~ ~~November 25, 2019,~~ ~~the SEC adopted Staff Accounting Bulletin (SAB)~~ ~~119.~~ ~~SAB~~ ~~119~~ ~~updated portions of SEC interpretative guidance to align with FASB ASC~~ ~~326,~~ ~~“Financial Instruments – Credit Losses.” It covers topics including (~~1~~) measuring current expected credit losses; (~~2~~) development, governance, and documentation of a systematic methodology; (~~3~~) documenting the results of a systematic methodology; and (~~4~~) validating a systematic methodology.~~

In ~~March 2020,~~ ~~the FASB issued ASU~~ ~~No.~~~~2020~~-~~04,~~ ~~“Reference Rate Reform (Topic~~ ~~848~~~~): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (ASU~~ ~~2020~~-04). These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of ~~March 12, 2020~~ ~~through~~ ~~December 31, 2022.~~ ~~Subsequently, in~~ ~~January 2021,~~ ~~the FASB issued ASU~~ ~~No.~~~~2021~~-01 ~~“Reference Rate Reform (Topic~~ ~~848~~~~): Scope” (ASU~~ ~~2021~~-01~~). This ASU clarifies that certain optional expedients and exceptions in Topic~~ ~~848~~ ~~for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic~~ ~~848~~ ~~to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity~~ ~~may~~ ~~elect to apply ASU~~ ~~2021~~-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes ~~March 12, 2020,~~ ~~or prospectively to new modifications from any date within the interim period that includes or is subsequent to~~ ~~January 7, 2021,~~ ~~up to the date that financial statements are available to be issued. An entity~~ ~~may~~ ~~elect to apply ASU~~ ~~2021~~-01 ~~to eligible hedging relationships existing as of the beginning of the interim period that includes~~ ~~March 12, 2020,~~ ~~and to new eligible hedging relationships entered into after the beginning of the interim period that includes~~ ~~March 12,~~ ~~2020.~~ ~~The Company has identified loans and other financial instruments that are directly or indirectly influenced by LIBOR. The~~ ~~Company is assessing ASU~~ ~~2020~~-04 ~~and its impact on the Company's transition away from LIBOR for its loan and other financial instruments.~~

In June 2022, the FASB issued ASU 2022-03, “Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions.” ASU 2022-03 clarifies that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. The ASU is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2023. Early adoption is permitted. The Company does not expect the adoption of ASU 2022-03 to have a material impact on its consolidated financial statements.

In March 2023, the FASB issued ASU 2023-01, “Leases (Topic 842): Common Control Arrangements”. These amendments require entities to amortize leasehold improvements associated with common control leases over the useful life to the common control group. The ASU is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted. If an entity adopts the amendments in an interim period, it must adopt them as of the beginning of the fiscal year that includes that interim period. Transition can be done either retrospectively or prospectively. The Company does not expect the adoption of ASU 2023-01 to have a material impact on its consolidated financial statements.

In March 2023, the FASB issued ASU 2023-02, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method”. These amendments allow reporting entities to elect to account for qualifying tax equity investments using the proportional amortization method, regardless of the program giving rise to the related income tax credits. The ASU is effective for public business entities for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for all entities in any interim period. The Company does not expect the adoption of ASU 2023-02 to have a material impact on its consolidated financial statements.

1112

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 2. Securities

The Company invests in U.S. Treasury securities, U.S. agency and mortgage-backed securities, obligations of state and political subdivisions, and corporate debt securities. Amortized ~~costs~~costs, gross unrealized gains and losses, allowance for credit losses, and fair values of debt securities at September 30, ~~2022~~2023 and December 31, ~~2021~~2022 were as follows (in thousands):

	September 30, 2022									September 30, 2023
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value		Allowance for Credit Losses
Securities available for sale:
U.S. Treasury securities	$	19,953	$	—	$	(2,422	)	$	17,531	$	12,474	$	—	$	(1,361	)	$	11,113	$	—
U.S. agency and mortgage-backed securities		122,190		113		(16,000	)		106,303		99,894		60		(15,660	)		84,294		—
Obligations of states and political subdivisions		64,472		20		(11,923	)		52,569		64,131		4		(11,367	)		52,768		—
Total securities available for sale	$	206,615	$	133	$	(30,345	)	$	176,403	$	176,499	$	64	$	(28,388	)	$	148,175	$	—
Securities held to maturity:
U.S. Treasury securities	$	37,994	$	—	$	(638	)	$	37,356	$	38,862	$	—	$	(734	)	$	38,128	$	—
U.S. agency and mortgage-backed securities		101,321		—		(9,351	)		91,970		96,563		—		(12,216	)		84,347		—
Obligations of states and political subdivisions		12,579		—		(1,701	)		10,878		11,654		—		(1,706	)		9,948		—
Corporate debt securities		3,000		—		(284	)		2,716		3,000		—		(564	)		2,436		(131	)
Total securities held to maturity	$	154,894	$	—	$	(11,974	)	$	142,920	$	150,079	$	-	$	(15,220	)	$	134,859	$	(131	)
Total securities	$	361,509	$	133	$	(42,319	)	$	319,323	$	326,578	$	64	$	(43,608	)	$	283,034	$	(131	)

December 31, 2021

Amortized Cost

Gross Unrealized Gains

Gross Unrealized (Losses)

Fair Value

Securities available for sale:

U.S. Treasury securities
$ 39,871 $ 37 $ (250 ) $ 39,658
U.S. agency and mortgage-backed securities
177,131 1,085 (1,837 ) 176,379
Obligations of states and political subdivisions
71,037 910 (509 ) 71,438
Corporate debt securities
2,019 1 — 2,020
Total securities available for sale
$ 290,058 $ 2,033 $ (2,596 ) $ 289,495
Securities held to maturity:

U.S. agency and mortgage-backed securities
$ 26,392 $ 124 $ (53 ) $ 26,463
Obligations of states and political subdivisions
7,049 118 (13 ) 7,154
Total securities held to maturity
$ 33,441 $ 242 $ (66 ) $ 33,617
Total securities
$ 323,499 $ 2,275 $ (2,662 ) $ 323,112

	December 31, 2022
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized (Losses)			Fair Value
Securities available for sale:
U.S. Treasury securities	$	12,468	$	—	$	(1,239	)	$	11,229
U.S. agency and mortgage-backed securities		109,972		95		(13,149	)		96,918
Obligations of states and political subdivisions		64,386		4		(9,630	)		54,760
Total securities available for sale	$	186,826	$	99	$	(24,018	)	$	162,907
Securities held to maturity:
U.S. Treasury securities	$	38,211	$	—	$	(568	)	$	37,643
U.S. agency and mortgage-backed securities		99,374		—		(9,189	)		90,185
Obligations of states and political subdivisions		12,573		—		(1,252	)		11,321
Corporate debt securities		3,000		—		(352	)		2,648
Total securities held to maturity	$	153,158	$	—	$	(11,361	)	$	141,797
Total securities	$	339,984	$	99	$	(35,379	)	$	304,704

1213

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Notes to Consolidated Financial Statements (Unaudited)

At ~~September 30, 2022~~Information pertaining to securities with gross unrealized losses aggregated by investment category and ~~December 31, 2021~~~~, investments~~length of time that individual securities have been in ~~an unrealized~~a continuous loss position ~~that were temporarily impaired were~~is as follows (in thousands):

	September 30, 2022															September 30, 2023
	Less than 12 months					12 months or more					Total					Less than 12 months					12 months or more					Total
	Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)
Securities available for sale:
U.S. Treasury securities	$	17,531	$	(2,422	)	$	—	$	—		$	17,531	$	(2,422	)	$	—	$	—		$	11,113	$	(1,361	)	$	11,113	$	(1,361	)
U.S. agency and mortgage-backed securities		33,107		(2,596	)		64,184		(13,404	)		97,291		(16,000	)		2,065		(37	)		77,201		(15,623	)		79,266		(15,660	)
Obligations of states and political subdivisions		33,128		(6,055	)		17,036		(5,868	)		50,164		(11,923	)		7,753		(382	)		44,511		(10,985	)		52,264		(11,367	)
Total securities available for sale	$	83,766	$	(11,073	)	$	81,220	$	(19,272	)	$	164,986	$	(30,345	)	$	9,818	$	(419	)	$	132,825	$	(27,969	)	$	142,643	$	(28,388	)
Securities held to maturity:
U.S. Treasury securities	$	28,517	$	(395	)	$	8,839	$	(243	)	$	37,356	$	(638	)
U.S. agency and mortgage-backed securities		68,723		(6,595	)		18,242		(2,756	)		86,965		(9,351	)
Obligations of states and political subdivisions		9,104		(1,576	)		1,774		(125	)		10,878		(1,701	)
Corporate debt securities		2,716		(284	)		—		—			2,716		(284	)
Total securities held to maturity	$	109,060	$	(8,850	)	$	28,855	$	(3,124	)	$	137,915	$	(11,974	)
Total securities	$	192,826	$	(19,923	)	$	110,075	$	(22,396	)	$	302,901	$	(42,319	)

	December 31, 2021															December 31, 2022
	Less than 12 months					12 months or more					Total					Less than 12 months					12 months or more					Total
	Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)			Fair Value		Unrealized (Loss)
Securities available for sale:
U.S. Treasury securities	$	29,656	$	(250	)	$	—	$	—		$	29,656	$	(250	)	$	9,041	$	(932	)	$	2,188	$	(307	)	$	11,229	$	(1,239	)
U.S. agency and mortgage-backed securities		109,950		(1,335	)		14,749		(502	)		124,699		(1,837	)		27,282		(1,945	)		62,342		(11,204	)		89,624		(13,149	)
Obligations of states and political subdivisions		34,611		(500	)		1,009		(9	)		35,620		(509	)		24,689		(2,581	)		26,362		(7,049	)		51,051		(9,630	)
Total securities available for sale	$	174,217	$	(2,085	)	$	15,758	$	(511	)	$	189,975	$	(2,596	)	$	61,012	$	(5,458	)	$	90,892	$	(18,560	)	$	151,904	$	(24,018	)
Securities held to maturity:
U.S. Treasury securities																$	19,302	$	(258	)	$	18,342	$	(310	)	$	37,644	$	(568	)
U.S. agency and mortgage-backed securities	$	5,411	$	(53	)	$	—	$	—		$	5,411	$	(53	)		58,019		(6,848	)		32,167		(2,341	)		90,186		(9,189	)
Obligations of states and political subdivisions		999		(13	)		—		—			999		(13	)		8,648		(1,008	)		2,672		(244	)		11,320		(1,252	)
Corporate debt securities																	2,648		(352	)		—		—			2,648		(352	)
Total securities held to maturity	$	6,410	$	(66	)	$	—	$	—		$	6,410	$	(66	)	$	88,617	$	(8,466	)	$	53,181	$	(2,895	)	$	141,798	$	(11,361	)
Total securities	$	180,627	$	(2,151	)	$	15,758	$	(511	)	$	196,385	$	(2,662	)	$	149,629	$	(13,924	)	$	144,073	$	(21,455	)	$	293,702	$	(35,379	)

The tables above provide information about securities that have been in an unrealized loss position for less than twelve consecutive months and securities that have been in an unrealized loss position for twelve consecutive months or more. Management evaluates securities ~~for other-than-temporary~~to determine whether the impairment is due to credit-related factors or noncredit-related factors at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. ~~Impairment~~Consideration is ~~considered~~given to ~~be other-than-temporary if~~the extent to which the fair value is less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company (1~~) intends~~ to ~~sell~~retain its investment in the security (2~~) more likely than~~ ~~not~~ ~~will be required~~for a period of time sufficient to ~~sell the security before recovering its cost, or (~~3~~) does~~ ~~not~~ ~~expect to recover the security’s entire amortized cost basis.~~ allow for any anticipated recovery in fair value. Presently, the Company does not intend to sell any of these securities, does not expect to be required to sell these securities, and expects to recover the entire amortized cost of all the securities.

~~Table of Contents~~

~~Notes~~Accrued interest receivable on securities available for sale and securities held to ~~Consolidated Financial Statements (Unaudited)~~maturity totaled $786 thousand and $593 thousand, respectively, at September 30, 2023. Accrued interest on debt securities is included in accrued interest receivable on the Company's consolidated balance sheets.

At September 30, 2023, there were three out of three U.S. Treasury securities, 94 out of 107 U.S. agency and mortgage-backed securities, and 97 out of 104 obligations of states and political subdivisions in an unrealized loss position. One hundred percent of the Company’s investment portfolio was considered investment grade. The weighted-average re-pricing term of the portfolio was 5.9 years at September 30, 2023. One hundred percent of the Company’s investment portfolio was considered investment grade at December 31, 2022. The weighted-average re-pricing term of the portfolio was 6.5 years at December 31, 2022. The unrealized losses at September 30, 2023 in the U.S. Treasury securities portfolio, U.S. agency and mortgage-backed securities portfolio, and obligations of states and political subdivisions portfolio were related to changes in market interest rates and not credit concerns of the issuers.

On September 1, 2022, the Bank transferred 24 securities designated as available for sale with a combined book value of $82.2 million, market value of $74.4 million, and unrealized loss of $7.8 million, to securities designated held to maturity. The unrealized loss is being amortized monthly over the life of the securities with an increase to the carrying value of securities and a decrease to the related accumulated other comprehensive loss, which is included in the shareholders’ equity section of the Company’s balance sheet. The amortization of the unrealized loss on the transferred securities totaled ~~$157 thousand, or $124 thousand net of tax,~~$1.2 million for the ~~third~~first ~~quarter~~nine months of ~~2022.~~2023. The securities selected for transfer had larger potential decreases in their fair market values in higher interest rate environments than most of the other securities in the available for sale portfolio and included U.S. Treasury, agency, municipal and commercial mortgage-backed securities. The securities were transferred to mitigate the potential unfavorable impact that higher market interest rates may have on the carrying value of the securities and on the related accumulated other comprehensive loss. ~~Securities designated as held to maturity are carried on the balance sheet at amortized cost, while securities designated as available for sale are carried at fair market value.~~

~~September 30, 2022~~14~~, there were 12 out~~

Table of 12 U.S. Treasury securities, 122 out of 145 U.S. agency and mortgage-backed securities, 111 out of 116 obligations of states and political subdivisions, and one out of one corporate debt securities in an unrealized loss position. One hundred percent of the Company’s investment portfolio is considered investment grade. The weighted-ave~~rage re-pricing term of the portfolio was 6.1 years a~~t ~~September 30, 2022~~~~. At~~ ~~December 31, 2021~~~~, there we~~re~~six~~ ~~out of~~ ~~eight~~ U.S. Treasury securities, 58 out of 135 U.S. agency and mortgage-backed securities and 37 out of 118 obligations of states and political subdivisions in an unrealized loss position. One hundred percent of the Company’s investment portfolio was considered investment grade at ~~December 31, 2021~~~~. The weighted-average re-pricing term of the portfolio was 5.2 years at~~ ~~December 31, 2021~~~~. The unrealized losses at~~ ~~September 30, 2022~~ in the U.S. Treasury securities portfolio, U.S. agency and mortgage-backed securities portfolio, obligations of states and political subdivisions portfolio, and the corporate debt securities portfolio were relatedContents

Notes to ~~changes in market interest rates and~~ ~~not~~ ~~credit concerns of the issuers.~~Consolidated Financial Statements (Unaudited)

The amortized cost and fair value of securities at September 30, ~~2022~~2023 by contractual maturity are shown below (in thousands). Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.

	Available for Sale				Held to Maturity				Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due within one year	$	-	$	-	$	907	$	902	$	760	$	757	$	20,828	$	20,642
Due after one year through five years		17,612		16,341		44,214		43,113		23,027		21,026		28,993		27,586
Due after five years through ten years		53,590		48,051		27,267		24,698		37,962		33,340		23,514		20,658
Due after ten years		135,413		112,011		82,506		74,207		114,750		93,052		76,744		65,973
	$	206,615	$	176,403	$	154,894	$	142,920	$	176,499	$	148,175	$	150,079	$	134,859

Federal Home Loan Bank, Federal Reserve Bank, and Community Bankers’ Bank stock are generally viewed as long-term investments and as restricted securities, which are carried at cost, because there is a minimal market for the stock. Therefore, when evaluating restricted securities for impairment, their value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. ~~The Company does~~ ~~not~~ ~~consider these investments to be other-than-temporarily impaired at~~ ~~September 30, 2022~~~~, and no impairment has been recognized.~~

The composition of restricted securities at September 30, ~~2022~~2023 and December 31, ~~2021~~2022 was as follows (in thousands):

	September 30, 2022		December 31, 2021		September 30, 2023		December 31, 2022
Federal Home Loan Bank stock	$	796	$	701	$	965	$	796
Federal Reserve Bank stock		980		980		980		980
Community Bankers’ Bank stock		132		132		132		132
	$	1,908	$	1,813	$	2,077	$	1,908

The Company also holds limited partnership investments in Small Business Investment Companies (SBICs), which are included in other assets in the Consolidated Balance Sheets. The limited partnership investments are measured as equity investments without readily determinable fair values at their cost, less any impairment. The amounts included in other assets for the limited partnership investments were ~~$566~~$642 thousand and ~~$504~~$599 thousand at September 30, ~~2022~~2023 and December 31, ~~2021~~2022, respectively.

Credit Quality Indicators & Allowance for Credit Losses - HTM

The Company monitors the credit quality of the debt securities held to maturity through the use of credit ratings from Moody's, S&P, and Egan-Jones. The Company monitors the credit ratings on a quarterly basis. The following table summarizes the amortized cost of debt securities held to maturity at September 30, 2023, aggregated by credit quality indicators.

	U.S. Treasury securities		U.S. agency and mortgage-backed securities		Obligations of states and political subdivisions		Corporate debt securities		Total Held to Maturity Securities
September 30, 2023
Aaa	$	38,862	$	22,877	$	2,812	$	—	$	64,551
Aa1 / Aa2 / Aa3		—		—		8,842		—		8,842
Baa1 / Baa2 / Baa3		—		—		—		3,000		3,000
Not rated - Agency ⁽¹⁾		—		73,686		—		—		73,686
Total	$	38,862	$	96,563	$	11,654	$	3,000	$	150,079
December 31, 2022
Aaa	$	38,211	$	22,706	$	3,126	$	—	$	64,043
Aa1 / Aa2 / Aa3		—		—		9,447		—		9,447
Baa1 / Baa2 / Baa3		—		—		—		3,000		3,000
Not rated - Agency ⁽¹⁾		—		76,668		—		—		76,668
Total	$	38,211	$	99,374	$	12,573	$	3,000	$	153,158

⁽¹⁾Generally considered not to have credit risk given the implied governmental guarantees associated with these agencies.

The following table summarizes the change in the allowance for credit losses on held to maturity securities for the nine months ended September 30, 2023.

	U.S. Treasury securities		U.S. agency and mortgage-backed securities		Obligations of states and political subdivisions		Corporate debt securities			Total Held to Maturity Securities
Balance, December 31, 2022	$	—	$	—	$	—	$	—		$	—
Adjustment for adoption of ASU 2016-13		—		—		—		134			134
Provision for credit losses		—		—		—		10			10
Charge-offs of securities		—		—		—		—			—
Recoveries		—		—		—		(13	)		(13	)
Balance, September 30, 2023	$	—	$	—	$	—	$	131		$	131

At September 30, 2023, the Company had no securities held-to-maturity that were past due 30 days or more as to principal and interest payments. The Company had no securities held-to-maturity classified as nonaccrual as of September 30, 2023.

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Notes to Consolidated Financial Statements (Unaudited)

Note 3. Loans

Loans at September 30, ~~2022~~2023 and December 31, ~~2021~~2022 are summarized as follows (in thousands):

	September 30, 2022			December 31, 2021			September 30, 2023			December 31, 2022
Real estate loans:
Construction and land development	$	51,352		$	55,721		$	50,405		$	51,840
Secured by 1-4 family residential		317,414			291,990			340,773			331,421
Other real estate loans		417,504			364,921			433,177			418,456
Commercial and industrial loans		112,145			99,805			117,130			111,225
Consumer and other loans		8,099			12,681			11,014			7,581
Total loans	$	906,514		$	825,118		$	952,499		$	920,523
Allowance for loan losses		(6,292	)		(5,710	)
Allowance for credit losses								(8,896	)		(7,446	)
Loans, net	$	900,222		$	819,408		$	943,603		$	913,077

Net deferred loan fees included in the above loan categories were ~~$856~~$929 thousand and ~~$871~~$838 thousand at September 30, ~~2022~~2023 and December 31, ~~2021~~2022, respectively. Consumer and other loans included ~~$163~~$368 thousand and ~~$175~~$197 thousand of demand deposit overdrafts at September 30, ~~2022~~2023 and December 31, ~~2021~~2022, respectively.

Risk characteristics of each loan portfolio class that are considered by the Company include:

•

1-4 family residential mortgage loans carry risks associated with the continued creditworthiness of the borrower and changes in the value of the collateral.

•

Real estate construction and land development loans carry risks that the project may not be finished according to schedule, the project may not be finished according to budget, and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure or other factors unrelated to the project.

•

Other real estate loans carry risks associated with the successful operation of a business or a real estate project, in addition to other risks associated with the ownership of real estate, because repayment of these loans may be dependent upon the profitability and cash flows of the business or project.

•

Commercial and industrial loans carry risks associated with the successful operation of a business because repayment of these loans may be dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much reliability. Commercial and industrial loans also include purchased loans which could have been originated outside of the Company's market area.

•

Consumer and other loans carry ~~risk~~risks associated with the continued creditworthiness of the borrower and the value of the collateral, if any. Consumer loans are typically either unsecured or secured by rapidly depreciating assets such as automobiles. They are also likely to be immediately and adversely affected by job loss, divorce, illness, personal bankruptcy, or other changes in circumstances. Consumer and other loans also include purchased consumer loans which could have been originated outside of the Company's market area. Other loans included in this category include loans to states and political subdivisions.

Loans acquired in business combinations are recorded in the Consolidated Balance Sheets at fair value at the acquisition date under the acquisition method of accounting. The principal balance of purchased loans is included in the allowance for credit losses calculation. The remaining net discount on purchased loans at September 30, 2023 was $2.0 million. The outstanding principal balance and the carrying amount at September 30, ~~2022~~2023 and December 31, 2022 of loans acquired in business combinations were as follows:

			September 30, 2023		December 31, 2022
	Acquired Loans-		Acquired Loans-		Acquired Loans-
	Purchased		Non-Purchased		Non-Purchased
(Dollars in thousands)	Performing		Credit Deteriorated		Credit Deteriorated
Outstanding principal balance	$	166,832	$	166,349	$	187,017

Carrying amount
Real estate loans:
Construction and land development	$	5,943	$	8,450	$	9,823
Secured by 1-4 family residential		44,046		36,405		42,915
Other real estate loans		86,226		95,313		103,521
Commercial and industrial loans		23,848		20,681		24,661
Consumer and other loans		4,115		3,472		3,560
Total acquired loans	$	164,178	$	164,321	$	184,480

1516

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Notes to Consolidated Financial Statements (Unaudited)

The following tables provide a summary of loan classes and an aging of past due loans as of September 30, ~~2022~~2023 and December 31, ~~2021~~2022 (in thousands):

	September 30, 2022																September 30, 2023
	30-59 Days Past Due		60-89 Days Past Due		> 90 Days Past Due		Total Past Due		Current		Total Loans		Non-accrual Loans		90 Days or More Past Due and Accruing		30-59 Days Past Due		60-89 Days Past Due		> 90 Days Past Due		Total Past Due		Current		Total Loans		Non-accrual Loans		90 Days or More Past Due and Accruing
Real estate loans:
Construction and land development	$	432	$	175	$	211	$	818	$	50,534	$	51,352	$	—	$	211	$	—	$	—	$	39	$	39	$	50,366	$	50,405	$	39	$	—
Secured by 1-4 family residential		153		—		286		439		316,975		317,414		549		95		1,242		58		534		1,834		338,939		340,773		546		368
Other real estate loans		—		—		—		—		417,504		417,504		17		—		—		—		62		62		433,115		433,177		67		—
Commercial and industrial		114		1,204		—		1,318		110,827		112,145		—		—		83		—		—		83		117,047		117,130		2,464		—
Consumer and other loans		39		—		—		39		8,060		8,099		—		—		10		2		2		14		11,000		11,014		—		2
Total	$	738	$	1,379	$	497	$	2,614	$	903,900	$	906,514	$	566	$	306	$	1,335	$	60	$	637	$	2,032	$	950,467	$	952,499	$	3,116	$	370

	December 31, 2021																December 31, 2022
	30-59 Days Past Due		60-89 Days Past Due		> 90 Days Past Due		Total Past Due		Current		Total Loans		Non-accrual Loans		90 Days or More Past Due and Accruing		30-59 Days Past Due		60-89 Days Past Due		> 90 Days Past Due		Total Past Due		Current		Total Loans		Non-accrual Loans		90 Days or More Past Due and Accruing
Real estate loans:
Construction and land development	$	—	$	115	$	—	$	115	$	55,606	$	55,721	$	—	$	—	$	115	$	20	$	1,045	$	1,180	$	50,660	$	51,840	$	1,045	$	—
Secured by 1-4 family residential		1,293		100		372		1,765		290,225		291,990		766		—		1,033		60		207		1,300		330,121		331,421		530		—
Other real estate loans		186		—		—		186		364,735		364,921		29		—		109		—		—		109		418,347		418,456		13		—
Commercial and industrial		1,474		—		—		1,474		98,331		99,805		1,509		—		31		130		1,085		1,246		109,979		111,225		1,085		—
Consumer and other loans		56		11		—		67		12,614		12,681		—		—		26		25		—		51		7,530		7,581		—		—
Total	$	3,009	$	226	$	372	$	3,607	$	821,511	$	825,118	$	2,304	$	—	$	1,314	$	235	$	2,337	$	3,886	$	916,637	$	920,523	$	2,673	$	—

Credit Quality Indicators

As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to the risk grading of specified classes of loans. The Company utilizes a risk grading matrix to assign a rating to each of its loans. The loan ratings are summarized into the following categories: pass, special mention, substandard, doubtful, and loss. Pass rated loans include all risk rated credits other than those included in special mention, substandard, or doubtful. Loans classified as loss are charged-off. Loan officers assign risk grades to loans at origination and as renewals arise. The Bank’s Credit Administration department reviews risk grades for accuracy on a quarterly basis and as credit issues arise. In addition, a certain amount of loans are reviewed each year through the Company’s internal and external loan review process. A description of the general characteristics of the loan grading categories is as follows:

Pass – Loans classified as pass exhibit acceptable operating trends, balance sheet trends, and liquidity. Sufficient cash flow exists to service the loan. All obligations have been paid by the borrower as agreed.

Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the Bank’s credit position at some future date.

~~Table of Contents~~

~~Notes to Consolidated Financial Statements (Unaudited)~~

Substandard – Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The Company considers all doubtful loans to be impaired and places the loan on non-accrual status.

Loss – Loans classified as loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

The following table presents the Company's recorded investment in loans by credit quality indicators by year of origination as of September 30, 2023 (in thousands).

	September 30, 2023
	Term Loans by Year of Origination
	2023		2022		2021		2020		2019		Prior		Revolving		Total
Construction and land development
Pass	$	2,625	$	3,311	$	7,824	$	2,613	$	2,127	$	3,290	$	28,576	$	50,366
Special Mention		—		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		39		—		39
Doubtful		—		—		—		—		—		—		—		—
Total Construction and land development	$	2,625	$	3,311	$	7,824	$	2,613	$	2,127	$	3,329	$	28,576	$	50,405

Current period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Secured by 1-4 family residential
Pass	$	32,461	$	78,044	$	65,455	$	42,454	$	33,258	$	78,826	$	9,438	$	339,936
Special Mention		—		—		—		—		—		—		—		—
Substandard		—		98		19		—		—		720		—		837
Doubtful		—		—		—		—		—		—		—		—
Total Secured by 1-4 family residential	$	32,461	$	78,142	$	65,474	$	42,454	$	33,258	$	79,546	$	9,438	$	340,773

Current period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Other real estate loans
Pass	$	34,365	$	93,010	$	87,799	$	42,599	$	40,686	$	123,320	$	11,331	$	433,110
Special Mention		—		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		—		67		67
Doubtful		—		—		—		—		—		—		—		—
Total Other real estate loans	$	34,365	$	93,010	$	87,799	$	42,599	$	40,686	$	123,320	$	11,398	$	433,177

Current period gross write-offs	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Commercial and industrial
Pass	$	21,279	$	30,216	$	25,491	$	4,373	$	5,135	$	8,729	$	18,050	$	113,273
Special Mention		—		—		—		—		—		—		—		—
Substandard		—		2,870		—		100		—		887		—		3,857
Doubtful		—		—		—		—		—		—		—		—
Total Commercial and industrial	$	21,279	$	33,086	$	25,491	$	4,473	$	5,135	$	9,616	$	18,050	$	117,130

Current period gross write-offs	$	—	$	—	$	—	$	624	$	—	$	253	$	—	$	877

Consumer and other loans
Pass	$	2,625	$	1,408	$	395	$	1,505	$	2,222	$	29	$	2,830	$	11,014
Special Mention		—		—		—		—		—		—		—		—
Substandard		—		—		—		—		—		—		—		—
Doubtful		—		—		—		—		—		—		—		—
Total Consumer and other loans	$	2,625	$	1,408	$	395	$	1,505	$	2,222	$	29	$	2,830	$	11,014

Current period gross write-offs	$	273	$	55	$	3	$	14	$	3	$	3	$	—	$	351

The following tables provide an analysis of the credit risk profile of each loan class as of ~~September 30, 2022~~ ~~and~~ December 31, ~~2021~~2022 (in thousands):

September 30, 2022

Pass
Special Mention
Substandard

Doubtful

Total

Real estate loans:

Construction and land development
$ 51,352 $ — $ — $ — $ 51,352
Secured by 1-4 family residential
316,561 — 853 — 317,414
Other real estate loans
415,966 1,521 17 — 417,504
Commercial and industrial
110,484 1,661 — — 112,145
Consumer and other loans
8,099 — — — 8,099
Total
$ 902,462 $ 3,182 $ 870 $ — $ 906,514

December 31, 2021

Pass
Special Mention
Substandard

Doubtful

Total

Real estate loans:

Construction and land development
$ 55,721 $ — $ — $ — $ 55,721
Secured by 1-4 family residential
290,909 — 1,081 — 291,990
Other real estate loans
364,892 — 29 — 364,921
Commercial and industrial
97,215 1,081 1,509 — 99,805
Consumer and other loans
12,681 — — — 12,681
Total
$ 821,418 $ 1,081 $ 2,619 $ — $ 825,118

~~Table of Contents~~

~~Notes to Consolidated Financial Statements (Unaudited)~~

~~Note~~ 4. ~~Allowance for Loan Losses~~

~~The following tables present, as of and during the periods ended~~ ~~September 30, 2022~~, ~~December 31, 2021~~ ~~and~~ ~~September 30, 2021~~~~, the total allowance for loan losses, the allowance by impairment methodology, and loans by impairment methodology (in thousands):~~

September 30, 2022

Construction and Land Development Secured by 1-4 Family Residential Other Real Estate Commercial and Industrial Consumer and Other Loans
Total

Allowance for loan losses:

Beginning Balance, December 31, 2021
$ 345 $ 1,077 $ 3,230 $ 718 $ 340 $ 5,710
Charge-offs
— (6 ) — — (387 ) (393 )
Recoveries
10 15 12 144 194 375
Provision for (recovery of) loan losses
99 (22 ) 331 69 123 600
Ending Balance, September 30, 2022
$ 454 $ 1,064 $ 3,573 $ 931 $ 270 $ 6,292
Ending Balance:

Individually evaluated for impairment
— — — — — —
Collectively evaluated for impairment
454 1,064 3,573 931 270 6,292
Loans:

Ending Balance
$ 51,352 $ 317,414 $ 417,504 $ 112,145 $ 8,099 $ 906,514
Individually evaluated for impairment
— 549 17 — — 566
Collectively evaluated for impairment
51,352 316,865 417,487 112,145 8,099 905,948

December 31, 2021

Construction and Land Development Secured by 1-4 Family Residential Other Real Estate Commercial and Industrial Consumer and Other Loans
Total

Allowance for loan losses:

Beginning Balance, December 31, 2020
$ 306 $ 1,022 $ 4,956 $ 784 $ 417 $ 7,485
Charge-offs
— (15 ) (992 ) (6 ) (434 ) (1,447 )
Recoveries
6 65 3 7 241 322
Provision for (recovery of) loan losses
33 5 (737 ) (67 ) 116 (650 )
Ending Balance, December 31, 2021
$ 345 $ 1,077 $ 3,230 $ 718 $ 340 $ 5,710
Ending Balance:

Individually evaluated for impairment
— — — 55 — 55
Collectively evaluated for impairment
345 1,077 3,230 663 340 5,655
Loans:

Ending Balance
$ 55,721 $ 291,990 $ 364,921 $ 99,805 $ 12,681 $ 825,118
Individually evaluated for impairment
— 765 30 1,509 — 2,304
Collectively evaluated for impairment
55,721 291,225 364,891 98,296 12,681 822,814

	December 31, 2022
	Pass		Special Mention		Substandard		Doubtful		Total
Real estate loans:
Construction and land development	$	50,795	$	—	$	1,045	$	—	$	51,840
Secured by 1-4 family residential		330,590		—		831		—		331,421
Other real estate loans		416,559		1,884		13		—		418,456
Commercial and industrial		110,065		75		1,085		—		111,225
Consumer and other loans		7,581		—		—		—		7,581
Total	$	915,590	$	1,959	$	2,974	$	—	$	920,523

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

September 30, 2021

Construction and Land Development Secured by 1-4 Family Residential Other Real Estate Commercial and Industrial Consumer and Other Loans
Total

Allowance for loan losses:

Beginning Balance, December 31, 2020
$ 306 $ 1,022 $ 4,956 $ 784 $ 417 $ 7,485
Charge-offs
— (15 ) (992 ) — (255 ) (1,262 )
Recoveries
— 46 2 6 157 211
(Recovery of) provision for loan losses
(25 ) (97 ) (813 ) (81 ) 16 (1,000 )
Ending Balance, September 30, 2021
$ 281 $ 956 $ 3,153 $ 709 $ 335 $ 5,434
Ending Balance:

Individually evaluated for impairment
— — — 84 — 84
Collectively evaluated for impairment
281 956 3,153 625 335 5,350
Loans:

Ending Balance
$ 45,120 $ 294,216 $ 362,643 $ 105,664 $ 14,768 $ 822,411
Individually evaluated for impairment
— 470 153 1,535 — 2,158
Collectively evaluated for impairment
45,120 293,746 362,490 104,129 14,768 820,253

Note 4. Allowance for Credit Losses

The following tables present, as of and during the periods ended September 30, 2023, December 31, 2022 and September 30, 2022, the activity in the Allowance for Credit Losses on Loans (ACLL) (previously Allowance for Loan Losses) by portfolio, and information about individually evaluated and collectively evaluated loans (in thousands):

	September 30, 2023
	Construction and Land Development			Secured by 1-4 Family Residential			Other Real Estate			Commercial and Industrial			Consumer and Other Loans			Total
Allowance for credit losses:
Beginning Balance, December 31, 2022	$	546		$	1,108		$	3,609		$	1,874		$	309		$	7,446
Adjustment to allowance for adoption of ASU 2016-13		(313	)		1,409			1,702			(387	)		(225	)		2,186
Charge-offs		—			—			—			(877	)		(351	)		(1,228	)
Recoveries		1			13			13			145			154			326
Provision for (recovery of) credit losses		68			(97	)		(179	)		165			209			166
Ending Balance, September 30, 2023	$	302		$	2,433		$	5,145		$	920		$	96		$	8,896
Ending Balance:
Individually evaluated		—			—			—			307			—			307
Collectively evaluated		302			2,433			5,145			613			96			8,589
Loans:
Ending Balance	$	50,405		$	340,773		$	433,177		$	117,130		$	11,014		$	952,499
Individually evaluated		39			546			67			2,464			—			3,116
Collectively evaluated		50,366			340,227			433,110			114,666			11,014			949,383

	December 31, 2022
	Construction and Land Development		Secured by 1-4 Family Residential			Other Real Estate		Commercial and Industrial			Consumer and Other Loans			Total
Allowance for loan losses:
Beginning Balance, December 31, 2021	$	345	$	1,077		$	3,230	$	718		$	340		$	5,710
Charge-offs		—		(6	)		—		(32	)		(491	)		(529	)
Recoveries		10		19			15		145			226			415
Provision for (recovery of) loan losses		191		18			364		1,043			234			1,850
Ending Balance, December 31, 2022	$	546	$	1,108		$	3,609	$	1,874		$	309		$	7,446
Ending Balance:
Individually evaluated for impairment		—		—			—		888			—			888
Collectively evaluated for impairment		546		1,108			3,609		986			309			6,558
Loans:
Ending Balance	$	51,840	$	331,421		$	418,456	$	111,225		$	7,581		$	920,523
Individually evaluated for impairment		1,045		530			13		1,085			—			2,673
Collectively evaluated for impairment		50,795		330,891			418,443		110,140			7,581			917,850

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

	September 30, 2022
	Construction and Land Development		Secured by 1-4 Family Residential			Other Real Estate		Commercial and Industrial		Consumer and Other Loans			Total
Allowance for loan losses:
Beginning Balance, December 31, 2021	$	345	$	1,077		$	3,230	$	718	$	340		$	5,710
Charge-offs		—		(6	)		—		—		(387	)		(393	)
Recoveries		10		15			12		144		194			375
Provision for (recovery of) loan losses		99		(22	)		331		69		123			600
Ending Balance, September 30, 2022	$	454	$	1,064		$	3,573	$	931	$	270		$	6,292
Ending Balance:
Individually evaluated for impairment		—		—			—		—		—			—
Collectively evaluated for impairment		454		1,064			3,573		931		270			6,292
Loans:
Ending Balance	$	51,352	$	317,414		$	417,504	$	112,145	$	8,099		$	906,514
Individually evaluated for impairment		—		549			17		—		—			566
Collectively evaluated for impairment		51,352		316,865			417,487		112,145		8,099			905,948

Nonaccrual loans

The following is a summary of the Company's nonaccrual loans by major categories for the periods indicated (in thousands):

	CECL						Incurred Loss
	September 30, 2023						December 31, 2022
	Nonaccrual Loans with No Allowance		Nonaccrual loans with an Allowance		Total Nonaccrual Loans		Nonaccrual Loans
Real estate loans:
Construction and land development	$	39	$	—	$	39	$	1,045
Secured by 1-4 family residential		546		—		546		530
Other real estate loans		67		—		67		13
Commercial and industrial		—		2,464		2,464		1,085
Total	$	652	$	2,464	$	3,116	$	2,673

Prior to the adoption of ASU 2016-13, loans were considered impaired when, based on current information and events, it was probable the Company would be unable to collect all amounts due in accordance with the original contractual terms of the loan agreements. Impaired loans included loans on nonaccrual status and accruing troubled debt restructurings. When determining if the Company would be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement, the Company considered the borrower's capacity to pay, which included such factors as the borrower's current financial statements, an analysis of global cash flow sufficient to pay all debt obligations and an evaluation of secondary sources of repayment, such as guarantor support and collateral value. The Company individually assessed for impairment all nonaccrual loans and troubled debt restructurings. The tables below include information on all loans deemed impaired. Interest payments on impaired loans were typically applied to principal unless collectability of the principal amount was reasonably assured, in which case interest was recognized on a cash basis.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Impaired loans and the related allowance as of and for the periods ended December 31, 2022 and September 30, 2022, ~~December 31, 2021~~ ~~and~~ ~~September 30, 2021~~, were as follows (in thousands):

	December 31, 2022
	Unpaid Principal Balance		Recorded Investment with No Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
Real estate loans:
Construction and land development	$	2,412	$	1,045	$	—	$	1,045	$	—	$	30	$	75
Secured by 1-4 family residential		680		530		—		530		—		580		11
Other real estate loans		26		13		—		13		—		22		—
Commercial and industrial		1,084		—		1,085		1,085		888		650		40
Total	$	4,202	$	1,588	$	1,085	$	2,673	$	888	$	1,282	$	126

	September 30, 2022
	Unpaid Principal Balance		Recorded Investment with No Allowance		Recorded Investment with Allowance		Total Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
Real estate loans:
Secured by 1-4 family residential	$	560	$	549	$	—	$	549	$	—	$	593	$	11
Other real estate loans		29		17		—		17		—		24		—
Commercial and industrial		—		—		—		—		—		823		—
Total	$	589	$	566	$	—	$	566	$	—	$	1,440	$	11

December 31, 2021

Unpaid Principal Balance Recorded Investment with No Allowance Recorded Investment with Allowance Total Recorded Investment Related Allowance Average Recorded Investment Interest Income Recognized
Real estate loans:

Construction and land development
$ — $ — $ — $ — $ — $ 91 $ —
Secured by 1-4 family residential
889 766 — 766 — 429 9
Other real estate loans
40 29 — 29 — 2,384 —
Commercial and industrial
1,673 — 1,509 1,509 55 1,613 —
Total
$ 2,602 $ 795 $ 1,509 $ 2,304 $ 55 $ 4,517 $ 9

September 30, 2021

Unpaid Principal Balance Recorded Investment with No Allowance Recorded Investment with Allowance Total Recorded Investment Related Allowance Average Recorded Investment Interest Income Recognized
Real estate loans:

Construction and land development
$ — $ — $ — $ — $ — $ 273 $ —
Secured by 1-4 family residential
611 470 — 470 — 420 3
Other real estate loans
167 153 — 153 — 3,159 1
Commercial and industrial
1,655 — 1,535 1,535 84 1,548 —
Total
$ 2,433 $ 623 $ 1,535 $ 2,158 $ 84 $ 5,400 $ 4

The “Recorded Investment” amounts in the table above represent the outstanding principal balance on each loan represented in the table. The “Unpaid Principal Balance” represents the outstanding principal balance on each loan represented in the table plus any amounts that have been charged off on each loan and/or payments that have been applied towards principal on non-accrual loans. Only loan classes with balances are included in the tables above.

As of ~~September 30,~~December 31, 2022, loans classified as ~~troubled debt restructurings (TDRs)~~TDRs and included in impaired loans in the disclosure above totaled ~~$110~~$101 thousand. At ~~September 30,~~December 31, 2022,, none of the loans classified as TDRs were performing under the restructured terms and all were considered non-performing assets. ~~There were $1.6 million in TDRs at~~ ~~December 31, 2021~~~~, $7 thousand of which were performing under the restructured terms.~~ Modified terms under TDRs ~~may~~ ~~include~~included rate reductions, extension of terms that are considered to be below market, conversion to interest only, and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. ~~There were no loans modified under TDRs during~~

For the ~~three~~ ~~and~~ nine months ended September 30, ~~2022~~ ~~and~~ ~~2021~~.

~~For the~~ ~~three~~ ~~and~~ ~~nine~~ ~~months ended~~ ~~September 30, 2022~~2023 and ~~2021~~2022, there were no TDRs that subsequently defaulted within twelve months of the loan modification. Management defines default as over ninety days past due or the foreclosure and repossession of the collateral or charge-off of the loan during the twelve month period subsequent to the modification.

Collateral-Dependent Loans

The Company may determine that an individual loan exhibits unique risk characteristics which differentiate it from other loans within our loan pools. In such cases, the loans are evaluated for expected credit losses on an individual basis and excluded from the collective evaluation. Specific allocations of the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. In such cases, expected credit losses are based on the fair value of the collateral at the measurement date, adjusted for estimated selling costs if satisfaction of the loan depends on the sale of the collateral. The Company reevaluates the fair value of collateral supporting collateral dependent loans on a quarterly basis. The fair value of real estate collateral supporting collateral dependent loans is evaluated by appraisal services using a methodology that is consistent with the Uniform Standards of Professional Appraisal Practice. The underlying collateral can vary based upon the type of loan. The following provides more detail about the types of collateral that secure collateral dependent loans:

•

Commercial real estate loans can be secured by either owner occupied commercial real estate or non-owner occupied investment commercial real estate. Typically, owner occupied commercial real estate loans are secured by office buildings, warehouses, manufacturing facilities and other commercial and industrial properties occupied by operating companies. Non-owner occupied commercial real estate loans are generally secured by office buildings and complexes, retail facilities, multifamily complexes, land under development, industrial properties, as well as other commercial or industrial real estate.

	•	Residential real estate loans are typically secured by first mortgages, and in some cases could be secured by a second mortgage.
	•	Home equity lines of credit are generally secured by second mortgages on residential real estate property.
	•	Consumer loans are generally secured by automobiles, motorcycles, recreational vehicles and other personal property. Some consumer loans are unsecured and have no underlying collateral.

The following table presents the amortized cost of collateral-dependent loans (in thousands):

	September 30, 2023
(Dollars in thousands)	Real Estate Secured		Non-Real Estate Secured		Total Collateral-Dependent Loans
Real estate loans:
Construction and land development	$	39	$	—	$	39
Secured by 1-4 family residential		546		—		546
Other real estate loans		67		—		67
Commercial and industrial		—		2,464		2,464
Total	$	652	$	2,464	$	3,116

At September 30, 2023, there was an allowance for credit losses of $307 thousand on collateral-dependent loans.

2021

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Modifications Made to Borrowers Experiencing Financial Difficulty

The allowance for credit losses incorporates an estimate of lifetime expected credit losses and is recorded on each asset upon asset origination or acquisition. The starting point for the estimate of the allowance for credit losses is historical loss information, which includes losses from modifications of receivables to borrowers experiencing financial difficulty. The Company uses a probability of default/loss given default model to determine the allowance for credit losses. An assessment of whether a borrower is experiencing financial difficulty is made on the date of a modification.

Because the effect of most modifications made to borrowers experiencing financial difficulty is already included in the allowance for credit losses because of the measurement methodologies used to estimate the allowance, a change to the allowance for credit losses is generally not recorded upon modification. Occasionally, the Company modifies loans by providing principal forgiveness on certain of its real estate loans. When principal forgiveness is provided, the amortized cost basis of the asset is written off against the allowance for credit losses. The amount of the principal forgiveness is deemed to be uncollectible; therefore, that portion of the loan is written off, resulting in a reduction of the amortized cost basis and a corresponding adjustment to the allowance for credit losses.

In some cases, the Company will modify a certain loan by providing multiple types of concessions. Typically, one type of concession, such as a term extension, is granted initially. If the borrower continues to experience financial difficulty, another concession, such as principal forgiveness, may be granted. For the real estate loans included in the “combination” columns below, multiple types of modifications have been made on the same loan within the current reporting period. The combination is at least two of the following: a term extension, principal forgiveness, and interest rate reduction.

The following table shows the amortized cost basis as of September 30, 2023 of the loans modified to borrowers experiencing financial difficulty, disaggregated by class of loans and type of concession granted and describes the financial effect of the modifications made to borrowers experiencing financial difficulty:

	Term Extension
(Dollars in thousands)	Amortized Cost Basis		% of Total Loan Type			Financial Effect
Real estate loans:
Construction and land development	$	—		0.00	%
Secured by 1-4 family residential		64		0.02	%	Converted HELOC to 15 year term loan.
Other real estate loans		—		0.00	%
Commercial and industrial		2,464		2.10	%	Decrease in loan payment
Total	$	2,528		2.12	%

	Principal Forgiveness
(Dollars in thousands)	Amortized Cost Basis		% of Total Loan Type			Financial Effect
Real estate loans:
Construction and land development	$	—		0.00	%
Secured by 1-4 family residential		17		0.01	%	Reduced the amortized cost basis of the loan by $29 thousand.
Other real estate loans		—		0.00	%
Commercial and industrial		—		0.00	%
Total	$	17		0.01	%

Upon the Company's determination that a modified loan (or portion of a loan) has subsequently been deemed uncollectible, the loan (or a portion of the loan) is written off. Therefore, the amortized cost basis of the loan is reduced by the uncollectible amount and the allowance for credit losses is adjusted by the same amount. For the nine months ended September 30, 2023 and 2022, there were no payment defaults of modified loans that were modified during the previous twelve months. At September 30, 2023, there was an allowance for credit losses of $307 thousand on modified loans.

Unfunded Commitments

The Company maintains a separate reserve for credit losses on off-balance-sheet credit exposures, including unfunded loan commitments, which is included in other liabilities on the consolidated balance sheet. The reserve for credit losses on off-balance-sheet credit exposures is adjusted as a provision for credit losses in the income statement. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life, utilizing the same models and approaches for the Company's other loan portfolio segments described in Note 1, as these unfunded commitments share similar risk characteristics as its loan portfolio segments. The Company has identified the unfunded portion of certain lines of credit as unconditionally cancellable credit exposures, meaning the Company can cancel the unfunded commitment at any time. No credit loss estimate is reported for off-balance-sheet credit exposures that are unconditionally cancellable by the Company or for undrawn amounts under such arrangements that may be drawn prior to the cancellation of the arrangement.

On January 1, 2023, the Company recorded an adjustment for unfunded commitments of $153 thousand for the adoption of ASC Topic 326. For the three months ended September 30, 2023, the Company recorded a recovery of credit losses for unfunded commitments of $8 thousand. At September 30, 2023, the liability for credit losses on off-balance-sheet exposures included in other liabilities was $189 thousand.

Table of Contents

Notes to Consolidated Financial Statements (Unaudited)

Note 5. Earnings per Common Share

Basic earnings per common share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.

The following table presents the computation of basic and diluted earnings per share for the three and nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (dollars in thousands, except per share data):

	Three Months Ended				Nine Months Ended				Three Months Ended				Nine Months Ended
	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021		September 30, 2023		September 30, 2022		September 30, 2023		September 30, 2022
(Numerator):
Net income	$	4,454	$	2,398	$	12,018	$	8,176	$	3,121	$	4,454	$	10,475	$	12,018
(Denominator):
Weighted average shares outstanding – basic		6,257,040		6,220,456		6,248,847		5,322,696		6,256,663		6,257,040		6,266,707		6,248,847
Potentially dilutive common shares – restricted stock units		7,067		9,068		6,121		7,243		14,688		7,067		9,795		6,121
Weighted average shares outstanding – diluted		6,264,107		6,229,524		6,254,968		5,329,939		6,271,351		6,264,107		6,276,502		6,254,968
Income per common share
Basic	$	0.71	$	0.39	$	1.92	$	1.54	$	0.50	$	0.71	$	1.67	$	1.92
Diluted	$	0.71	$	0.38	$	1.92	$	1.53	$	0.50	$	0.71	$	1.67	$	1.92

Restricted stock units for 603 shares of common stock were not considered in computing diluted earnings per share for the three ~~months~~ and nine months ended September 30, ~~2022~~ 2023because they were antidilutive. There were no antidilutive shares of common stock for the three ~~months~~ and nine months ended September 30, ~~2022~~2023 and 2022.

Note 6. Fair Value Measurements

Determination of Fair Value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the “Fair Value Measurement and Disclosures” topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

~~Table of Contents~~

~~Notes to Consolidated Financial Statements (Unaudited)~~

Fair Value Hierarchy

In accordance with this guidance, the Company groups its assets and liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 -

Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 -

Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 -

Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires a significant management judgment or estimation.

An instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a recurring basis in the financial statements:

Securities available for sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

Derivative asset/liability - cash flow hedges

Cash flow hedges are recorded at fair value on a recurring basis. The fair value of the Company's cash flow hedges is determined by a third party vendor using the discounted cash flow method (Level 2).

2223

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Notes to Consolidated Financial Statements (Unaudited)

The following tables present the balances of assets measured at fair value on a recurring basis as of September 30, ~~2022~~2023 and December 31, ~~2021~~2022 (in thousands).

			Fair Value Measurements at September 30, 2022								Fair Value Measurements at September 30, 2023
Description	Balance as of September 30, 2022		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of September 30, 2023		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale
U.S. Treasury securities	$	17,531	$	—	$	17,531	$	—	$	11,113	$	—	$	11,113	$	—
U.S. agency and mortgage-backed securities		106,303		—		106,303		—		84,294		—		84,294		—
Obligations of states and political subdivisions		52,569		—		52,569		—		52,768		—		52,768		—
Total securities available for sale	$	176,403	$	—	$	176,403	$	—	$	148,175	$	—	$	148,175	$	—
Derivatives - cash flow hedges		2,723		—		2,723		—		3,065		—		3,065		—
Total assets	$	179,126	$	—	$	179,126	$	—	$	151,240	$	—	$	151,240	$	—

			Fair Value Measurements at December 31, 2021								Fair Value Measurements at December 31, 2022
Description	Balance as of December 31, 2021		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of December 31, 2022		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Securities available for sale
U.S. Treasury securities	$	39,658	$	—	$	39,658	$	—	$	11,229	$	—	$	11,229	$	—
U.S. agency and mortgage-backed securities		176,379		—		176,379		—		96,918		—		96,918		—
Obligations of states and political subdivisions		71,438		—		71,438		—		54,760		—		54,760		—
Corporate debt securities		2,020		—		2,020		—
Total securities available for sale	$	289,495	$	—	$	289,495	$	—	$	162,907	$	—	$	162,907	$	—
Derivatives - cash flow hedges		941		—		941		—		2,679		—		2,679		—
Total assets	$	290,436	$	—	$	290,436	$	—	$	165,586	$	—	$	165,586	$	—

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

~~Impaired~~Collateral Dependent Loans with an ACLL

~~Loans~~In accordance with ASC 326, the Company may determine that an individual loan exhibits unique risk characteristics which differentiate it from other loans within our loan pools. In such cases, the loans are ~~designated as impaired when, in~~evaluated for expected credit losses on an individual basis and excluded from the ~~judgment~~collective evaluation. Specific allocations of ~~management based on current information and events, it is probable that all~~the allowance for credit losses are determined by analyzing the borrower’s ability to repay amounts ~~due according to~~owed, collateral deficiencies, the ~~contractual terms~~relative risk grade of the loan ~~agreements will~~ ~~not~~and economic conditions affecting the borrower’s industry, among other things. A loan is considered to be ~~collected. The measurement of loss associated with impaired loans can~~collateral dependent when, based upon management's assessment, the borrower is experiencing financial difficulty and repayment is expected to be ~~based on~~provided substantially through the ~~present value of expected future cash flows discounted at the loan’s effective interest rate, the observable market price~~operation or sale of the ~~loan, or~~collateral. In such cases, expected credit losses are based on the fair value of the collateral ~~less~~at the measurement date, adjusted for estimated selling costs ~~to sell. Collateral~~ ~~may~~ ~~be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority~~if satisfaction of the ~~Company’s~~loan depends on the sale of the collateral. We reevaluate the fair value of collateral ~~is real estate.~~supporting collateral dependent loans on a quarterly basis. The fair value of real estate collateral supporting collateral dependent loans is ~~determined utilizing~~evaluated by appraisal services using a ~~market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level~~methodology that is consistent with the Uniform Standards of Professional Appraisal Practice. There was 2no~~) within the last~~ ~~twelve~~ ~~months. However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than~~ ~~one~~ ~~year old and~~ ~~not~~ ~~solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then a Level~~ 3 ~~valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal, of~~ ~~one~~ ~~year or less, if deemed significant, or the net book value on the applicable business’s financial statements if~~ ~~not~~ ~~considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level~~ 3~~). Impaired loans allocated to the~~ allowance for ~~loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan~~credit losses on ~~the Consolidated Statements of Income. At~~collateral dependent loans at September 30, ~~2022,~~ 2023~~there was no allowance for loan losses relating to impaired loans.~~.

Other Real Estate Owned

Certain assets such as OREO are measured at fair value less cost to sell. Valuation of OREO is determined using current appraisals from independent parties, a Level 2 input. If current appraisals cannot be obtained prior to reporting dates, or if declines in value are identified after a recent appraisal is received, appraisal values are discounted, resulting in Level 3 estimates. If the Company markets the property with a realtor, estimated selling costs reduce the fair value, resulting in a valuation based on Level 3 inputs.

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Notes to Consolidated Financial Statements (Unaudited)

The following tables summarize the Company’s assets that were measured at fair value on a nonrecurring basis during the periods (dollars in thousands):

Fair Value Measurements at September 30, 2022

Description
Balance as of September 30, 2022 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3)
Other real estate owned, net
$ 1,578 $ — $ — $ 1,578
Impaired loans, net
1,454 — — 1,454

			Fair Value Measurements at September 30, 2023
Description	Balance as of September 30, 2023		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Collateral dependent loans	$	3,116	$	—	$	—	$	3,116

			Fair Value Measurements at December 31, 2021								Fair Value Measurements at December 31, 2022
Description	Balance as of December 31, 2021		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance as of December 31, 2022		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Other real estate owned, net	$	1,848	$	—	$	—	$	1,848
Other real estate owned									$	184	$	—	$	—	$	184
Impaired loans, net		1,454		—		—		1,454		197		—		—		197

Quantitative information about Level 3 Fair Value Measurements for September 30, 2022

Fair Value

Valuation Technique

Unobservable Input

Range (Weighted Average) (1)

Other real estate owned, net
$ 1,578
Property appraisals

Selling cost
10.00 %

	Quantitative information about Level 3 Fair Value Measurements for September 30, 2023
	Fair Value		Valuation Technique	Unobservable Input	Range (Weighted Average) (1)
Collateral dependent loans	$	3,116	Property appraisals	Selling cost		6.00	%

Quantitative information about Level 3 Fair Value Measurements for December 31, 2021

Fair Value

Valuation Technique

Unobservable Input

Range (Weighted Average) (1)

Other real estate owned, net
$ 1,848
Property appraisals

Selling cost
10.00 %

	Quantitative information about Level 3 Fair Value Measurements for December 31, 2022
	Fair Value		Valuation Technique	Unobservable Input	Range (Weighted Average) (1)
Other real estate owned	$	184	Property appraisals	Selling cost		10.00	%
Impaired loans, net		197	Present value of cash flows	Discount rate		6.50	%

(1)	Unobservable inputs were weighted by the relative fair value of the instruments.

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Notes to Consolidated Financial Statements (Unaudited)

Accounting guidance requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The carrying values and estimated fair values of the Company’s financial instruments at September 30, ~~2022~~2023 and December 31, ~~2021~~2022 are as follows (in thousands):

			Fair Value Measurements at September 30, 2022 Using										Fair Value Measurements at September 30, 2023 Using
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Fair Value		Carrying Amount		Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Fair Value
Financial Assets
Cash and interest-bearing deposits in banks	$	75,785	$	75,785	$	—	$	—	$	75,785	$	50,099	$	50,099	$	—	$	—	$	50,099
Securities available for sale		176,403		—		176,403		—		176,403		148,175		—		148,175		—		148,175
Securities held to maturity		154,894		—		142,920		—		142,920
Securities held to maturity, net												149,948		—		134,728		—		134,728
Restricted securities		1,908		—		1,908		—		1,908		2,077		—		2,077		—		2,077
Loans, net		900,222		—		—		TBD		—		943,603		—		—		901,921		901,921
Bank owned life insurance		24,375		—		24,375		—		24,375		24,734		—		24,734		—		24,734
Accrued interest receivable		4,247		—		4,247		—		4,247		4,502		—		4,502		—		4,502
Derivatives - cash flow hedges		2,723		—		2,723		—		2,723		3,065		—		3,065		—		3,065
Financial Liabilities
Deposits	$	1,266,046	$	—		TBD		TBD	$	—	$	1,235,173	$	—		1,050,754		179,959	$	1,230,713
Subordinated debt		4,995		—		—		TBD		—		4,997		—		—		5,161		5,161
Junior subordinated debt		9,279		—		—		TBD		—		9,279		—		—		6,290		6,290
Accrued interest payable		184		—		184		—		184		667		—		667		—		667

			Fair Value Measurements at December 31, 2021 Using										Fair Value Measurements at December 31, 2022 Using
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Fair Value		Carrying Amount		Quoted Prices in Active Markets for Identical Assets Level 1		Significant Other Observable Inputs Level 2		Significant Unobservable Inputs Level 3		Fair Value
Financial Assets
Cash and interest-bearing deposits in banks	$	176,006	$	176,006	$	—	$	—	$	176,006	$	66,914	$	66,914	$	—	$	—	$	66,914
Securities available for sale		289,495		—		289,495		—		289,495		162,907		—		162,907		—		162,907
Securities held to maturity		33,441		—		33,617		—		33,617
Securities held to maturity, net												153,158		—		141,797		—		141,797
Restricted securities		1,813		—		1,813		—		1,813		1,908		—		1,908		—		1,908
Loans held for sale		—		—		—		—		—
Loans, net		819,408		—		—		827,248		827,248		913,077		—		—		880,473		880,473
Bank owned life insurance		24,294		—		24,294		—		24,294		24,531		—		24,531		—		24,531
Accrued interest receivable		3,903		—		3,903		—		3,903		4,543		—		4,543		—		4,543
Derivatives - cash flow hedges		941		—		941		—		941		2,679		—		2,679		—		2,679
Financial Liabilities
Deposits	$	1,248,752	$	—	$	1,103,186	$	145,101	$	1,248,287	$	1,241,332	$	—	$	1,104,483	$	131,304	$	1,235,787
Subordinated debt		9,993		—		—		8,932		8,932		4,995		—		—		5,267		5,267
Junior subordinated debt		9,279		—		—		8,145		8,145		9,279		—		—		6,067		6,067
Accrued interest payable		152		—		152		—		152		163		—		163		—		163

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Notes to Consolidated Financial Statements (Unaudited)

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

Note 7. Stock Compensation Plans

On May ~~13,~~10, ~~2014,~~2023, the Company’s shareholders approved the First National Corporation ~~2014~~2023 Stock Incentive Plan, which replaced the 2014 Stock Incentive Plan and makes available up to ~~240,000~~325,000 shares of common stock for the granting of stock options, restricted stock awards, restricted stock units, stock appreciation rights, and other ~~stock-based~~stock-based awards.Beginning on May 11, 2023, new equity awards granted by the Company are from the 2023 Stock Incentive Plan and not from the 2014 Stock Incentive Plan. Awards are made at the discretion of the Board of Directors and compensation cost equal to the fair value of the award is recognized over the vesting period.

Stock Awards

Whenever the Company deems it appropriate to grant a stock award, the recipient receives a specified number of unrestricted shares of employer stock. Stock awards may be made by the Company at its discretion without cash consideration and may be granted as settlement of a performance-based compensation award.

Compensation expense related to stock awards totaled ~~$131~~$202 thousand and ~~$481~~$402 thousand for the three months and nine months ended September 30, ~~2022~~2023, respectively. ~~The Company did~~ ~~not~~ ~~have compensation~~Compensation expense related to stock awards totaled $130 thousand and $481 thousand for the three months and nine months ~~ended~~ended September 30, 2022~~and~~ ~~2021~~., respectively.

Restricted Stock Units

Restricted stock units are an award of units that correspond in number and value to a specified number of shares of employer stock which the recipient receives according to a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with the employer for a particular length of time. Each restricted stock unit that vests entitles the recipient to receive one share of common stock on a specified issuance date.

During the first quarter of ~~2022~~2023, ~~10,110~~13,727 restricted stock units were granted to employees, with ~~3,375~~4,580 units vesting immediately, and ~~6,735~~9,147 units subject to a two year vesting schedule with one half of the units vesting each year. During the second quarter of 2023, 10,000 restricted stock units were granted to employees, with 4,000 units vesting in February 2025, and 6,000 units subject to a three-year vesting schedule beginning in February 2026 with onethird of the units vesting each year. The recipient does not have any stockholder rights, including voting, dividend, or liquidation rights, with respect to the shares underlying awarded restricted stock units until vesting has occurred and the recipient becomes the record holder of those shares. The unvested restricted stock units will vest on the established schedule if the employees remain employed by the Company on future vesting dates.

A summary of the activity for the Company’s restricted stock units for the period indicated is presented in the following table:

	Nine Months Ended					Nine Months Ended
	September 30, 2022					September 30, 2023
	Shares			Weighted Average Grant Date Fair Value		Shares			Weighted Average Grant Date Fair Value
Unvested, beginning of year		30,781		$	19.79		29,181		$	20.31
Granted		10,110			22.19		23,727			16.56
Vested		(11,643	)		20.58		(11,401	)		19.20
Forfeited		—			—		—			—
Unvested, end of period		29,248		$	20.31		41,507		$	18.47

At September 30, ~~2022~~2023, based on restricted stock unit awards outstanding at that time, the total unrecognized pre-tax compensation expense related to unvested restricted stock unit awards was ~~$367~~$422 thousand. This expense is expected to be recognized through ~~2026.~~2028. Compensation expense related to restricted stock unit awards recognized for the three ~~nine~~months ended September 30, ~~2022~~2023 and ~~2021~~2022totaled ~~$56~~$72 thousand and ~~$54~~$56 thousand, respectively. Compensation expense related to restricted stock unit awards recognized for the nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 totaled $279 thousand and $247 thousand, respectively.

On May 11, 2023, the Company’s shareholders approved the First National Corporation 2023 Stock Incentive Plan, which makes available up to 325,000 shares of common stock for the granting of stock options, restricted stock awards, stock appreciation rights, and ~~$172 thousand, respectively.~~other stock-based awards. Awards are made at the discretion of the Board of Directors and compensation cost is equal to the fair value of the award and recognized over the vesting period.

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Notes to Consolidated Financial Statements (Unaudited)

Note 8. Accumulated Other Comprehensive Income (Loss)

Changes in each component of accumulated other comprehensive income (loss) were as follows (in thousands):

	Net Unrealized Gains (Losses) on Securities			Change in Fair Value of Cash Flow Hedges		Accumulated Other Comprehensive Income (Loss)			Net Unrealized Gains (Losses) on Securities			Change in Fair Value of Cash Flow Hedges		Accumulated Other Comprehensive Income (Loss)
Balance at June 30, 2021	$	1,696		$	702	$	2,398
Unrealized holding (losses) (net of tax, $211)		(798	)		—		(798	)
Change in fair value (net of tax, $21)		—			80		80
Change during period		(798	)		80		(718	)
Balance at September 30, 2021	$	898		$	782	$	1,680
Balance at June 30, 2022	$	(24,450	)	$	1,748	$	(22,702	)	$	(24,450	)	$	1,748	$	(22,702	)
Unrealized holding gains net of tax, $155		581			—		581
Unrealized holding losses transferred from available for sale to held to maturity (net of tax and amortization of ($1,605) and ($157), respectively)		(6,036	)		—		(6,036	)
Unrealized holding losses (net of tax, $155)										581			—		581
Unrealized holding losses transferred from available for sale to held to maturity (net of tax and amortization of ($1,605) and ($157), respectively)										(6,036	)		—		(6,036	)
Change in fair value of cash flow hedge (net of tax, $106)		—			404		404			—			404		404
Change during period		(5,455	)		404		(5,051	)		(5,455	)		404		(5,051	)
Balance at September 30, 2022	$	(29,905	)	$	2,152	$	(27,753	)	$	(29,905	)	$	2,152	$	(27,753	)
Balance at June 30, 2023									$	(23,355	)	$	1,996	$	(21,359	)
Unrealized holding losses (net of tax, ($1,080))										(4,063	)		—		(4,063	)
Amortization of unrealized holding losses on available-for-sale securities transferred to held to maturity (net of tax of $86)										323			—		323
Change in fair value of cash flow hedge (net of tax, $113)										—			424		424
Change during period										(3,740	)		424		(3,316	)
Balance at September 30, 2023									$	(27,095	)	$	2,420	$	(24,675	)

Net Unrealized (Losses) on Securities

Change in Fair Value of Cash Flow Hedges

Accumulated Other Comprehensive Income (Loss)

Balance at December 31, 2020
$ 3,058 $ 340 $ 3,398
Unrealized holding losses (net of tax, ($565))
(2,131 ) — (2,131 )
Reclassification adjustment (net of tax, ($8))
(29 ) — (29 )
Change in fair value (net of tax, $117)
— 442 442
Change during period
(2,160 ) 442 (1,718 )
Balance at September 30, 2021
$ 898 $ 782 $ 1,680
Balance at December 31, 2021
$ (445 ) $ 743 $ 298
Unrealized holding losses (net of tax, ($6,225))
(23,424 ) — (23,424 )
Unrealized holding losses transferred from available for sale to held to maturity (net of tax and amortization of ($1,605) and ($157), respectively)
(6,036 ) — (6,036 )
Change in fair value of cash flow hedge (net of tax, $373)
— 1,409 1,409
Change during period
(29,460 ) 1,409 (28,051 )
Balance at September 30, 2022
$ (29,905 ) $ 2,152 $ (27,753 )

~~The following table presents information related to reclassifications from accumulated other comprehensive income (loss) for the~~ ~~three~~ ~~and~~ ~~nine~~ ~~months ended~~ ~~September 30, 2022~~ ~~and~~ ~~2021~~ ~~(in thousands):~~

~~Details About Accumulated Other Comprehensive Income (Loss)~~	~~Amount Reclassified from Accumulated Other Comprehensive Income (Loss)~~				~~Affected Line Item in the Consolidated Statements of Income~~
	~~Three Months Ended~~
	~~September 30, 2022~~		~~September 30, 2021~~
~~Securities available for sale:~~
~~Net securities gains reclassified into earnings~~	$	—	$	—	~~Net gains on securities available for sale~~
~~Related income tax expense~~		—		—	~~Income tax expense~~
~~Total reclassifications~~	$	—	$	—	~~Net of tax~~

Details About Accumulated Other Comprehensive Income (Loss)

Amount Reclassified from Accumulated Other Comprehensive Income (Loss)

Affected Line Item in the Consolidated Statements of Income

Nine Months Ended

September 30, 2022

September 30, 2021

Securities available for sale:

Net securities gains reclassified into earnings
$ — $ (37 )
Net gains on securities available for sale
Related income tax expense
— 8
Income tax expense
Total reclassifications
$ — $ (29 )
Net of tax

	Net Unrealized (Losses) on Securities			Change in Fair Value of Cash Flow Hedges		Accumulated Other Comprehensive Income (Loss)
Balance at December 31, 2021	$	(445	)	$	743	$	298
Unrealized holding losses (net of tax, ($6,225))		(23,424	)		—		(23,424	)
Unrealized holding losses transferred from available for sale to held to maturity (net of tax and amortization of ($1,605) and ($157), respectively)		(6,036	)		—		(6,036	)
Change in fair value of cash flow hedge (net of tax, $373)		—			1,409		1,409
Change during period		(29,460	)		1,409		(28,051	)
Balance at September 30, 2022	$	(29,905	)	$	2,152	$	(27,753	)
Balance at December 31, 2022	$	(24,587	)	$	2,116	$	(22,471	)
Unrealized holding losses (net of tax, ($925))		(3,480	)		—		(3,480	)
Amortization of unrealized holding losses on available-for-sale securities transferred to held to maturity (net of tax of $258)		972			—		972
Change in fair value of cash flow hedge (net of tax, $82)		—			304		304
Change during period		(2,508	)		304		(2,204	)
Balance at September 30, 2023	$	(27,095	)	$	2,420	$	(24,675	)

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Notes to Consolidated Financial Statements (Unaudited)

Note 9. Revenue Recognition

Most revenue associated with financial instruments, including interest income, loan origination fees, and credit card fees, is outside the scope of ASC topic 606. Gains and losses on investment securities, derivatives, financial guarantees, and sales of financial instruments are similarly excluded from the scope. The guidance is applicable to noninterest revenue streams such as service charges on deposit accounts, ATM and check card fees, wealth management fees, and fees for other customer services. Noninterest revenue streams within the scope of Topic 606 are discussed below.

Service charges on deposit accounts

Service charges on deposit accounts consist of monthly service fees, overdraft and nonsufficient funds fees, and other deposit account related fees. The Company's performance obligation for monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers' accounts. Overdraft and nonsufficient funds fees and other deposit account related fees are transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue recognized, at a point in time.

ATM and check card fees

ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. ATM fees are transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue recognized, at a point in time. Check card fees are primarily comprised of interchange fee income. Interchange fees are earned whenever the Company's debit cards are processed through card payment networks, such as Visa. The Company's performance obligation for interchange fee income is largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. ~~In compliance with Topic~~ ~~606,~~ ~~debit card fee income is presented net of associated expense.~~

Wealth management fees

Wealth management fees are primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company's performance obligation is generally satisfied over time and the resulting fees are primarily recognized monthly, based upon the month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month-end through a direct charge to customers' accounts. Estate management fees are based upon the size of the estate. Revenue for estate management fees are recorded periodically, according to a fee schedule, and are based on the services that have been provided.

Brokered mortgage fees

Brokered mortgage fees are comprised of loan fee income earned from generating loans in the secondary market. Brokered mortgage fee income is recognized at loan closing.

Fees for other customer services

Fees for other customer services include fees for brokered loans, check ordering charges, merchant services income, safe deposit box rental fees, and other service charges. Check ordering charges are transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue recognized, at a point in time. Merchant services income mainly represent fees charged to merchants to process their debit and credit card transactions. The Company's performance obligation for merchant services income is largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.

The following table presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Accounting Standards Codification Topic 606, for the three and nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (in thousands):

	Three Months Ended				Nine Months Ended				Three Months Ended				Nine Months Ended
	September 30, 2022		September 30, 2021		September 30, 2022		September 30, 2021		September 30, 2023		September 30, 2022		September 30, 2023		September 30, 2022
Noninterest Income
Service charges on deposit accounts	$	708	$	547	$	2,015	$	1,436	$	733	$	708	$	2,062	$	2,015
ATM and check card fees		915		753		2,462		2,036		976		915		2,624		2,462
Wealth management fees		739		696		2,302		1,996		811		739		2,336		2,302
Brokered mortgage fees		72		155		224		416		38		72		73		224
Income from bank owned life insurance										175		166		459		441
Fees for other customer services		180		279		601		611		122		14		538		160
Noninterest income (in-scope of Topic 606)	$	2,614	$	2,430	$	7,604	$	6,495	$	2,855	$	2,614	$	8,092	$	7,604
Noninterest income (out-of-scope of Topic 606)		413		218		914		731		198		413		623		914
Total noninterest income	$	3,027	$	2,648	$	8,518	$	7,226	$	3,053	$	3,027	$	8,715	$	8,518

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Notes to Consolidated Financial Statements (Unaudited)

Note 10. Derivative Financial Instruments

On April 21, 2020, the Company entered into two interest rate swap agreements related to its outstanding junior subordinated debt. One swap agreement was related to the Company’s junior subordinated debt with a redemption date of June 17, 2034, which became effective on March 17, 2020. The notional amount of the interest rate swap was $5.0 million and terminates on June 17, 2034. Under the terms of the agreement, the Company pays interest quarterly at a fixed rate of 0.79% and receives interest quarterly at a variable rate of three-month ~~LIBOR.~~CME Term SOFR plus 0.26161%. The variable rate resets on each interest payment date. The other swap agreement was related to the Company’s junior subordinated debt with a redemption date of October 1, 2036, which became effective on April 1, 2020. The notional amount of the interest rate swap was $4.0 million and terminates on October 1, 2036. Under the terms of the agreement, the Company pays interest quarterly at a fixed rate of 0.82% and receives interest quarterly at a variable rate of the three-month ~~LIBOR.~~CME Group Term Secured Overnight Financing Rate ("CME Term SOFR") plus 0.26161%. The variable rate resets on each interest payment date. The ~~Company expects the~~Company’s junior subordinated debt instruments ~~to transition~~transitioned from a LIBOR-indexed floating rate of interest to a ~~SOFR-indexed~~Secured Overnight Financing Rate ("SOFR") indexed floating rate byon ~~June 30,~~July 3, 2023.

The Company entered into interest rate swaps to reduce interest rate risk and to manage interest expense. By entering into these agreements, the Company converted variable rate debt into fixed rate debt. Alternatively, the Company may enter into interest rate swap agreements to convert fixed rate debt into variable rate debt. Interest differentials paid or received under interest rate swap agreements are reflected as adjustments to interest expense. The Company designated the interest rate swaps as hedging instruments in qualifying cash flow hedges. Changes in fair value of these designated hedging instruments is reported as a component of other comprehensive (loss) income. Interest rate swaps designated as cash flow hedges are expected to be highly effective in offsetting the effect of changes in interest rates on the amount of variable rate interest payments, and the Company assesses the effectiveness of each hedging relationship quarterly. If the Company determines that a cash flow hedge is no longer highly effective, future changes in the fair value of the hedging instrument would be reported as earnings. As of September 30, ~~2022~~2023, the Company has designated cash flow hedges to manage its exposure to variability in cash flows on certain variable rate borrowings for periods that end between June 2034 and October 2036. The notional amounts of the interest rate swaps were not exchanged and do not represent exposure to credit loss. In the event of default by a counterparty, the risk in these transactions is the cost of replacing the agreements at current market rates.

All interest rate swaps were entered into with counterparties that met the Company's credit standards and the agreements contain collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in these derivative contracts is not significant.

Unrealized gains or losses recorded in other comprehensive (loss) income related to cash flow hedges are reclassified into earnings in the same period(s) during which the hedged interest payments affect earnings. When a designated hedging instrument is terminated and the hedged interest payments remain probable of occurring, any remaining unrecognized gain or loss in other comprehensive (loss) income is reclassified into earnings in the period(s) during which the forecasted interest payments affect earnings. Amounts reclassified into earnings and interest receivable or payable under designated interest rate swaps are reported in interest expense. The Company does not expect any unrealized losses related to cash flow hedges to be reclassified into earnings in the next twelve months.

The following table summarizes key elements of the Company's derivative instruments at September 30, ~~2022~~2023 and December 31, ~~2021 (~~2022in (in thousands):

	September 30, 2022								September 30, 2023
	Notional Amount		Assets		Liabilities		Collateral Pledged(1)		Notional Amount		Assets		Liabilities		Collateral Pledged(1)
Cash Flow Hedges
Interest rate swap contracts	$	9,000	$	2,723	$	—	$	—	$	9,000	$	3,065	$	—	$	—

	December 31, 2021								December 31, 2022
	Notional Amount		Assets		Liabilities		Collateral Pledged(1)		Notional Amount		Assets		Liabilities		Collateral Pledged(1)
Cash Flow Hedges
Interest rate swap contracts	$	9,000	$	941	$	—	$	—	$	9,000	$	2,679	$	—	$	—

(1)	Collateral pledged may be comprised of cash or securities.

Note 11. Subsequent Events

OnDuring the month of October ~~3, 2022,~~2023, ~~First Bank Financial Services, Inc.,~~the Company signed two new leases for real estate to be occupied in 2024. The first lease is for a ~~wholly owned subsidiary~~new retail branch office expected to be opened in Roanoke, Virginia. This lease is for a 120-month term and includes an option to renew the term of the ~~Bank, received proceeds totaling $3.1 million from the sale of its interest~~lease for two additional 60-month periods. Occupancy is expected to begin no later than June 1, 2024. The second lease will replace an existing lease for a loan production office in ~~a broker-dealer of investments. First Bank Financial Services, Inc. expects~~Glen Allen, Virginia. This lease is for an 86-month term. Occupancy is expected to ~~record a gain on the sale of the investment totaling $2.9 million in the~~begin ~~fourth~~no ~~quarter of~~later than ~~2022.~~ ~~The gain has~~ ~~not~~ ~~been reflected on the Company’s income statement for the~~ ~~three~~ or ~~nine~~ ~~months ended~~ ~~September 30, 2022.~~February 1, 2024.

On ~~October 12, 2022~~ ~~the Board of Directors of the Company authorized a stock repurchase~~ p~~lan pursuant to which the Company is authorized to repurchase up to $5.0 million of the Company’s outstanding common stock through~~ ~~December 31, 2023.~~ ~~Through~~ ~~November 10, 2022,~~ ~~there have been~~ no ~~stock repurchases under the plan.~~

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

Cautionary Statement Regarding Forward-Looking Statements

First National Corporation (the Company) makes forward-looking statements in this Form 10-Q that are subject to risks and uncertainties. These forward-looking statements include, but are not limited to, statements regarding profitability, liquidity, adequacy of capital, allowance for ~~loan~~credit losses, interest rate sensitivity, market risk, growth strategy, and the impact of the Company’s acquisitions of The Bank of Fincastle (Fincastle) and the SmartBank loan portfolio, including the expected benefits of the acquisition of Fincastle (Merger) and the potential impact of the acquisitions on the Company’s and First Bank’s (the Bank) financial and other goals.strategy. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements. These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:

•

general business conditions, as well as conditions within the financial markets;

•

general economic conditions, including unemployment levels, inflation and slowdowns in economic growth;

•

the Company’s branch and market expansions, technology initiatives and other strategic initiatives;

•

the impact of competition from banks and non-banks, including financial technology companies (Fintech);

•

the composition of the loan and deposit portfolio, including the types of accounts and customers, may change, which could impact the amount of net interest income and noninterest income in future periods, including revenue from service charges on deposits;

•

limited availability of financing or inability to raise capital;

•

reliance on third parties for key services;

•

the Company’s credit standards and its on-going credit assessment processes might not protect it from significant credit losses;

	•	the quality of the loan portfolio and the value of the collateral securing those loans;
	•	demand for loan products;
	•	deposit flows;

•

the level of net charge-offs on loans and the adequacy of the allowance for loan losses;

•

the concentration in loans secured by real estate may adversely affect earnings due to changes in the real estate markets;

•

the value of securities held in the Company's investment portfolio;

•

legislative or regulatory changes or actions, including the effects of changes in tax laws;

•

changes in accounting principles, policies and guidelines and elections made by the Company thereunder;

•

cyber threats, attacks or events;

•

the ability to maintain adequate liquidity by retaining deposit customers and secondary funding sources, especially if the Company’s or the industry's reputation ~~would~~were to become damaged;

•

monetary and fiscal policies of the U.S. Government, including policies of the U.S. Department of the Treasury and the Federal Reserve Board, and the effect of those policies on interest rates and business in the Company's markets;

	•	changes in interest rates could have a negative impact on the value of the Company’s securities portfolio and its net interest income and an unfavorable impact on the Company’s customers’ ability to repay loans;
	•	geopolitical conditions, including acts or threats of terrorism, international hostilities, or actions taken by the U.S. or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in the U.S. and abroad; and

•

other factors identified in Item 1A. Risk Factors of the Company’s Form 10-K for the year ending December 31, ~~2021.~~2022.

Because of these and other uncertainties, actual results may be materially different from the results indicated by these forward-looking statements. In addition, past results of operations do not necessarily indicate future results. The following discussion and analysis of the financial condition at September 30, ~~2022~~2023 and statements of income of the Company for the three ~~andnine~~andnine months ended September 30, ~~2022~~2023 and ~~2021~~2022 should be read in conjunction with the consolidated financial statements and related notes included in Part I, Item 1, of this Form 10-Q and in Part II, Item 8, of the Form 10-K for the period ending December 31, ~~2021.~~2022. The statements of income for the three ~~andnine~~andnine months ended September 30, ~~2022~~2023 may not be indicative of the results to be achieved for the year.

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Executive Overview

The Company

First National Corporation (the Company) is the bank holding company of:

•

First Bank (the Bank). The Bank owns:

•

First Bank Financial Services, Inc.

	•	Bank of Fincastle Services, Inc.
	•	ESF, LLC
	•	Shen-Valley Land Holdings, LLC

•

First National (VA) Statutory Trust II (Trust II)

•

First National (VA) Statutory Trust III (Trust III and, together with Trust II, the Trusts)

First Bank Financial Services, Inc. owns an interest in an entity that provides title insurance services. Bank of Fincastle Services, Inc. is no longer an active operating entity. Shen-Valley Land Holdings, LLC and ESF, LLC were formed to hold other real estate owned and future office sites. The Trusts were formed for the purpose of issuing redeemable capital securities, commonly known as trust preferred securities and are not included in the Company’s consolidated financial statements in accordance with authoritative accounting guidance because management has determined that the Trusts qualify as variable interest entities.

Products, Services, Customers and Locations

The Bank offers loan, deposit, and wealth management products and services. Loan products and services include consumer loans, residential mortgages, home equity loans, and commercial loans. Deposit products and services include checking accounts, treasury management solutions, savings accounts, money market accounts, certificates of deposit, and individual retirement accounts. Wealth management services include estate planning, investment management of assets, trustee under an agreement, trustee under a will, individual retirement accounts, and estate settlement. Customers include small and medium-sized businesses, individuals, estates, local governmental entities, and non-profit organizations. The Bank’s office locations are well-positioned in attractive markets along the Interstate 81, Interstate 66, and Interstate 64 corridors in the Shenandoah Valley, the Roanoke Valley, central regions of Virginia, and the city of Richmond. Within these markets, there are diverse types of industry including medical and professional services, manufacturing, retail, warehousing, Federal and local government, hospitality, and higher education. The Bank’s products and services are delivered through 20 bank branch offices, a loan production office and customer service centers in two retirement villages. For the location and general character of each of these offices, see Item 2 of the Company's Form 10-K for the year ended December 31, ~~2021.~~2022. Many of the Bank’s services are also delivered through the Bank’s mobile banking platform, its website, www.fbvirginia.com, and a network of ATMs located throughout its market area.

Revenue Sources and Expense Factors

The primary source of revenue is from net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense and typically represents between 70% and 80% of the Company’s total revenue. Interest income is determined by the amount of interest-earning assets outstanding during the period and the interest rates earned on those assets. The Bank’s interest expense is a function of the amount of interest-bearing liabilities outstanding during the period and the interest rates paid. In addition to net interest income, noninterest income is the other source of revenue for the Company. Noninterest income is derived primarily from service charges on deposits, fee income from wealth management services, and ATM and check card fees.

Primary expense categories are salaries and employee benefits, which comprised ~~58%~~ 57% of noninterest expenses for the nine months ended September 30, ~~2022,~~2023, followed by occupancy and equipment expense, which ~~comprised 13%~~comprised 12% of noninterest expenses. The provision for ~~loan~~credit losses is also typically a primary expense of the Bank. The provision is determined by factors that include net charge-offs, asset quality, economic conditions, and loan growth. Changing economic conditions caused by inflation, recession, unemployment, or other factors beyond the Company’s control have a direct correlation with asset quality, net charge-offs, and ultimately the required provision for ~~loan~~credit losses.

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Overview of Quarterly Financial Performance

~~The following had a significant impact on financial performance in~~Comparing the ~~third quarter of 2022 compared to the same period in 2021.~~Three-Month Periods EndingSeptember 30, 2023andSeptember 30, 2023

●

Net interest income increased to $11.7 million from $9.7 million in the prior year, which was a $2.0 million, or 20% increase, and was favorably impacted by a change in the composition of average earning assets. Average loan balances increased by $124.7 million, or 16%, while average interest-bearing deposits in banks decreased by $122.0 million, or 61%.

●

~~Accretion of PPP income, net of costs decreased to $0 from $737 thousand in the prior year.~~

●

~~Merger related expenses decreased to $0 from $1.3 million in the prior year.~~

Net income ~~increased $2.1~~decreased $1.3 million, or ~~86%~~30%, to $3.1 million, or $0.50 per diluted share, for the three months ended September 30, 2023, compared to $4.5 million, or $0.71 per diluted share, for the ~~three~~same period in 2022. Return on average assets was 0.91% and return on average equity was 10.96% for the third quarter of 2023, compared to 1.27% and 17.27%, respectively, for the same period in 2022.

The decrease in net income resulted from a $1.0 million, or 9%, decrease in net interest income and a $701 thousand, or 8%, increase in total noninterest expense, which were partially offset by a $26 thousand, or 1%, increase in total noninterest income, a $100 thousand decrease in the provision for credit losses, and a $286 thousand decrease in income tax expense.

Net interest income decreased from a 23-basis point decrease in the net interest margin and a 1% decrease in average earning assets. The net interest margin was impacted by changes in market interest rates, including the Federal funds target rate, which averaged 5.43% in the third quarter of 2023, compared to 2.35% for the same period one year ago. The rise in the Federal funds rate had an impact on the Company’s cost of funds, which increased 94 basis points. The higher cost of funds was partially offset by a 68-basis point increase in the yield on earning assets.

The net interest margin decreased by 1 basis point in the third quarter of 2023 compared to the linked second quarter of 2023, which was an improvement compared to a 24-basis point decrease in the second quarter of 2023 compared to the linked first quarter of 2023, and a 10-basis point decrease in the first quarter of 2023 compared to the linked fourth quarter of 2022.

Total noninterest expenses increased by $701 thousand, or 8%, and was primarily attributable to increases in salaries and employee benefits, legal and professional expenses, ATM and check card expenses, and FDIC assessment costs.

Comparing the Nine-Month Periods EndingSeptember 30, 2023andSeptember 30, 2023

Net income decreased $1.5 million, or 13%, to $10.5 million, or $1.67 per diluted share, for the nine months ended September 30, ~~2022,~~2023, compared to ~~$2.4~~$12.0 million, or ~~$0.39~~$1.92 per diluted share, for the same period in ~~2021.~~2022. Return on average assets was ~~1.27%~~1.03% and return on average equity was ~~17.27%~~12.57% for the ~~third quarter of 2022,~~nine months ending 2023, compared to ~~0.71%~~1.14% and ~~8.64%~~15.12%, respectively, for the same period in ~~2021.~~2022.

The ~~increase~~decrease in net income resulted ~~primarily~~ from a ~~$2.0 million,~~$961 thousand, or ~~20%~~3%, ~~increase~~decrease in net interest income and a ~~$379~~$1.5 million, or 6%, increase in total noninterest expense, which were partially offset by a $197 thousand, or ~~14%~~2%, increase in total noninterest income, a $400 thousand decrease in the provision for credit losses, and a ~~$343~~$318 thousand ~~or 4%,~~ decrease in ~~total noninterest~~income tax expense. ~~These favorable variances were partially offset by a $200 thousand increase in provision for loan losses.~~

Net interest income ~~increased by $2.0 million~~decreased from a ~~$2.5 million increase~~13-basis point decrease in ~~total~~the net interest ~~income,~~margin, which was partially offset by a ~~$472 thousand increase in total interest expense. Net interest income increased from a 52-basis point increase in the net interest margin and a 3%~~1% increase in average earning assets. The ~~change in the composition of average earning assets had a significant impact on the increase in the~~ net interest margin ~~as average loans increased to 68% of average earning assets~~was impacted by changes in market interest rates, including the Federal funds target rate, which averaged 5.09% for the ~~third quarter of 2022,~~nine months ending September 30, 2023, compared to ~~60% of average earning assets~~1.20% for the same period ofone year ago. The rise in the ~~prior year, while interest-bearing deposits in banks decreased to 6% of average earning assets from 16% for the same period of 2021. The Bank acquired~~Federal funds rate had an $82.6 million loan portfolio from SmartBank’s Richmond-area branch on September 30, 2021, which made a significant contribution to the increase in average loan balances when comparing the third quarter of 2022 to the same period of 2021 as the acquisition occurredimpact on the ~~last day~~Company’s cost of ~~the quarter.~~

~~Accretion~~funds, which increased 85 basis points. The higher cost of PPP income, net of costs, is recorded in interest income and fees on loans and positively impacts net interest income. Accretion totaled $0 for the third quarter of 2022 compared to $737 thousand for the same period in 2021.

The provision for loan losses totaled $200 thousand for third quarter of 2022 compared to no provision of loan losses for same period in the prior year. The allowance for loan losses totaled $6.3 million, or 0.69% of total loans on September 30, 2022, 0.69% of total loans on December 31, 2021, and 0.66% of total loans on September 30, 2021.

Total noninterest income increased $379 thousand, or 14%, primarily from increases in service charges on deposits, ATM and check card fees, wealth management fees, and other operating income. The increases werefunds was partially offset by ~~decreases~~a 68 basis point increase in ~~fees for other customer services and brokered mortgage fees.~~the yield on earning assets.

Total noninterest expense ~~decreased $343 thousand,~~increased by $1.5 million, or 4%6%, and was primarily ~~from decreases~~attributable to increases in salaries and employee benefits, ~~legal~~marketing expense, ATM and ~~professional fees,~~check card expenses, and ~~data processing expense, which were partially offset by an increase in~~ other operating expense. Merger related expenses decreased to $0 in the third quarter of 2022 compared to $1.3 million in the same period of the prior year. The decrease in merger related expenses had a significant impact on the decrease in total noninterest expense.expenses.

For a more detailed discussion of the Company's quarterly performance, see "Net Interest Income,” “Provision for ~~Loan~~Credit Losses,” "Noninterest Income," "Noninterest Expense" and "Income Taxes" below.

3233

Table of Contents

~~Acquisition of The Bank of Fincastle~~

On July 1, 2021, the Company completed the acquisition of The Bank of Fincastle for an aggregate purchase price of $33.8 million of cash and stock. The Company paid cash consideration of $6.8 million and issued 1,348,065 shares of its common stock to the shareholders of Fincastle. Upon completion of the transaction, Fincastle was merged with and into First Bank. At the time of closing of the acquisition, The Bank of Fincastle had six bank branch offices operating in the Roanoke Valley region of Virginia and reported total assets of $267.9 million, total loans of $194.5 million and total deposits of $236.3 million. After the merger, the former Fincastle branches continued to operate as The Bank of Fincastle, a division of First Bank, until the systems were converted on October 16, 2021. All branch offices have been operating as First Bank since the system conversion. For the nine months ended September 30, 2022, the Company recorded merger related expenses of $20 thousand in connection with the acquisition of Fincastle. There were no merger related expenses recorded in the three months ended September 30, 2022.

Purchased performing loans were recorded at fair value, including a credit discount. The fair value discount will be accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan losses on the purchased loans is expected in future periods as the accretion decreases the fair value discount amount. A provision may also be required for any deterioration in these loans in future periods.

The Company expected to benefit from cost savings after the acquisition of Fincastle. As of September 30, 2022, the Company believes that it had substantially achieved all expected cost savings related to the merger of Fincastle with and into First Bank.

~~Acquisition of SmartBank Loan Portfolio~~

On September 30, 2021, the Bank acquired $82.6 million of loans and certain fixed assets from SmartBank related to its Richmond area branch, located in Glen Allen, Virginia. First Bank paid cash consideration of $83.7 million for the loans and fixed assets. Additionally, an experienced team of bankers based out of the SmartBank location transitioned to become employees of First Bank. First Bank did not assume any deposit liabilities from SmartBank in connection with the transaction, and SmartBank closed their branch operation on December 31, 2021. First Bank assumed the facility lease and acquired the remaining assets at the branch on December 31, 2021 and now operates a loan production office in the location of the former SmartBank branch. The Company incurred expenses totaling $101 thousand related to the acquisition of loans and fixed assets of SmartBank in the fourth quarter of 2021. There were no additional expenses related to the acquisition for the three and nine months ended September 30, 2022.

Non-GAAP Financial Measures

This report refers to the efficiency ratio, which is computed by dividing noninterest expense, excluding amortization of intangibles, net gains (loss) on disposal of premises and equipment, other real estate owned (income) expense, net, and merger related expenses, by the sum of net interest income on a tax-equivalent basis and noninterest income, excluding securities gains. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be construed as such. Management believes, however, such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The methodology for determining this measurement may differ among companies. The Company, in referring to its net income, is referring to income under GAAP. The components of the efficiency ratio calculation are summarized in the following table (dollars in thousands).

Efficiency Ratio

Three Months Ended

Nine Months Ended

September 30, 2022

September 30, 2021

September 30, 2022

September 30, 2021

Noninterest expense
$ 9,083 $ 9,426 $ 26,645 $ 22,706
Add/(Subtract): other real estate owned (expense), net
(14 ) — (83 ) —
Subtract: amortization of intangibles
(6 ) (5 ) (15 ) (24 )
Add: gains on disposal of premises and equipment, net
— — — 26
Subtract: merger related expenses
— (1,341 ) (20 ) (2,023 )
$ 9,063 $ 8,080 $ 26,527 $ 20,685
Tax-equivalent net interest income
$ 11,809 $ 9,810 $ 33,818 $ 24,938
Noninterest income
3,027 2,648 8,518 7,226
Subtract: securities gains, net
— — — (37 )
$ 14,836 $ 12,458 $ 42,336 $ 32,127
Efficiency ratio
61.09 % 64.86 % 62.66 % 64.39 %

~~Table of Contents~~

	Efficiency Ratio
	Three Months Ended						Nine Months Ended
	September 30, 2023			September 30, 2022			September 30, 2023			September 30, 2022
Noninterest expense	$	9,784		$	9,083		$	28,142		$	26,645
Add/(Subtract): other real estate owned (income) expense, net		(15	)		(14	)		201			(83	)
Subtract: amortization of intangibles		(5	)		(6	)		(14	)		(15	)
Subtract: merger related expenses		—			—			—			(20	)
	$	9,764		$	9,063		$	28,329		$	26,527
Tax-equivalent net interest income	$	10,764		$	11,809		$	32,848		$	33,818
Noninterest income		3,053			3,027			8,715			8,515
	$	13,817		$	14,836		$	41,563		$	42,333
Efficiency ratio		70.67	%		61.09	%		68.16	%		62.66	%

This report also refers to net interest margin, which is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for both ~~2022~~2023 and ~~2021~~2022 is 21%. The reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below (in thousands).

	Reconciliation of Net Interest Income to Tax-Equivalent Net Interest Income												Reconciliation of Net Interest Income to Tax-Equivalent Net Interest Income
	Three Months Ended						Nine Months Ended						Three Months Ended						Nine Months Ended
	September 30, 2022			September 30, 2021			September 30, 2022			September 30, 2021			September 30, 2023			September 30, 2022			September 30, 2023			September 30, 2022
GAAP measures:
Interest income – loans	$	10,759		$	9,215		$	30,218		$	23,432		$	12,640		$	10,759		$	36,038		$	30,218
Interest income – investments and other		2,033			1,116			5,437			3,039			1,991			2,033			6,407			5,437
Interest expense – deposits		(927	)		(369	)		(1,680	)		(1,060	)		(3,810	)		(927	)		(9,428	)		(1,680	)
Interest expense – subordinated debt		(70	)		(156	)		(208	)		(464	)		(69	)		(70	)		(207	)		(208	)
Interest expense – junior subordinated debt		(68	)		(68	)		(202	)		(202	)		(69	)		(68	)		(203	)		(202	)
Interest expense – other borrowings														—			—			(3	)		—
Total net interest income	$	11,727		$	9,738		$	33,565		$	24,745		$	10,683		$	11,727		$	32,604		$	33,565
Non-GAAP measures:
Tax benefit realized on non-taxable interest income – loans	$	—		$	8		$	8		$	24		$	—		$	—		$	—		$	8
Tax benefit realized on non-taxable interest income – municipal securities		82			64			245			169			81			82			244			245
Total tax benefit realized on non-taxable interest income	$	82		$	72		$	253		$	193		$	81		$	82		$	244		$	253
Total tax-equivalent net interest income	$	11,809		$	9,810		$	33,818		$	24,938		$	10,764		$	11,809		$	32,848		$	33,818

Table of Contents

Critical Accounting Policies
~~General~~

The Company’s consolidated financial statements ~~and related notes~~ are prepared in accordance with GAAP. The financial information contained within ~~the~~our statements is, to a significant extent, ~~financial information that is~~ based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value ~~that is~~ obtained ~~either~~ when earning income, recognizing an expense, recovering an asset or relieving a liability. The Bank uses historical losses as one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another. Although the economics of the Company’s transactions ~~would be the same,~~may not change, the timing of events that would impact the transactions could change.

~~Presented below is a discussion of those~~Critical accounting policies ~~that management believes~~ are ~~the~~ most important ~~(Critical Accounting Policies)~~ to the portrayal ~~and understanding~~ of the Company’s financial condition ~~and~~or results of ~~operations. The Critical Accounting Policies~~operations and require management’s most difficult, subjective, and complex judgments about matters that are inherently uncertain. ~~In the event~~If conditions occur that ~~different~~differ from our assumptions, ~~or conditions were to prevail, and~~ depending upon the severity of such ~~changes,~~differences, the ~~possibility of materially different~~Company’s financial condition or results of operations ~~is a reasonable likelihood.~~

may be materially impacted. The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them as needed. ~~Allowance for Loan Losses~~The Company provides additional information on its critical accounting policies and estimates under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” in its 2022 Form 10-K and in Note 1 “Significant Accounting Policies and Estimates” in Part I, Item 1 of this Quarterly Report.

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management determines that the loan balance is uncollectible. Subsequent recoveries, if any, are credited to the allowance. For further information about the Company’s loans and the allowance for loan losses, see Notes 3 and 4 to the Consolidated Financial Statements included in this Form 10-Q.

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

~~Table of Contents~~

The Company performs regular credit reviews of the loan portfolio to review credit quality and adherence to underwriting standards. The credit reviews consist of reviews by its internal credit administration department and reviews performed by an independent third party. Upon origination, each loan is assigned a risk rating ranging from one to nine, with loans closer to one having less risk. This risk rating scale is the Company's primary credit quality indicator. The Company has various committees that review and ensure that the allowance for loans losses methodology is in accordance with GAAP and loss factors used appropriately reflect the risk characteristics of the loan portfolio.

The allowance represents an amount that, in management’s judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of the collateral, overall portfolio quality, and review of specific potential losses. The evaluation also considers the following risk characteristics of each loan portfolio class:

•

~~1-4 family residential mortgage loans carry risks associated with the continued creditworthiness of the borrower and changes in the value of the collateral.~~

•

Real estate construction and land development loans carry risks that the project may not be finished according to schedule, the project may not be finished according to budget, and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure or other factors unrelated to the project.

•

Other real estate loans carry risks associated with the successful operation of a business or a real estate project, in addition to other risks associated with the ownership of real estate, because repayment of these loans may be dependent upon the profitability and cash flows of the business or project.

•

Commercial and industrial loans carry risks associated with the successful operation of a business because repayment of these loans may be dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much reliability.

•

Consumer and other loans carry risk associated with the continued creditworthiness of the borrower and the value of the collateral, if any. Consumer loans are typically either unsecured or secured by rapidly depreciating assets such as automobiles. These loans are also likely to be immediately and adversely affected by job loss, divorce, illness, personal bankruptcy, or other changes in circumstances. Other loans included in this category include loans to states and political subdivisions.

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows, fair value of collateral less estimated costs to sell, or observable market price of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal is ordered if a current one is not on file. Appraisals are typically performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions among other considerations.

The general component covers loans that are not considered impaired and is based on historical loss experience adjusted for qualitative factors. The historical loss experience is calculated by loan type and uses an average loss rate during the preceding twelve quarters. The qualitative factors are assigned by management based on delinquencies and asset quality, national and local economic trends, effects of the changes in the value of underlying collateral, trends in volume and nature of loans, effects of changes in the lending policy, the experience and depth of management, concentrations of credit, quality of the loan review system, and the effect of external factors such as competition and regulatory requirements. The factors assigned differ by loan type. The general allowance estimates losses whose impact on the portfolio has yet to be recognized by a specific allowance. Allowance factors and the overall size of the allowance may change from period to period based on management’s assessment of the above described factors and the relative weights given to each f~~actor. For further information regarding the allowance for loan losses, see Note 4 to the Consolidated Financial Statements included in this Form 10-Q.~~

~~Loans acquired from Fincastle and SmartBank were recorded at fair value. The~~re ~~was $230 thousand of allowance for loan losses attributable to purchased loans~~at ~~September 30, 2022~~.

~~Loans Acquired in a Business Combination~~

~~Acquired loans are classified as either (i) purchased credit-impaired (PCI) loans or (ii) purchased performing loans and are recorded at fair value on the date of acquisition.~~

PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Corporation will not collect all contractually required principal and interest payments. When determining fair value, PCI loans are aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. There were no acquire~~d loans classified as PCI in the acquisition of the Fincastle and the SmartBank loan portfolios.~~

~~Goodwill and Other Intangible Assets~~

Goodwill arises from business combinations and is determined as the excess fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed. The Company has selected June 30 as the date to perform the annual impairment test. Intangible assets with finite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on the balance sheet.

Other intangible assets consist of core deposit intangible assets arising from whole bank and branch acquisitions and are amortized on an accelerated method over their estimated useful lives, which range from 6 to 10 years.

~~Table of Contents~~

Lending Policies

There have been no material changes in the Company’s lending policies disclosed in the Annual Report on Form 10-K for the year ended December 31, ~~2021.~~2022.

Results of Operations

General

Net interest income represents the primary source of earnings for the Company. Net interest income equals the amount by which interest income on interest-earning assets, predominantly loans and securities, exceeds interest expense on interest-bearing liabilities, including deposits, other borrowings, subordinated debt, and junior subordinated debt. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, are the components that impact the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets. The provision for ~~loan~~credit losses, noninterest income, and noninterest expense are the other components that determine net income. Noninterest income and expense primarily ~~consists~~consist of income from service charges on deposit accounts, revenue from wealth management services, ATM and check card income, revenue from other customer services, income from bank owned life insurance, general and administrative expenses, amortization expense, and other real estate owned expense.

Net Income

Three Month Period EndedSeptember 30, ~~2022~~2023

Net income ~~increased by $2.1~~decreased $1.3 million, or ~~86%~~30%, to $3.1 million, or $0.50 per diluted share, for the three months ended September 30, 2023, compared to $4.5 million, or $0.71 per diluted share, for the ~~three months ended September 30, 2022, compared to $2.4 million, or $0.38 per diluted share, for the~~ same period in ~~2021.~~2022. Return on average assets was ~~1.27%~~0.91% and return on average equity was ~~17.27%~~10.96% for the third quarter of ~~2022,~~2023, compared to ~~0.71%~~1.27% and ~~8.64%~~17.27%, respectively, for the same period in ~~2021.~~2022.

The ~~increase~~decrease in net income resulted ~~primarily~~ from a ~~$2.0~~$1.0 million, or ~~20%~~9%, ~~increase~~decrease in net interest income, and a ~~$379~~$701 thousand, or ~~14%~~8%, increase in total noninterest expense, which were partially offset by a $26 thousand, or 1%, increase in total noninterest income, a $100 thousand decrease in the provision for credit losses, and a ~~$343~~$286 thousand ~~or 4%,~~ decrease in ~~total noninterest~~income tax expense. ~~The provision for loan losses totaled $200 thousand for the third quarter of 2022. There was no provision for loan losses for the same period of 2021.~~

Nine Month Period Ended September 30, ~~2022~~2023

Net income ~~increased by $3.9~~decreased $1.5 million, or ~~47%~~13%, to $10.5 million, or $1.67 per diluted share, for the nine months ended September 30, 2023, compared to $12.0 million, or $1.92 per diluted share, for the ~~nine months ended September 30, 2022, compared to $8.2 million, or $1.53 per diluted share, for the~~ same period in ~~2021.~~2022. Return on average assets was ~~1.14%~~1.03% and return on average equity was ~~15.12%~~12.57% for the nine months ended September 30, ~~2022,~~2023, compared to ~~0.97%~~1.14% and ~~11.40%~~15.12%, respectively, for the same period in ~~2021.~~2022.

The ~~increase~~decrease in net income ~~resulted primarily from~~was attributable to a ~~$8.8~~$1.5 million, or ~~36%~~6%, increase in noninterest expenses, and a $961 thousand decrease in net interest ~~income and a $1.2 million, or 18%, increase in total noninterest income, which~~income. These changes were partially offset by a ~~$3.9 million, or 17%,~~$197 thousand increase in ~~total~~ noninterest ~~expense~~income, and ~~an increase~~a $400 thousand decrease in the provision for ~~loan losses. The provision for loan~~credit losses, ~~totaled $600~~and a $318 thousand ~~for the nine months ended September 30, 2022, compared to a recovery of loan losses of $1.0 million for the same period of 2021.~~decrease in income tax expense.

Net Interest Income

Three Month Period Ended September 30, ~~2022~~2023

~~For~~Net interest income decreased from a 23-basis point decrease in the net interest margin and a 1% decrease in average earning assets. The net interest margin was impacted by changes in market interest rates, including the Federal funds target rate, which averaged 5.43% in the third quarter of ~~2022, net interest income increased~~2023, compared to ~~$11.7 million from $9.7 million~~2.35% for the same period one year ago. The rise in the ~~prior year,~~Federal funds rate had an impact on the Company’s cost of funds, which increased 94 basis points. The higher cost of funds was partially offset by a 68-basis point increase in the yield on earning assets.

The net interest margin decreased by 1 basis point in the third quarter of 2023 compared to the linked second quarter of 2023, which was an improvement compared to a ~~$2.0~~24-basis point decrease in the second quarter of 2023 compared to the linked first quarter of 2023, and a 10-basis point decrease in the first quarter of 2023 compared to the linked fourth quarter of 2022.

Net interest income decreased by $1.0 million ~~or 20%, increase and~~as total interest income increased by $1.8 million, which was ~~favorably impacted~~offset by a ~~change~~$2.9 million increase in total interest expense. Although both interest income and interest expense increased as a result of the ~~composition of average earning assets. Average loan balances~~higher interest rate environment in 2023, interest expense increased ~~by $124.7 million, or 16%, while average interest-bearing deposits in banks decreased by $122.0 million, or 61%,~~more than interest income, comparing the ~~periods.~~ third quarter of 2023 with the same period of the prior year.

Total interest income increased ~~by $2.5 million, which was partially offset by a $472 thousand increase in total interest expense. Net interest income increased~~ primarily from ~~a 52-basis point increase in the net~~ interest ~~margin to 3.58%. The increase in net interest margin~~and fees on loans, which resulted from ~~a 65-basis point increase in the yield~~both higher yields and higher average balances, while interest on average earning assets, which was partially offset by a 14-basis point increase in the cost of funds. The change in the composition of average earning assets had a significant impact on the increase in the yield on average earning assets as average loans increased to 68% from 60% of average earning assets, while average interest-bearing deposits in banks increased solely from higher yields, as their average balances decreased ~~to 6% from 16%, comparing the third quarter 2022~~compared to the same period of ~~2021.~~the prior year. The ~~Bank’s acquisition~~yield on loans increased by 52 basis points to 5.31% and the average balance of ~~an $82.6 million loan portfolio from SmartBank~~loans increased to 74% of average earning assets, compared to 68% for the same period one year ago. The yield on ~~September 30, 2021 made a significant contribution~~interest-bearing deposits in banks increased by 344 basis points to 5.39%, while the ~~increase in~~ average ~~loan balances when comparing the third quarter~~balance decreased to 2% of ~~2022~~average earning assets, compared to 6% for the same period of ~~2021. The loan portfolio acquisition occurred on the last day of the third quarter of 2021, and as a result, average loans and net interest income were not favorably impacted during~~ the prior ~~year period.~~year.

Net accretion of discounts on purchased loans totaled $61 thousand in the third quarter of 2023 compared to $295 thousand for the third quarter of 2022.

The increase in interest expense was ~~included~~attributable to higher interest expense on deposits. Deposit costs increased from higher interest rates paid on deposit accounts in 2023, as well as a change in the deposit portfolio composition, as interest-bearing deposits increased as a percentage of total deposits, while noninterest-bearing deposits decreased. Additionally, within the interest-bearing deposit portfolio, higher cost time deposit balances and money market balances increased, while lower cost checking and savings balances decreased. The average balance of time deposits increased to 22% of average interest-bearing deposits, compared to 16% for the same period of the prior year. The cost of interest-bearing deposits increased by 139 basis points to 1.82% for the current period, compared to 0.43% for the same period of the prior year. The total cost of funds increased 94-basis points to 1.27% for the current period compared to 0.33% for the same period of the prior year.

Nine Month Period Ended September 30, 2023

Net interest income decreased from a 13-basis point decrease in the net interest margin, which was partially offset by a 1% increase in average earning assets. The net interest margin was impacted by changes in market interest rates, including the Federal funds target rate, which averaged 5.09% for the nine months ending September 30, 2023, compared to 1.20% for the same period one year ago. The rise in the Federal funds rate had an impact on the Company’s cost of funds, which increased 85 basis points. The higher cost of funds was partially offset by a 68-basis point increase in the yield on earning assets.

Net interest income decreased $961 thousand as total interest income increased $6.8 million and was offset by a $7.8 million increase in total interest expense. Although both interest income and interest expense increased as a result of the higher interest rate environment in 2023, the increase in interest income was offset by the increase in interest expense, comparing the nine-month period of 2023 with the same period of the prior year.

Total interest income increased from interest and fees on loans and ~~totaled $295 thousand~~from interest on deposits in ~~the third quarter of 2022~~banks. Interest and fees on loans increased from higher yields and higher average balances. Interest on deposits in banks increased solely from higher yields, as their average balances decreased compared to ~~$238 thousand~~the same period of the prior year. The yield on loans increased by 49 basis points to 5.19% and the average balance increased to 73% of total average earning assets, compared to 68% for the same period of the prior year. The yield on interest-bearing deposits in banks increased by 420 basis points to 4.95%, while the ~~third quarter~~average balance of ~~2021.~~ interest-bearing deposits decreased to 3% of average earning assets, compared to 10% for the same period of the prior year.

Accretion of ~~Paycheck Protection Program (“PPP”) loan~~PPP income, net of costs, ~~was also~~and accretion of discounts on purchased loans, net of premiums, were included in interest and fees on loans. ~~Net~~There was no accretion of PPP income ~~totaled $0 in the third quarter of 2022 compared to $737 thousand in the same period of 2021.~~

~~Nine Month Period Ended September 30, 2022~~

~~For~~for the nine months ended September 30, ~~2022, net interest income increased~~2023, compared to ~~$33.6 million, which was an $8.8 million, or 36%, increase from $24.7 million~~$358 thousand for the same period ~~in the prior year. The higher net interest income resulted from a 19% increase in average earning assets and a 44-basis point increase in the net interest margin.~~

~~The acquisition~~ of The Bank of Fincastle (“Fincastle”) occurred on July 1, 2021 and made a greater impact on average earning assets for the nine month period ending September 30, 2022 than it did for the same period in 2021. The acquisition of Fincastle occurred on the first day of the third quarter of 2021, and as a result, average earning assets for the third quarter of 2021 was favorably impacted, while the first two quarters of 2021 were not impacted.

The increase in net interest margin resulted from higher yields in all earning asset categories and no change in interest expense as a percentage of average earning assets. The net interest margin also benefited from a favorable change in the composition of average earning assets. As a percentage of average earning assets, average loans increased to 68% from 64%, and total securities increased to 22% from 19%, while average interest-bearing deposits in banks decreased to 10% from 16%, comparing the periods. The Bank’s acquisition of an $82.6 million loan portfolio from SmartBank on September 30, 2021 contributed to the increase in average loan balances when comparing the nine months ending September 30, 2022 to the same period of 2021. The loan portfolio acquisition occurred on the last day of the third quarter of 2021, and as a result, average loans and net interest income were not impacted during the nine-month period of the prior year.

2022. Net accretion of discounts on purchased loans ~~was included in interest and fees on loans and~~ totaled ~~$1.0 million~~$510 thousand for the nine-month period ~~of 2022~~ended September 30, 2023, compared to $238 thousand for the same period of 2021. Accretion of Paycheck Protection Program (“PPP”) loan income, net of costs was also included in interest and fees on loans. Net accretion of PPP income totaled $358 thousand for nine-month period of 2022 compared to $1.8$1.0 million for the same period of ~~2021.~~2022.

The increase in interest expense was attributable to higher interest expense on deposits and a change in the deposit portfolio composition. Interest expense on deposits increased from higher interest rates paid on deposit accounts in 2023, as well as an increase in the average balances of higher cost deposits and a decrease in the average balances of lower cost deposits. The average balance of time deposits balances increased to 20% of total average interest-bearing deposits, compared to 16% for the same period one year ago. The cost of interest-bearing deposits increased by 126 basis points to 1.52% for the current period, compared to 0.26% for the same period of the prior year. The total cost of funds increased 85-basis points to 1.06% for the current period compared to 0.21% for the same period of the prior year.

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Table of Contents

The following tables show interest income on earning assets and related average yields as well as interest expense on interest-bearing liabilities and related average rates paid for the periods indicated (dollars in thousands):

Average Balances, Income and Expenses, Yields and Rates (Taxable Equivalent Basis)

	Three Months Ended																Three Months Ended
	September 30, 2022								September 30, 2021								September 30, 2023								September 30, 2022
	Average Balance			Interest Income/Expense		Yield/Rate			Average Balance			Interest Income/Expense		Yield/Rate			Average Balance			Interest Income/Expense		Yield/Rate			Average Balance			Interest Income/Expense		Yield/Rate
Assets
Securities:
Taxable	$	285,482		$	1,323		1.84	%	$	190,182		$	767		1.60	%	$	251,623		$	1,323		2.09	%	$	285,482		$	1,323		1.84	%
Tax-exempt ⁽¹⁾		54,319			389		2.84	%		49,492			306		2.46	%		53,238			384		2.87	%		54,319			389		2.84	%
Restricted		1,908			23		4.75	%		2,408			21		3.48	%		1,904			27		5.57	%		1,908			23		4.75	%
Total securities	$	341,709		$	1,735		2.01	%	$	242,082		$	1,094		1.79	%	$	306,765		$	1,734		2.24	%	$	341,709		$	1,735		2.01	%
Loans: ⁽²⁾
Taxable	$	890,696		$	10,759		4.79	%	$	762,623		$	9,185		4.78	%	$	943,452		$	12,640		5.31	%	$	890,696		$	10,759		4.79	%
Tax-exempt ⁽¹⁾		—			—		—			3,378			38		4.49	%		—			—		—			—			—		0.00	%
Total loans	$	890,696		$	10,759		4.79	%	$	766,001		$	9,223		4.78	%	$	943,452		$	12,640		5.31	%	$	890,696		$	10,759		4.79	%
Federal funds sold		1			—		—			65,514			8		0			—			—		—			1			—		—
Interest-bearing deposits with other institutions		77,388			380		1.95	%		199,372			78		0.15	%		24,894			338		5.39	%		77,388			380		1.95	%
Total earning assets	$	1,309,794		$	12,874		3.90	%	$	1,272,969		$	10,403		3.25	%	$	1,275,111		$	14,712		4.58	%	$	1,309,794		$	12,874		3.90	%
Less: allowance for loan losses		(6,152	)							(5,450	)
Less: allowance for credit losses on loans																		(8,847	)							(6,152	)
Total non-earning assets		89,667								69,728								88,914								89,666
Total assets	$	1,393,309							$	1,337,247							$	1,355,178							$	1,393,308
Liabilities and Shareholders’ Equity
Interest bearing deposits:
Checking	$	293,169		$	416		0.56	%	$	266,623		$	105		0.16	%	$	264,193		$	1,194		1.79	%	$	293,169		$	416		0.56	%
Regular savings		205,608			56		0.11	%		196,025			41		0.08	%		163,550			49		0.12	%		205,608			56		0.11	%
Money market accounts		215,199			284		0.52	%		182,350			47		0.10	%		223,121			1,348		2.40	%		215,199			284		0.52	%
Time deposits:
$100,000 and over		59,892			95		0.63	%		60,977			110		0.72	%
Under $100,000		72,847			76		0.42	%		86,565			66		0.30	%
Brokered		554			—		0.12	%		767			1		0.28	%
Time deposits																		180,729			1,219		2.68	%		133,293			171		0.51	%
Total interest-bearing deposits	$	847,269		$	927		0.43	%	$	793,307		$	370		0.18	%	$	831,593		$	3,810		1.82	%	$	847,269		$	927		0.43	%
Federal funds purchased		—			—		—	%		—			—		0.00	%
Subordinated debt		4,995			70		5.50	%		9,993			155		6.17	%		4,996			69		5.50	%		4,995			70		5.50	%
Junior subordinated debt		9,279			68		2.91	%		9,279			68		2.91	%		9,279			69		2.95	%		9,279			68		2.91	%
Total interest-bearing liabilities	$	861,542		$	1,065		0.49	%	$	812,579		$	593		0.29	%	$	845,868		$	3,948		1.85	%	$	861,542		$	1,065		0.49	%
Non-interest bearing liabilities
Demand deposits		425,630								410,439								391,342								425,630
Other liabilities		3,795								4,076								4,909								3,795
Total liabilities	$	1,290,967							$	1,227,094							$	1,242,119							$	1,290,967
Shareholders’ equity		102,341								110,153								113,059								102,341
Total liabilities and Shareholders’ equity	$	1,393,308							$	1,337,247							$	1,355,178							$	1,393,308
Net interest income				$	11,809							$	9,810							$	10,764							$	11,809
Interest rate spread							3.41	%							2.95	%							2.73	%							3.41	%
Cost of funds							0.33	%							0.19	%							1.27	%							0.33	%
Interest expense as a percent of average earning assets							0.32	%							0.18	%							1.23	%							0.32	%
Net interest margin							3.58	%							3.06	%							3.35	%							3.58	%

(1)	Income and yields are reported on a taxable-equivalent basis assuming a federal tax rate of 21%. The tax-equivalent adjustment was $81 and $82 thousand for the three months ended September 30, 2023 and 2022, respectively.

(2)	Loans on non-accrual status are reflected in the balances.

Table of Contents

	Nine Months Ended
	September 30, 2023								September 30, 2022
	Average Balance			Interest Income/Expense		Yield/Rate			Average Balance			Interest Income/Expense		Yield/Rate
Assets
Securities:
Taxable	$	255,648		$	3,968		2.08	%	$	221,708		$	3,750		2.26	%
Tax-exempt⁽¹⁾		54,134			1,161		2.87	%		57,359			1,166		2.72	%
Restricted		1,871			81		5.82	%		1,881			65		4.65	%
Total securities	$	311,653		$	5,210		2.24	%	$	280,948		$	4,981		2.37	%
Loans: ⁽²⁾
Taxable	$	927,525		$	36,038		5.19	%	$	858,150		$	30,202		4.70	%
Tax-exempt ⁽¹⁾		—			—		0.00	%		733			24		4.49	%
Total loans	$	927,525		$	36,038		5.19	%	$	858,883		$	30,226		4.70	%
Federal funds sold		—			—		—			—			—		0.00	%
Interest-bearing deposits with other institutions		38,957			1,441		4.95	%		125,677			701		0.75	%
Total earning assets	$	1,278,135		$	42,689		4.47	%	$	1,265,508		$	35,908		3.79	%
Less: allowance for credit losses on loans		(9,054	)							(5,923	)
Total non-earning assets		90,669								155,714
Total assets	$	1,359,750							$	1,415,299
Liabilities and Shareholders’ Equity
Interest bearing deposits:
Checking	$	270,076		$	3,253		1.61	%	$	294,386		$	671		0.31	%
Regular savings		178,924			165		12.00	%		207,302			108		0.07	%
Money market accounts		215,468			3,380		2.10	%		227,330			410		0.24	%
Time deposits		163,647			2,630		2.15	%		138,118			491		0.48	%
Total interest-bearing deposits	$	828,115		$	9,428		1.52	%	$	867,136		$	1,680		0.26	%
Federal funds purchased		2			—		0.00	%		1			—		0.00	%
Subordinated debt		4,997			207		5.56	%		5,494			208		5.05	%
Junior subordinated debt		9,279			203		2.91	%		9,279			202		2.91	%
Other borrowings		73			3		4.91	%		—			—		0.00	%
Total interest-bearing liabilities	$	842,466		$	9,841		1.56	%	$	881,910		$	2,090		0.32	%
Non-interest bearing liabilities
Demand deposits		401,162								423,069
Other liabilities		4,633								4,035
Total liabilities	$	1,248,261							$	1,309,014
Shareholders’ equity		111,489								106,285
Total liabilities and Shareholders’ equity	$	1,359,750							$	1,415,299
Net interest income				$	32,848							$	33,818
Interest rate spread							2.90	%							3.48	%
Cost of funds							1.06	%							0.21	%
Interest expense as a percent of average earning assets							1.03	%							0.22	%
Net interest margin							3.44	%							3.57	%

(1)	Income and yields are reported on a taxable-equivalent basis assuming a federal tax rate of 21%. The tax-equivalent adjustment was ~~$82~~$244 and ~~$72~~$245 thousand for the ~~three~~six months ended September 30, ~~2022~~2023 and ~~2021,~~2022, respectively.

(2)	Loans on non-accrual status are reflected in the balances.

Table of Contents

Nine Months Ended

September 30, 2022

September 30, 2021

Average Balance

Interest Income/Expense

Yield/Rate

Average Balance

Interest Income/Expense

Yield/Rate

Assets

Securities:

Taxable
$ 221,708 $ 3,750 2.26 % $ 153,793 $ 2,180 1.90 %
Tax-exempt ⁽¹⁾
57,359 1,166 2.72 % 42,446 806 2.54 %
Restricted
1,881 65 4.65 % 1,964 65 4.45 %
Total securities
$ 280,948 $ 4,981 2.37 % $ 198,203 $ 3,051 2.06 %
Loans: ⁽²⁾

Taxable
$ 858,150 $ 30,202 4.70 % $ 673,375 $ 23,342 4.63 %
Tax-exempt ⁽¹⁾
733 24 4.49 % 3,400 114 4.49 %
Total loans
$ 858,883 $ 30,226 4.70 % $ 676,775 $ 23,456 4.63 %
Federal funds sold
— — — 22,122 8 0.05 %
Interest-bearing deposits with other institutions
125,677 701 0.75 % 166,497 148 0.12 %
Total earning assets
$ 1,265,508 $ 35,908 3.79 % $ 1,063,597 $ 26,663 3.35 %
Less: allowance for loan losses
(5,923 ) (6,468 )
Total non-earning assets
155,583 64,096
Total assets
$ 1,415,168 $ 1,121,225
Liabilities and Shareholders’ Equity

Interest bearing deposits:

Checking
$ 294,386 $ 671 0.31 % $ 242,821 $ 321 0.18 %
Regular savings
207,302 108 0.07 % 152,424 80 0.07 %
Money market accounts
227,330 410 0.24 % 166,141 135 0.11 %
Time deposits:

$100,000 and over
62,230 258 0.55 % 47,991 292 0.81 %
Under $100,000
75,332 230 0.41 % 66,078 231 0.47 %
Brokered
556 3 0.73 % 647 2 0.37 %
Total interest-bearing deposits
$ 867,136 $ 1,680 0.26 % $ 676,102 $ 1,061 0.21 %
Federal funds purchased
1 — — 1 — 0.46 %
Subordinated debt
5,494 208 5.05 % 9,992 464 6.20 %
Junior subordinated debt
9,279 202 2.91 % 9,279 202 2.91 %
Other borrowings
— — — % — — 0.00 %
Total interest-bearing liabilities
$ 881,910 $ 2,090 0.32 % $ 695,374 $ 1,727 0.33 %
Non-interest bearing liabilities

Demand deposits
423,069 327,263
Other liabilities
4,035 2,728
Total liabilities
$ 1,309,014 $ 1,025,365
Shareholders’ equity
103,285 95,860
Total liabilities and Shareholders’ equity
$ 1,412,299 $ 1,121,225
Net interest income
$ 33,818 $ 24,936
Interest rate spread
3.48 % 3.02 %
Cost of funds
0.21 % 0.23 %
Interest expense as a percent of average earning assets
0.22 % 0.22 %
Net interest margin
3.57 % 3.13 %

~~(1)~~

~~Income and yields are reported on a taxable-equivalent basis assuming a federal tax rate of 21%.~~ ~~The tax-equivalent adjustment was $253 and $193 thousand for the nine months ended September 30, 2022 and 2021, respectively.~~

~~(2)~~

~~Loans on non-accrual status are reflected in the balances.~~

~~Table of Contents~~

Provision for ~~Loan~~Credit Losses

Three Month Period Ended September 30, ~~2022~~2023

The provision for ~~loan~~credit losses totaled ~~$200~~$100 thousand for the third quarter of ~~2022. There was no provision for loan losses~~2023, compared to $200 thousand for the same period of ~~2021.~~the prior year. The provision was comprised of a $120 thousand provision on loans, an $8 thousand recovery on unfunded commitments, and a $12 thousand recovery on held-to-maturity securities. The provision for ~~loan~~credit losses on loans resulted from growth of the loan portfolio, net charge-offs, and an increase in the ~~general~~specific reserve component of the allowance for ~~loan losses. The increase~~credit losses, which were partially offset by a decrease in the general reserve component ~~resulted~~ from ~~loan growth during the quarter~~lower expected loss rates and ~~was partially offset by~~ an ~~improvement~~adjustment to a qualitative factor. The qualitative factor related to asset quality was improved for the other real estate loan category as all loans that had modified loan payments in prior years under the CARES Act resumed original contractual loan payments. There were no specific reserves on impaired loans on September 30, 2022, compared $55 thousand of specific reserves on December 31, 2021, and $84 thousand on September 30, 2021. Net charge-offs totaled $111 thousand during the third quarter of 2022, compared to $31 thousand of net charge-offs for the same period of 2021.

The allowance for loan losses totaled $6.3 million, or 0.69% of total loans on September 30, 2022, compared to $5.7 million, or 0.69% of total loans on December 31, 2021, and $5.4 million, or 0.66% of total loans on September 30, 2021. The net discount on purchased loans totaled $2.7 million on September 30, 2022, $3.7 million on December 31, 2021, and $3.8 million on September 30, 2021.

Nine Month Period Ended September 30, ~~2022~~2023

The provision for ~~loan~~credit losses totaled ~~$600~~$200 thousand for the ~~nine months~~nine-months ended September 30, ~~2022,~~2023, compared to ~~a $1.0 million recovery of loan losses~~$600 thousand for the same period of ~~2021.~~the prior year. The provision was comprised of a $165 thousand provision on loans, a $36 thousand provision on unfunded commitments, and a $1 thousand net recovery on held-to-maturity securities. The provision for credit losses on loans resulted from growth of the loan ~~losses resulted primarily from a $637 thousand~~portfolio, net charge-offs, and an increase in the ~~general~~specific reserve component of the allowance for ~~loan~~credit losses, which ~~was~~were partially offset by a ~~$55 thousand~~ decrease ~~in the specific reserve component. The increase~~ in the general reserve component ~~resulted~~ from ~~loan growth during the period~~lower expected loss rates and ~~was partially offset by improvements~~an adjustment to a qualitative factors. During the nine-month period ended September 30, 2022, the qualitative factor related to asset quality was improved for the commercial and industrial and the other real estate loan categories, and the factor related to economic conditions was improved for all loan categories.factor.

Noninterest Income

Three Month Period Ended September 30, ~~2022~~2023

Noninterest income increased ~~$379~~$26 thousand, or ~~14%~~1%, to ~~$3.0~~$3.1 million for the third quarter of ~~2022,~~2023, compared to the same period of ~~2021. Service charges on deposits increased $161 thousand, or 29%,~~2022. ATM and check card fees increased ~~$162~~$61 thousand, or ~~22%~~7%, and wealth management fees increased ~~$43~~$72 thousand, or ~~6%, and other operating income increased $191 thousand.~~10%. These ~~increases~~increases were partially offset by ~~an $83~~a $58 thousand, or ~~54%, decrease in brokered mortgage fees, and a $99 thousand, or 35%~~32%, decrease in fees for other customer ~~services.~~

~~The increases in service charges on deposits~~services, and ATM and check card fees were impacted by an increase in customer transactions. The increase in ATM and check card fees was also attributable to the timing of annual check card revenue that was received in third quarter of 2022, compared to the prior year when it was received during the fourth quarter. The increase in wealth management income was attributable to an increase in the number of client accounts. The increase in other operating income was primarily a result of a $170 thousand death benefit payment received from a bank-owned life insurance policy. Brokered mortgage fees decreased from a reduction in the number of mortgage loans originated. The decrease in fees for other customer services resulted from higher amounts of fees earned on loans in the third quarter of the prior year.

~~Nine Month Period Ended September 30, 2022~~

~~Noninterest income increased $1.3 million, or 18%, to $8.5 million for the nine months ended September 30, 2022, compared to the same period of 2021. Service charges on deposits increased $579~~$34 thousand, or 40%, ATM and check card fees increased $426 thousand, or 21%, wealth management fees increased $306 thousand, or 15%, and other operating income increased $178 thousand, or 60%. The increases were partially offset by a $192 thousand, or 46%47%, decrease in brokered mortgage fees.

The increases in ~~service charges on deposits and~~ ATM and check card fees were favorably impacted by an increase in customer ~~transactions and addition of customers from the acquisition of The Bank of Fincastle on July 1, 2021.~~transactions. The increase in wealth management ~~income was attributable to~~fees resulted primarily from an increase in assets under management from higher market values.

Nine Month Period Ended September 30, 2023

Total noninterest income increased $197 thousand, or 2%, for the ~~number~~nine months ended September 30, 2023, compared to the same period of ~~client accounts.~~2022. The increase resulted primarily from a $162 thousand, or 7%, increase in ATM and check card fees, a $150 thousand increase in other operating income, and a $47 thousand, or 2%, increase in service charges on deposit accounts, which were partially offset by a $151 thousand decrease in income from brokered mortgage fees. An increase in customer transactions favorably impacted ATM and check card fees. The increase in other operating income was ~~due primarily~~attributable to a ~~$170 thousand~~ death benefit payment received from a bank-owned life insurance ~~policy. Brokered mortgage fees decreased from a reduction~~policy in ~~the number of mortgage loans originated.~~2023.

~~Table of Contents~~

Noninterest Expense

Three Month Period Ended September 30, ~~2022~~2023

Noninterest ~~expense decreased $343~~expenses increased $701 thousand, or 4%8%, to ~~$9.1~~$9.8 million for the three-month period ended September 30, ~~2022,~~2023, compared ~~$9.4 million for the same period one year ago. The decrease was primarily attributable~~ to a $272 thousand, or 5% decrease in salaries and employee benefits, a $225 thousand, or 38%, decrease in legal and professional expense, and a $222 thousand, or 48%, decrease in data processing expense, which were partially o~~ffset by a $276 thousand, or 30% increase in other operating expense and an $85 thousand, or 56%, increase in bank franchise tax expense.~~

~~Costs related to the acquisition of Fincastle and the acquisition of the loan portfolio and branch assets from SmartBank totaled $1.3 million in the third quarter of 202~~1 and had a significant impact on the decrease in noninterest expense when comparing the third quarter of 2022 to the same period of 2021, as merger related costs decreased to $0 for the three months ended September 30, 2022. The decreases in merger related costs impacted legal and professional expense and data processing expense comparing the periods. The decrease in salaries and employee benefits reflected the reduction of operating costs and efficiencies created from the merger of Fincastle into First Bank.

The increase in other operating expense resulted primarily from an increase in education and training, courier and armored services, and an increase in losses related to customer account fraud. Bank franchise tax increased primarily from the growth of the balance sheet that resulted from the Fincastle acquisition.

~~Nine Month Period Ended September 30, 2022~~

~~Noninterest expense increased $3.9 million, or 17%, to $26.6 million for the nine-month period ended September 30, 2022, compared to $22.7 million for~~ the same period one year ago. The increase was primarily attributable to a ~~$2.7 million,~~$331 thousand, or ~~21%~~6%, increase in salaries and employee benefits, a ~~$342~~$78 thousand ~~or 25%,~~increase in legal and professional fees, a $108 thousand increase in ATM and check card expense, a $52 thousand increase in FDIC assessment, and a $52 thousand increase in equipment expense.

Salaries and employee benefits increased primarily from annual increases in employee salaries and wages. Legal and professional fees increased from wealth management advisory expense. ATM and check expenses increased from higher volume of customer transactions. FDIC assessment increased from higher assessed rates during 2023. The increase in equipment expense resulted primarily from higher depreciation expense on software.

Nine Month Period Ended September 30, 2023

Noninterest expense increased $1.5 million, or 6%, to $28.1 million for the nine-month period ended September 30, 2023, compared to the same period one year ago. The increase was primarily attributable to a ~~$310~~$656 thousand, or 4% increase in salaries and employee benefits, a $135 thousand, or 23%, increase in ~~occupancy expense,~~marketing, a ~~$154~~$283 thousand, or ~~19%~~29%, increase in ATM and check card expense, and a ~~$159~~$387 thousand, or ~~68%, increase in FDIC assessment, a $98 thousand, or 20%, increase in marketing, a $199 thousand, or 40%, increase in bank franchise tax, and a $786 thousand, or 36%~~13%, increase in other operating ~~expense.~~expenses. These increases were partially offset by a ~~$731~~$284 thousand ~~or 40%,~~ decrease in ~~legal~~OREO expense, net, which resulted from gains on the sale of other real estate during 2023.

Salaries and ~~professional fees~~employee benefits increased primarily from an annual increase in employee salaries and wages. Marketing expenses increased from additional advertising and active promotion initiatives. ATM and check card expense increased primarily from a ~~$185 thousand, or 21% decrease in data processing expense.~~higher volume of customer transactions. Other operating expenses increased primarily from higher recruiting expense, education and training expense, loan collection expense, and courier and armored services.

The increases were primarily attributable to the increase in the number of employees, branch offices and customers that resulted from the acquisition of Fincastle on July 1, 2021 and the acquisition of the loan portfolio, branch assets and the addition of employees from SmartBank on September 30, 2021. The decreases in legal and professional fees and data processing were primarily attributable to merger related costs during the first nine months of 2021. Merger related expenses totaled $20 thousand for the first nine months of 2022 compared to $2.0 million for the same period of 2021.

Income Taxes

Three Month Period Ended September 30, ~~2022~~2023

Income tax expense ~~increased $455~~decreased $286 thousand for the third quarter of ~~2022,~~2023, compared to the same period one year ago. The effective tax rate for the ~~third~~second quarter of ~~2022~~2023 was ~~18.6%~~19.0% compared to ~~19.0%~~18.6% for the same period in ~~2021.~~2022. The ~~reduced~~increased effective tax rate for ~~2022~~2023 was the result of ~~lower~~higher non-deductible expenses and ~~higher non-taxable~~lower nontaxable income in ~~2022~~2023 compared to ~~2021. The~~2022. The Company’s income tax expense differed from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the three months ended September 30, ~~2022,~~2023, and ~~2021.~~2022. The difference was a result of net permanent tax deductions, primarily comprised of tax-exempt interest income, and income from bank owned life insurance. A more detailed discussion of the Company’s tax calculation is contained in Note 11 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2021.~~2022.

Nine Month Period Ended September 30, ~~2022~~2023

Income tax expense ~~increased $731~~decreased $318 thousand, or ~~35%~~11.3%, for the first nine months of ~~2022~~2023 compared with the same period in ~~2021.~~2022. The effective tax rate for the first nine months of ~~2022~~2023 was ~~19.0%~~19.3% compared with ~~20.4%~~19.0% for the same period in ~~2021.~~2022. Like the three month period ended September 30, ~~2022,~~2023, the ~~reduced~~increased effective tax rate for ~~2022~~2023 was also the result of lower non-deductible expenses ~~and higher non-taxable income~~ in ~~2022~~2023 compared to ~~2021.~~

2022.

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Table of Contents

Financial Condition

General

Assets totaled $1.4 ~~billio~~nbillion on September 30, ~~2022~~2023, which waswas a slight decrease of ~~$5.8~~$3.2 million from December 31, ~~2021. Although there was not a significant change in total assets, the~~2022. The asset composition changed ~~notably~~during the first nine months of the year as ~~total loans increased~~cash and due from banks decreased by ~~$81.4~~$3.6 million, ~~or 10%, to $906.5 million and resulted in a loan-to-asset ratio of 66% compared to 59% at year-end. While loans increased,~~ interest-bearing deposits in banks decreased by ~~$104.3~~$13.2 million, ~~to $53.0~~and total securities decreased by $14.7 million, ~~or 4%~~while loans, net of ~~total assets compared to 11% of total assets at year-end.~~the allowance for credit losses, increased by $30.5 million.

Total liabilities ~~increased~~decreased by ~~$12.1~~$6.8 million ~~to $1.3 billion on~~ during the nine-month period ended September 30, ~~2022, compared to December 31, 2021, as total deposits increased by $17.3 million and was partially offset~~2023, primarily byfrom a ~~$5.0~~$6.2 million decrease in ~~subordinated debt. Deposits totaled $1.3 billion and was an increase~~total deposits. Although total deposits decreased slightly, the composition of ~~$17.3 million, or 1%, from December 31, 2021. The deposit composition~~deposits changed ~~slightly~~ as noninterest-bearing ~~demand~~ deposits ~~increased by $25.1, or 6%, to $438.3 million~~ and ~~represented 35% of total deposits, up from 33% of total deposits at year-end. While noninterest-bearing deposits increased,~~ savings and interest-bearing deposits decreased $23.6 million and $30.2 million, respectively, while time deposits ~~decreased slightly as a percentage~~increased $47.6 million. The change in composition of ~~total deposits. On January 1, 2022,~~ the ~~Company repaid $5.0 million of subordinated debt~~deposit portfolio during the period was attributable to customers shifting deposits into products with ~~a fixed~~higher interest ~~rate of 6.75%.~~rates.

Total shareholders’ equity ~~decreased $18.0~~increased by $3.6 million ~~to $99.1~~during the first nine months of 2023, primarily from a $5.7 million ~~on September 30, 2022, compared to $117.0~~increase in retained earnings, which was partially offset by a $2.2 million ~~on December 31, 2021. This was primarily attributable to a $28.1 million decrease~~increase in accumulated other comprehensive ~~(loss) income (AOCI).~~loss. The ~~decrease~~increase in ~~AOCI~~accumulated other comprehensive loss was ~~related~~attributable to higher unrealized losses in the available-for-sale securities ~~portfolio stemming~~portfolio. Retained earnings increased from ~~market rate increases during the first nine months~~$10.5 million of ~~2022. This decrease~~net income, which was partially offset by $2.8 million of cash dividends on common stock and a ~~$9.4~~$2.0 million ~~increase in retained earnings.~~decrease from the adoption of CECL on January 1, 2023. The ~~Company's~~Bank's capital ratios continued to exceed the minimum capital requirements for regulatory purposes.

Loans

Loans totaled $952.5 million at

~~Loans, net~~September 30, 2023, which was a $32.0 million, or 5% annualized, increase from December 31, 2022, and a $46.0 million, or 5%, increase over September 30, 2023. The growth in loans over the periods did not have a significant impact on the composition of the ~~allowance for~~ loan ~~losses, increased $80.8 million to $900.2 million on September 30, 2022, compared to $819.4 million on December 31, 2021. This change~~portfolio. The loan portfolio was primarily ~~due to increases in~~comprised of loans secured by one-to-four family residential real estate, loans secured by commercial real estate, and commercial and industrial loans, which totaled 36%, 46%, and 12% of ~~$25.4 million, $52.9 million, and $12.6 million,~~the loan portfolio, respectively, ~~during the first nine months of 2022. Construction and land development loans and consumer and other loans decreased by $4.4 million and $3.8 million, respectively, during the same period.~~at September 30, 2023.

The Bank actively participated as a lender in the U.S. Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”) to support local small businesses and non-profit organizations by providing forgivable loans. Loan fees received from the SBA are accreted by the Bank into income evenly over the life of the loans, net of loan origination costs, through interest and fees on loans. PPP loans totaled $471 thousand on September 30, 2022, and the loans are scheduled to mature in the first and second quarters of 2026. The total amount of deferred PPP income, net of origination costs, that has not yet been recognized through interest and fees on loans totaled $8 thousand on September 30, 2022. The Company believes the loans will ultimately be forgiven and repaid by the SBA in accordance with the terms of the program. It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan losses through additional provision for loan losses charged to earnings.

During the fourth quarter of 2020, the Bank modified terms of certain loans for customers that continued to be negatively impacted by the pandemic. The loan modifications lowered borrower loan payments by allowing interest only payments for periods ranging between 6 and 24 months. All loans that were modified have resumed original contractual loan payments as of September 30, 2022.

~~Table of Contents~~

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances less the allowance for ~~loan~~credit losses and any deferred fees or costs on originated loans. Interest income is accrued and credited to income based on the unpaid principal balance. Loan origination fees, net of certain origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. Interest income includes amortization of purchase premiums and discounts, recognized evenly over the life of the loans.

A loan’s past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on non-accrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. Loans greater than 90 days past due and still accruing totaled ~~$306~~$368 thousand at September 30, ~~2022~~2023. There were no loans greater than 90 days past due and still accruing at December 31, ~~2021~~.2022. For those loans that are carried on non-accrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. These policies are applied consistently across the loan portfolio.

All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. When a loan is returned to accrual status, interest income is recognized based on the new effective yield to maturity of the loan.

Any unsecured loan that is deemed uncollectible is charged-off in full. Any secured loan that is considered by management to be uncollectible is partially charged-off and carried at the fair value of the collateral less estimated selling costs. This charge-off policy applies to all loan segments.

Asset Quality

~~Impaired Loans~~

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value (net of selling costs), and the probability of collecting scheduled principal and interest payments when due. Additionally, management generally evaluates substandard and doubtful loans greater than $250 thousand for impairment. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair market value of the collateral, net of selling costs, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company typically does not separately identify individual consumer, residential, and certain small commercial loans that are less than $250 thousand for impairment disclosures, except for troubled debt restructurings (TDRs) as noted below. ~~The recorded investment in impaired loans totaled $566 thousand and $2.3 million~~ ~~at September 30, 2022 and December 31, 2021, respectively.~~

~~Troubled Debt Restructurings (TDR)~~

In situations where, for economic or legal reasons related to a borrower’s financial condition, management grants a concession to the borrower that it would not otherwise consider, the related loan is classified as a TDR. TDRs are considered impaired loans. Upon designation as a TDR, the Company evaluates the borrower’s payment history, past due status, and ability to make payments based on the revised terms of the loan. If a loan was accruing prior to bein~~g modified~~ ~~as a~~ ~~TDR~~ a~~nd if the~~ ~~Company concludes that the borrower is able to make such payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the loan~~ will remain on an accruing status. If a loan was on non-accrual status at the time of the TDR, the loan will remain on non-accrual status following the modification and may be returned to accrual status based on the policy for returning loans to accrual status as noted above. There were $110 thousand in loans classified as TDRs a~~s of September 30, 2022 and $1.6 million as of December 31, 2021.~~

~~Asset Quality~~

Management classifies ~~non-performing~~non-performing assets as non-accrual loans and OREO. Non-performing assets ~~totaled $2.1~~totaled $3.1 million and ~~$4.2~~$2.9 million at September 30, ~~2022~~2023 and December 31, ~~2021~~,2022, representing approximately ~~0.15%~~0.23% and ~~0.30%~~0.21% of total assets, respectively. Nonaccrual loans totaled $3.1 million and $2.7 million at September 30, 2023 and December 31, 2022, respectively. OREO totaled $0 and $185 thousand at September 30, 2023 and December 31, 2022, respectively. OREO represents real property taken by the Bank when its customers do not meet the contractual obligation of their loans, either through foreclosure or through a deed in lieu thereof from the borrower and properties originally acquired for, or used in ~~branch~~bank operations, but no longer intended to be used for that purpose. OREO is recorded at the lower of cost or fair value, less estimated selling costs, and is marketed by the Bank through brokerage channels. The Bank ~~had $1.6 million and $1.8 million~~did not have any consumer mortgage loans secured by real estate properties for which formal foreclosure proceedings were in ~~assets classified~~process as ~~OREO at~~ of September 30, ~~2022~~2023 ~~and~~ ~~December 31, 2021, respectively. OREO included $1.6 million in properties formerly classified as bank premises by The Bank of Fincastle which are now classified as held for sale.~~

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AtOn September 30, ~~2022~~2023~~, 21%~~ 17.5% of non-performing assets were comprised of residential real estate loans. ~~Additionally, 79% was comprised of OREO.~~ Non-performing assets could increase due to other loans identified by management as potential problem loans. Other potential problem loans are defined as performing loans that possess certain risks, including the borrower’s ability to pay and the collateral value securing the loan, that management has identified that may result in the loans not being repaid in accordance with their terms. Other potential problem loans totaled ~~$304 thousand~~$1.7 million and ~~$1.1~~$2.3 million at September 30, ~~2022~~2023 and December 31, ~~2021~~,2022, respectively. The amount of other potential problem loans in future periods may be dependent on economic conditions and other factors influencing a customers’ ability to meet their debt requirements.

~~Loans greater than 90 days past due and still accruing totaled $306 thousand at~~ ~~September 30, 2022. There were no loans greater than 90 days past due and still accruing at~~ ~~December 31, 2021~~.

The allowance for loan losses represents management’s analysis of the existing loan portfolio and related credit risks. The provision for loan losses is based upon management’s current estimate of the amount required to maintain an adequate allowance for loan losses reflective of the risks in the loan portfolio. The allowance for loan losses totaled $6.3 million at ~~September 30, 2022~~ ~~and $5.7 million~~ ~~December 31, 2021, representing 0.69% and 0.69% of total loans, respectively. For further discussion regarding the allowance for loan losses, see “Provision for Loan Losses” above.~~

Provision for loan losses totaling $99 thousand, $331 thousand, $69 thousand, and $123 thousand were recorded in the construction and land development, other real estate, commercial and industrial, and consumer and other loan classes, respectively, during the ~~nine months ended September 30, 2022~~. The provisions were offset by a recovery of loan losses of $22 thousand in the 1-4 family residential loans class. For more detailed information regarding the provision for (recovery of) loan losses, see Note 4 to the Consolidated Financial Statements.

~~Impaired loans totaled $566 thousand and $2.3 million at~~ ~~September 30, 2022~~ ~~and~~ ~~December 31, 2021, respectively. There was no related allowance for loan losses recorded for these loans at~~ ~~September 30, 2022. The related allowance for loan losses provided for these loans totaled $55 thousand at~~ ~~December 31, 2021. The average recorded investment in impaired loans during the~~ ~~nine~~ ~~months ended~~ ~~September 30, 2022~~ ~~and the year ended~~ ~~December 31, 2021~~ ~~was $1.4 million and $4.5 million, respectively. Included in the impaired loans total are loans classified as TDRs totaling $110 thousand and $1.6 million at~~ ~~September 30, 2022~~ ~~and~~ ~~December 31, 2021, respectively. Loans classified as TDRs represent situations in which a modification to the contractual interest rate or repayment structure has been granted to address a financial hardship. As of~~ ~~September 30, 2022, none of these TDRs were performing under the restructured terms and all were considered non-performing assets.~~

Management believes, based upon its review and analysis, that the Bank has sufficient reserves to cover losses inherent within the loan portfolio. For each period presented, the provision for ~~loan~~credit losses charged to expense was based on management’s judgment after taking into consideration all factors connected with the collectability of the existing portfolio. Management considers economic conditions, historical ~~loss factors,~~losses, past due percentages, internally generated loan quality reports, and other relevant factors when evaluating the loan portfolio. There can be no assurance, however, that an additional provision for ~~loan~~credit losses will not be required in the future, including as a result of changes in the qualitative factors underlying management’s estimates and judgments, changes in accounting standards, adverse developments in the economy, on a national basis or in the Company’s market area, loan growth, or changes in the circumstances of particular borrowers. For further discussion regarding the allowance for ~~loan~~credit losses, see “Critical Accounting Policies” above.

~~Table of Contents~~

Securities

The securities portfolio plays a primary role in the management of the Company’s interest rate sensitivity and serves as a source of liquidity. The portfolio is used as needed to meet collateral requirements, such as those related to secure public deposits and balances with the Reserve Bank. The investment portfolio consists of held to maturity, available for sale, and restricted securities. Securities are classified as available for sale or held to maturity based on the Company’s investment strategy and management’s assessment of the intent and ability to hold the securities until maturity. Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Company has the ability at the time of purchase to hold the investment securities to maturity, they are classified as investment securities held to maturity and are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Investment securities which the Company may not hold to maturity are classified as investment securities available for sale, as management has the intent and ability to hold such investment securities for an indefinite period of time, but not necessarily to maturity. Securities available for sale may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, general liquidity needs and other similar factors and are carried at estimated fair value. Restricted securities, including Federal Home Loan Bank, Federal Reserve Bank, and Community Bankers’ Bank stock, are generally viewed as long-term investments because there is minimal market for the stock and are carried at cost.

OnSeptember 30, ~~2022~~2023 securities totaled ~~$333.2~~$300.2 million, ~~an increase~~a decrease of ~~$8.5~~$17.8 million, or ~~2.6%~~5.6%, from ~~$324.7~~$318.0 million at December 31, ~~2021~~.2022. Investment securities are comprised of U.S. Treasury securities, U.S. agency and mortgage-backed securities, obligations of state and political subdivisions, corporate debt securities, and restricted securities. As of September 30, ~~2022~~2023, neither the Company nor the Bank held any derivative financial instruments in their respective investment security portfolios. Gross unrealized gains in the available for sale portfolio totaled ~~$133~~$64 thousand and ~~$2.0 million~~$99 thousand at September 30, ~~2022~~2023 and December 31, ~~2021~~,2022, respectively. Gross unrealized losses in the available for sale portfolio totaled ~~$30.3~~$28.4 million and ~~$2.6~~$24.0 million at September 30, ~~2022~~2023 and December 31, ~~2021~~,2022, respectively. ~~Gross~~There were no gross unrealized gains in the held to maturity portfolio ~~totaled $0 and $242 thousand~~ at September 30, ~~2022~~2023 and December 31, ~~2021~~,2022, respectively. Gross unrealized losses in the held to maturity portfolio totaled ~~$12.0~~$15.2 million and ~~$66 thousand~~$11.4 million at September 30, ~~2022~~2023 and December 31, ~~2021. Investments in an unrealized loss position were considered temporarily impaired at~~ ~~September 30,~~ 2022, ~~and~~ ~~December 31, 2021~~. respectively. The change in the unrealized gains and losses of investment securities from December 31, ~~2021~~2022 to September 30, ~~2022~~2023 was related to changes in market interest rates and was not related to credit concerns of the issuers.

On September 1, 2022, the Bank transferred 24 securities designated as available for sale with a combined book value of $82.2 million, market value of $74.4 million, and an unrealized loss of $7.8 million, to securities designated held to maturity. The unrealized loss is being amortized monthly over the life of the securities with an increase to the carrying value of securities and a decrease to the related accumulated other comprehensive loss, which is included in the shareholders’ equity section of the Company’s balance sheet. The amortization of the unrealized loss on the transferred securities totaled ~~$157 thousand,~~$1.2 million, or ~~$124~~$972 thousand net of tax, for the ~~third quarter~~first nine months of 2022. The securities selected for transfer had larger potential decreases in their fair market values in higher interest rate environments than most of the other securities in the available-for-sale portfolio and included U.S. Treasury, agency, municipal and commercial mortgage-backed securities. The securities were transferred to mitigate the potential unfavorable impact that higher market interest rates may have on the carrying value of the securities and on the related accumulated other comprehensive loss.2023. Securities designated as held to maturity are carried on the balance sheet at amortized cost, while securities designated as available for sale are carried at fair market value.

At Deposits~~September 30, 2022~~, the securities portfolio was comprised of $176.4 million of securities available for sale and $154.9 million of securities held to maturity compared to $289.5 million and $33.4 million at December 31, 2021, respectively. Securities held to maturity increased by $43.8 million during the first nine months of 2022 as a result of the transfer disclosed above and new purchases as a part of the Company's strategy to mitigate the risk of potential fluctuations in value and the related impact on total shareholders' equity.

Deposits

At totaled $1.2 billion on September 30, ~~2022~~2023, ~~deposits totaled $1.3 billion, an increase of $17 thousand,~~which was a $6.2 million decrease from ~~$1.2 billion at~~ December 31, ~~2021. There was~~2022, and a ~~slight change in~~$30.3 million, or 2%, decrease from September 30, 2022. The composition of the deposit ~~mix when comparing the~~portfolio has changed compared to prior periods. At ~~September 30, 2022, noninterest-bearing demand~~Noninterest-bearing deposits, savings and interest-bearing ~~demand~~ deposits, and time deposits, ~~composed~~totaled 33%, 52%, and 15%, of total deposits, respectively on September 30, 2023, compared to 34%, 55%, and 11% ~~of total deposits, respectively, compared to 33%~~on December 31, 2022, and 34%, ~~57%~~55%, and ~~10% at~~ ~~December 31, 2021~~.11%, on September 30, 2022. The change in deposit composition was attributable to deposits that shifted into products paying higher interest rates.

Liquidity

Liquidity ~~represents~~sources available to the ~~ability~~Bank, including interest-bearing deposits in banks, unpledged securities available for sale, at fair value, unpledged securities held-to-maturity, at par, eligible to ~~meet present~~be pledged to the Federal Reserve Bank through its Bank Term Funding Program, and ~~future financial obligations through either the sale or maturity~~available lines of ~~existing assets or with borrowings from correspondent banks or other deposit markets. The Company classifies cash, interest-bearing~~credit totaled $532.1 million on September 30, 2023, and noninterest-bearing deposits with banks, federal funds sold, investment securities, and loans maturing within one year as liquid assets. As part of the Bank’s liquidity risk management, stress tests and cash flow modeling are performed quarterly.$417.2 million on December 31, 2022.

~~As a result of the Bank’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the~~The Bank maintains ~~overall~~ liquidity ~~sufficient~~ to ~~satisfy~~fund loan growth and meet the potential demand from its ~~depositors’ requirements~~ deposit customers, including potential volatile deposits. The estimated amount of uninsured customer deposits totaled $346.9 million on September 30, 2023, and ~~to meet its customers’ borrowing needs.~~$261.7 million on December 31, 2022. Excluding municipal deposits, the estimated amount of uninsured customer deposits totaled $268.4 million on September 30, 2023, and $185.3 million on December 31, 2022.

AtThe Bank also has access to off-balance sheet liquidity through its available lines of credit from other institutions, which totaled $347.1 million ~~September 30, 2022, cash, interest-bearing and noninterest-bearing deposits with banks, securities, and loans maturing within one year totaled $163.4 million. At~~ ~~September 30, 2022, 9.6% or $86.7 million of the loan portfolio matured within one year. Non-deposit sources of available funds totaled $300.7 million~~ at September 30, ~~2022~~2023, ~~which included $204.6~~ $287.3 million ~~of secured funds~~at December 31, 2022, and $379.0 million at September 30, 2023. The available ~~from Federal Home Loan Bank of Atlanta (FHLB), $45.2 million of secured funds available through the Federal Reserve Discount Window, and $51.0 million of unsecured federal funds~~ lines of credit ~~with other correspondent banks.~~were comprised of secured and unsecured lines of credit. The Bank had no borrowings on the lines of credit at September 30, 2023, December 31, 2022, or September 30, 2023.

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Capital Resources

The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Company’s asset and liability levels and consistent with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses. The Company meets eligibility criteria of a small bank holding company in accordance with the Federal Reserve Board’s Small Bank Holding Company Policy Statement ~~issued in February 2015~~ and is not obligated to report consolidated regulatory capital.

~~Effective January 1, 2015, the~~The Bank ~~became~~is subject to capital rules adopted by federal bank regulators ~~implementing~~that implemented the Basel III regulatory capital reforms adopted by the Basel Committee on Banking Supervision (the Basel Committee), and certain changes required by the Dodd-Frank Act.

The minimum capital level requirements applicable to the Bank under the final rules are as follows: a ~~new~~ common equity Tier 1 capital ratio of 4.5%; a Tier 1 capital ratio of 6%; a total capital ratio of 8%; and a Tier 1 leverage ratio of 4% for all institutions. ~~The final rules~~There is also ~~established~~ a ~~“capital~~capital conservation ~~buffer”~~buffer, which is 2.5% above the ~~new~~ regulatory minimum capital requirements. ~~The~~If capital ~~conservation~~levels fall below the required minimum ratios plus the buffer, ~~was phased-in over four years~~institutions are subject to limitations on paying dividends, engaging in share repurchases, and ~~as fully implemented effective January 1, 2019, requires~~paying discretionary bonuses. These limitations establish a ~~buffer~~maximum percentage of ~~2.5% of risk-weighted assets.~~eligible retained income that could be utilized for such actions. This results in the following minimum capital ratios ~~beginning in 2019:~~required to exceed the buffer: a common equity Tier 1 capital ratio of 7.0%, a Tier 1 capital ratio of 8.5%, and a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions. Management believes, as of September 30, ~~2022~~2023 and December 31, ~~2021~~,2022, that the Bank met all capital adequacy requirements to which it is subject, including the capital conservation buffer.

The following table shows the Bank’s regulatory capital ratios at September 30, ~~2022:~~2023:

	First Bank
Total capital to risk-weighted assets		~~14.18~~14.80	%
Tier 1 capital to risk-weighted assets		~~13.52~~13.86	%
Common equity Tier 1 capital to risk-weighted assets		~~13.52~~13.86	%
Tier 1 capital to average assets		~~9.27~~9.96	%
Capital conservation buffer ratio⁽¹⁾		~~6.18~~6.80	%

(1)	Calculated by subtracting the regulatory minimum capital ratio requirements from the Company’s actual ratio for Common equity Tier 1, Tier 1, and Total risk based capital. The lowest of the three measures represents the Bank’s capital conservation buffer ratio.

The prompt corrective action framework is designed to place restrictions on insured depository institutions if their capital levels begin to show signs of weakness. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following capital level requirements in order to qualify as “well capitalized:” a common equity Tier 1 capital ratio of 6.5%; a Tier 1 capital ratio of 8%; a total capital ratio of 10%; and a Tier 1 leverage ratio of 5%. The Bank met the requirements to qualify as "well capitalized" as of September 30, ~~2022~~2023 and December 31, ~~2021~~2022.

~~On September 17, 2019~~During the ~~FDIC finalized a rule that introduces an optional simplified measure~~fourth quarter of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the Economic Growth Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities. The CARES Act temporarily lowered the tier 1 leverage ratio requirement to 8% until December 31, 2020. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the "well-capitalized" ratio requirements under the prompt corrective action regulations and will not be required to report or calculate risk-based capital. Although, the Company did not opt into the CBLR framework at ~~September 30, 2022, it may opt into the CBLR framework in a future quarterly period.~~

~~On October 12,~~ 2022, the Board of ~~Directors~~Directors of the Company authorized a stock repurchase plan pursuant to which the Company ~~is authorized to~~could repurchase up to $5.0 million of ~~the Company’s~~its outstanding common stock through December 31, 2023. AsThe Company repurchased 37,532 shares under this plan during the first nine months of ~~November 10, 2022, there have been no stock repurchases under the plan.~~2023 at an average price of $15.14 per share.

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Contractual Obligations

There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, ~~2021.~~2022.

Off-Balance Sheet Arrangements

The Company, through the Bank, is a party to credit related financial instruments with risk not reflected in the consolidated financial statements in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance sheet instruments.

Commitments to extend credit, which ~~amounte~~damounted to ~~$163.1~~$171.9 million aat t September 30, ~~2022~~2023, and ~~$161.4~~$158.3 million at December 31, ~~2021~~2022, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Bank, is based on management’s credit evaluation of the customer.

Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized as deemed necessary and may or may not be drawn upon to the total extent to which the Bank is committed.

On January 1, 2023, the Company recorded an adjustment for unfunded commitments of $153 thousand for the adoption of ASC Topic 326. The Company recorded an additional provision for credit losses for unfunded commitments of $36 thousand during the nine months ended September 30, 2023. At September 30, 2023, the liability for credit losses on off-balance sheet exposures included in other liabilities was $189 thousand.

Commercial and standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments if deemed necessary. At September 30, ~~2022~~2023 and December 31, ~~2021~~2022, the Bank had ~~$21.4~~$12.1 million and ~~$18.9~~$18.0 million in outstanding standby letters of credit, respectively.

On April 21, 2020, the Company entered into interest rate swap agreements related to its outstanding junior subordinated debt. The Company uses derivatives to manage exposure to interest rate risk through the use of interest rate swaps. Interest rate swaps involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date with no exchange of underlying principal amounts.

The interest rate swaps qualified and are designated as cash flow hedges. The Company’s cash flow hedges effectively modify the Company’s exposure to interest rate risk by converting variable rates of interest on $9.0 million of the Company’s junior subordinated debt to fixed rates of interest. The cash flow hedges end and the junior subordinated debt matures between June 2034 and October 2036. The cash flow hedges’ total notional amount is $9.0 million. At September 30, ~~2022~~2023, the cash flow hedges had a fair value of ~~$2.7~~$3.1 million, which is recorded in other assets. The net gain/loss on the cash flow hedges is recognized as a component of other comprehensive (loss) income and reclassified into earnings in the same period(s) during which the hedged transactions affect earnings. The Company’s derivative financial instruments are described more fully in Note 1610 to the Consolidated Financial Statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not required.

Item 4. Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to provide assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods required by the SEC and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. An evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of September 30, ~~2022~~2023 was carried out under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based on and as of the date of such evaluation, the aforementioned officers concluded that the Company’s disclosure controls and procedures were effective.

The Company’s management is also responsible for establishing and maintaining ~~adequate~~adequate internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company is a party or to which the property of the Company is subject.

Item 1A. Risk Factors

There were no material changes to the Company’s risk factors as disclosed in its Annual Report on Form 10-K for the year ended December 31, ~~2021.~~2022.

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

~~None~~Issuer Purchases of Equity Securities

During the fourth quarter of 2022, the Board of Directors of the Company authorized a stock repurchase plan pursuant to which the Company could repurchase up to $5.0 million of its outstanding common stock. The repurchase plan was publicly announced on October 23, 2022. Repurchases under the plan can be made through privately negotiated transactions or in the open market in accordance with Securities and Exchange Commission rules. The Company's Board of Directors authorized the purchase plan through December 31, 2023, unless the entire amount authorized to repurchase has been acquired before that date.

The following table summarizes the Company's purchases of its common stock during the three months ended September 30, 2023 (dollars in thousands, except per share data):

	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Plan		Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plan
July 1, 2023 - July 31, 2023		1,078	$	16.54		1,078	$	4,475,675
August 1, 2023 - August 31, 2023		1,196		17.05		1,196		4,455,279
September 1, 2023 - September 30, 2023		1,400		16.74		1,400		4,431,843
		3,674	$	16.78		3,674	$	4,431,843

Item 3. Defaults upon Senior Securities

None

Item 4. Mine Safety Disclosures

None

Item 5. Other Information

None

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Item 6. Exhibits

The following documents are attached hereto as Exhibits:

~~3.1~~10.1	~~Bylaws~~Form of First National Corporation ~~(attached as Exhibit 3.1 to the Company's current report on~~ Restricted Stock Unit Agreement

10.2	Form ~~8-K filed October 26, 2022 and incorporated herein by reference).~~of First National Corporation Director Stock Award Agreement

31.1	Certification of Chief Executive Officer, Section 302 Certification.

31.2	Certification of Chief Financial Officer, Section 302 Certification.

32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350.

32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.

101	The following materials from First National Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, ~~2022~~2023 formatted in Inline eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss) ~~Income~~ (iv) Consolidated Statements of Cash Flows, (v) Consolidated Statements of Shareholders’ Equity, and (vi) Notes to Consolidated Financial Statements.

104	The cover page from First National Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, ~~2022,~~2023, formatted in Inline XBRL (included with Exhibit 101).

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SIGNATURES

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

FIRST NATIONAL CORPORATION
(Registrant)

/s/ Scott C. Harvard				November ~~10, 2022~~13, 2023
Scott C. Harvard				Date
President and Chief Executive Officer

/s/ M. Shane Bell				November ~~10, 2022~~13, 2023
M. Shane Bell				Date
Executive Vice President and Chief Financial Officer

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Details About Accumulated Other Comprehensive Income (Loss)	Amount Reclassified from Accumulated Other Comprehensive Income (Loss)					Affected Line Item in the Consolidated Statements of Income
	Nine Months Ended
	September 30, 2022		September 30, 2021
Securities available for sale:
Net securities gains reclassified into earnings	$	—	$	(37	)	Net gains on securities available for sale
Related income tax expense		—		8		Income tax expense
Total reclassifications	$	—	$	(29	)	Net of tax