Skyline Bankshares (SLBK) 10-K 2018 FY Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2018

Commission File Number:333-209052

PARKWAY ACQUISITION CORP.

(Exact name of registrant as specified in its charter)

Virginia	47-5486027
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

101 Jacksonville Circle Floyd, Virginia	24091
(Address of principal executive offices)	(Zip Code)

(540) 745-4191

(Registrant’s telephone number, including area code)

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

None

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

None

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

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

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of RegulationS-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form10-K or any amendment to thisForm 10-K.  ☑

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, anon-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 Rule12b-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 Rule12b-2 of the Act).    Yes  ☐    No  ☑

State the aggregate market value of the voting andnon-voting common equity held bynon-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter. $61,433,021

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date. 6,213,275 shares of Common Stock as of March 28, 2019

DOCUMENTS INCORPORATED BY REFERENCE

None

TABLE OF CONTENTS

		Page Number
Part I			1
Item 1.	Business		1
Item 1A.	Risk Factors		12
Item 1B.	Unresolved Staff Comments		18
Item 2.	Properties		18
Item 3.	Legal Proceedings		18
Item 4.	Mine Safety Disclosures		18
Part II			19
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities		19
Item 6.	Selected Financial Data		19
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk		39
Item 8.	Financial Statements and Supplementary Data		39
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		85
Item 9A.	Controls and Procedures		85
Item 9B.	Other Information		86
Part III			86
Item 10.	Directors, Executive Officers and Corporate Governance		86
Item 11.	Executive Compensation		91
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		95
Item 13.	Certain Relationships and Related Transactions, and Director Independence		96
Item 14.	Principal Accounting Fees and Services		97
Part IV			98
Item 15.	Exhibits, Financial Statement Schedules		98
Item 16.	Form10-K Summary		99

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PART I

Item 1. Business.

General

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

On March 1, 2018, Parkway entered into a definitive agreement pursuant to which Parkway acquired Great State Bank (“Great State”), based in Wilkesboro, North Carolina. The agreement provided for the merger of Great State with and into the Bank, with the Bank as the surviving bank (the “Great State merger”). The transaction closed and the merger became effective on July 1, 2018. Each share of Great State common stock was converted into the right to receive 1.21 shares of Parkway common stock. The Company issued 1,191,899 shares and recognized $15.5 million in surplus in the Great State merger. Parkway was considered the acquiror and Great State was considered the acquiree in the transaction for accounting purposes. Pursuant to the Great State merger, the Company acquired $145.5 million of assets, including $95.1 million in loans and assumed $133.0 million in liabilities, including $130.6 million of deposits, on July 1, 2018. Such accounts include preliminary estimated fair value adjustments, which are subject to change.

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

For purposes of this annual report on Form10-K, all information contained herein as of and for periods prior to July 1, 2016 reflects the operations of Grayson prior to the Cardinal merger. Unless this report otherwise indicates or the context otherwise requires, all references to “Parkway” or the “Company” as of and for periods subsequent to July 1, 2016 refer to the combined company and its subsidiary as a combined entity after the Cardinal merger, and all references to the “Company” as of and for periods prior to July 1, 2016 are references to Grayson and its subsidiary as a combined entity prior to the Cardinal merger. All information contained herein as of and for periods prior to July 1, 2018 reflects the operations of Parkway prior to the Great State merger. Unless this report otherwise indicates or the context otherwise requires, all references to “Parkway” or the “Company” as of and for periods subsequent to July 1, 2018 refer to the combined company and its subsidiary as a combined entity after the Great State merger, and all references to “Parkway” or the “Company” as of and for periods prior to July 1, 2018 are references to Parkway and its subsidiary as a combined entity prior to the merger.

Lending Activities

The Bank’s lending services include real estate, commercial, agricultural, and consumer loans. The loan portfolio constituted 87.51% of the interest earning assets of the Bank at December 31, 2018, and has historically produced the highest interest rate spread above the cost of funds. The Bank’s loan personnel have the authority to extend credit under guidelines established and approved by the Bank’s Board of Directors. The Directors’ Loan Committee has the authority to approve loans up to $2.0 million of total indebtedness to a single customer. All loans in excess of that amount must be presented to the full Board of Directors of the Bank for ultimate approval or denial.

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The Bank has in the past and intends to continue to make most types of real estate loans, including, but not limited to, single and multi-family housing, farm loans, residential and commercial construction loans, and loans for commercial real estate. At December 31, 2018, the Bank had 43.94% of the loan portfolio in single and multi-family housing, 32.84% innon-farm,non-residential real estate loans, 6.21% in farm related real estate loans, and 6.23% in real estate construction and development loans.

The Bank’s loan portfolio includes commercial and agricultural production loans totaling 6.99% of the portfolio at December 31, 2018. Consumer and other loans make up approximately 3.79% of the total loan portfolio. Consumer loans include loans for household expenditures, car loans, and other loans to individuals. While this category has historically experienced a greater percentage of charge-offs than the other classifications, the Bank is committed to continue to make this type of loan to fulfill the needs of the Bank’s customer base.

All loans in the Bank’s portfolio are subject to risk from the state of the economy in the Bank’s service area and also that of the nation. The Bank has used and continues to use conservativeloan-to-value ratios and thorough credit evaluation to lessen the risk on all types of loans. The use of conservative appraisals has also reduced exposure on real estate loans. Thorough credit checks and evaluation of past internal credit history has helped reduce the amount of risk related to consumer loans. Government guarantees of loans are used when appropriate, but apply to a minimal percentage of the portfolio. Commercial loans are evaluated by collateral value and ability to service debt. Businesses seeking loans must have a good product line and sales, responsible management, and demonstrated cash flows sufficient to service the debt.

Investments

The Bank invests a portion of its assets in U.S. Treasury, U.S. Government agency, and U.S. Government Sponsored Enterprise securities, state, county and local obligations, corporate and equity securities. The Bank’s investments are managed in relation to loan demand and deposit growth, and are generally used to provide for the investment of excess funds at reduced yields and risks relative to increases in loan demand or to offset fluctuations in deposits.

Deposit Activities

Deposits are the major source of funds for lending and other investment activities. The Bank considers the majority of its regular savings, demand, NOW, money market deposits, individual retirement accounts and small denomination certificates of deposit to be core deposits. These accounts comprised approximately 87.07% of the Bank’s total deposits at December 31, 2018. Certificates of deposit in denominations of $100,000 or more represented the remaining 12.93% of deposits at December 31, 2018.

Market Area

The Bank’s primary market area consists of:

• all of Grayson County, Virginia

• all of Floyd County, Virginia

• all of Carroll County, Virginia

• all of Wythe County, Virginia

• all of Pulaski County, Virginia

• all of Montgomery County, Virginia

• portions of Roanoke County, Virginia

• all of Alleghany County, North Carolina

• all of Ashe County, North Carolina

• all of Watauga County, North Carolina

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• all of Wilkes County, North Carolina

• all of Yadkin County, North Carolina

• the City of Galax, Virginia

• the City of Salem, Virginia

• the City of Roanoke, Virginia

Grayson, Carroll, Alleghany, Ashe, Wilkes, and Yadkin Counties, as well as the City of Galax, are rural in nature and employment in these areas was once dominated by furniture and textile manufacturing. As those industries have declined employment has shifted to healthcare, retail and service, light manufacturing, tourism, and agriculture. Median household income in these markets ranged from a low of $31,002 in Grayson County, to a high of $38,623 in Yadkin County, based upon 2016 census data. Montgomery, Pulaski, Floyd, Wythe and Watauga counties, while largely rural, are more economically diverse. Montgomery County is home to two major universities, Virginia Tech and Radford University, Watauga County is home to Appalachia State University, while community colleges are located in both Wythe County and Pulaski County. The university presence has led to the development of several technology related companies in the region. Manufacturing, agriculture, tourism, retail, healthcare and service industries are also prevalent in these markets. The increased economic diversity of these markets is reflected in the median household incomes which range from a low of $39,443 in Watauga County, to a high of $49,712 in Montgomery County, according to the 2016 census data. The Bank has a lesser presence in Roanoke County and the Cities of Roanoke and Salem where median household incomes ranged from a low of $39,201 in Roanoke City, to a high of $60,380 in Roanoke County.

Competition

The Bank encounters strong competition both in making loans and attracting deposits. The deregulation of the banking industry and the widespread enactment of state laws that permit multi-bank holding companies as well as an increasing level of interstate banking have created a highly competitive environment for commercial banking. In one or more aspects of its business, the Bank competes with other commercial banks, savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries, as well as marketplace lenders and other financial technology firms. Many of these competitors have substantially greater resources and lending limits and may offer certain services that the Bank does not currently provide. In addition, many of the Bank’s competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks. Recent federal and state legislation has heightened the competitive environment in which financial institutions must conduct their business, and the potential for competition among financial institutions of all types has increased significantly.

To compete, the Bank relies upon specialized services, responsive handling of customer needs, and personal contacts by its officers, directors, and staff. Large multi-branch banking competitors tend to compete primarily by rate and the number and location of branches, while smaller, independent financial institutions tend to compete primarily by rate and personal service.

Employees

At December 31, 2018, the Company had 211 total employees representing 206 full time equivalents, none of whom are represented by a union or covered by a collective bargaining agreement. The Company’s management considers employee relations to be good.

Internet Site

The Company maintains an internet website at www.skylinenationalbank.bank. Shareholders of the Company and the public may access, free of charge, the Company’s periodic and current reports (including annual reports on Form10-K, quarterly reports on Form10-Q and current reports on Form8-K, and any amendments to those reports) filed with or furnished to the Securities and Exchange Commission (the “SEC”), through the “Investor Relations” section of the Company’s website. The reports are made available on this website as soon as practicable following the filing of the reports with the SEC. The information is free of charge and may be reviewed, downloaded and printed from the website at any time.

Government Supervision and Regulation

The Company and the Bank are extensively regulated under federal and state law. The following information describes certain aspects of that regulation applicable to the Company and the Bank and does not purport to be complete. Proposals to change the laws and regulations governing the banking industry are frequently raised in U.S. Congress, in state legislatures, and before the various bank regulatory agencies. The likelihood and timing of any changes and the impact such changes might have on the Company and the Bank are impossible to determine with any certainty. A change in applicable laws or regulations, or a change in the way such laws or regulations are interpreted by regulatory agencies or courts, may have a material impact on the business, operations, and earnings of the Company and the Bank.

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Parkway Acquisition Corp.

The Company is a bank holding company (“BHC”) within the meaning of the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is registered as such with the Federal Reserve. As a bank holding company, the Company is subject to supervision, regulation and examination by the Federal Reserve Bank of Richmond and is required to file various reports and additional information with the Federal Reserve. The Company is also registered under the bank holding company laws of Virginia and is subject to supervision, regulation and examination by the Virginia State Corporation Commission (the “SCC”).

Skyline National Bank

The Bank is a federally chartered national bank. It is subject to federal regulation by the OCC and the FDIC.

The OCC conducts regular examinations of the Bank, reviewing such matters as the adequacy of loan loss reserves, quality of loans and investments, management practices, compliance with laws, and other aspects of its operations. In addition to these regular examinations, the Bank must furnish the OCC with periodic reports containing a full and accurate statement of its affairs. Supervision, regulation and examination of banks by these agencies are intended primarily for the protection of depositors rather than shareholders.

The regulations of the OCC, the FDIC and the Federal Reserve govern most aspects of the Company’s and the Bank’s business, including deposit reserve requirements, investments, loans, certain check clearing activities, issuance of securities, payment of dividends, branching, deposit interest rate ceilings, and numerous other matters. The OCC, the FDIC and the Federal Reserve have adopted guidelines and released interpretative materials that establish operational and managerial standards to promote the safe and sound operation of banks and bank holding companies. These standards relate to the institution’s key operating functions, including but not limited to capital management, internal controls, internal audit system, information systems and data and cybersecurity, loan documentation, credit underwriting, interest rate exposure and risk management, vendor management, executive management and its compensation, asset growth, asset quality, earnings, liquidity and risk management.

The Dodd-Frank Act

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act significantly restructured the financial regulatory regime in the United States and continues to have a broad impact on the financial services industry as a result of the significant regulatory and compliance changes required under the act. While significant rulemaking under the Dodd-Frank Act has occurred, certain of the act’s provisions require additional rulemaking by the federal bank regulatory agencies. The Dodd-Frank Act has increased our operations and compliance costs in the short-term; however, the ultimate impact of the Dodd-Frank Act remains dependent on future regulatory rulemaking and interpretations. Certain provisions of the Dodd-Frank Act, as currently in effect, that have impacted or could impact the Company are set forth below:

• Creation of a new agency, the Consumer Financial Protection Bureau (“CFPB”), that has rulemaking authority for a wide range of consumer protection laws that would apply to all banks and have broad powers to supervise and enforce consumer protection laws.

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• Changes in standards for Federal preemption of state laws related to federally chartered institutions, such as the Bank, and their subsidiaries.

• Permanent increase of deposit insurance coverage to $250 thousand and permission for depository institutions to pay interest on business checking accounts.

• Changes in the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminates the ceiling on the size of the Deposit Insurance Fund (“DIF”), and increases the floor of the size of the DIF.

• Prohibition on banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (the “Volker Rule”).

The Economic Growth Act

In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “Economic Growth Act”), was enacted to modify or remove certain regulatory financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion, such as the Bank, and for large banks with assets of more than $50 billion.

Among other matters, the Economic Growth Act expands the definition of qualified mortgages which may be held by a financial institution with total consolidated assets of less than $10 billion, exempts community banks from the Volcker Rule, and includes additional regulatory relief regarding regulatory examination cycles, call reports, mortgage disclosures and risk weights for certain high-risk commercial real estate loans.

In addition, the Economic Growth Act simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” of between 8 and 10 percent. Any qualifying depository institution or its holding company that exceeds the “community bank leverage ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be considered to be “well capitalized” under the prompt corrective action rules. The Economic Growth Act also expands the category of holding companies that may rely on the “Small Bank Holding Company and Savings and Loan Holding Company Policy Statement” (the “HC Policy Statement”) by raising the maximum amount of assets a qualifying holding company may have from $1 billion to $3 billion. This expansion also excludes such holding companies from the minimum capital requirements of the Dodd-Frank Act.

It is difficult at this time to predict when or how any new standards under the Economic Growth Act will ultimately be applied to us or what specific impact the Economic Growth Act and implementing rules and regulations will have on community banks.

Deposit Insurance

The deposits of the Bank are insured by the DIF up to applicable limits and are subject to deposit insurance assessments to maintain the DIF. On April 1, 2011, the deposit insurance assessment base changed from total deposits to average total assets minus average tangible equity, pursuant to a rule issued by the FDIC as required by the Dodd-Frank Act.

The Federal Deposit Insurance Act (the “FDIA”), as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits of at least 1.35%. The FDIC uses a risk-based system to calculate assessment rates and revised its methodology in April 2016 to calculate assessment rates for banks with under $10 billion in assets based upon certain financial measures of the bank and its supervisory ratings. Initial base assessment rates currently range from 3 to 30 basis points, subject to a decrease for certain unsecured debt. The reserve ratio reached 1.35% during the third quarter of 2018. Once the reserve ratio reaches 2.0% or greater, initial base assessment rates will range from 2 to 28 basis points and, once the reserve ratio reaches 2.5% or greater, the initial base assessment rates will range from 1 to 25 basis points.

Capital Requirements

The Federal Reserve, the OCC and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to banks and bank holding companies. In addition, those regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth. Pursuant to the HC Policy Statement, qualifying bank holding companies with total consolidated assets of less than $3 billion, such as the Company, are not subject to consolidated regulatory capital requirements.

Effective January 1, 2015, the federal banking regulators adopted rules to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rules required the Bank to comply with the following new minimum capital ratios: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6% of risk-weighted assets; (iii) a total capital ratio of 8% of risk-weighted assets; and (iv) a leverage ratio of 4% of total assets. As fully phased in on January 1, 2019, the rules require the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.

The capital conservation buffer requirement has been phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

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The rules also revised the prompt corrective action framework, which 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.

Based on management’s understanding and interpretation of the new capital rules, it believes that, as of December 31, 2018, the Bank meets all capital adequacy requirements under such rules on a fullyphased-in basis as if such requirements were in effect as of such date.

In December 2017, the Basel Committee published standards that it described as the finalization of the Basel III post-crisis regulatory reforms (the standards are commonly referred to as “Basel IV”). Among other things, these standards revise the Basel Committee’s standardized approach for credit risk (including by recalibrating risk weights and introducing new capital requirements for certain “unconditionally cancellable commitments,” such as unused credit card lines of credit) and provide a new standardized approach for operational risk capital. Under the proposed framework, these standards will generally be effective on January 1, 2022, with an aggregate output floorphasing-in through January 1, 2027. Under the current capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company. The impact of Basel IV on the Company and the Bank will depend on the manner in which it is implemented by the federal bank regulatory agencies.

As directed by the Economic Growth Act, on November 21, 2018, the federal banking regulators jointly issued a proposed rule that would permit qualifying banks that have less than $10 billion in total consolidated assets to elect to be subject to a 9% “community bank leverage ratio.” A qualifying bank that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements and would be considered to have met the capital ratio requirements to be “well capitalized” under prompt corrective action rules, provided it has a community bank leverage ratio greater than 9%. This proposed rule has not been finalized and, as a result, the content and scope of any final rule, and its impact on the Bank (if any), cannot be determined at this time.

Dividends

The Company’s ability to distribute cash dividends depends primarily on the ability of the Bank to pay dividends to it. The Company is a legal entity, separate and distinct from its subsidiaries. A significant portion of the Company’s revenues result from dividends paid to it by the Bank. There are various legal limitations applicable to the payment of dividends by the Bank to the Company and to the payment of dividends by the Company to its shareholders. As a national bank, the Bank is subject to certain restrictions on its reserves and capital imposed by federal banking statutes and regulations. Under OCC regulations, a national bank may not declare a dividend in excess of its undivided profits. Additionally, a national bank may not declare a dividend if the total amount of all dividends, including the proposed dividend, declared by the national bank in any calendar year exceeds the total of the national bank’s retained net income of that year to date, combined with its retained net income of the two preceding years, unless the dividend is approved by the OCC. A national bank may not declare or pay any dividend if, after making the dividend, the national bank would be “undercapitalized,” as defined in regulations of the OCC.

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In addition, under the current supervisory practices of the Federal Reserve, the Company should inform and consult with its regulators reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the Company’s capital structure.

Permitted Activities

As a bank holding company, the Company is limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity reasonably can be expected to produce benefits to the public that outweigh possible adverse effects. Possible benefits include greater convenience, increased competition, and gains in efficiency. Possible adverse effects include undue concentration of resources, decreased or unfair competition, conflicts of interest, and unsound banking practices. Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any activity or to terminate ownership or control of any subsidiary when the Federal Reserve has reasonable cause to believe that a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company may result from such an activity.

Banking Acquisitions; Changes in Control

The BHC Act requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless it already owns a majority of such voting shares), (ii) acquire all or substantially all of the assets of another bank or bank holding company, or (iii) merge or consolidate with any other bank holding company. In determining whether to approve a proposed bank acquisition, the Federal Reserve will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s performance under the Community Reinvestment Act of 1977 (the “CRA”) and its compliance with fair housing and other consumer protection laws.

Subject to certain exceptions, the BHC Act and the Change in Bank Control Act, together with the applicable regulations, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company acquiring “control” of a bank or bank holding company. A conclusive presumption of control exists if an individual or company acquires the power, directly or indirectly, to direct the management or policies of an insured depository institution or to vote 25% or more of any class of voting securities of any insured depository institution. A rebuttable presumption of control exists if a person or company acquires 10% or more but less than 25% of any class of voting securities of an insured depository institution and either the institution has registered its securities with the Securities and Exchange Commission under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”) or no other person will own a greater percentage of that class of voting securities immediately after the acquisition. The Company’s common stock currently is not registered under Section 12 of the Exchange Act.

In addition, Virginia law requires the prior approval of the SCC for (i) the acquisition of more than 5% of the voting shares of a Virginia bank or any holding company that controls a Virginia bank, or (ii) the acquisition by a Virginia bank holding company of a bank or its holding company domiciled outside Virginia.

Source of Strength

Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

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Safety and Soundness

There are a number of obligations and restrictions imposed on bank holding companies and their subsidiary banks by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event of a depository institution default. For example, under the Federal Deposit Insurance Corporation Improvement Act of 1991, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

Under the FDIA, the federal bank regulatory agencies have adopted guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines.

The Federal Deposit Insurance Corporation Improvement Act

Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), the federal bank regulatory agencies possess broad powers to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institution is “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” as defined by the law.

Reflecting changes under the new Basel III capital requirements, the relevant capital measures that became effective on January 1, 2015 for prompt corrective action are the total capital ratio, the common equity Tier 1 capital ratio, the Tier 1 capital ratio and the leverage ratio. A bank will be (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a common equity Tier 1 capital ratio of 6.5% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any capital directive order; (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a common equity Tier 1 capital ratio of 4.5% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 4.0% or greater and is not “well capitalized”; (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a common equity Tier 1 capital ratio less than 4.5%, a Tier 1 risk-based capital ratio of less than 6.0% or a leverage ratio of less than 4.0%; (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a common equity Tier 1 capital ratio less than 3.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 3.0%; and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes. Management believes, as of December 31, 2018 and 2017, the Company met the requirements for being classified as “well capitalized.”

As discussed under “Capital Requirements” above, federal banking regulators have jointly issued a proposed rule that would permit qualifying banks that have less than $10 billion in total consolidated assets to elect to be subject to a 9% “community bank leverage ratio,” in which case a bank that has chosen such proposed framework would be considered to have met the capital ratio requirements to be “well capitalized” under prompt corrective action rules, provided it has a community bank leverage ratio greater than 9%.

As required by FDICIA, the federal bank regulatory agencies also have adopted guidelines prescribing safety and soundness standards relating to, among other things, internal controls and information systems, internal audit systems, loan documentation, credit underwriting, and interest rate exposure. In general, the guidelines require appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. In addition, the agencies adopted regulations that authorize, but do not require, an institution which has been notified that it is not in compliance with safety and soundness standard to submit a compliance plan. If, after being so notified, an institution fails to submit an acceptable compliance plan, the agency must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is subject under the prompt corrective action provisions described above.

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Branching

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended (the “Interstate Banking Act”), generally permits well capitalized bank holding companies to acquire banks in any state, and preempts all state laws restricting the ownership by a bank holding company of banks in more than one state. The Interstate Banking Act also permits a bank to merge with anout-of-state bank and convert any offices into branches of the resulting bank if both states have not opted out of interstate branching; and permits a bank to acquire branches from anout-of-state bank if the law of the state where the branches are located permits the interstate branch acquisition. Under the Dodd-Frank Act, a bank holding company or bank must be well capitalized and well managed to engage in an interstate acquisition. Bank holding companies and banks are required to obtain prior Federal Reserve approval to acquire more than 5% of a class of voting securities, or substantially all of the assets, of a bank holding company, bank or savings association. The Interstate Banking Act and the Dodd-Frank Act permit banks to establish and operate de novo interstate branches to the same extent a bank chartered by the host state may establish branches.

Transactions with Affiliates

Pursuant to Sections 23A and 23B of the Federal Reserve Act and Regulation W, the authority of the Bank to engage in transactions with related parties or “affiliates” or to make loans to insiders is limited. Loan transactions with an affiliate generally must be collateralized and certain transactions between the Bank and its affiliates, including the sale of assets, the payment of money or the provision of services, must be on terms and conditions that are substantially the same, or at least as favorable to the Bank, as those prevailing for comparable nonaffiliated transactions. In addition, the Bank generally may not purchase securities issued or underwritten by affiliates.

Loans to executive officers, directors or to any person who directly or indirectly, or acting through or in concert with one or more persons, owns, controls or has the power to vote more than 10% of any class of voting securities of a bank (a “10% Shareholders”), are subject to Sections 22(g) and 22(h) of the Federal Reserve Act and their corresponding regulations (Regulation O) and Section 13(k) of the Exchange Act relating to the prohibition on personal loans to executives (which exempts financial institutions in compliance with the insider lending restrictions of Section 22(h) of the Federal Reserve Act). Among other things, these loans must be made on terms substantially the same as those prevailing on transactions made to unaffiliated individuals and certain extensions of credit to those persons must first be approved in advance by a disinterested majority of the entire board of directors. Section 22(h) of the Federal Reserve Act prohibits loans to any of those individuals where the aggregate amount exceeds an amount equal to 15% of an institution’s unimpaired capital and surplus plus an additional 10% of unimpaired capital and surplus in the case of loans that are fully secured by readily marketable collateral, or when the aggregate amount on all of the extensions of credit outstanding to all of these persons would exceed the Bank’s unimpaired capital and unimpaired surplus. Section 22(g) of the Federal Reserve Act identifies limited circumstances in which the Bank is permitted to extend credit to executive officers.

Consumer Financial Protection

The Company is subject to a number of federal and state consumer protection laws that extensively govern its relationship with its customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Service Members Civil Relief Act, laws governing flood insurance, federal and state laws prohibiting unfair and deceptive business practices, foreclosure laws, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans and providing other services. If the Company fails to comply with these laws and regulations, it may be subject to various penalties. Failure to comply with consumer protection requirements may also result in failure to obtain any required bank regulatory approval for merger or acquisition transactions the Company may wish to pursue or being prohibited from engaging in such transactions even if approval is not required.

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The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency, the CFPB, and giving it responsibility for implementing, examining, and enforcing compliance with federal consumer protection laws. The CFPB focuses on (i) risks to consumers and compliance with the federal consumer financial laws, (ii) the markets in which firms operate and risks to consumers posed by activities in those markets, (iii) depository institutions that offer a wide variety of consumer financial products and services, and(iv) non-depository companies that offer one or more consumer financial products or services. The CFPB has broad rule making authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. Abusive acts or practices are defined as those that materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service or take unreasonable advantage of a consumer’s (i) lack of financial savvy, (ii) inability to protect himself in the selection or use of consumer financial products or services, or (iii) reasonable reliance on a covered entity to act in the consumer’s interests. The CFPB can issuecease-and-desist orders against banks and other entities that violate consumer financial laws. The CFPB may also institute a civil action against an entity in violation of federal consumer financial law in order to impose a civil penalty or injunction.

Community Reinvestment Act

The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank’s record in meeting the credit needs of the communities served by the bank, including low and moderate income neighborhoods. Furthermore, such assessment is also required of banks that have applied, among other things, to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch. In the case of a BHC applying for approval to acquire a bank or BHC, the record of each subsidiary bank of the applicant BHC is subject to assessment in considering the application. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantialnon-compliance.” The Company was rated “outstanding” in its most recent CRA evaluation.

Anti-Money Laundering Legislation

The Company is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA Patriot Act of 2001. Among other things, these laws and regulations require the Company to take steps to prevent the use of the Company for facilitating the flow of illegal or illicit money, to report large currency transactions, and to file suspicious activity reports. The Company is also required to carry out a comprehensive anti-money laundering compliance program. Violations can result in substantial civil and criminal sanctions. In addition, provisions of the USA Patriot Act require the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing bank mergers and BHC acquisitions.

Privacy Legislation

Several recent laws, including the Right to Financial Privacy Act, and related regulations issued by the federal bank regulatory agencies, also provide new protections against the transfer and use of customer information by financial institutions. A financial institution must provide to its customers information regarding its policies and procedures with respect to the handling of customers’ personal information. Each institution must conduct an internal risk assessment of its ability to protect customer information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated parties without prior notice and approval from the customer.

Incentive Compensation

In June 2010, the federal bank regulatory agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of financial institutions do not undermine the safety and soundness of such institutions by encouraging excessive risk-taking. The Interagency Guidance on Sound Incentive Compensation Policies, which covers all employees that have the ability to materially affect the risk profile of a financial institutions, either individually or as part of a group, is based upon the key principles that a financial institution’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the institution’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the financial institution’s board of directors.

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The OCC will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as the Bank, that are not “large, complex banking organizations.” These reviews will be tailored to each financial institution based on the scope and complexity of the institution’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the institution’s safety and soundness and the financial institution is not taking prompt and effective measures to correct the deficiencies. At December 31, 2018, the Company had not been made aware of any instances ofnon-compliance with the final guidance.

Cybersecurity

In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If the Company fails to observe the regulatory guidance, it could be subject to various regulatory sanctions, including financial penalties.

Effect of Governmental Monetary Policies

The Company’s operations are affected not only by general economic conditions, but also by the policies of various regulatory authorities. In particular, the Federal Reserve regulates money and credit conditions and interest rates to influence general economic conditions. These policies have a significant impact on overall growth and distribution of loans, investments

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and deposits; they affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve monetary policies have had a significant effect on the operating results of commercial banks, including the Company, in the past and are expected to do so in the future. As a result, it is difficult for the Company to predict the potential effects of possible changes in monetary policies upon its future operating results.

Item 1A. Risk Factors.

We may be adversely affected by economic conditions in our market area.

We are located in southwestern Virginia, and our local economy is heavily influenced by the furniture and textile industries, both of which have been in decline in recent years. Further changes in the economy may influence the growth rate of our loans and deposits, the quality of the loan portfolio and loan and deposit pricing. Higher unemployment rates may lead to future increases inpast-due and nonperforming loans thus having a negative impact on the earnings of the Bank. An additional, significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control, would impact these local economic conditions and the demand for banking products and services generally, which could negatively affect our financial condition and performance.

Our concentration in loans secured by real estate may increase our credit losses, which would negatively affect our financial results.

We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area. At December 31, 2018, the Company had $478.6 million of such loans outstanding, or 89.22% of its total loans. A major change in the real estate market, such as deterioration in the value of this collateral, or in the local or national economy, could adversely affect our customers’ ability to pay these loans, which in turn could impact us. Risk of loan defaults and foreclosures are unavoidable in the banking industry, and we try to limit our exposure to this risk by monitoring our extensions of credit carefully. We cannot fully eliminate credit risk, and as a result credit losses may occur in the future.

Should our loan quality deteriorate, and our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.

Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. In addition, we maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within our loan portfolio. We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations.

The amount of future loan losses will be influenced by changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in the loan portfolio, we cannot precisely predict such losses or be certain that the loan loss allowance will be adequate in the future. While the risk of nonpayment is inherent in banking, we could experience greater nonpayment levels than we anticipate. Further deterioration in the quality of our loan portfolio could cause our interest income and net interest margin to decrease and our provisions for loan losses to increase further, which could adversely affect our results of operations and financial condition.

Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of management. Any increase in the amount of the provision or loanscharged-off as required by these regulatory agencies could have a negative effect on our operating results and financial condition.

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An inability to maintain our regulatory capital position could adversely affect our operations.

As of December 31, 2018, the Bank was classified as “well capitalized” for regulatory capital purposes. If we do not maintain the expected levels of regulatory capital in the future, it could increase the regulatory scrutiny on Parkway and the Bank, and the OCC could establish individual minimum capital ratios or take other regulatory actions against us. Further, if the Bank were no longer “well capitalized” for regulatory capital purposes, it would not be able to offer interest rates on deposit accounts that are significantly higher than the average rates in its market area. As a result, it may be more difficult for us to increase deposits. If we are not able to attract new deposits, our ability to fund our loan portfolio may be adversely affected. In addition, we would pay higher insurance premiums to the FDIC, which would reduce our earnings.

Our ability to maintain adequate sources of liquidity may be negatively impacted by the economic environment which could adversely affect our financial condition and results of operations.

In managing our consolidated balance sheet, we depend on cash and due from banks, federal funds sold, loan and investment security payments, core deposits, lines of credit with correspondent banks and lines of credit with the Federal Home Loan Bank to provide sufficient liquidity to meet our commitments and business needs, and to accommodate the transaction and cash management needs of clients. The availability of these funding sources is highly dependent upon the perception of the liquidity and creditworthiness of the financial institution, and such perception can change quickly in response to market conditions or circumstances unique to a particular company. Any event that limits our access to these sources, such as a decline in the confidence of debt purchasers, or our depositors or counterparties, may adversely affect our liquidity, financial position, and results of operations.

We may incur losses if we are unable to successfully manage interest rate risk.

Our profitability will depend in substantial part upon the spread between the interest rates earned on investments and loans and interest rates paid on deposits and other interest-bearing liabilities. Changes in interest rates will affect our operating performance and financial condition in diverse ways including the pricing of securities, loans and deposits and the volume of loan originations in our mortgage-origination office. We attempt to minimize our exposure to interest rate risk, but we will be unable to eliminate it. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary and fiscal policies, and economic conditions generally.

We may be adversely impacted by changes in market conditions.

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

Oursmall-to-medium sized business target market may have fewer financial resources to weather a downturn in the economy.

We target our business development and marketing strategy primarily to serve the banking and financial services needs of small and medium sized businesses. These businesses generally have less capital or borrowing capacity than larger entities. If general economic conditions adversely affect this major economic sector in our markets, our results of operations and financial condition may be adversely affected.

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Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.

We face vigorous competition from other banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions for deposits, loans and other financial services in our market area. A number of these banks and other financial institutions are significantly larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services. In addition, credit unions have been able to increasingly expand their membership definition and, because they enjoy a favorable tax status, may be able to offer more attractive loan and deposit pricing. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, marketplace lenders and other financial technology firms, insurance companies and governmental organizations which may offer more favorable financing than we can. Many of ournon-bank competitors are not subject to the same extensive regulations that govern us. As a result, thesenon-bank competitors have advantages over us in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.

Our ability to operate profitably may be dependent on our ability to implement various technologies into our operations.

The market for financial services, including banking and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, online banking and tele-banking. The pace of technological change has increased in the “fintech” environment, in which industry-changing technology-driven products and services are often introduced and adopted, including innovative ways that customers can make payments, access products, and manage accounts. Our ability to compete successfully in our market may depend on the extent to which we are able to exploit such technological changes. If we are not able to afford such technologies, properly or timely anticipate or implement such technologies, or effectively train our staff to use such technologies, our business, financial condition or operating results could be adversely affected.

Consumers may decide not to use banks to complete their financial transactions.

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. The activity and prominence ofso-called marketplace lenders and other technological financial service companies have grown significantly over recent years and are expected to continue growing. In addition, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions, such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. If we are unable to address the competitive pressures that we face, we could lose market share, which could result in reduced net revenue and profitability and lower returns. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

Our exposure to operational risk may adversely affect our business.

We are exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Reputational risk, or the risk to our earnings and capital from negative public opinion, could result from our actual alleged conduct in any number of activities, including lending practices, corporate governance, regulatory compliance or the occurrence of any of the events or instances mentioned below, or from actions taken by government regulators or community organizations in response to that conduct. Negative public opinion could also result from adverse news or publicity that impairs the reputation of the financial services industry generally.

Further, if any of our financial, accounting, or other data processing systems fail or have other significant shortcomings, we could be adversely affected. We depend on internal systems and outsourced technology to support these data storage and processing operations. Our inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of our business operations. We could be adversely affected if one of our employees causes a significant operational break-down or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our operations or systems. We are also at risk of the impact of natural disasters, terrorism and international hostilities on our systems or for the effects of outages or other failures involving power or communications systems operated by others.

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Misconduct by employees could include fraudulent, improper or unauthorized activities on behalf of clients or improper use of confidential information. We may not be able to prevent employee errors or misconduct, and the precautions we take to detect this type of activity might not be effective in all cases. Employee errors or misconduct could subject us to civil claims for negligence or regulatory enforcement actions, including fines and restrictions on our business. In addition, there have been instances where financial institutions have been victims of fraudulent activity in which criminals pose as customers to initiate wire and automated clearinghouse transactions out of customer accounts. Although we have policies and procedures in place to verify the authenticity of our customers, we cannot assure that such policies and procedures will prevent all fraudulent transfers. Such activity can result in financial liability and harm to our reputation.

If any of the foregoing risks materialize, it could have a material adverse affect on our business, financial condition and results of operations.

Our operations depend upon third party vendors that perform services for us.

We are reliant upon certain external vendors to provide products and services necessary to maintain ourday-to-day operations, including data processing and interchange and transmission services for the ATM network. Accordingly, our success depends on the services provided by these vendors, and our operations are exposed to risk that these vendors will not perform in accordance with the contracted service agreements. Although we maintain a system of policies and procedures designed to monitor and mitigate vendor risks, the failure of an external vendor to perform in accordance with the contracted arrangements under service agreements could disrupt our operations, which could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

Our operations may be adversely affected by cybersecurity risks.

In the ordinary course of business, we collect and store sensitive data, including proprietary business information and personally identifiable information of our customers and employees, in systems and on networks. The secure processing, maintenance and use of this information is critical to our operations and business strategy. We have invested in accepted technologies and review processes and practices that are designed to protect our networks, computers and data from damage or unauthorized access. Despite these security measures, our computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. A breach of any kind could compromise systems and the information stored there could be accessed, damaged or disclosed. A breach in security could result in legal claims, regulatory penalties, disruption in operations and damage to our reputation, which could adversely affect our business.

Our inability to successfully manage growth or implement our growth strategy may adversely affect our results of operations and financial condition.

A key aspect of our long-term business strategy is our continued growth and expansion. We may not be able to successfully implement this strategy if we are unable to identify attractive expansion locations or opportunities in the future. In addition, our successful implementation and management of growth will be contingent upon whether we can maintain appropriate levels of capital to support our growth, maintain control over expenses, maintain adequate asset quality, attract talented bankers and successfully integrate into the organization, any branches or businesses acquired. As we continue to implement our growth strategy, we expect to incur increased personnel, occupancy and other operating expenses. In many cases, our expenses will increase prior to the income we expect to generate from the growth. For instance, in the case of new branches, we must absorb these expenses prior to or as we begin to generate new deposits, and there is a further time lag involved in redeploying the new deposits into attractively priced loans and other higher yielding earning assets. Thus, our plans to branch or expand loan or mortgage operations could depress earnings in the short run, even if we are able to efficiently execute our strategy.

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Our profitability may suffer because of rapid and unpredictable changes in the highly regulated environment in which we operate.

We are subject to extensive supervision by several governmental regulatory agencies at the federal and state levels. Recently enacted, proposed and future banking legislation and regulations have had, and will continue to have, a significant impact on the financial services industry. These regulations, which are intended to protect depositors and not our shareholders, and the interpretation and application of them by federal and state regulators, are beyond our control, may change rapidly and unpredictably and can be expected to influence our earnings and growth. Our success depends on our continued ability to comply with these regulations.

We may be subject to more stringent capital requirements, which could adversely affect our results of operations and future growth.

In 2013, the Federal Reserve, the FDIC and the OCC approved a new rule that substantially amended the regulatory risk-based capital rules applicable to us. The final rule implemented the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The final rule included new minimum risk-based capital and leverage ratios that became effective for us on January 1, 2015, and refined the definition of what constitutes “capital” for purposes of calculating these ratios. The new minimum capital requirements are: (i) a new common equity Tier 1 (“CET1”) capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The final rule also established a “capital conservation buffer” of 2.5% above the new regulatory minimum capital ratios, and when fully effective on January 1, 2019, resulted in the following minimum ratios: (a) a common equity Tier 1 capital ratio of 7.0%; (b) a Tier 1 to risk-based assets capital ratio of 8.5%; and (c) a total capital ratio of 10.5%. The new capital conservation buffer requirement has been phased in beginning in January 2016 at 0.625% of risk-weighted assets and increased each year until fully implemented in January 2019. An institution will be 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 will establish a maximum percentage of eligible retained income that can be utilized for such activities. In addition, the final rule provides for a number of new deductions from and adjustments to capital and prescribes a revised approach for risk weightings that could result in higher risk weights for a variety of asset categories.

While the recently passed Economic Growth Act requires that federal banking regulators establish a simplified leverage capital framework for smaller banks, these more stringent capital requirements for us could, among other things, result in lower returns on equity, require the raising of additional capital, adversely affect our future growth opportunities, and result in regulatory actions such as a prohibition on the payment of dividends or on the repurchase shares if we were unable to comply with such requirements.

The full impact of changes to federal tax laws is uncertain and may negatively impact our financial performance.

We are subject to changes in tax law that could increase our effective tax rates. These law changes may be retroactive to previous periods and, as a result, could negatively affect our current and future financial performance.

The Tax Cuts and Jobs Act (the “Tax Act”), the full impact of which is subject to further evaluation and analysis, is likely to have both positive and negative effects on our financial performance. For example, the new legislation resulted in a reduction in our federal corporate tax rate from 35% to 21% beginning in 2018, which has had and is expected to continue to have a favorable impact on our earnings and capital generation abilities. However, the new legislation also enacted limitations on certain deductions, such as the deduction of FDIC deposit insurance premiums, which will partially offset the anticipated increase in net earnings from the lower tax rate. Further, the full impact of the Tax Act may differ from the foregoing and from our expectations, possibly materially, due to changes in interpretations or in assumptions that we have made or that we make in 2019, guidance or regulations that may be promulgated, and other actions that we may take as a result of the Tax Act.

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Similarly, the Bank’s customers are likely to experience varying effects from both the individual and business tax provisions of the Tax Act. For example, changes to tax deductibility of business interest expense could impact business customer borrowing. Such effects, whether positive or negative, may have a corresponding impact on our business and the economy as a whole.

Government measures to regulate the financial industry could materially affect our businesses, financial condition or results of operations.

As a financial institution, we are heavily regulated at the state and federal levels. Banking regulations generally are intended to protect depositors, not investors, and regulators have broad interpretive and enforcement powers beyond our control that may change rapidly and unpredictably and could influence our earnings and growth. Future changes in the laws or regulations or their interpretations or enforcement could be materially adverse to us and our shareholders.

Further, as a result of the financial crisis and related global economic downturn that began in 2008, we have faced, and expect to continue to face, increased public and legislative scrutiny as well as stricter and more comprehensive regulation of our financial services practices. In July 2010, the Dodd-Frank Act was signed into law. Many of the provisions of the Dodd-Frank Act are subject both to further rulemaking and the discretion of applicable regulatory bodies. Although we cannot predict the full effect of the Dodd-Frank Act on our operations, it, as well as the future rules implementing its reforms, could impose significant additional costs on us, limit the products we offer, limit our ability to pursue business opportunities in an efficient manner, require us to increase our regulatory capital, impact the values of assets that we hold, significantly reduce our revenues or otherwise materially and adversely affect our businesses, financial condition, or results of operations. The ultimate impact of the final rules on our businesses and results of operations, however, will depend on regulatory interpretation and rulemaking, as well as the success of our actions to mitigate the negative earnings impact of certain provisions.

Combining the Company and Great State Bank may be more difficult, costly or time-consuming than we expect.

The success of the merger with Great State Bank will depend, in part, on our ability to realize the anticipated benefits and estimated cost savings from combining the businesses of the Company and Great State Bank. However, to realize these anticipated benefits and cost savings, we must successfully combine the businesses of the Company and Great State Bank. If we are not able to achieve these objectives, the anticipated benefits and cost savings of the merger may not be realized fully, or at all, or may take longer to realize than expected.

After the completion of the merger, we have integrated Great State Bank’s business into our own. The success of the merger will depend on a number of factors, including, but not limited to our ability to:

• timely and successfully integrate the operations of the Company and Great State Bank;

• retain key employees of the Company and Great State Bank, and retain and attract qualified personnel to, the combined company; and

• maintain existing relationships with customers, suppliers and vendors of the Company and Great State Bank.

It is possible that the integration process could result in the loss of key employees, the disruption of ongoing business or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the merger.

The Bank may be required to transition from the use of the London Interbank Offered Rate (“LIBOR”) index in the future.

The Bank has certain variable-rate loans indexed to LIBOR to calculate the loan interest rate. The United Kingdom Financial Conduct Authority, which regulates LIBOR, has announced that the continued availability of the LIBOR on the current basis is not guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR, and it is impossible to predict the effect of any such alternatives on the value of LIBOR-based variable-rate loans, as well as LIBOR-based securities, subordinated notes, trust preferred securities, or other securities or financial arrangements. The implementation of a substitute index or indices for the calculation of interest rates under the Bank’s loan agreements with borrowers or other financial arrangements may cause the Bank to incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may result in disputes or litigation with customers or other counter-parties over the appropriateness or comparability to LIBOR of the substitute index or indices, any of which could have a material adverse effect on the Bank’s results of operations.

Changes in accounting standards could impact reported earnings and capital.

The authorities that promulgate accounting standards, including the Financial Accounting Standards Board (the “FASB”), the SEC, and other regulatory authorities, periodically change the financial accounting and reporting standards that govern the preparation of the Company’s consolidated financial statements. These changes are difficult to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of financial statements for prior periods. Such changes could also impact the capital levels of the Company and the Bank, or require the Company to incur additional personnel or technology costs. Most notably, new guidance on the calculation of credit reserves using current expected credit losses, referred to as CECL, was finalized in June, 2016. The standard will be effective for the Company beginning January 1, 2020. To implement the new standard, the Company will incur costs related to data collection and documentation, technology and training. For additional information, see “Recent Accounting Pronouncements” in Note 1 of the consolidated financial statements. Although the Company is currently unable to reasonably estimate the impact of the new standard on its financial statements, adoption of the new standard could necessitate, among other things, higher loan loss reserve levels, and the Company expects to recognize aone-time cumulative effect adjustment to the allowance for loan losses during the quarter in which the standard becomes effective. If the Company is required to materially increase the level of the allowance for loan losses or incurs additional expenses to determine the appropriate level of the allowance for loan losses, such changes could adversely affect the Company’s capital levels, financial condition and results of operations.

17

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

The Company is headquartered at 101 Jacksonville Circle, Floyd, Virginia. The Bank is headquartered in the Main Office at 113 West Main Street, Independence, Virginia. The Bank operates branches at the following locations, all of which are owned by the Bank, except for the offices in Boone, Salem, and Willis, which are leased facilities:

East Independence Office – 802 East Main St., Independence, VA	276-773-2811	Full service
Elk Creek Office – 60 Comers Rock Rd., Elk Creek, VA	276-655-4011	Full service
Galax Office – 209 West Grayson St., Galax, VA	276-238-2411	Full service
Troutdale Office – 101 Ripshin Rd., Troutdale, VA	276-677-3722	Full service
Carroll Office – 8351 Carrollton Pike, Galax, VA	276-238-8112	Full service
Sparta Office – 98 South Grayson St., Sparta NC	336-372-2811	Full service
Hillsville Office – 419 South Main St., Hillsville, VA	276-728-2810	Full service
Whitetop Office – 16303 Highlands Parkway, Whitetop, VA	276-388-3811	Full service
Wytheville Office – 420 North 4th St., Wytheville, VA	276-228-6050	Full service
Floyd Office - 101 Jacksonville Circle, Floyd, VA	540-745-4191	Full service
Cave Spring Office - 4094 Postal Drive, Roanoke, VA	540-774-1111	Full service
Christiansburg Office - 2145 Roanoke St., Christiansburg, VA	540-381-8121	Full service
Fairlawn Office - 7349 Peppers Ferry Blvd., Radford, VA	540-633-1680	Full service
Salem Office - 1634 West Main St., Salem, VA	540-387-4533	Full service
West Jefferson – 1055 Mount Jefferson Road, West Jefferson, NC	336-489-7811	Full service
Boone – 189 Boone Heights Drive, Boone, NC	828-264-4260	Full service
Wilkesboro – 1422 US Highway 421, Wilkesboro, NC	336-903-4948	Full service
Yadkinville – 516 Hawthorne Drive, Yadkinville, NC	336-849-4194	Full service
Willis Office - 5598 B Floyd Highway South, Willis, VA	540-745-4191	Limited service/conducts normal teller transactions

The Bank has two conference centers located at 558 East Main Street, Independence, Virginia, and 203 E. Oxford Street, Floyd, Virginia, which are used for various board and committee meetings, as well as continuing education and training programs for bank employees. The Bank owns an operations center adjacent to the main office in Independence, Virginia. The Bank also leases an administrative office in the town of Wilkesboro, North Carolina. The Bank operates four loan production offices in leased facilities in the town of Blacksburg, Virginia, and the cities of Hickory, Lenoir, and Shelby, North Carolina. The Bank purchased an existing vacant building in Salem, Virginia in July of 2018. The Bank anticipates opening this building as a full service branch banking facility in June of 2019.

Item 3. Legal Proceedings.

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

Item 4. Mine Safety Disclosures.

Not applicable.

18

PART II

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

The Company’s common stock is quoted on the OTC Markets Group’s OTCQX tier under the symbol “PKKW.” As of March 12, 2019, there were 6,213,275 shares of the Company’s common stock outstanding, held by 1,713 shareholders of record.

The Company’s common stock began quotation on the OTC Market on or about August 31, 2016, before which there was no trading market and no market price for the Company’s common stock. The Company was incorporated under Virginia law on November 2, 2015, solely to facilitate the merger between Cardinal and Grayson that was completed on July 1, 2016.

Following are the high and low prices of sales of common stock known to the Company, along with the dividends that were paid quarterly (per share).

	High		Low		Dividends
2017
First quarter		9.60		8.60		0.08
Second quarter		10.50		9.55		0.00
Third quarter		11.25		10.30		0.08
Fourth quarter		12.75		11.21		0.00
2018
First quarter		12.99		12.10		0.10
Second quarter		13.15		12.60		0.00
Third quarter		13.30		13.00		0.10
Fourth quarter		13.20		10.90		0.00

Dividend Policy

The final determination of the timing, amount and payment of dividends on the Company’s common stock is at the discretion of the Company’s Board of Directors and will depend upon the earnings of the Company and its subsidiaries, principally the Bank, the financial condition of the Company and other factors, including general economic conditions and applicable governmental regulations and policies as discussed in “Item 1., Business – Government Supervision and Regulation – Dividends,” above.

The Company’s ability to distribute cash dividends will depend primarily on the ability of the Bank to pay dividends to it. As a national bank, the Bank is subject to certain restrictions on our reserves and capital imposed by federal banking statutes and regulations. Furthermore, under Virginia law, the Company may not declare or pay a cash dividend on its capital stock if it is insolvent or if the payment of the dividend would render it insolvent or unable to pay its obligations as they become due in the ordinary course of business. For additional information on these limitations, see “Item 1. Business – Government Supervision and Regulation – Dividends,” above.

Stock Repurchases

The Company did not repurchase any shares of its common stock during 2018.

Item 6. Selected Financial Data.

Financial Highlights¹

	2018		2017		2016			2015			2014
Summary of Operations
Interest income	$	26,186	$	22,274	$	17,562		$	12,703		$	12,996
Interest expense		1,901		1,474		1,728			2,226			2,600
Net interest income		24,285		20,800		15,834			10,477			10,396
Provision for (reduction of) loan losses		325		217		(5	)		(187	)		294
Other income		4,637		4,228		4,570			2,511			2,961
Other expense		22,857		19,280		16,816			11,580			11,902
Income taxes		1,214		3,104		1,175			598			295
Net income	$	4,526	$	2,427	$	2,418		$	997		$	866
Per Share Data
Net income	$	.81	$	.48	$	.60		$	.58		$	.50
Cash dividends declared		.20		.16		.12			.10			—
Book value		12.17		11.39		11.05			17.83			17.43
Year-end Balance Sheet Summary
Loans, net	$	532,970	$	421,418	$	408,548		$	237,798		$	218,805
Investment securities		45,428		50,675		62,540			56,050			69,037
Total assets		680,284		547,961		558,856			331,760			333,064
Deposits		601,868		488,441		499.387			279,876			282,136
Stockholders’ equity		75,622		57,182		55,466			30,656			29,698
Selected Ratios
Return on average assets		0.75%		0.44%		0.55%			0.30%			0.26%
Return on average equity		7.02%		4.28%		5.62%			3.22%			2.93%
Average equity to average assets		10.66%		10.32%		9.78%			9.33%			8.94%

¹  In thousands of dollars, except per share data.

19

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

Management’s Discussion and Analysis

Management’s Discussion and Analysis of Operations

Overview

Management’s Discussion and Analysis is provided to assist in the understanding and evaluation of Parkway Acquisition Corp’s. financial condition and its results of operations. The following discussion should be read in conjunction with the Company’s consolidated financial statements.

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

On March 1, 2018, Parkway entered into a definitive agreement pursuant to which Parkway acquired Great State Bank (“Great State”), based in Wilkesboro, North Carolina. The agreement provided for the merger of Great State with and into the Bank, with the Bank as the surviving bank (the “Great State merger”). The transaction closed and the merger became effective on July 1, 2018. Each share of Great State common stock was converted into the right to receive 1.21 shares of Parkway common stock. The Company issued 1,191,899 shares and recognized $15.5 million in surplus in the Great State merger. Parkway was considered the acquiror and Great State was considered the acquiree in the transaction for accounting purposes. Pursuant to the Great State merger, the Company acquired $145.5 million of assets, including $95.1 million in loans and assumed $133.0 million in liabilities, including $130.6 million of deposits, on July 1, 2018. Such accounts include preliminary estimated fair value adjustments, which are subject to change.

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

For purposes of this annual report on Form10-K, all information contained herein as of and for periods prior to July 1, 2016 reflects the operations of Grayson prior to the Cardinal merger. Unless this report otherwise indicates or the context otherwise requires, all references to “Parkway” or the “Company” as of and for periods subsequent to July 1, 2016 refer to the combined company and its subsidiary as a combined entity after the Cardinal merger, and all references to the “Company” as of and for periods prior to July 1, 2016 are references to Grayson and its subsidiary as a combined entity prior to the Cardinal merger. All information contained herein as of and for periods prior to July 1, 2018 reflects the operations of Parkway prior to the Great State merger. Unless this report otherwise indicates or the context otherwise requires, all references to “Parkway” or the “Company” as of and for periods subsequent to July 1, 2018 refer to the combined company and its subsidiary as a combined entity after the Great State merger, and all references to the “Company” as of and for periods prior to July 1, 2018 are references to Parkway and its subsidiary as a combined entity prior to the merger.

20

Management’s Discussion and Analysis

Parkway had net earnings of $4.5 million for 2018 compared to $2.4 million for 2017. Earnings in 2018 and 2017 were impacted significantly by the acquisition of Great State, including merger-related expenses during 2018 and the inclusion of Great State’s financial results beginning July 1, 2018. Interest income and interest expense increased due to the acquired loans and deposits, in addition to increases in interest rates earned on loans and paid on deposits.Non-recurring merger related expenses totaled approximately $2.0 million in 2018 and $748 thousand in 2017. Earnings in 2017 were also significantly impacted by a nonrecurring charge to income tax expense to reflect the impact of the Tax Cuts and Jobs Act which was signed into law on December 22, 2017. The new legislation reduced tax rates effective January 1, 2018, resulting in are-measurement of the Company’s deferred tax assets and liabilities. The change in value of the Company’s deferred tax assets was recorded as an addition to 2017 income tax expense of $1.44 million.

Forward Looking Statements

From time to time, the Company and its senior managers have made and will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements may be contained in this report and in other documents that the Company files with the Securities and Exchange Commission. Such statements may also be made by the Company and its senior managers in oral or written presentations to analysts, investors, the media and others. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. Also, forward-looking statements can generally be identified by words such as “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “seek,” “expect,” “intend,” “plan” and similar expressions.

Forward-looking statements provide management’s expectations or predictions of future conditions, events or results. They are not guarantees of future performance. By their nature, forward-looking statements are subject to risks and uncertainties. These statements speak only as of the date they are made. The Company does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made. There are a number of factors, many of which are beyond the Company’s control that could cause actual conditions, events or results to differ significantly from those described in the forward-looking statements. These factors, some of which are discussed elsewhere in this report, include:

• any required increase in our regulatory capital ratios;

• inflation, interest rate levels and market and monetary fluctuations;

• the difficult market conditions in our industry;

• trade, monetary and fiscal policies and laws, including interest rate policies of the federal government;

• applicable laws and regulations and legislative or regulatory changes;

• the timely development and acceptance of new products and services of the Company;

• the willingness of customers to substitute competitors’ products and services for the Company’s products and services;

• the financial condition of the Company’s borrowers and lenders;

• the Company’s success in gaining regulatory approvals, when required;

• technological and management changes;

• growth and acquisition strategies;

• the Company’s critical accounting policies and the implementation of such policies;

• lower-than-expected revenue or cost savings or other issues in connection with mergers and acquisitions;

• combining the Company and Great State may be more difficult than we expect, and we may not be able to realize the anticipated benefits and estimated cost savings in the proposed merger;

• disruptions to customer and employee relationships and business operations caused by the Great State merger or otherwise;

• changes in consumer spending and saving habits;

• the strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations; and

• the Company’s success at managing the risks involved in the foregoing.

21

Management’s Discussion and Analysis

Critical Accounting Policies

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The notes to the audited consolidated financial statements included in the Annual Report for the year ended December 31, 2018 contain a summary of its significant accounting policies. Management believes the Company’s policies with respect to the methodology for the determination of the allowance for loan losses, and asset impairment judgments, such as the recoverability of intangible assets and other-than-temporary impairment of investment securities, involve a higher degree of complexity and require management to make difficult and subjective judgments that often require assumptions or estimates about highly uncertain matters. Accordingly, management considers the policies related to those areas as critical.

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: the first of which requires that losses be accrued when they are probable of occurring and estimable, and the second, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market, and the loan balance.

The allowance for loan losses has three basic components: (i) the formula allowance, (ii) the specific allowance, and (iii) the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The specific allowance uses various techniques to arrive at an estimate of loss. Historical loss information, expected cash flows and fair market value of collateral are used to estimate these losses. The use of these techniques is inherently subjective and our actual losses could be greater or less than the estimates. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance.

22

Management’s Discussion and Analysis

Table 1. Net Interest Income and Average Balances (dollars in thousands)

	2018								2017								2016
				Interest								Interest								Interest
	Average			Income/		Yield/			Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Cost			Balance			Expense		Cost			Balance			Expense		Cost
Interest-earning assets:
Interest-bearing deposits	$	9,365		$	106		1.13	%	$	9,611		$	48		0.50	%	$	9,977		$	37		0.37	%
Federal funds sold		10,584			228		2.15	%		9,703			111		1.14	%		9,316			46		0.49	%
Investment securities		50,504			1,278		2.53	%		59,210			1,393		2.35	%		51,027			1,195		2.34	%
Loans1, 2		476,900			24,574		5.15	%		417,723			20,722		4.96	%		325,723			16,284		5.00	%
Total		547,353			26,186					496,247			22,274					396,043			17,562
Yield on average interest-earning assets							4.78	%							4.49	%							4.43	%
Non interest-earning assets:
Cash and due from banks		8,218								7,145								10,256
Premises and equipment		19,055								17,852								14,603
Interest receivable and other		35,400								33,449								22,279
Allowance for loan losses		(3,435	)							(3,539	)							(3,927	)
Unrealized gain/(loss) on securities		(1,283	)							(356	)							364
Total		57,955								54,551								43,575
Total assets	$	605,308							$	550,798							$	439,618
Interest-bearing liabilities:
Demand deposits	$	115,409			194		0.17	%	$	59,485			52		0.09	%	$	42,848			44		0.10	%
Savings deposits		117,479			347		0.30	%		143,895			342		0.24	%		107,546			247		0.23	%
Time deposits		163,932			1,326		0.81	%		159,733			1,079		0.68	%		132,637			995		0.75	%
Borrowings		1,757			34		1.94	%		37			1		1.93	%		11,412			442		3.87	%
Total		398,577			1,901					363,150			1,474					294,443			1,728
Cost on average interest-bearing liabilities							0.48	%							0.41	%							0.59	%
Non interest-bearing liabilities:
Demand deposits		139,409								128,356								100,425
Interest payable and other		2,826								2,351								1,729
Total		142,235								130,707								102,154
Total liabilities		540,812								493,857								396,597
Stockholder’s equity:		64,496								56,941								43,021
Total liabilities and stockholder’s equity	$	605,308							$	550,798							$	439,618
Net interest income				$	24,285							$	20,800							$	15,834
Net yield on interest-earning assets							4.44	%							4.19	%							3.99	%

¹ Includes nonaccural loans

²  Interest income includes loan fees

23

Management’s Discussion and Analysis

Table 2. Rate/Volume Variance Analysis (dollars in thousands)

	2018 Compared to 2017								2017 Compared to 2016
	Interest Income/			Variance Attributable To(1)					Interest Income/			Variance Attributable To(1)
	Expense Variance			Rate		Volume			Expense Variance			Rate			Volume
Interest-earning assets:
Interest bearing deposits	$	58		$	59	$	(1	)	$	11		$	12		$	(1	)
Federal funds sold		117			106		11			65			63			2
Investment securities		(115	)		121		(236	)		198			5			193
Loans		3,852			827		3,025			4,438			(131	)		4,569
Total		3,912			1,113		2,799			4,712			(51	)		4,763
Interest-bearing liabilities:
Demand deposits		142			70		72			8			(4	)		12
Savings deposits		5			21		(16	)		95			11			84
Time deposits		247			218		29			84			(100	)		184
Borrowings		33			—		33			(441	)		(1	)		(440	)
Total		427			309		118			(254	)		(94	)		(160	)
Net interest income	$	3,485		$	804	$	2,681		$	4,966		$	43		$	4,923

(1) The variance in interest attributed to both volume and rate has been allocated to variance attributed to volume and variance attributed to rate in proportion to the absolute value of the change in each.

Net Interest Income

Net interest income, the principal source of Company earnings, is the amount of income generated by earning assets (primarily loans and investment securities) less the interest expense incurred on interest-bearing liabilities (primarily deposits used to fund earning assets). Table 1 summarizes the major components of net interest income for the past three years and also provides yields and average balances.

For the year ended December 31, 2018, total interest income increased by $3.9 million compared to the year ended December 31, 2017. As noted above, the Great State merger was completed on July 1, 2018; therefore, the operating results for 2018 include six months of combined earnings along with six months of Parkway earnings prior to the merger. As a result, the increase in interest income on loans for the year ended December 31, 2018 was due to increased volume resulting from the merger, along with increase in rates on loans. The increases in interest income on federal funds sold and interest-bearing deposits in banks were due more to increases in overnight borrowing rates established by the Federal Reserve. Interest expense on deposits increased by $394 thousand due to the addition of interest-bearing deposits from the Great State merger, along with increases in the rates paid on deposits. Amortization of premiums on acquired time deposits, which reduces interest expense, totaled $327 thousand for the year ended December 31, 2018, compared to $228 thousand for the year ended December 31, 2017. Interest on borrowings increased by $33 thousand due to overnight borrowings which were accessed in the second and third quarters of 2018 along with FHLB Advances that were acquired as part of the Great State merger. The effects of changes in volumes and rates on net interest income in 2018 compared to 2017, and 2017 compared to 2016 are shown in Table 2.

The aforementioned factors led to an increase in net interest income of $3.5 million or 16.75% for 2018 as compared to 2017. The net yield on interest-earning assets increased by 25 basis points to 4.44% in 2018 compared to 4.19% in 2017.

24

Management’s Discussion and Analysis

Provision for Credit Losses

The allowance for credit losses is established to provide for expected losses in the Company’s loan portfolio. Management determines the provision for credit losses required to maintain an allowance adequate to provide for probable losses. Some of the factors considered in making this decision are the levels and collectability of past due loans, volume of new loans, composition of the loan portfolio, and general economic outlook.

The provision for loan losses was $325 thousand for the year ended December 31, 2018, compared to $217 thousand for the year ended December 31, 2017. Asset quality has remained relatively consistent over the past year; therefore, the increase in loan loss provisions from 2017 to 2018 was due primarily to overall growth in the loan portfolio. The reserve for loan losses at December 31, 2018 was approximately 0.65% of total loans, compared to 0.81% at December 31, 2017. Management’s estimate of probable credit losses inherent in the acquired Great State loan portfolio was reflected as a purchase discount which will continue to be accreted into income over the remaining life of the acquired loans in addition to the previously acquired loan portfolio from the merger with Cardinal Bankshares Corporation. As of December 31, 2018, the remaining unaccreted discount on the acquired loan portfolios totaled $5.0 million. Management believes the provision and the resulting allowance for loan losses are adequate.

Additional information is contained in Tables 12 and 13, and is discussed in Nonperforming and Problem Assets.

Other Income

Noninterest income consists of revenues generated from a broad range of financial services and activities. The majority of noninterest income is traditionally a result of service charges on deposit accounts including charges for overdrafts and fees charged fornon-deposit services. Noninterest income increased by $409 thousand in 2018 compared to 2017. The increase was due to service-related income from the Company’s increased customer base following the merger with Great State as well as nonrecurring proceeds from life insurance contracts totaling $303 thousand in 2018. Securities gains decreased by $237 thousand for the year ended December 31, 2018 compared to the same period last year as increases in interest rates led to decreases in the market value of the Bank’s investment securities portfolio. Noninterest income decreased by $342 thousand in 2017 compared to 2016. The decrease was due to the nonrecurring bargain purchase gain of $891 thousand which was recognized in 2016 in connection with the Cardinal merger. Without this gain, noninterest income increased by $549 thousand in 2017, due primarily to increases in service charges and fees resulting from additional accounts acquired through the merger with Cardinal.

Table 3. Sources of Noninterest Income (dollars in thousands)

	2018		2017		2016
Service charges on deposit accounts	$	1,538	$	1,326	$	1,256
Increase in cash value of life insurance		433		444		382
Life insurance income		303		—		—
Mortgage originations fees		396		293		167
Safe deposit box rental		93		94		78
Gain on securities		5		242		364
ATM income		1,324		967		750
Investment services income		126		84		133
Merchant services income		171		147		144
Bargain purchase gain		—		—		891
Interchange income		126		305		206
Other income		122		326		199
Total noninterest income	$	4,637	$	4,228	$	4,570

25

Management’s Discussion and Analysis

Other Expense

The major components of noninterest expense for the past three years are illustrated at Table 4.

Total noninterest expenses increased by $3.6 million, or 18.55% for the year ended December 31, 2018, compared to the year ended December 31, 2017. As noted above, the overall increase in expenses for the comparative periods was due primarily to the Great State merger, as the 2018 expenses reflect six months of combined operations. Accordingly, salaries and employee benefits increased by $1.5 million due to the increase in the number of employees, and occupancy expenses increased by $177 thousand due to the addition of six banking facilities. Data processing expense increased by $176 thousand due to the increased accounts and transaction volume. Nonrecurring merger related expenses totaled $2.0 million in 2018, compared to $748 thousand in 2017. The increase in noninterest expense in 2017, compared to 2016, was also due primarily to the Cardinal merger.

Table 4. Sources of Noninterest Expense (dollars in thousands)

	2018		2017		2016
Salaries & wages	$	9,034	$	8,230	$	6,772
Employee benefits		2,768		2,053		1,858
Total personnel expense		11,802		10,283		8,630
Director fees		370		327		257
Occupancy expense		1,260		1,083		815
Data processing expense		1,353		1,177		888
Other equipment expense		988		1,117		1,170
FDIC/OCC assessments		390		426		350
Insurance		121		129		127
Professional fees		452		430		327
Advertising		569		612		208
Postage & freight		362		311		235
Supplies		212		277		159
Franchise tax		438		397		270
Telephone		415		370		279
Travel, dues & meetings		490		414		299
ATM expense		423		388		355
Foreclosure expenses		32		44		79
Core deposit intangible amortization		578		282		142
Merger related expenses		1,978		748		1,483
Other expense		624		465		743
Total noninterest expense	$	22,857	$	19,280	$	16,816

The overhead efficiency ratio of noninterest expense to adjusted total revenue (net interest income plus noninterest income) was 79.03% in 2018, 77.03% in 2017, and 82.42% in 2016. The ratios for 2018 and 2017, without the effect of nonrecurring merger related costs, would have been 72.19% and 74.05%, respectively.

26

Management’s Discussion and Analysis

Income Taxes

Income tax expense is based on amounts reported in the statements of income (after adjustments fornon-taxable income andnon-deductible expenses) and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. The deferred tax assets and liabilities represent the future Federal income tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.

Income tax expense (substantially all Federal) was $1.2 million in 2018 and $3.1 million in 2017, resulting in effective tax rates of 21.1% and 56.1%, respectively. The decrease in 2018 along with the increase in 2017 was due to aone-time charge of $1.4 million to reflect impact of the Tax Cuts and Jobs Act which was signed into law on December 22, 2017. The new legislation reduced tax rates effective January 1, 2018, resulting in are-measurement of the Company’s deferred tax assets and liabilities.

Net deferred tax assets of $1.9 million, and $3.0 million existed at December 31, 2018 and 2017 respectively. At December 31, 2018, net deferred tax assets included $247 thousand of deferred tax assets applicable to unrealized losses on investment securities available for sale, and $276 thousand of deferred tax assets applicable to unfunded projected pension benefit obligations. Accordingly, these amounts were not charged to income but recorded directly to the related stockholders’ equity account.

Analysis of Financial Condition

Average earning assets increased 10.30% from 2017 to 2018 due primarily to the Great State merger. Total earning assets represented 90.43% of total average assets in 2018 and 90.09% in 2017. The mix of average earning assets changed from 2017 to 2018 as average loans increased by $59.2 million, or 14.17% and average investment securities decreased by $8.7 million, or 14.70%.

Table 5. Average Asset Mix (dollars in thousands)

	2018						2017
	Average Balance			%			Average Balance			%
Earning assets:
Loans	$	476,900			78.79	%	$	417,723			75.84	%
Investment securities		50,504			8.34	%		59,210			10.75	%
Federal funds sold		10,584			1.75	%		9,703			1.76	%
Deposits in other banks		9,365			1.55	%		9,611			1.74	%
Total earning assets		547,353			90.43	%		496,247			90.09	%
Non earning assets:
Cash and due from banks		8,218			1.36	%		7,145			1.30	%
Premises and equipment		19,055			3.14	%		17,852			3.24	%
Other assets		35,400			5.85	%		33,449			6.07	%
Allowance for loan losses		(3,435	)		-0.57	%		(3,539	)		-0.64	%
Unrealized gain (loss) on securities		(1,283	)		-0.21	%		(356	)		-0.06	%
Total nonearning assets		57,955			9.57	%		54,551			9.91	%
Total assets	$	605,308			100.00	%	$	550,798			100.00	%

27

Management’s Discussion and Analysis

Average loans for 2018 represented 78.79% of total average assets compared to 75.84% in 2017. Average federal funds sold decreased from 1.76% to 1.75% of total average assets while average investment securities decreased from 10.75% to 8.34% of total average assets over the same time period. The balances of nonearning assets to total average assets decreased from 9.91% to 9.57%.

Loans

Average loans totaled $476.9 million over the year ended December 31, 2018. This represents an increase of 14.17% from the average of $417.7 million for 2017. The increase was due primarily to loans acquired from the Great State merger. Average loans increased by 28.24% from 2016 to 2017.

The loan portfolio consists primarily of real estate and commercial loans. These loans accounted for 95.35% of the total loan portfolio at December 31, 2018. This is down slightly from the 95.67% that the two categories maintained at December 31, 2017. The amount of loans outstanding by type at December 31 of each of the past five years and the maturity distribution for variable and fixed rate loans as of December 31, 2018 are presented in Tables 6 and 7, respectively.

Table 6. Loan Portfolio Summary (dollars in thousands)

	December 31, 2018					December 31, 2017					December 31, 2016
	Amount		%			Amount		%			Amount		%
Construction and development	$	33,449		6.23	%	$	25,475		6.00	%	$	26,464		6.42	%
Residential,1-4 families		199,662		37.22	%		170,080		40.03	%		160,502		38.96	%
Residential, 5 or more families		36,027		6.72	%		29,040		6.84	%		26,686		6.48	%
Farm land		33,291		6.21	%		33,353		7.85	%		33,531		8.14	%
Nonfarm, nonresidential		176,192		32.84	%		125,661		29.57	%		128,515		31.20	%
Total real estate		478,621		89.22	%		383,609		90.29	%		375,698		91.20	%
Agricultural		4,600		0.86	%		2,792		0.66	%		2,779		0.67	%
Commercial		32,891		6.13	%		22,880		5.38	%		23,307		5.66	%
Consumer		7,396		1.38	%		5,868		1.38	%		5,491		1.33	%
Other		12,957		2.41	%		9,722		2.29	%		4,693		1.14	%
Total	$	536,465		100.00	%	$	424,871		100.00	%	$	411,968		100.00	%
						December 31, 2015					December 31, 2014
						Amount		%			Amount		%
Construction and development						$	14,493		6.01	%	$	17,158		7.70	%
Residential,1-4 families							112,781		46.76	%		110,519		49.56	%
Residential, 5 or more families							12,203		5.06	%		8,606		3.86	%
Farm land							31,512		13.06	%		28,570		12.81	%
Nonfarm, nonresidential							52,463		21.75	%		43,046		19.30	%
Total real estate							223,452		92.64	%		207,899		93.23	%
Agricultural							1,383		0.57	%		1,338		0.60	%
Commercial							11,399		4.73	%		8,954		4.02	%
Consumer							3,962		1.64	%		3,816		1.71	%
Other							1,020		0.42	%		984		0.44	%
Total						$	241,216		100.00	%	$	222,991		100.00	%

28

Management’s Discussion and Analysis

Table 7. Maturity Schedule of Loans, as of December 31, 2018 (dollars in thousands)

	Real		Agricultural		Consumer		Total
	Estate		& Commercial		& Other		Amount		%
Fixed rate loans:
Three months or less	$	4,375	$	1,554	$	4,273	$	10,202		1.90	%
Over three to twelve months		12,579		4,014		1,738		18,331		3.42	%
Over one to five years		116,157		15,115		5,854		137,126		25.56	%
Over five years		38,510		2,501		6,427		47,438		8.84	%
Total fixed rate loans	$	171,621	$	23,184	$	18,292	$	213,097		39.72	%
Variable rate loans:
Three months or less	$	6,486	$	2,057	$	151	$	8,694		1.62	%
Over three to twelve months		8,403		6,004		71		14,478		2.70	%
Over one to five years		7,397		1,902		88		9,387		1.75	%
Over five years		284,714		4,344		1,751		290,809		54.21	%
Total variable rate loans	$	307,000	$	14,307	$	1,751	$	290,809		60.28	%
Total loans:
Three months or less	$	10,861	$	3,611	$	4,424	$	18,896		3.52	%
Over three to twelve months		20,982		10,018		1,809		32,809		6.12	%
Over one to five years		123,554		17,017		5,942		146,513		27.31	%
Over five years		323,224		6,845		8,178		338,247		63.05	%
Total loans	$	478,621	$	37,491	$	20,353	$	536,465		100.00	%

Interest rates charged on loans vary with the degree of risk, maturity and amount of the loan. Competitive pressures, money market rates, availability of funds, and government regulations also influence interest rates. On average, loans yielded 5.15% in 2018 compared to an average yield of 4.96% in 2017. The increase in loan yields was due primarily to the Great State merger, along with repricing of loans at higher rates.

Investment Securities

The Company uses its investment portfolio to provide liquidity for unexpected deposit decreases or loan generation, to meet the Bank’s interest rate sensitivity goals, and to generate income.

Management of the investment portfolio has always been conservative with the majority of investments taking the form of purchases of U.S. Treasury, U.S. Government Agencies, U.S. Government Sponsored Enterprises and State and Municipal bonds, as well as investment grade corporate bond issues. Management views the investment portfolio as a source of income, and purchases securities with the intent of retaining them until maturity. However, adjustments are necessary in the portfolio to provide an adequate source of liquidity which can be used to meet funding requirements for loan demand and deposit fluctuations and to control interest rate risk. Therefore, from time to time, management may sell certain securities prior to their maturity. Table 8 presents the investment portfolio at the end of 2018 by major types of investments and contractual maturity ranges. Investment securities in Table 8 may have repricing or call options that are earlier than the contractual maturity date. Yields on tax exempt obligations are not computed on atax-equivalent basis in Table 8.

The total amortized cost of investment securities decreased by approximately $4.7 million from December 31, 2017 to December 31, 2018, while the average balance of investment securities carried throughout the year decreased by approximately $8.7 million from 2017 to 2018. The decrease in total amortized cost came as cash generated from liquidating investment securities was used to fund loan growth. The average yield of the investment portfolio increased to 2.53% for the year ended December 31, 2018 compared to 2.35% for 2017.

29

Management’s Discussion and Analysis

Table 8. Investment Securities - Maturity/Yield Schedule (dollars in thousands)

	December 31, 2018
	In One Year or Less			After One Through Five Years			After Five Through Ten Years			After Ten Years			Book Value 12/31/18			Market Value 12/31/18		Book Value 12/31/17		Book Value 12/31/16
Investment securities:
U.S. Government agencies	$	—		$	244		$	—		$	—		$	244		$	245	$	—	$	—
Govt. sponsored enterprises		—			—			—			—			—			—		—		2,046
Mortgage-backed securities		451			5,427			11,672			8,077			25,627			24,763		28,780		36,021
Corporate securities		—			1,470			1,500			—			2,970			2,789		3,016		3,061
State and municipal securities		252			7,889			2,399			7,224			17,764			17,631		19,542		22,282
Total	$	703		$	15,030		$	15,571		$	15,301		$	46,605		$	45,428	$	51,338	$	63,410
Weighted average yields:
U.S. Government agencies		0.00	%		2.89	%		0.00	%		0.00	%		2.89	%
Mortgage-backed securities		2.81	%		2.21	%		2.15	%		2.34	%		2.23	%
Corporate securities		0.00	%		3.00	%		3.20	%		0.00	%		3.10	%
State and municipal securities		2.79	%		2.94	%		2.94	%		2.94	%		2.83	%
Total		2.81	%		2.55	%		2.37	%		2.62	%		2.52	%

Deposits

The Company relies on deposits generated in its market area to provide the majority of funds needed to support lending activities and for investments in liquid assets. More specifically, core deposits (total deposits less certificates of deposit in denominations of $100,000 or more) are the primary funding source. The Company’s balance sheet growth is largely determined by the availability of deposits in its markets, the cost of attracting the deposits, and the prospects of profitably utilizing the available deposits by increasing the loan or investment portfolios. We believe that recent market conditions have resulted in depositors shopping for deposit rates more than in the past. An increased customer awareness of interest rates adds to the importance of rate management. The Company’s management must continuously monitor market pricing, competitor’s rates, and the internal interest rate spreads to maintain the Company’s growth and profitability. The Company attempts to structure rates so as to promote deposit and asset growth while at the same time increasing overall profitability of the Company.

Average total deposits for the year ended December 31, 2018 amounted to $536.2 million, which was an increase of $44.8 million, or 9.11% from 2017. The increase was due primarily to deposits acquired in the Great State merger. Average core deposits totaled $473.6 million in 2018 representing a 7.98% increase over the $438.6 million in 2017. The percentage of the Company’s average deposits that are interest-bearing has remained consistent in recent years at 73.8% in 2016, 73.9% in 2017, and 74.0% in 2018. Average demand deposits, which earn no interest, increased 8.61% from $128.4 million in 2017 to $139.4 million in 2018. Average deposits for the periods ended December 31, 2018, 2017, and 2016 are summarized in Table 9.

30

Management’s Discussion and Analysis

Table 9. Deposit Mix (dollars in thousands)

	December 31, 2018								December 31, 2017
	Average Balance		% of Total Deposits			Average Rate Paid			Average Balance		% of Total Deposits			Average Rate Paid
Interest-bearing deposits:
Interest-bearing DDA accounts	$	66,984		12.5	%		0.10	%	$	59,485		12.1	%		0.09	%
Money market		48,425		9.0	%		0.26	%		42,711		8.7	%		0.21	%
Savings		117,479		21.9	%		0.30	%		101,184		20.6	%		0.25	%
Individual retirement accounts		45,598		8.5	%		0.99	%		47,045		9.6	%		0.91	%
Small denomination certificates		55,700		10.4	%		0.57	%		59,820		12.2	%		0.41	%
Large denomination certificates		62,634		11.7	%		0.89	%		52,868		10.7	%		0.76	%
Total interest-bearing deposits		396,820		74.0	%		0.47	%		363,113		73.9	%		0.41	%
Noninterest-bearing deposits		139,409		26.0	%		0.00	%		128,356		26.1	%		0.00	%
Total deposits	$	536,229		100.0	%		0.35	%	$	491,469		100.0	%		0.30	%
									December 31, 2016
									Average Balance		% of Total Deposits			Average Rate Paid
Interest-bearing deposits:
Interest-bearing DDA accounts									$	42,848		11.2	%		0.10	%
Money market										30,482		7.9	%		0.21	%
Savings										77,064		20.1	%		0.24	%
Individual retirement accounts										41,770		10.9	%		1.06	%
Small denomination certificates										49,942		13.0	%		0.52	%
Large denomination certificates										40,925		10.7	%		0.71	%
Total interest-bearing deposits										283,031		73.8	%		0.45	%
Noninterest-bearing deposits										100,425		26.2	%		0.00	%
Total deposits									$	383,456		100.0	%		0.33	%

The average balance of certificates of deposit issued in denominations of $100,000 or more increased by $9.8 million, or 18.47%, for the year ended December 31, 2018 due to the Great State merger. The strategy of management has been to support loan and investment growth with core deposits and not to aggressively solicit the more volatile, large denomination certificates of deposit. Loan growth in 2018 was primarily funded through reductions in interest bearing deposits in banks and investment securities, thus reducing management’s reliance on large denomination certificates of deposit for funding purposes. Table 10 provides maturity information relating to certificates of deposit of $100,000 or more at December 31, 2018.

Table 10. Large Denomination Certificate of Deposit Maturities (dollars in thousands)

Analysis of certificates of deposit of $100,000 or more at December 31, 2018:
Remaining maturity of three months or less	$	12,260
Remaining maturity over three months through six months		7,322
Remaining maturity over six months through twelve months		19,206
Remaining maturity over twelve months		39,022
Total certificates of deposit of $100,000 or more	$	77,810

31

Management’s Discussion and Analysis

Equity

Stockholders’ equity totaled $75.6 million at December 31, 2018 compared to $57.2 million at December 31, 2017. $15.5 million of the increase is due to the issuance of common stock in connection with the merger with Great State. The remaining increase was due to earnings of $4.5 million, less a net change in accumulated other comprehensive losses totaling $457 thousand, and the payment of dividends of $1.1 million. Book value increased from $11.39 per share at December 31, 2017 to $12.17 per share at December 31, 2018. Tangible book value increased from $10.98 per share at December 31, 2017 to $11.03 per share at December 31, 2018.

Effective January 1, 2015, the federal banking regulators adopted rules to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rules required the Bank to comply with the following minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6% of risk-weighted assets; (iii) a total capital ratio of 8% of risk-weighted assets; and (iv) a leverage ratio of 4% of total assets. As fully phased in on January 1, 2019, the rules will require the Company and the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.

Table 11. Bank’sYear-end Risk-Based Capital (dollars in thousands)

	2018			2017
Tier 1 Capital	$	67,899		$	53,483
Unrealized gains on AFS preferred stock		—			—
Qualifying allowance for loan losses (limited to 1.25% of risk-weighted assets)		3,525			3,479
Total regulatory capital	$	71,424		$	56,962
Total risk-weighted assets	$	549,292		$	433,604
Tier 1 capital as a percentage of risk-weighted assets		12.4	%		12.3	%
Common Equity Tier 1 capital as a percentage of risk-weighted assets		12.4	%		12.3	%
Total regulatory capital as a percentage of risk-weighted assets		13.0	%		13.1	%
Leverage ratio*		10.1	%		9.8	%

*Tier 1 capital divided by average total assets for the quarter ended December 31 of each year.

32

Management’s Discussion and Analysis

Nonperforming and Problem Assets

Certain credit risks are inherent in making loans, particularly commercial and consumer loans. Management prudently assesses these risks and attempts to manage them effectively. The Bank attempts to use shorter-term loans and, although a portion of the loans have been made based upon the value of collateral, the underwriting decision is generally based on the cash flow of the borrower as the source of repayment rather than the value of the collateral. The Bank also attempts to reduce repayment risk by adhering to internal credit policies and procedures. These policies and procedures include officer and customer limits, periodic loan documentation review and follow up on exceptions to credit policies.

Nonperforming assets at December 31, 2018, 2017, 2016, 2015, and 2014 are analyzed in Table 12.

Table 12. Nonperforming Assets (dollars in thousands)

	2018			2017			2016			2015			2014
Nonperforming loans:
Nonaccrual loans	$	5,579		$	5,335		$	4,664		$	1,589		$	4,608
Restructured loans		6,961			7,743			9,239			10,008			10,525
Loans past due 90 days or more and still accruing		—			—			—			—			—
Total nonperforming loans		12,540			13,078			13,903			11,597			15,133
Foreclosed assets		753			—			70			408			657
Total nonperforming assets	$	13,293		$	13,078		$	13,973		$	12,005		$	15,790
Total nonperforming loans as a percentage to total loans		2.3	%		3.1	%		3.4	%		4.8	%		6.8	%
Total nonperforming assets as a percentage to total assets		2.0	%		2.4	%		2.5	%		3.6	%		4.7	%

Total nonperforming loans were 2.3% and 3.1% of total outstanding loans as of December 31, 2018 and 2017, respectively. The majority of the increase in nonaccrual loans from 2017 to 2018 came in the “commercial mortgage” category. Nonaccrual loans in this category increased by $546 thousand. Loans are placed in nonaccrual status when, in management’s opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Loans are removed from nonaccrual status when they are deemed a loss and charged to the allowance, transferred to foreclosed assets, or returned to accrual status based upon performance consistent with the original terms of the loan or a subsequent restructuring thereof. Management’s ability to ultimately resolve these loans either with or without significant loss will be determined, to a great extent, by general economic and real estate market conditions.

For the years ended December 31, 2018 and 2017, interest income recognized on loans in nonaccrual status was approximately $58 thousand and $181 thousand, respectively. Had these credits been current in accordance with their original terms, the gross interest income for these credits would have been approximately $277 thousand and $337 thousand, respectively for the years ended December 31, 2018 and 2017.

Restructured loans represent troubled debt restructurings (TDRs) that have returned to accrual status after a period of performance in accordance with their modified terms. The decrease in restructured loans from 2017 to 2018 came primarily in the form of principal reductions. A TDR is considered to be successful if the borrower maintains adequate payment performance under the modified terms and is financially stable.

The increase in foreclosed assets from 2017 to 2018 resulted from the transfer of a nonfarm, nonresidential property during the year. Sales and market adjustments of foreclosed assets in 2018 resulted in a net loss of $10 thousand. More information on nonperforming assets can be found in Note 6 of the “Notes to Consolidated Financial Statements” found in the company’s 2018 Annual Report.

33

Management’s Discussion and Analysis

As of December 31, 2018 and 2017 we had loans with a current principal balance of $56.0 million and $38.2 million rated “Watch” or “Special Mention”. The increase was due primarily to the acquisition of loans in the Great state merger, along with loan risk rating reclassifications. The “Watch” classification is utilized by us when we have an initial concern about the financial health of a borrower that indicate above average risk. We then gather current financial information about the borrower and evaluate our current risk in the credit. After this review we will either move the loan to a higher risk rating category or move it back to its original risk rating. Loans may be left rated “Watch” for a longer period of time if, in management’s opinion, there are risks that cannot be fully evaluated without the passage of time, and we want to review it on a more regular basis. Assets that do not currently expose the Bank to sufficient risk to warrant a classification such as “Substandard” or “Doubtful” but otherwise possess weaknesses are designated “Special Mention”. Loans rated as “Watch” or “Special Mention” are not considered “potential problem loans” until they are determined by management to be classified as “Substandard”.    Past due loans are often regarded as a precursor to further credit problems which would lead to future increases in nonaccrual loans or other real estate owned. As of December 31, 2018 loans past due30-89 days and still accruing totaled $863 thousand compared to $421 thousand at December 31, 2017.

Certain types of loans, such as option ARM products, subprime loans and loans with initial teaser rates, can have a greater risk ofnon-collection than other loans. The Bank has not offered these types of loans in the past and does not offer them currently. Junior-lien mortgages can also be considered higher risk loans. Our junior-lien portfolio at December 31, 2018 totaled $6.2 million, or 1.2% of total loans. Thecharge-off rates in this category do not vary significantly from other real estate secured loans in the current year.

The allowance for loan losses is maintained at a level adequate to absorb potential losses. Some of the factors which management considers in determining the appropriate level of the allowance for loan losses are: past loss experience, an evaluation of the current loan portfolio, identified loan problems, the loan volume outstanding, the present and expected economic conditions in general, and in particular, how such conditions relate to the market area that the Bank serves. Bank regulators also periodically review the Bank’s loans and other assets to assess their quality. Loans deemed uncollectible are charged to the allowance. Provisions for loan losses and recoveries on loans previously charged off are added to the allowance. The reserve for loan losses at December 31, 2018 was approximately 0.65% of total loans, compared to 0.81% at December 31, 2017. Management’s estimate of probable credit losses inherent in the acquired Great State loan portfolio was reflected as a purchase discount which will continue to be accreted into income over the remaining life of the acquired loans in addition to the previously acquired loan portfolio from the merger with Cardinal Bankshares Corporation. As of December 31, 2018, the remaining unaccreted discount on the acquired loan portfolios totaled $5.0 million. Management believes the provision and the resulting allowance for loan losses are adequate.

To quantify the specific elements of the allowance for loan losses, the Bank begins by establishing a specific reserve for larger-balance,non-homogeneous loans, which have been identified as being impaired. This reserve is determined by comparing the principal balance of the loan with the net present value of the future anticipated cash flows or the fair market value of the related collateral. If the impaired loan is collateral dependent, then any excess in the recorded investment in the loan over the fair value of the collateral that is identified as uncollectible in the near term is charged off against the allowance for loan losses at that time. The bank also collectively evaluates for impairment smaller-balance troubled debt restructurings (TDRs). The specific component of the allowance for smaller-balance TDR loans is calculated on a pooled basis considering historical experience adjusted for qualitative factors. The bank then reviews certain loans in the portfolio and assigns grades to loans which have been reviewed. Loans which are adversely classified are given a specific allowance based on the historical loss experience of similar type loans in each adverse grade with further adjustments for external factors. The remaining portfolio is segregated into loan pools consistent with regulatory guidelines. An allocation is then made to the reserve for these loan pools based on the bank’s historical loss experience with further adjustments for external factors. The allowance is allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the respective categories of loans, although the entire allowance is available to absorb any actual charge-offs that may occur.

34

Management’s Discussion and Analysis

The provision for loan losses, net charge-offs, and the resulting allowance for loan losses, are detailed in Table 13. The allocation of the reserve for loan losses is detailed in Table 14.

Table 13. Analysis of the Allowance for Loan Losses (dollars in thousands)

	2018			2017			2016			2015			2014
Allowance for loan losses, beginning	$	3,453		$	3,420		$	3,418		$	4,185		$	4,591
Provision for (reduction of) loan losses, added		325			217			(5	)		(187	)		294
Charge-offs:
Commercial and agricultural		(23	)		(27	)		(19	)		(1	)		(78	)
Real estate – construction		(20	)		(33	)		(20	)		(186	)		(268	)
Real estate – mortgage		(259	)		(182	)		(105	)		(469	)		(599	)
Consumer and other		(175	)		(76	)		(70	)		(30	)		(4	)
Recoveries:
Commercial and agricultural		9			33			8			10			15
Real estate – construction		—			56			98			16			17
Real estate – mortgage		147			23			81			23			185
Consumer and other		38			22			34			57			32
Net (charge-offs) recoveries		(283	)		(184	)		7			(580	)		(700	)
Allowance for loan losses, ending	$	3,495		$	3,453		$	3,420		$	3,418		$	4,185
Ratio of net charge-offs during the period to average loans outstanding during the period		0.06	%		0.04	%		0.00	%		0.26	%		0.32	%

Table 14. Allocation of the Allowance for Loan Losses (dollars in thousands)

	December 31, 2018					December 31, 2017					December 31, 2016
Balance at the end of the period applicable to:	Amount		% of Loans to Total Loans			Amount		% of Loans to Total Loans			Amount		% of Loans to Total Loans
Commercial and agricultural	$	281		6.99	%	$	282		6.04	%	$	210		6.33	%
Real estate – construction		246		6.23	%		239		6.00	%		319		6.42	%
Real estate – mortgage		2,874		82.99	%		2,852		84.29	%		2,783		84.78	%
Consumer and other		94		3.79	%		80		3.67	%		108		2.47	%
Total	$	3,495		100.00	%	$	3,453		100.00	%	$	3,420		100.00	%
						December 31, 2015					December 31, 2014
Balance at the end of the period applicable to:						Amount		% of Loans to Total Loans			Amount		% of Loans to Total Loans
Commercial and agricultural						$	136		5.30	%	$	154		4.62	%
Real estate – construction							344		6.01	%		591		7.70	%
Real estate – mortgage							2,900		86.63	%		3,388		85.53	%
Consumer and other							38		2.06	%		52		2.15	%
Total						$	3,418		100.00	%	$	4,185		100.00	%

35

Management’s Discussion and Analysis

Financial Instruments withOff-Balance Sheet Risk

The Bank is party to financial instruments withoff-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the consolidated balance sheets.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as foron-balance sheet instruments. A summary of the Bank’s commitments at December 31, 2018 and 2017 is as follows:

	2018		2017
Commitments to extend credit	$	76,977	$	56,912
Standby letters of credit		1,227		1,106
	$	78,204	$	58,018

Commitments to extend credit 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on acase-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Bank deems necessary.

Quantitative and Qualitative Disclosure about Market Risk

The principal goals of the Bank’s asset and liability management strategy are the maintenance of adequate liquidity and the management of interest rate risk. Liquidity is the ability to convert assets to cash to fund depositors’ withdrawals or borrowers’ loans without significant loss. Interest rate risk management balances the effects of interest rate changes on assets that earn interest or liabilities on which interest is paid, to protect the Bank from wide fluctuations in its net interest income which could result from interest rate changes.

Management must insure that adequate funds are available at all times to meet the needs of its customers. On the asset side of the balance sheet, maturing investments, loan payments, maturing loans, federal funds sold, and unpledged investment securities are principal sources of liquidity. On the liability side of the balance sheet, liquidity sources include core deposits, the ability to increase large denomination certificates, federal fund lines from correspondent banks, borrowings from the Federal Home Loan Bank, as well as the ability to generate funds through the issuance of long-term debt and equity.

The liquidity ratio (the level of liquid assets divided by total deposits plus short-term liabilities) was 11.6% at December 31, 2018 compared to 12.4% at December 31, 2017. These ratios are considered to be adequate by management.

The Bank uses cash and federal funds sold to meet its daily funding needs. If funding needs are met through holdings of excess cash and federal funds, then profits might be sacrificed as higher-yielding investments are foregone in the interest of liquidity. Therefore management determines, based on such items as loan demand and deposit activity, an appropriate level of cash and federal funds and seeks to maintain that level.

36

Management’s Discussion and Analysis

The primary goals of the investment portfolio are liquidity management and maturity gap management. As investment securities mature the proceeds are reinvested in federal funds sold if the federal funds level needs to be increased, otherwise the proceeds are reinvested in similar investment securities. The majority of investment security transactions consist of replacing securities that have been called or matured. The Bank keeps a portion of its investment portfolio in unpledged assets that are less than 60 months to maturity or next repricing date. These investments are a preferred source of funds in that they can be disposed of in most interest rate environments without causing significant damage to that quarter’s profits.

Interest rate risk is the effect that changes in interest rates would have on interest income and interest expense as interest-sensitive assets and interest-sensitive liabilities either reprice or mature. Management attempts to maintain the portfolios of interest-earning assets and interest-bearing liabilities with maturities or repricing opportunities at levels that will afford protection from erosion of net interest margin, to the extent practical, from changes in interest rates. Table 15 shows the sensitivity of the Bank’s balance sheet on December 31, 2018. This table reflects the sensitivity of the balance sheet as of that specific date and is not necessarily indicative of the position on other dates. At December 31, 2018, the Bank appeared to be cumulatively asset-sensitive (interest-earning assets subject to interest rate changes exceeding interest-bearing liabilities subject to changes in interest rates). However, in the one year window liabilities subject to changes in interest rates exceed assets subject to interest rate changes (non asset-sensitive).

Matching sensitive positions alone does not ensure the Bank has no interest rate risk. The repricing characteristics of assets are different from the repricing characteristics of funding sources. Thus, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched.

Table 15. Interest Rate Sensitivity (dollars in thousands)

	December 31, 2018 Maturities/Repricing
	1 to 3 Months			4 to 12 Months			13 to 60 Months			Over 60 Months			Total
Interest-Earning Assets:
Interest bearing deposits	$	12,159		$	—		$	—		$	—		$	12,159
Federal funds sold		18,990			—			—			—			18,990
Investments		1,447			701			14,767			28,513			45,428
Loans		93,506			48,009			315,668			79,282			536,465
Total	$	126,102		$	48,710		$	330,435		$	107,795		$	613,042
Interest-Bearing Liabilities:
Interest-bearing DDA accounts	$	77,861		$	—		$	—		$	—		$	77,861
Money market		54,584			—			—			—			54,584
Savings		129,114			—			—			—			129,114
Time deposits		22,904			51,459			104,966			814			180,143
Borrowings		—			—			—			—			—
Total	$	284,463		$	51,459		$	104,966		$	814		$	441,702
Interest sensitivity gap	$	(158,361	)	$	(2,749	)	$	225,469		$	106,981		$	171,340
Cumulative interest sensitivity gap	$	(158,361	)	$	(161,110	)	$	64,359		$	171,340		$	171,340
Ratio of sensitivity gap to total earning assets		-25.8	%		-0.4	%		36.8	%		17.5	%		27.9	%
Cumulative ratio of sensitivity gap to total earning assets		-25.8	%		-26.3	%		10.5	%		27.9	%		27.9	%

37

Management’s Discussion and Analysis

The Company uses a number of tools to monitor its interest rate risk, including simulating net interest income under various scenarios, monitoring the present value change in equity under the same scenarios, and monitoring the difference or gap between rate sensitive assets and rate sensitive liabilities over various time periods (as displayed in Table 15).

The earnings simulation model forecasts annual net income under a variety of scenarios that incorporate changes in the absolute level of interest rates, changes in the shape of the yield curve, and changes in interest rate relationships. Management evaluates the effect on net interest income and present value equity from gradual changes in rates of up to 400 basis points up or down over a12-month period. Table 16 presents the Bank’s twelve-month forecasts for changes in net interest income and market value of equity resulting from changes in rates of up to 300 basis points up or down, as of December 31, 2018.

Table 16. Interest Rate Risk (dollars in thousands)

Rate Shocked Net Interest Income and Market Value of Equity
Rate Change	-300bp			-200bp			-100bp			0bp		+100bp			+200bp			+300bp
Net Interest Income:
Net interest income	$	23,857		$	24,473		$	25,814		$	27,001	$	26,972		$	26,977		$	26,923
Change	$	(3,144	)	$	(2,528	)	$	(1,187	)	$	—	$	(29	)	$	(24	)	$	(78	)
Change percentage		-11.64	%		-9.36	%		-4.40	%				-0.11	%		-0.09	%		-0.29	%
Market Value of Equity	$	97,463		$	106,535		$	119,116		$	128,790	$	130,531		$	129,122		$	126,403

Impact of Inflation and Changing Prices

The consolidated financial statements and the accompanying notes presented elsewhere in this document have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all Company assets and liabilities are monetary in nature, therefore the impact of inflation is reflected primarily in the increased cost of operations. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Table 17. Key Financial Ratios

	2018			2017			2016
Return on average assets		0.75	%		0.44	%		0.55	%
Return on average equity		7.02	%		4.28	%		5.62	%
Dividend payout ratio		24.81	%		33.09	%		19.56	%
Average equity to average assets		10.66	%		10.32	%		9.78	%

38

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Not applicable.

Item 8. Financial Statements and Supplementary Data.

39

Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors of Parkway Acquisition Corp.

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Parkway Acquisition Corp. and its subsidiary (the “Company”) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in stockholders’ equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ Elliott Davis, PLLC

We have served as the Company’s auditor since 1995.

Charlotte, North Carolina

March 29, 2019

Elliott Davis PLLC | www.elliottdavis.com

40

Consolidated Balance Sheets

December 31, 2018 and 2017

(dollars in thousands)	2018			2017
Assets
Cash and due from banks	$	8,858		$	6,367
Interest-bearing deposits with banks		12,159			8,739
Federal funds sold		18,990			7,769
Investment securities available for sale		45,428			50,675
Restricted equity securities		2,053			1,388
Loans, net of allowance for loan losses of $3,495 at December 31, 2018 and $3,453 at December 31, 2017		532,970			421,418
Cash value of life insurance		17,413			17,348
Foreclosed assets		753			—
Properties and equipment, net		20,685			17,646
Accrued interest receivable		2,084			1,737
Core deposit intangible		3,892			2,045
Goodwill		3,198			—
Deferred tax assets, net		1,853			2,965
Other assets		9,948			9,864
	$	680,284		$	547,961
Liabilities and Stockholders’ Equity
Liabilities
Deposits
Noninterest-bearing	$	160,166		$	130,847
Interest-bearing		441,702			357,594
Total deposits		601,868			488,441
Accrued interest payable		89			46
Other liabilities		2,705			2,292
		604,662			490,779
Commitments and contingencies (Note 17)
Stockholders’ Equity
Preferred stock, no par value; 5,000,000 shares authorized, none issued		—			—
Common stock, no par value; 25,000,000 shares authorized, 6,213,275 and 5,021,376 issued and outstanding at December 31, 2018 and 2017, respectively		—			—
Surplus		41,660			26,166
Retained earnings		35,929			32,526
Accumulated other comprehensive income (loss)		(1,967	)		(1,510	)
		75,622			57,182
	$	680,284		$	547,961

See Notes to Consolidated Financial Statements

41

Consolidated Statements of Income

Years ended December 31, 2018 and 2017

(dollars in thousands except share amounts)	2018		2017
Interest income
Loans and fees on loans	$	24,574	$	20,722
Interest-bearing deposits with banks		106		48
Federal funds sold		228		111
Interest on taxable securities		1,181		1,302
Dividends		97		91
		26,186		22,274
Interest expense
Deposits		1,867		1,473
Interest on borrowings		34		1
		1,901		1,474
Net interest income		24,285		20,800
Provision for loan losses		325		217
Net interest income after provision for loan losses		23,960		20,583
Noninterest income
Service charges on deposit accounts		1,538		1,326
Other service charges and fees		1,840		1,597
Net realized gains on securities		5		242
Mortgage origination fees		396		293
Increase in cash value of life insurance		433		444
Life insurance income		303		—
Other income		122		326
		4,637		4,228
Noninterest expenses
Salaries and employee benefits		11,802		10,283
Occupancy and equipment		2,671		2,588
Foreclosed asset expense, net		32		44
Data processing expense		1,353		1,177
FDIC Assessments		231		272
Advertising		569		612
Bank franchise tax		438		397
Director fees		370		327
Professional fees		452		430
Telephone expense		415		370
Core deposit intangible amortization		578		282
Merger related expenses		1,978		748
Other expense		1,968		1,750
		22,857		19,280
Income before income taxes		5,740		5,531
Income tax expense related to ordinary operations		1,214		1,669
Income tax expense related to change in tax rate		—		1,435
Total income tax expense		1,214		3,104
Net income	$	4,526	$	2,427
Basic earnings per share	$	0.81	$	0.48
Weighted average shares outstanding		5,622,224		5,021,376
Dividends declared per share	$	0.20	$	0.16

See Notes to Consolidated Financial Statements

42

Consolidated Statements of Comprehensive Income

Years ended December 31, 2018 and 2017

(dollars in thousands)	2018			2017
Net Income	$	4,526		$	2,427
Other comprehensive income (loss)
Net change in pension reserve:
Change in pension reserve during the year		(64	)		(67	)
Tax related to change in pension reserve		13			23
Unrealized gains (losses) on investment securities available for sale:
Unrealized gains (losses) arising during the year		(509	)		449
Tax related to unrealized (gains) losses		107			(153	)
Reclassification of net realized gains during the year		(5	)		(242	)
Tax related to realized gains		1			82
Total other comprehensive income (loss)		(457	)		92
Total comprehensive income	$	4,069		$	2,519

See Notes to Consolidated Financial Statements

43

Consolidated Statements of Changes in Stockholders’ Equity

Years ended December 31, 2018 and 2017

(dollars in thousands except share amounts)
	Common Stock							Retained			Accumulated Other Comprehensive
	Shares		Amount		Surplus			Earnings			Loss			Total
Balance, December 31, 2016		5,021,376	$	—	$	26,166		$	30,654		$	(1,354	)	$	55,466
Net income		—		—		—			2,427			—			2,427
Other comprehensive loss		—		—		—			—			92			92
Reclassification of accumulated other comprehensive loss due to tax rate change		—		—		—			248			(248	)		—
Dividends paid ($0.16 per share)		—		—		—			(803	)		—			(803	)
Balance, December 31, 2017		5,021,376	$	—	$	26,166		$	32,526		$	(1,510	)	$	57,182
Net income		—		—		—			4,526			—			4,526
Other comprehensive income		—		—		—			—			(457	)		(457	)
Issuance of common stock in connection with acquisition of Great State Bank		1,191,899		—		15,495			—			—			15,495
Redemption of fractional shares Issued in acquisition of Great State Bank		—		—		(1	)		—			—			(1	)
Dividends paid ($0.20 per share)		—		—		—			(1,123	)		—			(1,123	)
Balance, December 31, 2018		6,213,275	$	—	$	41,660		$	35,929		$	(1,967	)	$	75,622

See Notes to Consolidated Financial Statements

44

Consolidated Statements of Cash Flows

Years ended December 31, 2018 and 2017

(dollars in thousands)	2018			2017
Cash flows from operating activities
Net income	$	4,526		$	2,427
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		1,187			1,315
Amortization of core deposit intangible		578			282
Accretion of loan discount and deposit premium, net		(1,539	)		(1,245	)
Provision for loan loss		325			217
Deferred income taxes		1,589			2,891
Net realized gains on securities		(5	)		(242	)
Accretion of discount on securities, net of amortization of premiums		521			671
Deferred compensation		19			(50	)
Net realized loss on foreclosed assets		10			23
Life insurance income		(303	)		—
Changes in assets and liabilities:
Cash value of life insurance		(434	)		(444	)
Accrued interest receivable		(13	)		(5	)
Other assets		(210	)		(4,127	)
Accrued interest payable		3			(11	)
Other liabilities		25			(1,604	)
Net cash provided by operating activities		6,279			98
Cash flows from investing activities
Activity in available for sale securities:
Purchases		—			(1,914	)
Sales		18,366			8,664
Maturities/calls/paydowns		5,252			4,893
Purchase of restricted equity securities		(142	)		(239	)
Net increase in loans		(16,785	)		(12,070	)
Proceeds from life insurance contracts		672			—
Proceeds from the sale of foreclosed assets		480			47
Purchases of property and equipment, net of sales		(2,830	)		(991	)
Cash received in business combination		25,761			—
Net cash provided by (used in) investing activities		30,774			(1,610	)
Cash flows from financing activities
Net decrease in deposits		(16,797	)		(10,718	)
Repayment of borrowings		(2,000	)		—
Cash paid for fractional shares		(1	)		—
Dividends paid		(1,123	)		(803	)
Net cash used in financing activities		(19,921	)		(11,521	)
Net increase (decrease) in cash and cash equivalents		17,132			(13,033	)
Cash and cash equivalents, beginning		22,875			35,908
Cash and cash equivalents, ending	$	40,007		$	22,875

See Notes to Consolidated Financial Statements

45

Consolidated Statements of Cash Flows, continued

Years ended December 31, 2018 and 2017

(dollars in thousands)	2018			2017
Supplemental disclosure of cash flow information
Interest paid	$	1,858		$	1,485
Taxes paid	$	135		$	70
Supplemental disclosure of noncash investing activities
Effect on equity of change in net unrealized loss on available for sale securities	$	(406	)	$	136
Effect on equity of change in unfunded pension liability	$	(51	)	$	(44	)
Transfers of loans to foreclosed properties	$	1,163		$	—
Business combinations
Assets acquired	$	145,455		$	—
Liabilities assumed		132,960			—
Net assets	$	12,495		$	—
Goodwill recorded	$	3,198		$	—
Stock issued to acquire Great State Bank	$	15,495		$	—

See Notes to Consolidated Financial Statements

46

Notes to Consolidated Financial Statements

Note 1. Organization and Summary of Significant Accounting Policies

Organization

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

On March 1, 2018, Parkway entered into a definitive agreement pursuant to which Parkway acquired Great State Bank (“Great State”), based in Wilkesboro, North Carolina. The agreement provided for the merger of Great State with and into the Bank, with the Bank as the surviving bank (the “Great State merger”). The transaction closed and the merger became effective on July 1, 2018. Each share of Great State common stock was converted into the right to receive 1.21 shares of Parkway common stock. The Company issued 1,191,899 shares and recognized $15.5 million in surplus in the Great State merger. Parkway was considered the acquiror and Great State was considered the acquiree in the transaction for accounting purposes. Pursuant to the Great State merger, the Company acquired $145.5 million of assets, including $95.1 million in loans and assumed $133.0 million in liabilities, including $130.6 million of deposits, on July 1, 2018. Such accounts include preliminary estimated fair value adjustments, which are subject to change.

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

Critical Accounting Policies

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

Principles of Consolidation

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

47

Notes to Consolidated Financial Statements

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

Business Segments

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

Business Combinations

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

Use of Estimates

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

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

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

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

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

48

Notes to Consolidated Financial Statements

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

Use of Estimates, continued

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

Cash and Cash Equivalents

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

Trading Securities

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

Securities Held to Maturity

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

Securities Available for Sale

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

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

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

Loans Receivable

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

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

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

49

Notes to Consolidated Financial Statements

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

Loans Receivable, continued

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

Allowance for Loan Losses

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

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

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

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

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

50

Notes to Consolidated Financial Statements

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

Troubled Debt Restructurings

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

Property and Equipment

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

	Years
Buildings and improvements		10-40
Furniture and equipment		5-12

Foreclosed Assets

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

Pension Plan

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

Transfers of Financial Assets

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

51

Notes to Consolidated Financial Statements

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

Goodwill and Other Intangible Assets

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

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

Revenue Recognition

On January 1, 2018, we adopted the requirements of Accounting Standards Update (“ASU”)2014-9,Revenue from Contracts with Customers (“ASU Topic 606”). The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASU, including deposit related fees, interchange fees, merchant income, and annuity and insurance commissions. Based on this assessment, the Company concluded that ASU2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company also completed its evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e., gross vs. net). Based on its evaluation, the Company determined that ASU2014-09 did not materially change the method in which the Company currently classifies certain costs associated with the related revenue streams. The Company adopted ASU2014-09 and its related amendments on its required effective date of January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary.

Income Taxes

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

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

52

Notes to Consolidated Financial Statements

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

Income Taxes, continued

The Company has early adopted ASU2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” which is considered a change in accounting principle. Because the required adjustment of deferred taxes is required to be included in income from continuing operations, the tax effects of items within accumulated other comprehensive income (commonly referred to as “stranded” tax effects) would not reflect the appropriate tax rate. Adoption of this ASU eliminates the “stranded” tax effects associated with the change in the federal corporate income tax rate in the Tax Cuts and Jobs Act of 2017. The Company has reclassified “stranded” tax effects totaling $248 thousand from accumulated other comprehensive loss to retained earnings and these reclassified amounts are reflected in the accompanying consolidated statements of changes in stockholders’ equity.

Comprehensive Income

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

(dollars in thousands)	Unrealized Gains And Losses On Available for Sale Securities			Defined Benefit Pension Items			Total
Balance, December 31, 2016	$	(574	)	$	(780	)	$	(1,354	)
Other comprehensive income (loss) before reclassifications		296			(44	)		252
Amounts reclassified from accumulated other comprehensive loss		(160	)		—			(160	)
Amounts reclassified to retained earnings from other comprehensive loss due to tax rate change		(85	)		(163	)		(248	)
Balance, December 31, 2017	$	(523	)	$	(987	)	$	(1,510	)
Balance, December 31, 2017	$	(523	)	$	(987	)	$	(1,510	)
Other comprehensive income (loss) before reclassifications		(402	)		(51	)		(453	)
Amounts reclassified from accumulated other comprehensive loss		(4	)		—			(4	)
Balance, December 31, 2018	$	(929	)	$	(1,038	)	$	(1,967	)

Advertising Expense

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

Basic Earnings per Share

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

Off-Balance Sheet Credit Related Financial Instruments

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

53

Notes to Consolidated Financial Statements

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

Fair Value of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 13. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or in market conditions could significantly affect the estimates.

Reclassification

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

Recent Accounting Pronouncements

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

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

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

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

The Company will apply the amendments to the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. While early adoption is permitted beginning in first quarter 2019, we do not expect to elect that option. We are evaluating the impact of the ASU on our consolidated financial statements. We expect the ASU will result in an increase in the recorded allowance for loan losses given the change to estimated losses over the contractual life of the loans adjusted for expected prepayments. The majority of the increase results from longer duration portfolios. In addition to our allowance for loan losses, we will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.

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

54

Notes to Consolidated Financial Statements

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

Recent Accounting Pronouncements, continued

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

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

In February 2018, the FASB amended the Financial Instruments Topic of the Accounting Standards Codification. The amendments clarify certain aspects of the guidance issued in ASU2016-01. The amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years beginning after June 15, 2018. All entities may early adopt these amendments for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, as long as they have adopted ASU2016-01. The Company does not expect these amendments to have a material effect on its financial statements.

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

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

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

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

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

55

Notes to Consolidated Financial Statements

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

Recent Accounting Pronouncements, continued

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

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

In October 2018, the FASB amended the Derivatives and Hedging Topic of the Accounting Standards Codification to expand the list of U.S. benchmark interest rates permitted in the application of hedge accounting. The amendments will be effective for the Company for fiscal years beginning after December 15, 2018. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In November 2018, the FASB amended the Collaborative Arrangements Topic of the Accounting Standards Codification to clarify the interaction between the guidance for certain collaborative arrangements and the new revenue recognition financial accounting and reporting standard. The amendments will be effective for the Company for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

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

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

Note 2. Business Combinations

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

56

Notes to Consolidated Financial Statements

Note 2. Business Combinations, continued

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

(dollars in thousands)	As Reported by Great State			Fair Value Adjustments				As Reported by Parkway
Assets
Cash and cash equivalents	$	25,761		$	—		—	$	25,761
Investment securities		19,630			(229	)	(a)		19,401
Restricted equity securities		523			—		—		523
Loans		97,549			(2,441	)	(b)		95,108
Allowance for loan losses		(1,436	)		1,436		(c)		—
Property and equipment		1,207			189		(d)		1,396
Intangible assets		—			2,425		(e)		2,425
Accrued interest receivable		334			—		—		334
Other assets		599			(92	)	(f)		507
Total assets acquired	$	144,167		$	1,288			$	145,455
Liabilities
Deposits	$	129,611		$	940		(g)	$	130,551
Borrowings		2,000			—		—		2,000
Accrued interest payable		40			—		—		40
Other liabilities		352			17		(h)		369
Total liabilities acquired	$	132,003		$	957			$	132,960
Net assets acquired									12,495
Elimination of Company’s existing investment in Great State									198
Stock consideration									15,495
Goodwill								$	3,198

Explanation of fair value adjustments:

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

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

(c) Existing allowance for loan losses eliminated to reflect accounting guidance.

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

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

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

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

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

57

Notes to Consolidated Financial Statements

Note 2. Business Combinations, continued

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

There are two methods to account for acquired loans as part of a business combination. Acquired loans that contain evidence of credit deterioration on the date of purchase are carried at the net present value of expected future proceeds in accordance with FASB ASC310-30. All other acquired loans are recorded at their initial fair value, adjusted for subsequent advances, pay downs, amortization or accretion of any premium or discount on purchase, charge-offs and any other adjustment to carrying value in accordance with ASC310-20.

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

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

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

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

The table below presents supplemental pro forma information as if the Great State acquisition had occurred at the beginning of the earliest period presented, which was January 1, 2017. Pro forma results include adjustments for amortization and accretion of fair value adjustments and do not include any projected cost savings or other anticipated benefits of the merger. Therefore, the pro forma financial information is not indicative of the results of operations that would have occurred had the transactions been effected on the assumed date.Pre-tax merger-related costs of $2.0 million and $748 thousand are included in the Company’s consolidated statements of income for the years ended December 31, 2018 and 2017 and are not included in the pro forma statements below.

	Year Ended
	December 31,
	2018		2017
	(Unaudited)		(Unaudited)
Net interest income	$	23,956	$	21,279
Net income (a)	$	4,266	$	2,743
Basic and diluted weighted average shares outstanding (b)		6,213,275		6,213,275
Basic and diluted earnings per common share	$	0.69	$	0.44

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

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

It is impractical to disclose the net interest income,non-interest income, and net income of Great State from the acquisition date of July 1, 2018 through December 31, 2018 due to the system conversion that occurred on September 7, 2018, which resulted in the combining of the operations of Great State into Parkway.

58

Notes to Consolidated Financial Statements

Note 3. Restrictions on Cash

To comply with banking regulations, the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirement was approximately $6.3 million and $3.6 million for the periods including December 31, 2018 and 2017, respectively.

Note 4. Investment Securities

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

(dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
2018
Available for sale:
U.S. Government Agencies	$	244	$	1	$	—		$	245
Mortgage-backed securities		25,627		1		(865	)		24,763
Corporate securities		2,970		—		(181	)		2,789
State and municipal securities		17,764		31		(164	)		17,631
	$	46,605	$	33	$	(1,210	)	$	45,428
2017
Available for sale:
Mortgage-backed securities	$	28,780	$	—	$	(626	)	$	28,154
Corporate securities		3,016		—		(80	)		2,936
State and municipal securities		19,542		155		(112	)		19,585
	$	51,338	$	155	$	(818	)	$	50,675

Restricted equity securities were $2.1 million and $1.4 million at December 31, 2018 and 2017, respectively. Restricted equity securities consist of investments in stock of the Federal Home Loan Bank of Atlanta (FHLB), CBB Financial Corp., Pacific Coast Bankers Bank, and the Federal Reserve Bank of Richmond, all of which are carried at cost. All of these entities are upstream correspondents of the Bank. The FHLB requires financial institutions to make equity investments in the FHLB in order to borrow money. The Bank is required to hold that stock so long as it borrows from the FHLB. The Federal Reserve requires Banks to purchase stock as a condition for membership in the Federal Reserve System. The Bank’s stock in CBB Financial Corp. and Pacific Coast Bankers Bank is restricted only in the fact that the stock may only be repurchased by the respective banks.

The following tables details unrealized losses and related fair values in the Company’s held to maturity and available for sale investment securities portfolios. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2018 and 2017.

	Less Than 12 Months					12 Months or More					Total
(dollars in thousands)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
2018
Available for sale:
Mortgage-backed securities	$	450	$	(1	)	$	24,227	$	(864	)	$	24,677	$	(865	)
Corporate securities		—		—			2,789		(181	)		2,789		(181	)
State and municipal securities		5,518		(19	)		6,834		(145	)		12,352		(164	)
Total securities available for sale	$	5,968	$	(20	)	$	33,850	$	(1,190	)	$	39,818	$	(1,210	)
2017
Available for sale:
Mortgage-backed securities	$	15,791	$	(324	)	$	12,361	$	(302	)	$	28,152	$	(626	)
Corporate securities		1,506		(10	)		1,430		(70	)		2,936		(80	)
State and municipal securities		5,284		(44	)		2,758		(68	)		8,042		(112	)
Total securities available for sale	$	22,581	$	(378	)	$	16,549	$	(440	)	$	39,130	$	(818	)

59

Notes to Consolidated Financial Statements

Note 4. Investment Securities, continued

At December 31, 2018, 46 debt securities with unrealized losses had depreciated 2.95 percent from their total amortized cost basis. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, and the financial condition and near-term prospects of the issuer. The relative significance of these and other factors will vary on a case by case basis. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition and the issuer’s anticipated ability to pay the contractual cash flows of the investments. Since the Company intends to hold all of its investment securities until maturity, and it is more likely than not that the Company will not have to sell any of its investment securities before unrealized losses have been recovered, and the Company expects to recover the entire amount of the amortized cost basis of all its securities, none of the securities are deemed other than temporarily impaired at December 31, 2018. Management continues to monitor all of these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of these securities are other than temporarily impaired, which could require a charge to earnings in such periods.

Proceeds from the sales of investment securities available for sale were $18.4 and $8.7 million for the years ended December 31, 2018 and 2017, respectively. Gross realized gains and losses for the years ended December 31 are as follows:

(dollars in thousands)	2018			2017
Realized gains	$	9		$	257
Realized losses		(4	)		(15	)
	$	5		$	242

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

The scheduled maturities of securities available for sale at December 31, 2018, were as follows:

(dollars in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	703	$	701
Due after one year through five years		15,030		14,766
Due after five years through ten years		15,571		14,943
Due after ten years		15,301		15,018
	$	46,605	$	45,428

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

Investment securities with amortized cost of approximately $13.9 million and $11.2 million at December 31, 2018 and 2017 respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.

60

Notes to Consolidated Financial Statements

Note 5. Loans Receivable

The major components of loans in the consolidated balance sheets at December 31, 2018 and December 31, 2017 are as follows:

(dollars in thousands)	2018			2017
Construction & development	$	33,449		$	25,475
Farmland		33,291			33,353
Residential		235,689			199,120
Commercial mortgage		176,192			125,661
Commercial & agricultural		37,491			25,672
Consumer & other		20,353			15,590
Total loans		536,465			424,871
Allowance for loan losses		(3,495	)		(3,453	)
Loans, net of allowance for loan losses	$	532,970		$	421,418

The major components of loans, net of fair value adjustments, acquired from Great State Bank as of July 1, 2018, the acquisition date, are as follows:

(dollars in thousands)
Construction & development	$	7,496
Farmland		720
Residential		26,006
Commercial mortgage		47,953
Commercial & agricultural		11,793
Consumer & other		1,140
Total loans acquired	$	95,108

As of December 31, 2018 and 2017, substantially all of the Bank’s residential1-4 family loans were pledged as collateral toward borrowings with the Federal Home Loan Bank.

Note 6. Allowance for Loan Losses and Impaired Loans

Allowance for Loan Losses

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

61

Notes to Consolidated Financial Statements

Note 6. Allowance for Loan Losses and Impaired Loans, continued

Allowance for Loan Losses, continued

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

The following table presents activity in the allowance by loan category and information on the loans evaluated individually for impairment and collectively evaluated for impairment as of December 31, 2018 and December 31, 2017:

Allowance for Loan Losses and Recorded Investment in Loans

(dollars in thousands)	Construction & Development			Farmland			Residential			Commercial Mortgage			Commercial & Agricultural			Consumer & Other			Total
December 31, 2018
Allowance for loan losses:
Beginning Balance	$	239		$	358		$	1,875		$	619		$	282		$	80		$	3,453
Charge-offs		(20	)		—			(117	)		(142	)		(23	)		(175	)		(477	)
Recoveries		—			34			44			69			9			38			194
Provision		27			(7	)		5			136			13			151			325
Ending Balance	$	246		$	385		$	1,807		$	682		$	281		$	94		$	3,495
Ending balance: individually evaluated for impairment	$	—		$	29		$	12		$	—		$	—		$	—		$	41
Ending balance: collectively evaluated for impairment	$	246		$	356		$	1,795		$	682		$	281		$	94		$	3,454
Loans outstanding:
Ending Balance	$	33,449		$	33,291		$	235,689		$	176,192		$	37,491		$	20,353		$	536,465
Ending balance: individually evaluated for impairment	$	—		$	4,552		$	1,018		$	—		$	—		$	—		$	5,570
Ending balance: collectively evaluated for impairment	$	33,449		$	28,739		$	234,671		$	176,192		$	37,491		$	20,353		$	530,895
December 31, 2017
Allowance for loan losses:
Beginning Balance	$	319		$	342		$	1,841		$	600		$	210		$	108		$	3,420
Charge-offs		(33	)		(34	)		(89	)		(59	)		(27	)		(76	)		(318	)
Recoveries		56			—			23			—			33			22			134
Provision		(103	)		50			100			78			66			26			217
Ending Balance	$	239		$	358		$	1,875		$	619		$	282		$	80		$	3,453
Ending balance: individually evaluated for impairment	$	—		$	49		$	42		$	—		$	—		$	—		$	91
Ending balance: collectively evaluated for impairment	$	239		$	309		$	1,833		$	619		$	282		$	80		$	3,362
Loans outstanding:
Ending Balance	$	25,475		$	33,353		$	199,120		$	125,661		$	25,672		$	15,590		$	424,871
Ending balance: individually evaluated for impairment	$	—		$	5,069		$	1,556		$	—		$	—		$	—		$	6,625
Ending balance: collectively evaluated for impairment	$	25,475		$	28,284		$	197,564		$	125,661		$	25,672		$	15,590		$	418,246

As of December 31, 2018 and December 31, 2017, the Bank had no unallocated reserves included in the allowance for loan losses.    

62

Notes to Consolidated Financial Statements

Note 6. Allowance for Loan Losses and Impaired Loans, continued

Allowance for Loan Losses, continued

Management closely monitors the quality of the loan portfolio and has established a loan review process designed to help grade the quality of the Bank’s loan portfolio. The Bank’s loan ratings coincide with the “Substandard,” “Doubtful” and “Loss” classifications used by federal regulators in their examination of financial institutions. Generally, an asset is considered Substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged. Substandard assets include those characterized by the distinct possibility that the insured financial institution will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all the weaknesses inherent in assets classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable. Assets classified as Loss are those considered uncollectible, and of such little value that its continuance on the books is not warranted. Assets that do not currently expose the insured financial institutions to sufficient risk to warrant classification in one of the aforementioned categories but otherwise possess weaknesses are designated “Special Mention.” Management also maintains a listing of loans designated “Watch”. These loans represent borrowers with declining earnings, strained cash flow, increasing leverage and/or weakening market fundamentals that indicate above average risk. As of December 31, 2018 and December 31, 2017, respectively, the Bank had no loans graded “Doubtful” or “Loss” included in the balance of total loans outstanding.

The following table lists the loan grades utilized by the Bank and the corresponding total of outstanding loans in each category as of December 31, 2018 and December 31, 2017:

Credit Risk Profile by Internally Assigned Grades

	Loan Grades
(dollars in thousands)	Pass		Watch		Special Mention		Substandard		Total
December 31, 2018
Real Estate Secured:
Construction & development	$	31,237	$	2,044	$	147	$	21	$	33,449
Farmland		23,250		4,933		750		4,358		33,291
Residential		213,670		18,794		299		2,926		235,689
Commercial mortgage		148,179		23,468		1,212		3,333		176,192
Non-Real Estate Secured:
Commercial & agricultural		33,537		2,908		70		976		37,491
Consumer & other		18,975		1,364		—		14		20,353
Total	$	468,848	$	53,511	$	2,478	$	11,628	$	536,465
December 31, 2017
Real Estate Secured:
Construction & development	$	24,612	$	652	$	—	$	211	$	25,475
Farmland		23,935		4,895		74		4,449		33,353
Residential		183,543		12,464		200		2,913		199,120
Commercial mortgage		106,102		15,291		1,611		2,657		125,661
Non-Real Estate Secured:
Commercial & agricultural		22,446		2,057		649		520		25,672
Consumer & other		15,262		328		—		—		15,590
Total	$	375,900	$	35,687	$	2,534	$	10,750	$	424,871

63

Notes to Consolidated Financial Statements

Note 6. Allowance for Loan Losses and Impaired Loans, continued

Allowance for Loan Losses, continued

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

The following table presents an age analysis of nonaccrual and past due loans by category as of December 31, 2018 and December 31, 2017:

(dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90+ Days Past Due and Still Accruing		Nonaccrual Loans
December 31, 2018
Real Estate Secured:
Construction & development	$	29	$	—	$	—	$	29	$	33,420	$	33,449	$	—	$	—
Farmland		71		100		989		1,160		32,131		33,291		—		3,914
Residential		762		145		241		1,148		234,541		235,689		—		653
Commercial mortgage		—		—		604		604		175,588		176,192		—		740
Non-Real Estate Secured:
Commercial & agricultural		7		—		264		271		37,220		37,491		—		264
Consumer & other		12		18		8		38		20,315		20,353		—		8
Total	$	881	$	263	$	2,106	$	3,250	$	533,215	$	536,465	$	—	$	5,579
December 31, 2017
Real Estate Secured:
Construction & development	$	—	$	—	$	227	$	227	$	25,248	$	25,475	$	—	$	226
Farmland		188		—		308		496		32,857		33,353		—		3,610
Residential		395		334		710		1,439		197,681		199,120		—		1,211
Commercial mortgage		—		—		194		194		125,467		125,661		—		194
Non-Real Estate Secured:
Commercial & agricultural		70		—		23		93		25,579		25,672		—		94
Consumer & other		2		24		—		26		15,564		15,590		—		—
Total	$	655	$	358	$	1,462	$	2,475	$	422,396	$	424,871	$	—	$	5,335

Impaired Loans

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

64

Notes to Consolidated Financial Statements

Note 6. Allowance for Loan Losses and Impaired Loans, continued

Impaired Loans, continued

As of December 31, 2018 and December 31, 2017, respectively, the recorded investment in impaired loans totaled $10.3 million and $12.3 million. The total amount of collateral-dependent impaired loans at December 31, 2018 and December 31, 2017, respectively, was $2.8 million and $3.7 million. As of December 31, 2018 and December 31, 2017, respectively, $3.4 million and $3.7 million of the recorded investment in impaired loans did not have a related allowance. The Bank had $7.3 million and $8.6 million in troubled debt restructured loans included in impaired loans at December 31, 2018 and December 31, 2017, respectively.

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

In 2015, management began collectively evaluating performing TDRs with a loan balance of $250,000 or less for impairment. As of December 31, 2018 and December 31, 2017, respectively, $4.7 million and $5.7 million of TDRs included in the following table were evaluated collectively for impairment and were deemed to have $259 thousand and $303 thousand of related allowance.

The following table is a summary of information related to impaired loans as of December 31, 2018 and December 31, 2017:

Impaired Loans

(dollars in thousands)	Recorded Investment1		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2018
With no related allowance recorded:
Construction & development	$	—	$	—	$	—	$	—	$	—
Farmland		3,284		3,284		—		3,523		23
Residential		85		85		—		448		13
Commercial mortgage		—		—		—		—		—
Commercial & agricultural		—		24		—		—		—
Consumer & other		—		—		—		—		—
Subtotal		3,369		3,393		—		3,971		36
With an allowance recorded:
Construction & development		69		69		4		306		11
Farmland		1,539		1,539		38		1,568		86
Residential		5,005		5,162		241		5,348		266
Commercial mortgage		275		358		15		522		27
Commercial & agricultural		37		37		2		47		3
Consumer & other		4		4		—		4		—
Subtotal		6,929		7,169		300		7,795		393
Totals:
Construction & development		69		69		4		306		11
Farmland		4,823		4,823		38		5,091		109
Residential		5,090		5,247		241		5,796		279
Commercial mortgage		275		358		15		522		27
Commercial & agricultural		37		61		2		47		3
Consumer & other		4		4		—		4		—
Total	$	10,298	$	10,562	$	300	$	11,766	$	429

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

65

Notes to Consolidated Financial Statements

Note 6. Allowance for Loan Losses and Impaired Loans, continued

Impaired Loans, continued

(dollars in thousands)	Recorded Investment1		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2017
With no related allowance recorded:
Construction & development	$	—	$	—	$	—	$	—	$	—
Farmland		3,422		3,456		—		3,774		10
Residential		300		300		—		300		8
Commercial mortgage		—		—		—		—		—
Commercial & agricultural		—		26		—		27		—
Consumer & other		—		—		—		—		2
Subtotal		3,722		3,782		—		4,101		20
With an allowance recorded:
Construction & development		361		361		16		718		111
Farmland		1,936		1,936		58		2,224		135
Residential		5,647		5,832		284		6,209		290
Commercial mortgage		602		737		33		1,020		54
Commercial & agricultural		55		55		3		89		13
Consumer & other		—		—		—		2		—
Subtotal		8,601		8,921		394		10,262		603
Totals:
Construction & development		361		361		16		718		111
Farmland		5,358		5,392		58		5,998		145
Residential		5,947		6,132		284		6,509		298
Commercial mortgage		602		737		33		1,020		54
Commercial & agricultural		55		81		3		116		13
Consumer & other		—		—		—		2		2
Total	$	12,323	$	12,703	$	394	$	14,363	$	623

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

Troubled Debt Restructuring

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

The loan terms which have been modified or restructured due to a borrower’s financial difficulty, include but are not limited to: a reduction in the stated interest rate; an extension of the maturity at an interest rate below current market; a reduction in the face amount of the debt; a reduction in the accrued interest; orre-aging, extensions, deferrals and renewals. The Bank had $7.3 million and $8.6 million in trouble debt restructured loans at December 31, 2018 and December 31, 2017, respectively. Troubled debt restructured loans are considered impaired loans.

66

Notes to Consolidated Financial Statements

Note 6. Allowance for Loan Losses and Impaired Loans, continued

Troubled Debt Restructuring, continued

The following table sets forth information with respect to the Bank’s troubled debt restructurings as of December 31, 2018 and December 31, 2017:

	TDRs identified during the period						TDRs identified in the last twelve months that subsequently defaulted(1)
(dollars in thousands)	Number of contracts		Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment		Number of contracts		Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment
December 31, 2018
Construction & development		—	$	—	$	—		—	$	—	$	—
Farmland		—		—		—		—		—		—
Residential		2		80		95		—		—		—
Commercial mortgage		—		—		—		—		—		—
Commercial & agricultural		—		—		—		—		—		—
Consumer & other		1		5		4		—		—		—
Total		3	$	85	$	99		—	$	—	$	—

During the twelve months ended December 31, 2018, three loans were modified that were considered to be TDRs. Term concessions were granted and additional funds were advanced for legal expenses and property taxes. No TDRs identified in the last twelve months subsequently defaulted in the year ended December 31, 2018.

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

	TDRs identified during the period						TDRs identified in the last twelve months that subsequently defaulted(1)
(dollars in thousands)	Number of contracts		Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment		Number of contracts		Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment
December 31, 2017
Construction & development		—	$	—	$	—		—	$	—	$	—
Farmland		2		298		298		—		—		—
Residential		1		48		48		—		—		—
Commercial mortgage		—		—		—		—		—		—
Commercial & agricultural		—		—		—		—		—		—
Consumer & other		—		—		—		—		—		—
Total		3	$	346	$	346		—	$	—	$	—

During the twelve months ended December 31, 2017, three loans were modified that were considered to be TDRs. Term concessions only were granted and no additional funds were advanced. No TDRs identified in the last twelve months subsequently defaulted in the year ended December 31, 2017.

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

67

Notes to Consolidated Financial Statements

Note 6. Allowance for Loan Losses and Impaired Loans, continued

Purchased Credit Impaired Loans

There were no purchased credit impaired loans as of December 31, 2017. During 2018, the Company acquired loans as a result of the Great State merger, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans at December 31, 2018 was a follows:

(dollars in thousands)	2018
Residential	$	167
Commercial mortgage		347
Commercial & agricultural		200
Outstanding balance	$	714
Carrying amount	$	714

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

Purchased credit impaired loans acquired during the year ended December 31, 2018 for which it was probable at acquisition that all contractually required payments would not be collected are as follows:

(dollars in thousands)	2018
Contractually required payments receivable of loans purchased during the year:
Residential	$	233
Commercial mortgage		1,724
Commercial & agricultural		221
	$	2,178
Cash flows expected to be collected at acquisition	$	1,781
Fair value of acquired loans at acquisition	$	1,781

Income is not recognized on purchased credit impaired loans if the Company cannot reasonably estimate cash flows expected to be collected. The carrying amounts of such loans are as follows:

(dollars in thousands)	2018
Loans at beginning of year	$	—
Loans purchased during the year	$	1,781
Loans at December 31, 2018	$	714

68

Notes to Consolidated Financial Statements

Note 7. Property and Equipment

Components of property and equipment and total accumulated depreciation at December 31, 2018 and 2017, are as follows:

(dollars in thousands)	2018			2017
Land	$	4,935		$	4,267
Buildings and improvements		17,493			14,950
Furniture and equipment		11,228			10,213
		33,656			29,430
Less accumulated depreciation		(12,971	)		(11,784	)
	$	20,685		$	17,646

Depreciation expense for the years ended December 31, 2018 and 2017 amounted to $1.2 million and $1.3 million, respectively.

Note 8. Cash Value of Life Insurance

The Bank is owner and beneficiary of life insurance policies on certain employees and directors. Policy cash values totaled approximately $17.4 million, and $17.3 million at December 31, 2018 and 2017, respectively.

Note 9. Goodwill and Intangible Assets

Goodwill

The change in goodwill during the year ended December 31, 2018 is as follows:

(dollars in thousands)	2018
Beginning of year	$	—
Acquired goodwill as result of Great State merger		3,198
Impairment		—
End of the period	$	3,198

Intangible Assets

The following table presents the activity for the Company’s core deposit intangible assets, which are the only identifiable intangible assets subject to amortization. Core deposit intangibles at December 31, 2018 and 2017 are as follows:

(dollars in thousands)	2018			2017
Balance at beginning of year, net	$	2,045		$	2,327
Core deposit intangible as result of Great State merger	$	2,425		$	—
Amortization expense	$	(578	)	$	(282	)
Net book value	$	3,892		$	2,045

69

Notes to Consolidated Financial Statements

Note 10. Deposits

The aggregate amount of time deposits in denominations of more than $250 thousand at December 31, 2018 and 2017 was $30.6 million, and $13.5 million, respectively. At December 31, 2018, the scheduled maturities of all time deposits are as follows:

(dollars in thousands)
2019	$	74,363
2020		37,302
2021		32,538
2022		19,946
2023		15,180
After Five Years		814
Total	$	180,143

Note 11. Short-Term Debt

At December 31, 2018 and 2017 the Bank had no debt outstanding classified as short-term.

At December 31, 2018, the Bank had established unsecured lines of credit of approximately $38.6 million with correspondent banks to provide additional liquidity if, and as needed. In addition, the Bank has the ability to borrow up to approximately $169.8 million from the Federal Home Loan Bank, subject to the pledging of collateral.

Note 12. Long-Term Debt

At December 31, 2018 and 2017 the Bank had no debt outstanding classified as long-term.

70

Notes to Consolidated Financial Statements

Note 13. Financial Instruments

FASB ASC 825, “Financial Instruments”, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value of future cash flows or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. FASB ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of December 31, 2018 and December 31, 2017. This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as noninterest-bearing demand, interest-bearing demand, and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

For loans, the carrying amount is net of unearned income and the allowance for loan losses. In accordance with the prospective adoption of ASUNo. 2016-01, the fair value of loans as of December 31, 2018 was measured using an exit price notion. The fair value of loans as of December 31, 2017 was measured using an entry price notion.

					Fair Value Measurements
(dollars in thousands)	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets or Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2018
Financial Instruments – Assets
Net Loans	$	532,970	$	529,155	$	—	$	528,784	$	371
Financial Instruments – Liabilities
Time Deposits		180,143		176,188		—		176,188		—
December 31, 2017
Financial Instruments – Assets
Net Loans	$	421,418	$	417,229	$	—	$	416,426	$	803
Financial Instruments – Liabilities
Time Deposits		147,725		144,656		—		144,656		—

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale and derivatives are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans or foreclosed assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

71

Notes to Consolidated Financial Statements

Note 13. Financial Instruments, continued

Fair Value Hierarchy

Under FASB ASC 820, “Fair Value Measurements and Disclosures”, the Company groups assets and liabilities 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. These levels are:

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques may include the use of option pricing models, discounted cash flow models and similar techniques.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in activeover-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. If a loan is identified as individually impaired, management measures impairment in accordance with applicable accounting guidance. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2018, a small percentage of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with accounting standards, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price the Company records the impaired loan as nonrecurring Level 2. When the fair value is based on either an external or internal appraisal and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

Derivative Assets and Liabilities

Derivative instruments held or issued by the Company for risk management purposes are traded inover-the-counter markets where quoted market prices are not readily available. Management engages third-party intermediaries to determine the fair market value of these derivative instruments and classifies these instruments as Level 2. Examples of Level 2 derivatives are interest rate swaps, caps and floors. No derivative instruments were held during the years ended December 31, 2018 or 2017.

72

Notes to Consolidated Financial Statements

Note 13. Financial Instruments, continued

Foreclosed Assets

Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price the Company records the foreclosed asset as nonrecurring Level 2. When the fair value of the collateral is based on either an external or internal appraisal and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

Assets Recorded at Fair Value on a Recurring Basis

(dollars in thousands)	Total		Level 1		Level 2		Level 3
December 31, 2018
Investment securities available for sale
U.S. Government Agencies	$	245	$	—	$	245	$	—
Mortgage-backed securities		24,763		—		24,763		—
Corporate securities		2,789		—		2,789		—
State and municipal securities		17,631		—		17,631		—
Total assets at fair value	$	45,428	$	—	$	45,428	$	—
December 31, 2017
Investment securities available for sale
Mortgage-backed securities	$	28,154	$	—	$	28,154	$	—
Corporate securities		2,936		—		2,936		—
State and municipal securities		19,585		—		19,585		—
Total assets at fair value	$	50,675	$	—	$	50,675	$	—

No liabilities were recorded at fair value on a recurring basis as of December 31, 2018 or 2017. There were no significant transfers between levels during the years ended December 31, 2018 or 2017.

Assets Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets and liabilities at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets and liabilities that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. No liabilities were recorded at fair value on a nonrecurring basis at December 31, 2018 or 2017. Assets measured at fair value on a nonrecurring basis are included in the table below.

(dollars in thousands)	Total		Level 1		Level 2		Level 3
December 31, 2018
Impaired loans	$	371	$	—	$	—	$	371
Foreclosed assets		753		—		—		753
Total assets at fair value	$	1,124	$	—	$	—	$	1,124

73

Notes to Consolidated Financial Statements

Note 13. Financial Instruments, continued

Assets Recorded at Fair Value on a Nonrecurring Basis, continued

(dollars in thousands)	Total		Level 1		Level 2		Level 3
December 31, 2017
Impaired loans	$	803	$	—	$	—	$	803
Foreclosed assets		—		—		—		—
Total assets at fair value	$	803	$	—	$	—	$	803

For Level 3 assets measured at fair value on a recurring ornon-recurring basis as of December 31, 2018 and 2017, the significant unobservable inputs used in the fair value measurements were as follows:

	Fair Value at December 31, 2018		Fair Value at December 31, 2017		Valuation Technique	Significant Unobservable Inputs	General Range of Significant Unobservable Input Values
Impaired Loans	$	371	$	803	Appraised Value/Discounted Cash Flows/Market Value of Note	Discounts to reflect current market conditions, ultimate collectability, and estimated costs to sell		0 – 10	%
Other Real Estate Owned	$	753	$	—	Appraised Value/Comparable Sales/Other Estimates from Independent Sources	Discounts to reflect current market conditions and estimated costs to sell		0 – 10	%

Note 14. Employee Benefit Plans

Prior to the merger, both Grayson National Bank (Grayson) and Bank of Floyd (Floyd) had qualified noncontributory defined benefit pension plans in place which covered substantially all of each bank’s employees. The benefits in each plan are primarily based on years of service and earnings. Both Grayson and Floyd plans were amended to freeze benefit accruals for all eligible employees prior to the effective date of the merger. A summary of each plan follows:

Grayson Plan

The following is a summary of the plan’s funded status as of December 31:

(dollars in thousands)	2018			2017
Change in benefit obligation
Benefit obligation at beginning of year	$	5,223		$	4,783
Interest cost		173			191
Actuarial (gain) loss		(824	)		637
Benefits paid		(79	)		(380	)
Settlement (gain) loss		—			(8	)
Benefit obligation at end of year		4,493			5,223
Change in plan assets
Fair value of plan assets at beginning of year		8,513			7,894
Actual return on plan assets		(342	)		999
Benefits paid		(79	)		(380	)
Fair value of plan assets at end of year		8,092			8,513
Funded status at the end of the year	$	3,599		$	3,290

74

Notes to Consolidated Financial Statements

Note 14. Employee Benefit Plans, continued

Grayson Plan, continued

(dollars in thousands)	2018			2017
Amounts recognized in the Balance Sheet
Plan benefit cost	$	4,912		$	4,539
Unrecognized net actuarial loss		(1,313	)		(1,249	)
Amount recognized in other assets	$	3,599		$	3,290
Amounts recognized in accumulated comprehensive income (loss)
Unrecognized net actuarial loss	$	(1,313	)	$	(1,249	)
Deferred taxes		275			262
Amount recognized in accumulated comprehensive income (loss), net	$	(1,038	)	$	(987	)
Prepaid benefit detail
Benefit obligation	$	(4,493	)	$	(5,223	)
Fair value of assets		8,092			8,513
Unrecognized net actuarial loss		1,313			1,249
Prepaid benefit cost		4,912			4,539
Components of net periodic pension cost
Interest cost	$	173		$	191
Expected return on plan assets		(576	)		(552	)
Recognized net loss due to settlement		—			86
Recognized net actuarial loss		30			28
Net periodic benefit expense		(373	)		(247	)
Additional disclosure information
Accumulated benefit obligation	$	4,493		$	5,223
Vested benefit obligation	$	4,493		$	5,223
Discount rate used for net periodic pension cost		3.50	%		4.00	%
Discount rate used for disclosure		4.25	%		3.50	%
Expected return on plan assets		7.00	%		7.00	%
Rate of compensation increase		N/A			N/A
Average remaining service (years)		12			13

Using the same fair value hierarchy described in Note 13, the fair values of the Company’s pension plan assets, by asset category, are as follows:

(dollars in thousands)	Total		Level 1		Level 2		Level 3
December 31, 2018
Cash equivalents and short term investments	$	—	$	—	$	—	$	—
Mutual funds – equities		3,848		3,848		—		—
Mutual funds – fixed income		4,244		4,244		—		—
Total assets at fair value	$	8,092	$	8,092	$	—	$	—
December 31, 2017
Cash equivalents and short term investments	$	—	$	—	$	—	$	—
Mutual funds – equities		4,368		4,368		—		—
Mutual funds – fixed income		4,145		4,145		—		—
Total assets at fair value	$	8,513	$	8,513	$	—	$	—

75

Notes to Consolidated Financial Statements

Note 14. Employee Benefit Plans, continued

Grayson Plan, continued

Estimated Future Benefit Payments

(dollars in thousands)	Pension Benefits
2019	$	439
2020		15
2021		250
2022		210
2023		1,091
2024 – 2028		1,407
	$	3,412

Funding Policy

It has been Bank practice to contribute the maximumtax-deductible amount each year as determined by the plan administrator. As a result of prior year contributions exceeding the minimum requirements, a Prefunding Balance existed as of December 31, 2018 and there is no required contribution for 2019. Based on this we do not anticipate making a contribution to the plan in 2019.

Long-Term Rate of Return

The plan sponsor selects the expected long-termrate-of-return-on-assets assumption in consultation with their investment advisors and actuary. This rate is intended to reflect the average rate of earnings expected to be earned on the funds invested or to be invested to provide plan benefits. Historical performance is reviewed – especially with respect to real rates of return (net of inflation) – for the major asset classes held, or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to recent experience – that may not continue over the measurement period – with higher significance placed on current forecasts of future long-term economic conditions.

Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Further – solely for this purpose the plan is assumed to continue in force and not terminate during the period during which the assets are invested. However, consideration is given to the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment andnon-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost).

Asset Allocation

The pension plan’s weighted-average asset allocations at December 31, 2018 and 2017, by asset category are as follows:

	2018			2017
Mutual funds – fixed income		52	%		49	%
Mutual funds – equity		48	%		51	%
Cash and equivalents		0	%		0	%
Total		100	%		100	%

The trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 50 percent fixed income and 50 percent equities. The Investment Manager selects investment fund managers with demonstrated experience and expertise, and funds with demonstrated historical performance, for the implementation of the Plan’s investment strategy. The Investment Manager will consider both actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure.

76

Notes to Consolidated Financial Statements

Note 14. Employee Benefit Plans, continued

Grayson Plan, continued

It is the responsibility of the Trustee to administer the investments of the Trust within reasonable costs, being careful to avoid sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administrative costs chargeable to the Trust.

Floyd Plan

The Company participates in the Pentegra Defined Benefit Plan for Financial Institutions (“The Pentegra DB Plan”), atax-qualified defined-benefit pension plan. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and is a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan.

The Pentegra DB Plan is a single plan under Internal Revenue Code Section 413 (C) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by a participating employer may be used to provide benefits to participants of other participating employers.

Funded Status (market value of plan assets divided by funding target) as of July 1,

	2018 Valuation			2017 Valuation
Source	Report			Report
Bank of Floyd Plan		106.44	%		108.63	%

Employer Contributions

Plan expenses paid by the Company totaled approximately $54 thousand and $58 thousand for the years ended December 31, 2018 and 2017, respectively.

Note 15. Deferred Compensation and Supplemental Executive Retirement Plans

Deferred compensation plans have been adopted for certain executive officers and members of the Board of Directors for future compensation upon retirement. Under plan provisions aggregate annual payments ranging from $1,992 to $37,200 are payable for ten years certain, generally beginning at age 65. Reduced benefits apply in cases of early retirement or death prior to the benefit date, as defined. Liability accrued for compensation deferred under the plan amounts to $258 thousand and $312 thousand at December 31, 2018 and 2017, respectively. Expense charged against income and included in salary and benefits expense was $23 thousand and $27 thousand in 2018 and 2017, respectively. Charges to income are based on changes in present value of future cash payments, discounted at 8 percent, consistent with prior years.

Supplemental executive retirement plans for certain executive officers were adopted in 2017. The plans provide for annual payments ranging from $55,000 to $90,000, payable in monthly installments, and continuing for the life of the executive. Reduced benefits apply in cases of early retirement. The liability accrued for this obligation was $143 thousand and $36 thousand at December 31, 2018 and 2017, respectively. Expense charged against income and included in salary and benefits expense was $107 thousand and $36 thousand in 2018 and 2017 respectively for these supplemental executive retirement plans.

Prior to the Cardinal merger, the Bank of Floyd had adopted supplemental executive plans to provide benefits for two former members of management. Aggregate annual payments of $69 thousand are payable for 20 years, beginning subsequent to the executive’s last day of employment. The liability is calculated by discounting the anticipated future cash flows at 4.00%. The liability accrued for this obligation was $768 thousand and $805 thousand at December 31, 2018 and 2017 respectively. Charges to income amounted to approximately $32 thousand for 2018 and 2017. These plans are unfunded, however, life insurance has been acquired in amounts sufficient to discharge the obligations of the agreements.

77

Notes to Consolidated Financial Statements

Note 16. Income Taxes

Current and Deferred Income Tax Components

The components of income tax expense (benefit) (substantially all Federal) are as follows:

(dollars in thousands)	2018			2017
Current	$	(375	)	$	213
Deferred		1,589			2,891
	$	1,214		$	3,104

Rate Reconciliation

A reconciliation of income tax expense computed at the statutory federal income tax rate to income tax expense (benefit) included in the statements of income follows:

(dollars in thousands)	2018			2017
Tax at statutory federal rate	$	1,205		$	1,881
Tax exempt interest income		(49	)		(61	)
Tax exempt insurance income		(155	)		(151	)
State income tax, net of federal benefit		21			9
Merger expenses		162			4
Other		30			(13	)
Deferred tax assetre-measurement		—			1,435
	$	1,214		$	3,104

Deferred Income Tax Analysis

The significant components of net deferred tax assets (all Federal) at December 31, 2018 and 2017 are summarized as follows:

(dollars in thousands)	2018		2017
Deferred tax assets
Allowance for loan losses	$	603	$	482
Acquired loan credit mark		1,061		842
Deferred compensation		322		335
Investment impairment charge recorded directly to stockholders’ equity as a component of other comprehensive income		57		19
Minimum pension liability		276		262
Net operating loss carryforward		1,738		2,131
Alternative minimum tax credit carryforward		294		638
Net unrealized losses on securities available for sale		247		139
Nonaccrual interest income		206		217
Purchase accounting adjustments		144		—
Other		216		76
	$	5,164	$	5,141
Deferred tax liabilities
Deferred loan origination costs		635		228
Core deposit intangible		831		433
Accrued pension costs		1,049		962
Depreciation		795		553
Accretion of discount on investment securities, net		1		—
	$	3,311	$	2,176
Net deferred tax asset	$	1,853	$	2,965

78

Notes to Consolidated Financial Statements

Note 16. Income Taxes, continued

On December 22, 2017, the Tax Cuts and Jobs Act was signed into legislation, lowering the corporate income tax rate to 21% effective January 1, 2018 and making many other significant changes to the US income tax code. Under ASC 740, the effects of changes in tax rates and laws are recognized in the period in which the new legislation is enacted. As a result, the Company’s income tax expense for the year ended December 31, 2017 includes tax expense from there-measurement of deferred assets and liabilities totaling $1.4 million.

The Bank has analyzed the tax positions taken or expected to be taken in its tax returns and concluded it has no liability related to uncertain tax positions in accordance with applicable regulations. Tax returns for the years subsequent to 2015 remain subject to examination by both federal and state tax authorities.

Deferred tax assets or liabilities are initially recognized for differences between the financial statement carrying amount and the tax basis of assets and liabilities which will result in future deductible or taxable amounts and operating loss and tax credit carry-forwards. A valuation allowance is then established, as applicable, to reduce the deferred tax asset to the level at which it is “more likely than not” that the tax benefits will be realized. Sources of taxable income that may allow for the realization of tax benefits include (1) taxable income in the current year or prior years that is available through carry-back, (2) future taxable income that will result from the reversal of existing taxable temporary differences, and (3) taxable income generated by future operations. There is no valuation allowance for deferred tax assets as of December 31, 2018 and 2017. The net operating loss of approximately $8.3 million, if not utilized, will begin to expire in 2031. It is management’s belief that realization of the deferred tax asset is more likely than not.

Note 17. Commitments and Contingencies

Litigation

In the normal course of business the Bank is involved in various legal proceedings. After consultation with legal counsel, management believes that any liability resulting from such proceedings will not be material to the consolidated financial statements.

Financial Instruments withOff-Balance Sheet Risk

The Bank is party to financial instruments withoff-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the consolidated balance sheets.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as foron-balance sheet instruments. A summary of the Bank’s commitments at December 31, 2018 and 2017 is as follows:

(dollars in thousands)	2018		2017
Commitments to extend credit	$	76,977	$	56,912
Standby letters of credit		1,227		1,106
	$	78,204	$	58,018

79

Notes to Consolidated Financial Statements

Note 17. Commitments and Contingencies, continued

Commitments to extend credit 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on acase-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property and equipment, residential real estate and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Bank deems necessary.

Concentrations of Credit Risk

Substantially all of the Bank’s loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Bank’s market area and such customers are generally depositors of the Bank. Investments in state and municipal securities involve governmental entities within and outside the Bank’s market area. The concentrations of credit by type of loan are set forth in Note 5. The distribution of commitments to extend credit approximates the distribution of loans outstanding. Standby letters of credit are granted primarily to commercial borrowers. The Bank’s primary focus is toward small business and consumer transactions, and accordingly, it does not have a significant number of credits to any single borrower or group of related borrowers in excess of $5,000,000. The Bank has cash and cash equivalents on deposit with financial institutions which exceed federally insured limits.

Note 18. Transactions with Related Parties

The Bank has entered into transactions with its directors, significant stockholders and their affiliates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features.

Aggregate 2018 and 2017 loan transactions with related parties were as follows:

(dollars in thousands)	2018			2017
Balance, beginning	$	4,769		$	5,112
New loans		2,662			1,388
Repayments		(2,502	)		(1,228	)
Change in relationship		2,620			(503	)
Balance, ending	$	7,549		$	4,769

The Company has accepted deposits during the ordinary course of business from certain directors and executive officers of the Company and from their affiliates and associates. The total amount of these deposits outstanding was $8.2 million, and $10.7 million at December 31, 2018 and 2017, respectively.

Note 19. Regulatory Restrictions

Dividends

The Company’s dividend payments are generally made from dividends received from the Bank. Under applicable federal law, the Comptroller of the Currency restricts national bank total dividend payments in any calendar year to net profits of that year, as defined, combined with retained net profits for the two preceding years. The Comptroller also has authority under the Financial Institutions Supervisory Act to prohibit a national bank from engaging in an unsafe or unsound practice in conducting its business. It is possible, under certain circumstances, the Comptroller could assert that dividends or other payments would be an unsafe or unsound practice.

Intercompany Transactions

The Bank’s legal lending limit on loans to the Company is governed by Federal Reserve Act 23A, and differs from legal lending limits on loans to external customers. Generally, a bank may lend up to 10 percent of its capital and surplus to its Parent, if the loan is secured. If collateral is in the form of stocks, bonds, debentures or similar obligations, it must have a market value when the loan is made of at least 20 percent more than the amount of the loan, and if obligations of a state or political subdivision or agency thereof, it must have a market value of at least 10 percent more than the amount of the loan. If such loans are secured by obligations of the United States or agencies thereof, or by notes, drafts, bills of exchange or bankers’ acceptances eligible for rediscount or purchase by a Federal Reserve Bank, requirements for collateral in excess of the loan amount do not apply. Under this definition, the legal lending limit for the Bank on loans to the Company was approximately $7.6 million at December 31, 2018. No 23A transactions were deemed to exist between the Company and the Bank at December 31, 2018.

80

Notes to Consolidated Financial Statements

Note 19. Regulatory Restrictions, continued

Capital Requirements

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

Effective January 1, 2015, the federal banking regulators adopted rules to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rules required the Bank to comply with the following minimum capital ratios: (i) a common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6% of risk-weighted assets; (iii) a total capital ratio of 8% of risk-weighted assets; and (iv) a leverage ratio of 4% of total assets. As fully phased in on January 1, 2019, the rules require the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.

The capital conservation buffer requirement has been phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

The rules also revised the prompt corrective action framework, which 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%.

81

Notes to Consolidated Financial Statements

Note 19. Regulatory Restrictions, continued

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, and is not obligated to report consolidated regulatory capital. The Bank’s actual capital amounts and ratios are presented in the following table as of December 31, 2018 and 2017. These ratios comply with Federal Reserve rules to align with the Basel III Capital requirements effective January 1, 2015.

	Actual					For Capital Adequacy Purposes					To Be Well- Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio
December 31, 2018
Total Capital
(to risk weighted assets)	$	71,424		13.00	%	$	43,943		8.00	%	$	54,929		10.00	%
Tier 1 Capital
(to risk weighted assets)	$	67,899		12.36	%	$	32,958		6.00	%	$	43,943		8.00	%
Common Equity Tier 1
(to risk weighted assets)	$	67,899		12.36	%	$	24,718		4.50	%	$	35,704		6.50	%
Tier 1 Capital
(to average total assets)	$	67,899		10.08	%	$	26,932		4.00	%	$	33,664		5.00	%
December 31, 2017
Total Capital
(to risk weighted assets)	$	56,962		13.14	%	$	34,688		8.00	%	$	43,360		10.00	%
Tier 1 Capital
(to risk weighted assets)	$	53,483		12.33	%	$	26,016		6.00	%	$	34,688		8.00	%
Common Equity Tier 1
(to risk weighted assets)	$	53,483		12.33	%	$	19,512		4.50	%	$	28,184		6.50	%
Tier 1 Capital
(to average total assets)	$	53,483		9.81	%	$	21,808		4.00	%	$	27,260		5.00	%

As directed by the Economic Growth Act, on November 21, 2018, the federal banking regulators jointly issued a proposed rule that would permit qualifying banks that have less than $10 billion in total consolidated assets to elect to be subject to a 9% “community bank leverage ratio.” A qualifying bank that has chosen the proposed framework would not be required to calculate the existing risk-based and leverage capital requirements and would be considered to have met the capital ratio requirements to be “well capitalized” under prompt corrective action rules, provided it has a community bank leverage ratio greater than 9%. This proposed rule has not been finalized and, as a result, the content and scope of any final rule, and its impact on the Bank (if any), cannot be determined at this time.

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Notes to Consolidated Financial Statements

Note 20. Parent Company Financial Information

Condensed financial information of Parkway Acquisition Corp. is presented as follows:

Balance Sheets

December 31, 2018 and 2017

(dollars in thousands)	2018			2017
Assets
Cash and due from banks	$	1,409		$	1,518
Investment in affiliate bank		73,813			55,115
Other assets		468			586
Total assets	$	75,690		$	57,219
Liabilities
Other liabilities	$	68		$	37
Stockholders’ Equity
Common stock		—			—
Surplus		41,660			26,166
Retained earnings		35,929			32,526
Accumulated other comprehensive loss		(1,967	)		(1,510	)
Total stockholders’ equity		75,622			57,182
Total liabilities and stockholders’ equity	$	75,690		$	57,219

Statements of Income

For the years ended December 31, 2018 and 2017

(dollars in thousands)	2018		2017
Income
Dividends from affiliate bank	$	1,123	$	803
Bargain purchase gain		—		—
Other income		1		1
		1,124		804
Expenses
Management and professional fees		39		35
Other expenses		37		36
		76		71
Income before tax benefit and equity in undistributed income of affiliate		1,048		733
Federal income tax expense		16		(161	)
Income before equity in undistributed income of affiliate		1,064		572
Equity in undistributed income of affiliate		3,462		1,855
Net income	$	4,526	$	2,427

83

Notes to Consolidated Financial Statements

Note 20. Parent Company Financial Information, continued

Statements of Cash Flows

For the years ended December 31, 2018 and 2017

(dollars in thousands)	2018			2017
Cash flows from operating activities
Net income	$	4,526		$	2,427
Adjustments to reconcile net income to net cash provided by operations:
Equity in undistributed income of affiliate		(3,462	)		(1,855	)
Change in other assets		(80	)		91
Change in other liabilities		31			37
Net cash provided by operating activities		1,015			700
Cash flows from investing activities
Net decrease in loans		—			—
Cash received in business combination		—			—
Net cash provided by investing activities		—			—
Cash flows from financing activities
Cash paid for fractional shares		(1	)		—
Dividends paid		(1,123	)		(803	)
Net cash used by financing activities		(1,124	)		(803	)
Net decrease in cash and cash equivalents		(109	)		(103	)
Cash and cash equivalents, beginning		1,518			1,621
Cash and cash equivalents, ending	$	1,409		$	1,518
Business combinations
Elimination of Company’s existing investment in Great State Bank	$	198		$	—
Stock issued to acquire Great State Bank	$	15,495		$	—

Note 21. Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management has reviewed the events occurring through the date the consolidated financial statements were issued and, other than what is disclosed below, no subsequent events occurred requiring accrual or disclosure.

In January 2019, the Board of Directors of the Company approved a stock repurchase plan. The Board of Directors has authorized an initial repurchase of up to 200,000 shares of its common stock from time to time for a period of two years ending in January 2021.

The Company intends to purchase shares periodically through privately negotiated transactions or in the open market in accordance with Securities and Exchange Commission rules. The actual timing, number and value of shares repurchased under the plan will be determined by management in its discretion and will depend on a number of factors, including the market price of the shares, general market and economic conditions, applicable legal requirements and other conditions.

84

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

Disclosure Controls and Procedures

The Company, under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this Annual Report on Form10-K. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2018 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Internal Control over Financial Reporting

Management is also responsible for establishing and maintaining adequate internal control over the Company’s financial reporting (as defined in Rule13a-15(f) promulgated under the Securities Exchange Act of 1934, as amended). Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, management has conducted and assessment of the design and effectiveness of its internal controls over financial reporting based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

Management maintains a comprehensive system of internal control to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The system of internal control provides for appropriate division of responsibility and is documented by written policies and procedures that are communicated to employees. Those policies and procedures: 1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and disposition of the assets of the Company, 2) provide reasonable assurance that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors, 3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements. Management recognizes that there are inherent limitations in the effectiveness of any internal control system, including the possibility of human effort and the circumvention or overriding of internal controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Changes in conditions will also impact the internal control effectiveness over time. Parkway Acquisition Corp. maintains an internal auditing program, under the supervision of the Audit Committee of the Board of Directors, which independently assesses the effectiveness of the system of internal control and recommends possible improvements.

Under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company has evaluated the effectiveness of its internal control over financial

85

reporting as of December 31, 2018, using the2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based upon this evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded as of December 31, 2018, the Company’s internal control over financial reporting is adequate and effective and meets the criteria of theInternal Control – Integrated Framework.

Management’s assessment did not determine any material weaknesses within the Company’s internal control structure. There were no changes in the Company’s internal control over financial reporting during the Company’s quarter ended December 31, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

This annual report does not include an attestation report of the Company’s registered public accounting firm, regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

Item 9B. Other Information.

None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance.

Directors

The following biographical information discloses each director’s age and business experience, and the year that each individual was first elected to the Board of Directors of the Company. Previous service on the boards of Grayson, Cardinal, or Great State prior to the merger with and into Parkway is also disclosed, as are the specific skills or attributes that qualify each director for service on the Board of Directors.

Thomas M. Jackson, Jr. (61) – Mr. Jackson has been Chairman of the Board of Parkway since its inception in November 2015. Prior to that he served as Chairman of the Board of Grayson and Grayson National Bank from 2011 to 2016 and a director from 2002. Mr. Jackson was Vice Chairman of Grayson and Grayson National Bank from 2009 to 2011. Mr. Jackson practices law in Hillsville and Wytheville, Virginia. He served as a representative of the 6^th District in the Virginia House of Delegates from 1988 to 2002. Mr. Jackson’s knowledge of real estate and contract law assists Skyline National Bank in its real estate and commercial lending activities. Through his service in the legislature and his current legal practice he has gained extensive knowledge of the communities served by Parkway and Skyline National Bank.

James W. Shortt (56) – Mr. Shortt has been a director of Parkway since its inception in November 2015 and has served as Vice Chairman since June 2016. Mr. Shortt served as a director of Cardinal and the Bank of Floyd from 2012 to 2016, serving as Vice Chairman from 2012 to 2015 and Chairman from 2015 to 2016. He is the founder and owner of James W. Shortt & Associates, P.C., a general practice law firm with its principal office in Floyd, Virginia. Mr. Shortt is particularly qualified to serve on the Board by virtue of his legal background, especially with regard to his knowledge of real estate law and business and estate transactions. Mr. Shortt has been practicing law in Virginia since 1988. Mr. Shortt is a graduate of the University of Richmond School of Law and Virginia Tech.

Jacky K. Anderson (67) –Mr. Anderson has been a director of Parkway since its inception in November 2015. He served as a director of Grayson and Grayson National Bank from 1992 to 2016. Mr. Anderson was President and Chief Executive Officer of Grayson and Grayson National Bank from 2000 to 2013. He served as Vice President of Grayson from 1992 to 2000 and as Executive Vice President of Grayson National Bank from 1991 to 2000. Mr. Anderson began working for Grayson National Bank in 1971, giving him over 45 years of experience in the banking industry. During his tenure Mr. Anderson gainedin-depth knowledge of the laws and regulations applicable to the banking industry and developed extensive customer and community relationships.

86

Dr. J. Howard Conduff, Jr. (60) – Dr. Conduff has been a director of Parkway since its inception in November 2015. He served as a director of Cardinal and the Bank of Floyd for many years, representing a third-generation family member to serve on the Cardinal Board. Dr. Conduff is a private practice dentist in Floyd, Virginia. He is a community leader in the Bank’s market area where he serves on numerous civic boards. Dr. Conduff has substantial banking experience due to the length of his service on the Cardinal Board, including his role as Chairman of Cardinal’s Audit Committee. Dr. Conduff is a graduate of the Virginia Military Institute and the MCV School of Dentistry.

Blake M. Edwards, Jr. (53) – Mr. Edwards, President and Chief Executive Officer of Parkway and Skyline National Bank since January 2019, previously served as the Senior Executive Vice President and Chief Financial Officer of Parkway and Skyline from November 2015 to December 2018. Prior to that he served as the Chief Financial Officer of Grayson and Grayson National Bank since 1999, and as Senior Executive Vice President since 2013. Before joining Grayson, Mr. Edwards worked with a public accounting firm where his primary focus was providing audit and advisory services to community banks. He is a graduate of Radford University and has also attended the AICPA’s School of Banking at the University of Virginia and the Graduate School of Bank Investments and Financial Management at the University of South Carolina. Mr. Edwards currently serves as a member of the Joint Governing Board of DLP, Twin County Regional Healthcare, Inc., as President of the Blue Ridge Discovery Center, and as a member of the Government Relations Committee of the Virginia Bankers Association.

Bryan L. Edwards (68) – Mr. Edwards has been a director of Parkway since its inception in November 2015. He served as a director of Grayson and Grayson National Bank from 2005 to 2016. Mr. Edwards has served as the Manager of the Town of Sparta, North Carolina since January 2004. Prior to that, he was employed as a real estate agent with Mountain Dreams Realty and served as Human Resources/Special Projects & Purchasing Director for NAPCO, Inc., a manufacturing company, also in Sparta. His experience allows him to provide working knowledge of local governments and tax authorities as well as insight into local economic and real estate market conditions. Mr. Edwards has served on the Board of Directors of the Blue Ridge Electric Membership Corporation, a rural electric cooperative based in Lenoir, North Carolina, since 2007 and is the current Chairman of the Virginia Carolina Water Authority.

T. Mauyer Gallimore (76) – Mr. Gallimore has been a director of Parkway since its inception in November 2015. He served as a director of Cardinal and the Bank of Floyd from 2012 to 2016. Mr. Gallimore is a native of Floyd, Virginia and he has been a small business owner in Floyd County for over 40 years. Mr. Gallimore is the retired owner and founder of Blue Ridge Land and Auction Co., Inc. and has over 30 years of experience as a Certified Real Estate Appraiser. His in depth knowledge of the real estate market in our primary service areas is a valuable resource for our board and management as the majority of the Bank’s loans are secured by real estate.

Melissa Gentry (54) –Ms. Gentry has been a director of Parkway since June 2016. She was appointed to the board of Cardinal in April 2016. Ms. Gentry is the Controller and Chief Financial Officer of Shelor Motor Mile, Inc., where she oversees all financial, accounting and recordkeeping functions for 31 affiliated entities. These entities include automotive sales and service, consumer finance, insurance sales, real estate investment, construction and development, restaurants and retail stores representing approximately $350 million in annual revenues and over $200 million in inventories and properties. Her business experience gives her vast insight into economic conditions in and around the New River Valley and her accounting expertise is a significant asset for the board and management. Ms. Gentry is a graduate of Virginia Tech and is currently serving on the Board of Directors for twonon-profit organizations; New River Valley Health Foundation and Friends of Calfee Park. Ms. Gentry has previously served on the Board for Carilion New River Valley Medical Center.

R. Devereux Jarratt (77) –Mr. Jarratt has been a director of Parkway since its inception in November 2015. He served as a director of Cardinal and the Bank of Floyd from 2013 to 2016. Prior to retiring on December 31, 2014, he had been the Chief Executive Officer of Physicians Care of Virginia since January 1996. Mr. Jarratt has 22 years of experience in the banking industry with various banking institutions, including First National Exchange Bank, Dominion Bankshares Corporation and First Union. Mr. Jarratt has an undergraduate degree in economics and a graduate degree in accounting. His vast business experience, including direct banking experience, combined with hisin-depth knowledge of the Cardinal legacy customers and shareholders, are significant assets to the Board.

Theresa S. Lazo (62) – Mrs. Lazo has been a director of Parkway since its inception in November 2015. She served as a director of Grayson and Grayson National Bank from 2011 to 2016. Mrs. Lazo currently serves on the Board of Directors of Oak Hill Academy, and she previously served on the Board of Directors of the Chestnut Creek School of

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the Arts from 2007 to 2014. She also served six years on the Arts Council of the Twin Counties where she held the offices of treasurer, vice president and president at various times during her tenure. Mrs. Lazo recently completed nine years of service on the Galax City School Board. Through her vast experience with localnon-profit organizations and public institutions she has developed extensive personal relationships within the communities served by Parkway and Skyline National Bank and offers a unique perspective on our markets.

W. David McNeill (62) – Mr. McNeill has been a director of Parkway since July 2018. He was one of the Founders of Great State Bank and served on the Board of Directors from 2008 to 2018. Mr. Mc Neill is owner and operator of Carolina Kia of High Point, Carolina Hyundai of High Point, and McNeill Nissan of Wilkesboro. He is also owner of Carolina Automotive Group, which is primarily a real estate company owning the properties the dealerships do business on. Mr. McNeill is a graduate of UNC -Chapel Hill.

Frank A. Stewart (57) –Mr. Stewart has been a director of Parkway since July 2018. He served as director of Great State Bank for 2009 to 2018. Mr. Stewart is President of Premier Body Armor, LLC of Kings Mountain, NC. He is also the owner of Stewart Realty and Stewart Property Management. Previously, he was the owner and founder of Ultra Machine and Fabricating, a sheet metal business specializing in armor plating primarily for the military, from 1989 to 2015.

John Michael Turman (72) – Mr. Turman has been a director of Parkway since July 2016. He is a long-time resident of Floyd County and has led a variety of businesses in southwest Virginia relating to land, lumber, real estate development, manufacturing, and retail sales. Mr. Turman has developed extensive personal and business relationships throughout the Bank’s market area giving him significant knowledge of both current and potential customers as well as shareholders of Parkway and Skyline. He attended the University of Virginia’s College at Wise and has served on the local Industrial Development Authority.

J. David Vaughan (51) – Mr. Vaughan has been a director of Parkway since its inception in November 2015. He served on the board of Grayson and Grayson National Bank from 1999 to 2016. He is the managing partner of My Home Furnishings, LLC, a distributor specializing in youth furniture, located in Mt. Airy, North Carolina, and serves as President of Vaughan Furniture, Incorporated, a furniture distributor located in Galax, Virginia. The furniture industry has historically played a significant role in the local economy of many of the communities served by Parkway and Skyline National Bank, and furniture manufacturing still provides a significant source of employment within those communities. Mr. Vaughan’s direct knowledge of this industry combined with his financial and managerial experience makes him a valuable resource to the Board. Mr. Vaughan also serves on the Boards of Directors for Vaughan Furniture Company, Inc., Big “V” Wholesale Company, Inc., the Vaughan Foundation, and Galax Hope House Ministries, Inc.

Executive Officers Who Are Not Directors

Lori C. Vaught (45) – Mrs. Vaught, Executive Vice President and Chief Financial Officer of Parkway and Skyline National Bank since January 2019, previously served as Controller of Skyline National Bank and its predecessor Grayson National Bank from August 2012 to January 2019. She also served as Grayson National Bank’s Vice President of Loan Operations from September 2002 to August 2012. Prior to those positions, she worked with two local public accounting firms with a primary focus on audit and tax services. She has a Bachelor of Business Administration with a concentration in Accounting from Radford University.

Beth R. Worrell (45) – Ms. Worrell, Executive Vice President and Chief Risk Officer of Skyline National Bank since January 2019, previously served as an independent consultant to community banks in Virginia and North Carolina, providing outsourced audit, credit review, and compliance services. Ms. Worrell also worked as a shareholder with a large regional public accounting firm where her work was also focused on community banks. She has a Bachelor of Arts degree in Mathematics and a Bachelor of Science degree in Business with a concentration in Accounting from Emory & Henry College. Ms. Worrell is a Certified Public Accountant and currently serves as Treasurer for the Chestnut Creek School of the Arts.

Lynn T. Murray(63) –Mrs. Murray, Executive Vice President and Chief Marketing and Human Resources Officer of Skyline National Bank, joined Bank of Floyd in April 2013 as a Senior Vice President and the Chief Administrative Officer. Mrs. Murray has over 20 years of experience in the banking industry. She most recently served as an independent consultant to community banks focusing her practice on building sales skills and improving performance of customer facing staff. Mrs. Murray previously spent 10 years in retail banking and marketing with banks in North Carolina and South Carolina. She is a graduate of Ithaca College in New York.

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Mary D. Tabor (55) – Mrs. Tabor, Executive Vice President and Chief Credit Officer of Skyline National Bank, joined Bank of Floyd in August 2013 as a Credit Manager, and was promoted to Chief Credit Officer in August 2014. Mrs. Tabor has over 30 years of experience in the banking industry related to lending, underwriting and credit. Prior to joining Bank of Floyd, Mrs. Tabor served in various roles with Central Fidelity, First National Bank and Stellar One. She earned a Bachelors and Masters in Agricultural Economics from Virginia Tech and is a graduate of the Stonier Graduate School of Banking.

Rodney R. Halsey (50) – Mr. Halsey, Executive Vice President and Chief Operations Officer of Skyline National Bank, previously worked for Grayson National Bank since 1992, when he began his career as Grayson National Bank’s Loan Review Officer. From 1996 to 2001, Mr. Halsey served as Grayson National Bank’s Assistant Vice President and Loan Officer. In 2002, he was promoted to Vice President of Information Systems/Loan Officer, and in 2009, Mr. Halsey was promoted to Senior Vice President of Information Systems/Commercial Loan Officer. In 2011, Mr. Halsey was named the Chief Operating Officer of Grayson National Bank. Mr. Halsey has previously served on the Alleghany Memorial Hospital Foundation and the Mount Rogers Planning District Loan Fund Board. He currently serves on the Board of Trustees for Oak Hill Academy. Mr. Halsey graduated from Appalachian State University with a degree in Business Administration.

C. Greg Edwards (61) – Mr. Edwards, Executive Vice President and Regional President, North Carolina for Skyline National Bank, previously served as President and Chief Executive Officer of Great State Bank from 2008 until its acquisition by Skyline National Bank in 2018. He was a member of the organizing group of Great State Bank and was elected to the board and President & CEO positions at the time the bank incorporated and began operations during July 2008. He previously served as a senior credit officer for Northwestern National Bank (formerly Wilkes National Bank) from 1994 until that bank was acquired by Integrity Financial Corp. (the parent company of Catawba Valley Bank) in 2002. Following that transaction, he joined Bank of Granite in April 2003 where he served as Senior Vice President and County Executive in Wilkes County until he joined the Great State Bank organizing group in December 2006. Mr. Edwards has 40 years of commercial banking experience and served in loan review, credit administration and lending roles prior to the positions above with Southern National Bank, First Union National Bank and Northwestern Bank.

Jonathan L. Kruckow (34) – Mr. Kruckow, Executive Vice President and Regional President, Virginia for Skyline National Bank, previously worked for Grayson National Bank since 2012, when he served as Senior Vice President of Commercial Lending. Prior to joining Grayson he worked for a large regional bank in the local market where his primary focus was providing commercial banking services for small tomid-sized businesses. He is a graduate of Virginia Tech and has also completed the VBA’s School of Bank Management at the University of Virginia and is currently enrolled in the Graduate School of Banking at Louisiana State University. Mr. Kruckow currently serves on the VBA’s Lending Executives Committee and the VBA’s School of Bank Management Board of Trustees.

Milo L. Cockerham (32) –Mr. Cockerham, Executive Vice President and Chief Retail Banking Officer of Skyline National Bank, joined Skyline National Bank as a consultant in December of 2016 to help with the systems conversion of the merger of Grayson National Bank and Bank of Floyd. He now leads our network of 20 retail branch locations. Mr. Cockerham has 11 years of experience in the banking and financial services industry. Prior to joining Skyline, he served in a managerial role assisting with branch operations in a large branch network for a community bank in North Carolina. Mr. Cockerham is a graduate Emory & Henry College with a BA in Economics and a BS in Business Management. He is currently enrolled in the Graduate School of Banking at Louisiana State University and serves as a board member on the Galax Foundation for Excellence.

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Corporate Governance

General

The business and affairs of the Company are managed under the direction of the Board of Directors in accordance with the Virginia Stock Corporation Act and the Company’s Articles of Incorporation and Bylaws. Members of the Board are kept informed of the Company’s business through discussions with the Chairman of the Board, the President and Chief Executive Officer and other officers, by reviewing materials provided to them and by participating in meetings of the Board and its committees.

Code of Ethics

The Board of Directors has approved a Code of Ethics for Executive Officers and Financial Managers for the Company’s Chief Executive Officer and Chief Financial Officer. The Code addresses such topics as protection and proper use of Company assets, compliance with applicable laws and regulations, conflicts of interest and insider trading. A copy of the Code will be provided, without charge, to any shareholder upon written request to the Secretary of the Company, whose address is 101 Jacksonville Circle, Floyd, Virginia 24091.

Committees of the Board

The Company has an Audit Committee and a Compensation Committee. The Company does not have a standing Nomination Committee.

Audit Committee.The Audit Committee assists the Board of Directors in fulfilling the Board’s oversight responsibility to the shareholders relating to the integrity of the Company’s financial statements, the Company’s compliance with legal and regulatory requirements, the qualifications, independence and performance of the Company’s independent auditor and the performance of the internal audit function. The Audit Committee is directly responsible for the appointment, compensation, retention and oversight of the work of the independent auditor engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attestation services for the Company.

The members of the Audit Committee are Frank A. Stewart, Chairman, Melissa Gentry, Vice Chair, Dr. J. Howard Conduff, Jr, Theresa S. Lazo, John Michael Turman, and T. Mauyer Gallimore, each of whom is independent as that term is defined by the Nasdaq Stock Market.

The Company has not currently designated an “audit committee financial expert.” The Company is located in a rural community where such expertise is limited; however, the Board believes that the current members of the Audit Committee have the ability to understand financial statements and generally accepted accounting principles, the ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves, an understanding of internal controls and procedures for financial reporting and an understanding of audit committee functions. The Audit Committee met four times during the year ended December 31, 2018.

Compensation Committee.The Compensation Committee reviews senior management’s performance and compensation and reviews and sets guidelines for compensation of all employees. All decisions by the Compensation Committee relating to the compensation of the Company’s executive officers are reported to the full Board of Directors.

The members of the Compensation Committee are Dr. J. Howard Conduff, Jr., Chairman, Bryan L. Edwards, Vice Chair, Thomas M. Jackson, Jr., Jacky K. Anderson, and James W. Shortt. Each member, with the exception Jacky K. Anderson, is independent as that term is defined by the Nasdaq Stock Market. The Compensation Committee met three times during the year ended December 31, 2018.

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Director Nomination Process.The Board does not believe it needs a separate nominating committee because the full Board is comprised predominantly of independent directors, with the exception of Messrs. Anderson and Edwards, and has the time and resources to perform the function of selecting board nominees. When the Board performs its nominating function, the Board acts in accordance with the Company’s Articles of Incorporation and Bylaws but does not have a separate charter related to the nomination process.

In identifying potential nominees with desired levels of diversification, the Board of Directors takes into account such factors as it deems appropriate, including the current composition of the Board, the range of talents, experiences and skills that would best complement those that are already represented on the Board, the balance of management and independent Directors, Director representation in geographic areas where the Company operates, and the need for specialized expertise. The Board considers candidates for Board membership suggested by its members and by management, and the Board will consider candidates suggested informally by a shareholder of the Company.

Shareholders entitled to vote for the election of directors may submit candidates for formal consideration by the Company if the Company receives timely written notice, in proper form, for each such recommended director nominee. If the notice is not timely and in proper form, the nominee will not be considered by the Company.

Item 11. Executive Compensation.

Objectives of Parkway’s Executive Compensation Program

The primary objective of Parkway’s executive compensation program is to attract and retain highly skilled and motivated executive officers who will manage Parkway in a manner to promote its growth and profitability and advance the interest of its shareholders. Additional objectives of Parkway’s executive compensation program include the following:

• to align executive pay with shareholders’ interests;

• to recognize individual initiative and achievements; and

• to unite the entire executive management team to a common objective.

Executive Compensation Principles

Parkway’s executive compensation program is not as complex as those of many companies of similar size and nature. Parkway’s program consists of base salaries, cash payments in the form of annual bonuses and long-term benefits in the form of pension and supplemental executive retirement plans. Executive officers also participate in Parkway’s 401(k) plan.

Parkway’s executive compensation program does not include the issuance of stock options or other equity-based incentives. The Board of Directors and Compensation Committee currently believe that executive compensation can be appropriately aligned with Parkway’s long-term performance goals and the creation of shareholder value through the use of other long-term compensation arrangements.

How Executive Pay Levels are Determined

The Compensation Committee regularly reviews Parkway’s executive compensation program and its elements. All decisions by the Compensation Committee relating to the compensation of Parkway’s executive officers are reported to the Board. The Compensation Committee also engages Matthews, Young & Associates, Inc., an independent, third-party compensation consulting firm to assist with the design and implementation of the Company’s overall executive compensation program. Matthews, Young & Associates, Inc. also compiles the comparative industry market data that the committee uses to assess overall compensation competitiveness.

The role of the Chief Executive Officer in determining executive compensation is limited to input in the performance evaluation of the other named executive officers. The Chief Executive Officer has no input in the determination of his own compensation. Likewise, the other named executive officers have no role in the determination of their own executive compensation.

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In determining the compensation of our executive officers, the Compensation Committee evaluates total overall compensation, as well as the mix of salary, cash bonuses and other long-term compensation, using a number of factors including the following:

• Parkway’s financial and operating performance, measured by attainment of strategic objectives and operating results;

• the duties, responsibilities and performance of each executive officer of Parkway, including the achievement of identified goals for the year as they pertain to the areas of Parkway’s operations for which the executive is personally responsible and accountable;

• historical cash and other compensation levels; and

• comparative industry market data to assess compensation competitiveness.

SUMMARY COMPENSATION TABLE

Immediately below is a table setting forth the compensation paid to the Chief Executive Officer, the Chief Financial Officer, and the Chief Risk Officer of Parkway, along with the compensation paid to the Chief Operations Officer of Skyline National Bank.

Name and Principal Position	Year		Salary ($)		Bonus ($)		All Other Compensation ($)(4)		Total ($)
J. Allan Funk(1) President and Chief Executive Officer		2018 2017		240,000 240,000		43,000 39,000		75,442 9,531		358,442 288,531
Blake M. Edwards, Jr.(2) President and Chief Executive Officer		2018 2017		190,000 190,000		31,000 31,500		10,294 7,577		231,294 229,077
Rebecca M. Melton(3) Executive VP and Chief Risk Officer		2018 2017		142,788 150,000		15,000 17,400		6,864 5,996		164,652 173,396
Rodney R. Halsey Executive VP and Chief Operations Officer		2018		134,000		14,000		3,917		151,917

(1) Mr. Funk retired as President and Chief Executive Officer effective December 31, 2018.

(2) Mr. Edwards was appointed as President and Chief Executive Officer effective January 1, 2019. Prior to his appointment he served as Senior Executive VP and Chief Financial Officer.

(3) Ms. Melton resigned as Executive VP and Chief Risk Officer effective November 2, 2018.

(4) Includes matching and discretionary contributions under the Company’s 401(k) plan and, for Mr. Funk, accrued and unused personal and sick time paid to Mr. Funk in connection with his retirement in 2018.

Supplemental Discussion of Compensation

Parkway has an employment agreement with Mr. Edwards as described below. All compensation that Parkway pays to its named executive officers is determined as described above.

Stock Options

No stock options or other stock-based awards were granted to any of Parkway’s employees during the fiscal year ended December 31, 2018. In addition, no such options or awards were exercised during the fiscal year ended December 31, 2018 or held at December 31, 2018 by any such employees.

Pension Benefits

Prior to the merger, both Grayson and Cardinal had qualified noncontributory defined benefit pension plans which covered substantially all of their employees. The benefits are primarily based on years of service and earnings. Both Grayson and Cardinal plans were amended to freeze benefit accruals for all eligible employees prior to the effective date of the merger.

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Nonqualified Deferred Compensation

Deferred compensation plans have been adopted for certain executive officers and members of the Board of Directors for future compensation upon retirement. Under plan provisions aggregate annual payments ranging from $1,992 to $37,200 are payable for ten years certain, generally beginning at age 65. Reduced benefits apply in cases of early retirement or death prior to the benefit date, as defined in the plan.

In addition, the Company adopted supplemental executive retirement plans (the “SERPs”) for certain executive officers, including Messrs. Funk and Edwards and Ms. Melton, in November 2017. The SERPs provide for a retirement benefit of $55,000 to $90,000 per year, payable monthly and continuing for the executive’s lifetime, beginning upon the later of the executive’s separation from service with the Bank or reaching age 65, subject to the vesting schedule set forth in the SERP agreement. Reduced benefits apply in cases of early retirement. In addition, the SERP agreements provide that the executive’s retirement benefit will be fully vested upon a Change in Control, as defined in the SERP agreement.

Payments upon Termination of Employment or a Change of Control

Employment Agreement of J. Allan Funk

The Company entered into an employment agreement with J. Allan Funk on November 22, 2017. Mr. Funk retired as President and Chief Executive Officer of Parkway and Skyline National Bank effective December 31, 2018 and, in connection therewith, received his accrued benefits through such date, including unused personal and sick time, and will be entitled to his vested retirement benefit in his SERP. Following his retirement, Mr. Funk is not entitled to any further compensation or benefits under this employment agreement or otherwise.

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Employment Agreement of Blake M. Edwards

On November 22, 2017, the Company entered into an executive employment agreement (the “Edwards Employment Agreement”) with Blake M. Edwards, the Company’s Current President and Chief Executive Officer.

The term of Mr. Edwards’s employment under the Edwards Employment Agreement began on November 22, 2017 and will continue for a term of three years, unless terminated earlier in accordance with its terms. After the expiration of this initial term, the Edwards Employment Agreement will automatically extend for successiveone-year periods, unless either Mr. Edwards or the Company elect not to so extend. The Edwards Employment Agreement provides for an initial base salary of $190,000 per year. Mr. Edwards will be eligible to be considered for incentive compensation, if any, in an amount determined appropriate by the Company based on the recommendation of the Compensation Committee of the Company’s Board of Directors. He is also entitled to participate in the Company’s employee benefit plans and programs for which he is or will be eligible.

The Edwards Employment Agreement provides for the termination of Mr. Edwards’s employment by the Company without “Cause” or by him for “Good Reason” in the absence of a “Change in Control” (as those terms are defined in the Edwards Employment Agreement). In such cases, Mr. Edwards will be entitled to receive his then-current base salary for the lesser of the remainder of the term or 18 months. The Edwards Employment Agreement also provides for the termination of Mr. Edwards’s employment by the Company following a “Change of Control” or by him for “Good Reason” following a “Change of Control.” In such cases, Mr. Edwards will be entitled to receive his then-current base salary and other compensation benefits for a period of 24 months. Mr. Edwards’s entitlement to the foregoing severance payments is subject to Mr. Edwards’s release and waiver of claims against the Company and his compliance with certain restrictive covenants as provided in the Edwards Employment Agreement.

In the event that Mr. Edwards is terminated by the Company as a result of a “Permanent Disability” (as defined in the Edwards Employment Agreement), Mr. Edwards will be entitled to receive a lump sum payment equal to 90 days of his then-current base salary. Mr. Edwards will not be entitled to any compensation or other benefits under the Edwards Employment Agreement if his employment is terminated upon his death, by the Company for “Cause,” or by him in the absence of “Good Reason.”

The Edwards Employment Agreement contains restrictive covenants relating to the protection of confidential information,non-disclosure,non-competition andnon-solicitation. Thenon-compete andnon-solicitation covenants generally continue for a period of 24 months following the last day of Mr. Edwards’ employment.

Change in Control Agreement with Rebecca M. Melton

The Company entered into a change in control agreement with Rebecca M. Melton on November 22, 2017. Ms. Melton resigned as the Company’s Chief Risk Officer on November 2, 2018, and her agreement was terminated at such time.

Following any termination of employment or change in control, the Company’s named executive officers are entitled to certain pension benefits and deferred compensation, as described above, and benefits under various health and insurance plans, which are available generally to all employees.

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Director Compensation

The following table shows the compensation earned by each of thenon-employee directors during 2018. Fees may also include reimbursement for ordinary business expenses such as lodging, meals, and mileage.

Name	Fees Paid ($)
Jacky K. Anderson		30,451
Dr. J. Howard Conduff, Jr.		27,616
Bryan L. Edwards		30,286
T. Mauyer Gallimore		28,246
Melissa Gentry		29,395
Thomas M. Jackson, Jr.		35,730
R. Devereux Jarratt.		31,128
Theresa S. Lazo		28,784
W. David McNeill(1)		16,707
Carl J. Richardson(2)		11,395
James W. Shortt		29,691
Frank A. Stewart(1)		15,087
John Michael Turman		26,727
J. David Vaughan		29,267

(1) W. David McNeill and Frank A. Stewart joined Parkway as directors in July 2018.

(2) Carl J. Richardson passed away in August 2018.

The Chairman of the Board receives fees of $1,000 per meeting and a monthly retainer of $400. All other directors receive $750 per meeting and a monthly retainer of $300. Additionally, $300 is paid to all directors for each committee meeting attended.

J. Allan Funk, the Company’s former President and Chief Executive Officer and director of the Company, did not receive any compensation for his services as a director.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The following table sets forth information as of March 12, 2019 regarding the number of shares of Parkway common stock beneficially owned by each director, each named executive officer and by all directors and executive officers as a group. Beneficial ownership includes shares, if any, held in the name of the spouse, minor children or other relatives of the director or executive officer living in such person’s home, as well as shares, if any, held in the name of another person under an arrangement whereby the director or executive officer can vest title in himself at once or at some future time.

The Company is not aware of any person who beneficially owns more than five percent of the Company’s common stock.

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Amount and Nature of Beneficial Ownership⁽¹⁾

Name of Beneficial Owner	Shares of Parkway Common Stock			Percent of Class
Directors and Named Executive Officers:
Jacky K. Anderson		12,355	(2)		*
Dr. J. Howard Conduff, Jr.		131,780	(3)		2.12	%
Bryan L. Edwards		1,408			*
T. Mauyer Gallimore		8,151	(4)		*
Melissa Gentry		1,500			*
Thomas M. Jackson, Jr.		11,120			*
R. Devereux Jarratt		36,951			*
Theresa S. Lazo		19,579	(5)		*
W. David McNeill		23,516			*
James W. Shortt		2,456	(6)		*
Frank A. Stewart		113,740			1.83	%
John Michael Turman		13,279	(7)		*
J. David Vaughan		9,783	(8)		*
J. Allan Funk.		6,952	(9)		*
Blake M. Edwards, Jr.		1,056			*
Rebecca M. Melton		5,258	(10)		*
Rodney R. Halsey		2,816	(11)		*
All of Parkway’s directors, executive officers, and executive officers of Skyline as a group (22 individuals)		428,470			6.90	%

(1) Based on 6,213,275 shares of Parkway common stock outstanding as of March 12, 2019.

(2) Shares are held jointly with children and former spouse.

(3) Includes 11,163 shares owned jointly with his spouse and 8,297 shares owned by his sons.

(4) Includes 7,501 shares owned jointly with his spouse.

(5) Includes 2,914 shares owned jointly with her spouse.

(6) Includes 1,189 shares owned by James W. Shortt & Associates, P.C.

(7) Shares are held jointly with spouse.

(8) Includes 1,526 shares owned jointly with his children.

(9) Reflects beneficial ownership as of December 31, 2018, when Mr. Funk retired as President and Chief Executive Officer of the Company.

(10) Reflects beneficial ownership as of November 2, 2018, when Ms. Melton resigned as Executive Vice President and Chief Risk Officer of the Company.

(11) Shares are held jointly with spouse.

* Represents less than 1% of outstanding common stock

Item 13. Certain Relationships and Related Transactions, and Director Independence.

Some of the directors and officers of Parkway are at present, as in the past, customers of Skyline National Bank, and Skyline National Bank has had, and expects to have in the future, banking relationships in the ordinary course of its business with directors, officers, principal shareholders, and their associates, on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the same time for comparable transactions with persons not related to Parkway. These transactions do not involve more than the normal risk of collectability or present other unfavorable features. The aggregate outstanding balance of loans to directors, executive officers, and their associates, as a group, at December 31, 2018 totaled $4.8 million or 8.34% of Parkway’s equity capital at that date.

There are no legal proceedings to which any director, officer, or principal shareholder, or any affiliate thereof, is a party that would be material and adverse to Parkway.

The Company has not adopted a formal policy that covers the review and approval of related person transactions by the Board of Directors. The Board of Directors, however, does review all such transactions that are proposed to it for approval. During such a review, the Board will consider, among other things, the related person’s relationship to Parkway, the facts and circumstances of the proposed transaction, the aggregate dollar amount of the transaction, the related person’s relationship to the transaction, and any other material information. Parkway’s Audit Committee also has the responsibility to review significant conflicts of interest involving directors or executive officers.

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Independence of Directors

The Board of Directors in its business judgment has determined that the following twelve of its fourteen members are independent as that term is defined by the Nasdaq Stock Market: Dr. J. Howard Conduff, Jr., Bryan L. Edwards, T. Mauyer Gallimore, Melissa Gentry, Thomas M. Jackson, Jr., R. Devereux Jarratt, Theresa S. Lazo, W. David McNeill, James W. Shortt, Frank A. Stewart, John Michael Turman, and J. David Vaughan.

The Board considered the following transactions between us and certain of our directors or their affiliates to determine whether such director was independent under the above standards:

• Prior to the Cardinal merger, Grayson had an advisory agreement in place with Mr. Anderson under which he was paid for various consultative and advisory services related to customer, shareholder, and employee related issues. The agreement expired in September of 2014. Mr. Anderson also served as President and Chief Executive Officer of Grayson from June 2000 until his retirement in September 2013.

Additional information about committees is included in “Corporate Governance – Committees of the Board” in Item 10.

Item 14. Principal Accounting Fees and Services.

Audit Fees

The aggregate fees billed by Elliott Davis, PLLC for professional services rendered for the audit of the Company’s annual financial statements for the fiscal years ended December 31, 2018 and 2017, and for the review of the financial statements included in the Company’s Quarterly Reports on Form10-Q, and services that are normally provided in connection with statutory and regulatory filings and engagements, were $140,000 for 2018 and $109,500 for 2017.

Audit Related Fees

The aggregate fees billed by Elliott Davis, PLLC for professional services for assurance and related services that are reasonably related to the performance of the audit or review of the Company’s financial statements and not reported under the heading “Audit Fees” above were $14,500 for 2018. During 2018, these services consisted primarily of merger-related accounting and regulatory filing assistance. There were no audit related fees in 2017.

Tax Fees

The aggregate fees billed by Elliott Davis, PLLC for professional services for tax compliance, tax advice and tax planning were $16,600 for 2018 and $29,200 for 2017. During 2018 and 2017, these services generally included Federal and state income tax return preparation.

All Other Fees

No fees for other services were billed by Elliott Davis, PLLC for the fiscal years ended December 31, 2018 or 2017.

Pre-Approval Policies and Procedures

All audit related services, tax services and other services werepre-approved by the Audit Committee, which concluded that the provision of such services by Elliott Davis, PLLC was compatible with the maintenance of that firms’ independence in the conduct of their auditing functions. The Audit Committee’s Charter provides forpre-approval of audit, audit-related and tax services. The Charter authorizes the Audit Committee to delegate to one or more of its memberspre-approval authority with respect to permitted services.

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PART IV

Item 15. Exhibits, Financial Statement Schedules.

(a) (1) The response to this portion of Item 15 is included in Item 8 above.

(2) The response to this portion of Item 15 is included in Item 8 above.

(3) The following documents are attached hereto or incorporated herein by reference to Exhibits:

Exhibit No.	Description
2.1	Agreement and Plan of Merger, dated as of November 6, 2015, by and among Parkway Acquisition Corp., Grayson Bankshares, Inc. and Cardinal Financial Corp. (attached as Exhibit 2.1 to the Company’s Registration Statement on FormS-4 filed on January 20, 2016, and incorporated herein by reference).
2.2	Agreement and Plan of Merger, dated as of March  1, 2018, by and among Parkway Acquisition Corp., Skyline National Bank and Great State Bank (attached as Exhibit 2.1 to the Company’s Current Report on Form8-K filed March  7, 2018, and incorporated herein by reference).
3.1	Articles of Incorporation of Parkway Acquisition Corp. (attached as Exhibit 3.1 to the Company’s Registration Statement on FormS-4 filed on January 20, 2016, and incorporated herein by reference).
3.2	Amended and Restated Bylaws of Parkway Acquisition Corp. (attached as Exhibit 3.1 to the Company’s Current Report on Form8-K filed on February 21, 2019, and incorporated herein by reference).
4.1	Form of Common Stock Certificate of Parkway Acquisition Corp. (attached as Exhibit 4.1 to the Company’s Registration Statement on FormS-4 filed on January 20, 2016, and incorporated herein by reference).
10.1	Executive Employment Agreement, dated November  22, 2017, by and between Parkway Acquisition Corp. and J. Allan Funk (attached as Exhibit 10.1 to the Company’s Current Report on Form8-K filed November  29, 2017, and incorporated herein by reference).
10.2	Executive Employment Agreement, dated November  22, 2017, by and between Parkway Acquisition Corp. and Blake M. Edwards (attached as Exhibit 10.2 to the Company’s Current Report on Form8-K filed November  29, 2017, and incorporated herein by reference).
10.3	Change in Control Agreement, dated November  22, 2017, by and between Parkway Acquisition Corp. and Rebecca M. Melton (attached as Exhibit 10.3 to the Company’s Current Report on Form8-K filed November  29, 2017, and incorporated herein by reference).
10.4	Supplemental Executive Retirement Plan, dated November  22, 2017, for the benefit of J. Allan Funk (attached as Exhibit 10.4 to the Company’s Current Report on Form8-K filed November 29, 2017, and incorporated herein by reference).
10.5	Supplemental Executive Retirement Plan, dated November  22, 2017, for the benefit of Blake M. Edwards (attached as Exhibit 10.5 to the Company’s Current Report on Form8-K filed November 29, 2017, and incorporated herein by reference).
10.6	Supplemental Executive Retirement Plan, dated November  22, 2017, for the benefit of Rebecca M. Melton (attached as Exhibit 10.6 to the Company’s Current Report on Form8-K filed November 29, 2017, and incorporated herein by reference).
10.7	Supplemental Executive Retirement Plan, dated November 22, 2017, for the benefit of Rodney R. Halsey.
21.1	Subsidiaries of the Company
31.1	Rule15(d)-14(a) Certification of Chief Executive Officer.
31.2	Rule15(d)-14(a) Certification of Chief Financial Officer.
32.1	Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C.Section 1350.
101	The following materials from the Annual Report on Form10-K for the year ended December 31, 2018, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Consolidated Financial Statements.

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(b) Exhibits

See Item 15(a)(3) above.

(c) Financial Statement Schedules

See Item 15(a)(2) above.

Item 16. Form 10-K Summary.

None

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.

	PARKWAY ACQUISITION CORP.
Date: March 29, 2019	By:	/s/ Blake M. Edwards
		Blake M. Edwards President and Chief Executive Officer (Principal Executive Officer)

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated on March 29, 2019.

Date: March 29, 2019	By:	/s/ Blake M. Edwards
		Blake M. Edwards President, Chief Executive Officer and Director (Principal Executive Officer)
Date: March 29, 2019	By:	/s/ Lori C. Vaught
		Lori C. Vaught Chief Financial Officer (Principal Financial and Accounting Officer)
Date: March 29, 2019	By:	/s/ Thomas M. Jackson, Jr.
		Thomas M. Jackson, Jr. Chairman of the Board
Date: March 29, 2019	By:	/s/ James W. Shortt
		James W. Shortt Vice Chairman
Date: March 29, 2019	By:	/s/ Melissa Gentry
		Melissa Gentry Director
Date: March 29, 2019	By:	/s/ Jacky K. Anderson
		Jacky K. Anderson Director
Date: March 29, 2019	By:	/s/ Bryan L. Edwards
		Bryan L. Edwards Director
Date: March 29, 2019	By:	/s/ J. David Vaughan
		J. David Vaughan Director
Date: March 29, 2019	By:	/s/ Theresa S. Lazo
		Theresa S. Lazo Director

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Date: March 29, 2019	By:	/s/ J. Howard Conduff, Jr.
		J. Howard Conduff, Jr. Director
Date: March 29, 2019	By:	/s/ T. Mauyer Gallimore
		T. Mauyer Gallimore Director
Date: March 29, 2019	By:	/s/ R. Devereux Jarratt
		R. Devereux Jarratt Director
Date: March 29, 2019	By:	/s/ John Michael Turman
		John Michael Turman Director
Date: March 29, 2019	By:	/s/ W. David McNeill
		W. David McNeill Director
Date: March 29, 2019	By:	/s/ Frank A. Stewart
		Frank A. Stewart Director

Supplemental Information to be Furnished With Reports Filed Pursuant to Section 15(d) of the Act by Registrants

Which Have Not Registered Securities Pursuant to Section 12 of the Act

As of the date of this report, we have not sent any annual reports or proxy materials to our stockholders. We intend to deliver (i) our annual report to stockholders for the fiscal year ended December 31, 2018 and (ii) our proxy materials for our 2019 Annual Meeting to our stockholders subsequent to the filing of this report. We will furnish copies of the annual report and the proxy materials to the SEC when we deliver such materials to our stockholders.

101