UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2017

Or

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

For the transition period from                      to                     

Commission File Number: 333- 209052

PARKWAY ACQUISITION CORP.

(Exact Name of Registrant as Specified in Its Charter)

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

(540) 745-4191

(Registrant’s Telephone Number, Including Area Code)

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

Indicate by checkmark whether the Registrant has submitted electronically and posted on its corporate website, if any, any Interactive Data File required to be submitted and posted pursuant to Rule 405 of regulation S-T (Section 232.405) of this chapter during the preceding 12 months or for such shorter period that the Registrant was required to submit and post such files.    Yes  ☒    No  ☐

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

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☐  (Do not check if a smaller reporting company)	Smaller reporting company	☒
		Emerging growth company	☐

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

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

The registrant had 5,021,376 shares of Common Stock, no par value per share, outstanding as of August 14, 2017.

PART I	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets—June 30, 2017 (Unaudited) and December 31, 2016 (Audited)	3
	Unaudited Consolidated Statements of Income—Six Months Ended June 30, 2017 and June 30, 2016	4
	Unaudited Consolidated Statements of Income—Three Months Ended June 30, 2017 and June 30, 2016	5
	Unaudited Consolidated Statements of Comprehensive Income—Six and Three Months Ended June 30, 2017 and June 30, 2016	6
	Unaudited Consolidated Statements of Changes in Stockholders’ Equity—Six Months Ended June 30, 2017 and June 30, 2016	7
	Unaudited Consolidated Statements of Cash Flows—Six Months Ended June 30, 2017 and June 30, 2016	8
	Notes to Consolidated Financial Statements	10
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	43
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	49
Item 4.	Controls and Procedures	50
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	51
Item 1A.	Risk Factors	51
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	51
Item 3.	Defaults Upon Senior Securities	51
Item 4.	Mine Safety Disclosures	51
Item 5.	Other Information	51
Item 6.	Exhibits	51
Signatures		52

Part I. Financial Information

Item 1. Financial Statements

Parkway Acquisition Corp. and Subsidiary

Consolidated Balance Sheets

June 30, 2017 and December 31, 2016

	June 30,			December 31,
(dollars in thousands except share amounts)	2017			2016
	(Unaudited)
Assets
Cash and due from banks	$	6,792		$	7,215
Interest-bearing deposits with banks		8,101			19,399
Federal funds sold		10,542			9,294
Investment securities available for sale		59,602			62,540
Restricted equity securities		1,388			1,149
Loans, net of allowance for loan losses of $3,568 at June 30, 2017 and $3,420 at December 31, 2016		417,018			408,548
Cash value of life insurance		17,126			16,850
Foreclosed assets		60			70
Property and equipment, net		18,010			17,970
Accrued interest receivable		1,665			1,732
Core deposit intangible		2,185			2,327
Deferred tax assets, net		4,960			5,872
Other assets		6,549			5,890
Total Assets	$	553,998		$	558,856
Liabilities and Stockholders’ Equity
Liabilities
Deposits
Noninterest-bearing	$	130,038		$	127,224
Interest-bearing		364,835			372,163
Total deposits		494,873			499,387
Accrued interest payable		41			57
Other liabilities		1,954			3,946
Total Liabilities		496,868			503,390
Commitments and contingencies (Note 7)
Stockholders’ equity
Preferred stock, no par value; 5,000,000 shares authorized; none issued		—			—
Common stock, no par value; 25,000,000 shares authorized; 5,021,376 issued and outstanding at June 30, 2017 and December 31, 2016		—			—
Surplus		26,166			26,166
Retained earnings		31,736			30,654
Accumulated other comprehensive loss		(772	)		(1,354	)
Total Stockholders’ Equity		57,130			55,466
Total Liabilities and Stockholders’ Equity	$	553,998		$	558,856

See Notes to Consolidated Financial Statements

3

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Income

For the Six Months ended June 30, 2017 and 2016

	Six Months Ended
	June 30,
(dollars in thousands except share amounts)	2017		2016
	(Unaudited)		(Unaudited)
Interest income
Loans and fees on loans	$	10,168	$	5,795
Interest-bearing deposits in banks		22		—
Federal funds sold		59		14
Investment securities:
Taxable		674		520
Exempt from federal income tax		—		1
Dividends		56		22
		10,979		6,352
Interest expense
Deposits		737		521
Interest on borrowings		—		248
		737		769
Net interest income		10,242		5,583
Provision for loan losses		158		(95	)
Net interest income after provision for loan losses		10,084		5,678
Noninterest income
Service charges on deposit accounts		637		517
Other service charges and fees		770		552
Net realized gains on securities		113		364
Mortgage loan origination fees		112		43
Increase in cash value of life insurance		222		144
Other income		56		18
		1,910		1,638
Noninterest expense
Salaries and employee benefits		5,040		2,982
Occupancy and equipment		1,097		545
Foreclosed asset expense, net		16		53
Data processing expense		579		246
FDIC assessments		150		120
Advertising		333		103
Bank franchise tax		168		90
Director fees		138		68
Merger related expense		642		236
Other expense		1,720		1,347
		9,883		5,790
Income before income taxes		2,111		1,526
Income tax expense		627		552
Net income	$	1,484	$	974
Basic earnings per share	$	0.30	$	0.57
Weighted average shares outstanding		5,021,376		1,718,968
Dividends declared per share	$	0.08	$	0.10

See Notes to Consolidated Financial Statements

4

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Income

For the Three Months ended June 30, 2017 and 2016

	Three Months Ended June 30,
(dollars in thousands except share amounts)	2017		2016
	(Unaudited)		(Unaudited)
Interest income
Loans and fees on loans	$	5,113	$	2,903
Interest-bearing deposits in banks		10		—
Federal funds sold		40		8
Investment securities:
Taxable		331		231
Exempt from federal income tax		—		—
Dividends		27		9
		5,521		3,151
Interest expense
Deposits		367		246
Interest on borrowings		—		97
		367		343
Net interest income		5,154		2,808
Provision for loan losses		50		(8	)
Net interest income after provision for loan losses		5,104		2,816
Noninterest income
Service charges on deposit accounts		315		274
Other service charges and fees		392		269
Net realized gains on securities		113		3
Mortgage loan origination fees		67		23
Increase in cash value of life insurance		111		72
Other income		24		8
		1,022		649
Noninterest expense
Salaries and employee benefits		2,490		1,540
Occupancy and equipment		431		265
Foreclosed asset expense, net		11		10
Data processing expense		308		132
FDIC assessments		75		60
Advertising		175		56
Bank franchise tax		86		45
Director fees		75		41
Merger related expense		327		68
Other expense		998		430
		4,976		2,647
Income before income taxes		1,150		818
Income tax expense		347		278
Net income	$	803	$	540
Basic earnings per share	$	0.16	$	0.32
Weighted average shares outstanding		5,021,376		1,718,968
Dividends declared per share	$	0.00	$	0.00

See Notes to Consolidated Financial Statements

5

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Comprehensive Income

For the Six Months and Three Months ended June 30, 2017 and 2016

	Six Months ended June 30,
(dollars in thousands)	2017			2016
	(Unaudited)			(Unaudited)
Net income	$	1,484		$	974
Other comprehensive income:
Unrealized gains on investment securities:
Unrealized gains arising during the period		995			1,156
Tax related to unrealized gains		(338	)		(393	)
Reclassification of realized gains during the period		(113	)		(364	)
Tax related to realized gains		38			124
Total other comprehensive income		582			523
Total comprehensive income	$	2,066		$	1,497

	Three Months Ended June 30,
(dollars in thousands)	2017			2016
	(Unaudited)			(Unaudited)
Net income	$	803		$	540
Other comprehensive income
Unrealized gains on investment securities available for sale:
Unrealized gains arising during the period		469			366
Tax related to unrealized gains		(159	)		(124	)
Reclassification of net realized gains during the period		(113	)		(3	)
Tax related to realized gains		38			1
Total other comprehensive income		235			240
Total comprehensive income	$	1,038		$	780

See Notes to Consolidated Financial Statements

6

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Changes in Stockholders’ Equity

For the Six Months ended June 30, 2017 and 2016 (unaudited)

	Common Stock						Retained			Accumulated Comprehensive
(dollars in thousands except share amounts)	Shares		Amount		Surplus		Earnings			Loss			Total
Balance, December 31, 2015		1,718,968	$	2,149	$	522	$	28,709		$	(724	)	$	30,656
Net income		—		—		—		974			—			974
Other comprehensive income		—		—		—		—			523			523
Dividends paid ($ 0.10 per share)		—		—		—		(172	)		—			(172	)
Balance, June 30, 2016		1,718,968	$	2,149	$	522	$	29,511		$	(201	)	$	31,981
Balance, December 31, 2016		5,021,376	$	—	$	26,166	$	30,654		$	(1,354	)	$	55,466
Net income		—		—		—		1,484			—			1,484
Other comprehensive income		—		—		—		—			582			582
Dividends paid ($ 0.08 per share)		—		—		—		(402	)		—			(402	)
Balance, June 30, 2017		5,021,376	$	—	$	26,166	$	31,736		$	(772	)	$	57,130

See Notes to Consolidated Financial Statements

7

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Cash Flows

For the Six Months ended June 30, 2017 and 2016

	Six Months Ended June 30,
(dollars in thousands)	2017			2016
	(Unaudited)			(Unaudited)
Cash flows from operating activities
Net income	$	1,484		$	974
Adjustments to reconcile net income to net cash (used in) provided by operations
Depreciation and amortization		636			300
Amortization of core deposit intangibles		142			—
Accretion of loan discount and deposit premium, net		(724	)		—
Provision for loan losses		158			(95	)
Deferred income taxes		612			129
Net realized gains on securities		(113	)		(364	)
Accretion of discount on securities, net of amortization of premiums		361			206
Deferred compensation		(43	)		(29	)
Net realized loss on foreclosed assets		10			38
Changes in assets and liabilities:
Cash value of life insurance		(276	)		(144	)
Accrued interest receivable		67			40
Other assets		(659	)		7
Accrued interest payable		(16	)		(73	)
Other liabilities		(1,949	)		116
Net cash (used in) provided by operating activities		(310	)		1,105
Cash flows from investing activities
Activity in available for sale securities:
Purchases		—			(1,122	)
Sales		662			17,928
Maturities/calls/paydowns		2,910			6,347
Sales (purchases) of restricted equity securities		(239	)		1
Net increase in loans		(8,052	)		(3,623	)
Proceeds from the sale of foreclosed assets		—			300
Purchases of property and equipment, net of sales		(676	)		(92	)
Net cash (used in) provided by investing activities		(5,395	)		19,739
Cash flows from financing activities
Net decrease in deposits		(4,366	)		(5,610	)
Net decrease in borrowings		—			(10,000	)
Dividends paid		(402	)		(172	)
Net cash used in financing activities		(4,768	)		(15,782	)
Net increase (decrease) in cash and cash equivalents		(10,473	)		5,062
Cash and cash equivalents, beginning		35,908			8,055
Cash and cash equivalents, ending	$	25,435		$	13,117

See Notes to Consolidated Financial Statements

8

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Cash Flows, continued

For the Six Months ended June 30, 2017 and 2016

Supplemental disclosure of cash flow information
Interest paid	$	753	$	841
Taxes paid	$	—	$	—
Supplemental disclosure of noncash investing activities
Effect on equity of change in net unrealized gain or loss on available for sale securities	$	582	$	523
Transfers of loans to foreclosed properties	$	—	$	25

See Notes to Consolidated Financial Statements

9

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 1. Organization and Summary of Significant Accounting Policies

Organization

Parkway Acquisition Corp. (“Parkway”) was incorporated as a Virginia corporation on November 2, 2015. Parkway was formed as a business combination shell 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 and Plan of Merger (the “merger agreement”), providing for the combination of the three companies. Terms of the merger agreement called for Grayson and Cardinal to merge with and into Parkway, with Parkway as the surviving corporation (the “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 merger was completed on July 1, 2016. Grayson is considered the acquiror and Cardinal is considered the acquiree in the transaction for accounting purposes.

Upon completion of the 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. 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 surrounding areas through sixteen full-service banking offices and one loan production office. Effective March 13, 2017, the Bank changed its name to Skyline National Bank. As an FDIC-insured National Banking Association, the Bank is subject to regulation by the Comptroller of the Currency. Parkway is regulated by the Board of Governors of the Federal Reserve System.

For purposes of this quarterly report on Form 10-Q, all information contained herein as of and for periods prior to July 1, 2016 reflects the operations of Grayson prior to the 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 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 merger.

The consolidated financial statements as of June 30, 2017 and for the periods ended June 30, 2017 and 2016 included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the information furnished in the interim consolidated financial statements reflects all adjustments necessary to present fairly the Company’s consolidated financial position, results of operations, changes in stockholders’ equity and cash flows for such interim periods. Management believes that all interim period adjustments are of a normal recurring nature. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto as of December 31, 2016, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016. The results of operations for the three-month and six-month periods ended June 30, 2017 are not necessarily indicative of the results to be expected for the full year.

10

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Critical Accounting Policies

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

Principles of Consolidation

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

Business Segments

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

Business Combinations

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

Use of Estimates

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

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

11

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Use of Estimates, continued

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

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

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

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

Cash and Cash Equivalents

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

Trading Securities

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

Securities Held to Maturity

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

Securities Available for Sale

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

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

12

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Securities Available for Sale, continued

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

Loans Receivable

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

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

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

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

Allowance for Loan Losses

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

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

13

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Allowance for Loan Losses, continued

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

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

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

Troubled Debt Restructurings

Under GAAP, the Bank is required to account for certain loan modifications or restructurings as “troubled debt restructurings” or “troubled debt restructured loans.” In general, the modification or restructuring of a debt constitutes a troubled debt restructuring if the Bank for economic or legal reasons related to the borrower’s financial difficulties grants a concession to the borrower that the Bank would not otherwise consider. Debt restructuring or loan modifications for a borrower do not necessarily always constitute a troubled debt restructuring, however, and troubled debt restructurings do not necessarily result in non-accrual loans. Troubled debt restructured loans are maintained in nonaccrual status until they have been performing in accordance with modified terms for a period of at least six months.

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

14

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Foreclosed Assets

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

Pension Plan

Prior to the 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. 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.

Core Deposit Intangible

Core deposit intangibles 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).

Income Taxes

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

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

15

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

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.

Comprehensive Income

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

(dollars in thousands)	Unrealized Gains And (Losses) On Available for Sale Securities			Defined Benefit Pension Items			Total
Balance, December 31, 2015	$	(116	)	$	(608	)	$	(724	)
Other comprehensive gain before reclassifications		763			—			763
Amounts reclassified from accumulated other comprehensive gain		(240	)		—			(240	)
Balance June 30, 2016	$	407		$	(608	)	$	(201	)
Balance, December 31, 2016	$	(574	)	$	(780	)	$	(1,354	)
Other comprehensive gain before reclassifications		657			—			657
Amounts reclassified from accumulated other comprehensive gain		(75	)		—			(75	)
Balance June 30, 2017	$	8		$	(780	)	$	(772	)

Off-Balance Sheet Credit Related Financial Instruments

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

Fair Value of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 8. 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.

16

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note1. Organization and Summary of Significant Accounting Policies, continued

Recent Accounting Pronouncements

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

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for annual periods beginning after December 15, 2017, and interim periods within annual reporting periods beginning after December 15, 2018. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In August 2015, the FASB deferred the effective date of ASU 2014-09, Revenue from Contracts with Customers. As a result of the deferral, the guidance in ASU 2014-09 will be effective for the Company for reposting periods beginning after December 15, 2017. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In November 2015, the FASB amended the Income Taxes topic of the Accounting Standards Codification to simplify the presentation of deferred income taxes by requiring that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments will be effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods, with early adoption permitted as of the beginning of an interim or annual reporting period. The Company applied the guidance prospectively. These amendments did not have a material effect on the Company’s consolidated financial statements.

In January 2016, the FASB amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

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. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to identifying performance obligations and accounting for licenses of intellectual property. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

17

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Recent Accounting Pronouncements, continued

In May 2016, the FASB amended the Revenue from Contracts with Customers topic of the Accounting Standards Codification to clarify guidance related to collectability, noncash consideration, presentation of sales tax, and transition. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its financial statements.

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. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

In August 2016, the FASB amended the Statement of Cash Flows topic of the Accounting Standards Codification to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including interim periods within those fiscal years. The Company does not expect these amendments to have a material effect on its financial statements.

In October 2016, the FASB amended the Income Taxes topic of the Accounting Standards Codification to modify the accounting for intra-entity transfers of assets other than inventory. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including 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 November 2016, the FASB amended the Statement of Cash Flows topic of the Accounting Standards Codification to clarify how restricted cash is presented and classified in the statement of cash flows. The amendments will be effective for the Company for fiscal years beginning after December 15, 2017 including 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 2016, the FASB issued technical corrections and improvements to the Revenue from Contracts with Customers Topic. These corrections make a limited number of revisions to several pieces of the revenue recognition standard issued in 2014. The effective date and transition requirements for the technical corrections will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

In January 2017, the FASB issued guidance to clarify the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendment to the Business Combinations Topic is intended to address concerns that the existing definition of a business has been applied too broadly and has resulted in many transactions being recorded as business acquisitions that in substance are more akin to asset acquisitions. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

18

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Recent Accounting Pronouncements, continued

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

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

In February 2017, the FASB amended the Other Income Topic of the Accounting Standards Codification to clarify the scope of the guidance on nonfinancial asset derecognition as well as the accounting for partial sales of nonfinancial assets. The amendments conform the derecognition guidance on nonfinancial assets with the model for transactions in the new revenue standard. The amendments will be effective for the Company for reporting periods beginning after December 15, 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 Compensation—Retirement Benefits Topic of the Accounting Standards Codification related to the income statement presentation of the components of net periodic benefit cost for an entity’s sponsored defined benefit pension and other postretirement plans. The amendments will be effective for the Company for interim and annual periods beginning after December 15, 2017. Early adoption is permitted. 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.

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.

19

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 2. Business Combinations

On July 1, 2016, Parkway completed its merger with Grayson and Cardinal. Parkway had no material assets or liabilities and did not conduct any business prior to consummation of the merger except to perform its obligations under the merger agreement. As such, Grayson is considered the acquiring entity in this business combination for accounting purposes. Under the terms of the merger agreement, 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. There was no trading market and no market price for Parkway common stock on the date of the transaction. Parkway was quoted on the OTC Markets and began trading on August 31, 2016; however, Parkway is a new company and the stock is thinly traded. Grayson, as the accounting acquirer at the time of the merger, was also thinly traded and the limited number of shares traded prior to the acquisition were not considered indicative of trading value. Due to the limited trading history of Parkway and Grayson, the Company engaged a third party to determine the value of the transaction as well as the value of the consideration paid to Cardinal as a result of the transaction. The Company also 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.

The following table presents the Cardinal assets acquired and liabilities assumed as of July 1, 2016 as well as the related fair value adjustments and determination of purchase gain.

(dollars in thousands)	As Reported by Cardinal			Fair Value Adjustments			As Reported by Parkway
Assets
Cash and cash equivalents	$	11,698		$	—		$	11,698
Investment securities		59,327			(322	)(a)		59,005
Restricted equity securities		1,308			—			1,308
Loans		164,044			(6,192	)(b)		157,852
Allowance for loan losses		(2,123	)		2,123	(c)		—
Cash value of life insurance		6,714			—			6,714
Property and equipment		5,384			1,039	(d)		6,423
Intangible assets		—			2,469	(e)		2,469
Accrued interest receivable		539			—			539
Other assets		2,450			4,677	(f)		7,127
Total assets acquired	$	249,341		$	3,794		$	253,135
Liabilities
Deposits	$	218,671		$	602	(g)	$	219,273
Borrowings		8,000			—	(h)		8,000
Accrued interest payable		35			—			35
Other liabilities		1,289			147	(i)		1,436
Total liabilities acquired	$	227,995		$	749		$	228,744
Net assets acquired								24,391
Total consideration paid								23,500
Purchase gain							$	891

20

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 2. Business Combinations, continued

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 Cardinal’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 = 34%). Also recognizes partial reversal of Cardinal’s deferred tax asset valuation allowance.

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

(h) Cardinal’s borrowings were overnight borrowings and carried at fair value therefore no adjustment was required.

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

The merger was accounted for under the acquisition method of accounting. The assets and liabilities of Cardinal have been recorded at their estimated fair values and added to those of Grayson for periods following the merger date. Valuations of acquired Cardinal 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 Financial Accounting Standards Board Accounting Standards Codification (“ASC”) 310-30. All other acquired loans are recorded at their initial fair value, adjusted for subsequent advances, pay downs, amortization or accretion of any premium or discount on purchase, charge-offs and any other adjustment to carrying value in accordance with ASC 310-20.

Due to the limited trading history of Parkway and Grayson, the Company engaged a third party to determine the value of the transaction as well as the value of the consideration paid to Cardinal as a result of the transaction. The determined value of consideration received by Cardinal, when compared to the fair value of the net assets acquired from Cardinal, resulted in a bargain purchase gain of $891 thousand for the year ended December 31, 2016. The determined value of consideration received by Cardinal represented a premium when compared to the market price of Parkway stock, which was not publicly traded on the date of the merger. The premium results from enhanced cash flows and a lower required rate of return which are expected to be realized by Parkway, as compared to Grayson or Cardinal on a standalone basis. The merger of Grayson and Cardinal is expected to increase loan revenues due to an increased legal lending limit and expanded market area. Fee income is also expected to increase due to the larger deposit population. Significant cost savings are expected to be realized, particularly in the areas of salaries and benefits, data processing fees, and professional fees. A lower required rate of return is anticipated due to increased access to capital and an expected increase in liquidity of shares due to higher trading volumes.

21

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 2. Business Combinations, continued

The following table presents the assets and liabilities of Parkway and Grayson prior to the merger, the estimated fair value of Cardinal assets acquired and liabilities assumed, and the resulting estimated balance sheet of Parkway immediately following the merger on July 1, 2016.

(dollars in thousands)	Pre-Merger Parkway		Pre-Merger Grayson			Cardinal Acquired		Post-Merger Parkway
Assets
Cash and cash equivalents	$	—	$	13,117		$	11,698	$	24,815
Investment securities		—		33,847			59,005		92,852
Restricted equity securities		—		971			1,308		2,279
Loans		—		244,800			157,852		402,652
Allowance for loan losses		—		(3,309	)		—		(3,309	)
Cash value of life insurance		—		10,122			6,714		16,836
Foreclosed assets		—		95			—		95
Property and equipment		—		11,548			6,423		17,971
Goodwill and other intangible assets		—		—			2,469		2,469
Accrued interest receivable		—		1,253			539		1,792
Other assets		—		5,044			7,127		12,171
Total assets	$	—	$	317,488		$	253,135	$	570,623
Liabilities
Deposits	$	—	$	274,265		$	219,273	$	493,538
Borrowings		—		10,000			8,000		18,000
Accrued interest payable		—		96			35		131
Other liabilities		—		1,146			1,436		2,582
Total liabilities	$	—	$	285,507		$	228,744	$	514,251
Stockholders’ Equity	$	—	$	31,981		$	24,391	$	56,372

22

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 2. Business Combinations, continued

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

The table below presents supplemental pro forma information as if the Cardinal acquisition had occurred at the beginning of the earliest period presented, which was January 1, 2016. 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 $327 thousand and $68 thousand are included in the Company’s consolidated statements of income for three-month periods ended June 30, 2017 and 2016, respectively. Pre-tax merger-related costs of $642 thousand and $236 thousand are included in the Company’s consolidated statements of income for the six-month periods ended June 30, 2017 and 2016 respectively. These pre-tax merger-related costs are not included in the pro forma statements below.

	Three Months Ended June 30,
	2017		2016
	(unaudited)		(unaudited)
Net interest income	$	5,119	$	4,795
Net income (a)	$	780	$	860
Basic weighted average shares outstanding (b)		5,021,376		5,021,376
Basic earnings per common share	$	0.16	$	0.17
	Six Months ended June 30,
	2017		2016
	(Unaudited)		(Unaudited)
Net interest income	$	10,156	$	9,760
Net income (a)	$	1,427	$	1,749
Basic weighted average shares outstanding (b)		5,021,376		5,021,376
Basic earnings per common share	$	0.28	$	0.35

(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 Cardinal acquisition as of the earliest reporting date.

23

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 3. Investment Securities

Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent. The amortized cost of securities and their approximate fair values at June 30, 2017 and December 31, 2016 follow:

(dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
June 30, 2017
Available for sale:
Government sponsored enterprises	$	2,022	$	82	$	(19	)	$	2,085
Mortgage-backed securities		34,489		67		(281	)		34,275
Corporate securities		3,038		23		(73	)		2,988
State and municipal securities		20,041		264		(51	)		20,254
	$	59,590	$	436	$	(424	)	$	59,602
December 31, 2016
Available for sale:
Government sponsored enterprises		2,046		236		(73	)		2,209
Mortgage-backed securities		36,021		4		(823	)		35,202
Corporate securities		3,061		—		(87	)		2,974
State and municipal securities		22,282		97		(224	)		22,155
	$	63,410	$	337	$	(1,207	)	$	62,540

Restricted equity securities were $1.4 million and $1.1 million at June 30, 2017 and December 31, 2016, respectively. Restricted equity securities consist of investments in stock of the Federal Home Loan Bank of Atlanta (FHLB), Community Bankers Bank, 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 Community Bankers Bank and Pacific Coast Bankers Bank is restricted only in the fact that the stock may only be repurchased by the respective banks.

The following tables details unrealized losses and related fair values in the Company’s held to maturity and available for sale investment securities portfolios. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of June 30, 2017 and December 31, 2016.

	Less Than 12 Months					12 Months or More					Total
(dollars in thousands)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
June 30, 2017
Available for sale:
Government sponsored enterprises	$	—	$	—		$	1,978	$	(19	)	$	1,978	$	(19	)
Mortgage-backed securities		22,924		(265	)		653		(16	)		23,577		(281	)
Corporate securities		—		—			1,427		(73	)		1,427		(73	)
State and municipal securities		3,598		(51	)		—		—			3,598		(51	)
Total securities available for sale	$	26,522	$	(316	)	$	4,058	$	(108	)	$	30,580	$	(424	)
December 31, 2016
Available for sale:
Government sponsored enterprises		—		—			1,924		(73	)		1,924		(73	)
Mortgage-backed securities		31,759		(789	)		688		(34	)		32,447		(823	)
Corporate securities		1,548		(12	)		1,425		(75	)		2,973		(87	)
State and municipal securities		12,208		(224	)		—		—			12,208		(224	)
Total securities available for sale	$	45,515	$	(1,025	)	$	4,037	$	(182	)	$	49,552	$	(1,207	)

24

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 3. Investment Securities, continued

At June 30, 2017, 23 debt securities with unrealized losses had depreciated 1.37 percent from their amortized cost basis. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, and the financial condition and near-term prospects of the issuer. The relative significance of these and other factors will vary on a case by case basis. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition and the issuer’s anticipated ability to pay the contractual cash flows of the investments. Since the Company intends to hold all of its investment securities until maturity, and it is more likely than not that the Company will not have to sell any of its investment securities before unrealized losses have been recovered, and the Company expects to recover the entire amount of the amortized cost basis of all its securities, none of the securities are deemed other than temporarily impaired at June 30, 2017. Management continues to monitor all of these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of these securities are other than temporarily impaired, which could require a charge to earnings in such periods.

Proceeds from sales of investment securities available for sale were $662 thousand and $17.9 million for the six month periods ended June 30, 2017 and 2016, respectively and $662 thousand for the three month period ended June 30, 2017. There were no sales in the three month period ended June 30, 2016, however a gain of $3 thousand was realized as a result of an investment security being called prior to its scheduled maturity. Gains and losses on the sale of investment securities are recorded on the trade date and are determined using the specific identification method. Gross realized gains and losses for the six-month and three-month periods ended June 30, 2017 and 2016 are as follows:

	Six Months Ended June 30,				Three Months Ended June 30,
(dollars in thousands)	2017		2016		2017		2016
Realized gains	$	113	$	364	$	113		3
Realized losses		—		—		—		—
	$	113	$	364	$	113	$	3

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

The scheduled maturities of securities available for sale at June 30, 2017, were as follows:

(dollars in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	531	$	534
Due after one year through five years		10,822		10,862
Due after five years through ten years		22,055		21,924
Due after ten years		26,182		26,282
	$	59,590	$	59,602

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 $11.3 million and $11.2 million at June 30, 2017 and December 31, 2016, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.

25

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 4. Loans Receivable

The major components of loans in the consolidated balance sheets at June 30, 2017 and December 31, 2016 are as follows:

(dollars in thousands)	2017			2016
Commercial & agricultural	$	28,232		$	26,086
Commercial mortgage		123,408			128,515
Construction & development		29,816			26,464
Farmland		34,326			33,531
Residential		192,947			187,188
Consumer & other		11,857			10,184
Total loans		420,586			411,968
Allowance for loan losses		(3,568	)		(3,420	)
Loans, net of allowance for loan losses	$	417,018		$	408,548

The major components of loans, net of fair value adjustments, acquired from Cardinal as of July 1, 2016, the acquisition date, are as follows:

(dollars in thousands)
Commercial & agricultural	$	15,897
Commercial mortgage		76,968
Construction & development		7,800
Farmland		4,146
Residential		49,609
Consumer & other		3,432
Total loans acquired	$	157,852

As of the acquisition date, all loans acquired from Cardinal were considered to be performing loans therefore there were no purchased credit impaired loans.

As of June 30, 2017 and December 31, 2016, substantially all of the Bank’s residential 1-4 family loans were pledged as collateral toward borrowings with the Federal Home Loan Bank.

26

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 5. Allowance for Loan Losses and Impaired Loans

Allowance for Loan Losses

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

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.

As of June 30, 2017 and December 31, 2016, the Bank had no unallocated reserves included in the allowance for loan losses.

27

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Allowance for Loan Losses, continued

The following table presents activity in the allowance for loan losses by loan category three months ended June 30, 2017 and 2016 and the related asset balances as of June 30, 2017 and December 31, 2016:

Allowance for Loan Losses and Recorded Investment in Loans

(dollars in thousands)	Commercial & Agricultural			Commercial Mortgage			Construction & Development			Farmland			Residential			Consumer & Other			Total
For the Three Months Ended June 30, 2017
Allowance for loan losses:
Balance, March 31, 2017	$	230		$	644		$	349		$	401		$	1,880		$	72		$	3,576
Charge-offs		(27	)		—			—			—			(13	)		(23	)		(63	)
Recoveries		2			—			—			—			—			3			5
Provision		9			(24	)		(20	)		(8	)		71			22			50
Balance, June 30, 2017	$	214		$	620		$	329		$	393		$	1,938		$	74		$	3,568
For the Three Months Ended June 30, 2016
Allowance for loan losses:
Balance, March 31, 2016	$	130		$	587		$	335		$	403		$	1,816		$	41		$	3,312
Charge-offs		—			—			—			—			(3	)		(14	)		(17	)
Recoveries		2			—			10			—			1			9			22
Provision		56			(16	)		(77	)		119			(97	)		7			(8	)
Balance, June 30, 2016	$	188		$	571		$	268		$	522		$	1,717		$	43		$	3,309
For the Six Months Ended June 30, 2017
Allowance for loan losses:
Balance, December 31, 2016	$	210		$	600		$	319		$	342		$	1,841		$	108		$	3,420
Charge-offs		(27	)		(42	)		—			—			(13	)		(38	)		(120	)
Recoveries		29			—			56			—			15			10			110
Provision		2			62			(46	)		51			95			(6	)		158
Balance, June 30, 2017	$	214		$	620		$	329		$	393		$	1,938		$	74		$	3,568
For the Six Months Ended June 30, 2016
Allowance for loan losses:
Balance, December 31, 2015	$	136		$	578		$	344		$	435		$	1,887		$	38		$	3,418
Charge-offs		(19	)		(11	)		—			—			(25	)		(36	)		(91	)
Recoveries		4			—			44			—			15			14			77
Provision		67			4			(120	)		87			(160	)		27			(95	)
Balance, June 30, 2016	$	188		$	571		$	268		$	522		$	1,717		$	43		$	3,309
June 30, 2017
Allowance for loan losses:
Ending balance	$	214		$	620		$	329		$	393		$	1,938		$	74		$	3,568
Ending balance: individually evaluated for impairment	$	—		$	—		$	—		$	73		$	163		$	—		$	236
Ending balance: collectively evaluated for impairment	$	214		$	620		$	329		$	320		$	1,775		$	74		$	3,332
Loans outstanding:
Ending balance	$	28,232		$	123,408		$	29,816		$	34,326		$	192,947		$	11,857		$	420,586
Ending balance: individually evaluated for impairment	$	—		$	113		$	385		$	5,612		$	1,570		$	—		$	7,680
Ending balance: collectively evaluated for impairment	$	28,232		$	123,295		$	29,431		$	28,714		$	191,377		$	11,857		$	412,906
December 31, 2016
Allowance for loan losses:
Ending balance	$	210		$	600		$	319		$	342		$	1,841		$	108		$	3,420
Ending balance: individually evaluated for impairment	$	—		$	—		$	—		$	57		$	184		$	—		$	241
Ending balance: collectively evaluated for impairment	$	210		$	600		$	319		$	285		$	1,657		$	108		$	3,179
Loans outstanding:
Ending balance	$	26,086		$	128,515		$	26,464		$	33,531		$	187,188		$	10,184		$	411,968
Ending balance: individually evaluated for impairment	$	—		$	114		$	580		$	5,030		$	1,533		$	—		$	7,257
Ending balance: collectively evaluated for impairment	$	26,086		$	128,401		$	25,884		$	28,501		$	185,655		$	10,184		$	404,711

28

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Allowance for Loan Losses, continued

Management closely monitors the quality of the loan portfolio and has established a loan review process designed to help grade the quality of the Bank’s loan portfolio. The Bank’s loan ratings coincide with the “Substandard,” “Doubtful” and “Loss” classifications used by federal regulators in their examination of financial institutions. Generally, an asset is considered Substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged. Substandard assets include those characterized by the distinct possibility that the insured financial institution will sustain some loss if the deficiencies are not corrected. Assets classified as Doubtful have all the weaknesses inherent in assets classified Substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable. Assets classified as Loss are those considered uncollectible, and of such little value that its continuance on the books is not warranted. Assets that do not currently expose the insured financial institutions to sufficient risk to warrant classification in one of the aforementioned categories but otherwise possess weaknesses are designated “Special Mention.” Management also maintains a listing of loans designated “Watch”. These loans represent borrowers with declining earnings, strained cash flow, increasing leverage and/or weakening market fundamentals that indicate above average risk. As of June 30, 2017 and December 31, 2016, 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 June 30, 2017 and December 31, 2016:

Credit Risk Profile by Internally Assigned Grades

	Loan Grades
(dollars in thousands)	Pass		Watch		Special Mention		Substandard		Total
June 30, 2017
Real Estate Secured:
1-4 residential construction	$	5,187	$	98	$	—	$	—	$	5,285
Commercial construction		4,539		125		—		—		4,664
Land development & other land		18,979		346		—		542		19,867
Farmland		24,036		5,566		666		4,058		34,326
1-4 residential mortgage		124,430		11,441		26		2,692		138,589
Multifamily		27,273		1,304		—		—		28,577
Home equity and second mortgage		24,595		952		—		234		25,781
Commercial mortgage		104,633		12,592		680		5,503		123,408
Non-Real Estate Secured:
Commercial & agricultural		25,284		2,125		466		357		28,232
Civic organizations		4,516		—		—		—		4,516
Consumer-auto		1,679		36		—		—		1,715
Consumer-other		5,459		167		—		—		5,626
Total	$	370,610	$	34,752	$	1,838	$	13,386	$	420,586

29

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Allowance for Loan Losses, continued

	Loan Grades
(dollars in thousands)	Pass		Watch		Special Mention		Substandard		Total
December 31, 2016
Real Estate Secured:
1-4 residential construction	$	4,056	$	370	$	—	$	—	$	4,426
Commercial construction		2,603		—		—		—		2,603
Land development & other land		18,000		532		—		903		19,435
Farmland		23,201		5,276		—		5,054		33,531
1-4 residential mortgage		122,301		11,517		—		2,111		135,929
Multifamily		25,365		1,321		—		—		26,686
Home equity and second mortgage		23,219		1,243		—		111		24,573
Commercial mortgage		105,317		13,449		3,353		6,396		128,515
Non-Real Estate Secured:
Commercial & agricultural		22,719		2,333		485		549		26,086
Civic organizations		3,603		—		—		—		3,603
Consumer-auto		1,400		21		—		—		1,421
Consumer-other		5,015		105		—		40		5,160
Total	$	356,799	$	36,167	$	3,838	$	15,164	$	411,968

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

The following table presents an age analysis of nonaccrual and past due loans by category as of June 30, 2017 and December 31, 2016:

Analysis of Past Due and Nonaccrual Loans

(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
June 30, 2017
Real Estate Secured:
1-4 residential construction	$	—	$	—	$	—	$	—	$	5,285	$	5,285	$	—	$	—
Commercial construction		—		—		—		—		4,664		4,664		—		—
Land development & other land		249		—		385		634		19,233		19,867		—		609
Farmland		—		—		969		969		33,357		34,326		—		4,212
1-4 residential mortgage		401		366		293		1,060		137,529		138,589		—		491
Multifamily		—		—		—		—		28,577		28,577		—		—
Home equity and second mortgage		59		—		130		189		25,592		25,781		—		130
Commercial mortgage		—		—		204		204		123,204		123,408		—		213
Non-Real Estate Secured:
Commercial & agricultural		—		103		31		134		28,098		28,232		—		107
Civic organizations		—		—		—		—		4,516		4,516		—		—
Consumer-auto		—		—		—		—		1,715		1,715		—		—
Consumer-other		—		—		—		—		5,626		5,626		—		—
Total	$	709	$	469	$	2,012	$	3,190	$	417,396	$	420,586	$	—	$	5,762

30

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Allowance for Loan Losses, continued

(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, 2016
Real Estate Secured:
1-4 residential construction	$	—	$	—	$	—	$	—	$	4,426	$	4,426	$	—	$	—
Commercial construction		—		—		—		—		2,603		2,603		—		—
Land development & other land		—		—		390		390		19,045		19,435		—		647
Farmland		343		—		—		343		33,188		33,531		—		3,310
1-4 residential mortgage		315		48		14		377		135,552		135,929		—		26
Multifamily		—		—		—		—		26,686		26,686		—		—
Home equity and second mortgage		98		—		5		103		24,470		24,573		—		5
Commercial mortgage		25		227		426		678		127,837		128,515		—		640
Non-Real Estate Secured:
Commercial & agricultural		67		—		25		92		25,994		26,086		—		31
Civic organizations		—		—		—		—		3,603		3,603		—		—
Consumer-auto		5		—		—		5		1,416		1,421		—		—
Consumer-other		—		6		—		6		5,154		5,160		—		5
Total	$	853	$	281	$	860	$	1,994	$	409,974	$	411,968	$	—	$	4,664

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.

As of June 30, 2017 and December 31, 2016, respectively, the recorded investment in impaired loans totaled $14.0 million and $13.3 million. The total amount of collateral-dependent impaired loans at June 30, 2017 and December 31, 2016, respectively, was $4.7 million and $4.0 million. As of June 30, 2017 and December 31, 2016, respectively, $4.5 million and $4.4 million of the recorded investment in impaired loans did not have a related allowance. The Bank had $9.8 million and $10.0 million in troubled debt restructured loans included in impaired loans at June 30, 2017 and December 31, 2016, respectively.

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

31

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Impaired Loans, continued

In 2015, management began collectively evaluating performing TDRs with a loan balance of $250,000 or less for impairment. As of June 30, 2017 and December 31, 2016, respectively, $6.4 million and $6.1 million of TDRs included in the following table were evaluated collectively for impairment and were deemed to have $351 thousand and $315 thousand of related allowance.

The following table is a summary of information related to impaired loans as of June 30, 2017 and December 31, 2016:

Impaired Loans

							Six months ended				Three months ended
			Unpaid				Average		Interest		Average		Interest
	Recorded		Principal		Related		Recorded		Income		Recorded		Income
(dollars in thousands)	Investment1		Balance		Allowance		Investment		Recognized		Investment		Recognized
June 30, 2017
With no related allowance recorded:
1-4 Residential Construction	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Land development & other land		385		385		—		387		—		385		—
Farmland		3,695		3,695		—		3,708		—		3,695		—
1-4 residential mortgage		175		175		—		175		5		175		2
Home equity and second mortgage		125		125		—		125		2		125		2
Commercial mortgage		113		113		—		114		—		113		—
Commercial & agricultural		—		—		—		—		—		—		—
Consumer & other		—		—		—		—		1		—		1
Subtotal		4,493		4,493		—		4,509		8		4,493		5
With an allowance recorded:
1-4 Residential Construction		—		—		—		—		—		—		—
Land development & other land		410		410		23		423		7		410		3
Farmland		2,361		2,361		98		2,493		65		2,362		34
1-4 residential mortgage		5,883		6,040		418		6,100		148		6,033		73
Home equity and second mortgage		172		177		9		178		4		177		2
Commercial mortgage		639		775		35		913		43		903		33
Commercial & agricultural		78		78		4		100		8		88		7
Consumer & other		—		—		—		2		—		1		—
Subtotal		9,543		9,841		587		10,209		275		9,974		152
Totals:
1-4 Residential Construction		—		—		—		—		—		—		—
Land development & other land		795		795		23		810		7		795		3
Farmland		6,056		6,056		98		6,201		65		6,057		34
1-4 residential mortgage		6,058		6,215		418		6,275		153		6,208		75
Home equity and second mortgage		297		302		9		303		6		302		4
Commercial mortgage		752		888		35		1,027		43		1,016		33
Commercial & agricultural		78		78		4		100		8		88		7
Consumer & other		—		—		—		2		1		1		1
Total	$	14,036	$	14,334	$	587	$	14,718	$	283	$	14,467	$	157

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

32

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Impaired Loans, continued

			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
(dollars in thousands)	Investment1		Balance		Allowance		Investment		Recognized
December 31, 2016
With no related allowance recorded:
1-4 Residential Construction	$	—	$	—	$	—	$	—	$	—
Land development & other land		581		581		—		840		17
Farmland		3,660		3,660		—		4,170		18
1-4 residential mortgage		—		—		—		347		10
Home equity and second mortgage		—		—		—		—		—
Commercial mortgage		114		114		—		115		4
Commercial & agricultural		—		—		—		—		—
Consumer & other		—		—		—		—		1
Subtotal		4,355		4,355		—		5,472		50
With an allowance recorded:
1-4 Residential Construction		—		—		—		—		—
Land development & other land		193		193		10		201		16
Farmland		1,679		1,679		73		1,705		84
1-4 residential mortgage		5,964		6,121		414		6,375		294
Home equity and second mortgage		174		179		9		254		8
Commercial mortgage		838		974		44		1,035		39
Commercial & agricultural		113		113		6		155		9
Consumer & other		4		4		—		10		1
Subtotal		8,965		9,263		556		9,735		451
Totals:
1-4 Residential Construction		—		—		—		—		—
Land development & other land		774		774		10		1,041		33
Farmland		5,339		5,339		73		5,875		102
1-4 residential mortgage		5,964		6,121		414		6,722		304
Home equity and second mortgage		174		179		9		254		8
Commercial mortgage		952		1,088		44		1,150		43
Commercial & agricultural		113		113		6		155		9
Consumer & other		4		4		—		10		2
Total	$	13,320	$	13,618	$	556	$	15,207	$	501

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; or re-aging, extensions, deferrals and renewals. Troubled debt restructured loans are considered impaired loans.

33

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Troubled Debt Restructuring, continued

The following table sets forth information with respect to the Bank’s troubled debt restructurings as of June 30, 2017 and June 30, 2016:

For the Six Months Ended June 30, 2017

							TDRs identified in the last twelve
(dollars in thousands)	TDRs identified during the period						months that subsequently defaulted(1)
			Pre-		Post-				Pre-		Post-
			modification		modification				modification		modification
	Number		outstanding		outstanding		Number		outstanding		outstanding
	of		recorded		recorded		of		recorded		recorded
	contracts		investment		investment		contracts		investment		investment
Land development & other land		—	$	—	$	—		—	$	—	$	—
Farmland		2		298		298		—		—		—
1-4 residential mortgage		1		48		48		—		—		—
Commercial mortgage		—		—		—		—		—		—
Commercial & agricultural		—		—		—		—		—		—
Consumer & other		—		—		—		—		—		—
Total		3	$	346	$	346		—	$	—	$	—

During the six months ended June 30, 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 quarter ended June 30, 2017.

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

For the Three Months Ended June 30, 2017

							TDRs identified in the last twelve
(dollars in thousands)	TDRs identified during the period						months that subsequently defaulted(1)
			Pre-		Post-				Pre-		Post-
			modification		modification				modification		modification
	Number		outstanding		outstanding		Number		outstanding		outstanding
	of		recorded		recorded		of		recorded		recorded
	contracts		investment		investment		contracts		investment		investment
Land development & other land		—	$	—	$	—		—	$	—	$	—
Farmland		—		—		—		—		—		—
1-4 residential mortgage		1		48		48		—		—		—
Commercial mortgage		—		—		—		—		—		—
Commercial & agricultural		—		—		—		—		—		—
Consumer & other		—		—		—		—		—		—
Total		1	$	48	$	48		—	$	—	$	—

During the quarter ended June 30, 2017, one loan was modified that was considered to be a TDR. Term concession was granted for the one loan and no additional funds were advanced.

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

34

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Troubled Debt Restructuring, continued

For the Six Months Ended June 30, 2016

							TDRs identified in the last twelve
(dollars in thousands)	TDRs identified during the period						months that subsequently defaulted(1)
			Pre-		Post-				Pre-		Post-
			modification		modification				modification		modification
	Number		outstanding		outstanding		Number		outstanding		outstanding
	of		recorded		recorded		of		recorded		recorded
	contracts		investment		investment		contracts		investment		investment
Land development & other land		—	$	—	$	—		—	$	—	$	—
Farmland		—		—		—		—		—		—
1-4 residential mortgage		5		565		588		—		—		—
Commercial mortgage		—		—		—		—		—		—
Commercial & agricultural		—		—		—		—		—		—
Consumer & other		—		—		—		—		—		—
Total		5	$	565	$	588		—	$	—	$	—

During the six months ended June 30, 2016, five loans were modified that were considered to be TDRs. Term concessions only were granted for five loans; and additional funds were advanced on two loans to pay real estate taxes and closing costs. No TDRs identified in twelve months prior to June 30, 2016 subsequently defaulted in the quarter ended June 30, 2016.

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

For the Three Months Ended June 30, 2016

							TDRs identified in the last twelve
(dollars in thousands)	TDRs identified during the period						months that subsequently defaulted(1)
			Pre-		Post-				Pre-		Post-
			modification		modification				modification		modification
	Number		outstanding		outstanding		Number		outstanding		outstanding
	of		recorded		recorded		of		recorded		recorded
	contracts		investment		investment		contracts		investment		investment
Land development & other land		—	$	—	$	—		—	$	—	$	—
Farmland		—		—		—		—		—		—
1-4 residential mortgage		1		171		180		—		—		—
Commercial mortgage		—		—		—		—		—		—
Commercial & agricultural		—		—		—		—		—		—
Consumer & other		—		—		—		—		—		—
Total		1	$	171	$	180		—	$	—	$	—

During the quarter ended June 30, 2016, one loan was modified that was considered to be a TDR. Term concession was granted for the one loan and additional funds were advanced to pay taxes and closing cost.

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

35

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 6. Employee Benefit Plan

The Bank has a qualified noncontributory defined benefit pension plan that covers substantially all of its employees. Effective December 31, 2012, the pension plan was amended to freeze benefit accruals for all eligible employees. The following is a summary of net periodic pension costs for the six-month and three-month periods ended June 30, 2017 and 2016.

	Six Months Ended June 30,						Three Months Ended June 30,
(dollars in thousands)	2017			2016			2017			2016
Service cost	$	—		$	—		$	—		$	—
Interest cost		96			98			48			49
Expected return on plan assets		(276	)		(280	)		(138	)		(140	)
Amortization of prior service cost		—			—			—			—
Recognized net loss due to settlement		—			28			—			14
Recognized net actuarial (gain)/loss		14			6			7			3
Net periodic benefit cost	$	(166	)	$	(148	)	$	(83	)	$	(74	)

It has been Bank practice to contribute the maximum tax-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, 2016 and there is no required contribution for 2017. Based on this we do not anticipate making a contribution to the plan in 2017.

Note 7. 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 with Off-Balance Sheet Risk

The Bank is party to financial instruments with off-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 for on-balance sheet instruments. A summary of the Bank’s commitments at June 30, 2017 and December 31, 2016 is as follows:

	June 30,		December 31,
(dollars in thousands)	2017		2016
Commitments to extend credit	$	48,774	$	54,667
Standby letters of credit		982		—
	$	49,756	$	54,667

36

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 7. Commitments and Contingencies, continued

Financial Instruments with Off-Balance Sheet Risk, 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 a case-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.

37

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 8. 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 June 30, 2017 and December 31, 2016. 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.

					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)
June 30, 2017
Financial Instruments - Assets
Net Loans	$	417,018	$	414,405	$	—	$	413,949	$	456
Financial Instruments – Liabilities
Time Deposits		159,755		157,615		—		157,615		—
December 31, 2016
Financial Instruments - Assets
Net Loans	$	408,548	$	405,876	$	—	$	405,410	$	466
Financial Instruments – Liabilities
Time Deposits		167,355		165,257		—		165,257		—

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.

38

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 8. 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 active over-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 June 30, 2017, 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.

39

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 8. 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
June 30, 2017
Investment securities available for sale
Government sponsored enterprises	$	2,085	$	—	$	2,085	$	—
Mortgage-backed securities		34,275		—		34,275		—
Corporate securities		2,988		—		2,988		—
State and municipal securities		20,254		—		20,254		—
Total assets at fair value	$	59,602	$	—	$	59,602	$	—
December 31, 2016
Investment securities available for sale
Government sponsored enterprises	$	2,209	$	—	$	2,209	$	—
Mortgage-backed securities		35,202		—		35,202		—
Corporate securities		2,974		—		2,974		—
State and municipal securities		22,155		—		22,155		—
Total assets at fair value	$	62,540	$	—	$	62,540	$	—

No liabilities were recorded at fair value on a recurring basis as of June 30, 2017 and December 31, 2016. There were no significant transfers between levels during the years ended June 30, 2017 and December 31, 2016.

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 June 30, 2017 and December 31, 2016. Assets measured at fair value on a nonrecurring basis are included in the table below.

	Total		Level 1		Level 2		Level 3
June 30, 2017
(dollars in thousands)
Impaired loans	$	456	$	—	$	—	$	456
Foreclosed assets		60		—		—		60
Total assets at fair value	$	516	$	—	$	—	$	516
	Total		Level 1		Level 2		Level 3
December 31, 2016
(dollars in thousands)
Impaired loans	$	466	$	—	$	—	$	466
Foreclosed assets		70		—		—		70
Total assets at fair value	$	536	$	—	$	—	$	536

40

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 8. Financial Instruments, continued

Assets Recorded at Fair Value on a Nonrecurring Basis, continued

For Level 3 assets measured at fair value on a recurring or non-recurring basis as of June 30, 2017 and December 31, 2016, the significant unobservable inputs used in the fair value measurements were as follows:

	Fair Value at June 30, 2017		Fair Value at December 31, 2016		Valuation Technique	Significant Unobservable Inputs	General Range of Significant Unobservable Input Values
Impaired Loans	$	456	$	466	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	$	60	$	70	Appraised Value/Comparable Sales/Other Estimates from Independent Sources	Discounts to reflect current market conditions and estimated costs to sell	0 – 10%

Note 9. Intangible Assets

The following table presents the gross carrying amount and accumulated amortization for the Company’s core deposit intangible assets, which are the only identifiable intangible assets subject to amortization. Core deposit intangibles at June 30, 2017 and December 31, 2016 is as follows:

(dollars in thousands)	June 30, 2017		December 31, 2016
Gross carrying amount	$	2,469	$	2,469
Accumulated amortization		284		142
Net book value	$	2,185	$	2,327

41

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 10. Capital Requirements

The Company meets eligibility criteria of a small bank holding company in accordance with the Federal Reserve Board’s Small Bank Holding Company Policy Statement issued in February 2015, and is no longer obligated to report consolidated regulatory capital. The Bank’s actual capital amounts and ratios are presented in the following table as of June 30, 2017 and December 31, 2016, respectively. 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
June 30, 2017
Total capital (to risk weighted assets)	$	55,028		13.05	%	$	33,726		8.00	%	$	42,157		10.00	%
Tier 1 Capital (to risk weighted assets)	$	51,397		12.19	%	$	25,294		6.00	%	$	33,726		8.00	%
Common Equity Tier 1 (to risk weighted assets)	$	51,397		12.19	%	$	18,971		4.50	%	$	27,402		6.50	%
Tier 1 Capital (to average total assets)	$	51,397		9.38	%	$	21,921		4.00	%	$	27,401		5.0	%
December 31, 2016
Total capital (to risk weighted assets)	$	53,657		12.72	%	$	33,744		8.00	%	$	42,180		10.00	%
Tier 1 Capital (to risk weighted assets)	$	50,111		11.88	%	$	25,308		6.00	%	$	33,744		8.00	%
Common Equity Tier 1 (to risk weighted assets)	$	50,111		11.88	%	$	18,981		4.50	%	$	27,417		6.50	%
Tier 1 Capital (to average total assets)	$	50,111		9.01	%	$	22,242		4.00	%	$	27,803		5.00	%

Note 11. 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 evaluated events occurring subsequent to the balance sheet date through the date these financial statements were issued, determining no events require additional disclosure in these consolidated financial statements.

42

Part I. Financial Information

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

General

The following discussion provides information about the major components of the results of operations and financial condition of the Company. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included in this report.

Critical Accounting Policies

For a discussion of the Company’s critical accounting policies, including its allowance for loan losses, see Note 1 in the Notes to Consolidated Financial Statements above, or the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Results of Operations

Results of Operations for the Three Months ended June 30, 2017 and 2016

The Company recorded pre-tax earnings of $1.2 million for the quarter ended June 30, 2017 compared to $818 thousand for the same period in 2016. Income tax expense increased by $69 thousand from the second quarter of 2016 to 2017 resulting in net income of $803 thousand for the second quarter of 2017 compared to $540 thousand for the same period in 2016. The increase in pre-tax earnings of $332 thousand from the second quarter of 2016 to the second quarter of 2017 was due primarily to the Company’s increased size as a result of the merger with Cardinal.

Total interest income increased by $2.4 million for the quarter ended June 30, 2017 compared to the quarter ended June 30, 2016, while total interest expense increased by $24 thousand over the same period. The increase in interest income was attributable primarily to the merger with Cardinal, which added approximately $157.9 million in loans and $16.0 million in investment securities to the Company’s earning assets. Interest income on loans was also positively impacted by the accretion of purchase accounting discounts applied to the Cardinal loan portfolio at acquisition. Interest expense on deposits increased by $121 thousand due to the addition of interest-bearing deposits from the Cardinal merger. Interest expense on borrowings decreased by $97 thousand compared to the second quarter of 2016 due to the elimination of borrowings in the fourth quarter of 2016.

The provision for loan losses was $50 thousand for the quarter ended June 30, 2017, compared to a negative $8 thousand for the quarter ended June 30, 2016. The reserve for loan losses at June 30, 2017 was approximately 0.85% of total loans, compared to 1.35% at June 30, 2016. The decrease in the reserve percentage was due to the Cardinal acquisition and the application of purchase accounting guidance which required the elimination of Cardinal’s loan loss reserves. Management’s estimate of probable credit losses inherent in the acquired Cardinal loan portfolio was reflected as a purchase discount which will be accreted into income over the remaining life of the acquired loans. Management believes the provision and the resulting allowance for loan losses are adequate.

Total noninterest income was $1.0 million in the second quarter of 2017 compared to $649 thousand in the second quarter of 2016. The increase was due primarily to service charges on deposit accounts, as well as other account-based service charges and fees, which were higher due to the increased number of accounts and deposit balances resulting from the Cardinal merger.

43

Part I. Financial Information

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

Results of Operations, continued

Total noninterest expense increased by $2.3 million for the quarter ended June 30, 2017 compared to the quarter ended June 30, 2016 due to the Cardinal acquisition. Salaries and employee benefit expenses increased by $950 thousand as the number of employees increased from approximately 110 in the second quarter of 2016, to 175 in the second quarter of 2017. Occupancy and equipment expenses increased by $166 thousand from the second quarter of 2016 to 2017, due to the addition of seven Cardinal branch facilities. Merger related expenses totaled $327 thousand in the second quarter of 2017 compared to $68 thousand in the second quarter of 2016. Merger related costs for the quarter ended June 30, 2017 primarily consisted of data processing costs related to the systems conversion that was completed in March 2017. Management believes the majority of all merger-related costs have now been recognized and any remaining charges are not expected to have a significant impact on future earnings.

Results of Operations for the Six Months ended June 30, 2017 and 2016

For the six months ended June 30, 2017, total interest income increased by $4.6 million compared to the six-month period ended June 30, 2016. As noted in the above discussion, the Company’s operations were impacted by the July 1, 2016 completion of the merger with Cardinal. The increase in income was due primarily to the increase in loans resulting from the merger. Interest expense on deposits increased by $216 thousand for the six-month period ended June 30, 2017 due to interest on acquired deposit balances. Overall deposit rates have continued to decrease as higher-yielding time deposits reprice to lower rates or migrate to lower-yielding non-maturity deposits. Interest on borrowings decreased by $248 thousand due to the repayment of fixed-rate borrowings in both the first and fourth quarters of 2016.

The provision for loan losses for the six-month period ended June 30, 2017 was $158 thousand, compared to a negative $95 thousand for the six-month period ended June 30, 2016. The increase in 2017 was due to overall growth in the loan portfolio. The negative provision in 2016 was due to improvement in the bank’s overall asset quality as evidenced by lower levels of charge-offs, non-performing assets, and past-due loans, when compared to prior years. Asset quality has remained relatively consistent over the past year.

Noninterest income increased by $272 thousand for the first six months of 2017, compared to the same period in 2016. Income from service charges and fees increased primarily as result of the merger with Cardinal. Securities gains decreased by $251 thousand due to the liquidation of investment securities in 2016 to fund loan growth and the repayment of borrowings. Without the nonrecurring securities gains, noninterest income would have increased by $523 thousand for the six-month period ended June 30, 2017 compared to the same period last year.

Total noninterest expenses increased by $4.1 million for the six-month period ended June 30, 2017, compared to the same period in 2016. Salaries and employee benefits increased by $2.1 million due primarily to the aforementioned increase in employees resulting from the Cardinal merger. Merger related expenses totaled $642 thousand for the six months ended June 30, 2017 compared to $236 thousand for the six months ended June 30, 2016.

In total, income before taxes increased by $585 thousand over the first six months of 2017 compared to the first six months of 2016. Income tax expense increased by $75 thousand over the prior year, resulting in an increase in net income of $510 thousand for the six months ended June 30, 2017.

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Part I. Financial Information

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

Financial Condition

Total assets decreased by $4.9 million, or 0.87%, from $558.9 million at December 31, 2016 to $554.0 million at June 30, 2017, due primarily to a decrease in interest-bearing deposits. Cash and cash equivalent balances decreased by $10.5 million and investment securities decreased by $2.9 million as balances were used to fund the decrease in deposits as well as an increase in loans. Net loans totaled $417.0 million at June 30, 2017 compared to $408.5 million at December 31, 2016. This represents an increase in net loans of $8.5 million, or 2.07% for the six-month period.

Noninterest bearing deposits increased by $2.8 million from $127.2 million at December 31, 2016 to $130.0 million at June 30, 2017. Interest bearing deposits decreased by $7.3 million over the same time period. The result was a decrease in total deposits of $4.5 million, or 0.90%, from $499.4 million at December 31, 2016 to $494.9 million at June 30, 2017.

Nonperforming assets, including nonaccrual loans, loans past due more than ninety days and foreclosed assets, increased from $4.7 million at December 31, 2016 to $5.8 million at June 30, 2017. Foreclosed assets consists of one property totaling $60 thousand at June 30, 2017. The foreclosed property is being marketed for sale. There were no loans past due more than ninety days and still accruing interest at June 30, 2017 or December 31, 2016.

Nonaccrual loans increased from $4.7 million at December 31, 2016 to $5.8 million at June 30, 2017. During the first six months of 2017, loans totaling $1.7 million were added to nonaccrual status. Loans are generally placed in nonaccrual status when principal or interest has been in default for a period of 90 days or more unless the loan is both well secured and in the process of collection.

The following table summarizes nonperforming assets:

(dollars in thousands)	June 30, 2017			December 31, 2016
Nonperforming Assets
Nonaccrual loans	$	5,762		$	4,664
Loans past due 90 days or more and still accruing interest		—			—
Total nonperforming loans		5,762			4,664
Other real estate owned		60			70
Total nonperforming assets	$	5,822		$	4,734
Nonperforming assets to total assets		1.05	%		0.85	%
Nonperforming loans to total loans		1.37	%		1.13	%

Loans less than 90 days past due may be placed in nonaccrual status if management determines that payment in full of principal or interest is not expected. 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 continues to closely monitor nonperforming assets and their impact on earnings and loan loss reserves.

45

Part I. Financial Information

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

At June 30, 2017, the allowance for loan losses included $587 thousand specifically reserved for impaired loans in the amount of $9.5 million. Based on impairment analysis, loans totaling $4.5 million were also considered to be impaired but did not require a specific reserve or the related reserve had previously been charged-off. Impaired loans at December 31, 2016 totaled $13.3 million, of which $9.0 million required specific reserves of $556 thousand.

Summary of Loan Loss Experience

	Six			Six
	months			months			Year
	ended			ended			ended
	June 30,			June 30,			December 31,
(dollars in thousands)	2017			2016			2016
Total loans outstanding at end of period	$	420,586		$	244,800		$	411,968
Allowance for loan losses, beginning of period	$	3,420		$	3,418		$	3,418
Charge offs:
Commercial & agricultural		(27	)		(19	)		(19	)
Commercial mortgage		(42	)		(11	)		(21	)
Construction & development		—			—			(20	)
Farmland		—			—			—
Residential		(13	)		(25	)		(84	)
Consumer & other		(38	)		(36	)		(70	)
Total charge-offs	$	(120	)	$	(91	)	$	(214	)
Recoveries:
Commercial & agricultural		29			4			8
Commercial mortgage		—			—			—
Construction & development		56			44			98
Farmland		—			—			59
Residential		15			15			22
Consumer & other		10			14			34
Total recoveries		110			77			221
Net charge-offs	$	(10	)	$	(14	)	$	7
Provision (recovery) of allowance		158			(95	)		(5	)
Allowance for loan losses at end of period	$	3,568		$	3,309		$	3,420
Ratios:
Allowance for loan losses to loans at end of period		0.85	%		1.35	%		0.83	%
Net charge-offs to allowance for loan losses		0.28	%		0.42	%		(0.20	)%
Net charge-offs to provisions for loan losses		6.33	%		n/a			n/a

Certain types of loans, such as option ARM (adjustable rate mortgage) products, interest-only loans, subprime loans and loans with initial teaser rates, can have a greater risk of non-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 June 30, 2017 totaled $5.0 million, or 1.20% of total loans. Historical charge-off rates in this category have not varied significantly from other real estate secured loans.

46

Part I. Financial Information

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

Stockholders’ equity totaled $57.1 million at June 30, 2017 compared to $55.5 million at December 31, 2016. The increase in equity resulted from earnings of $1.5 million plus a net change in unrealized depreciation of investment securities classified as available for sale totaling $582 thousand, less the payment of dividends of $402 thousand.

Liquidity

Liquidity is the ability to convert assets to cash to fund depositors’ withdrawals or borrowers’ loans without significant loss. Unsecured federal fund lines available from correspondent banks totaled $28.0 million at June 30, 2017. No balances were outstanding on these lines at June 30, 2017 or December 31, 2016. In addition, the Bank has the ability to borrow up to approximately $139.6 million from the Federal Home Loan Bank, subject to the pledging of collateral. The Bank had no debt outstanding classified as long-term at June 30, 2017 or December 31, 2016.

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.

The Bank’s investment security portfolio also serves as a source of liquidity. 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 with average lives or repricing terms of less than 60 months. These investments are a preferred source of funds because their market value is not as sensitive to changes in interest rates as investments with longer durations.

As a result of the steps described above, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

Capital Resources

A significant measure of the strength of a financial institution is its capital base. Federal regulations have classified and defined capital into the following components: (1) Tier 1 capital, which includes common shareholders’ equity and qualifying preferred equity, and (2) Tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred stock which does not qualify as Tier 1 capital. Financial institutions and holding companies were also subject to the new BASEL III requirements starting the first quarter of 2016. A new part of the capital ratios profile is the Common Equity Tier 1 risk-based ratio. Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require a financial institution to maintain capital as a percentage of its assets, and certain off-balance sheet items adjusted for predefined credit risk factors (risk-adjusted assets).

Regulatory guidelines relating to capital adequacy provide minimum risk-based ratios at the Bank level which assess capital adequacy while encompassing all credit risks, including those related to off-balance sheet activities. At June 30, 2017, the Company and the Bank both exceeded minimum regulatory capital requirements and are considered to be “well capitalized.”

47

Part I. Financial Information

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

Forward-Looking Statements

Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, changes in general economic and business conditions, the Company’s ability to successfully integrate the businesses of Grayson and Cardinal and achieve the expected cost savings, interest rate fluctuations, competition within and from outside the banking industry, new products and services in the banking industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with technology utilized by the Company, changing trends in customer profiles, changes in laws and regulations applicable to the Company and other factors described in Item 1A, “Risk Factors,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

48

Part I. Financial Information

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not required.

49

Part I. Financial Information

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

50

Part II. Other Information

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

In connection with the information set forth in this Form 10-Q, the factors discussed under “Risk Factors” in our Form 10-K for the year ended December 31, 2016 should be considered. These risks could materially and adversely affect our business, financial condition and results of operations. There have been no material changes to the factors discussed in our Form 10-K.

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

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

None

Item 5. Other Information

None

Item 6. Exhibits

31.1	Rule 15(d)-14(a) Certification of Chief Executive Officer.
31.2	Rule 15(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 Quarterly Report on Form 10-Q for the quarter ended June 30, 2017, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Consolidated Financial Statements.

51

Part II. Other Information

SIGNATURES

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

	Parkway Acquisition Corp.
Date: August 14, 2017	By:	/s/ J. Allan Funk
		J. Allan Funk
		President and Chief Executive Officer
	By:	/s/ Blake M. Edwards
		Blake M. Edwards
		Chief Financial Officer

52

Exhibit Index

Exhibit No.	Description
31.1	Rule 15(d)-14(a) Certification of Chief Executive Officer.
31.2	Rule 15(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 Quarterly Report on Form 10-Q for the quarter ended June 30, 2017, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Consolidated Financial Statements.

53