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 March 31, 2020

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)

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

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
None

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 any Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405) of this chapter during the preceding 12 months or for such shorter period that the Registrant was required to submit such files. Yes ☑ No ☐

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

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

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

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

The registrant had 6,067,275 shares of Common Stock, no par value per share, outstanding as of May 14, 2020.

PART I     FINANCIAL INFORMATION

Item 1.	Financial Statements
	Consolidated Balance Sheets—March 31, 2020 (Unaudited) and December 31, 2019 (Audited)	3
	Unaudited Consolidated Statements of Income—Three Months Ended March 31, 2020 and March 31, 2019	4
	Unaudited Consolidated Statements of Comprehensive Income—Three Months Ended March 31, 2020 and March 31, 2019	5
	Unaudited Consolidated Statements of Changes in Stockholders’ Equity—Three Months Ended March 31, 2020 and March 31, 2019	6
	Unaudited Consolidated Statements of Cash Flows—Three Months Ended March 31, 2020 and March 31, 2019	7
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	46
Item 4.	Controls and Procedures	47
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	48
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 3.	Defaults Upon Senior Securities	49
Item 4.	Mine Safety Disclosures	49
Item 5.	Other Information	49
Item 6.	Exhibits	49
Signatures		50

Part I. Financial Information

Item 1. Financial Statements

Parkway Acquisition Corp. and Subsidiary

Consolidated Balance Sheets

March 31, 2020 and December 31, 2019

(dollars in thousands)	March 31,			December 31,
	2020			2019
	(Unaudited)			(Audited)
Assets
Cash and due from banks	$	12,704		$	8,388
Interest-bearing deposits with banks		36,176			34,861
Federal funds sold		204			1,138
Investment securities available for sale		29,170			32,881
Restricted equity securities		2,416			2,394
Loans, net of allowance for loan losses of $4,252 at March 31, 2020 and $3,893 at December 31, 2019		572,939			566,460
Cash value of life insurance		17,963			17,855
Properties and equipment, net		25,950			23,437
Accrued interest receivable		1,936			2,072
Core deposit intangible		2,877			3,070
Goodwill		3,257			3,257
Deferred tax assets, net		970			985
Other assets		9,892			9,492
	$	716,454		$	706,290
Liabilities and Stockholders’ Equity
Liabilities
Deposits
Noninterest-bearing	$	172,533		$	165,900
Interest-bearing		448,772			445,311
Total deposits		621,305			611,211
FHLB advances		10,000			10,000
Accrued interest payable		204			132
Other liabilities		3,474			3,519
		634,983			624,862
Commitments and contingencies (Note 8)
Stockholders’ Equity
Preferred stock, no par value; 5,000,000 shares authorized, none issued		-			-
Common stock, no par value; 25,000,000 shares authorized, 6,067,275 and 6,137,275 issued and outstanding at March 31, 2020 and December 31, 2019, respectively		-			-
Surplus		39,952			40,752
Retained earnings		42,482			41,600
Accumulated other comprehensive loss		(963	)		(924	)
		81,471			81,428
	$	716,454		$	706,290

See Notes to Consolidated Financial Statements

3

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Income

For the Three Months ended March 31, 2020 and 2019

	Three Months Ended
	March 31,
(dollars in thousands except share amounts)	2020		2019
	(Unaudited)		(Unaudited)
Interest income
Loans and fees on loans	$	7,419	$	7,121
Interest-bearing deposits in banks		127		58
Federal funds sold		3		70
Interest on taxable securities		171		276
Dividends		18		14
		7,738		7,539
Interest expense
Deposits		833		590
Interest on borrowings		21		-
		854		590
Net interest income		6,884		6,949
Provision for loan losses		322		238
Net interest income after provision for loan losses		6,562		6,711
Noninterest income
Service charges on deposit accounts		421		360
Other service charges and fees		493		513
Net realized gains (losses) on securities		212		(14	)
Mortgage origination fees		129		84
Increase in cash value of life insurance		108		108
Other income		98		21
		1,461		1,072
Noninterest expenses
Salaries and employee benefits		3,469		3,157
Occupancy and equipment		783		725
Foreclosed asset expense, net		-		1
Data processing expense		416		369
FDIC Assessments		15		72
Advertising		106		135
Bank franchise tax		110		111
Director fees		70		60
Professional fees		142		182
Telephone expense		84		114
Core deposit intangible amortization		193		219
Other expense		541		556
		5,929		5,701
Net income before income taxes		2,094		2,082
Income tax expense		418		417
Net income	$	1,676	$	1,665
Net income per share	$	0.27	$	0.27
Weighted average shares outstanding		6,121,616		6,213,275
Dividends declared per share	$	0.13	$	0.12

See Notes to Consolidated Financial Statements

4

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Comprehensive Income

For the Three Months ended March 31, 2020 and 2019

	Three Months Ended
	March 31,
(dollars in thousands)	2020			2019
	(Unaudited)			(Unaudited)
Net Income	$	1,676		$	1,665
Other comprehensive income (loss)
Unrealized gains (losses) on investment securities available for sale:
Unrealized gains arising during the period		163			703
Tax related to unrealized gains		(34	)		(147	)
Reclassification of net realized (gains) losses during the period		(212	)		14
Tax related to realized gains (losses)		44			(3	)
Total other comprehensive income (loss)		(39	)		567
Total comprehensive income	$	1,637		$	2,232

See Notes to Consolidated Financial Statements

5

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Changes in Stockholders’ Equity

For the Three Months ended March 31, 2020 and 2019 (unaudited)

(dollars in thousands except share amounts)
												Accumulated
												Other
	Common Stock								Retained			Comprehensive
	Shares			Amount		Surplus			Earnings			Loss			Total
Balance, December 31, 2018		6,213,275		$	-	$	41,660		$	35,929		$	(1,967	)	$	75,622
Net income		-			-		-			1,665			-			1,665
Other comprehensive income		-			-		-			-			567			567
Dividends paid ($0.12 per share)		-			-		-			(746	)		-			(746	)
Balance, March 31, 2019		6,213,275		$	-	$	41,660		$	36,848		$	(1,400	)	$	77,108
Balance, December 31, 2019		6,137,275		$	-	$	40,752		$	41,600		$	(924	)	$	81,428
Net income		-			-		-			1,676			-			1,676
Other comprehensive loss		-			-		-			-			(39	)		(39	)
Dividends paid ($0.13 per share)		-			-		-			(794	)		-			(794	)
Common stock repurchased		(70,000	)		-		(800	)		-			-			(800	)
Balance, March 31, 2020		6,067,275		$	-	$	39,952		$	42,482		$	(963	)	$	81,471

See Notes to Consolidated Financial Statements

6

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Cash Flows

For the Three Months ended March 31, 2020 and 2019

	Three Months Ended
	March 31,
(dollars in thousands)	2020			2019
	(Unaudited)			(Unaudited)
Cash flows from operating activities
Net income	$	1,676		$	1,665
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		339			303
Amortization of core deposit intangible		193			219
Accretion of loan discount and deposit premium, net		(506	)		(643	)
Provision for loan losses		322			238
Deferred income taxes		25			361
Net realized (gains) losses on securities		(212	)		14
Accretion of discount on securities, net of amortization of premiums		75			125
Deferred compensation		(1	)		(5	)
Changes in assets and liabilities:
Cash value of life insurance		(108	)		(108	)
Accrued interest receivable		136			105
Other assets		(421	)		467
Accrued interest payable		72			89
Other liabilities		(23	)		(121	)
Net cash provided by operating activities		1,567			2,709
Cash flows from investing activities
Activity in available for sale securities:
Purchases		(4,748	)		-
Sales		7,798			-
Maturities/calls/paydowns		749			1,399
Purchases of restricted equity securities		(22	)		-
Net decrease (increase) in loans		(6,355	)		3,280
Proceeds from sale of foreclosed assets		-			753
Purchases of property and equipment		(2,852	)		(510	)
Net cash provided by (used in) investing activities		(5,430	)		4,922
Cash flows from financing activities
Net increase (decrease) in deposits		10,154			(8,196	)
Common stock repurchased		(800	)		-
Dividends paid		(794	)		(746	)
Net cash provided by (used in) financing activities		8,560			(8,942	)
Net increase (decrease) in cash and cash equivalents		4,697			(1,311	)
Cash and cash equivalents, beginning		44,387			40,007
Cash and cash equivalents, ending	$	49,084		$	38,696

See Notes to Consolidated Financial Statements

7

Parkway Acquisition Corp. and Subsidiary

Consolidated Statements of Cash Flows, continued

For the Three Months ended March 31, 2020 and 2019

	Three Months Ended
	March 31,
(dollars in thousands)	2020			2019
	(Unaudited)			(Unaudited)
Supplemental disclosure of cash flow information
Interest paid	$	782		$	501
Taxes paid	$	-		$	-
Supplemental disclosure of noncash investing activities
Effect on equity of change in net unrealized (gain) loss on available for sale securities	$	(39	)	$	567
Business combinations
Goodwill recorded	$	-		$	59

See Notes to Consolidated Financial Statements

8

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

On March 1, 2018, Parkway entered into a definitive agreement pursuant to which Parkway acquired Great State Bank (“Great State”), based in Wilkesboro, North Carolina. The agreement provided for the merger of Great State with and into the Bank, with the Bank as the surviving bank (the “Great State merger”). The transaction closed and the merger became effective on July 1, 2018. Each share of Great State common stock was converted into the right to receive 1.21 shares of Parkway common stock. The Company issued 1,191,899 shares and recognized $15.5 million in surplus in the Great State merger. Parkway was considered the acquiror and Great State was considered the acquiree in the transaction for accounting purposes.

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

The consolidated financial statements as of March 31, 2020 and for the periods ended March 31, 2020 and 2019 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, 2019, included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019. The results of operations for the three-month ended March 31, 2020 are not necessarily indicative of the results to be expected for the full year.

9

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, such as the recoverability of intangible assets and other-than-temporary impairment of investment securities, involve a higher degree of complexity and require management to make difficult and subjective judgements that 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 (“GAAP”) 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.

10

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.  The amortization of premiums and accretion of discounts are recognized in interest income using the effective interest method over the period to maturity for discounts and the earlier of call date or maturity for premiums.

11

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.

12

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.

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

13

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 Cardinal merger, both the Bank 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 the Bank’s and Floyd’s plans were amended to freeze benefit accruals for all eligible employees prior to the effective date of the Cardinal merger. The Bank’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.

Goodwill and Other Intangible Assets

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

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

14

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Revenue Recognition

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

Service Charges on Deposit Accounts - Service charges on deposit accounts consist of monthly service fees, overdraft and nonsufficient funds fees, ATM fees, wire transfer fees and other deposit account related fees. The Company’s performance obligation for monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Wire transfer fees, overdraft and nonsufficient funds fees, and other deposit account related fees are transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time.

Other Service Charges and Fees - Other service charges include safety deposit box rental fees, check ordering charges, and other service charges. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation. Check ordering charges are transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time.

Credit and Debit Card Fees - Credit and debit card fees are primarily comprised of interchange fee income and merchant services income. Interchange fees are earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa or Mastercard. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. The Company’s performance obligation for interchange fee income and merchant services income are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.

Insurance and Investment - Insurance income primarily consists of commissions received on insurance product sales. The Company acts as an intermediary between the Company’s customer and the insurance carrier. The Company’s performance obligation is generally satisfied upon the issuance of the insurance policy. Shortly after the insurance policy is issued, the carrier remits the commission payment to the Company, and the Company recognizes the revenue. Investment income consists of recurring revenue streams such as commissions from sales of mutual funds and other investments. Commissions from the sale of mutual funds and other investments are recognized on trade date, which is when the Company has satisfied its performance obligation. The Company also receives periodic service fees (i.e., trailers) from mutual fund companies typically based on a percentage of net asset value. Trailer revenue is recorded over time, usually monthly or quarterly, as net asset value is determined.

15

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

Leases

In February 2016, the FASB amended the Leases topic of the ASC to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions.  The amendments were effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.

Effective January 1, 2019, we adopted the guidance using the modified retrospective method and practical expedients for transition. The practical expedients allow us to largely account for our existing leases consistent with current guidance except for the incremental balance sheet recognition for lessees. We have performed an evaluation of our leasing contracts and activities. We have developed our methodology to estimate the right-of use assets and lease liabilities, which is based on the present value of lease payments.  There was not a material change to the timing of expense recognition.  See additional discussion of leases in Note 7 to the consolidated financial statements.

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.

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.

16

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

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

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:

	Unrealized Gains
	And (Losses)
(dollars in thousands)	On Available for			Defined Benefit
	Sale Securities			Pension Items			Total
Balance, December 31, 2018	$	(929	)	$	(1,038	)	$	(1,967	)
Other comprehensive income before reclassifications		556			-			556
Amounts reclassified from accumulated other comprehensive income, net of tax		11			-			11
Balance March 31, 2019	$	(362	)	$	(1,038	)	$	(1,400	)
Balance, December 31, 2019	$	51		$	(975	)	$	(924	)
Other comprehensive income before reclassifications		129			-			129
Amounts reclassified from accumulated other comprehensive income, net of tax		(168	)		-			(168	)
Balance March 31, 2020	$	12		$	(975	)	$	(963	)

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 9. 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.

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

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

In June 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-13 to change the accounting for credit losses and modify the impairment model for certain debt securities.  The Company will apply the amendments to the ASU through a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption. We are currently evaluating the impact of the ASU on our consolidated financial statements. We expect the ASU will result in an increase in the recorded allowance for loan losses given the change to estimated losses over the contractual life of the loans adjusted for expected prepayments. The majority of the increase results from longer duration portfolios.  In addition to our allowance for loan losses, we will also record an allowance for credit losses on debt securities instead of applying the impairment model currently utilized. The amount of the adjustments will be impacted by each portfolio’s composition and credit quality at the adoption date as well as economic conditions and forecasts at that time.  In July 2019, the FASB proposed changes to the effective date of the ASU for smaller reporting companies, as defined by the SEC, and other non-SEC reporting entities. The proposal delayed the effective date to fiscal years beginning after December 31, 2022, including interim periods within those fiscal periods.  On October 16, 2019 the proposed changes were approved by the FASB.  As the Company is a smaller reporting company, the delay is applicable to the Company. 

In November 2019, the FASB issued guidance that addresses issues raised by stakeholders during the implementation of ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments affect a variety of Topics in the Accounting Standards Codification. For entities that have not yet adopted the amendments in ASU 2016-13, the amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal. Early adoption is permitted in any interim period as long as an entity has adopted the amendments in ASU 2016-13. The Company does not expect these amendments to have a material effect on its financial statements.

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, 2022.  Early adoption is permitted for interim and annual goodwill impairment tests performed on testing dates after January 1, 2017.

In May 2019, the FASB issued guidance to provide entities with an option to irrevocably elect the fair value option, applied on an instrument-by-instrument basis for eligible instruments, upon adoption of ASU 2016-13, Measurement of Credit Losses on Financial Instruments. The amendments will be effective for the Company for reporting periods beginning after December 15, 2022. The Company does not expect these amendments to have a material effect on its financial statements.

In November 2019, the FASB issued guidance to defer the effective dates for private companies, not-for-profit organizations, and certain smaller reporting companies applying standards on current expected credit losses (“CECL”). Since the Company is a smaller reporting company, the new effect date for CECL will be fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.

In December 2019, the FASB issued guidance to simplify accounting for income taxes by removing specific technical exceptions that often produce information investors have a hard time understanding. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The amendments are effective for fiscal years beginning after December 15, 2020, 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.

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 2020, the FASB issued guidance to address accounting for the transition into and out of the equity method and measuring certain purchased options and forward contracts to acquire investments. The amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted, including early adoption in an interim period. The Company does not expect these amendments to have a material effect on its financial statements.

In February 2020, the FASB issued guidance to add and amend SEC paragraphs in the ASC to reflect the issuance of SEC Staff Accounting Bulletin No. 119 related to the new credit losses standard and comments by the SEC staff related to the revised effective date of the new leases standard. The amendments were effective upon issuance. The Company does not expect these amendments to have a material effect on its financial statements.

In March 2020, the FASB issued guidance that makes narrow-scope improvements to various aspects of the financial instrument guidance, including the CECL guidance issued in 2016. Since the Company is a smaller reporting company, it should adopt the amendments in ASU 2016-13 during 2023. 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. 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 March 31, 2020 and December 31, 2019 follow:

(dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
March 31, 2020
Available for sale:
Mortgage-backed securities	$	16,926	$	320	$	(46	)	$	17,200
Corporate securities		1,500		-		(276	)		1,224
State and municipal securities		10,729		46		(29	)		10,746
	$	29,155	$	366	$	(351	)	$	29,170
December 31, 2019
Available for sale:
Mortgage-backed securities	$	19,540	$	61	$	(97	)	$	19,504
Corporate securities		1,500		-		(67	)		1,433
State and municipal securities		11,777		168		(1	)		11,944
	$	32,817	$	229	$	(165	)	$	32,881

Restricted equity securities totaled $2.4 million at March 31, 2020 and December 31, 2019, respectively.  Restricted equity securities consist of investments in stock of the Federal Home Loan Bank of Atlanta (“FHLB”), CBB Financial Corp., Pacific Coast Bankers Bank, and the Federal Reserve Bank of Richmond, all of which are carried at cost.  All of these entities are upstream correspondents of the Bank.  The FHLB requires financial institutions to make equity investments in the FHLB in order to borrow money.  The Bank is required to hold that stock so long as it borrows from the FHLB.  The Federal Reserve requires banks to purchase stock as a condition for membership in the Federal Reserve System.  The Bank’s stock in CBB Financial Corp. and Pacific Coast Bankers Bank is restricted only in the fact that the stock may only be repurchased by the respective banks.

The following tables details unrealized losses and related fair values in the Company’s 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 March 31, 2020 and December 31, 2019.

	Less Than 12 Months					12 Months or More					Total
(dollars in thousands)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
March 31, 2020
Available for sale:
Mortgage-backed securities	$	3,942	$	(46	)	$	-	$	-		$	3,942	$	(46	)
Corporate securities		-		-			1,224		(276	)		1,224		(276	)
State and municipal securities		1,886		(29	)		-		-			1,886		(29	)
Total securities available for sale	$	5,828	$	(75	)	$	1,224	$	(276	)	$	7,052	$	(351	)
December 31, 2019
Available for sale:
Mortgage-backed securities	$	8,625	$	(97	)	$	-	$	-		$	8,625	$	(97	)
Corporate securities		-		-			1,433		(67	)		1,433		(67	)
State and municipal securities		1,010		(1	)		-		-			1,010		(1	)
Total securities available for sale	$	9,635	$	(98	)	$	1,433	$	(67	)	$	11,068	$	(165	)

20

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 2. Investment Securities, continued

At March 31, 2020, 7 debt securities with unrealized losses had depreciated 4.73 percent from their total amortized cost basis. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, and the financial condition and near-term prospects of the issuer. The relative significance of these and other factors will vary on a case by case basis. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the results of reviews of the issuer’s financial condition and the issuer’s anticipated ability to pay the contractual cash flows of the investments. Since the Company intends to hold all of its investment securities until maturity, and it is more likely than not that the Company will not have to sell any of its investment securities before unrealized losses have been recovered, and the Company expects to recover the entire amount of the amortized cost basis of all its securities, none of the securities are deemed other than temporarily impaired at March 31, 2020. Management continues to monitor all of these securities with a high degree of scrutiny. There can be no assurance that the Company will not conclude in future periods that conditions existing at that time indicate some or all of these securities are other than temporarily impaired, which could require a charge to earnings in such periods.

Proceeds from the sale of investment securities available for sale were $7.8 million for the three-month period ended March 31, 2020. Gross realized losses for the three-month period ended March 31, 2019 resulted from investment securities available for sale being called prior to their maturity date. Gross proceeds from called securities totaled $10 thousand and $220 thousand for the three-month periods ended March 31, 2020 and 2019, respectively. 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 three-month periods ended March 31, 2020 and 2019 are as follows:

	Three Months Ended March 31
(dollars in thousands)	2020		2019
Realized gains	$	212	$	-
Realized losses		-		(14	)
	$	212	$	(14	)

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 March 31, 2020, were as follows:

(dollars in thousands)	Amortized Cost		Fair Value
Due in one year or less	$	2,754	$	2,754
Due after one year through five years		6,488		6,523
Due after five years through ten years		9,395		9,140
Due after ten years		10,518		10,753
	$	29,155	$	29,170

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 $16.0 million and $15.5 million at March 31, 2020 and December 31, 2019, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.

21

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 3. Loans Receivable

The major components of loans in the consolidated balance sheets at March 31, 2020 and December 31, 2019 are as follows:

(dollars in thousands)	2020			2019
Construction & development	$	38,102		$	39,649
Farmland		33,894			34,166
Residential		265,599			253,674
Commercial mortgage		185,779			190,817
Commercial & agricultural		34,298			32,426
Consumer & other		19,519			19,621
Total loans		577,191			570,353
Allowance for loan losses		(4,252	)		(3,893	)
Loans, net of allowance for loan losses	$	572,939		$	566,460

As of March 31, 2020 and December 31, 2019, substantially all of the Bank’s residential 1-4 family loans were pledged as collateral for borrowing lines at the Federal Home Loan Bank of Atlanta.

Note 4. 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.

22

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 4. Allowance for Loan Losses and Impaired Loans, continued

Allowance for Loan Losses, continued

The following table presents activity in the allowance by loan category and information on the loans evaluated individually for impairment and collectively evaluated for impairment as of March 31, 2020 and December 31, 2019:

Allowance for Loan Losses and Recorded Investment in Loans

(dollars in thousands)	Construction & Development		Farmland			Residential			Commercial Mortgage			Commercial & Agricultural			Consumer & Other			Total
For the Three Months Ended March 31, 2020
Allowance for loan losses:
Balance, December 31, 2019	$	305	$	487		$	1,822		$	924		$	211		$	144		$	3,893
Charge-offs		-		-			-			-			-			(53	)		(53	)
Recoveries		4		-			8			65			2			11			90
Provision		32		(22	)		168			65			33			46			322
Balance, March 31, 2020	$	341	$	465		$	1,998		$	1,054		$	246		$	148		$	4,252
For the Three Months Ended March 31, 2019
Allowance for loan losses:
Balance, December 31, 2018	$	246	$	385		$	1,807		$	682		$	281		$	94		$	3,495
Charge-offs		-		(14	)		(12	)		(41	)		(44	)		(52	)		(163	)
Recoveries		-		-			7			28			2			11			48
Provision		22		36			(69	)		28			146			75			238
Balance, March 31, 2019	$	268	$	407		$	1,733		$	697		$	385		$	128		$	3,618
March 31, 2020
Allowance for loan losses:
Ending Balance	$	341	$	465		$	1,998		$	1,054		$	246		$	148		$	4,252
Ending balance: individually evaluated for impairment	$	-	$	-		$	-		$	-		$	-		$	-		$	-
Ending balance: collectively evaluated for impairment	$	341	$	465		$	1,998		$	1,054		$	246		$	148		$	4,252
Ending balance: purchased credit impaired loans	$	-	$	-		$	-		$	-		$	-		$	-		$	-
Loans outstanding:
Ending Balance	$	38,102	$	33,894		$	265,599		$	185,779		$	34,298		$	19,519		$	577,191
Ending balance: individually evaluated for impairment	$	-	$	2,858		$	908		$	-		$	-		$	-		$	3,766
Ending balance: collectively evaluated for impairment	$	38,102	$	31,036		$	264,544		$	185,465		$	34,152		$	19,519		$	527,818
Ending balance: purchased credit impaired loans	$	-	$	-		$	147		$	314		$	146		$	-		$	607
December 31, 2019
Allowance for loan losses:
Ending Balance	$	305	$	487		$	1,822		$	924		$	211		$	144		$	3,893
Ending balance: individually evaluated for impairment	$	-	$	-		$	-		$	-		$	-		$	-		$	-
Ending balance: collectively evaluated for impairment	$	305	$	487		$	1,822		$	924		$	211		$	144		$	3,893
Ending balance: purchased credit impaired loans	$	-	$	-		$	-		$	-		$	-		$	-		$	-
Loans outstanding:
Ending Balance	$	39,649	$	34,166		$	253,674		$	190,817		$	32,426		$	19,621		$	570,353
Ending balance: individually evaluated for impairment	$	-	$	3,240		$	909		$	-		$	-		$	-		$	4,149
Ending balance: collectively evaluated for impairment	$	39,649	$	30,926		$	252,615		$	190,496		$	32,280		$	19,621		$	565,587
Ending balance: purchased credit impaired loans	$	-	$	-		$	150		$	321		$	146		$	-		$	617

As of March 31, 2020 and December 31, 2019, the Bank had no unallocated reserves included in the allowance for loan losses.

23

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 4. 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 March 31, 2020 and December 31, 2019, respectively, the Bank had no loans graded “Doubtful” or “Loss” included in the balance of total loans outstanding.

During the first quarter of 2020, Management evaluated loan grades included in the “Watch” category and determined that loans associated with a certain grade should be classified as “Pass” credits. As a result of this reclassification, the loan grades previously reported as “Watch” & “Pass” of December 31, 2019 have been reclassified as follows:

	Loan Grades
(dollars in thousands)	Watch As Reported		Reclass			Watch Adjusted
December 31, 2019
Real Estate Secured:
Construction & development	$	4,801	$	(4,244	)	$	557
Farmland		4,059		(2,565	)		1,494
Residential		19,887		(19,349	)		538
Commercial mortgage		21,960		(19,557	)		2,403
Non-Real Estate Secured:
Commercial & agricultural		4,346		(3,805	)		541
Consumer & other		300		(300	)		-
Total	$	55,353	$	(49,820	)	$	5,533

	Loan Grades
(dollars in thousands)	Pass As Reported		Reclass		Pass Adjusted
December 31, 2019
Real Estate Secured:
Construction & development	$	34,701	$	4,244	$	38,945
Farmland		22,969		2,565		25,534
Residential		231,629		19,349		250,978
Commercial mortgage		163,584		19,557		183,141
Non-Real Estate Secured:
Commercial & agricultural		27,503		3,805		31,308
Consumer & other		19,314		300		19,614
Total	$	499,700	$	49,820	$	549,520

These reclassifications did not have an impact on our calculation of the allowance for loan losses or our provision expense.

24

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 4. Allowance for Loan Losses and Impaired Loans, continued

Allowance for Loan Losses, continued

The following table lists the loan grades utilized by the Bank and the corresponding total of outstanding loans in each category as of March 31, 2020 and December 31, 2019 (reclassified as noted above):

Credit Risk Profile by Internally Assigned Grades

	Loan Grades
(dollars in thousands)	Pass		Watch		Special Mention		Substandard		Total
March 31, 2020
Real Estate Secured:
Construction & development	$	37,412	$	76	$	-	$	614	$	38,102
Farmland		26,298		817		731		6,048		33,894
Residential		261,138		654		1,741		2,066		265,599
Commercial mortgage		178,154		2,288		837		4,500		185,779
Non-Real Estate Secured:
Commercial & agricultural		33,093		503		147		555		34,298
Consumer & other		19,517		-		-		2		19,519
Total	$	555,612	$	4,338	$	3,456	$	13,785	$	577,191
December 31, 2019
Real Estate Secured:
Construction & development	$	38,945	$	557	$	-	$	147	$	39,649
Farmland		25,534		1,494		673		6,465		34,166
Residential		250,978		538		176		1,982		253,674
Commercial mortgage		183,141		2,403		930		4,343		190,817
Non-Real Estate Secured:
Commercial & agricultural		31,308		541		103		474		32,426
Consumer & other		19,614		-		-		7		19,621
Total	$	549,520	$	5,533	$	1,882	$	13,418	$	570,353

25

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 4. Allowance for Loan Losses and Impaired Loans, continued

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

The following table presents an age analysis of nonaccrual and past due loans by category as of March 31, 2020 and December 31, 2019:

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
March 31, 2020
Real Estate Secured:
Construction & development	$	-	$	-	$	10	$	10	$	38,092	$	38,102	$	-	$	10
Farmland		1,218		-		116		1,334		32,560		33,894		-		3,734
Residential		257		47		258		562		265,037		265,599		-		364
Commercial mortgage		220		-		184		404		185,375		185,779		-		378
Non-Real Estate Secured:
Commercial & agricultural		195		-		189		384		33,914		34,298		-		191
Consumer & other		22		-		2		24		19,495		19,519		-		2
Total	$	1,912	$	47	$	759	$	2,718	$	574,473	$	577,191	$	-	$	4,679
December 31, 2019
Real Estate Secured:
Construction & development	$	-	$	-	$	10	$	10	$	39,639	$	39,649	$	-	$	10
Farmland		893		-		971		1,864		32,302		34,166		-		4,192
Residential		292		48		365		705		252,969		253,674		-		412
Commercial mortgage		185		-		-		185		190,632		190,817		-		198
Non-Real Estate Secured:
Commercial & agricultural		135		8		163		306		32,120		32,426		-		165
Consumer & other		2		6		2		10		19,611		19,621		-		2
Total	$	1,507	$	62	$	1,511	$	3,080	$	567,273	$	570,353	$	-	$	4,979

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.

26

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 4. Allowance for Loan Losses and Impaired Loans, continued

Impaired Loans, continued

As of March 31, 2020 and December 31, 2019, respectively, the recorded investment in impaired loans totaled $7.7 million and $7.8 million. The total amount of collateral-dependent impaired loans at March 31, 2020 and December 31, 2019, respectively, was $2.5 million and $2.9 million. As of March 31, 2020 and December 31, 2019, respectively, $3.8 million and $4.1 million of the recorded investment in impaired loans did not have a related allowance. The Bank had $5.2 million and $4.8 million in troubled debt restructured loans included in impaired loans at March 31, 2020 and December 31, 2019, 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.

Management collectively evaluates performing TDRs with a loan balance of $250,000 or less for impairment.  As of March 31, 2020 and December 31, 2019, respectively, $3.9 million and $3.6 million of TDRs included in the following table were evaluated collectively for impairment and were deemed to have $190 thousand and $174 thousand of related allowance.

The following table is a summary of information related to impaired loans as of March 31, 2020 and December 31, 2019:

Impaired Loans

							Three months ended
(dollars in thousands)	Recorded Investment1		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
March 31, 2020
With no related allowance recorded:
Construction & development	$	-	$	-	$	-	$	-	$	-
Farmland		2,858		2,858		-		3,049		5
Residential		908		908		-		908		10
Commercial mortgage		-		-		-		-		-
Commercial & agricultural		-		-		-		-		-
Consumer & other		-		-		-		-		-
Subtotal		3,766		3,766		-		3,957		15
With an allowance recorded:
Construction & development		414		414		21		420		6
Farmland		150		150		2		150		1
Residential		3,319		3,469		165		3,332		46
Commercial mortgage		10		55		1		11		1
Commercial & agricultural		30		30		1		30		-
Consumer & other		2		2		-		3		-
Subtotal		3,925		4,120		190		3,946		54
Totals:
Construction & development		414		414		21		420		6
Farmland		3,008		3,008		2		3,199		6
Residential		4,227		4,377		165		4,240		56
Commercial mortgage		10		55		1		11		1
Commercial & agricultural		30		30		1		30		-
Consumer & other		2		2		-		3		-
Total	$	7,691	$	7,886	$	190	$	7,903	$	69

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

27

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 4. Allowance for Loan Losses and Impaired Loans, continued

Impaired Loans, continued

(dollars in thousands)	Recorded Investment1		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
December 31, 2019
With no related allowance recorded:
Construction & development	$	-	$	-	$	-	$	-	$	-
Farmland		3,240		3,240		-		3,505		25
Residential		909		909		-		921		40
Commercial mortgage		-		-		-		-		-
Commercial & agricultural		-		-		-		-		-
Consumer & other		-		-		-		-		-
Subtotal		4,149		4,149		-		4,426		65
With an allowance recorded:
Construction & development		72		72		3		76		6
Farmland		150		150		2		1,545		70
Residential		3,345		3,495		166		4,161		225
Commercial mortgage		11		56		1		268		11
Commercial & agricultural		31		31		1		34		2
Consumer & other		3		3		1		4		-
Subtotal		3,612		3,807		174		6,088		314
Totals:
Construction & development		72		72		3		76		6
Farmland		3,390		3,390		2		5,050		95
Residential		4,254		4,404		166		5,082		265
Commercial mortgage		11		56		1		268		11
Commercial & agricultural		31		31		1		34		2
Consumer & other		3		3		1		4		-
Total	$	7,761	$	7,956	$	174	$	10,514	$	379

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.

28

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 4. 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 March 31, 2020 and March 31, 2019:

For the Three Months Ended March 31, 2020

(dollars in thousands)	TDRs identified during the period						TDRs identified in the last twelve months that subsequently defaulted(1)
	Number of contracts		Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment		Number of contracts		Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment
Construction & development		1	$	344	$	344		-	$	-	$	-
Farmland		-		-		-		-		-		-
Residential		-		-		-		-		-		-
Commercial mortgage		-		-		-		-		-		-
Commercial & agricultural		-		-		-		-		-		-
Consumer & other		-		-		-		-		-		-
Total		1	$	344	$	344		-	$	-	$	-

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

During the three months ended March 31, 2020, one loan was modified that was considered to be a TDR.  For this one loan, a term concession was granted.  No TDRs identified in the last twelve months subsequently defaulted in the quarter ended March 31, 2020.

For the Three Months Ended March 31, 2019

(dollars in thousands)	TDRs identified during the period						TDRs identified in the last twelve months that subsequently defaulted(1)
	Number of contracts		Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment		Number of contracts		Pre- modification outstanding recorded investment		Post- modification outstanding recorded investment
Construction & development		-	$	-	$	-		-	$	-	$	-
Farmland		-		-		-		-		-		-
Residential		1		117		129		-		-		-
Commercial mortgage		-		-		-		-		-		-
Commercial & agricultural		-		-		-		-		-		-
Consumer & other		-		-		-		-		-		-
Total		1	$	117	$	129		-	$	-	$	-

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

During the three months ended March 31, 2019, one loan was modified that was considered to be a TDR. Term concessions were granted and additional funds were advanced for legal expenses and property taxes. No TDRs identified in the last twelve months subsequently defaulted in the quarter ended March 31, 2019.

29

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 4. Allowance for Loan Losses and Impaired Loans, continued

Purchased Credit Impaired Loans

During 2018, the Company acquired loans as a result of the Great State merger, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans at March 31, 2020 and December 31, 2019 are as follows:

(dollars in thousands)	2020		2019
Residential	$	147	$	150
Commercial mortgage		314		321
Commercial & agricultural		146		146
Outstanding balance	$	607	$	617
Carrying amount	$	607	$	617

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

There were no purchased credit impaired loans acquired during the three months ended March 31, 2020 and during the year ended December 31, 2019.

Income is not recognized on purchased credit impaired loans if the Company cannot reasonably estimate cash flows expected to be collected. The carrying amounts of such loans as of March 31, 2020 and December 31, 2019 are as follows:

(dollars in thousands)	2020		2019
Loans at beginning of year	$	617	$	714
Loans purchased during the year		-		-
Loans at end of period	$	607	$	617

30

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 5. 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 three-month periods ended March 31, 2020 and 2019.

	Three Months Ended March 31,
(dollars in thousands)	2020			2019
Interest cost	$	41		$	46
Expected return on plan assets		(157	)		(138	)
Recognized net actuarial loss		7			10
Net periodic benefit cost	$	(109	)	$	(82	)

It has been Company 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, 2019 and there is no required contribution for 2020. Based on this we do not anticipate making a contribution to the plan in 2020.

Note 6. Goodwill and Intangible Assets

Goodwill

The change in goodwill during the three-month period ended March 31, 2020 and for the year ended December 31, 2019 is as follows:

	March 31,		December 31,
(dollars in thousands)	2020		2019
Beginning of year	$	3,257	$	3,198
Measurement period adjustment		-		59
Impairment		-		-
End of the period	$	3,257	$	3,257

Intangible Assets

The following table presents the activity for the Company’s core deposit intangible assets, which are the only identifiable intangible assets subject to amortization. Core deposit intangibles at March 31, 2020 and December 31, 2019 are as follows:

	March 31,			December 31,
(dollars in thousands)	2020			2019
Balance at beginning of year, net	$	3,070		$	3,892
Amortization expense		(193	)		(822	)
Net book value	$	2,877		$	3,070

Aggregate amortization expense was $193 thousand and $219 thousand for the three-month periods ended March 31, 2020 and 2019, respectively.

31

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 7. Leases

On January 1, 2019, the Company adopted ASU No. 2016-02 “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842. We adopted the guidance using the modified retrospective method and practical expedients for transition. The practical expedients allow us to largely account for our existing leases consistent with current guidance except for the incremental balance sheet recognition for lessees. We have performed an evaluation of our leasing contracts and activities. We have developed our methodology to estimate the right-of use assets and lease liabilities, which is based on the present value of lease payments. Prior to adoption, all of the Company’s leases were classified as operating leases and remain operating leases at adoption.

Contracts that commence subsequent to adoption are evaluated to determine whether they are or contain a lease in accordance with Topic 842. The Company has elected the practical expedient provided by Topic 842 not to allocate consideration in a contract between lease and non-lease components. The Company also elected, as provided by the standard, not to recognize right-of-use assets and lease liabilities for short-term leases, defined by the standard as leases with terms of 12 months or less. Since adoption, the Company entered into a new operating lease during 2019 and recognized right-of-use assets and lease liabilities.

Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows.  Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease.  For our incremental borrowing rate, we used the Federal Home Loan Bank available at the time of lease inception.  The right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.  The contracts in which the Company is lessee are with parties external to the Company and not related parties.  The Company’s lease right-of-use assets are included in other assets and the lease liabilities are included in other liabilities.  The following tables present information about leases:

	March 31,			December 31,
(dollars in thousands)	2020			2019
Lease liabilities	$	708		$	729
Right-of-use assets	$	708		$	729
Weighted average remaining lease term (years)		7.93			8.06
Weighted average discount rate		2.65	%		2.39	%

	Three Months Ended March 31,
(dollars in thousands)	2020		2019
Lease Expense
Operating lease expense	$	25	$	11
Short-term lease expense		16		38
Total lease expense	$	41	$	49
Cash paid for amounts included in lease liabilities	$	25	$	11

The following table presents a maturity schedule of undiscounted cash flows that contribute to the lease liabilities:

(dollars in thousands)
Nine months ending December 31, 2020	$	98
Twelve months ending December 31, 2021		128
Twelve months ending December 31, 2022		97
Twelve months ending December 31, 2023		66
Twelve months ending December 31, 2024		68
Thereafter		330
Total undiscounted cash flows	$	787
Less discount		(79	)
Lease liabilities	$	708

32

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 8. 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 March 31, 2020 and December 31, 2019 is as follows:

	March 31,		December 31,
(dollars in thousands)	2020		2019
Commitments to extend credit	$	105,654	$	95,190
Standby letters of credit		1,243		1,313
	$	106,897	$	96,503

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 3. 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.

33

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 9. Financial Instruments

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments not recorded at fair value on a recurring basis as of March 31, 2020 and December 31, 2019. 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 non-marketable equity securities such as Federal Home Loan Bank and Federal Reserve Bank stock, the carrying amount is a reasonable estimate of the fair value as these securities can only be redeemed or sold at their par value and only to the respective issuing government supported institution or to another member institution. For financial liabilities such as noninterest-bearing demand, interest-bearing demand, and savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.

For loans, the carrying amount is net of unearned income and the allowance for loan losses. In accordance with the prospective adoption of ASU No. 2016-01, the fair value of loans as of March 31, 2020 and December 31, 2019, was measured using an exit price notion.

					Fair Value Measurements
					Quoted Prices in Active Markets for Identical Assets or		Significant Other Observable		Significant Unobservable
(dollars in thousands)	Carrying Amount		Fair Value		Liabilities (Level 1)		Inputs (Level 2)		Inputs (Level 3)
March 31, 2020
Financial Instruments – Assets
Net Loans	$	572,939	$	560,260	$	-	$	560,058	$	202
Financial Instruments – Liabilities
Time Deposits		189,347		191,921		-		191,921		-
FHLB Advances		10,000		9,677		-		9,677		-
December 31, 2019
Financial Instruments – Assets
Net Loans	$	566,460	$	557,054	$	-	$	556,851	$	203
Financial Instruments – Liabilities
Time Deposits		191,988		192,365		-		192,365		-
FHLB Advances		10,000		10,021		-		10,021		-

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.

34

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 9. 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.

Impaired 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 March 31, 2020, 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.

35

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 9. Financial Instruments, continued

Assets Recorded at Fair Value on a Recurring Basis

(dollars in thousands)	Total		Level 1		Level 2		Level 3
March 31, 2020
Investment securities available for sale
Mortgage-backed securities	$	17,200	$	-	$	17,200	$	-
Corporate securities		1,224		-		1,224		-
State and municipal securities		10,746		-		10,746		-
Total assets at fair value	$	29,170	$	-	$	29,170	$	-
December 31, 2019
Investment securities available for sale
Mortgage-backed securities	$	19,504	$	-	$	19,504	$	-
Corporate securities		1,433		-		1,433		-
State and municipal securities		11,944		-		11,944		-
Total assets at fair value	$	32,881	$	-	$	32,881	$	-

No liabilities were recorded at fair value on a recurring basis as of March 31, 2020 and December 31, 2019. There were no significant transfers between levels during the three-month period ended March 31, 2020 and the year ended December 31, 2019.

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 March 31, 2020 and December 31, 2019. Assets measured at fair value on a nonrecurring basis are included in the table below.

(dollars in thousands)	Total		Level 1		Level 2		Level 3
March 31, 2020
Impaired loans	$	202	$	-	$	-	$	202
Total assets at fair value	$	202	$	-	$	-	$	202

(dollars in thousands)	Total		Level 1		Level 2		Level 3
December 31, 2019
Impaired loans	$	203	$	-	$	-	$	203
Total assets at fair value	$	203	$	-	$	-	$	203

For Level 3 assets measured at fair value on a recurring or non-recurring basis as of March 31, 2020 and December 31, 2019, the significant unobservable inputs used in the fair value measurements were as follows:

	Fair Value at March 31, 2020		Fair Value at December 31, 2019		Valuation Technique	Significant Unobservable Inputs	General Range of Significant Unobservable Input Values
Impaired Loans	$	202	$	203	Appraised Value/Discounted Cash Flows/Market Value of Note	Discounts to reflect current market conditions, ultimate collectability, and estimated costs to sell	0	–	10%

36

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 10. Short-Term Debt

At March 31, 2020 and December 31, 2019, the Bank had no debt outstanding classified as short-term.

At March 31, 2020, the Bank had established unsecured lines of credit of approximately $50.0 million with correspondent banks to provide additional liquidity if, and as needed. In addition, the Bank has the ability to borrow up to approximately $166.4 million from the Federal Home Loan Bank, subject to the pledging of collateral.

Note 11. Long-Term Debt

At March 31, 2020 and December 31, 2019, the Bank’s long-term debt consisted of a $10.0 million advance from FHLB. The advance, which is secured by substantially all the Bank’s 1-4 family loans, is scheduled to mature on December 6, 2029. Interest on the advance was fixed at 0.819 percent and the advance is convertible by FHLB to a variable rate quarterly on June 8, 2020. The Bank has the option to repay the advance amount in whole or in part on the conversion date.

Note 12. 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, and is not obligated to report consolidated regulatory capital. The Bank’s actual capital amounts and ratios are presented in the following table as of March 31, 2020 and December 31, 2019, 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
March 31, 2020
Total Capital (to risk weighted assets)	$	79,814		13.48	%	$	47,370		8.00	%	$	59,212		10.00	%
Tier 1 Capital (to risk weighted assets)	$	75,529		12.76	%	$	35,527		6.00	%	$	47,370		8.00	%
Common Equity Tier 1 (to risk weighted assets)	$	75,529		12.76	%	$	26,646		4.50	%	$	38,488		6.50	%
Tier 1 Capital (to average total assets)	$	75,529		10.70	%	$	28,245		4.00	%	$	35,307		5.00	%
December 31, 2019
Total Capital (to risk weighted assets)	$	78,652		13.53	%	$	46,499		8.00	%	$	58,124		10.00	%
Tier 1 Capital (to risk weighted assets)	$	74,726		12.86	%	$	34,874		6.00	%	$	46,499		8.00	%
Common Equity Tier 1 (to risk weighted assets)	$	74,726		12.86	%	$	26,156		4.50	%	$	37,780		6.50	%
Tier 1 Capital (to average total assets)	$	74,726		10.80	%	$	27,680		4.00	%	$	34,599		5.00	%

On September 17, 2019 the Federal Deposit Insurance Corporation finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (“CBLR”) framework, as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

37

Parkway Acquisition Corp. and Subsidiary

Notes to Consolidated Financial Statements

(unaudited)

Note 12. Capital Requirements, continued

In order to qualify for the CBLR framework, a community banking organization must have a Tier 1 leverage ratio of greater than 9.00%, less than $10.0 billion in total consolidated assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the prompt corrective action regulations and will not be required to report or calculated risk-based capital.

The CBLR framework was available for banks to use in their March 31, 2020, Call Report.  At this time the Company has elected not to opt into the CBLR framework for the Bank, but may opt into the CBLR framework in the future.

Note 13. Subsequent Events

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

As a qualified Small Business Administration (“SBA”) lender, we were automatically authorized to originate Paycheck Protection Program (“PPP”) loans and began taking applications on April 3, 2020. An eligible business can apply for a PPP loan up to the lesser of: (1) 2.5 times its average monthly “payroll costs;” or (2) $10.0 million. PPP loans will have: (a) an interest rate of 1.0%, (b) a two-year term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP so long as employee and compensation levels of the business are maintained and 75% of the loan proceeds are used for payroll expenses, with the remaining 25% of the loan proceeds used for other qualifying expenses.

As of April 30, 2020, the Bank had closed and funded approximately $62.4 million in PPP loans. 

To bolster to effectiveness of the PPP, the Federal Reserve provides liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The Payroll Protection Program Liquidity Facility (“PPPLF”) extends credit on a non-recourse basis to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value. On April 20, 2020, the Bank borrowed $5.4 million in PPPLF funding, that has a maturity date of April 15, 2022 and is secured by $5.4 million in PPP loans. The interest rate on the PPPLF is 35 basis points. The Bank may request additional PPPLF funding through September 30, 2020.

38

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 and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Critical Accounting Policies

For a discussion of the Company’s critical accounting policies, including its allowance for loan losses and asset impairment judgments, see Note 1 in the Notes to Consolidated Financial Statements above, and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Executive Summary

● Net income was $1.7 million in the first quarters of 2020 and 2019, respectively. 

● Earnings per share was $0.27 for the quarters ended March 31, 2020 and 2019, respectively. 

● Net interest margin (“NIM”) was 4.28% percent for the first quarter 2020, compared to 4.58% in the first quarter of 2019.  The NIM compression during the first quarter of 2020 was primarily the result of continual competitive pressure for both loans and deposits, as well as the swift reduction in short term interest rates attributable to the COVID-19 pandemic

● Total assets increased by $10.2 million, or 1.44%, to $716.5 million at March 31, 2020 from $706.3 million at December 31, 2019.

● Net loans increased $6.5 million, or 1.14%, from December 31, 2019 to $572.9 million as of March 31, 2020. 

● Total deposits increased 1.65%, to $621.3 million at March 31, 2020 from $611.2 million at December 31, 2019.

● Return on average assets decreased to 0.94% for the quarter ended March 31, 2020, from 1.01% for the quarter ended March 31, 2019.

● Return on average equity decreased to 8.23% for the quarter ended March 31, 2020, from 8.83% for the quarter ended March 31, 2019.

Coronavirus (“COVID-19”) Response

Due to the impact of COVID-19, the spread of this virus has created uncertainty in our markets and in our communities. The Company has taken many steps to protect the health and safety of our employees and customers during this pandemic. Some of the initiatives implemented by the Bank, and other updates, include the following:

Operational Initiatives

● Pandemic response team meets on at least a weekly basis and actively monitors guidance released by regulators and banking associations.

● All in-person meetings have been cancelled until further notice.

● Employees are working remotely, temporarily relocated or are working alternate days to increase social distancing.

● Branch and operational offices are cleaned and sanitized regularly. Employees have access to masks, gloves and disinfectant.

● Beginning on March 20, branch lobbies were closed to lessen the spread of the virus and protect both our employees and our customers. Drive through facilities remain open and branch lobby services are available by appointment.

39

Part I. Financial Information

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

Coronavirus (“COVID-19”) Response, continued

Operational Initiatives, continued

● Management provides updates to employees and directors on a regular basis.

● Call center hours have been increased to assist with customer inquiries.

● To protect the well-being of our staff and customers, the Company has set up resources for several employees to work from home. To facilitate the move, we allocated laptop computers and desktop computers, with WiFi access, to staff and enabled our ability to network offsite via secure VPN.

Loan Deferment Requests 

The Bank, like many other financial institutions, has received requests to defer principal and/or interest payments, and has agreed to such deferrals or is in the process of doing so.  The banking regulatory agencies, through an Interagency Statement dated April 7, 2020, are encouraging financial institutions to work prudently with borrowers who request loan modifications or deferrals as a result of COVID-19.  The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), was signed into law on March 27, 2020, and provides over $2.0 trillion in emergency economic relief to individuals and businesses impacted by the COVID-19 pandemic.  Under Section 4013 of the CARES Act, loans less than 30 days past due as of December 31, 2019 will be considered current for purposes of COVID-19 related modifications.  A financial institution can then suspend the requirements under GAAP for loan modifications related to COVID-19 that would otherwise be categorized as a troubled debt restructuring (“TDR”), and suspend any determination of a loan modified as a result of COVID-19 as being a TDR, including the requirement to determine impairment for accounting purposes.  Financial institutions wishing to utilize this authority must make a policy election, which applies to any COVID-19 modifications made between March 1, 2020 and the earlier of either December 31, 2020 or the 60^th day after the end of the COVID-19 national emergency.  Similarly, the Financial Accounting Standards Board has confirmed that short-term modifications made on a good-faith basis in response to COVID-19 to loan customers who were current prior to any relief are not TDRs.  Lastly, prior to the enactment of the CARES Act, the banking regulatory agencies provided guidance as to how certain short-term modifications would not be considered TDRs, and have subsequently confirmed that such guidance could be applicable for loans that do not qualify for favorable accounting treatment under Section 4013 of the CARES Act.

The Bank began receiving request for loan deferments on March 23, 2020. The payment accommodation provided by the Bank is generally up to three months with the Bank recognizing that an additional three month payment accommodation may be required for some customers. Payments received upon the expiration of the payment accommodation period will generally be first applied to interest accrued, then towards escrow advances, and any remaining amount toward principal. As of April 30, 2020, the Bank had received 133 requests for loan payment deferment of approximately $33.6 million in loans, or 5.4% of the loan portfolio.

Paycheck Protection Program

As a qualified SBA lender, we were automatically authorized to originate PPP loans and began taking applications on April 3, 2020.  An eligible business can apply for a PPP loan up to the lesser of: (1) 2.5 times its average monthly “payroll costs;” or (2) $10.0 million.  PPP loans will have: (a) an interest rate of 1.0%, (b) a two-year term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement.  The SBA will guarantee 100% of the PPP loans made to eligible borrowers.  The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP so long as employee and compensation levels of the business are maintained and 75% of the loan proceeds are used for payroll expenses, with the remaining 25% of the loan proceeds used for other qualifying expenses.

As of April 30, 2020, the Bank had closed and funded approximately $62.4 million in PPP loans.

40

Part I. Financial Information

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

Coronavirus (“COVID-19”) Response, continued

Paycheck Protection Program, continued

To bolster to effectiveness of the PPP, the Federal Reserve provides liquidity to participating financial institutions through term financing backed by PPP loans to small businesses.  The Payroll Protection Program Liquidity Facility (“PPPLF”) extends credit on a non-recourse basis to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value.  On April 20, 2020, the Bank borrowed $5.4 million in PPPLF funding, that has a maturity date of April 15, 2022 and is secured by $5.4 million in PPP loans.  The interest rate on the PPPLF is 35 basis points.  The Bank may request additional PPPLF funding through September 30, 2020.

Results of Operations

Results of Operations for the Three Months ended March 31, 2020 and 2019

Parkway recorded net income of $1.7 million, or $0.27 per share for the quarters ended March 31, 2020 and 2019, respectively.  Income tax expense related to ordinary operations totaled $418 thousand for the first quarter of 2020 compared to $417 thousand for the first quarter of 2019.  Net income before income taxes totaled $2.1 million or $0.34 per share for the quarters ended March 31, 2020 and 2019, respectively.  First quarter earnings represented an annualized return on average assets (“ROAA”) of 0.94% and an annualized return on average equity (“ROAE”) of 8.23% for the quarter ended March 31, 2020, compared to ROAA of 1.01% and ROAE of 8.83% for the quarter ended March 31, 2019.

Total interest income was $7.7 million for the quarter ended March 31, 2020 compared to $7.5 million for the quarter ended March 31, 2019, representing an increase of $199 thousand.  Interest income on loans increased by $298 thousand from March 31, 2019 compared to March 31, 2020.  The increase in interest income was attributable primarily to the loan growth experienced in 2019 as well as an increase of $6.8 million in gross loans in the first quarter of 2020.  Accretion of purchased loan discounts increased interest income by $446 thousand in the first quarter of 2020 compared to $526 thousand in the first quarter of 2019, representing a decrease of $80 thousand.  Interest earned on investments decreased by $105 thousand from March 31, 2019 compared to March 31, 2020.  The Bank strategically decreased its investment portfolio during the quarter ended March 31, 2020 to take advantage of gains in the portfolio to help offset the declining rates on the Company’s interest-bearing cash equivalent accounts.   

Interest expense on deposits increased by $243 thousand for the quarter ended March 31, 2020 compared to the quarter ended March 31, 2019. Amortization of premiums on acquired time deposits, which reduces interest expense, totaled $60 thousand in the first quarter of 2020, compared to $117 thousand in the first quarter of 2019, representing a decrease of $57 thousand.

The provision for loan losses was $322 thousand for the quarter ended March 31, 2020, compared to $238 thousand for the quarter ended March 31, 2019.  During the first quarter of 2020, Parkway recognized $37 thousand in net recoveries compared to $115 thousand in net charge-offs for the first quarter of 2019 and net charge-offs of $70 thousand in the fourth quarter of 2019.  The reserve for loan losses at March 31, 2020 was approximately 0.74% of total loans, compared to 0.68% at March 31, 2019.  Management’s estimate of probable credit losses inherent in the acquired loan portfolio from Cardinal Bankshares Corporation and Great State Bank was reflected as a purchase discount which will continue to be accreted into income over the remaining life of the acquired loans.  As of March 31, 2020, the remaining unaccreted discount on the acquired loan portfolios totaled $2.7 million.

In response to shutdowns of non-essential businesses and the stay-at-home orders issued in connection with COVID-19, management is taking steps to assess asset quality and maintain an adequate allowance for loan loss. Among other things, we have stress tested certain concentrations within our portfolio (hotels, restaurants, retail and 1-4 family rentals) on a worst-case scenario. Due to the Bank’s rural footprint, past economic factors tend to be delayed, the “trickle down” effect, compared to urban areas. We have also been fortunate to see a very low level of COVID-19 cases in our footprint. In an abundance-of caution, we have increased our allowance to reflect negative economic factors, including a potential rise in unemployment.

41

Part I. Financial Information

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

Results of Operations, continued

Results of Operations for the Three Months ended March 31, 2020 and 2019, continued

Total noninterest income was $1.5 million in the first quarter of 2020 compared to $1.1 million in the first quarter of 2019.  The majority of the increase was due to gains realized on the sale of investments during the first quarter of 2020 totaling $212 thousand compared to losses of $14 thousand for the same period in 2019.

Total noninterest expenses increased by $228 thousand for the quarter ended March 31, 2020 compared to the quarter ended March 31, 2019. Salary and benefit costs increased by $312 thousand due to the increase in employees, primarily from the addition of staffing in our newly opened Mocksville and Lenoir, NC locations, as well as future locations in Hickory and Hudson, NC. We also added three commercial lenders during 2019 that impacted the quarter to quarter comparison. Occupancy and equipment expenses increased by $58 thousand and data processing expenses increased by $47 thousand from the first quarter of 2019 to 2020, due to the addition of new branch facilities. Amortization of core deposit intangibles decreased by $26 thousand in the quarter to quarter comparison.

Income tax expense remained flat in the quarter to quarter comparison, totaling $418 thousand for the quarter ended March 31, 2020 compared to $417 thousand for the quarter ended March 31, 2019.

Financial Condition

Total assets increased by $10.2 million, or 1.44%, to $716.5 million at March 31, 2020 from $706.3 million at December 31, 2019.  Net loans increased during the first quarter by $6.5 million and property and equipment increased as well during the quarter by $2.5 million as the Bank continues to expand its branching presence in adjacent markets.  Cash and cash equivalent balances increased by $4.7 million and investment securities decreased by $3.7 million during the quarter.   

Total deposits increased by $10.1 million, or 1.65%, to $621.3 million at March 31, 2020 from $611.2 million at December 31, 2019. The increases in deposit liabilities can be attributed to the Bank’s branch expansion into new markets as well as growth in our existing locations. Total increases for the first quarter of 2020 included a $6.6 million increase in noninterest bearing deposits, while interest bearing deposits increased by $3.5 million over the same time period. The increase in interest bearing deposits was primarily due to a $6.1 million increase in saving accounts offset by a $2.6 million decrease in certificate of deposits. Competition for deposits continues to increase in many of our markets, however, our liquidity position has continued to allow us to fund our balance sheet without “paying up” for high rate, volatile deposits.

Nonperforming assets, including nonaccrual loans, loans past due more than ninety days and foreclosed assets, decreased from $4.98 million at December 31, 2019 to $4.68 million at March 31, 2020. There were no foreclosed assets and no loans past due more than ninety days and still accruing interest at March 31, 2020 and December 31, 2019.

Nonaccrual loans decreased from $4.98 million at December 31, 2019 to $4.68 million at March 31, 2020. 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:

	March 31,			December 31,
(dollars in thousands)	2020			2019
Nonperforming Assets
Nonaccrual loans	$	4,679		$	4,979
Loans past due 90 days or more and still accruing interest		-			-
Total nonperforming loans		4,679			4,979
Foreclosed assets		-			-
Total nonperforming assets	$	4,679		$	4,979
Nonperforming assets to total assets		0.65	%		0.70	%
Nonperforming loans to total loans		0.81	%		0.87	%

42

Part I. Financial Information

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

Financial Condition, continued

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.

At March 31, 2020, the allowance for loan losses included $190 thousand specifically reserved for impaired loans in the amount of $3.9 million.  Based on impairment analysis, loans totaling $3.8 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, 2019 totaled $7.8 million, of which $3.6 million required specific reserves of $174 thousand.

Summary of Loan Loss Experience	Three			Three
	months			months			Year
	ended			ended			ended
(dollars in thousands)	March 31,			March 31,			December 31,
	2020			2019			2019
Total loans outstanding at end of period	$	577,191		$	533,596		$	570,353
Allowance for loan losses, beginning of period	$	3,893		$	3,495		$	3,495
Charge offs:
Construction & development		-			-			-
Farmland		-			(14	)		(13	)
Residential		-			(12	)		(55	)
Commercial mortgage		-			(41	)		(41	)
Commercial & agricultural		-			(44	)		(77	)
Consumer & other		(53	)		(52	)		(212	)
Total charge-offs		(53	)		(163	)		(398	)
Recoveries:
Construction & development		4			-			-
Farmland		-			-			-
Residential		8			7			8
Commercial mortgage		65			28			69
Commercial & agricultural		2			2			10
Consumer & other		11			11			54
Total recoveries		90			48			141
Net charge-offs		37			(115	)		(257	)
Provision for allowance		322			238			655
Allowance for loan losses at end of period	$	4,252		$	3,618		$	3,893
Ratios:
Allowance for loan losses to loans at end of period		0.74	%		0.68	%		0.68	%
Net charge-offs to allowance for loan losses		0.87	%		3.18	%		6.60	%
Net charge-offs to provisions for loan losses		11.49	%		48.32	%		39.24	%

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 March 31, 2020 totaled $4.2 million, or 0.72% of total loans. Historical charge-off rates in this category have not varied significantly from other real estate secured loans.

43

Part I. Financial Information

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

Financial Condition, continued

Stockholders’ equity remained flat from $81.4 million at December 31, 2019 to $81.5 million at March 31, 2020. The first quarter 2020 earnings of $1.7 million were offset by dividend payments of $794 thousand and stock repurchases of $800 thousand. Book value increased from $13.27 per share at December 31, 2019 to $13.43 per share at March 31, 2020.

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 $50.0 million at March 31, 2020. The Bank had no balances outstanding on these lines as of March 31, 2020 and December 31, 2019, respectively. In addition, the Bank has the ability to borrow up to approximately $166.4 million from the Federal Home Loan Bank (“FHLB”), subject to the pledging of collateral. The Bank had long-term FHLB advances of $10.0 million outstanding at March 31, 2020 and December 31, 2019, respectively.

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.  The liquidity ratio (the level of liquid assets divided by total deposits plus short-term liabilities) was 9.9% for the periods ended March 31, 2020 and December 31, 2019, respectively.  These ratios are considered to be adequate by management.

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 are also subject to the BASEL III requirements, which includes as part of the capital ratios profile 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 March 31, 2020, the Bank exceeded minimum regulatory capital requirements and is considered to be “well capitalized.”

At March 31, 2020, Parkway’s equity to asset ratio was 11.37% and the Bank’s capital was in excess of regulatory requirements as discussed above. The Company will continue to monitor the effects of COVID-19 in determining future cash dividends and any requirements for additional capital each quarter. Parkway declared and paid dividends of $794 thousand, and had $800 thousand of stock repurchases for the first quarter of 2020.

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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 Act of 1934 as amended.  These include statements as to expectations future financial performance and any other statements regarding future results or expectations.  We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and are including this statement for purposes of these safe harbor provisions.  Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of the Company, are generally identified by the use of words such as "believe," "expect," "intend," "anticipate," "estimate," or "project" or similar expressions.  Our ability to predict results, or the actual effect of future plans or strategies, is inherently uncertain.  Factors which could have a material adverse effect on the operations and future prospects of the combined company and its subsidiaries include, but are not limited to:  changes in interest rates, general economic conditions; the effects of the COVID-19 pandemic, including the Company’s credit quality and business operations, as well as its impact on general economic and financial market conditions; the effect of changes in banking, tax and other laws and regulations and interpretations or guidance thereunder; monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board; the quality and composition of the loan and securities portfolios; demand for loan products; deposit flows; competition; demand for financial services in the combined company’s market area; the implementation of new technologies; the ability to develop and maintain secure and reliable electronic systems; accounting principles, policies, and guidelines and other factors identified in Item 1A, “Risk Factors,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.  These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  We undertake no obligation to update or clarify these forward‐looking statements, whether as a result of new information, future events or otherwise.

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Part I. Financial Information

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not required.

46

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 the Company’s 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, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

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

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Part II. Other Information

Item 1. Legal Proceedings

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the 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, 2019 should be considered.  These risks could materially and adversely affect our business, financial condition and results of operations.  Other than as set forth below, there have been no material changes to the factors discussed in our Form 10-K.

The ongoing COVID-19 pandemic and measures intended to prevent its spread may adversely affect our business, financial condition and operations; the extent of such impacts are highly uncertain and difficult to predict.

Global health and economic concerns relating to the COVID-19 outbreak and government actions taken to reduce the spread of the virus have had a material adverse impact on the macroeconomic environment, and the outbreak has significantly increased economic uncertainty. The pandemic has resulted in federal, state and local authorities, including those who govern the markets in which we operate, implementing numerous measures to try to contain the virus.  These measures, including shelter in place orders and business limitations and shutdowns, have significantly contributed to rising unemployment and negatively impacted consumer and business spending.

The COVID-19 outbreak has adversely impacted and is likely to continue to adversely impact our workforce and operations and the operations of our customers and business partners. In particular, we may experience adverse effects due to a number of operational factors impacting us or our customers or business partners, including but not limited to:

● credit losses resulting from financial stress experienced by our borrowers, especially those operating in industries most hard hit by government measures to contain the spread of the virus;

● operational failures, disruptions or inefficiencies due to changes in our normal business practices necessitated by our internal measures to protect our employees and government-mandated measures intended to slow the spread of the virus;

● possible business disruptions experienced by our vendors and business partners in carrying out work that supports our operations;

● decreased demand for our products and services due to economic uncertainty, volatile market conditions and temporary business closures;

● any financial liability, credit losses, litigation costs or reputational damage resulting from our origination of PPP loans; and

● heightened levels of cyber and payment fraud, as cyber criminals try to take advantage of the disruption and increased online activity brought about by the pandemic.

The extent to which the pandemic impacts our business, liquidity, financial condition and operations will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, its duration and severity, the actions to contain it or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume.  In addition, the rapidly changing and unprecedented nature of COVID-19 heightens the inherent uncertainty of forecasting future economic conditions and their impact on our loan portfolio, thereby increasing the risk that the assumptions, judgments and estimates used to determine the allowance for loan losses and other estimates are incorrect.  Further, our loan deferral program could delay or make it difficult to identify the extent of asset quality deterioration during the 90-day deferral period.  As a result of these and other conditions, the ultimate impact of the pandemic is highly uncertain and subject to change, and we cannot predict the full extent of the impacts on our business, our operations or the global economy as a whole.  To the extent any of the foregoing risks or other factors that develop as a result of COVID-19 materialize, it could exacerbate the risk factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2019, or otherwise materially and adversely affect our business, liquidity, financial condition and results of operations. 

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Part II. Other Information

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

The following table details the Company’s purchase of its common stock during the first quarter of 2020.

	Total number of shares purchased		Average price paid per Share		Total number of shares purchased as part of publicly announced program		Maximum number of shares that may yet be purchased under the plan
Purchased 1/1 through 1/31		-	$	-		-		124,000
Purchased 2/1 through 2/29		-	$	-		-		124,000
Purchased 3/1 through 3/31		70,000	$	11.43		70,000		54,000
Total		70,000	$	11.43		70,000

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 March 31, 2020, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Consolidated Financial Statements.

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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: May 15, 2020	By:	/s/ Blake M. Edwards
		Blake M. Edwards
		President and Chief Executive Officer
	By:	/s/ Lori C. Vaught
		Lori C. Vaught
		Chief Financial Officer

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