Pinnacle Bankshares Corp
Annual Report 2015

Plain-text annual report

~o~ z8(os KS ES C O R P O R A T I O N .,_ r'' ~:c ~` . . -,- l .— j `:, BOARD OF DIRECTORS Front Row: C. Bryan Stott, James E. Burton, N, (Chairman), Aubrey H. Hall, III, A. Patricia Merryman Back Row: Robert L. Johnson, II, Robert L. Finch, Jr., Michael E. Watson, Thomas F. Hall, Judson H. Dalton, Carroll E. Shelton, James O. Watts, N, Fsq., Elton W. Blackstock, Jr. SENIOR MANAGEMENT Front Row: Vivian S. Brown, Aubrey H. Hall, III (President and CEO), Judith A, Clements Back Row: Thomas R. Burnett, Jr., Tony J. Bowling, Bryan M. L.emley, William J. Sydnor, II On the cover: Branch locatioru Old Forest Road and Timberlake. Projects expected to be completed by July of 2016. PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY Table of Contents First National Bank Office Locations ............................................................................................... 2 Page Officers and Managers .......................................................................................... President's Letter .............................................................................................................................. Selected Consolidated Financial Information ................................................................................... Results of Operations ........................................................................................................................ Consolidated Balance Sheets ............................................................................................................ Consolidated Statements of Income .................................................................................................. Consolidated Statements of Comprehensive Income ...................................................... Consolidated Statements of Changes in Stockholders' Equity ......................................................... Consolidated Statements of Cash Flows ........................................................................................... Notes to Consolidated Financial Statements ..................................................................................... 3 4 6 7 12 13 14 15 16 17 Management's Report on Internal Control over Financial Reporting ........................................... 49 Report of Independent Auditor ......................................................................................................... Shareholder Information ................................................................................................................... 50 52 PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY First National Bank Office Locations ALTAVISTA MAIN OFFICE 622 Broad Street Altavista, Virginia 24517 Telephone: (434) 369-3000 VISTA OFFICE 1303 Main Street Altavista, Virginia 24517 Telephone: (434) 369-3001 LYNCHBURG AIRPORT OFFICE 14580 Wards Road Lynchburg, Virginia 24502 Telephone: (434) 237-3788 TIMBERLAKE OFFICE 20865 Timberlake Road Lynchburg, Virginia 24502 Telephone: (434) 237-7936 OLD FOREST ROAD OFFICE 3309 Old Forest Road Lynchburg, Virginia 24501 Telephone: (434)385-4432 FOREST FOREST OFFICE 14417 Forest Road Forest, Virginia 24551 Telephone: (434) 534-0451 AMHERST AMHERST OFFICE 130 South Main Street Amherst, Virginia 24521 Telephone: (434)946-7814 RUSTBURG RUSTBURG OFFICE 1033 Village Highway Rustburg, Virginia 24588 Telephone: (434) 332-1742 2 PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY Officers of Pinnacle Bankshares Corporation Aubrey H. Hall, III Bryan M. Lemley William J. Sydnor, II Officers and Managers of First National Bank Aubrey H. Hall, III Bryan M. Lemley William J. Sydnor, II Judith A. Clements Thomas R. Burnett, Jr. Vivian S. Brown Tony J. Bowling Lucy H. Johnson Pamela R. Adams James M. Minear Shawn D. Stone Daniel R. Wheeler George D. Vaughan, IV Penelope P. Wallace Trade A. Callahan John E. Tucker Lisa M. Landrum Tarry R. Pribble Vicki G. Greer Melissa T. Campbell Jeffrey S. Walker Janet H. Whitehead M. Amanda Ramsey Andria C. Smith Kathleen P. Morgan Arin L. Brown AnnMarie W. King Patricia D. Canada Christine A. Hunt Dianna C. Hamlett Romonda F. Davis Allison G. Daniels Ann L. Dalton Cathy C. Simms Monica L. Woody Tammie W. Griffin Cheria B. Taylor Nickolas R. Gillan Scott W. Martin Alison N. Ayers LaDonna S. Davis Sophie M. Lovell Brandy M. Marcum Helen J. Rasnake Jean W. Clay Jennifer T. Edgell Kenneth M. Selmer Shirley B. Brooks Brandi N. Evans Robert L. Warren Courtney M. Woody John Kovack Robert A. Sears, Jr. Ruby C. Smith President &Chief Executive Officer Secretary, Treasurer &Chief Financial Officer Vice President President, Chief Executive Officer &Trust Officer Senior Vice President, Cashier &Chief Financial Officer Senior Vice President &Chief Credit Officer Senior Vice President &Director of Human Resources Senior Vice President &Chief Lending Officer Senior Vice President &Branch Administration Officer Senior Vice President &Chief Operating Officer Senior Vice President &Data Processing Manager Vice President &Loan Operations Manager Vice President &Commercial Officer Vice President &Commercial Officer Vice President &Commercial Officer Vice President &Commercial Officer Vice President &Commercial Officer Vice President &Mortgage Division Manager Vice President &Investment Consultant Vice President &Dealer Finance Officer Vice President &Collections and Recovery Manager Vice President &Financial Analyst Assistant Vice President &Branch Operations Manager Assistant Vice President &Branch Manager (Main) Assistant Vice President &Branch Manager (Airport) Assistant Vice President &Branch Manager (Amherst) Assistant Vice President &Branch Manager (Rustburg) Assistant Vice President &Branch Manager (Forest) Assistant Vice President &Branch Manager (Vista) Assistant Vice President &Branch Manager (Timberlake) Assistant Vice President &Branch Manager (Old Forest Road) Assistant Vice President &Internal Auditor Assistant Vice President, Compliance &Bank Secrecy Act Officer Assistant Vice President & E-Commerce Sales Representative Assistant Vice President &Loan Quality Control Officer Assistant Vice President &Real Estate Loan Portfolio Manager Assistant Vice President &Dealer Finance Officer Human Resources Manager E-commerce Sales Representative Retail Business Development Officer (Main) Retail Business Development Officer (Timberlake) Retail Business Development Officer (Airport) Retail Business Development Officer (Rustburg) Retail Business Development Officer (Vista) Retail Business Development Officer (Airport) Retail Business Development Officer (Forest) Retail Business Development Officer (Amherst) Retail Business Development Officer (Main) Bank Officer &Credit Analyst Bank Officer &Credit Analyst Collections Officer Collections Officer Bank Officer &Construction Loan Administrator Bank Officer &Mortgage Loan Originator Network Administrator Facilities Manager Customer Support Manager PINNACI.F BEAN KSHARES C O R P O R A T I O N DEAR SHAREHOLDERS, I am pleased to report to you that Pinnacle Bankshares Corporation, the one-bank holding company for First National Bank, increased core operating net income in 2015 for the seventh straight year and improved your returns in terms of annual cash dividends and share price appreciation. Your Company also made significant progress in executing growth plans aimed at expanding First National's presence across Central Virginia. These achievements combined with strengthened asset quality and better efficiency demonstrate our commitment to enhancing the value of your investment over the long term. For 2015 Pinnacle generated net income of $2,740,000, which included $234,000 of after tax income resulting from our conversion to the equity method of accounting for First National Bank's investment in Bankers Insurance, LLC. The change aligns us with other community bank owners of the full service, independent insurance agency. Future returns are expected from commissions on insurance referrals provided by the Bank and growth of the agency across Virginia and North Carolina. Core net income, excluding the accounting change, was $2,506,000 in 2015, which was a 17% increase as compared to 2014. Profitability as commonly measured by return on average assets and return on average equity improved to 0.68% and 7.44%, respectively, net of the change. Net interest income growth of $449,000 was the catalyst for improvement, which was primarily driven by a decline in our cost of funds as the Bank experienced further growth of demand deposits and other transaction accounts. Additionally, noninterest income increased $215,000, net of the accounting change, due to increased interchange fees derived from check card usage and a rebound in income generated from our Investment and Mortgage Divisions prior to related expenses. The provision for loan losses was $129,000 for the year, an increase of only $38,000 compared to 2014, as improved credit quality helped to offset material loan growth experienced during the second half of 2015. In fact, nonperforming loans (loans in nonaccrual status or past due greater than ninety days) were less than 0.50% of total loans as of year-end due in part to payoffs received on several long term problem credits. Our allowance for loans losses was $2,889,000 as of December 31, 2015, which represented 0.94% of total loans outstanding. The allowance balance was 208% of nonperforming loans as of year-end, which we believe provides appropriate reserves for potential future losses associated with our loan portfolio. Noninterest expense was well controlled, increasing only $53,000 during 2015 despite higher salaries and employee benefits as a result of adding several new sales positions associated with First National's expansion in Lynchburg. Two new Commercial Officers along with an additional E-Commerce Officer have been brought on board in an effort to boost loan production and further increase business deposits through utilization of electronic delivery channels, including merchant bankcard services and remote deposit capture. Pinnacle's total assets as of December 31, 2015 were $371,261,000, an increase of $9,073,000 or 3% as compared to the end of the prior year. While overall asset growth was modest, loan growth for the year was more robust with total loans increasing $22,569,000 or 8% to $306,088,000. The growth was led by strong performances from the Bank's Retail Branch Network and Dealer (Indirect-Auto) Division. Additionally, volume was boosted from several non- organic sources including loan participations, medical loans purchased from Bankers Healthcare Group and municipal funding. The increased loan volume, which occurred primarily during the second half of the year, combined with only a slight decline in the Bank's investment portfolio to $27,148,000 resulted in better utilization of available funds and an $83,000 increase in interest income despite declining asset yields. Total liabilities, consisting primarily of deposits, were $336,479,000 as of year-end, which was an increase of approximately 2%. Demand deposits, savings and NOW accounts (interest checking) grew $18,976,000 or 9% during 2015 to $230,326,000 and reflect our continued focus on the expansion of core deposit relationships, which 4 have driven the Company's lower cost of funds. This increase was partially offset by a decrease in time deposits of $11,777,000 or approximately 10%. While we have intentionally grown our checking accounts to become less time deposit dependent, we would like to maintain our current deposit base composition of approximately 18% demand accounts, 52%savings and NOW accounts and 30% time deposits. Stockholders' equity as of December 31, 2015 was $34,782,000, representing an increase of $2,128,000 or 7% as compared to the prior year end. Pinnacle and First National Bank remain "well capitalized" per all current regulatory definitions and meet applicable Basel III capital standards. Capital requirements to support future growth are anticipated to be generated internally through increased retained earnings resulting from improved profitability. Operating banks of all sizes requires constant attention to ever changing technology. We continue to expand our electronic product lineup and have been pleased with the growth of online bill pay and mobile banking users since the adoption of new platforms in 2014. Always remaining mindful of protecting our clients, First National Bank has implemented a comprehensive cyber security program based on guidelines establish by federal agencies. Your Board and Management Team are extremely pleased that a return has been paid to you in the form of a cash dividend over the last fourteen quarters and that the amount of annual cash dividends paid increased 6% from $0.32 per share in 2014 to $0.34 per share in 2015. We are also encouraged by the increase in the trading price of Pinnacle's stock, which ended the year up 11% at $19.70. While the trading price of our stock continues to improve, we believe that it still does not fully reflect the true value of your Company. For this reason the Company remains willing to utilize its Share Repurchase Program when appropriate to potentially increase trading volume in our stock and provide liquidity in the market. First National Bank's Lynchburg Market Plan, which is intended to increase the Bank's presence and visibility across Central Virginia, is well under way with construction commencing during 2015 on the renovation and expansion of the Timberlake Road Branch and the relocation of the Old Forest Road Branch to a new facility on the same corridor. These projects are now expected to be completed by July of 2016. The plan also includes the construction of a new branch /Lynchburg headquarters building on Odd Fellows Road. Planning is under way for this new facility with construction expected to commence in mid-2016. Completion of the project will allow positions currently housed in the Bank's Wyndhurst Administrative Office to be moved to Odd Fellows Road and alleviate space shortages at several branches. First National Bank's Altavista Main Office will remain the Company's corporate headquarters with the functions performed there remaining in place. In closing, 2015 signified a breakout year for your Company from a financial performance, loan growth and asset quality perspective. Our Board, Management and team of dedicated financial professionals look forward to further improvement as we continue to set our sights on being recognized as the premier community banking organization in Central Virginia. To hear more about the performance and direction of Pinnacle Bankshares Corporation, please plan to attend our Annual Meeting of Shareholders to be held at 11:00 a.m., Tuesday, April 12, 2016 in the Fellowship Hall of Altavista Presbyterian Church, located at 707 Broad Street, Altavista, Virginia. We are hopeful that you will be able to join us for this occasion. As always, thank you for your support, confidence and the opportunity to serve your interests as President and Chief Executive Officer of Pinnacle Bankshares Corporation. Sincerely, ~- • ~~-t~ Aubrey H. Hall, lIl "Todd" President &Chief Executive Officer PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY Selected Consolidated Financial Information (In thousands, except ratios, share and per share data) Years ended December 31 Income Statement Data: Net interest income Provision for loan losses Noninterest income Noninterest expense Income tax expense Net income Per Share Data: Basic net income Diluted net income Cash dividends Book value Weighted-Average Shares Outstanding: Basic Diluted Balance Sheet Data: Assets Loans, net Securities Cash and cash equivalents Deposits Stockholders' equity Performance Ratios: Return on average assets Return on average equity Dividend payout Asset Quality Ratios: Allowance for loan losses to total loans, net of unearned income and fees Net chazge-offs to average loans, 20t~ 2014 2013 2012 2011 $ 12,505 129 3,730 12,060 1,306 2,740 1.80 1.79 0.34 22.88 S 12,056 91 3,162 12,008 970 2,149 1.42 1.40 032 21.60 11,709 143 4,554 12,228 1,241 2,651 1.75 1.74 0.23 21.08 11,601 1,177 3,443 11,910 619 1,338 0.89 0.89 0.05 18.63 12,091 2,227 3,253 11, 544 510 1,063 0.71 0.71 0.00 18.01 1,519,159 1,531,436 1,512,661 1,530,831 1,512,545 1,523,105 1,503,952 1,496,260 1,503,952 1,496,260 $ 371,261 303,199 27,148 16,739 332,403 34,782 0.74% 8.12% 18.96% 362,188 280,449 29,277 29,451 325,204 32,654 0.60% 6.59% 22.48% 358,601 274,349 29,125 35,457 322,130 31,942 0.75% 8.96% 12.86% 348,694 273,672 22,206 35,790 315,157 28,089 0.39% 4.83% 5.61% 342,484 267,123 24,769 37,547 310,393 26,947 0.31% 3.95% 0.00% 0.94% 1.08% 1.23% 1.31% 1.48% net of unearned income and fees 0.11°/a 0.15% 0.12% 0.57% 0.84% Capital Ratios: Leverage Risk-based: Tier I capital Total capital Average equity to average assets 9.68% 9.25% 8.88% 8.49% 8.12% 11.37% 1232% 9.17% 10.96% 11.98% 9.11% 10.84% 12.03% 8.33% 10.15% 11.39% 8.04% 9.99% 11.24% 7.93% 6 Results of Operations (in thousands, except ratios, share and per share data) Cautionary Statement Regarding Forward-Looking Statements The following discussion is qualified in its entirety by the more detailed information and the consolidated financial statements and accompanying notes appearing elsewhere in this Annual Report. In addition to the historical information contained herein, this Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are not statements of historical fact and are based on certain assumptions and describe future plans, strategies, and expectations of management, are generally identifiable by use of words such as "believe," "expect," "intend," "anticipate," "estimate," "project," "may," "will" or similar expressions. These forward-looking statements may include, but are not limited to, anticipated future financial performance, impairment of goodwill, funding sources including cash generated by banking operations, loan portfolio composition, trends in asset quality and strategies to address nonperforming assets and nonaccrual loans, adequacy of the allowance for loan losses and future provisions for loan losses, securities portfolio composition and future performance, interest rate environments, deposit insurance assessments, and strategic business initiatives. Although we believe our plans, intentions and expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain, and actual results, performance or achievements could differ materially from those contemplated. Factors that could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in: the effectiveness of management's efforts to maintain asset quality and control operating expenses; the quality, composition and growth of the loan and investment portfolios; interest rates; decrease in net interest margin; declining collateral values, especially in the real estate market; general economic conditions, including stagnation in general business and economic conditions and in the financial markets; unemployment levels; the legislative/regulatory climate, including the impact of any policies or programs implemented pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act ("the Dodd-Frank AcY') or other laws; monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Board of Governors of the Federal Reserve System; demand for loan products; deposit flows; competition; demand for financial services in our market area; regulatory compliance costs; accounting principles, policies and guidelines; and an increase in shareholders that would require the Company to be subject to the reporting obligations of the Securities Exchange Act of 1934, as amended. These risks and uncertainties should be considered in evaluating forward-looking statements contained herein. We base our forward-looking statements on management's beliefs and assumptions based on information available as of the date of this report. You should not place undue reliance on such statements, because the assumptions, beliefs, expectations and projections about future events on which they are based may, and often do, differ materially from actual results. We undertake no obligation to update any forward-looking statement to reflect developments occurring after the statement is made. Company Overview Pinnacle Bankshares Corporation, a Virginia corporation (the "Company" or "Bankshares"), was organized in 1997 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Bankshares is headquartered in Altavista, Virginia. Bankshares conducts all of its business activities through the branch offices of its wholly owned subsidiary bank, First National Bank (the "Bank"). Bankshares exists primarily for the purpose of holding the stock of its subsidiary, the Bank, and of such other subsidiaries as it may acquire or establish. First National Bank was organized in 1908 and currently maintains a total of eight offices to serve its customers. The Main Office and Vista Branch are located in the Town of Altavista, the Airport Branch, Timberlake Branch and Rustburg Branch in Campbell County, the Old Forest Road Branch in the City of Lynchburg, the Forest Branch in Bedford County and the Amherst Branch in the Town of Amherst. The Bank also maintains an administrative and training facility in the Wyndhurst section of the City of Lynchburg. First National Bank has developed a Lynchburg Market Plan in an effort to increase its presence and visibility in Central Virginia. The plan includes renovation and expansion of the Bank's Timberlake Branch and relocation of its Old Forest Road Branch to a new facility on Old Forest Road. Both of these projects are well under way and are expected to be completed by July of 2016. The plan also includes the construction of a new branch /Lynchburg headquarters building on Odd Fellows Road. Planning is under way for this new facility with construction expected to commence in 2016. Completion of the project will allow positions currently housed in the Wyndhurst administrative and training facility to be moved to Odd Fellows Road and alleviate space shortages at several branches. First National Bank's Altavista Main Office will remain the Company's corporate headquarters. A total ofone-hundred tin full and part-time staff members serve the Bank's customers. With an emphasis on personal service, the Bank today offers a broad range of commercial and retail banking products and services including checking, savings and time deposits, individual retirement accounts, merchant bankcard processing, residential and commercial mortgages, home equity loans, consumer installment loans, agricultural loans, investment loans, small business loans, commercial lines of credit and letters of credit. The Bank also offers a full range of investment, insurance and annuity products through its association with Infinex Investments, Inc. and Banker's Insurance, LLC. The Bank has two wholly-owned subsidiaries: FNB Property Corp., which holds title to future Bank premises real estate as needed; and First Properties, Inc., which holds title to other real estate owned acquired through foreclosures. Results of Operations The Company had net income of $2,740 for the year ended December 31, 2015, compared to net income of $2,149 for the yeaz ended December 31, 2014, an increase of 27.50%. This increase in net income was driven mainly by a $449, or 3.72% increase in net interest income and a $569 or 17.99% increase in noninterest income. These positive factors that contributed to the increase in net income were partially offset by a $53, or 0.44% increase in noninterest expense and a $38 or 41.76% increase in provision for loan losses. Net interest income increased as net interest margin grew from 3.60% in 2014 to 3.63% in 2015. Noninterest income increased mainly due to the recognition of $354 in Bankers Insurance income as the Company adopted the equity method of accounting for the investment in the limited liability corporation that had previously been accounted for under the cost method as an investment. See note 1(e) "Change in Accounting Method" of the "Notes to Consolidated Financial Statements for additional information. The Company also saw increases in service charges, commissions, mortgage loan fees, interchange fees and other recoveries. Noninterest expense increased as salaries and commissions increased by $301 and defined benefit plan expense increased by $117 to $128 in 2015. The defined benefit plan expense is expected to increase to $200 in 2016. Provision for loan losses increased due to an increase in loan volume. We expect continued gains in net income for 2016 due to loan growth and the December 2015 interest rate increase as well as the continued success of our Lynchburg Market Plan. The Company is well positioned if interest rates continue to increase in 2016, which we would expect to result in a further increase in net interest margin. We expect an increase in noninterest income in 2016 with additional sales staff. Finally, we expect an increase in noninterest expense in 2016 due to additional personnel and an increase in our defined benefit plan expense as referenced previously. Profitability as measured by the Company's return on average assets ("ROA") was 0.74% in 2015, compared to 0.60% in 2014. Return on average equity ("ROE"), was 8.12% for 2015, compared to 6.59% for 2014. Total assets as of December 31, 2015 were $371,261, up 2.51% from $362,188 as of December 31, 2014. The principal components of the Company's assets at the end of the year were $16,739 in cash and cash equivalents, $27,148 in securities and $303,199 in net loans. During the year ended December 31, 2015, gross loans increased 7.96% or $22,568. The Company's lending activities are a principal source of income. Total liabilities as of December 31, 2015 were $336,479, up 2.11% from $329,534 as of December 31, 2014, due to an increase in total deposits of $7,199 or 2.21%, to $332,403 as of December 31, 2015 from $325,204 as of December 31, 2014. Noninterest-bearing demand deposits increased $8,094 or 15.93% and represented 17.72% of total deposits as of December 31, 2015, compared to 15.62% as of December 31, 2014. Savings and NOW accounts increased $10,882 or 6.78% and represented 51.57% of total deposits as of December 31, 2015, compared to 49.37% as of December 31, 2014. Time deposits decreased $11,777 or 10.34% and represented 30.71 % of total deposits as of December 31, 2015, compared to 35.01 % as of December 31, 2014. The Company's deposits are provided by individuals and businesses primarily located within the communities served. The Company had no brokered deposits as of December 31, 2015 and December 31, 2014. Total stockholders' equity as of December 31, 2015 was $34,782, including $30,442 in retained earnings. As of December 31, 2014, stockholders' equity totaled $32,654, including $28,219 in retained earnings. The increase in stockholders' equity resulted mainly from the Company's net income of $2,740 partially offset by dividends of $517 paid to shareholders. Net Interest Income. The net interest spread increased to 3.50% for the year ended December 31, 2015 from 3.47% for the year ended December 31, 2014. Yield on earning assets was 4.09% and cost of funds was 0.59% for the year ended December 31, 2015 as compared to a yield on earning assets of 4.19% and a cost of funds of 0.72% for the year ended December 31, 2014. The net interest margin increased to 3.63% for the year ended December 31, 2015 from 3.60% for the year ended December 31, 2014 as the cost to fund earning assets was 0.46% for the year ended December 31, 2015 as compared to the cost to fund earning assets of 0.59% for the year ended December 31, 2014. Net interest income was $12,505 for the year ended December 31, 2015, compared to $12,056 for the year ended December 31, 2014, and is attributable to interest income from loans, federal funds sold and securities exceeding the cost associated with interest paid on deposits and other borrowings. In 2015, the Company's deposits repriced at lower rates more rapidly than its loans in the low interest rate environment, and the Company's higher-cost time deposits declined while lower-cost demand, savings and NOW deposits grew, causing the Company's interest rate spread to increase. Provision for Loan Losses. The provisions for loan losses for the years ended December 31, 2015 and 2014 were $129 and $91, respectively. The provision for loan losses increased slightly in 2015 but has remained at a low level since 2013, as the Company continues to strengthen its asset quality. The provision for loan losses increased $38 from 2014 to 2015 due to loan volume growth as criticized and classified loans declined due to the continued success of an aggressive asset quality improvement plan implemented in 2011. The Company expects to maintain the quality of its loan portfolio in 2016. Noninterest Income. Total noninterest income for the year ended December 31, 2015 increased $569, or 17.99%, to $3,731 from $3,162 in 2014 mainly due to $354 in income from Bankers Insurance recognized using the equity method in 2015. See Note 1(e) "Change in Accounting Method" of the "Notes to Consolidated Financial Statements" for additional information. The Company's principal sources of noninterest income are service charges and fees on deposit accounts, particularly transaction accounts, interchange fees from debit cards, fees on sales of mortgage loans, and commissions and fees from investment, insurance, annuity and other bank products. Noninterest income exclusive of equity method income increased $214, or 6.77% to $3,376. The increase in 2015 is primarily attributable to a $44 or 2.70% increase in service charge on deposit accounts, a $46 or 12.20% increase in commissions and fees, a $38 or 9.69% increase in mortgage loan fees and an $87 or 16.63% increase in other operating income as recoveries from nonperforming problem assets increased by $39. Noninterest Expense. Total noninterest expense for the year ended December 31, 2015 increased $53, or 0.44%, to $12,061 from $12,008 in 2014. The increase in noninterest expense is primarily due to a $411, or 6.85%, increase in salary and employee benefits as salaries and commissions increased $301 or 6.14% and defined benefit plan expense increased $117 to $128 in 2015 from $11 in 2014 These increases were partially offset by a $63 or 8.32% decrease in occupancy expense, a $92 or 11.59% decrease in furniture and equipment, a $23 or 10.70% decrease in office supplies and printing, a $25 or X0.08% decrease in capital stock tax, a $13 or 6.37% decrease in advertising expense and $162 or 4.56% decrease in other operating expenses. Other operating expenses declined due to a $180 decrease in losses on sales of nonperforming assets. Income Tax Expense. Applicable income taxes on 2015 earnings amounted to $1,306, resulting in an effective tax rate of 32.28% compared to $970, and an effective tax rate of 31.10%, in 2014. G] Investment Portfolio Investment securities as of December 31, 2015 totaled $27,148, a decrease of $2,129, or 7.27% from $29,277 as of December 31, 2014. Investment securities held-to-maturity decreased to $5,073 as of December 31, 2015 from $5,680 as of December 31, 2014, a decrease of $607 or 10.69%. Available-for sale investments decreased to $22,075 as of December 31, 2015 from $23,597 as of December 31, 2014, a decrease of $1,522 or 6.45%. Investments decreased in 2015 as funds from pay downs and maturing and called bonds were used to fund loan growth. Loan Portfolio The Company's net loans were $303,199 as of December 31, 2015, an increase of $22,750, or 8.11 %, from $280,449 as of December 31, 2014. This increase resulted from a $14,741 increase in commercial loans, a $6,982 increase consumer loans and an $875 increase in real estate loan originations during 2015. The Company's ratio of net loans to total deposits was 91.21% as of December 31, 2015 compared to 86.24% as of December 31, 2014. Bank Premises and Equipment Bank premises and equipment increased $338, or 4.01% in 2015 due in part to the renovations in progress of our Timberlake Branch and the construction in progress of our new Old Forest Road Branch. The projects are expected to be completed by July 2016. The Company plans to start the construction of its Odd Fellows Road location in mid-2016 which will house its Lynchburg headquarters and branch office. The Odd Fellows Road office will not replace our Altavista headquarters, but will relocate our administrative and training facility currently leased in the Wyndhurst section of Lynchburg. Deposits Average deposits were $331,013 for the year ended December 31, 2015, an increase of $9,859 or 3.07% from $321,154 of average deposits for the year ended December 31, 2014. As of December 31, 2015, total deposits were $332,403 representing an increase of $7,199, or 2.21%, from $325,204 in total deposits as of December 31, 2014. The change in deposits during 2015 was primarily due to increased deposit balances in previously existing deposit accounts, new deposit accounts opened as a result of new banking relationships, growth at the Company's branch locations and competitive pricing of the Company's products and services. Capital Resources The Company's financial position as of December 31, 2015 reflects liquidity and capital levels currently adequate to support anticipated funding needs and budgeted growth of the Company. Capital ratios are in excess of required regulatory minimums fora "well-capitalized" institution. The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The adequacy of the Company's capital is reviewed by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses. In July 2013, the Federal Reserve Board approved and published the final Basel III Capital Rules establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee's December 2010 framework ("Basel III") for strengthening international capital standards as well as certain provisions of the Dodd Frank Act. The Basel III Capital Rules, among other things, (i) introduce a new capital measure called "Common Equity Tier 1" ("CET1"), (ii) specify that Tier 1 capital consists of CET1 and "Additional Tier 1 Capital" instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations. The Basel III Capital Rules were effective for Bankshares and the Bank on January 1, 2015 (subject to a phase in period for certain components). CET1 capital for the Bankshares and the Bank consists of common stock, related paid in capital, and retained earnings. In 10 connection with the adoption of the Basel III Capital Rules, we elected to opt out of the requirement to include most components of accumulated other comprehensive income in CET1. CETI for Bankshares and the Bank is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities and subject to transition provisions. Basel III limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a "capital conservation buffer" consisting of 2.50% of CET1 capital, Tier 1 capital and total capital to risk weighted assets in addition to the amount necessary to meet minimum risk-based capital requirements. The capital conservation buffer will be phased in beginning January 1, 2016, at 0.625% of risk weighted assets, increasing each year until fully implemented at 2.50% on January 1, 2019. When fully phased in on January 1, 2019, Basel III will require (i) a minimum ratio of CET1 capital to risk weighted assets of at least 4.50%, plus a 2.50% capital conservation buffer, (ii) a minimum ratio of Tier lcapital to risk weighted assets of at least 6.00%, plus the capital conservation buffer, (iii) a minimum ratio of total capital to risk weighted assets of at least 8.00%, plus the capital conservation buffer and (iv) a minimum leverage ratio of 4.00%. Bankshares and the Bank continue to be well capitalized under the Basel III rules. See Note 12 "Dividend Restrictions and Capital Requirements" of the "Notes to Consolidated Financial Statements" for additional information. The Company's CET1 and Tier 1 Risk-based Capital Ratio was 11.45% of December 31, 2015. The Total Risk-based Capital Ratio was 12.41 %and the Company's Tier 1 Leverage Ratio was 9.68% as of December 31, 20]5. Stockholders' equity was $34,782 as of December 31, 2015 compared to $32,654 as of December 31, 2014. Dividends paid to shareholders were $0.34 per share paid in 2015 as compared to the $0.32 per share paid in 2014. PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, 2015 and 2014 (In thousands of dollazs, except shaze data) (Audited) Assets 2015 2014 Cash and cash equivalents (note 2): Cash and due from banks Certificates of deposits Securities (note 3): Available-for-sale, at fair value Held-tamaturity, at amortized cost Federal Reserve Bank stock, at cost (note 1(d)) Federal Home Loan Bank stock, at cost (note 1(d)) Loans, net (notes 4, 9 and 11) Bank premises and equipment, net (note 5) Accrued interest receivable Bank owned life insurance Goodwill Other real estate owned Other assets (notes 7 and 8) $ 16,739 $ 985 22,075 5,073 144 325 303,199 8,770 962 6,459 539 1,733 4,258 28,466 985 23,597 5,680 144 322 280,449 8,432 887 6,288 539 1,107 5,292 Total assets $ 371,261 $ 362,188 Liabilities and Stockholders' Equity Liabilities: Deposits (note 6): Demand Savings and NOW accounts Time 58,895 $ 171,431 102,077 Total deposits 332,403 $ 1,091 Note payable under line of credit (note 1(~) Accrued interest payable 121 Other liabilities (note 7) 2,864 50,801 160,549 113,854 325,204 1,368 169 2,793 Total liabilities 336,479 329,534 Stockholders' equity (notes 7, 12 and IS): Common stock, $3 par value. Authorized 3,000,000 shares, issued and outstanding 1,520,221 shares in 2015 and 1,511,970 shares in 2014 Capital surplus Retained earnings Accumulated other comprehensive loss, net Total stockholders' equity Commitments, contingencies and other matters (notes 9, 10 and 1 I ) 4,508 1,065 30,442 (1,233) 34,782 4,497 1,004 28,219 (1,066) 32,654 Total liabilities and stcekholders' equity $ 371,261 $ ,62,1825 See accompanying notes to consolidated financial statements. 12 PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 2015 and 2014 (In thousands of dollazs, except per shaze data) (Audited) 2015 2014 $ 13,530 $ 13,463 309 73 107 96 3 267 79 122 100 4 14,118 14,035 440 794 379 1,613 12,505 129 12,376 1,671 423 430 249 958 731 6,412 694 702 192 255 223 191 3,392 12,061 4,046 1,306 ~ 441 1,024 514 1,979 12,056 91 11,965 1,627 377 392 249 517 3,162 6,001 757 794 215 235 248 204 3,554 12,008 3,119 970 $ 2,740 $ 2,149 $ $ 1.80 $ 1.79 $ 1.42 1.40 Interest income: Interest and fees on loans Interest on securities: U.S. Government agencies States and political subdivisions (taxable) States and political subdivisions (tax-exempt) Other Interest on federal funds sold Total interest income Interest expense: Interest on deposits: Savings and NOW accounts Time -under $100,000 Time - $100,000 and over Total interest expense Net interest income Provision for loan losses and unfunded commitments (note 4) Net interest income after provision for loan losses Nonioterest income: Service chazges on deposit accounts Commissions and fees Mortgage loan fees Service charges on loan accounts Other operating income Total noninterest income Noninterest expense: Salaries and employee benefits (note 7) Occupancy expense Furniture and equipment expense Office supplies and printing Federal deposit insurance premiums Capital stock tax Advertising expense Oiher operating expenses Total noninterest expense Income before income tax expense Income taac expense (note 8) Net income Basic net income per share (note 1(r)) Diluted net income per share (notel(t)) See accompanying notes to consolidated financial statements 13 PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Years ended December 31, 2015 and 2014 (In thousands of dollars) (Audited) Net income Other comprehensive income (losses), net of related income taxes: Unrealized gains on availabile-for-sale securities Before tax Income tax expense Changes in plan assets and benefit obligation of defined benefit pension plan Before tax Income tax expense Total other comprehensive loss Comprehensive income See accompanying notes to consolidated financial statements. 2015 2014 $ 2,740 $ 2,149 133 (45) 88 (30) (1,469) 499 (912) $ 2,573 $ 1,237 (386) 131 (167) 14 PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years ended December 31, 2015 and 2014 (In thousands of dollars, except share and per share data) (Audited) Balances, December 31, 2013 (As Restated) 1,515,007 $ 4.507 S 1.035 S 26.554 $ (154) ~ 31,942 Common Stock Capital Shares Par Value Surplus Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Net income Other Comprehensive Loss Issuance of restricted stcek and related expense Stcek options exercised Repurchased stcek Cash dividends declazed by Bankshares ($032 per shaze) Balances, December 31, 2014 Net income Other Comprehensive Loss Issuance of restricted stock and related expense Stock options exercised Repurchased stock Cash dividends declared by Bankshares ($0.34 per share) Balances, December 31, 2015 See accompanying notes to consolidated financial statements. 8,400 628 (12,065) 26 138 (36) (169) 2, 149 (484) 1912) 2,149 (912) 164 (205) (484) 1,511,970 $ 4,497 S 1,004 5 28.'19 S (1.066) 5 32,654 5,971 4,680 ~~.4~) 18 ~~) 98 (3~) ?,740 (517) (167) 2,740 Q67) 116 ~~) (517) 1,5?0,22I ~ 4,508 ~ 1,065 $ 30,442 $ (1,233) $ 34,782 15 CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2015 and 2014 (In thousands of dollars) (Audited) Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of bank premises and equipment Accretion of unearned fees, net Net amortization of premiums and discounts on securities Provision for loan losses Provision for deferred income taaces Stock based compensation expense Increase in cash value of bank owned life insurance Valuation loss on OREO Net decrease (increase) in: Accrued interest receivable Other assets Net increase (decrease)in: Accrued interest payable Other liabilities Net cash provided by operating activities Cash flows from investing activities: Purchases ofavailable-for-sale securities Proceeds from maturities and calls ofheld-to-maturity securities Proceeds from maturities and calls of available-for-sale securities Proceeds from paydowns and maturities ofavailable-for-sale mortgage-backed secwities Proceeds from the sale of OREO Purchase of Federal Reserve Stock Sale of Federal Home Loan Bank stock Net increase in loans made to customers Purchases of bank premises and equipment Purchase of bank owned life insurance Additions to foreclosed assets Net cash used in investing activities Cash flows from financing activities: Net increase in demand, savings and NOW deposits Net decrease in time deposits Repurchase of common stock Repayment of line of credit Cash dividends paid Net cash provided by financing activities Net decrease in cash and cash equivalents 2015 2014 $ 2,740 $ 2,149 409 29 57 129 57 116 (171) 43 (75) 1,063 (48) (315) 458 30 50 91 56 164 (175) 235 91 (340) (54) 128 4,034 2,883 (13,504) 570 14,849 290 ],003 (3) - (24,524) (747) - (56) (4,450) - 4,067 161 222 (2) 96 (6,512) (1,594) (3,000) (3) (22,122) (11,012) 18,976 (11,777) (44) (277) (517) 9,678 (6,604) (205) (262) (484) 6,361 2,123 (11,727) (6,006) Cash and cash equivalents, beginning of yeaz 28,466 34,472 Cash and cash equivalents, end of year $ 16,739 $ 28,466 Supplemental disclosure of cash flows information Cash paid during the yeaz for: Income taxes Interest Supplemental schedule of noncash investing and financing activities: Transfer from loans to foreclosed assets Loans chazged against the allowance for loan losses Unrealized gains on available-for-sale securities Defined benefit plan adjushnent per ASC topic Compensation-Retirement Benefrts See accompanying notes to consolidated financial statements. 16 $ $ 875 $ 1,661 990 2,033 1,616 $ 639 133 (386) 263 630 88 (1,469) PINNACLE BANKSHARES CORPORATION AND SUBSIDIARY Notes to Consolidated Financial Statements (In thousands, except ratios, share and per share data) (1) Summary of Significant Accounting Policies and Practices Pinnacle Bankshares Corporation, a Virginia corporation (the "Company" or "Bankshares"), was organized in 1997 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Bankshares is headquartered in Altavista, Virginia. Bankshares conducts all of its business activities through the branch offices of its wholly owned subsidiary bank, First National Bank (the Bank). Bankshares exists primarily for the purpose of holding the stock of its subsidiary, (the "Bank"), and of such other subsidiaries as it may acquire or establish. The Company has a single reportable segment for purposes of segment reporting. The accounting and reporting policies of Bankshares and its wholly owned subsidiary (collectively, the "Company"), conform to generally accepted accounting principles in the United States of America ("GAAP") and general practices within the banking industry. The following is a summary of the more significant accounting policies and practices: (a) Consolidation The consolidated financial statements include the accounts of Bankshares and the Bank. All material intercompany balances and transactions have been eliminated. (b) Use of Estimates In preparing the consolidated financial statements in accordance with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated balance sheets and revenues and expenses for the years ended December 31, 2015 and 2014. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan losses, payments/obligations under benefit and pensions plans, other real estate owned and fair value of investments. (c) Securities The Company classifies its securities in three categories: (1) debt securities that the Company has the positive intent and ability to hold to maturity are classified as "held-to-maturity securities" and reported at amortized cost; (2) debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as "trading securities" and reported at fair value, with unrealized gains and losses included in net income; and (3) debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as "available-for-sale securities" and reported at fair value, with unrealized gains and losses excluded from net income and reported in accumulated other comprehensive income, a separate component of stockholders' equity, net of deferred taxes. Fair value is determined from quoted prices obtained and reviewed by management. Held-to-maturity securities are stated at cost, adjusted for amortization of premiums and accretion of discounts on a basis, which approximates the level yield method. As of December 31, 2015 and 2014, the Company does not maintain trading securities. Gains or losses on disposition are based on the net proceeds and adjusted carrying values of the securities called or sold, using the specific identification method on a trade date basis. Management evaluates securities for other-than-temporary impairment ("OTTI") on a least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. The Company assesses OTTI based upon whether it intends to sell a security or if it is likely that it would be required to sell the security before recovery of the amortized cost basis of the 17 investment, which may be maturity. For debt securities, if the Company intends to sell the security or it is likely that the Company will be required to sell the security before recovering its cost basis, the entire impairment loss would be recognized in earnings as an OTTI. If the Company does not intend to sell the security and it is not likely that the Company will be required to sell the security but we do not expect to recover the entire amortized cost basis of the security, only the portion of the impairment loss representing credit losses would be recognized in earnings. The credit loss on a security is measured as the difference between the amortized cost basis and the present value of the cash flows expected to be collected. Projected cash flows are discounted by the original or current effective interest rate depending on the nature of the security being measured for potential OTTI. The remaining impairment related to all other factors, the difference between the present value of the cash flows expected to be collected and fair value, is recognized as a charge to other comprehensive income ("OCI"). Impairment losses related to all other factors are presented as separate categories within OCI. For investment securities held to maturity, this amount is accreted over the remaining life of the debt security prospectively based on the amount and timing of future estimated cash flows. The accretion of the amount recorded in OCI increases the carrying value of the investment and does not affect earnings. If there is an indication of additional credit losses the security is re-evaluated according to the procedures described above. (d) Restricted Equity Investments As a member of the Federal Reserve Bank ("FRB") and the Federal Home Loan Bank of Atlanta ("FHLB"), the Company is required to maintain certain minimum investments in the common stock of the FRB and FNLB, which are carried at cost. Required levels of investment are based upon the Company's capital and a percentage of qualifying assets. In addition, the Company is eligible to borrow from the FHLB with borrowings collateralized by qualifying assets, primarily residential mortgage loans, and the Company's capital stock investment in the FHLB. Management's determination of whether these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted, (2) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB, and (4) the liquidity position of the FHLB. (e) Change in Accounting Method During the year ended December 31, 2015, the Company elected to adopt the equity method of accounting for an investment in a limited liability corporation that had previously been accounted for as a cost method investment. During the year ended December 31, 2015, the Company determined that it had the ability to exercise significant influence over the investee, as the Company's president was elected to the board of directors of the limited liability corporation. In conjunction with the change in accounting method, the Company has reported a $354 gain on the investment in noninterest income for the year ended December 31, 2015. (~ Borro►~~iirgs As of December 31, 2015, the Company's available borrowing limit with the FHLB was approximately $48,637. The Company had $0 in borrowings from the FHLB outstanding at December 31, 2015 and 2014. The Company also has a $3,000 line of credit commitment with no outstanding balance secured by the authorized capital stock of the Bank with a correspondent bank. The Company has a term loan with the same correspondent bank with $1,091 outstanding as of December 31, 2015 and $1,368 outstanding as of December 31, 2014 with a 5.00% interest rate that matures on June 30, 2017. [E:3 (;) Loans and Allowance. for Loan Losses Loans are stated at the amount of unpaid principal, reduced by unearned income and fees on loans, and an allowance for loan losses. Income is recognized over the terms of the loans using methods that approximate the level yield method. The allowance for loan losses is a cumulative valuation allowance consisting of an annual provision for loan losses, plus any amounts recovered on loans previously charged off, minus loans charged off. The provision for loan losses charged to operations is the amount necessary in management's judgment to maintain the allowance for loan losses at a level it believes adequate to absorb probable losses inherent in the loan portfolio. Management determines the adequacy of the allowance based upon reviews of individual credits, recent loss experience, delinquencies, current economic conditions, the risk characteristics of the various categories of loans and other pertinent factors. Management uses historical loss data by loan type as well as current economic factors in its calculation of allowance for loan loss. Management also uses qualitative factors such as changes in lending policies and procedures, changes in national and local economies, changes in the nature and volume of the loan portfolio, changes in experience of lenders and the loan department, changes in volume and severity of past due and classified loans, changes in quality of the Company's loan review system, the existence and effect of concentrations of credit and external factors such as competition and regulation in its allowance for loan loss calculation. Each qualitative factor is evaluated and applied to each type of loan in the Company's portfolio and a percentage of each loan is reserved as allowance. A percentage of each loan type is also reserved according to the loan type's historical loss data. Larger percentages of allowance are taken as the risk for a loan is determined to be greater. Loans are charged against the allowance for loan losses when management believes the principal is uncollectible. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions or the Company's recent loss experience. It is reasonably possible that management's estimate of loan losses and the related allowance may change materially in the near term. However, the amount of change that is reasonably possible cannot be estimated. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examinations. Loans are charged against the allowance when, in management's opinion, they are deemed doubtful, although the Company continues to aggressively pursue collection. The Company considers a number of factors to determine the need for and timing of charge-offs including the following: whenever any commercial loan becomes past due for 120 days for any scheduled principal or interest payment and collection is considered unlikely; whenever foreclosure on real estate collateral or liquidation of other collateral does not result in full payment of the obligation and the deficiency or some portion thereof is deemed uncollectible, the uncollectible portion shall be charged-off; whenever any installment loan becomes past due for 120 days and collection is considered unlikely; whenever any repossessed vehicle remains unsold for 60 days after repossession; whenever a bankruptcy notice is received on any installment loan and review of the facts results in an assessment that all or most of the balance will not be collected, the loan will be placed in non-accrual status; whenever a bankruptcy notice is received on a small, unsecured, revolving installment account; and whenever any other small, unsecured, revolving installment account becomes past due for 180 days. Loans are generally placed in non-accrual status when the collection of principal and interest is 90 days or more past due, unless the obligation relates to a consumer or residential real estate loan or is both well-secured and in the process of collection. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Generally, loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured, which usually requires a minimum of six months of sustained repayment performance. Impaired loans are required to be presented in the financial statements at net realizable value of the expected future cash flows or at the fair value of the loan's collateral. Homogeneous loans such as real estate mortgage loans, individual consumer loans and home equity loans are evaluated collectively for impairment. Management, considering current information and events regarding the borrower's ability to repay their obligations, considers a loan to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impairment losses are included in the allowance for loan losses through a charge to the provision for loan losses. Cash receipts on impaired loans receivable are applied first to reduce interest on such loans to the extent of interest contractually due and any remaining amounts are applied to principal. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan's effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported at the fair value of the collateral less cost to sell. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses. (h) Loan Origination and Commitment Fees and Certain Related Direct Costs Loan origination and commitment fees and certain direct loan origination costs charged by the Company are deferred and the net amount amortized as an adjustment of the related loan's yield. The Company amortizes these net amounts over the contractual life of the related loans or, in the case of demand loans, over the estimated life. Fees related to standby letters of credit are recognized over the commitment period. (i) Bank Premises and Equipment Bank premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is computed by the straight-line and declining-balance methods over the estimated useful lives of the assets. Depreciable lives include 15 years for land improvements, 39 years for buildings, and 3 to 7 years for equipment, furniture and fixtures. The cost of assets retired and sold and the related accumulated depreciation are eliminated from the accounts and the resulting gains or losses are included in determining net income. Expenditures for maintenance and repairs are charged to expense as incurred, and improvements and betterments are capitalized. (j) Bank Owned Life I»sirrance The Company has purchased life insurance policies on certain key members of management. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. (k) Goodwill The Company performs a goodwill impairment analysis on an annual basis as of December 31st. Additionally, the Company performs a goodwill impairment evaluation on an interim basis when events or circumstances indicate impairment potentially exists. During 2015, the Company reviewed its goodwill for impairment and determined that goodwill is not impaired. Management will continue to monitor the relationship of Bankshares' market capitalization to both its book value and tangible book value, which management attributes to both financial services industry- wide and Company-specific factors, and to evaluate the carrying value of goodwill. (1) Other Real Estate Owned Foreclosed properties consist of properties acquired through foreclosure or deed in lieu of foreclosure. At time of foreclosure, the properties are recorded at the fair value less costs to sell. Subsequently, these properties are carried at the lower of cost or fair value less estimated costs to 20 i ~ '' ~' sell. Losses from the acquisition of property in full or partial satisfaction of loans are charged against the allowance for loan losses. Subsequent write-downs, if any, are charged to expense. Gains and losses on the sales of foreclosed properties are included in determining net income in the year of the sale. (nr) /mpnirment or Disposal of Long-Lived Assets The Company's long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used, such as bank premises and equipment, is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of, such as foreclosed properties, are reported at the lower of the carrying amount or fair value less costs to sell. (n) Pension Plan The Company maintains a noncontributory defined benefit pension plan, which covers substantially all of its employees. The net periodic pension expense includes a service cost component, interest on the projected benefit obligation, a component reflecting the actual return on plan assets, the effect of deferring and amortizing certain actuarial gains and losses, and the amortization of any unrecognized net transition obligation on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plan. The Company's funding policy is to make annual contributions in amounts necessary to satisfy the Internal Revenue Service's funding standards, to the extent that they are tax deductible. ASC Topic 715, Defined Benefit Pension Plans requires a business entity to recognize the overfunded or underfunded status of asingle-employer defined benefit postretirement plan as an asset or liability in its statement of financial position and to recognize changes in that funded status in comprehensive income in the year in which the changes occur. Defined Benefit Pension Plans also requires a business entity to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. (o) Advertising The Company recognizes advertising expenses as incurred. (p) Income Taxes Income taxes are accounted for under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in net income in the period that includes the enactment date. Deferred taxes are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount 21 measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination. (q) Stock Options and Restricted Stock The Company accounts for its stock based compensation plan by recognizing expense for options and restricted stock granted equal to the grant date fair value of the unvested amounts over their remaining vesting periods. There were 6,250 shares of restricted stock granted in 2015 compared to 8,400 shares of restricted stock granted in 2014. There were 43,000 stock options outstanding as of December 31, 2015 compared to 58,000 stock options outstanding as of December 31, 2014. Future levels of compensation cost recognized related to share-based compensation awards may be impacted by new awards and/or modification, repurchases and cancellations of existing awards after the adoption of this standard. (r) Net Income per Share Basic net income per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted net income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock that are not anti-dilutive were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. The following is a reconciliation of the numerators and denominators of the basic and diluted net income per share computations for the periods indicated: Year ended December 31, 2015 Basic net income per share Effect of dilutive stock options Diluted net incorre per share $ $ Net income (numerator) 2,740 Shares (denominator) Per share amount 1,519,159 $ 1-~u 2,740 1,531,436 $ IJ~~ 12,277 Year ended December 31, 2014 Basic net income per share Effect of dilutive stock options Diluted net income per share Net income (numerator) 2,149 $ Shares (denominator) Per share amount 1,512,661 $ 18,170 I.-t? 1.-1U $ 2,149 1,530,831 $ (s) ('nnsolidnted Statements of Cash Flows For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks (with original maturities of three months or less), and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. (t) Comprehensive Income ASC Topic 220 Comprehensive Income, requires the Company to classify items of "Other Comprehensive Income" (such as net unrealized gains (losses) on available-for-sale securities) by their nature in a financial statement and present the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. The Company's other comprehensive income consists of net income, and net unrealized gains (losses) on securities available-for-sale, net of income taxes, and adjustments relating to its defined benefit plan, net of income taxes. ~a (u) Fair Value Measurements ASC Topic 820, Fair Value Measurements and Disclosures establishes a framework for using fair value. It defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. In accordance with Fair Value Measurements and Disclosures, the Company groups its financial assets and financial liabilities 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. The most significant instruments that the Company measures at fair value are available-for-sale securities. All available-for-sale securities fall into Level 2 fair value hierarchy. Valuation methodologies for the fair value hierarchy are as follows: Level 1 —Valuations are based on quoted prices for identical assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 2 —Valuations for assets and liabilities are obtained from readily available pricing sources via independent providers for market transactions involving similar assets or liabilities, model- based valuation techniques, or other observable inputs. Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and are not based on market exchange, dealer, or broker traded transactions. Leve13 valuations incorporate certain assumptions and projections in determining fair value assigned to such assets and liabilities. (v) Current Accounting Developments In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, "Revenue Recognition (Topic 606): Revenue from Contracts with Customers. " ASU 2014-09 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in GAAP when it becomes effective. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the standard on its ongoing financial reporting. In August 2015, the FASB issued ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, "which deferred the effective date of ASU 2014-09 to annual and interim periods beginning after December 15, 2017. Early application is not permitted. In June 2014, the FASB issued ASU 2014-12, "Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. " ASU 2014-12 will be effective for annual and interim periods beginning after December 15, 2015. ASU 2014-12 applies to all reporting entities that grant their employees share-based payments in which the terms of the award provide for a performance target that affects vesting could be achieved after the requisite service period. That is the case when an employee is eligible to retire or otherwise terminate employment before the end of the period in which a performance target (for example, an initial public offering or a profitability target) could be achieved and still be eligible to vest in the award if and when the performance target is achieved. We do not currently have outstanding performance-based awards and, as a result, ASU 2014-12 would not impact our financial statements and its related disclosures. In January 2015, the FASB issued ASU 2015-01, "Income Statement -Extraordinary and Unusual Items (Subtopic 225-20): Simpl~ing Income Statement Presentation by Eliminating the 23 Concept of Extraordinary Items," which eliminates the concept of extraordinary items from U.S. GAAP as part of its simplification initiative. Under ASU 2015-01, an entity will no longer separate out an extraordinary item from the results of ordinary operations and separately present this extraordinary item on its income statement, nor will related income tax and earnings-per- share data applicable to an extraordinary item need to be disclosed. Despite these simplifications, ASU 2015-01 does not affect disclosure guidance for events or transactions that are unusual in nature or infrequent in their occurrence. ASU 2015-01 is effective for annual periods beginning after December 15, 2015, and interim periods within those annual periods. The Company does not expect the effect of ASU 2015-01 to have a material impact on its financial statements and related disclosures. In February 2015, the FASB issued ASU 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis, " which changes the way reporting enterprises evaluate whether (a) they should consolidate limited partnerships and similar entities, (b) fees paid to a decision maker or service provider are variable interests in a variable interest entity (VIE), and (c) variable interests in a VIE held by related parties of the reporting enterprise require the reporting enterprise to consolidate the VIE. It also eliminates the VIE consolidation model based on majority exposure to variability that applied to certain investment companies and similar entities. ASU 2015-2 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Company does not expect the effect of ASU 2015-02 to have a material impact on its financial statements and related disclosures. In April 2015, the FASB issued ASU 2015-03, "Interest—Imputation of Interest (Subtopic 835- 30): Simpl~ing the Presentation of Debt Issuance Costs" to modify the presentation of debt issuance costs. Prior to ASU 2015-03, issuance costs were presented as an asset on the statement of financial position, which the FASB concluded was inconsistent with both IFRS as well as FASB Concept Statement No. 6. This ASU requires that issuance costs be presented as a direct deduction of debt balances on the statement of financial position, similar to the presentation of debt discounts. ASU 2015-03 is effective for public companies for years beginning after December I5, 2015, and interim periods within those fiscal periods. For all other entities, ASU 2015-03 is effective for years beginning after December 15, 2015 and interim periods within annual periods beginning after December 15, 2016, while early adoption is permitted for financial statements that have not already been issued. Additionally, the provisions should be applied on a retrospective basis as a change in accounting principle. ASU 2015-03 will not have an impact on the Company's financial statements and related disclosures. Subsequent to the issuance of ASU 2015-03, the Securities and Exchange ("SEC") staff made an announcement regarding the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements, which were not addressed in ASU 2015-03. In August 2015, the FASB codified the SEC announcement in the issuance of ASU 2015-15, "Interest -Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements." Per ASU 2015-15, for debt issuance costs related to line-of-credit arrangements, the SEC would not object to an entity deferring and presenting such costs as an asset and subsequently amortizing the costs ratably over the term of the line-of-credit arrangement, regardless of whether there were any outstanding borrowings on the line-of-credit arrangement. The SEC Staff guidance is effective upon adoption of ASU 2015-03. ASU 2015-15 will not have an impact on the Company's financial statements and related disclosures. In April 2015, the FASB issued ASU 2015-05, "Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement." Under ASU 2015-05, a customer should determine whether the arrangement includes a software license. If so, the customer should account for the software license component in a manner consistent with the accounting for other software licenses. If the arrangement does not include a software license, the arrangement should be accounted for as a service contract. The 24 provisions of ASU 2015-OS must be applied by public entities to annual periods beginning after December 15, 2015 as well as interim periods within those annual periods. The Company does not expect the effect of ASU 2015-OS to have a material impact on its financial statements and related disclosures. In May 2015, the FASB issued ASU 2015-08, "Business Combinations, Pushdown Accounting (Topic 805): Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 11 S" which revised the requirement for recognition and disclosure of a new basis of accounting (or pushdown accounting) for certain business combination situations. The Company does not expect ASU 2015-08 to have any impact on its financial statements and related disclosures. In September 2015, the FASB issued ASU 2015-16, "Business Combinations (Topic 80S): Simplifying the Accounting for Measurement-Period Adjustments," which eliminates the requirement for an acquirer to retrospectively adjust the financial statements for measurement- period adjustments that occur in periods after a business combination is consummated. ASU 2015-16 will be effective for annual and interim periods beginning after December 15, 2015. Early adoption is permitted. The Company does not expect ASU 2015-16 to have any impact on its financial statements and related disclosures. The FASB has issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Tazes, which changes how deferred taxes are classified on organizations' balance sheets. ASU 2015-17 eliminates the current requirement for organizations to present deferred tax liabilities and assets as current and noncurrent in a classified balance sheet. Instead, organizations will be required to classify all deferred tax assets and liabilities as noncurrent. The amendments apply to all organizations that present a classified balance sheet. For private companies, the amendments are effective for financial statements issued for annual periods beginning after December 15, 2017. The FASB has issued ASU 2016-01, Financial Instruments —Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The new guidance is intended to improve the recognition and measurement of financial instruments. ASU 2016-01 affects public and private companies, not-for-profit organizations, and employee benefit plans that hold financial assets or owe financial liabilities. The new guidance makes targeted improvements to existing U.S. GAAP by 1) requiring equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; 2) requiring separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; 3) eliminating the requirement to disclose the fair value of financial instruments measured at amortized cost for organizations that are not public business entities; and 4) requiring a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk (also referred to as "own credit") when the organization has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. The new guidance is effective for private companies for fiscal years beginning after December 15, 2018, and for interim periods within fiscal years beginning after December 15, 2019. (2) Restrictions on Cash To comply with Federal Reserve regulations, the Company is required to maintain certain average reserve balances. The daily average reserve requirements were approximately $3,043 and $3,258 for the weeks including December 31, 2015 and 2014, respectively. 25 (3) Securities The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities as of December 31, 2015 and 2014 are as follows: Available-for-Sale U.S. Treasury securities and obligations of U.S. Government corporations and agencies Obligations of states and political subdivisions Mortgage-backed securities — govemrrent Total available-for-sale 2015 Amortized Gross unrealized costs wins Gross unrealized losses $ $ 18,677 1,741 1,486 21,904 84 117 22 »; (43) — (9) ~52~ Helc~to-Maturity Obligations of states and political subdivisions $ 2015 Gross unrealized gains 121 Gross unrealized losses — Amortized costs 5,073 Fair values 18,718 1,858 1,499 ,,,(~7~ Fair values 5.19-1 Available-for-Sale 2014 Amortized Gross unrealized costs wins Gross unrealized losses Hair values U.S. Treasury securities and obligations of U.S. Government corporations and agencies $ Obligations of states and political subdivisions Mortgage-backed securities —government 20,538 1,746 1,275 Total available-for-sale $ '_3.SS~ Helc~to-Maturtty Obligations of states and political subdivisions $ Amortized costs 5,680 62 126 ~2 (181) 1 I) 20,419 1,872 1,306 ~ ~~ i (I tip) 23,597 __ o 2014 Gross unrealized gains 148 Gross unrealized losses I~.~i ~- vilueti (6) ~.~~~ The following table shows the gross unrealized losses and fair value of the Company's investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2015: Fair Description of Securiries value U.S. Treasury securities and oblip~tions of Less than l2 months Gross unrealized losses Tot:~l Fair value Gruss unrealized losses U.S. Government corporations and agencies $ 11,867 Mortgpge-backed securities-government 1,219 43 9 11,867 4R2 Total temporarily impaired securities $ 13,086 52 I ~.~~s~~ 43 1 ~~ (~ There were no securities that have been in a continuous unrealized loss position for over 12 months as of December 31, 2015. The following table shows the gross unrealized losses and fair value of the Company's investments, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of December 31, 2014: Descriprion of Securities U.S. Treasury securities and obli~tions of Less than 12 months Gross unrealized losses Fair value Total Fair value Gross unrealized losses U.S. Government corporations and agencies Morta~ee-backed securities-government $ 3,462 482 25 1 3,462 482 25 I Total temporarily impaired securities Description of Securities U.S. Treasury securities and obligations of $ 3,944 26 3,944 26 More than 12 months ~ otal Fair value Gross unrealized losses Fair value Gross unrealized losses U.S. Government corporations and agencies $ 16, 156 162 ] 6,156 162 Total temporazily imp aced securities $ 16,156 ~~~ 16,156 162 162 The Company does not consider the unrealized losses other-than-temporary losses based on the volatility of the securities market price involved, the credit quality of the securities, and the Company's ability, if necessary, to hold the securities until maturity. For 2015, the securities include 16 bonds that have continuous losses for less than 12 months and no bonds that have continuous losses for more than 12 months. For 2014, the securities include 4 bonds that had continuous losses for less than 12 months and 19 bonds that had continuous losses for more than 12 months. There were no gross realized gains or losses on securities sold in 2015 and 2014. The amortized costs and fair values of available-for-sale and held-to-maturity securities as of December 31, 2015, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Due in one year or less Due after one year through five years Due after five years through ten years $ Mortgage-backed securities 2015 Available-for-Sale Fair values Amortized costs Helc~to-Maturity Amortized costs Fair values 2,311 16,646 1,461 20,418 1,486 2,310 16,730 1,537 20,577 1,498 1,308 3,765 — 5,073 1,319 3,875 — 5,194 Totals $ 21.9 (~ Securities with amortized costs of approximately $5,807 and $4,312 (fair values of $5,925 and $4,404, respectively) as of December 31, 2015 and 2014, respectively, were pledged as collateral for public deposits and to the FRB for overdraft protection. 27 (4) Loans, Allowance for Loan Losses and Credit Quality A summary of loans as of December 31, 2015 and 2014 follows: Real estate loans: Res idential-mortgage Res idential-construction Cottn~r~ercial $ Loans to individuals for household, family and other consumer e~enditures Corrnnercial and industrial loans Total loans, gross Less unearned income and fees Loans, net of unearned income and fees Less allowance for loan losses Loans, net $ 2015 2014 106,474 6,468 86,013 60,854 46,376 306,185 (97) 306,088 (2,889) 303,199 108,128 8,927 81,025 53,872 31,635 283,587 (68) 283,519 (3,070) 280,449 In the normal course of business, the Bank has made loans to executive officers and directors. As of December 31, 2015 and 2014, loans to executive officers and directors totaled $210 and $197, respectively. During 2015, new loans made to executive officers and directors totaled $144, advances totaled $76 and repayments amounted to approximately $203. There were no loans to companies in which executive officers and directors have an interest as of December 31, 2015 and 2014. All such loans were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with unrelated persons, and, in the opinion of management, do not involve more than normal risk of collectability or present other unfavorable features. The fair value of loans, net of unearned income and fees, was $307,151 as of December 31, 2015 and $287,399 as of December 31, 2014. The following table presents information on the Company's allowance for loan losses and recorded investment in loans: Allowance f'or Loan Losses and Recorded Investment in Loans For the Year Ended December 31, 2015 Commercial Commercial Real Estate Consumer Residential Total Allowance for Loan Losses: Beginning balance Charge-offs Recoveries Provision for loan losses $264 (20) 29 39 Ending Balance $312 $795 (13) 7 (94) $695 $520 (434) 215 322 $623 $1,491 (172) 88 (148) $1,259 $3,070 (639) 339 119 $2,889 Allowance: Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment $- $- $- $- $- $314 676 650 1,249 2,889 28 Commercial Commercial Real Estate Consumer Kesidentixl Total Loans: Total loans ending balance $46,376 86,013 60,854 112,942 306,185 Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment $12 984 25 1,835 2,856 $46,364 85,029 60,829 111,107 303,329 For the Year Ended December 31, 2014 Commercial Commercial Real Estate Consumer Residential Total $211 (23) 5 71 $264 $1,697 (97) 2 (807) $795 $434 (374) 189 271 $520 $1,067 (136) 8 552 $3,409 (630) 204 87 $1,491 $3,070 $- $- $- ~- ~- $264 795 520 1,491 3,070 Allowance for Loan Losses: Beginning balance Charge-offs Recoveries Provision for loan losses Ending Balance Allowance: Ending balance individually evaluated for impairment Ending balance: collectively evaluated for impairment Loans: Total loans ending balance $31,635 81,025 53,872 117,055 283,587 Ending balance: individually evaluated for impairment Ending balance: collectively evaluated for impairment $- 2,125 4 2,155 4,284 $31,635 78,900 53,868 114,900 279,303 The Company utilizes a risk rating matrix to assign a risk grade to each of its loans. A description of the general characteristics of the risk grades is as follows: Pass -These loans have minimal and acceptable credit risk. Special Mention -These loans have potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan at some future date. Substandard -These loans are inadequately protected by the net worth or paying capacity of the obligor or collateral pledged, if any. Loans classified as substandard must have a well- 29 defined weakness, or weaknesses, that jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct probability that the Company will sustain some loss if the deficiencies are not corrected. Doubtful -These loans have all of the weakness inherent in one classified as substandard with the added characteristic that the weaknesses make collection liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable. The following table illustrates the Company's credit quality indicators: Credit Quality Indicators As of December 31, 2015 Credit Exposure $46,360 Pass - Special Mention Substandard 16 Doubtful - Total $46,376 Commercial Commercial Real Estate Consumer $60,432 - 422 - 60,854 $84,205 1,492 316 - 86,013 Credit Exposure $30,844 Pass 450 Special Mention Substandard 341 Doubtful - $31,635 Total As of December 31, 2014 Commercial Commercial Real Estate Consumer $53,454 76 342 - 53,872 $77,824 1,352 1,849 - 81,025 Residential $111,605 2 1,335 - 112,942 Total $302,602 1,494 2,089 - 306,185 Residential $113,846 1,641 1,568 - 1 17,055 Total $275,968 3,519 4,100 283,587 The following table represents an age analysis of the Company's past due loans: Age Analysis of Past Due Loans As of December 31, 2015 30-59 Days 60-89 Days Greater Than Total Past Recorded Investment 90 Days and I otal Past Due Past Due 90 Days Due ('urrcnt Loans Accruin¢ Commercial Commercial real estate Consumer $- - 211 Residential 276 Total $487 - 111 22 - 133 12 - 25 1,350 1,387 12 46,364 46,376 111 85,902 86,013 258 60,596 60,854 1,626 111,316 1]2,942 2,007 304,178 306,185 - - - - - 30 Age Analysis of Past Due Loans As of December 31, 2014 30-59 Days 60-89 Days Greater Than Total Past Recorded Investment 90 Days and Total Past Due Past Due 90 Days Due Current Loans Accruing Commercial Commercial real estate Consumer Residential $27 - 53 123 Total $203 - - 41 124 165 - 27 31,608 31,635 2,125 2,125 87,827 89,952 4 98 53,774 53,872 2,155 4,284 2,402 105,726 108,128 4,652 278,935 283,587 - - - - - As of December 31, 2015 and 2014, the recorded investment in loans for which impairment has been identified totaled approximately $2,856 and $4,284, respectively, with no corresponding valuation allowances for either year. The average recorded investment in impaired loans receivable during 2015 and 2014 was approximately $3,571 and $3,436, respectively. Interest income recognized on a cash basis on impaired loans during 2015 and 2014 was approximately $21 and $64, respectively. The following table presents information on the Company's impaired loans and their related allowance for loan losses: Impaired Loans For the Year Ended December 31, 2015 Unpaid Average Recorded Principal Related Recorded Interest Income Investment Balance Allowance Investment Recognized $ 12 984 25 12 984 25 1,835 1,835 12 984 25 $1,835 $2,856 12 984 25 1,835 2,856 - - - - - - - - - 6 1,555 15 1,995 6 1,555 IS - - 1 20 - - 1 20 1,995 3,571 21 With no related allowance recorded Commercial Commercial real estate Consumer Residential Total: Commercial Commercial real estate Consumer Residential Total 31 For the Year Ended December 31, 2014 Unpaid Average Recorded Principal Related Recorded Interest Income Investment Balance Allowance Investment RecoEnized $ - 2,125 4 - 2,125 4 2,155 2,155 - - 2,125 2,125 4 $2,155 $4,284 4 2,155 4,284 - - - - - - - - - 33 1,528 59 1,816 33 1,528 59 1,816 3,436 - 9 - 55 9 - 55 64 With no related allowance recorded: Commercial Commercial real estate Consumer Residential Total: Commercial Commercial real estate Consumer Residential Total The following presents information on the Company's nonaccrual loans: Loans in Nonaccrual Status As of December 31, 2015 and 2014 2015 $12 Commercial - Commercial real estate 25 Consumer Residential 1,350 Total $1,387 2014 $- 678 4 1,446 $2,128 The Company had six restructured loans totaling $1,895 as of December 31, 2015 and had eight restructured loans totaling $2,608 as of December 31, 2014. All of these restructured loans constituted troubled debt restructurings as of December 31, 2015 and 2014. The Company offers a variety of modifications to borrowers. The modification categories offered can generally be described in the following categories. Rate Modification is a modification in which the interest rate is changed. Term Modification is a modification in which the maturity date, timing of payments or frequency of payments is changed. Interest Only Modification is a modification in which the loan is converted to interest only payments for a period of time. Payment Modification is a modification in which the dollar amount of the payment is changed, other than an interest only modification described above. Combination Modification is any other type of modification, including the restructuring of two or more loan terms through the use of multiple categories above. 32 There were no additional commitments to extend credit related to these troubled debt restructurings that were outstanding as of December 31, 2015 or December 31, 2014. The following tables present troubled debt restructurings as of December 31, 2015 and 2014: December 31, 2015 Accrual Non-Accrual Total Status Status Modifications Commercial Commercial real estate Consumer Residential Total $ - 984 - 485 5 I ,469 - - - 426 426 - 984 - 911 1,895 December 31, 2014 Accrual Non-Accrual Total Status Status Modifications Commercial Commercial real estate Consumer Residential Total $ - 1,448 - ?08 $ 2,156 - 26 - 426 452 1,474 - 1,134 2,608 For 2015, there was one commercial real estate loan that was considered a combination modification that had apre-modification balance of $970 and a post modification balance of $990. There were also two residential loans that were considered combination modifications that had apre-modification balance of $310 and a post modification balance of $323. For loans modified and classified as troubled debt restructurings, one experienced a payment default and is currently listed as other real estate owned at $1,075. During 2014, there were two commercial real estate loans that were considered combination modifications that had apre-modification balance of $138 and a post modification balance of $138. There were also two residential loans that were considered combination modifications that had a pre- modification balance of $387 and a post modification balance of $390 in 2015. For loans modified and classified as troubled debt restructurings in 2014, none experienced payment defaults. 33 (5) Bank Premises and Equipment Bank premises and equipment, net were comprised of the following as of December 31, 2015 and 2014: 2015 2014 Land improvements Buildings Equipment, furniture and fiadures Construction in progress Less accumulated depreciation Land Bank premises and equipment, net $ 571 7,289 5,294 648 13,802 (7,664) 6,138 2,632 8,770 571 7,270 5,214 - 13,055 (7,255) 5,800 2,632 8,432 (6) Deposits A summary of deposits as of December 31, 2015 and 2014 follows: 2015 2014 Noninterest-bearing demand deposits Interest-bearing: Savings and money market accounts NOW accounts Tirre deposits -under $100,000 Time deposits - $100,000 and over Total interest-bearing deposits Total deposits $ $ 58,895 95,650 75,781 70,766 31,311 273,508 33?.4~3 50,801 89,127 71,422 77,697 36,157 274,403 325.x(14 At December 31, 2015, the scheduled maturity of time deposits is as follows: $37,050 in 2016; $7,864 in 2017; $24,404 in 2018, $16,004 in 2019 and $16,755 in 2020. In the normal course of business, the Bank has received deposits from executive officers and directors. As of December 31, 2015 and 2014, deposits from executive officers and directors were approximately $1,547 and $906, respectively. All such deposits were received in the ordinary course of business on substantially the same terms and conditions, including interest rates, as those prevailing at the same time for comparable transactions with unrelated persons. The fair value of deposits was $330,676 as of December 31, 2015 and $323,888 as of December 31, 2014. (7) Employee Benefit Plans The Bank maintains a noncontributory defined benefit pension plan that covers substantially all of its employees. Benefits are computed based on employees' average final compensation and years of credited service. Pension expense amounted to approximately $128 and $11 in 2015 and 2014, respectively. The change in benefit obligation, change in plan assets and funded status of the pension plan as of December 31, 2015 and 2014 and pertinent assumptions are as follows: 34 Change in Benefit Obligation Benefit obligation at beginning ofyear Service cost Interest cost Actuarial income (loss) Benefits paid Settlement Loss zui~ ?oia ti 8,029 446 307 (249) (641) Benefit obligation at end of year $ 7,892 Change in Plan Assets Fair value of plan assets at beginning ofyear Actualretum on plan assets Fanployer contribution Benefits paid Projected fair value of plan assets at end ofyear $ Funded Status at the Frd of the Year Amounts Recognized in the Balance Sheet Other liabilities, accrued pension Amounts Recognized in Accumul.itcd Othcr ('omprchcnsi~ Income Net of Taac F~'fect Unrecognized net actuarial loss 8,828 (9) 180 (642) 8,357 465 465 1,345 Benefit obligation included in accunailated other comprehensive income $ 1,345 6,506 361 314 1,239 (391) 8>029 8,786 433 — (391 8,828 799 799 1,090 I.i~~+~i Ftinded Status Benefit obligation Fair value ofassets Unrecognized net actuarial loss Prepaid benefit cost included in the balance sheet (7,892) 8,358 2,038 (8,029) 8,828 1,653 Pension BeneTits WeightedA~+erage Assumptions as of December 31, 2015 and ' 2014: 2015 Discount rate Expected long-termretum on plan assets Rate of compensation increase 4.25% 7.75% 3.00% 2014 4.00% 7.75% 3.00% Pension Benefits Net (gain)/loss Prior service cost Amortization of prior service cost Net obligation at transition Amortization of net obligation at transition Total recognized in other comprehensive income 2015 2014 $ $ 255 - - - - 255 970 - - - 970 Total Recognized in Net Periodic Benefit Cost and Other Comprehensive Income $ 514 1,480 The estimated portion of prior service cost and net transition obligation included in accumulated other comprehensive income that will be recognized as a component of net periodic pension cost over the next fiscal year is $199. 35 The Company selects the expected long-term rate-of-return-on-assets assumption in consultation with its investment advisors and actuary. This rate is intended to reflect the average rate of return expected to be earned on the funds invested or to be invested to provide plan benefits. Historical performance is reviewed especially with respect to real rates of return (net of inflation) for the major asset classes held or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to recent experience, which may not continue over the measurement period, and higher significance is placed on current forecasts of future long-term economic conditions. Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Further, solely for this purpose, the plan is assumed to continue in force and not terminate during the period during which assets are invested. However, consideration is given to the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment and non- investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost). The components of net pension benefit cost under the plan for the years ended December 31, 2015 and 2014 is summarized as follows: Pension Benefits 2015 2014 Service cost Interest cost Eag~ected return on plan assets Recognized net (gain)/loss due to settlement Net armrtization Recognized net actuarial loss Net pension benefit cost $ 446 308 (672) 46 128 360 314 (663) 11 Projected Benefit Payments The projected benefit payments under the plan are summarized as follows for the years ending December 31: 2016 2017 2018 2019 2020 2021-2025 $ 405 1,061 324 34 311 3,449 Plan Asset Allocation Plan assets are held in a pooled pension trust fund administered by the Virginia Bankers Association. The pooled pension trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 39% fixed income and 61 %equities. The Investment Manager selects investment fund managers with demonstrated experience and expertise, and funds with demonstrated historical performance, for the implementation of the pension plan's investment strategy. The Investment Manager will consider both actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure. It is the responsibility of the Virginia Bankers Association to administer the investments of the pooled pension trust fund within reasonable costs, being careful to avoid sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administrative costs. 36 The asset or liability's fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. Following is a description of the valuation methodologies used for assets measured at fair value. Mutual funds-fixed income and equity funds: Valued at the net asset value of shares held at year-end. Cash and equivalents: Valued at cost which approximates fair value. The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, although the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine fair value of certain financial instruments could result in a different fair value measurement as of December 31, 2015 and 2014. The following table presents the fair value of the assets, by asset category, as of December 31, 2014 and 2013. Mutual funds-fixed income $ Mutual funds-equity Total assets at fair value 2015 3,260 5,098 $ 8,358 2014 2,207 6,621 8,828 The following table sets forth by level, within the fair value hierarchy, the assets carried at fair value as of December 31, 2015 and 2014. Mutual funds-fixed income Mutual funds-equity Total assets at fair value Mutual funds-fixed income Mutual funds-equity Total assets at fair value Assets at Fair Value as of December 31, 2015 L.evell $ 3,260 5,098 $ 8,358 L.eve12 - - - L.eve13 - - - 3,260 5,098 8,358 Total Assets at Fair Value as of December 31, 2014 I.evell $ 2,207 6,621 $ 8,828 Level3 - - - L.evel2 - - - 2,207 6,621 8,828 Total Contributions The Company expects to contribute $0 to its pension plan in 2016. The Company also has a 401(k) plan under which the Company matches employee contributions to the plan. In 2015 and 2014, the Company matched 100% of the first 1 % of salary deferral and 50% of the next 5% of salary deferral to the 401(k) plan. The amount expensed for the 401(k) plan was $124 during the year ended December 31, 2015 and $109 during the year ended December 31, 2014. ~8) Income Taxes Income tax expense attributable to income before income tax expense for the years ended December 31, 2015 and 2014 is summarized as follows: 2015 2111-1 Current Deferred $ Total incorre taxe~ense $ 1,249 57 1,306 914 56 970 37 Reported income tax expense for the years ended December 31, 2015 and 2014 differed from the amounts computed by applying the U.S. Federal income tax rate of 34% to income before income tax expense as a result of the following: Computed at statutory Federal taxrate Increase (reduction) in income tax expense resulting from: Tax exempt interest Disallowance of interest expense Other, net Reported income taxe~ense $ 2015 2014 $ 1,376 1,060 (42) 1 (29) L ;(~r, (41) 2 (51) ~»( ~ The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2015 and 2014 are as follows: 2015 2014 $ Deferred tax assets: Loans, principally due to allowance for loan losses Defined benefit plan valuation adjustments Loans, due to unearned fees, net Other Total gross deferred tax assets Deferred tax liabilities: Bank premises and equipment, due to differences in depreciation Accrued pension, due to actual pension contributions in excess of accrual for financial reporting purposes Net unrealized gains on available-for-sale securities Other Total gross deferred tax liabilities Net deferred tax liability, included in other liabilities $ 590 693 4 171 1,458 (457) (852) (58) (192) (1,559) (101) 585 562 8 250 1,405 (514) (833) (13) (176) (1,53 (131) The Bank has determined that a valuation allowance for the gross deferred tax assets is not necessary as of December 31, 2015 and 2014, since realization of the entire gross deferred tax assets can be supported by the amounts of taxes paid during the carry back periods available under current tax laws. The Company did not recognize any interest or penalties related to income tax during the years ended December 31, 2015 and 2014. The Company does not have an accrual for uncertain tax positions as deductions taken and benefits accrued are based on widely understood administrative practices and procedures and are based on clear and unambiguous tax law. Tax returns for all years 2012 and thereafter are subject to future examination by tax authorities. (9) Financial Instruments with Off-Balance-Sheet Risk The Company is a 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 mortgage sale lock commitments, commitments to extend credit and standby letters of credit. These instruments may involve, to varying degrees, credit risk in excess of the amount recognized in the balance sheets. The contract amounts of these instruments reflect the extent of involvement the Bank has in particular classes of financial instruments. Credit risk is defined as the possibility of sustaining a loss because the other parties to a financial instrument fail to perform in accordance with the terms of the contract. The Company's maximum exposure to credit loss under commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. The Company requires collateral to support financial instruments when it is deemed necessary. The Bank evaluates such customers' creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the counterparty. 38 Collateral may include deposits held in financial institutions, U.S. Treasury securities, other marketable securities, real estate, accounts receivable, inventory, and property, plant and equipment. Financial instruments whose contract amounts represent credit risk: Corrnrritrrents to eadend credit $ 73,122 Standby letters ofcredit $ 3,677 61,953 3,~7~ December 31, 2015 2014 In the ordinary course of business, the Company may enter into mortgage rate lock commitments that are subsequently funded by the Company. The Company then sells the mortgage loan to a secondary market bank that had underwritten the mortgage loan before the Company funded the loan. The secondary market bank pays a fee that was agreed upon on the lock commitment date to the Company and buys the loan within five days of the initial funding by the Company. As of December 31, 2015 the Company had $265 in outstanding mortgage rate lock commitments and no outstanding mortgage rate lock commitments as of December 31, 2014. 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. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and similar transactions. Unless renewed, substantially all of the Company's standby letters of credit commitments as of December 31, 2015 will expire within one year. Management does not anticipate any material losses as a result of these transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. (10) Leases The Company leases premises and equipment under various operating lease agreements. Generally, operating leases provide for one or more renewal options on the same basis as current rental terms. Certain leases require increased rentals under cost-of-living escalation clauses. The following are future minimum lease payments as required under the agreements: Year Payments 2016 2017 2018 2019 2020 $154 152 152 152 160 Thereafter 1,289 Total $2,059 The Company entered into a lease of the Amherst branch facility, with an entity in which a director of the Company has a 50% ownership interest, in 2009. The original term of the lease is twenty years and. may be renewed at the Company's option for two additional terms of five years each. The Company's current rental payment under the lease is $141 annually. 39 (11) Concentrations of Credit Risk and Contingencies The Company grants commercial, residential and consumer loans to customers primarily in the central Virginia area. As a whole, the portfolio is affected by general economic conditions in the central Virginia region. The Company's commercial and real estate loan portfolios are diversified, with no significant concentrations of credit other than the geographic focus on the central Virginia region. The installment loan portfolio consists of consumer loans primarily for automobiles and other personal property. Overall, the Company's loan portfolio is diversified and is not concentrated within a single industry or group of industries, the loss of any one or more of which would generate a materially adverse impact on the business of the Company. The Company has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property. Credit approval is primarily based on the creditworthiness of the borrower, the ability to repay and the value of the collateral pledged. At times, the Company may have cash and cash equivalents at a financial institution in excess of insured limits. The Company places its cash and cash equivalents with high credit quality financial institutions whose credit rating and financial condition is monitored by management to minimize credit risk. In the ordinary course of business, various claims and lawsuits are brought by and against the Company. In the opinion of management, there is no pending or threatened proceeding in which an adverse decision could result in a material adverse change in the Company's consolidated financial condition or results of operations. (12) Dividend Restrictions and Capital Requirements Bankshares' principal source of funds for dividend payments is dividends received from its subsidiary Bank. For the years ended December 31, 2015 and 2014, dividends from the subsidiary Bank totaled $993 and $1,016, respectively. Substantially all of Bankshares' retained earnings consist of undistributed earnings of its subsidiary Bank, which are restricted by various regulations administered by federal banking regulatory agencies. Under applicable federal laws, the Comptroller of the Currency restricts, without prior approval, the total dividend payments of the Bank in any calendar year to the net profits of that year, as defined, combined with the retained net profits for the two preceding years. As of December 31, 2015, retained net profits of the Bank that were free of such restriction approximated $6,466 Bankshares and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Bankshares' consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bankshares and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Bankshares and the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Beginning January 1, 2015, banks became subject to new Basel III Capital Rules. As a result, certain items in the risk-based capital calculation have changed. In addition, a new ratio, Common Equity Tier for "CET 1" Risk-Based Capital Ratio, is now measured and monitored. For Bankshares and the Bank and given its capital structure, the Common Equity Tier 1 Risk-Based Capital Ratio and the Tier 1 Risk- Based Capital Ratio are identical. Bankshares and the Bank's actual regulatory capital amounts and ratios as of December 31, 2015 are listed on the following page: 40 Re~„ulator~ Capital Ratios as of December 31, 2015 Total Risk-Based Capital Ratio (to Risk Weighted Assets) CET 1 Risk Based Capital Ratio (to Risk Weighted Assets) Tier 1 Risk-Based Capital Ratio (to Risk Weighted Assets) Tier 1 Leverage Capital Ratio (to Average Assets) Bankshares consolidated Bank Amount $38,440 $35,475 $35,475 $35,475 Amount Ratio Ratio 1232% $38,602 12.41% $35,637 11.45% 11.37% $35,637 11.45% 11.37% 9.75% $35,637 9.68% Basel III limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a "capital conservation buffer" consisting of 2.50% of CET1 capital, Tier 1 capital and total capital to risk weighted assets in addition to the amount necessary to meet minimum risk-based capital requirements. The capital conservation buffer will be phased in beginning January 1, 2016, at 0.625% of risk weighted assets, increasing each year until fully implemented at 2.50% on January 1, 2019. When fully phased in on January 1, 2019, Basel III will require (i) a minimum ratio of CET1 capital to risk weighted assets of at least 4.50%, plus a 2.50% capital conservation buffer, (ii) a minimum ratio of Tier 1 capital to risk weighted assets of at least 6.00%, plus the capital conservation buffer, (iii) a minimum ratio of total capital to risk weighted assets of at least 8.00%, plus the 2.50% capital conservation buffer and (iv) a minimum leverage ratio of 4.00%. As of December 31, 2015, the most recent notification from Office of the Comptroller of the Currency categorized Bankshares and the Bank as "well capitalized" under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed Bankshares and the Bank's category. Bankshares and the Bank's actual capital amounts and ratios as of December 31, 2014 using the former capital measurements before the implementation of Basel III are presented in the table below. ~c~ual mount atio For Capital Adequacy Purposes ~o oun To Be "Well Capitalized" Under Prompt Corrective Action Provisions too ount As of December 31, 2014: Total Capital (to Risk Weighted Assets): Bankshares consolidated $ 36,521 36,828 Bank 11.98% $ 24,379 24,310 12.12% 8.0% $ N/A 8.0% 30,387 N/A 10.0% Tier 1 Capital (to Risk Weighted Assets): Bankshazes consolidated Battk 33,385 33,692 10.96% 17.09% 12,189 12,155 4.0% 4.0% N/A 18,232 N/A 6.0% Tier 1 Capital (L.everage) (to Average Assets): Bankshares consolidated Bank 33,385 33,692 9.25% 936% 14,434 14,399 4.0% 4.0% N/A 17,999 N/A 5.0% (13) Disclosures about Fair Value of Financial Instruments Generally accepted accounting principles require the Company to disclose estimated fair values of its financial instruments. The following methods and assumptions were used to estimate the approximate fair value of each class of financial instrument for which it is practicable to estimate that value. (u) Securities The fair value of securities is estimated based on bid prices as quoted on national exchanges or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations; so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued. 41 (b) Loans Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, real estate -residential, real estate -commercial, loans to individuals and other loans. Each loan category is further segmented into fixed and adjustable rate interest terms. The fair value of fixed rate loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan as well as estimates for prepayments. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. (c) Deposits The fair value of demand deposits, NOW accounts, and savings deposits is the amount payable on demand. The fair value of fixed maturity time deposits, certificates of deposit is estimated by discounting scheduled cash flows through the estimated maturity using the rates currently offered for deposits or borrowings of similar remaining maturities. (~ Commitments to Extend Credit and Standby Letters of Credit The only amounts recorded for commitments to extend credit and standby letters of credit are the deferred fees arising from these unrecognized financial instruments. These deferred fees are not deemed significant as of December 31, 2015 and 2014, and as such, the related fair values have not been estimated. Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated funding needs and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred tax assets and premises and equipment and other real estate owned. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. (g) Fair Value Methodologies The following is a description of valuation methodologies used for assets and liabilities recorded at fair value. Available-for-Sale Securities Available-for-sale securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available, and would in such case be included as a Level 1 asset. The Company currently carries no Level 1 securities. If quoted prices are not available, valuations are obtained from readily available pricing sources from independent providers for market transactions involving similar assets or liabilities. The Company's principal market for these securities is the secondary institutional markets, and valuations are based on observable market data in those markets. These would be classified as Level 2 assets. The Company's entire available-for-sale securities portfolio is classified as Level 2 securities. The 42 Company currently carries no Level 3 securities for which fair value would be determined using unobservable inputs. 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 a specific allowance for loan losses is established for that loan. 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. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC Topic 360, "Impairment of a Loan. " The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of a similar debt, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans at which fair value of the expected repayments or collateral exceed the recorded investments in such loans. As of December 31, 2015, substantially all of the impaired loans were evaluated based on the fair value of the collateral. In accordance with "Impairment of a Loan," impaired loans where an allowance is established based on the fair value of the collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as a nonrecurring Level 2 asset. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as a nonrecurring Level 3 asset. For substantially all of the Company`s impaired loans as of December 31, 2015 and December 31, 2014, the valuation methodology utilized by the Company was collateral based measurements such as a real estate appraisal and the primary unobservable input was adjustments for differences between the comparable real estate sales. The discount to reflect current market conditions and ultimately collectability ranged from 0% to 25% for each of the respective periods. Other Real Estate Owned Other real estate owned is adjusted to fair value less estimated selling costs upon transfer of the loans to foreclosed assets. Subsequently, other real estate owned is carried at the lower of carrying value or fair value less estimated selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management's estimation of the value of the collateral. When the fair value of the collateral is based on observable market price or a current appraised value, the Company records the foreclosed asset as a nonrecurring Leve12 asset. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the other real estate owned as a nonrecurring Level 3 asset. For substantially all of the Company's other real estate owned as of December 31, 2015 and December 31, 2014, the valuation methodology utilized by the Company was collateral based measurements such as a real estate appraisal and the primary unobservable input was adjustments for differences between the comparable real estate sales. The discount to reflect current market conditions ranged from 0% to 25% for each of the respective periods. 43 The following tables present information about certain assets and liabilities measured at fair value: Fair Value Measurements on December 31, 2015 Assets/Liabilities Measured at Fair Value Total Carrying Amount in The Consolidated Balance Sheet Quoted Prices in Active Markets for Identical Assets (Level 1) Significant ~ Other Observable Inputs (Leve12) Significant Unobservable Inputs (Level 3) $22,075 $22,075 $- $22,075 $- $2,856 $2,856 $- $1,733 $1,733 $- $- $- $2,856 $1,733 Fair Value Measurements on December 31, 2014 Assets/Liabilities Measured at Fair Value Total Carrying Amount in The Consolidated Balance Sheet Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Quoted Prices in Active Markets for Identical Assets (Level 1) $23,597 $23,597 $- $23,597 $ - $4,284 $4,284 $- $- $4,284 $1,107 $1,107 $- $- $1,107 Ucscription Available-for- sale securities Impaired loans (nonrecurring) Other Real Estate Owned (nonrecurring) Description Available-for- sale securities Impaired loans (nonrecurring) Other Real Estate Owned (nonrecurring) 44 The following table sets forth a summary of changes in the fair value of the Company's nonrecurring Leve13 assets for the year ended December 31, 2015: Leve13 Assets Year Faded December 31, 2015 Impaired Other Real Loans Estate Owned Balance, beginning ofthe year Purchases, sales, issuances, and settlements (net) Balance, end ofyear $ 4,284 $ (1,428) 2,856 1,107 626 1,733 There were no transfers between Level 1 and Level 2 investments during the year ended December 31, 2015. The following table sets forth a summary of changes in the fair value of the Company's nonrecurring Leve13 assets for the year ended December 31, 2014: Leve13 Assets Year Ended December 31, 2014 Other Real Impaired Loans Estate Owned Balance, beginning ofthe year Purchases, sales, issuances, and settlements (net) Balance, end ofyear $ 2,586 $ 1,698 4,284 1,297 (190) 1,107 There were no transfers between Level 1 and Level 2 investments during the year ended December 31, 2014. 45 (14) Parent Company Financial Information Condensed financial information of Bankshares ("Parent") is presented below: Condensed Balance Sheets December 31, 2015 2014 Assets Cash due &omsubsidiary Investment in subsidiary, at equity Other assets Total assets Liabilities and stockholders' equity Notes payable Other liabilities Total liabilities Stockholders' equity Common stock of $3 par value, authorized 3,000,000 shares; issued and outstanding 1,520,221 shares in 2015 and 1,511,970 in 2014 Capital surplus Retained earnings Accumulated other comprehensive income (loss), net Total stockholders' equity Total liabilities and stockholders' equity $ $ $ 22 34,946 929 35,897 1,091 24 1,115 $ 4,508 1,065 30,442 (1,233) $ 34,782 16 33,165 865 34,046 1,367 25 1,392 4,497 1,004 28,219 (1,066) 32,654 Condensed Statements of Income Years ended December 31, 2015 2014 Income: Dividends from subsidiary $ Equity in undisVibuted net income of subsidiary Totallncome Expenses: Other expenses Income before income tax benefit Applicable income tax benefit 992 1,874 2,866 191 2,675 65 Net income $ 2,740 1,016 1,302 2,318 257 2.061 88 2,149 46 Condensed Statements of Cash Flows Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net income of subsidiary Increase in other assets Net cash provided by operating activities Cash flows from financing activities Cash dividends paid Repayment of line of credit Increase (decrease) in other liabilities Net cash used in financing activities Net increase in cash due from subsidiary Cash due fromsubsidiary, beginning ofyear Cash due fromsubsidiary, end ofyear (15) Stock-based Compensation Years ended December 31, 2015 2014 $ 2,740 2,149 (1,874) (64) 802 (517) (278) (I) (796) 6 16 22 ~ $ (1,302) (89) 758 (484) (264) 1 (747) 11 5 16 The Company's 2004 Incentive Stock Plan (the "2004 Plan"), pursuant to which the Company's Board of Directors may grant stock options and other equity-based awards to officers and key employees, was approved by shareholders on April 13, 2004 and became effective as of May 1, 2004. The 2004 Plan authorized grants of up to 100,000 shares of the Company's authorized, but unissued common stock. All stock options were granted with an exercise price equal to the stock's fair market value at the date of the grant. As of December 31, 2014, the 2004 Plan has expired and no additional awards may be granted under this plan. Stock options granted under the 2004 Plan generally have 10-year terms, vest at the rate of 25% per year, and become fully exercisable four years from the date of grant. Under the 2004 Plan during 2014, 23,500 options for shares were granted, and in 2013 no stock options were granted. On May 1, 2013, 10,000 shares, of restricted stock were granted to employees. The 2013 grants will vest on the third anniversary of the grant date. At December 31, 2015, options for 20,500 shares were exercisable at an exercise price of $9.00 per share and options for 5,750 shares were exercisable at an exercise price of $18.10 per share under the 2004 Plan. On April 8, 2014, shareholders approved the 2014 Incentive Stock Plan (the "2014 Plan"), pursuant to which the Company's Board of Directors may grant stock options and other equity-based awards to officers and key employees. The 2014 Plan authorizes grants of up to 150,000 shares of the Company's authorized, but unissued common stock. All stock options are granted with an exercise price equal to the stock's fair market value at the date of the grant. As of December 31, 2015, there were 128,222 shares available for grant under the 2014 Plan. On May 1, 2015, 6,250 shares of restricted stock were granted to employees pursuant to the 2014 Plan. On May 1, 2014, 8,400 shares of restricted stock were granted to employees pursuant to the 2014 Plan. The 2014 restricted stock grants will vest on the third anniversary of the grant date. At December 31, 2015, no options for shares were exercisable under the 2014 Plan. The Company expensed $0 in 2015 and $3 in 2014 in compensation expense as a direct result of the issuance of the 34,750 incentive stock options with tandem stock appreciation rights in previous years and recognized $37 in compensation expense related to 23,125 unvested stock options. For the 2004 Plan stock options granted May 1, 2010, the fair value of $3.96 per share of each option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions used: dividend yield of 2.065%, expected volatility of 45.61 %, a risk-free interest 47 rate of 4.63%, and expected lives of 9 years. For the 2004 Plan stock options granted February 11, 2014, the fair value of $5.45 per share of each option grant is estimated on the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions used: dividend yield of 4.00%, expected volatility of 44.70%, arisk-free interest rate of 2.69%, and expected lives of 9 years. The Company also expensed $116 in 2015 in compensation expense as a direct result of the granting of 11,000 shares of restricted stock in 2012, 10,000 shares of restricted stock in 2013, 8,400 shares of restricted stock in 2014 and 6,250 shares of restricted stock in 2015 and will recognize $102 in 2016 and $70 in 2017 and $12 in 2018 on such restricted stock. Stock option activity during the years ended December 31, 2015 and 2014 is as follows: Balance as of December 31, 2013 Forfeited Exercised Granted Balance as of December 31, 2014 Forfeited Exercised Granted Balance as of December 31, 2015 Number Weighted of Shares Average Exercise Price 37,000 250 2,000 23,500 58,250 375 15,000 0 42,875 $9.00 $9.00 $9.00 $18.10 $12.67 18.10 9.00 - 13.91 The following table summarizes information about stock options outstanding as of December 31, 2015: Options Outstanding Options F~cercisable Exercise Price Number Outstanding at 12/31/15 Weighted- Average Remaining Weighted- Contractual Life (in years) Average Exercise Price Number Exercisable at 12/31/2015 W eighted- Average Eacercise Price $ 9.00 18.10 19,750 23,125 5.4 8.4 $ 9.00 18.10 19,750 $ 5,750 9.00 18.10 The aggregate intrinsic value of options outstanding was $223, of options exercisable was $206, and of options unvested and expected to vest was $17 as of December 31, 2015. The aggregate intrinsic value of restricted stock granted was $119 for 2015 and $150 for 2014. The total intrinsic value (market value on date of exercise less exercise price) of options exercised was $127 for the year ended December 31, 2015 and $19 for the year ended December 31, 2014. 48 The following table summarizes information about stock options outstanding at December 31, 2014: Options Outstanding Weighted- Average Remaining Contractual Life (in years) Weighted- Average Exercise Price F~cercise Price Number Outstanding at 12/31/14 Options Exercisable Number F.~cercisable at 12/31/2014 Weighted- Average Exercise Price 9.00 15.10 34,750 23,500 5.4 9.4 $ 9.00 18.10 34,750 $ - 9.00 - (16) Share Repurchase Program On November 12, 2013, the Board of Directors adopted a resolution authorizing the repurchase of up to $500 worth of shares of the Company's common stock. The Board of Directors extended this resolution on May 13, 2014, November 11, 2014, May 12, 2015 and December 8, 2015. Purchases are made, as conditions warrant, from time to time in the open market. The current resolution expires June 30, 2016 and the timing of future purchases will depend on market conditions. As of December 31, 2015, the Company repurchased 14,465 shares of its common stock under the stock repurchase program and expensed $249 for these repurchases. The timing and amount of future repurchases will depend upon the market price for our common stock, securities laws restricting repurchases, asset growth, earnings, and our capital plan. (17) Subsequent Events The Company has evaluated subsequent events for potential recognition and/or disclosure in the December 31, 2015 consolidated financial statements through March 5, 2016, the date the consolidated financial statements were available to be issued. Management's Report on Internal Control over Financial Reporting. The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Management assessed the effectiveness of the Company's internal control over financial reporting as of December 31, 2015. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control —Integrated Framework. Based on this assessment, our management concluded that, as of December 31, 2015, the Company's internal control over financial reporting was effective based on those criteria. This annual report does not include an attestation report of the Company's independent auditor regarding internal control over financial reporting. 49 ~'~ Cherry Bekaert Report of Independent Auditor To the Board of Directors and Stockholders of Pinnacle Bankshares Corporation Altavista, Virginia Report on the Consolidated Financial Statements We have audited the accompanying consolidated financial statements of Pinnacle Bankshares Corporation and Subsidiary (the "Company"), which comprise the consolidated balance sheets as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management's Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pinnacle Bankshares Corporation and Subsidiary as of December 31, 2015 and 2014, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. ~ i~riu~ ~~~~~ <

150 x a~ ~ 130 110 90 70 50 12/31/10 12/31 / 11 12/31 / 12 12/31 / 13 12/31 /14 12/31 /15 Index Pinnacle Bankshares Corporation NASDAQ Market Index S&P 500 SNL Bank and Thrift 12/31/10 100.00 100.00 100.00 100.00 12/31/11 92.73 99.21 102.11 77.76 12/31/12 94.99 116.82 118.45 104.42 12/31/13 175.73 163.75 156.82 142.97 12/31/14 210.95 188.03 178.28 159.60 12/31/15 237.96 201.40 180.75 162.83 Period Ending 52 Annual Meeting Shareholder Information The 2016 Annual Meeting of Shareholders will be held on April 12, 2016, at 11:00 a.m. at the Fellowship Hall of Altavista Presbyterian Church, located at 707 Broad Street, Altavista, Virginia. Market for Common Equity and Related Stockholder Matters The Company's Common Stock is quoted on the OTC Bulletin Board. The following table presents the high and low bid prices per share of the Common Stock, as reported on the OTCQX marketplace, and dividend information of the Company for the quarters presented. The high and low bid prices of the Common Stock presented below reflect inter-dealer prices and do not include retail markups, markdowns or commissions, and may not represent actual transactions. High 2015 Low Dividends High 2014 Low Ditidends First Quarter $17.82 $17.51 $0.085 $17.00 $15.10 $0.075 Second Quarter $17.70 $17.41 $0.085 $18.50 $17.00 $0.075 Third Quarter $17.99 $17.41 $0.085 $18.40 $17.51 $0.085 Fourth Quarter $19.70 $17.65 $0.085 $18.05 $17.52 $0.085 Each share of Common Stock is entitled to participate equally in dividends, which are payable as and when determined by the Board of Directors after consideration of the earnings, general economic conditions, the financial condition of the business and other factors as might be appropriate. The Company's ability to pay dividends is dependent upon its receipt of dividends from its subsidiary. Prior approval from the Comptroller of the Currency is required if the total of all dividends declared by a national bank, including the proposed dividend, in any calendar year will exceed the sum of the bank's net profits for that year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. This limitation has not had a material impact on the Bank's ability to declare dividends during 2015 and 2014 and is not expected to have a material impact during 2016. As of March 1, 2016, there were approximately 311 shareholders of record of Bankshares' Common Stock. Requests for Infor►nation Requests for information about the Company should be directed to Bryan M. Lemley, Secretary, Treasurer and Chief Financial Officer, P.O. Box 29, Altavista, Virginia 24517, telephone (434) 369-3000. Shareholders seeking information regarding lost certificates and dividends should contact Computershare Inc. in College Station, Texas, telephone (800) 368-5948. Please submit address changes in writing to: Shareholder correspondence should be mailed to: Computershare Shareholder Services P.O. Box 30170 College Station, TX 77842-3170 Overnight correspondence should be mailed to: Computershare Shareholder Services 211 Quality Circle, Suite 210 College Station TX 77845 PINNACLE BAN KSHARES C O R P O R A T I O N 

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