What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-10-30 compared with 2020-08-06 · 149 added, 143 removed, 684 unchanged (30% of the section changed)

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The following discussion and analysis is designed to provide a better understanding of various factors related to the results of operations and financial condition of the Company and the Bank.

This discussion is intended to supplement and highlight information contained in the accompanying unaudited condensed consolidated financial statements and related notes for the quarters and six months ended June 30, 2020 and 2019 , as well as the information contained in our Annual Report on Form 10-K for the year ended December 31, 2019 and our Quarterly Reports on Form 10-Q.

This discussion is intended to supplement and highlight information contained in the accompanying unaudited condensed consolidated financial statements and related notes for the quarters and nine months ended September 30, 2020 and 2019, as well as the information contained in our annual report on Form 10-K for the year ended December 31, 2019 and our interim reports on Form 10-Q for the quarters ended March 31, 2020 and June 30, 2020.

Special Notice Regarding Forward-Looking Statements

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• the significant disruptive effects of the COVID-19 pandemic, and local, state, national and international economic activity, including decreases in gross domestic product (“GDP”) and increases in unemployment;

• governmental monetary and fiscal policies, generally, and reductions of market interest rates, injections of liquidity by the Federal Reserve federal lending and market support programs and facilities, government spending and aid to businesses and consumers as a result of the COVID-19 pandemic, and its effects and public health and economic activity;

• governmental monetary and fiscal policies, generally, and reductions of market interest rates, injections of liquidity by the Federal Reserve, Federal Reserve lending and market support programs and facilities, government spending and aid to businesses and consumers as a result of the COVID-19 pandemic, and the COVID-19 pandemic’s effects and public health and economic activity;

• the effects of public health, economic activity and measures taken to restore public health in light of the COVID-19 pandemic;

• legislative and regulatory changes, including the CARES Act, changes in banking, securities, and tax laws, regulations and rules and their application by our regulators, including capital and liquidity requirements, and changes in the scope and cost of FDIC insurance, including temporary other changes to address the effects of the COVID-19 pandemic and stabilize and stimulate the economy;

• legislative and regulatory changes, including the CARES Act, changes in banking, securities, and tax laws, regulations and rules and their application by our regulators, including capital and liquidity requirements, and changes in the scope and cost of FDIC insurance, including temporary other changes in accounting and capital requirements to address the effects of the COVID-19 pandemic and stabilize and stimulate the economy and delays in PPP loan forgiveness rules and processing;

• changes in accounting policies, rules, and practices;

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• cyber attacks and data breaches that may compromise our systems or customers’ information, including increased fraud during the COVID-19 pandemic;

• the failure of assumptions and estimates, as well as differences in, and changes to, economic, market, and credit conditions, including changes in borrowers’ credit risks and payment behaviors from those used in our loan portfolio stress tests and other evaluations, including price and market volatility and liquidity issues resulting from the COVID-19 pandemic;

• the failure of assumptions and estimates, as well as differences in, and changes to, economic, market, and credit conditions, including changes in borrowers’ credit risks and payment behaviors from those used in our loan portfolio stress tests and other evaluations, including price and market volatility, deferrals on loans, suspension of residential mortgage foreclosure and liquidity issues resulting from the COVID-19 pandemic;

• the risk that our deferred tax assets, if any, could be reduced if estimates of future taxable income from our operations and tax planning strategies are less than currently estimated, and sales of our capital stock could trigger a reduction in the amount of net operating loss carry-forwards, if any, that we may be able to utilize for income tax purposes;

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Summary of Results of Operations

Quarter ended June 30,

Six months ended June 30,

Quarter ended September 30,

Nine months ended September 30,

(Dollars in thousands, except per share amounts)

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Financial Summary

The Company’s net earnings were $3.5 million for the first six months of 2020 , compared to $4.9 million for the first six months of 2019 .

Basic and diluted earnings per share were $0.97 per share for the first six months of 2020 , compared to $1.35 per share for the first six months of 2019 .

Net interest income (tax-equivalent) was $12.5 million for the first six months of 2020 , a 7% decrease compared to $13.5 million for the first six months of 2019 .

This decrease was primarily due to the lower rate environment, including a 150 basis point reduction in the Fed Funds rate that occurred late in the first quarter of 2020.

Average loans were also down 3% to $459.1 million in the first six months of 2020 , compared to $475.3 million in the first six months of 2019 .

The Company’s net interest margin (tax-equivalent) decreased to 3.09% in the first six months of 2020 , compared to 3.52% for the first six months of 2019 primarily due to the lower rate environment and changes in our asset mix from the significant short-term liquidity increase in customer deposits.

At June 30, 2020 , the Company’s allowance for loan losses was $5.3 million, or 1.14% of total loans, compared to $4.4 million, or 0.95% of total loans, at December 31, 2019, and $4.9 million, or 1.02% of total loans, at June 30, 2019 .

At June 30, 2020, the Company’s allowance for loan losses was 1.24% of total loans, excluding PPP loans.

The provision for loan losses was $0.9 million for the first six months of 2020 , compared to no provision for loan losses during the first six months of 2019 .

The increase in the provision for loan losses was related to changes in economic conditions driven by the impact of COVID-19 and resulting adverse economic conditions, including higher unemployment in our primary market area.

The Company’s net earnings were $5.4 million for the first nine months of 2020, compared to $7.1 million for the first nine months of 2019.

Basic and diluted earnings per share were $1.51 per share for the first nine months of 2020, compared to $1.97 per share for the first nine months of 2019.

Net interest income (tax-equivalent) was $18.5 million for the first nine months of 2020, an 8% decrease compared to $20.2 million for the first nine months of 2019.

This decrease was primarily due to the lower interest rate environment, including a 150 basis point reduction in the federal funds rate that occurred late in the first quarter of 2020.

Average loans were also down 3% to $461.2 million in the first nine months of 2020, compared to $474.4 million in the first nine months of 2019.

The Company’s net interest margin (tax-equivalent) decreased to 2.96% in the first nine months of 2020, compared to 3.48% for the first nine months of 2019 primarily due to the lower interest rate environment and changes in our asset mix from the significant short-term liquidity increase in customer deposits.

At September 30, 2020, the Company’s allowance for loan losses was $5.6 million, or 1.18% of total loans, compared to $4.4 million, or 0.95% of total loans, at December 31, 2019, and $4.8 million, or 1.03% of total loans, at September 30, 2019.

At September 30, 2020, the Company’s allowance for loan losses was 1.28% of total loans, excluding PPP loans.

The provision for loan losses was $1.1 million for the first nine months of 2020, compared to no provision for loan losses during the first nine months of 2019.

The increase in the provision for loan losses was related to changes in economic conditions and portfolio trends driven by the impact of COVID-19 and resulting adverse economic conditions, including higher unemployment in our primary market area.

The provision for loan losses is based upon various estimates and judgements, including the absolute level of loans, loan growth, credit quality and the amount of net charge-offs.

Noninterest income was $2.6 million for the first six months of 2020 compared to $2.0 million for the first six months of 2019 .

The increase was primarily due to an increase mortgage lending income of $0.5 million during first six months of 2020 compared to the first six months of 2019.

Noninterest income was $4.0 million for the first nine months of 2020 compared to $3.0 million for the first nine months of 2019.

The increase was primarily due to an increase in mortgage lending income of $1.0 million during first nine months of 2020 compared to the first nine months of 2019.

The increase was primarily due to an increase in mortgage lending income as lower interest rates for mortgage loans positively affected refinance activity and pricing margins improved.

Noninterest expense was $9.8 million for the first six months of 2020 compared to $9.2 million for the first six months of 2019 .

Noninterest expense was $14.5 million for the first nine months of 2020 compared to $14.1 million for the first nine months of 2019.

The increase was primarily due to $0.8 million of various expenses related to the redevelopment of the Company’s headquarters in downtown Auburn, including revised depreciation estimates and temporary relocation costs.

The Company expects it will incur additional expense in 2020 related to this redevelopment project.

Income tax expense was $0.8 million and $1.2 million for the first six months of 2020 and 2019 , respectively, reflecting an effective tax rate of 17.86% and 19.46%, respectively.

Income tax expense was $1.2 million and $1.7 million for the first nine months of 2020 and 2019, respectively, reflecting an effective tax rate of 17.64% and 19.40%, respectively.

This change was primarily due to a decrease in the level of earnings before taxes relative to tax-exempt sources of income.

The Company’s effective income tax rate is principally impacted by tax-exempt earnings from the Company’s investments in municipal securities and bank-owned life insurance.

The Company paid cash dividends of $0.51 per share in the first six months of 2020 , an increase of 2% from the same period of 2019.

At June 30, 2020, the Bank’s regulatory capital ratios were well above the minimum amounts required to be “well capitalized” under current regulatory standards with a total risk-based capital ratio of 19.04%, a tier 1 leverage ratio of 10.62% and a common equity tier 1 (“CET1”) ratio of 18.00% at June 30, 2020.

For the second quarter of 2020 , net earnings were $1.7 million, or $0.47 per share, compared to $2.3 million, or $0.64 per share, for the second quarter of 2019 .

Net interest income (tax-equivalent) was $6.2 million for the second quarter of 2020 compared to $6.7 million for the second quarter of 2019 .

The Company’s net interest margin (tax-equivalent) decreased to 2.95% in the second quarter of 2020, compared to 3.50% for the second quarter of 2019 primarily due to the lower rate environment and changes in our asset mix from the significant short-term liquidity increase in customer deposits.

The Company recorded a provision for loan losses of $0.5 million during the second quarter of 2020 and no provision during the second quarter 2019 .

Noninterest income was $1.4 million in the second quarter of 2020 and $0.9 million in the second quarter of 2019 .

The Company paid cash dividends of $0.765 per share in the first nine months of 2020, an increase of 2% from the same period of 2019.

At September 30, 2020, the Bank’s regulatory capital ratios were well above the minimum amounts required to be “well capitalized” under current regulatory standards with a total risk-based capital ratio of 18.77%, a tier 1 leverage ratio of 10.38% and a common equity tier 1 (“CET1”) ratio of 17.70% at September 30, 2020.

For the third quarter of 2020, net earnings were $1.9 million, or $0.54 per share, compared to $2.2 million, or $0.62 per share, for the third quarter of 2019.

Net interest income (tax-equivalent) was $6.0 million for the third quarter of 2020 compared to $6.7 million for the third quarter of 2019.

The Company’s net interest margin (tax-equivalent) decreased to 2.72% in the third quarter of 2020, compared to 3.41% for the third quarter of 2019 primarily due to the lower rate environment and changes in our asset mix from the significant short-term liquidity increase in customer deposits.

The Company recorded a provision for loan losses of $0.3 million during the third quarter of 2020 and no provision during the third quarter 2019.

Noninterest income was $1.4 million in the third quarter of 2020 and $1.0 million in the third quarter of 2019.

The increase was primarily due to an increase in mortgage lending income as lower interest rates for mortgage loans positively affected refinance activity and pricing margins improved.

Noninterest expense was $5.0 million in the second quarter of 2020 compared to $4.6 million during the second quarter of 2019 .

The increase was mainly due to $0.6 million of various expenses related to the redevelopment of the Company’s headquarters in downtown Auburn, including revised depreciation estimates and temporary relocation costs.

Income tax expense was $0.4 million for the second quarter of 2020 compared to $0.5 million during second quarter of 2019 .

The Company's effective tax rate for the second quarter of 2020 was 17.93%, compared to 19.14% in the second quarter of 2019 .

Noninterest expense was $4.7 million in the third quarter of 2020 compared to $4.8 million during the third quarter of 2019.

Income tax expense was $0.4 million for the third quarter of 2020 compared to $0.5 million during third quarter of 2019.

The Company's effective tax rate for the third quarter of 2020 was 17.23%, compared to 19.28% in the third quarter of 2019.

COVID-19 Impact Assessment

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In response to the COVID-19 pandemic, the State of Alabama, and most other states, have taken preventative or protective actions to prevent the spread of the virus, including imposing restrictions on travel and business operations and a statewide mask mandate, advising or requiring individuals to limit or forego their time outside of their homes, limitations on gathering of people and social distancing, and causing temporary closures of businesses that have been deemed to be non-essential.

Though certain of these measures have been relaxed or eliminated, recent increases in reported cases could cause these measures to be reestablished.

Though certain of these measures have been relaxed or eliminated, increases in reported cases could cause these measures to be reestablished.

Auburn University, a major source of economic activity in Lee County, went to remote instruction on March 16, 2020.

Auburn University announced its guidelines for the fall semester of 2020, which will involve both remote and in person instruction as well as other social distancing measures.

Auburn University announced its guidelines for the fall semester of 2020, which involves both remote and in person instruction as well as other social distancing measures.

The economic effects of these measures are not presently known.

COVID-19 has significantly affected local state, national and global health and economic activity and its future effects are uncertain and will depend on various factors, including, among others, the duration and scope of the pandemic, the development and distribution of COVID-19 testing and contact tracing, effective drug treatments and vaccines, together with governmental, regulatory and private sector responses.

COVID-19 has had significant effects on the economy, financial markets and our employees, customers and vendors.

COVID-19 has had continuing significant effects on the economy, financial markets and our employees, customers and vendors.

Our business, financial condition and results of operations generally rely upon the ability of our borrowers to make deposits and repay their loans, the value of collateral underlying our secured loans, market value, stability and liquidity and demand for loans and other products and services we offer, all of which are affected by the pandemic.

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As part of our efforts to exercise social distancing in accordance with the guidelines of the Centers for Disease Control, starting March 23, we limited branch lobby service to appointment only while continuing to operate our branch drive-thru facilities and automated teller machines (“ATMs”).

On June 1, 2020, we re-opened some of our branch lobbies as permitted by state public health guidelines.

We continue to provide services through our online and other electronic channels.

In addition, we established remote work access to help employees stay at home where job duties permit.

On June 1, 2020 we re-opened some of our branch lobbies as permitted by state public health guidelines.

• We are focused on servicing the financial needs of our commercial and consumer clients with extensions and deferrals to loan customers effected by COVID-19, provided such customers were not more than 30 days past due at the time of the request;

• We are a participating lender in the Paycheck Protection Program (“PPP”).

PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirement of the PPP.

PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP.

These loans carry a fixed rate of 1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5, 2020), if not forgiven, in whole or in part.

Payments are deferred until either the date on which the SBA remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness with that 10-month period.

Payments are deferred until either the date on which the Small Business Administration (“SBA”) remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10-month period.

We believe these loans and our participation in the program is good for our customers and the communities we serve.

A summary of our loans as of June 30, 2020 follows:

A summary of our PPP loans as of September 30, 2020 follows:

(Dollars in thousands)

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Up to $350,000

The Company extended a total of $36.5 million in loans to 422 small businesses under the Small Business Administration’s Paycheck Protection Program during the second quarter of 2020.

The PPP closed on August 8, 2020 and the SBA no longer accepts PPP applications from participating lenders.

The Company extended $36.5 million in loans to 422 small businesses under the PPP during the second quarter of 2020.

We collected approximately $1.5 million in fees related to our PPP loans, which will be recognized net of related costs, as a yield adjustment over the life of the underlying PPP loans.

We continue to closely monitor this pandemic, and are working to continue our services during the pandemic and to address developments as those occur.

Our results of operations for the six months ended June 30, 2020, and our financial condition at that date reflect only the initial effects of the pandemic, and may not be indicative of future results or financial conditions.

As of June 30, 2020, all of our capital ratios were in excess of all regulatory requirements to be well capitalized.

Our results of operations for the nine months ended September 30, 2020, and our financial condition at that date reflect only the initial effects of the pandemic, and may not be indicative of future results or financial conditions, including possible additional monetary or fiscal stimulus, and the possible effects of the expiration or extension of temporary accounting and bank regulatory relief measures in response to the COVID-19 pandemic.

As of September 30, 2020, all of our capital ratios were in excess of all regulatory requirements to be well capitalized.

The effects of the COVID-19 pandemic on our borrowers could result in adverse changes to credit quality and our regulatory capital ratios.

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For loan segments where the Company believes it does not have sufficient historical loss data, the Company may make adjustments based, in part, on loss rates of peer bank groups.

At June 30, 2020 and December 31, 2019 , and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

At September 30, 2020 and December 31, 2019, and for the periods then ended, the Company adjusted its historical loss rates for the commercial real estate portfolio segment based, in part, on loss rates of peer bank groups.

The estimated loan loss allocation for all five loan portfolio segments is then adjusted for management’s estimate of probable losses for several “qualitative and environmental” factors.

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Absent this extension, the early cycle periods in which the Company experienced significant losses would be excluded from the determination of the allowance for loan losses and its balance would decrease.

For the quarter ended June 30, 2020 , the Company increased its look-back period to 45 quarters to continue to include losses incurred by the Company beginning with the first quarter of 2009.

For the quarter ended September 30, 2020, the Company increased its look-back period to 46 quarters to continue to include losses incurred by the Company beginning with the first quarter of 2009.

The Company will likely continue to increase its look-back period to incorporate the effects of at least one economic downturn in its loss history.

During the first six months of 2020, the Company adjusted certain qualitative and economic factors related to changes in economic conditions driven by the impact of the COVID-19 pandemic and resulting adverse economic conditions, including higher unemployment in our primary market area.

During the first nine months of 2020, the Company adjusted certain qualitative and economic factors related to changes in economic conditions and portfolio trends driven by the impact of the COVID-19 pandemic and resulting adverse economic conditions, including higher unemployment in our primary market area.

Further adjustments may be made in the future as a result of the continuing COVID-19 pandemic.

Assessment for Other-Than-Temporary Impairment of Securities

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As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales, and other estimates used to determine the fair value of other OREO.

At June 30, 2020 and December 31, 2019 the company had no OREO properties.

At September 30, 2020 and December 31, 2019 the Company had no OREO properties.

Deferred Tax Asset Valuation

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Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.

Based upon the level of taxable income over the last three years and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible differences at June 30, 2020 .

The amount of the deferred tax assets considered realizable, however, could be reduced if estimates of future taxable income are reduced.

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Average Balance Sheet and Interest Rates

Six months ended June 30,

Nine months ended September 30,

(Dollars in thousands)

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Net Interest Income and Margin

Net interest income (tax-equivalent) was $12.5 million for the first six months of 2020 compared to $13.5 million for the first six months of 2019 .

Net interest income (tax-equivalent) was $18.5 million for the first nine months of 2020 compared to $20.2 million for the first nine months of 2019.

This decrease was due to a decline in the Company’s net interest margin (tax-equivalent).

The tax-equivalent yield on total interest-earning assets decreased by 47 basis points to 3.58% in the first six months of 2020 compared to 4.05% in the first six months of 2019 .

This decrease was primarily due to the lower rate environment, including a 150 basis point reduction in the Fed Funds rate that occurred late in the first quarter of 2020 and changes in our asset mix from the significant short-term liquidity increase in customer deposits.

The cost of total interest-bearing liabilities was 0.75% and 0.78%, for the first six months of 2020 and 2019 , respectively.

The tax-equivalent yield on total interest-earning assets decreased by 58 basis points to 3.44% in the first nine months of 2020 compared to 4.02% in the first nine months of 2019.

This decrease was primarily due to the lower rate environment, including a 150 basis point reduction in the federal funds rate that occurred late in the first quarter of 2020 and changes in our asset mix from the significant short-term liquidity increase in customer deposits.

The cost of total interest-bearing liabilities was 0.72% and 0.79%, for the first nine months of 2020 and 2019, respectively.

Such costs declined less than the declines in rates earned on our interest earning assets.

The Company continues to deploy various asset liability management strategies to manage its risk to interest rate fluctuations.

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The provision for loan losses represents a charge to earnings necessary to provide an allowance for loan losses that management believes, based on its processes and estimates, should be adequate to provide for the probable losses on outstanding loans.

The provision for loan losses was $0.9 million for the first six months of 2020 , compared to no provision for loan losses for the first six months of 2019 .

The increase in the provision for loan losses was related to adverse changes in economic conditions driven by the impact of COVID-19 pandemic, including higher unemployment in our primary market area.

The provision for loan losses was $1.1 million for the first nine months of 2020, compared to no provision for loan losses for the first nine months of 2019.

The increase in the provision for loan losses was related to adverse changes in economic conditions and portfolio trends driven by the impact of COVID-19 pandemic, including higher unemployment in our primary market area.

The provision for loan losses is based upon various factors, including the absolute level of loans, loan growth, the credit quality, and the amount of net charge-offs or recoveries.

Based upon its assessment of the loan portfolio, management adjusts the allowance for loan losses to an amount it believes should be appropriate to adequately cover its estimate of probable losses in the loan portfolio.

The Company’s allowance for loan losses as a percentage of total loans was 1.14% at June 30, 2020 , compared to 0.95% at December 31, 2019.

At June 30, 2020, the Company’s allowance for loan losses was 1.24% of total loans, excluding PPP loans.

The Company’s allowance for loan losses as a percentage of total loans was 1.18% at September 30, 2020, compared to 0.95% at December 31, 2019.

At September 30, 2020, the Company’s allowance for loan losses was 1.28% of total loans, excluding PPP loans.

While the policies and procedures used to estimate the allowance for loan losses, as well as the resulting provision for loan losses charged to operations, are considered adequate by management and are reviewed from time to time by our regulators, they are based on estimates and judgments and are therefore approximate and imprecise.

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Noninterest Income

Quarter ended June 30,

Six months ended June 30,

Quarter ended September 30,

Nine months ended September 30,

(Dollars in thousands)

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The following table presents a breakdown of the Company’s mortgage lending income.

Quarter ended June 30,

Six months ended June 30,

Quarter ended September 30,

Nine months ended September 30,

(Dollars in thousands)

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The Company’s income from mortgage lending typically fluctuates as mortgage interest rates change and is primarily attributable to the origination and sale of new mortgage loans.

The increase in mortgage lending income was partially offset by a decrease in servicing fees, net of related amortization expense as prepayment speeds increased in the first six months of 2020 , resulting in increased amortization expense.

Income from bank-owned life insurance increased primarily due to $0.3 million in non-taxable death benefits received in the first six months of 2020 .

The increase in mortgage lending income was partially offset by a decrease in servicing fees, net of related amortization expense as prepayment speeds increased in the first nine months of 2020, resulting in increased amortization expense.

Income from bank-owned life insurance increased primarily due to $0.3 million in non-taxable death benefits received in the first nine months of 2020.

The assets that support these policies are administered by the life insurance carriers and the income we receive (i.e., increases or decreases in the cash surrender value of the policies and death benefits received) on these policies is dependent upon the returns the insurance carriers are able to earn on the underlying investments that support these policies.

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Noninterest Expense

Quarter ended June 30,

Six months ended June 30,

Quarter ended September 30,

Nine months ended September 30,

(Dollars in thousands)

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Total noninterest expense

The decrease in salaries and benefits expense was primarily due to lower incentive accruals and an increase in deferred costs related to the PPP loan program.

The decrease in salaries and benefits expense was primarily due to lower full-time equivalent employees, incentive accruals and an increase in deferred costs related to the PPP loan program.

The increase in net occupancy and equipment expense was primarily due to various expenses related to the redevelopment of the Company’s headquarters in downtown Auburn.

This amount includes revised depreciation estimates and other temporary relocation costs.

The Company expects it will incur additional expense in 2020 related to the redevelopment project.

The Company expects it will incur additional expense in the fourth quarter of 2020 related to the redevelopment project.

Income Tax Expense

Income tax expense was $0.8 million and $1.2 million for the first six months of 2020 and 2019 reflecting an effective tax rate of 17.86% and 19.46%, respectively.

Income tax expense was $1.2 million and $1.7 million for the first nine months of 2020 and 2019 reflecting an effective tax rate of 17.64% and 19.40%, respectively.

This change was primarily due to a decrease in the level of earnings before taxes relative to tax-exempt sources of income.

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BALANCE SHEET ANALYSIS

Securities available-for-sale were $302.2 million at June 30, 2020 compared to $235.9 million at December 31, 2019 .

Securities available-for-sale were $320.9 million at September 30, 2020 compared to $235.9 million at December 31, 2019.

This increase reflects an increase in the amortized cost basis of securities available-for-sale of $77.9 million, and an increase of $7.1 million in the fair value of securities available-for-sale.

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Loans, net of unearned income

Total loans, net of unearned income, were $464.3 million at June 30, 2020 , a increase of $3.4 million, or 1%, from $460.9 million at December 31, 2019.

Total loans, net of unearned income, were $472.5 million at September 30, 2020, an increase of $11.6 million, or 3%, from $460.9 million at December 31, 2019.

Excluding PPP loans, total loans net of unearned income, were $436.0 million, a decrease of $24.9 million, or 5% from December 31, 2019.

This decrease was primarily due to a decrease in commercial real estate loans and residential real estate loans of $19.3 million and $7.5 million, respectively, as lower rates increased refinance activity and payoffs for multi-family residential and consumer mortgage loans.

Four loan categories represented the majority of the loan portfolio at June 30, 2020 :

commercial real estate (54%), residential real estate (18%), construction and land development (7%) and commercial and industrial (19%).

Approximately 20% of the Company’s commercial real estate loans were classified as owner-occupied at June 30, 2020 .

Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $10.6 million, or 2% of total loans, at June 30, 2020 , compared to $10.8 million, or 2% of total loans, at December 31, 2019 .

For residential real estate mortgage loans with a consumer purpose, the company had no loans that required interest-only payments at June 30, 2020 , compared to $0.8 million at December 31, 2019 .

Four loan categories represented the majority of the loan portfolio at September 30, 2020:

commercial real estate (53%), residential real estate (18%), commercial and industrial (21%) and construction and land development (7%).

Approximately 20% of the Company’s commercial real estate loans were classified as owner-occupied at September 30, 2020.

Within the residential real estate portfolio segment, the Company had junior lien mortgages of approximately $9.8 million, or 2% of total loans, at September 30, 2020, compared to $10.8 million, or 2% of total loans, at December 31, 2019.

For residential real estate mortgage loans with a consumer purpose, the Company had no loans that required interest-only payments at September 30, 2020, compared to $0.8 million at December 31, 2019.

The Company’s residential real estate mortgage portfolio does not include any option ARM loans, subprime loans, or any material amount of other high-risk consumer mortgage products.

The average yield earned on loans and loans held for sale was 4.75% in the first six months of 2020 and 4.87% in the first six months of 2019 .

The average yield earned on loans and loans held for sale was 4.71% in the first nine months of 2020 and 4.86% in the first nine months of 2019.

The specific economic and credit risks associated with our loan portfolio include, but are not limited to, the effects of current economic conditions, including the COVID-19 pandemic’s effects, on our borrowers’ cash flows, real estate market sales volumes, valuations, availability and cost of financing properties, real estate industry concentrations, competitive pressures from a wide range of other lenders, deterioration in certain credits, interest rate fluctuations, reduced collateral values or non-existent collateral, title defects, inaccurate appraisals, financial deterioration of borrowers, fraud, and any violation of applicable laws and regulations.

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or 20% of capital, if loans in excess of 10% of capital are fully secured.

Under these regulations, we are prohibited from having secured loan relationships in excess of approximately $19.

Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $ 17.

Under these regulations, we are prohibited from having secured loan relationships in excess of approximately $20.2 million.

Furthermore, we have an internal limit for aggregate credit exposure (loans outstanding plus unfunded commitments) to a single borrower of $18.1 million.

Our loan policy requires that the Loan Committee of the Board of Directors approve any loan relationships that exceed this internal limit.

At June 30, 2020 , the Bank had no relationships exceeding these limits.

At September 30, 2020, the Bank had no relationships exceeding these limits.

We periodically analyze our commercial and industrial and commercial real estate loan portfolios to determine if a concentration of credit risk exists in any one or more industries.

We use classification systems broadly accepted by the financial services industry in order to categorize our commercial borrowers.

Loan concentrations to borrowers in the following classes exceeded 25% of the Bank’s total risk-based capital at June 30, 2020 (and related balances at December 31, 2019 ).

(In thousands)

Loan concentrations to borrowers in the following classes exceeded 25% of the Bank’s total risk-based capital at September 30, 2020 (and related balances at December 31, 2019).

September 30,

(Dollars in thousands)

Lessors of 1 to 4 family residential properties

4 unchanged sentences

We have identified certain commercial sectors with enhanced risk resulting from the impact of COVID-19.

See table below for a summary of loans outstanding for these sectors at June 30, 2020.

Loans within these sectors represent 49% of the Company’s total COVID-19 related modifications at September 30, 2020.

The table below summarizes the loans outstanding for these sectors at September 30, 2020.

Portfolio Segment

4 unchanged sentences

% of Total Loans

June 30, 2020:

September 30, 2020:

Shopping centers

Retail, excluding shopping centers

In light of recent disruptions in economic conditions caused by COVID-19, the financial regulators have issued guidance encouraging banks to work constructively with borrowers affected by the virus in our community.

This guidance provides that the agencies will not criticize financial institutions that mitigate credit risk through prudent actions consistent with safe and sound practices.

In light of disruptions in economic conditions caused by COVID-19, the financial regulators have issued guidance encouraging banks to work constructively with borrowers affected by the virus in our community.

This guidance, including the Interagency Statement on COVID-19 Loan Modifications and the Interagency Examiner Guidance for Assessing Safety and Soundness Considering the Effect of the COVID-19 Pandemic on Institutions, provides that the agencies will not criticize financial institutions that mitigate credit risk through prudent actions consistent with safe and sound practices.

Specifically, examiners will not criticize institutions for working with borrowers as part of a risk mitigation strategy intended to improve existing loans, even if the restructured loans have or develop weaknesses that ultimately result in adverse credit classification.

Upon demonstrating the need for payment relief, the bank will work with qualified borrowers that were otherwise current before the pandemic to determine the most appropriate deferral option.

3 unchanged sentences

The bank recognizes that a combination of the payment relief options may be prudent dependent on a borrower’s business type.

As of June 30, 2020 we have granted loan payment deferrals or payments of interest only on loans totaling $112.7 million, or 24% of total loans.

The table below provides information concerning the composition of these COVID-19 modifications through June 30, 2020.

COVID-19 Modifications through June 30, 2020

As of September 30, 2020 we have granted loan payment deferrals or payments of interest-only primarily on commercial and industrial and commercial real estate loans totaling $87.1 million, or 18% of total loans, compared to $112.7 million, or 24% of total loans at June 30, 2020.

The tables below provide information concerning the composition of these COVID-19 modifications as of September 30, 2020.

COVID-19 Modifications

Modification Types

8 unchanged sentences

Consumer installment

COVID-19 Modifications within High Exposure Commercial Real Estate Segments

COVID-19 Modifications within Commercial Real Estate Segments

(Dollars in thousands)

7 unchanged sentences

The Company maintains the allowance for loan losses at a level that management believes appropriate to adequately cover the Company’s estimate of probable losses inherent in the loan portfolio.

The allowance for loan losses was $5.3 million at June 30, 2020 compared to $4.4 million at December 31, 2019 , which management believed to be adequate at each of the respective dates.

The allowance for loan losses was $5.6 million at September 30, 2020 compared to $4.4 million at December 31, 2019, which management believed to be adequate at each of the respective dates.

The judgments and estimates associated with the determination of the allowance for loan losses are described under “Critical Accounting Policies.”

A summary of the changes in the allowance for loan losses and certain asset quality ratios for the second quarter of 2020 and the previous four quarters is presented below.

A summary of the changes in the allowance for loan losses and certain asset quality ratios for the third quarter of 2020 and the previous four quarters is presented below.

(Dollars in thousands)

4 unchanged sentences

Total charge-offs

Net (charge-offs) recoveries

Net recoveries (charge-offs)

Provision for loan losses

2 unchanged sentences

as a % of nonperforming loans

Net charge-offs (recoveries) as % of average loans (a)

(a) Net charge-offs (recoveries) are annualized.

Net (recoveries) charge-offs as % of average loans (a)

(a) Net (recoveries) charge-offs are annualized.

As described under “Critical Accounting Policies,” management assesses the adequacy of the allowance prior to the end of each calendar quarter.

1 unchanged sentence

This evaluation is inherently subjective as it requires various material estimates and judgments, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change.

The ratio of our allowance for loan losses to total loans outstanding was 1.14% at June 30, 2020 , compared to 0.95% at December 31, 2019 .

At June 30, 2020, the Company’s allowance for loan losses was 1.24% of total loans, excluding PPP loans.

In the future, the allowance to total loans outstanding ratio will increase or decrease to the extent the factors that influence our quarterly allowance assessment, including COVID-19 effects, in their entirety either improve or weaken.

The ratio of our allowance for loan losses to total loans outstanding was 1.18% at September 30, 2020, compared to 0.95% at December 31, 2019.

At September 30, 2020, the Company’s allowance for loan losses was 1.28% of total loans, excluding PPP loans.

In the future, the allowance to total loans outstanding ratio will increase or decrease to the extent the factors that influence our quarterly allowance assessment, including the duration and magnitude of COVID-19 effects, in their entirety either improve or weaken.

In addition, our regulators, as an integral part of their examination process, will periodically review the Company’s allowance for loan losses, and may require the Company to make additional provisions to the allowance for loan losses based on their judgment about information available to them at the time of their examinations.

1 unchanged sentence

Nonperforming Assets

The Company had $0.7 million and $0.2 million in nonperforming assets at June 30, 2020 and December 31, 2019, respectively .

The table below provides information concerning total nonperforming assets and certain asset quality ratios for the second quarter of 2020 and the previous four quarters.

The Company had $0.5 million and $0.2 million in nonperforming assets at September 30, 2020 and December 31, 2019, respectively.

The table below provides information concerning total nonperforming assets and certain asset quality ratios for the third quarter of 2020 and the previous four quarters.

(Dollars in thousands)

6 unchanged sentences

Nonperforming loans as a % of total loans

The table below provides information concerning the composition of nonaccrual loans for the second quarter of 2020 and the previous four quarters.

The table below provides information concerning the composition of nonaccrual loans for the third quarter of 2020 and the previous four quarters.

(In thousands)

5 unchanged sentences

The Company discontinues the accrual of interest income when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected or (2) the principal or interest is 90 days or more past due, unless the loan is both well-secured and in the process of collection.

At June 30, 2020 , the Company had $0.7 million in loans on nonaccrual status compared to $0.2 million at December 31, 2019 .

The Company had $49 thousand in loans 90 days or more past due and still accruing at June 30, 2020 compared to no loans at December 31, 2019.

The table below provides information concerning the composition of OREO for the second quarter of 2020 and the previous four quarters.

At September 30, 2020, the Company had $0.5 million in loans on nonaccrual status compared to $0.2 million at December 31, 2019.

The Company had $71 thousand in loans 90 days or more past due and still accruing at September 30, 2020 compared to no such loans at December 31, 2019.

The table below provides information concerning the composition of OREO for the third quarter of 2020 and the previous four quarters.

(In thousands)

4 unchanged sentences

This definition is believed to be substantially consistent with the standards established by the Federal Reserve, the Company’s primary regulator, for loans classified as substandard, excluding nonaccrual loans.

Potential problem loans, which are not included in nonperforming assets, amounted to $3.6 million, or 0.8% of total loans at June 30, 2020 , and $4.4 million, or 1.0% of total loans at December 31, 2019 .

The table below provides information concerning the composition of potential problem loans for the second quarter of 2020 and the previous four quarters.

Potential problem loans, which are not included in nonperforming assets, amounted to $3.5 million, or 0.7% of total loans at September 30, 2020, and $4.4 million, or 1.0% of total loans at December 31, 2019.

The table below provides information concerning the composition of potential problem loans for the third quarter of 2020 and the previous four quarters.

(In thousands)

6 unchanged sentences

Total potential problem loans

At June 30, 2020 the Company had no potential problem loans that were past due at least 30 days, but less than 90 days.

The following table is a summary of the Company’s performing loans that were past due at least 30 days, but less than 90 days, for the second quarter of 2020 and the previous four quarters

At September 30, 2020 the Company had $101 thousand in potential problem loans that were past due at least 30 days, but less than 90 days.

The following table is a summary of the Company’s performing loans that were past due at least 30 days, but less than 90 days, for the third quarter of 2020 and the previous four quarters.

(In thousands)

5 unchanged sentences

Consumer installment

Total deposits were $829.8 million at June 30, 2020 , compared to $724.2 million at December 31, 2019 .

Noninterest-bearing deposits were $247.4 million, or 29.8% of total deposits, at June 30, 2020 , compared to $196.2 million, or 27.1% of total deposits at December 31, 2019 .

These increases reflect deposits from customers who received PPP loans, the impact of government stimulus checks, delayed tax payment and less customer spending during the COVID-19 pandemic.

The average rate paid on total interest-bearing deposits was 0.75% in the first six months of 2020 compared to 0.78% in the first six months of 2019 .

Total deposits were $824.0 million at September 30, 2020, compared to $724.2 million at December 31, 2019.

Noninterest-bearing deposits were $238.5 million, or 28.9% of total deposits, at September 30, 2020, compared to $196.2 million, or 27.1% of total deposits at December 31, 2019.

These increases reflect deposits from customers who received PPP loans, the impact of government stimulus checks, delayed tax payments and less customer spending during the COVID-19 pandemic.

The average rate paid on total interest-bearing deposits was 0.72% in the first nine months of 2020 compared to 0.79% in the first nine months of 2019.

Other Borrowings

Other borrowings consist of short-term borrowings and long-term debt.

Short-term borrowings generally consist of federal funds purchased and securities sold under agreements to repurchase with an original maturity less than one year.

The Bank had available federal funds lines totaling $41.0 million with none outstanding at June 30, 2020 , and at December 31, 2019 , respectively.

Securities sold under agreements to repurchase totaled $2.0 million at June 30, 2020 , compared to $1.1 million at December 31, 2019 .

The average rate paid on short-term borrowings was 0.50% in the first six months of 2020 compared to 0.74% in the first six months of 2019 .

The Company had no long-term debt at June 30, 2020 and December 31, 2019 .

Short-term borrowings generally consist of federal funds purchased and agreements with certain customers to sell certain securities under agreements to repurchase with an original maturity less than one year.

The Bank had available federal funds lines totaling $41.0 million with none outstanding at September 30, 2020, and at December 31, 2019, respectively.

Securities sold under agreements to repurchase totaled $2.1 million at September 30, 2020, compared to $1.1 million at December 31, 2019.

The average rate paid on short-term borrowings was 0.50% in the first nine months of 2020 and 2019.

The Company had no long-term debt at September 30, 2020 and December 31, 2019.

CAPITAL ADEQUACY

The Company’s consolidated stockholders’ equity was $105.3 million and $98.3 million as of June 30, 2020 and December 31, 2019 , respectively.

The Company’s consolidated stockholders’ equity was $106.3 million and $98.3 million as of September 30, 2020 and December 31, 2019, respectively.

The increase from December 31, 2019 was primarily driven by net earnings of $5.4 million and other comprehensive income due to the change in unrealized gains on securities available-for-sale, net of tax of $5.3 million, partially offset by cash dividends paid of $2.7 million.

3 unchanged sentences

A banking organization with a conservation buffer of less than the required amount will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers.

At June 30, 2020 , the Bank’s ratio was sufficient to meet the fully phased-in conservation buffer.

At September 30, 2020, the Bank’s ratio was sufficient to meet the fully phased-in conservation buffer.

Effective March 20, 2020, the Federal Reserve and the other federal banking regulators adopted an interim final rule that amended the capital conservation buffer.

The interim final rule was adopted as a final rule on August 26, 2020.

The new rule revises the definition of “eligible retained income” for purposes of the maximum payout ratio to allow banking organizations to more freely use their capital buffers to promote lending and other financial intermediation activities, by making the limitations on capital distributions more gradual.

4 unchanged sentences

Accordingly, our capital adequacy is evaluated at the Bank level, and not for the Company and its consolidated subsidiaries.

The Bank’s tier 1 leverage ratio was 10.62%, CET1 risk-based capital ratio was 18.00%, tier 1 risk-based capital ratio was 18.00%, and total risk-based capital ratio was 19.04% at June 30, 2020 .

These ratios exceed the minimum regulatory capital percentages of 5.0% for tier 1 leverage ratio, 6.5% for CET1 risk-based capital ratio, 8.0% for tier 1 risk-based capital ratio, and 10.0% for total risk-based capital ratio to be considered “well capitalized.” The Bank’s capital conservation buffer was 11.04% at June 30, 2020.

The Bank’s tier 1 leverage ratio was 10.62%, CET1 risk-based capital ratio was 17.70%, tier 1 risk-based capital ratio was 17.70%, and total risk-based capital ratio was 18.77% at September 30, 2020.

MARKET AND LIQUIDITY RISK MANAGEMENT

15 unchanged sentences

 +/- 5% for a gradual change of 100 basis points

At June 30, 2020 , our earnings simulation model indicated that we were in compliance with the policy guidelines noted above.

At September 30, 2020, our earnings simulation model indicated that we were in compliance with the policy guidelines noted above.

Economic Value of Equity .

8 unchanged sentences

 15% for an instantaneous change of +/- 100 basis points

At June 30, 2020 , our EVE model indicated that we were in compliance with the policy guidelines noted above.

At September 30, 2020, our EVE model indicated that we were in compliance with the policy guidelines noted above.

Each of the above analyses may not, on its own, be an accurate indicator of how our net interest income will be affected by changes in interest rates.

10 unchanged sentences

These interest rate swaps qualify as derivatives, but are not designated as hedging instruments.

At June 30, 2020 and December 31, 2019, the Company had no derivative contracts designated as part of a hedging relationship to assist in managing its interest rate sensitivity.

At September 30, 2020 and December 31, 2019, the Company had no derivative contracts designated as part of a hedging relationship to assist in managing its interest rate sensitivity.

Liquidity Risk Management

14 unchanged sentences

Advances include both fixed and variable terms and may be taken out with varying maturities.

At June 30, 2020 , the Bank had a remaining available line of credit with the FHLB of $256.5 million.

At June 30, 2020 , the Bank also had $41.0 million of available federal funds lines with none outstanding.

At September 30, 2020, the Bank had a remaining available line of credit with the FHLB of $282.9 million.

At September 30, 2020, the Bank also had $41.0 million of available federal funds lines with no borrowings outstanding.

Primary uses of funds include repayment of maturing obligations and growing the loan portfolio.

1 unchanged sentence

Off-Balance Sheet Arrangements, Commitments, Contingencies and Contractual Obligations

At June 30, 2020 , the Bank had outstanding standby letters of credit of $1.6 million and unfunded loan commitments outstanding of $70.5 million.

At September 30, 2020, the Bank had outstanding standby letters of credit of $1.1 million and unfunded loan commitments outstanding of $75.5 million.

Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements.

4 unchanged sentences

Although the representations and warranties vary among investors, they typically cover ownership of the loan, validity of the lien securing the loan, the absence of delinquent taxes or liens against the property securing the loan, compliance with loan criteria set forth in the applicable agreement, compliance with applicable federal, state, and local laws, among other matters.

As of June 30, 2020 , the unpaid principal balance of residential mortgage loans, which we have originated and sold, but retained the servicing rights was $271.4 million.

As of September 30, 2020 , the unpaid principal balance of residential mortgage loans, which we have originated and sold, but retained the servicing rights was $266.4 million.

Although these loans are generally sold on a non-recourse basis, we may be obligated to repurchase residential mortgage loans or reimburse investors for losses incurred (make whole requests) if a loan review reveals a potential breach of seller representations and warranties.

2 unchanged sentences

We seek to reduce and manage the risks of potential repurchases, make whole requests, or other claims by mortgage loan investors through our underwriting and quality assurance practices and by servicing mortgage loans to meet investor and secondary market standards.

The Company was not required to repurchase any loans during the first six months of 2020 as a result of representation and warranty provisions contained in the Company’s sale agreements with Fannie Mae, and had no pending repurchase or make-whole requests at June 30, 2020 .

The Company was not required to repurchase any loans during the first nine months of 2020 as a result of representation and warranty provisions contained in the Company’s sale agreements with Fannie Mae, and had no pending repurchase or make-whole requests at September 30, 2020.

We service all residential mortgage loans originated and sold by us to Fannie Mae.

10 unchanged sentences

Although repurchase and make whole requests related to representation and warranty provisions and servicing activities have been limited to date, it is possible that requests to repurchase mortgage loans or reimburse investors for losses incurred (make whole requests) may increase in frequency if investors more aggressively pursue all means of recovering losses on their purchased loans.

As of June 30, 2020 , we do not believe that this exposure is material due to the historical level of repurchase requests and loss trends, in addition to the fact that 99% of our residential mortgage loans serviced for Fannie Mae were current as of such date.

As of September 30, 2020 , we do not believe that this exposure is material due to the historical level of repurchase requests and loss trends, in addition to the fact that 99% of our residential mortgage loans serviced for Fannie Mae were current as of such date.

We maintain ongoing communications with our investors and will continue to evaluate this exposure by monitoring the level and number of repurchase requests as well as the delinquency rates in our investor portfolios.

2 unchanged sentences

During forbearance, no fees, penalties or interest shall be charged beyond those applicable if all contractual payments were fully and timely paid.

Except for vacant or abandoned properties, Fannie Mae servicers may not initiate foreclosures on similar procedures or related evictions or sales until May 17, 2020 .

Except for vacant or abandoned properties, Fannie Mae servicers may not initiate foreclosures on similar procedures or related evictions or sales until December 31, 2020.

The Bank sells mortgage loans to Fannie Mae and services these on an actual/actual basis.

35 unchanged sentences

Net interest income (Tax-equivalent)

Six months ended June 30,

Nine months ended September 30,

(In thousands)

18 unchanged sentences

Basic and diluted

Shares outstanding

Shares outstanding, at period end

Common stock price

9 unchanged sentences

Nonperforming assets as a % of:

Loans and other real estate owned

Loans and foreclosed properties

Nonperforming loans as a % of total loans

Annualized net chargeoffs (recoveries) as a % of average loans

Annualized net (recoveries) charge-offs as % of average loans

Capital Adequacy:

21 unchanged sentences

Table 3 - Selected Financial Data

Six months ended June 30,

Nine months ended September 30,

(Dollars in thousands, except per share amounts)

51 unchanged sentences

Table 4 - Average Balances and Net Interest Income Analysis

Quarter ended June 30,

Quarter ended September 30,

(Dollars in thousands)

24 unchanged sentences

Table 5 - Average Balances and Net Interest Income Analysis

Six months ended June 30,

Nine months ended September 30,

(Dollars in thousands)

41 unchanged sentences

Total charge-offs

Net (charge-offs) recoveries

Net recoveries (charge-offs)

Provision for loan losses

1 unchanged sentence

as a % of loans

as a % of nonperforming loans

as a % of loans (excluding PPP loans)

as a % of nonperforming loans

Net charge-offs (recoveries) as % of avg.

Net (recoveries) charge-offs as % of avg.

Nonperforming assets:

2 unchanged sentences

Total nonperforming assets

as a % of loans and other real estate owned

as a % of loans and foreclosed properties

as a % of total assets

1 unchanged sentence

Accruing loans 90 days or more past due

(a) Net (charge-offs) recoveries are annualized.

(a) Net (recoveries) charge-offs are annualized.

Table 8 - Allocation of Allowance for Loan Losses

Third Quarter

Second Quarter

2 unchanged sentences

Third Quarter

Second Quarter

(Dollars in thousands)

4 unchanged sentences

Consumer installment

Total allowance for loan losses

Total allowance for

* Loan balance in each category expressed as a percentage of total loans.

1 unchanged sentence

(Dollars in thousands)

June 30, 2020

September 30, 2020

3 months or less

6 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis