Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain matters discussed in this Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risks and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward- looking statements as a result of a wide variety or range of factors including, but not limited to:
● the effect of the novel coronavirus disease 2019 (“COVID-19”) pandemic, including on our credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and economic activity, employment levels and market liquidity global economies, and consumer and corporate clients;
● the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses;
● changes in economic conditions in general and in California, Colorado, New Mexico and Washington;
● changes in the levels of general interest rates and the relative differences between short and long-term interest rates, loan and deposit interest rates;
● uncertainly regarding transition away from London Interbank Offered Rate (“LIBOR”) toward new interest rate benchmarks;
● our net interest margin and funding sources;
● fluctuations in the demand for loans and the number of unsold homes, land and other properties;
● fluctuations in real estate values in our market areas;
● secondary market conditions for loans and our ability to sell loans in the secondary market;
● results of examinations of us by regulatory authorities and the possibility that any such regulatory authority may, among other things, limit our business activities, require us to change our business mix, increase our allowance for loan and lease losses, write-down asset values or increase our capital levels, affect our ability to borrow funds or maintain or increase deposits;
● risks related to our acquisition strategy, including our ability to identify future suitable acquisition candidates, exposure to potential asset and credit quality risks and unknown or contingent liabilities, the need for capital to finance such transactions, our ability to obtain required regulatory approvals and possible failures in realizing the anticipated benefits from acquisitions;
● challenges arising from attempts to expand into new geographic markets, products, or services;
● future goodwill impairment due to changes in our business, market conditions, or other factors;
● legislative or regulatory changes that adversely affect our business including changes in banking, securities and tax law, and regulatory policies and principles, or the interpretation of regulatory capital or other rules, including those required by BASEL III;
● the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and the implementing regulations;
● our ability to attract and retain deposits;
● our ability to control operating costs and expenses;
● the use of estimates in determining fair value of certain of our assets and liabilities, which estimates may prove to be incorrect and result in significant changes in valuation;
● difficulties in reducing risk associated with the loans and securities on our balance sheet;
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● staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our work force and potential associated charges;
● the effectiveness of our risk management framework;
● disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing functions, which could expose us to litigation or reputational harm;
● an inability to keep pace with the rate of technological advances;
● our ability to retain key members of our senior management team and our ability to attract, motivate and retain qualified personnel;
● costs and effects of litigation, including settlements and judgments;
● our ability to implement our business strategies and manage our growth;
● liquidity issues, including our ability to borrow funds or raise additional capital, if necessary;
● the loss of our large loan and deposit relationships;
● increased competitive pressures among financial services companies;
● changes in consumer spending, borrowing and savings habits;
● the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
● adverse changes in the securities markets;
● inability of key third-party providers to perform their obligations to us;
● statements with respect to our intentions regarding disclosure and other changes resulting from the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”);
● changes in accounting principles, policies or guidelines and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods, including as a result of the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act") and the Consolidated Appropriations Act, 2021 (“CAA 2021”);
● other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, including as a result of the CARES Act, CAA 2021, recent COVID-19 vaccination efforts and economic stimulus efforts, and other risks described elsewhere in this Form 10-Q and other filings with the Securities and Exchange Commission (“SEC”).
Further, statements about the potential effects of the proposed acquisition of Pacific Enterprise Bancorp (“PEB”) on our business, financial results, and condition may constitute forward-looking statements and are subject to the risk that the actual effects may differ, possibly materially, from what is reflected in the forward-looking statements due to factors and future developments which are uncertain, unpredictable and in many cases beyond our control, including, but not limited to:
● the possibility that expected revenues, cost savings, synergies and other benefits from the proposed merger might not be realized within the expected time frames or at all including but not limited to customer and employee retention, and costs or difficulties relating to integration matters, might be greater than expected including as a result of changes in general economic and market conditions, interest and exchange rates, monetary policy, laws and regulations and their enforcement, and the degree of competition in the geographic and business areas in which we and PEB operate;
● the possibility that the proposed merger does not close when expected or at all because required regulatory, shareholder or other approvals, financial tests or other conditions to closing are not received or satisfied on a timely basis or at all;
● the risk that the benefits from the proposed merger may not be fully realized or may take longer to realize than expected or be more costly to achieve;
● the failure to attract new customers and retain existing customers in the manner anticipated;
● reputational risks and the potential adverse reactions or changes to business, customer or employee relationships, including those resulting from the announcement or completion of the proposed merger;
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● Our or PEB’s businesses may experience disruptions due to transaction-related uncertainty or other factors making it more difficult to maintain relationships with employees, customers, other business partners or governmental entities;
● deposit attrition, operating costs, customer loss and business disruption following the transaction, including difficulties in maintaining relationships with employees, may be greater than expected;
● the diversion of managements' attention from ongoing business operations and opportunities as a result of the proposed merger or otherwise;
● changes in our or PEB’s stock price before closing, including as a result of its financial performance prior to closing or transaction-related uncertainty, or more generally due to broader stock market movements, and the performance of financial companies and peer group companies;
● the occurrence of any event, change or other circumstance that could give risk to the right of one or both of the parties to terminate the merger agreement;
● the outcome of pending or threatened litigation, or of matters before regulatory agencies, whether currently existing or commencing in the future, including litigation related to the merger;
● changes in interest rates which may affect our and PEB’s expected revenues, credit quality deterioration, reductions in real estate values, or reductions in our and PEB’s net income, cash flows or the market value of assets, including its investment securities;
● each of our and PEB’s potential exposure to unknown or contingent liabilities of the other party;
● dilution caused by our issuance of additional shares of BayCom Corp common stock in connection with the proposed merger;
● the possibility that the proposed merger is more expensive to complete than anticipated, including as a result of unexpected factors or events;
● future acquisitions by us of other depository institutions or lines of business; and
● that the COVID-19 pandemic, including uncertainty and volatility in financial, commodities and other markets, and disruptions to banking and other financial activity, could harm our or PEB’s business, financial position and results of operations, and could adversely affect the timing and anticipated benefits of the proposed merger.
In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur, and you should not put undue reliance on any forward-looking statements. Moreover, you should treat these statements as speaking only as of the date they are made and based only on information then actually known to us. We do not undertake and specifically disclaim any obligation to revise any forward- looking statements included in this report or the reasons why actual results could differ from those contained in such statements, whether as a result of new information or to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements. These risks could cause our actual results for 2021 and beyond to differ materially from those expressed in any forward-looking statements by, or on behalf of us and could negatively affect our consolidated financial condition and consolidated results of operations as well as our stock price performance.
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Executive Overview
General. BayCom is a bank holding company headquartered in Walnut Creek, California. BayCom’s wholly owned banking subsidiary, United Business Bank, provides a broad range of financial services to businesses and business owners as well as individuals through its network of 33 full-service branches, with 15 locations in California, two in Washington, five in Central New Mexico and 11 in Colorado. The Company’s business activities generally are limited to passive investment activities and oversight of its investment in the Bank. Accordingly, the information set forth in this report, including consolidated financial statements and related data, relate primarily to the Bank.
Our principal objective is to continue to increase shareholder value and generate consistent earnings growth by expanding our commercial banking franchise through both strategic acquisitions and organic growth. Since 2010, we have expanded our geographic footprint through nine strategic acquisitions. We believe our strategy of selectively acquiring and integrating community banks has provided us with economies of scale and improved our overall franchise efficiency. Looking forward, we expect to continue to pursue strategic acquisitions and believe our targeted market areas present us with many and varied acquisition opportunities. We are also focused on continuing to grow organically and believe the metropolitan and community markets in which we operate currently provide meaningful opportunities to expand our commercial client base and increase both interest-earning assets and market share. We believe our geographic footprint, which now includes the San Francisco Bay area, the metropolitan markets of Los Angeles, California, Seattle, Washington, and Denver, Colorado, and community markets including Albuquerque, New Mexico, and Custer, Delta, and Grand counties, Colorado, provides us with access to low cost, stable core deposits in community markets that we can use to fund commercial loan growth. We strive to provide an enhanced banking experience for our clients by providing them with a comprehensive suite of sophisticated banking products and services tailored to meet their needs, while delivering the high-quality, relationship-based client service of a community bank. At September 30, 2021, the Company had approximately $2.4 billion in total assets, $1.6 billion in total loans, $2.0 billion in total deposits and $257.3 million in shareholders’ equity.
We continue to focus on growing our commercial loan portfolios through acquisitions as well as organic growth. At September 30, 2021, our $1.6 billion total loan portfolio included $449.3 million , or 27.3%, of acquired loans (all of which were recorded to their estimated fair values at the time of acquisition), and the remaining $1.2 billion, or 72.7%, consisted of loans we originated.
The profitability of our operations depends primarily on our net interest income after provision for loan losses, which is the difference between interest earned on interest earning assets and interest paid on interest bearing liabilities less provision for loan losses. Our net income is also affected by other factors, including the provision for credit losses on loans, noninterest income and noninterest expense.
On September 7, 2021, the Company entered into a definitive agreement with Pacific Enterprise Bancorp (“PEB”), which is headquartered in Irvine, California. Pursuant to the merger agreement PEB will merge with and into the Company, with the Company as the surviving corporation in the merger. The transaction is expected to be completed in the first calendar quarter of 2022, subject to customary closing conditions, regulatory approval, and approval of the Company’s and PEB’s shareholders. For a more detailed description of the proposed merger, see “Note 3 – Acquisitions”.
Set forth below is a discussion of the primary factors affecting our results of operations:
Net interest income. Net interest income represents interest income less interest expense. We generate interest income from interest and fees received on interest earning assets, including loans and investment securities and dividends on Federal Home Loan Bank of San Francisco (“FHLB”) and Federal Reserve Bank of San Francisco (“FRB”) stock we own. We incur interest expense from interest paid on interest bearing liabilities, including interest bearing deposits and borrowings. To evaluate net interest income, we measure and monitor: (i) yields on our loans and other interest earning assets; (ii) the costs of our deposits and other funding sources; (iii) our net interest margin; and (iv) the regulatory risk weighting associated with the assets. Net interest margin is calculated as the annualized net interest income divided by average interest earning assets. Because noninterest bearing sources of funds, such as noninterest bearing deposits and shareholders’ equity, also fund interest earning assets, net interest margin includes the benefit of these noninterest bearing sources.
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Changes in market interest rates, the slope of the yield curve, and interest we earn on interest earning assets or pay on interest bearing liabilities, as well as the volume and types of interest earning assets, interest bearing and noninterest bearing liabilities and shareholders’ equity, usually have the largest impact on changes in our net interest spread, net interest margin and net interest income during a reporting period. The significant 150 basis point reduction in the targeted federal funds rate during the quarter ended March 31, 2020, resulted in a larger impact to our interest-earning assets than to our interest bearing liabilities, reducing our net interest margin. In addition, our net interest margin is adversely impacted by the low loan yields from loans originated pursuant to the U.S. Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”). Because the length of the COVID-19 pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the 150 basis point reductions in the targeted federal funds rate in 2020, until the pandemic subsides, the Company expects its net interest income and net interest margin will be adversely affected in 2021 and possibly longer.
Noninterest income. Noninterest income consists of, among other things: (i) service charges on loans and deposits; (ii) gain on sale of loans; and (iii) other noninterest income. Gain on sale of loans includes income (or losses) from the sale of the guaranteed portion of SBA loans, capitalized loan servicing rights and other related income.
Provision for loan losses. We established an allowance for loan losses by charging amounts to loan provision at a level required to reflect estimated credit losses in the loan portfolio. Management considers many factors including historical experience, types and amounts of the portfolio and adverse situations that may affect borrowers’ ability to repay, among other factors. See “Critical Accounting Policies and Estimates - Allowance for loan loss” for a description of the manner in which the provision for loan losses is established.
Noninterest expense. Noninterest expense includes, among other things: (i) salaries and related benefits; (ii) occupancy and equipment expense; (iii) data processing; (iv) Federal Deposit Insurance Corporation (“FDIC”) and state assessments; (v) outside and professional services; (vi) other general and administrative expenses, including amortization of intangible assets. Salaries and related benefits include compensation, employee benefits and employment tax expenses for our personnel. Occupancy expense includes depreciation expense on our owned properties, lease expense on our leased properties and other occupancy-related expenses. Data processing expense includes data fees paid to our third-party data processing system provider and other data service providers. FDIC and state assessments expense represents the assessments that we pay to the FDIC for deposit insurance and other regulatory costs to various states. Outside and professional fees include legal, accounting, consulting and other outsourcing arrangements. Amortization of intangibles represents the amortization of our core deposit intangible from various acquisitions. Other general and administrative expenses include expenses associated with travel, meals, training, supplies and postage. Noninterest expenses generally increase as we grow our business. Noninterest expenses have increased significantly over the past few years as we have grown through acquisitions and organically, and as we have built out our operational infrastructure.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The JOBS Act permits us an extended transition period for complying with new or revised accounting standards affecting public companies. We have elected to take advantage of this extended transition period, which means that the condensed consolidated financial statements included in this Form 10-Q report, as well as any financial statements that we file in the future, will not be subject to all new or revised accounting standards generally applicable to public companies for the transition period for so long as we remain an emerging growth company or until we affirmatively and irrevocably opt out of the extended transition period under the JOBS Act. The following represent our critical accounting policies:
Allowance for loan losses . The allowance for loan losses is evaluated on a regular basis by management. Periodically, we charge current earnings with provisions for estimated probable losses of loans receivable. The provision or adjustment takes into consideration the adequacy of the total allowance for loan losses giving due consideration to specifically identified problem loans, the financial condition of the borrowers, fair value of the underlying collateral, recourse provisions, prevailing economic conditions, and other factors. Additional consideration is given to our historical loan loss experience relative to our loan portfolio concentrations related to industry, collateral and geography. Additional analysis was also completed on the allowance for loan losses based on the significance of loan modifications in accordance
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with the CARES Act and regulatory guidance, loan risk rating downgrades as well as additional risk factors related to COVID-19. Our evaluation of the allowance for loan losses is inherently subjective and requires estimates that are susceptible to significant change as additional or new information becomes available. In addition, regulatory examiners may require additional allowances based on their judgments of the information regarding problem loans and credit risk available to them at the time of their examinations.
Generally, the allowance for loan losses consists of various components including a component for specifically identified weaknesses as a result of individual loans being impaired, a component for general non- specific weakness related to historical experience, economic conditions and other factors that indicate probable loss in the loan portfolio. Loans determined to be impaired are individually evaluated by management for specific risk of loss.
In situations where, for economic or legal reasons related to a borrower’s financial difficulties, we grant a concession to the borrower that we would not otherwise consider, the related loan is classified as a troubled debt restructuring, or TDR. We measure any loss on the TDR in accordance with the guidance concerning impaired loans set forth above. Additionally, TDRs are generally placed on nonaccrual status at the time of restructuring and included in impaired loans. These loans are returned to accrual status after the borrower demonstrates performance with the modified terms for a sustained period of time (generally six months) and has the capacity to continue to perform in accordance with the modified terms of the restructured debt.
Estimated expected cash flows related to purchased credit impaired loans . Loans purchased with evidence of credit deterioration since origination for which it is probable that all contractually required payments will not be collected are accounted for under Accounting Standards Codification (“ASC”) 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. In situations where such PCI loans have similar risk characteristics, loans may be aggregated into pools to estimate cash flows. A pool is accounted for as a single asset with a single interest rate, cumulative loss rate and cash flow expectation.
The cash flows expected over the life of the PCI loan or pool are estimated using an internal cash flow model that projects cash flows and calculates the carrying values of the pools, book yields, effective interest income and impairment, if any, based on pool level events. Assumptions as to default rates, loss severity and prepayment speeds are utilized to calculate the expected cash flows.
Expected cash flows at the acquisition date in excess of the fair value of loans are considered to be accretable yield, which is recognized as interest income over the life of the loan or pool using a level yield method if the timing and amounts of the future cash flows of the pool are reasonably estimable. Subsequent to the acquisition date, any increase in cash flow over those expected at purchase date in excess of fair value is recorded as interest income prospectively. Any subsequent decreases in cash flow over those expected at purchase date are recognized by recording an allowance for loan losses. Any disposals of loans, including sales of loans, payments in full or foreclosures result in the removal of the loan from the loan pool at the carrying amount.
Business combinations . We apply the acquisition method of accounting for business combinations. Under the acquisition method, the acquiring entity in a business combination recognizes all of the identifiable assets acquired and liabilities assumed at their acquisition date fair values. Management utilizes prevailing valuation techniques appropriate for the asset or liability being measured in determining these fair values. Any excess of the purchase price over amounts allocated to assets acquired, including identifiable intangible assets, and liabilities assumed is recorded as goodwill. Where amounts allocated to assets acquired and liabilities assumed is greater than the purchase price, a bargain purchase gain is recognized. Acquisition related costs are expensed as incurred unless they are directly attributable to the issuance of the Company’s common stock in a business combination.
Loan sales and servicing of financial assets . Periodically, we sell loans and retain the servicing rights. The gain or loss on sale of loans depends in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the retained interests based on their relative fair value at the date of transfer. All servicing assets and liabilities are initially measured at fair value. In addition, we amortize servicing rights in proportion to and over the period of the estimated net servicing income or loss and assess the rights for impairment.
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Income taxes . Deferred income taxes are computed using the asset and liability method, which recognizes a liability or asset representing the tax effects, based on current tax law, of future deductible or taxable amounts attributable to events that have been recognized in the financial statements. A valuation allowance is established to reduce the deferred tax asset to the level at which it is “more likely than not” that the tax asset or benefits will be realized. Realization of tax benefits of deductible temporary differences and operating loss carry forwards depends on having sufficient taxable income of an appropriate character within the carry forward periods.
We recognize that the tax effects from an uncertain tax position can be recognized in the financial statements only if, based on its merits, the position is more likely than not to be sustained on audit by the taxing authorities. Interest and penalties related to uncertain tax positions are recorded as part of income tax expense.
Goodwill. Goodwill, which has resulted from a number of our acquisitions, is reviewed for impairment annually, or between annual assessments if a triggering event occurs or circumstances change that would more likely than not result in the fair value of a reporting unit being below its carrying amount. We make a qualitative assessment whether it is more likely than not that the fair value of a reporting unit where goodwill is assigned is less than its carrying amount. Such indicators may include, among others: a significant adverse change in legal factors or in the general business climate; significant decline in the Company’s stock price and market capitalization; unanticipated competition; and an adverse action or assessment by a regulator. Any adverse changes in these factors could have a significant impact on the recoverability of goodwill and could have a material impact on our financial condition and results of operations.
Due to the adverse and unknown economic impacts resulting from the COVID-19 pandemic, the Company performed a goodwill impairment qualitative assessment during the third quarter of 2021 to determine if it is not more likely than not that the fair value of the Company’s reporting unit exceeded its carrying value, including goodwill. As of September 30, 2021, the Company’s qualitative assessment, which considered the Company’s continued profitability, positive equity, average community bank merger deal values realized as of September 30, 2021, net interest margin, allowance for loan loss, and the continued growth in its core deposit portfolio, concluded that the goodwill of the Company’s reporting unit, the Bank, is not more likely than not to be impaired.
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BayCom’s Response to COVID-19
Paycheck Protection Program ("PPP") Participation . During the third quarter of 2021, the Bank continued its participation in the SBA PPP which ended August 8, 2020, by processing applications for PPP loan forgiveness. As of September 30, 2021, the Bank had 764 PPP loans outstanding totaling $113.2 million, with unrecognized fees of $4.0 million. As of September 30, 2021, the Bank has received SBA forgiveness for 1,291 PPP loans totaling $121.5 million out of the $140.2 million in PPP loans funded during the first PPP. As of September 30, 2021, the Bank has received SBA forgiveness for 75 PPP loans totaling $22.2 million out of the 771 PPP loans totaling $116.7 million funded during the second PPP, which concluded on May 31, 2021.
Allowance for Loan Losses and Loan Modifications . At September 30, 2021, the Company’s allowance for loan losses was $17.3 million, or 1.05% of total loans, compared to $17.5 million, or 1.06% of total loans, at December 31, 2020.
Based on our review of the appropriateness of the allowance for loan losses at September 30, 2021, the Company recorded a provision (recovery) for loan losses of $477,000 and ($30,000) for the three and nine months ended September 30, 2021, compared to a $2.3 million and $8.4 million provision for loan losses for the three and nine months ended September 30, 2020, respectively. The provision for loan losses recorded in the third quarter of 2021 related primarily to new loan production and net change in qualitative factor adjustments. The reversal of the provision for loan for the nine months ended September 20, 2021 reflects improvements since December 31, 2020 in the economic forecast and corresponding decline in qualitative factor adjustments utilized to calculate the allowance for loan losses at September 30, 2021. The prior periods provision for loan losses was due primarily to probable loan losses reflecting the uncertain adverse impact of the COVID-19 pandemic on the economy last year.
The Company provided payment and financial relief programs for borrowers impacted by COVID-19. All loans modified due to COVID-19 were separately monitored and any request for continuation of relief beyond the initial modification was reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating was appropriate. As of September 30, 2021, no loan was subject to a COVID-19 related payment adjustment agreement compared to 43 loans totaling $66.7 million at December 31, 2020. We believe the steps we have taken over the course of the last year are necessary to effectively manage our portfolio and assist our clients through the ongoing uncertainty surrounding the duration, impact and government response to the COVID-19 pandemic.
Branch Operations and Additional Client Support . The Company remains focused on keeping its employees safe and the Bank running effectively to serve its clients. The Bank is managing branch access and occupancy levels in relation to cases and close contact scenarios, following governmental restrictions and public health authority guidelines, and encouraging remote work and supporting employees with paid time off. As of September 30, 2021, all of the Bank’s branch lobbies were open. The Company is aware of COVID-19 infections arising out of the Delta variant and is prepared to restore other protocols, as may prove to be necessary.
Comparison of Financial Condition at September 30, 2021 and December 31, 2020
Total assets. Total assets increased $168.2 million, or 7.7%, to $2.4 billion at September 30, 2021, from $2.2 billion at December 31, 2020. The increase was primarily the result of cash and cash equivalents increasing $145.1 million or 48.5%, and securities available for sale increasing $26.7 million or 23.1%. These increases in total assets were primarily funded by deposit growth.
Cash and cash equivalents. Cash and cash equivalents increased $145.1 million, or 48.5%, to $444.5 million, at September 30, 2021, from $299.3 million at December 31, 2020. The increase was primarily a result of loan repayments and an increase in total deposits, which exceeded the funds required for loan originations and used for purchases of investment securities.
Securities. Investment securities, all of which are classified as available-for-sale, increased $26.7 million, or 23.1%, to $142.3 million at September 30, 2021 from $115.6 million at December 31, 2020. The increase was primarily
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due to the purchase of $48.4 million of investment securities during the nine months ended September 30, 2021, partially offset by the routine amortization and repayment of investment principal balances and securities called and matured.
Loans receivable, net. We originate a wide variety of loans with a focus on commercial real estate (“CRE”) loans and commercial and industrial loans. Loans receivable, net of allowance for loan losses, decreased $2.3 million, or 0.1%, to $1.6 billion at September 30, 2021 from December 31, 2020. The decrease was primarily due to loan repayments totaling $453.2 million, including $120.7 million in PPP loan forgiveness, partially offset by loan originations totaling $399.7 million, including $116.7 million of new PPP loans, with the remaining change due to normal loan amortization and payoffs. The decrease in loan originations for the current period compared to the comparable period in 2020 reflected overall lower loan production due to the COVID-19 pandemic, despite the PPP loan activity.
The following table provides information about our loan portfolio by type of loan, with PCI loans presented as a separate balance, at the dates presented .
September 30,
December 31,
% Change
2021
2020
(Dollars in thousands)
Commercial and industrial (1)
$
283,327
$
309,339
(8.4)
%
Real estate:
Residential
123,175
162,203
(24.1)
Multifamily residential
215,308
238,179
(9.6)
Owner occupied CRE
384,035
404,213
(5.0)
Non-owner occupied CRE
605,939
489,752
23.7
Construction and land
16,384
22,645
(27.6)
Total real estate
1,344,841
1,316,992
2.1
Consumer
4,060
5,218
(22.2)
PCI loans
12,573
15,610
(19.5)
Total Loans
1,644,801
1,647,159
(0.1)
Net deferred loan fees
(3,965)
(3,847)
3.1
Allowance for loan losses
(17,300)
(17,500)
(1.1)
Loans, net
$
1,623,536
$
1,625,812
(0.1)
%
(1) Includes $113.2 million and $135.6 million of PPP loans as of September 30, 2021 and December 31, 2020, respectively.
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The following table shows as of September 30, 2021, the geographic distribution of our loan portfolio by type of loan in dollar amounts and percentages:
San Francisco Bay
Total in State of
Area (1)
Other California
California
All Other States (2)
Total
% of
% of
% of
% of
% of
Total in
Total in
Total in
Total in
Total in
Amount
Category
Amount
Category
Amount
Category
Amount
Category
Amount
Category
(Dollars in thousands)
September 30, 2021
Commercial and industrial
$
102,105
19.6
%
$
82,244
14.1
%
$
184,349
16.6
%
$
99,282
18.4
%
$
283,631
17.2
%
Real estate:
Residential
24,846
4.8
%
41,408
7.1
%
66,254
6.0
%
58,821
10.9
%
125,075
7.6
%
Multifamily residential
58,947
11.3
97,868
16.7
156,815
14.2
61,611
11.4
218,426
13.3
Owner occupied CRE
171,058
32.8
149,727
25.6
320,785
29.0
68,436
12.7
389,221
23.7
Non-owner occupied CRE
163,270
31.3
210,397
36.0
373,667
33.8
234,297
43.5
607,964
37.0
Construction and land
1,673
0.3
1,322
0.2
2,995
0.3
13,429
2.5
16,424
1.0
Total real estate
419,794
500,722
920,516
436,594
1,357,110
Consumer
11
0.0
%
1,711
0.3
%
1,722
0.2
%
2,338
0.4
%
4,060
0.2
%
Total loans
$
521,910
$
584,677
$
1,106,587
$
538,214
$
1,644,801
December 31, 2020
Commercial and industrial
$
110,940
20.8
%
$
89,184
15.0
%
$
200,124
17.7
%
$
109,837
21.1
%
$
309,961
18.8
%
Real estate:
Residential
$
39,174
7.4
%
$
47,381
8.0
%
$
86,555
7.7
%
$
78,169
15.0
%
$
164,724
10.0
%
Multifamily residential
62,325
11.7
118,627
20.0
180,952
16.1
60,483
11.6
241,435
14.7
Owner occupied CRE
154,953
29.1
167,840
28.3
322,793
28.7
87,017
16.7
409,810
24.9
Non-owner occupied CRE
163,986
30.8
167,102
28.2
331,088
29.4
162,227
31.1
493,315
29.9
Construction and land
1,142
0.2
3,170
0.5
4,312
0.4
18,384
3.5
22,696
1.4
Total real estate
$
421,580
$
504,120
$
925,700
$
406,280
$
1,331,980
Consumer
13
0.0
%
4
0.0
%
17
0.0
%
5,201
1.0
%
5,218
0.3
%
Total loans
$
532,533
$
593,308
$
1,125,841
$
521,318
$
1,647,159
(1) Includes Alameda, Contra Costa, Solano, Napa, Sonoma, Marin, San Francisco, San Joaquin, San Mateo and Santa Clara counties.
(2) Includes loans located primarily in the states of Colorado, New Mexico and Washington. At September 30, 2021, loans in Colorado, New Mexico and Washington totaled $135.7 million, $77.1 million and $97.2 million, respectively. At December 31, 2020, loans in Colorado, New Mexico and Washington totaled $200.0 million, $78.2 million and $116.7 million, respectively.
Nonperforming assets and nonaccrual loans. Nonperforming assets consists of nonaccrual loans, accruing loans that are 90 days or more past due and other real estate owned (“OREO”). Nonperforming assets decreased $770,000, or 8.5%, to $8.3 million at September 30, 2021 from $9.1 million at December 31, 2020, primarily due to a $408,000 decrease in OREO and a $1.1 million decrease in nonaccrual loans, partially offset by a $767,000 increase in accruing loans 90 days and more past due. The Company had nonperforming loans, consisting of nonaccrual loans and accruing loans that are 90 days or more past due, totaling $8.3 million or 0.50% of total loans, of which $841,000 were guaranteed by governmental agencies at September 30, 2021, compared to $8.7 million or 0.53% of total loans, of which $850,000 were SBA guaranteed at December 31, 2020. Included in nonperforming loans at September 30, 2021 and December 31, 2020, were $1.6 million and $567,000, respectively, of TDR loans. At September 30, 2021 and December 31, 2020, nonaccrual loans included $2.5 million and $620,000 of loans 30-89 days past due and $2.5 million and $4.1 million of loans less than 30 days past due, respectively. At September 30, 2021, the $2.5 million in nonaccrual loans 30-89 days past due primarily was comprised of two loans and the $2.5 million of loans less than 30 days past due was comprised of 13 small balance loans. At December 31, 2021, nonaccrual loans 30-89 days past due of $620,000 primarily was comprised of four loans and the $4.1 million of loans less than 30 days past due was comprised of 12 small balance loans. All of these loans were placed on nonaccrual due to concerns over the client’s financial condition.
In general, loans are placed on nonaccrual status after being contractually delinquent for more than 90 days, or earlier, if management believes full collection of future principal and interest on a timely basis is unlikely. When a loan is placed on nonaccrual status, all interest accrued but not received is charged against interest income. When the ability to fully collect nonaccrual loan principal is in doubt, cash payments received are applied against the principal balance of the loan until such time as full collection of the remaining recorded balance is expected. Generally, loans with temporarily impaired values and loans to borrowers experiencing financial difficulties are placed on nonaccrual status even though the
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borrowers continue to repay the loans as scheduled. Such loans are categorized as performing nonaccrual loans and are reflected in nonperforming assets. Interest received on such loans is recognized as interest income when received. A nonaccrual loan is restored to an accrual basis when principal and interest payments are paid current, and full payment of principal and interest is probable. Loans that are well secured and in the process of collection will remain on accrual status .
Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date, without a carryover of the related allowance for loan and lease losses. These acquired loans are segregated into three types: pass rated loans with no discount attributable to credit quality, non-impaired loans with a discount attributable at least in part to credit quality, and impaired loans with evidence of significant credit deterioration .
● Pass rated loans (typically performing loans) are accounted for in accordance with ASC Topic 310-20 “Nonrefundable Fees and Other Costs” as these loans do not have evidence of credit deterioration since origination.
● Non-impaired loans (typically performing substandard loans) are accounted for in accordance with ASC Topic 310-30 if they display at least some level of credit deterioration since origination.
● Impaired loans (typically substandard loans on nonaccrual status) are accounted for in accordance with ASC Topic 310-30 as they display significant credit deterioration since origination.
For pass rated loans (non-purchased credit-impaired loans), the difference between the estimated fair value of the loans and the principal outstanding is accreted over the remaining life of the loans.
In accordance with ASC Topic 310-30, for both purchased non-impaired loans (performing substandard loans) and purchased credit-impaired loans, the loans are pooled by loan type and the difference between contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable difference. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan pools when there is a reasonable expectation about the amount and timing of such cash flows .
Troubled debt restructured loans. Troubled debt restructured loans, or TDR loans, which are accounted for under ASC Topic 310-40, are loans which have renegotiated loan terms to assist borrowers who are unable to meet the original terms of their loans. Such modifications to loan terms may include a below market interest rate, a reduction in principal, or a longer term to maturity . TDR loans as of September 30, 2021 totaled $1.6 million, of which $765,000 were accruing and performing according to their restructuring terms. TDR loans as of December 31, 2020 totaled $1.4 million, of which $798,000 were accruing and performing according to their restructuring terms. The accruing TDR loans are not considered nonperforming assets as they continue to accrue interest despite being considered impaired due to the restructured status. There were related allowance for loan losses on the TDR loans of $130,000 and $35,000 at September 30, 2021 and December 31, 2020, respectively.
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The following table sets forth the nonperforming loans, nonperforming assets and troubled debt restructured loans as of the dates indicated:
September 30,
December 31,
2021
2020
(Dollars in thousands)
Loans accounted for on a nonaccrual basis:
Commercial and industrial
$
693
$
848
Real estate:
Residential
1,688
2,195
Multifamily residential
217
254
Owner occupied CRE
4,236
4,651
Non-owner occupied CRE
422
437
Construction and land
36
36
Total real estate
6,599
7,573
Consumer
—
—
Total nonaccrual loans
7,292
8,421
Accruing loans 90 days or more past due
1,000
233
Total nonperforming loans
8,292
8,654
Real estate owned
21
429
Total nonperforming assets (1)
$
8,313
$
9,083
Troubled debt restructurings – performing
765
798
PCI loans
$
12,573
$
15,610
Nonperforming assets to total assets (1)
0.35
%
0.41
%
Nonperforming loans to total loans (1)
0.50
%
0.53
%
(1) PCI and performing TDR loans are neither included in nonperforming loans above nor are they included in the numerators used to calculate this ratio.
Loans under ASC Topic 310-30 are considered performing and are not included in nonperforming assets in the table above. At September 30, 2021 and December 31, 2020, we had no credit impaired loans under ASC Topic 310-30 that were 90 days past due and still accruing.
Interest foregone on nonaccrual loans was approximately $61,000 and $157,500 for the three and nine months ended September 30, 2021 compared to $117,500 and $338,500 for the three and nine months ended September 30, 2020, respectively, none of which was included in interest income.
Potential problem loans. Potential problem loans are those loans that are currently accruing interest and are not considered impaired, but which we are monitoring because the financial information of the borrower causes us concern as to their ability to comply with their loan repayment terms. We define potential problem loans as loans classified as “Substandard”, “Doubtful” or “Loss” that are not included in the amounts of nonaccrual or restructured loans. During the ordinary course of business, management may become aware of borrowers that may not be able to meet the contractual requirements of their loan agreements. Such loans are placed under closer supervision with consideration given to placing the loan on nonaccrual status, the need for an additional allowance for loan losses, and (if appropriate) partial or full charge-off. At September 30, 2021, there are $13.7 million of potential problem loans, compared to $12.7 million at December 31, 2020. Also, see Note 5 — Loans in the Notes to the Condensed Consolidated Financial Statements included in “Item 1 - Financial Statements” within this report .
Allowance for loan losses. The allowance for loan losses is maintained to cover losses that are estimated in accordance with GAAP. It is our estimate of loan losses inherent in our loan portfolio at each balance sheet date. Our methodology for analyzing the allowance for loan losses consists of general and specific components. For the general component, we stratify the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and apply a loss ratio to these groups of loans to estimate the credit losses in the loan portfolio. We use both historical loss ratios and qualitative loss factors assigned to major loan collateral types to establish general component loss allocations. Qualitative loss factors are based on management’s judgment of company, market, industry or business
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specific data and external economic indicators, which may not yet be reflected in the historical loss ratios, and that could impact our specific loan portfolios. Management and the Board of Directors sets and adjusts qualitative loss factors by regularly reviewing changes in underlying loan composition and the seasonality of specific portfolios. Management and the Board of Directors also considers credit quality and trends relating to delinquency, nonperforming and classified loans within our loan portfolio when evaluating qualitative loss factors. Additionally, management and the Board of Directors adjusts qualitative factors to account for the potential impact of external economic factors, including the unemployment rate, vacancy, capitalization rates, commodity prices and other pertinent economic data specific to our primary market area and lending portfolios.
For the specific component, the allowance for loan losses is established for impaired loans. Management evaluates current information and events regarding a borrower’s ability to repay its obligations and considers a loan to be impaired when the ultimate collectability of amounts due, according to the contractual terms of the loan agreement, is in doubt. If an impaired loan is collateral-dependent, the fair value of the collateral, less the estimated cost to sell, is used to determine the amount of impairment. If an impaired loan is not collateral-dependent, the impairment amount is determined using the negative difference, if any, between the estimated discounted cash flows and the loan amount due. For impaired loans, the amount of the impairment can be adjusted, based on current data, until such time as the actual basis is established by acquisition of the collateral or until the basis is collected. Impairment losses are reflected in the allowance for loan losses through a charge to the provision for credit losses. Subsequent recoveries are credited to the allowance for loan losses. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are applied first to principal.
In accordance with acquisition accounting, loans acquired in our acquisitions were recorded at their estimated fair value, which resulted in a net discount to the loans contractual amounts, of which a portion reflects a discount for possible credit losses. Credit discounts are included in the determination of fair value and as a result no allowance for loan losses is recorded for acquired loans at the acquisition date. Although the discount recorded on the acquired loans is not reflected in the allowance for loan losses, or related allowance coverage ratios, we believe it should be considered when comparing the current ratios to similar ratios in periods prior to the acquisition. As of September 30, 2021, acquired loans, net of their discounts, totaled $55.2 million compared to $164.0 million at December 31, 2020, with the decrease due to the migration of acquired loans out of the discounted acquired loan portfolio. The remaining net discount on these acquired loans was $2.2 million and $3.3 million at September 30, 2021 and December 31, 2020, respectively. The $113.2 million balance of PPP loans was omitted from the calculation for the allowance for loan losses at September 30, 2021 as these loans are fully guaranteed by the SBA and management expects that the great majority of PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which in turn will reimburse the Bank for the amount forgiven .
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The following table presents an analysis of changes in the allowance for loan losses as of the dates indicated:
September 30,
December 31,
2021
2020
(Dollars in thousands)
Balance at beginning of period
$
17,500
$
7,400
Provisions for (reversal of) loan losses
(30)
10,320
Recoveries
Commercial and industrial
9
13
Residential
—
—
Owner occupied CRE
—
—
Non-owner occupied CRE
—
4
Construction
4
—
Consumer
—
—
Total recoveries
13
17
Charge-offs
Commercial and industrial
(182)
(199)
Residential
—
(1)
Owner occupied CRE
(1)
—
Non-owner occupied CRE
—
—
Construction
—
(20)
Consumer
—
(17)
Total charge-offs
(183)
(237)
Net charge-offs
(170)
(220)
Balance at end of period
$
17,300
$
17,500
Allowance for loan losses as a percentage of total loans
1.05
%
1.06
%
Allowance for loan losses to total loans excluding PCI loans (1)
1.06
1.07
Allowance for loan losses excluding acquired loans (loans not covered by the allowance) (1)
1.09
1.18
Allowance for loan losses excluding acquired loans and PPP loans (loans not covered by the allowance) (1)
1.17
1.30
Allowance for loan losses as a percentage of total nonperforming loans
237.25
202.22
Net recoveries/(charge-offs) as a percentage of average loans outstanding for the period
(4.01)
%
(0.01)
%
(1) See non-GAAP financial measures herein.
The allowance for loan losses decreased to $17.3 million at September 30, 2021 from $17.5 million at December 31, 2020. The decrease in the allowance for loan losses at September 30, 2021 was primarily due to the continued improvement since December 31, 2020 in the national and local economy associated with the recovery from the COVID-19 pandemic, which reduced the loss rates utilized to calculate the allowance for loan losses at September 30, 2021 as compared to the uncertain economic outlook and loss rates utilized at December 31, 2020, partially offset by net charge offs of $170,000. Our PPP loans were omitted from the calculation of the required allowance for loan losses at September 30, 2021 and December 31, 2020 as these loans are fully guaranteed by the SBA and management expects that a majority of SBA PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA, which in turn, the SBA will reimburse the Bank for the amount forgiven. Included in the carrying value of loans are net discounts on acquired loans which may reduce the need for an allowance for loan losses on these loans because they are carried at their estimated fair value on the date on which they were acquired.
As of September 30, 2021, the Company identified $8.1 million in impaired loans, inclusive of $7.3 million of nonperforming loans and $805,000 of accruing TDR loans. Of these impaired loans, only $1.0 million had a specific allowance of $701,000 as of September 30, 2021. As of December 31, 2020, the Company identified $9.2 million in impaired loans, inclusive of $8.4 million of nonperforming loans and $798,000 of accruing TDR loans. Of these impaired loans, only $1.3 million had a specific allowance of $521,000 as of December 31, 2020.
Management considers the allowance for loan losses at September 30, 2021 to be adequate to cover losses inherent in the loan portfolio based on the assessment of the above-mentioned factors affecting the loan portfolio. While management believes the estimates and assumptions used in its determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future losses will not exceed the amount of the established allowance for loan losses or that any increased allowance for loan losses that may be required will not adversely impact our financial condition and results of
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operations. Uncertainties relating to our allowance for loan losses are heightened as a result of the risks surrounding the COVID-19 pandemic, including whether government programs will provide adequate relief to borrowers. The ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic. A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations. Recently we have seen most of our market areas reporting a fairly significant increase in COVID transmissions, which we understand from our public health authorities is largely attributed to lagging vaccination rates and an increase in cases related to the Delta variant. To date, we are not seeing renewed business activity restrictions in our primary markets. To the extent business activity restrictions are renewed, due to COVID-19 or otherwise, this will likely affect our business operations which may, in turn, require us to increase our allowance through our provision for loan losses which would adversely affect our financial performance. In addition, the determination of the amount of our allowance for loan losses is subject to review by bank regulators, as part of the routine examination process, which may result in additions to our provision for loan losses based upon their judgment of information available to them at the time of their examination.
Deposits. Deposits are our primary source of funding and consist of core deposits from the communities served by our branch and office locations. We offer a variety of deposit accounts with a competitive range of interest rates and terms to both consumers and businesses. Deposits include interest bearing and noninterest bearing demand accounts, savings, money market, certificates of deposit and individual retirement accounts. These accounts earn interest at rates established by management based on competitive market factors, management’s desire to increase certain product types or maturities, and in keeping with our asset/liability, liquidity and profitability objectives. Competitive products, competitive pricing and high touch client service are important to attracting and retaining these deposits.
Total deposits increased $169.4 million, or 9.2%, to $2.0 billion at September 30, 2021 from $1.8 billion at December 31, 2020. The increase in deposits was primarily driven by organic growth in client relationships, proceeds from PPP loans and government stimulus checks deposited directly into customer accounts, and reduced withdrawals from deposit accounts due to a change in spending habits as a result of COVID-19. At September 30, 2021, noninterest bearing demand deposits totaled $733.1 million or 36.5% of total deposits, compared to $678.4 million or 36.9% of total deposits at December 31, 2020.
The following table sets forth the dollar amount of deposits in the various types of deposit programs offer at the dates indicated.
September 30,
December 31,
2021
2020
% Change
(Dollars in thousands)
Noninterest bearing demand deposits
$
733,101
$
678,365
8.1
%
NOW accounts and savings
448,717
399,772
12.2
Money market
604,970
516,560
17.1
Time deposits
220,963
243,700
(9.3)
Total
$
2,007,751
$
1,838,397
9.2
%
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Borrowings. Although deposits are our primary source of funds, we may from time to time utilize borrowings as a cost effective source of funds when they can be invested at a positive interest rate spread, for additional capacity to fund loan demand, or to meet our asset/liability management goals. We are a member of and may obtain advances from the FHLB of San Francisco, which is part of the Federal Home Loan Bank System. The eleven regional Federal Home Loan Banks provide a central credit facility for their member institutions. These advances are provided upon the security of certain of our mortgage loans and mortgage-backed securities. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features. In May 2020, the Bank secured a $10.0 million advance from the FHLB of San Francisco, comprised of two $5.0 million tranches, at no cost, maturing in November 2020 and May 2021. As of September 30, 2021, the two tranches were repaid and the Bank had no borrowings outstanding from the FHLB of San Francisco. At September 30, 2021 and December 31, 2020, we had the ability to borrow up to $434.9 million and $421.2 million, respectively, from the FHLB of San Francisco.
At September 30, 2021, the Company had outstanding junior subordinated deferrable interest debentures, net mark-to-market adjustments, totaling $8.4 million which were assumed in connection with our previous acquisitions. The Company issued $65.0 million of subordinated debt during the third quarter of 2020. At September 30, 2021, the Company had outstanding subordinated debt, net of cost to issue, totaling $63.5 million.
If needed, we may also utilize Fed Funds purchased from correspondent banks as a source of short-term funding. At September 30, 2021 and December 31, 2020, we had a total of $75.0 million in federal funds line available from third-party financial institutions and no balances outstanding at these dates.
We are required to provide collateral for certain local agency deposits. As of September 30, 2021 and December 31, 2020, the FHLB of San Francisco had issued a letters of credit on behalf of the Bank totaling $41.5 million and $30.1 million, respectively as collateral for local agency deposits.
Shareholders’ equity. Shareholders’ equity increased $4.7 million, to $257.3 million at September 30, 2021 from $252.6 million at December 31, 2020. The increase in shareholders’ equity was primarily due to net income of $15.3 million partially offset by the repurchase of $11.5 million of our common stock. During the nine months ended September 30, 2021, the Company repurchased a total of 643,609 shares of its common stock at a total cost of $11.5 million, or $17.80 per share, leaving 657 shares available for future purchases under the current stock repurchase plan. For additional information see Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds”.
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Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2021 and 2020
Earnings summary. Net income was $5.4 million for the three months ended September 30, 2021, compared to $3.2 million for the three months ended September 30, 2020, an increase of $2.2 million or 66.6%. The increase was the result of a $1.8 million decrease in provision for loan losses, a $2.2 million increase in noninterest income and a $276,000 decrease in noninterest expenses, partially offset by a $1.3 million decrease in net interest income, and an $845,000 increase in the provision for income taxes. Diluted earnings per share were $0.51 for the three months ended September 30, 2021, an increase of $0.24 from diluted earnings per share of $0.27 for the three months ended September 30, 2020.
Net income was $15.3 million for the nine months ended September 30, 2021, compared to $9.2 million for the nine months ended September 30, 2020, an increase of $6.1 million or 66.0%. The increase was the result of $8.4 million decrease in the provision for loan losses, a $3.0 million increase in noninterest income and a $3.2 million decrease in noninterest expense, partially offset by a $6.4 million decrease in net interest income and a $2.2 million increase in provision for income taxes. There were no acquisition-related expenses during the nine months ended September 30, 2021, compared to $3.0 million during the nine months ended September 30, 2020. Diluted earnings per share were $1.39 for the nine months ended September 30, 2021, an increase of $0.63 from diluted earnings per share of $0.76 for the nine months ended September 30, 2020.
Our efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income before provision for loan losses and noninterest income, was 63.82% and 66.40% for the three and nine months ended September 30, 2021, compared to 67.95% and 67.90% for the three and nine months ended September 30, 2020. The improvement in the efficiency ratio during the three months ended September 30, 2021 compared to the same period in 2020 was due to higher revenues coupled with lower noninterest expense during the current quarter compared to the comparable quarter in 2020. The improvement in the efficiency ratio during the nine months ended September 30, 2021 was primarily due higher revenues and reduced noninterest expense due to the absence of acquisition-related expenses.
Interest income. Interest income for the three months ended September 30, 2021 was $20.0 million, compared to $21.2 million for the three months ended September 30, 2020, a decrease of $1.2 million or 5.94%. The decrease in interest income was due to the low interest rate environment and a decrease in average loans outstanding, which more than offset the $122.6 million, or 5.85%, increase in average interest earning assets resulting from higher average balance of lower yielding cash and cash equivalents.
Interest income on loans, including fees, decreased $1.7 million, or 8.37%, to $18.5 million during the three months ended September 30, 2021, compared to $20.1 million for the three months ended September 30, 2020 primarily due to a $93.7 million decrease in average loan balance and a 14 basis point decline in the average loan yield. The average yield on loans for the three months ended September 30, 2021 was 4.50%, compared to 4.64% for the same period in 2020. Interest income on loans for the quarters ended September 30, 2021 and 2020 included $338,000 and $824,000, respectively, in accretion of purchase accounting fair value adjustments on acquired loans. The remaining net discount on these acquired loans was $2.2 million and $4.1 million at September 30, 2021 and 2020, respectively. Interest income for the three months ended September 30, 2021 included $1.1 million in fees earned related to PPP loans compared to $594,000 during the same period in 2020. As of September 30, 2021, total unrecognized fees on PPP loans were $4.0 million. For the three months ended September 30, 2021, average PPP loans were $127.5 million and the average yield, including fees, was 4.52%. The impact of PPP loans on loan yields will change during any period based on the volume of prepayments or amounts forgiven by the SBA as certain criteria are met, but will cease completely after the maturity of the loans. Approximately two-thirds of the PPP loans are set to mature by the end of 2022, while the remaining loans have a five-year maturity date.
Interest income on interest bearing deposits in banks increased $44,000 as a result of a $193.6 million increase in the average balance of interest bearing deposits in banks, partially offset by a seven basis point decrease in the average yield on interest bearing deposits to 0.18% for the three months ended September 30, 2021 compared to 0.25% for the three months ended September 30, 2020.
Interest income on investment securities available-for-sale increased by $356,000 as a result of a 63 basis point increase in the average yield to 3.15% for the three months ended September 30, 2021 compared to 2.52% for the three
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months ended September 30, 2020, and a $22.1 million increase in the average balance of investment securities available-for-sale.
Interest income for the nine months ended September 30, 2021 was $60.2 million, compared to $66.5 million for the nine months ended September 30, 2020, a decrease $6.3 million or 9.5%. The decrease in interest income primarily was due to a 68 basis point decline in the average yield on interest earning assets and a $41.6 million or 2.5% decline in the average loan balance.
Interest income on loans, including fees, decreased $6.2 million, or 9.86%, primarily as a result of a 36 basis point decrease in the average loan yield to 4.67% for the nine months ended September 30,2021 compared to 5.03% for the nine months ended September 30, 2020 and, to a lesser extent, the $41.6 million decrease in the average loan balance. The average yield on loans for the accretion of the net discount on acquired loans decreased the average yield on loans by 19 basis points during the nine months ended September 30, 2021 and 2020. During the nine months ended September 30, 2021 compared to this same period in 2020, the accretion of the net discount on acquired loans increased the yield on loans by eight basis points and 36 basis points, respectively. Interest income on loans for the nine months ended September 30, 2021 included $1.4 million in accretion of purchase accounting fair value adjustments on acquired loans, compared to $4.4 million for the nine months ended September 30, 2020. The remaining net discount on these purchased loans was $2.2 million and $4.1 million at September 30, 2021 and 2020, respectively. Interest income for the nine months ended September 30, 2021 also included $3.4 million in fees earned related to PPP loans compared to $1.1 million during the same period in 2020. For the nine months ended September 30, 2021, average PPP loans were $117.8 million and the average yield, including fees, was 4.90%.
Interest income on interest bearing deposits in banks decreased $679,000 as a result a 52 basis point decrease in the average yield to 0.16% for the nine months ended September 30, 2021 compared to 0.68% for the nine months ended September 30, 2020, partially offset by a $184.1 million increase in the average balance of interest bearing deposits in banks.
Interest income on investment securities available for sale increased $472,000 as a result of a 46 basis point increase in the average yield on investment securities to 3.01% for the nine months ended September 30, 2021 compared to 2.55% for the nine months ended September 30, 2020, and a $3.6 million increase in the average balance of investment securities available-for-sale.
Interest expense. Interest expense remained relatively unchanged at $2.2 million for both the three months ended September 30, 2021 and 2020, as a decrease in interest expense on deposits was offset by an increase in interest expense on subordinated debt. Total average interest bearing liabilities increased $89.4 million, or 7.1%, to $1.3 billion for the three months ended September 30, 2021, compared to $1.3 billion for the three months ended September 30, 2020. The average rate paid on interest bearing liabilities decreased by four basis points to 0.66% for the three months ended September 30, 2021, from 0.70% for the three months ended September 30, 2020.
Interest expense on deposits decreased $322,000, or 20.61%, to $1.2 million for the three months ended September 30, 2021 compared to $1.6 million for the three months ended September 30, 2020, primarily due to decreases in the targeted federal funds rate, earlier in 2020, partially offset by a $71.1 million increase in the average balance of deposits. The average rate paid on interest bearing deposits decreased by 13 basis points to 0.39% for the three months ended September 30, 2021, from 0.52% for the three months ended September 30, 2020. The overall average cost of deposits for the three months ended September 30, 2021 declined to 0.25%, compared to 0.32% for the three months ended September 30, 2020, due to an increase in noninterest bearing deposits and a reduction in market interest rates over the last year. The average balance of noninterest bearing deposits increased $25.0 million, or 3.39%, to $763.1 million for the three months ended September 30, 2021 compared to $738.1 million for the same period in 2020. The market’s response to lowering deposit pricing to reflect the targeted federal funds rate decreases over the past year typically lags declines in the yield on interest earning assets.
Interest expense on borrowings increased $325,000 or 49.7%, to $981,000 for the three months ended September 30, 2021, from $656,000 for the three months ended September 30, 2020, as a result of the issuance of subordinated debt in August 2020, which currently has a 5.25% interest rate. The average balance of borrowings outstanding increased $18.3 million to $71.8 million during the three months ended September 30, 2021, compared to
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$53.5 million during the three months ended September 30, 2020. The average cost of borrowing increased to 5.42% for the three months ended September 30, 2021, compared to 4.86% for the three months ended September 30, 2020.
Interest expense increased by $89,000, or 1.4%, to $6.6 million for the nine months ended September 30, 2021 compared to $6.5 million for the nine months ended September 30, 2020 as a result of the costs from the issuance of subordinated debt in August 2020 exceeding decreased deposit costs from the decline in the average rate paid on interest bearing deposits. The average cost of interest bearing liabilities decreased four basis points to 0.68% for the nine months ended September 30, 2021 compared to 0.72% for the nine months ended September 30, 2020. Total average interest bearing liabilities increased $98.2 million, or 8.16%, to $1.3 million for the nine months ended September 30, 2021 from $1.2 million for the nine months ended September 30, 2020.
Interest expense on deposits decreased $1.9 million, or 34.0%, to $3.7 million during the nine months ended September 30, 2021 from $5.6 million the same period in 2020, primarily as a result of a decline in the average rate paid on interest bearing deposits and a $51.9 decrease in the average balance of higher interest bearing time deposits. The average rate paid on interest bearing deposits decreased by 23 basis points to 0.40% for the nine months ended September 30, 2021 compared to 0.63% for the nine months ended September 30, 2020.
The overall average cost of deposits for the nine months ended September 30, 2021 declined to 0.25%, compared to 0.32% for the nine months ended September 30, 2020 due to an increase in noninterest bearing deposits and a reduction in market interest rates over the last year. The average balance of noninterest bearing deposits increased $59.9 million, or 9.1%, to $721.0 million for the nine months ended September 30, 2021 compared to $661.1 million for the nine months ended September 30, 2020.
Interest expense on borrowings increased $2.0 million, or 198.8%, to $2.9 million for the nine months ended September 30, 2021, from $968,000 for the nine months ended September 30, 2020, as a result of a higher average balance of borrowings outstanding due to the issuance of the subordinated debt in August 2020. The average balance of borrowing outstanding increased $49.1 million to $74.1 million during the nine months ended September 30, 2021, compared to $25.0 million during the nine months ended September 30, 2020. The average cost of borrowing increased to 5.32% for the nine months ended September 30, 2021, compared to 5.17% for the nine months ended September 30, 2020.
Net interest income and net interest margin. Net interest income decreased $1.3 million, or 6.7%, to $17.7 million for the three months ended September 30, 2021, compared to $19.0 million for the three months ended September 30, 2020, and decreased $6.4 million to $53.6 million for the nine months ended September 30, 2021, compared to $60.0 million for the nine months ended September 30, 2020. The decrease in net interest income during the three months ended September 30, 2021 compared to the same period in 2020 was primarily due to the decline in the average loan balance between periods, while the decrease during the nine months ended September 30, 2021 compared to the same period in 2020 was primarily due to the decline in the average yield on interest earning assets.
The average yield on interest earning assets for the three months ended September 30, 2021 was 3.57%, a 44 basis point decrease from 4.01% for the three months ended September 30, 2020, due primarily to lower market interest rates, while the average cost of interest bearing liabilities for the three months ended September 30, 2021 decreased to 0.66%, or four basis points from 0.70% for the three months ended September 30, 2020. The average yield on interest earning assets for the nine months ended September 30, 2021 was 3.72%, a 68 basis point decrease from 4.40% for the nine months ended September 30, 2020, while the average cost of interest bearing liabilities for the nine months ended September 30, 2021 decreased to 0.68%, or four basis points from 0.72% for the nine months ended September 30, 2020, due primarily to lower market interest rates, partially offset by the cost of the subordinated debt.
The net interest margin for the three and nine months ended September 30, 2021 was 3.17% and 3.51%, respectively, compared to 3.59% and 3.96% for the three and nine months ended September 30, 2020. During the three and nine months ended September 30, 2021, the interest margin was impacted by lower yielding loans, including PPP loans and resetting adjustable rate instruments as well as reduced interest rates on new fixed-rate real estate loan and adjustable-rate commercial loan originations and the increase in low yielding overnight cash balances causing a decrease in the average yield on interest-earning assets that outweighed the contribution to net interest margin from the decrease in the average cost of interest-bearing liabilities. The decrease in net interest margin was offset partially by an increase in deferred SBA PPP loan fees recognized due to the volume of forgiven SBA PPP loans during the three and nine months
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ended September 30, 2021, which benefited net interest margin compared to a reduction in net interest margin from the Company’s origination of low yielding PPP loans during the same periods in 2020. PPP loans are originated at an interest rate of 1%, although the effective yield is higher as a result of the origination fees paid to us by the SBA. The average yield on PPP loans was 4.52% and 4.90%, including the recognition of deferred fees, resulting in a positive impact to the net interest margin of 20 basis points and 21 basis points during the three and nine months ended September 30, 2021, compared to a positive impact of 11 basis points and eight basis points during the comparable periods in 2020, respectively. The impact of PPP loans on net interest margin will change during any period based on the volume of prepayments or amounts forgiven by the SBA as certain criteria are net, but will cease completely after the maturity of the loans. Accretion of acquisition accounting discounts on loans and the recognition of revenue from acquired loans in excess of discounts decreased our net interest margin by 12 and 19 basis points during the three and nine months ended September 30, 2021 and 19 and 51 basis points during the three and nine months ended September 30 2020, respectively.
Average Balances, Interest and Average Yields/Cost. The following table presents, for the periods indicated, information about (i) average balances, the total dollar amount of interest income from interest earning assets and the resultant average yields; (ii) average balances, the total dollar amount of interest expense on interest bearing liabilities and the resultant average yields; (iii) net interest income; (iv) the interest rate spread; and (v) the net interest margin. Yields have been calculated on a pre-tax basis. The loan yields include the effect of amortization or accretion of deferred loan fees/costs and purchase accounting premiums/discounts to interest and fees on loans.
Three months ended September 30,
2021
2020
Annualized
Annualized
Average
Average
Average
Average
Balance(1)
Interest
Yield
Balance(1)
Interest
Yield
(Dollars in thousands)
Interest earning assets
Interest bearing deposits in banks
$
441,440
$
198
0.18
%
$
247,861
$
154
0.25
%
Investments securities available-for-sale
135,721
1,077
3.15
113,657
721
2.52
FHLB Stock
8,385
125
5.93
7,612
95
4.94
FRB Stock
7,634
112
5.84
7,741
117
6.00
Total loans
1,626,946
18,451
4.50
1,720,631
20,136
4.64
Total interest earning assets
2,220,126
19,963
3.57
%
2,097,502
21,223
4.01
%
Noninterest earning assets
142,666
150,820
Total average assets
$
2,362,792
$
2,248,322
Interest bearing liabilities
Savings
$
121,928
$
41
0.13
%
$
114,461
$
41
0.14
%
NOW accounts
329,518
75
0.09
278,587
66
0.09
Money market
592,229
601
0.40
546,475
637
0.46
Time deposits
227,731
523
0.91
260,785
818
1.24
Total deposit accounts
1,271,406
1,240
0.39
1,200,308
1,562
0.52
Subordinated debt, net
63,473
895
5.59
35,865
416
4.60
Junior subordinated debentures, net
8,371
86
4.06
8,290
184
8.82
Other borrowings
—
—
—
9,348
56
2.37
Total interest bearing liabilities
1,343,250
2,221
0.66
%
1,253,811
2,218
0.70
%
Noninterest bearing liabilities
763,140
738,143
Total average liabilities
2,106,390
1,991,954
Average equity
256,402
256,368
Total average liabilities and equity
$
2,362,792
$
2,248,322
Net interest income
$
17,742
$
19,005
Interest rate spread (2)
2.91
%
3.31
%
Net interest margin (3)
3.17
%
3.59
%
Ratio of average interest earning assets to average interest bearing liabilities
165.28
%
167.29
%
(1) Average balances are computed using average daily balances.
(2) Interest rate spread is calculated as the average rate earned on interest earning assets minus the average rate paid on interest bearing liabilities.
(3) Net interest margin is calculated as net interest income divided by total average interest earning assets.
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Nine months ended September 30,
2021
2020
Annualized
Annualized
Average
Average
Average
Average
Balance (1)
Interest
Yield
Balance(1)
Interest
Yield
(Dollars in thousands)
Interest earning assets
Interest bearing deposits in banks
$
411,811
$
479
0.16
%
$
227,706
$
1,158
0.68
%
Investments securities available-for-sale
120,734
2,714
3.01
117,090
2,242
2.55
FHLB Stock
8,136
346
5.69
7,395
274
4.94
FRB Stock
7,624
341
5.98
7,526
339
6.00
Total loans
1,614,608
56,348
4.67
1,656,232
62,511
5.03
Total interest earning assets
2,162,913
60,228
3.72
%
2,015,949
66,524
4.40
%
Noninterest earning assets
141,084
150,380
Total average assets
$
2,303,997
$
2,166,329
Interest bearing liabilities
Savings
$
118,326
$
123
0.14
%
$
105,575
$
126
0.16
%
NOW accounts
313,775
211
0.09
265,372
186
0.09
Money market
562,263
1,660
0.39
522,390
2,101
0.54
Time deposits
233,208
1,680
0.96
285,153
3,151
1.47
Total deposit accounts
1,227,572
3,674
0.40
1,178,490
5,564
0.63
Subordinated debt, net
63,431
2,686
5.66
12,042
510
5.64
Junior subordinated debentures, net
8,351
261
4.17
8,270
308
4.97
Other borrowings
2,308
—
—
4,652
150
4.29
Total interest bearing liabilities
1,301,662
6,621
0.68
%
1,203,454
6,532
0.72
%
Noninterest bearing liabilities
747,289
707,293
Total average liabilities
2,048,951
1,910,747
Average equity
255,046
255,582
Total average liabilities and equity
$
2,303,997
$
2,166,329
Net interest income
$
53,607
$
59,992
Interest rate spread (2)
3.04
%
3.68
%
Net interest margin (3)
3.31
%
3.96
%
Ratio of average interest earning assets to average interest bearing liabilities
166.17
%
167.51
%
(1) Average balances are computed using average daily balances.
(2) Interest rate spread is calculated as the average rate earned on interest earning assets minus the average rate paid on interest bearing liabilities.
(3) Net interest margin is calculated as net interest income divided by total average interest earning assets.
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Rate/Volume Analysis. Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest earning assets and interest bearing liabilities, as well as changes in weighted average interest rates. The following table sets forth the effects of changing rates and volumes on our net interest income during the periods shown. Information is provided with respect to (i) effects on interest income attributable to changes in volume (changes in volume multiplied by prior rate) and (ii) effects on interest income attributable to changes in rate (changes in rate multiplied by prior volume). Changes applicable to both volume and rate have been allocated to volume. Yields have been calculated on a pre-tax basis.
Three months ended September 30,
Nine months ended September 30,
2021 compared to 2020
2021 compared to 2020
Increase/(Decrease)
Increase/(Decrease)
Attributable to
Attributable to
Rate
Volume
Total
Rate
Volume
Total
(Dollars in thousands)
(Dollars in thousands)
Interest earning assets
Interest bearing deposits in banks
$
(76)
$
120
$
44
$
(1,766)
$
1,087
$
(679)
Investments available-for-sale
216
140
356
115
357
472
FHLB stock and FRB stock
16
9
25
29
45
74
Total loans
(370)
(1,315)
(1,685)
(4,636)
(1,527)
(6,163)
Total interest income
(214)
(1,046)
(1,260)
(6,258)
(38)
(6,296)
Interest bearing liabilities
Savings
(3)
3
—
(23)
20
(3)
NOW accounts
(3)
12
9
(20)
45
25
Money market accounts
(89)
53
(36)
(722)
281
(441)
Time deposits
(191)
(104)
(295)
(836)
(635)
(1,471)
Total deposit accounts
(286)
(36)
(322)
(1,601)
(289)
(1,890)
Subordinated debt, net
—
479
479
—
2,176
2,176
Junior subordinated debentures, net
(100)
2
(98)
(51)
4
(47)
Other borrowings
—
(56)
(56)
—
(150)
(150)
Total interest expense
(386)
389
3
(1,652)
1,741
89
Net interest income
$
172
$
(1,435)
$
(1,263)
$
(4,606)
$
(1,779)
$
(6,385)
Provision for loan losses. We recorded $477,000 provision for loan losses and $30,000 reversal of the provision for loan losses for the three and nine months ended September 30, 2021, compared to a provision for loan losses of $2.3 million and $8.4 million for the three and nine months ended September 30, 2020 respectively. The provision for loan losses recorded in the third quarter of 2021 related primarily to new loan production. The reversal of the provision for loan losses for the nine months ended September 30, 2021 was primarily due to an adjustment to the qualitative factors utilized to calculate the allowance for loan losses resulting from improvements in the economic forecast since December 31, 2020. We had net charge-offs on loans of $177,000 and $170,000 for the three and nine months ended September 30, 2021 , compared to $7,000 of net charge-offs and recoveries on loans of $4,000 for the three and nine months ended September 30, 2020 , respectively . The allowance for loan losses to total loans was 1.05% at September 30, 2021, compared to 0.93% at September 30, 2020.
Noninterest income. Noninterest income for the three months ended September 30, 2021 increased $2.2 million, or 119.2%, to $4.0 million compared to $1.8 million for the three months ended September 30, 2020. The increase in noninterest income for the current quarter compared to the same period in 2020 was primarily due to a $2.0 million increase in gain on sale of loans and a $338,000 increase in income from our investment in the SBIC fund, partially offset by a $150,000 decrease in loan servicing fees and other fees. During the three months ended September 30, 2021, the Company sold $20.3 million of SBA loans (guaranteed portion), resulting in a gain on sale of $2.2 million, compared to the sale of $3.3 million of SBA loans (guaranteed portion) resulting in a gain on sale of $176,000 during the three months ended September 30, 2020.
Noninterest income increased $3.0 million, or 52.4%, to $8.7 million for the nine months ended September 30, 2021 compared to $5.7 million for the nine months ended September 30, 2020 primarily due to a $2.7 million increase in gain on sale of loans and a $798,000 increase in income in our investment in the SBIC fund. During the nine months ended September 30, 2021 , the Company sold $36.0 million of SBA loans (guaranteed portion), resulting
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in a gain on sale of $3.8 million, compared to the sale of $15.0 million of SBA loans (guaranteed portion) resulting in a gain of $1.0 million during the nine months ended September 30, 2020 . These increase were partially offset by a decrease in loan servicing and other loan fees of $426,000, or 23.0%, to $1.4 million for the nine months ended September 30, 2021 , compared to $1.8 million for the nine months ended September 30, 2020 , as a result of lower transaction volume.
The following table presents the key components of noninterest income for the periods indicated:
Three months ended September 30,
2021
2020
$ Change
% Change
(Dollars in thousands)
Gain on sale of loans
$
2,176
$
176
$
2,000
1,136.4
%
Service charges and other fees
611
648
(37)
(5.7)
Loan servicing and other loan fees
458
608
(150)
(24.7)
Income on investment in SBIC fund
526
188
338
(179.8)
Gain (loss) on sale of premises
—
(25)
25
100.0
Gain (loss) on sale of OREO
(21)
—
(21)
(100.0)
Other income and fees
257
233
24
10.3
Total noninterest income
$
4,007
$
1,828
$
2,179
119.2
%
Nine months ended September 30,
2021
2020
$ Change
% Change
(Dollars in thousands)
Gain on sale of loans
$
3,705
$
1,030
$
2,675
259.7
%
Service charges and other fees
1,819
1,963
(144)
(7.3)
Loan servicing and other loan fees
1,423
1,849
(426)
(23.0)
Gain (loss) on sale of premises
12
(25)
37
148.0
Income on investment in SBIC fund
1,021
223
798
357.8
Gain on sale of OREO
15
28
(13)
(46.4)
Other income and fees
704
640
64
10.0
Total noninterest income
$
8,699
$
5,708
$
2,991
52.4
%
Noninterest expense. Noninterest expense decreased $276,000, or 1.9%, to $13.9 million for the three months ended September 30, 2021 compared to $14.2 million for the three months ended September 30, 2020. The decrease was primarily due to a $319,000, or 3.8% decrease in salaries and employee benefits expense as a result of overall lower staff combined with a $160,000 or 9.7% decrease in data processing expense due to decreased customer transactions , partially offset by a $196,000, or 11.2% increase in occupancy and equipment expense primarily as a result of normal increases in rent.
Noninterest expense for the nine months ended September 30, 2021 decreased $3.2 million, or 7.3%, to $41.4 million from $44.6 million in the same period in 2020. This decrease primarily was due to decreases in data processing expenses of $2.5 million and other expenses of $747,000 for the nine months ended September 30, 2021 , compared to the same period in 2020. The higher data processing and other expenses during the nine months ended September 30, 2020, were primarily related to our acquisition of Grand Mountain Bancshares in February 2020, compared to no acquisition-related expenses incurred during the nine months ended September 30, 2021. Salaries and benefits decreased $284,000, or 11.0% during the nine months ended September 30, 2021 compared to the same period in 2020, primarily due to a decrease in staffing levels. Partially offsetting these decreases was a $276,000 or 11.2% increase in occupancy and equipment expense primarily as a result of normal increases in rent.
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The following table details the components of noninterest expense for the periods indicated:
Three months ended September 30,
2021
2020
$ Change
% Change
(Dollars in thousands)
Salaries and related benefits
$
8,163
$
8,482
$
(319)
(3.8)
%
Occupancy and equipment
1,945
1,749
196
11.2
Data processing
1,482
1,642
(160)
(9.7)
Other
2,290
2,283
7
0.3
Total noninterest expense
$
13,880
$
14,156
$
(276)
(1.9)
%
Nine months ended September 30,
2021
2020
$ Change
% Change
(Dollars in thousands)
Salaries and related benefits
$
25,158
$
25,442
$
(284)
(1.1)
%
Occupancy and equipment
5,610
5,334
276
5.2
Data processing
4,235
6,716
(2,481)
(36.9)
Other
6,371
7,118
(747)
(10.5)
Total noninterest expense
$
41,374
$
44,610
$
(3,236)
(7.3)
%
Income taxes. The provision for income taxes increased $845,000, or 74.4%, to $2.0 million for the three months ended September 30, 2021 compared to $1.1 million for the three months ended September 30, 2020. For the nine months ended September 30, 2021, the provision for income taxes increased $2.2 million, or 63.1%, to $5.7 million, compared to $3.5 million for the nine months ended September 30, 2020. The Company’s effective tax rate was 26.8% and 27.2% for three and nine months ended September 30, 2021 compared to 25.9% and 27.6% for the three and nine months ended September 30, 2020. The increases in the provision for income taxes for the periods primarily was due to increased taxable income.
Liquidity and Capital Resources
Planning for our normal business liquidity needs, both expected and unexpected, is done on a daily and short-term basis through the cash management function. On a longer-term basis, it is accomplished through the budget and strategic planning functions, with support from internal asset/liability management software model projections.
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit run off that may occur in the normal course of business. We rely on a number of different sources in order to meet our potential liquidity demands. Our primary sources of funds are deposits, escrow and custodial deposits, principal and interest payments on loans and proceeds from sale of loans. While maturities and scheduled amortization of loans are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, economic conditions, and competition. Our most liquid assets are cash, short-term investments, including interest bearing demand deposits and investment securities available-for-sale. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period. At September 30, 2021, the Company had $448.5 million in cash and cash equivalents, and interest bearing deposits in banks, and $142.3 million in investment securities. The Company classifies its investment securities portfolio as available for sale, providing an additional source of liquidity. Management believes that our security portfolio is of high quality and the securities would therefore be marketable.
In addition to these primary sources of funds, management has several secondary sources available to meet potential funding requirements. At September 30, 2021, the Bank had an available borrowing capacity of $434.9 million with the FHLB of San Francisco, and Federal Funds lines with available commitments totaling $75.0 million with four correspondent banks. There were no amounts outstanding under these facilities at September 30, 2021 and December 31, 2020.
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We use our sources of funds primarily to meet our ongoing commitments, pay maturing deposits and fund withdrawals, and to fund loan commitments. Loan commitments and letters of credit totaled $96.3 million at September 30, 2021, and certificates of deposits scheduled to mature in one year or less at September 30, 2021, totaled $181.0 million. It is management's policy to manage deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that most of our maturing certificates of deposit will remain with us.
Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities for the nine months ended September 30, 2021 was $5.4, compared to $6.2 million for the nine months ended September 30, 2020. During the nine months ended September 30, 2021, net cash used in investing activities was $13.2 million, which consisted primarily of net change in loans receivable, compared to $132.0 million of cash used in investing activities for the nine months ended September 30, 2020. Net cash provided by financing activities for the nine months ended September 30, 2021 was $152.9 million, which was comprised primarily of net change in deposits, compared to $150.3 million during the nine months ended September 30, 2020.
The Company is a separate legal entity from the Bank and must provide for its own liquidity. At September 30, 2021, the Company, on an unconsolidated basis, had liquid assets of $35.2 million. In addition to its operating expenses, the Company is responsible for paying any dividends declared, if any, to its shareholders, funds paid for Company stock repurchases, and payments on trust-preferred securities and subordinated notes held at the Company level. The Company has the ability to receive dividends or capital distributions from the Bank, although there are regulatory restrictions on the ability of the Bank to pay dividends.
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with GAAP, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage clients’ requests for funding and take the form of loan commitments, lines of credit and standby letters of credit. For additional information about our loan commitments, unused lines of credit and standby letters of credit, see Note 18 - Commitment and Contingencies in the Notes to the Condensed Consolidated Financial Statements included in “Item 1 - Financial Statements” within this report. We have not engaged in any other off-balance sheet transactions in the normal course of our lending activities.
Regulatory Capital
The Company is a bank holding company subject to capital adequacy requirements of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve, except that, pursuant to the Economic Growth, Regulatory Relief and Consumer Protection Act, effective August 30, 2018, a bank holding company with consolidated assets of less than $3 billion is generally not subject to the Federal Reserve’s capital regulations.
Under the capital regulations, the minimum capital ratios are: (1) a common equity Tier 1 capital ratio (“CET1 capital”) of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6.0% of risk-weighted assets (“Tier 1 capital”); (3) a total risk-based capital ratio of 8.0% of risk-weighted assets; and (4) a leverage ratio (the ratio of Tier 1 capital to average total consolidated assets) of 4.0%. CET1 capital generally consists of common stock, retained earnings, accumulated other comprehensive income (“AOCI”) unless an institution elects to exclude AOCI from regulatory capital, and certain minority interests (all of which are subject to applicable regulatory adjustments and deductions). Tier 1 capital generally consists of CET1 capital and noncumulative perpetual preferred stock. Tier 2 capital generally consists of other preferred stock and subordinated debt which meet certain conditions, plus an amount of the allowance for loan and lease losses up to 1.25% of assets. Total capital is the sum of Tier 1 and Tier 2 capital.
The Bank is subject to various regulatory capital requirements administered by the Federal Reserve. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines of the regulatory framework for prompt corrective action, the Bank must meet specific capital adequacy guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also
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subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital to total average assets (as defined), and minimum ratios of Tier 1 capital (as defined) and CET1 capital to risk-weighted assets (as defined).
Management reviews capital ratios on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet our anticipated future needs. As of September 30, 2021, the most recent regulatory notifications from the Federal Reserve categorized 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 would have changed the category.
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The following is a summary of actual capital amounts and ratios as of the dates indicated, for the Company (assuming it was subject to regulatory capital requirements) and the Bank compared to the requirements for minimum capital adequacy and classification as Well Capitalized:
At September 30, 2021
At December 31, 2020
Amount
Ratio
Amount
Ratio
(Dollars in thousands)
Leverage Ratio
BayCom Corp
$
207,678
9.39
%
$
201,519
9.58
%
Minimum requirement for "Well Capitalized"
110,577
5.00
%
105,225
5.00
%
Minimum regulatory requirement
88,461
4.00
%
84,180
4.00
%
United Business Bank
243,806
10.63
%
224,169
10.18
%
Minimum requirement for "Well Capitalized"
114,732
5.00
%
110,136
5.00
%
Minimum regulatory requirement
91,785
4.00
%
88,109
4.00
%
Common Equity Tier 1 Ratio
BayCom Corp
207,678
12.51
%
201,519
12.78
%
Minimum requirement for "Well Capitalized"
107,901
6.50
%
102,472
6.50
%
Minimum regulatory requirement
74,701
4.50
%
70,942
4.50
%
United Business Bank
243,806
14.83
%
224,169
14.22
%
Minimum requirement for "Well Capitalized"
106,856
6.50
%
102,440
6.50
%
Minimum regulatory requirement
73,977
4.50
%
70,920
4.50
%
Tier 1 Risk-Based Capital Ratio
BayCom Corp
217,163
13.08
%
211,004
13.38
%
Minimum requirement for "Well Capitalized"
132,801
8.00
%
126,120
8.00
%
Minimum regulatory requirement
99,601
6.00
%
94,590
6.00
%
United Business Bank
243,806
14.83
%
224,169
14.22
%
Minimum requirement for "Well Capitalized"
131,515
8.00
%
126,080
8.00
%
Minimum regulatory requirement
98,636
6.00
%
94,560
6.00
%
Total Risk-Based Capital Ratio
BayCom Corp
299,878
18.06
%
293,919
18.64
%
Minimum requirement for "Well Capitalized"
166,002
10.00
%
157,650
10.00
%
Minimum regulatory requirement
132,801
8.00
%
126,120
8.00
%
United Business Bank
261,521
15.91
%
242,084
15.36
%
Minimum requirement for "Well Capitalized"
164,394
10.00
%
157,600
10.00
%
Minimum regulatory requirement
131,515
8.00
%
126,080
8.00
%
In addition to the minimum CET1 capital, Tier 1 capital, leverage ratio and total capital ratios, the Bank must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum risk-based capital levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. At September 30, 2021, the Bank’s CET1 capital exceeded the required capital conservation buffer.
Non-GAAP financial measures
This report contains certain financial information by methods other than GAAP. These measures include allowance for loan losses as a percentage of total loans, excluding PCI loans, acquired loans and PPP loans. Management uses these non-GAAP financial measures, together with the related GAAP measures, in its analysis of the Company’s
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performance and in making business decisions. Management believes that presenting allowance for loan losses as a percentage of total loans excluding PCI, acquired loans and PPP loans is useful in assessing the credit quality of the Company’s core portfolio. These non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Further, these non-GAAP financial measures should not be considered in isolation or as a substitute for the comparable financial measures determined in accordance with GAAP and may not be comparable to a similarly titled measure reported by other companies.
Reconciliation of the GAAP and non-GAAP financial measures are presented as of the dates indicated:
September 30,
December 31,
Allowance for loan losses excluding acquired loans and PPP loans
2021
2020
(Dollars in thousands)
Allowance for loan losses (GAAP)
$
(17,300)
$
(17,500)
Total loans (GAAP)
1,644,801
1,647,159
Exclude PCI loans
12,573
15,610
Adjusted total loans excluding PCI loans (non-GAAP)
$
1,632,228
$
1,631,549
Total loans (GAAP)
$
1,644,801
$
1,647,159
Exclude acquired loans
55,357
164,029
Adjusted total loans excluding acquired loans (non-GAAP)
$
1,589,444
$
1,483,130
Exclude PPP loans
113,223
135,635
Adjusted total loans excluding acquired loans and PPP loans (non-GAAP)
$
1,476,221
$
1,347,495
Allowance for loan losses as a percentage of total loans (GAAP)
1.05
%
1.06
%
Allowance for loan losses to total loans excluding PCI loans (non-GAAP)
1.06
1.07
Allowance for loan losses excluding acquired loans (loans not covered by the allowance) (non-GAAP)
1.09
1.18
Allowance for loan losses excluding acquired loans and PPP loans (loans not covered by the allowance) (non-GAAP)
1.17
1.30
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.