Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain matters discussed in this report contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and the Company intends that these forward-looking statements be covered by the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of forward-looking words or phrases such as “anticipate,” “believe,” “could,” “expect,” “estimates”, “intend,” “may,” “preliminary,” “planned,” “potential,” “should,” “will,” “would,” or the negative of those terms or other words of similar meaning. Similarly, statements that describe the Company’s future plans, objectives or goals are also forward-looking statements. Such forward-looking statements are inherently subject to many uncertainties in the Company’s operations and business environment.
Factors that could affect actual results or outcomes include the matters described under the caption “Risk Factors” in Item 1A of our annual report on Form 10-K for the year ended December 31, 2020, filed with the SEC on March 8, 2021 (“2020 10-K”), the matters described in “Risk Factors” in Item 1A of our Form 10Q for the quarters ended March 31, 2021 and June 30, 2021, and in Item 1A of this Form 10-Q, and the following:
• conditions in the financial markets and economic conditions generally;
• adverse impacts to the Company or Bank arising from the COVID-19 pandemic;
• the possibility of a deterioration in the residential real estate markets;
• interest rate risk;
• lending risk;
• the impact of changing long-term interest rates on the fair market value of the Company’s mortgage servicing rights (MSR );
• the sufficiency of loan allowances;
• changes in the fair value or ratings downgrades of our securities;
• competitive pressures among depository and other financial institutions;
• our ability to maintain our reputation;
• our ability to realize the benefits of net deferred tax assets;
• our ability to maintain or increase our market share;
• acts of terrorism and political or military actions by the United States or other governments;
• legislative or regulatory changes or actions, or significant litigation, adversely affecting the Company or Bank;
• increases in FDIC insurance premiums or special assessments by the FDIC;
• disintermediation risk;
• our inability to obtain needed liquidity;
• our ability to successfully execute our acquisition growth strategy;
• risks posed by acquisitions and other expansion opportunities, including difficulties and delays in integrating the acquired business operations or fully realizing the cost savings and other benefits;
• our ability to raise capital needed to fund growth or meet regulatory requirements;
• the possibility that our internal controls and procedures could fail or be circumvented;
• our ability to attract and retain key personnel;
• our ability to keep pace with technological change;
• cybersecurity risks;
• changes in federal or state tax laws;
• changes in accounting principles, policies or guidelines and their impact on financial performance;
• restrictions on our ability to pay dividends; and
• the potential volatility of our stock price.
Stockholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this filing and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances occurring after the date of this report.
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GENERAL
The following discussion sets forth management’s discussion and analysis of our consolidated financial condition as of September 30, 2021, and our consolidated results of operations for the three and nine months ended September 30, 2021, compared to the same period in the prior fiscal year for the three and nine months ended September 30, 2020. This discussion should be read in conjunction with the interim consolidated financial statements and the condensed notes thereto included with this report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the financial statements and notes related thereto included in our 2020 10-K. Unless otherwise stated, all monetary amounts in this Management’s Discussion and Analysis of Financial Condition and Results of Operations, other than share, per share and capital ratio amounts, are stated in thousands.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events and apply judgments that affect the reported amount of assets, liabilities, revenue, expenses, and their related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that our management believes to be relevant at the time our consolidated financial statements are prepared. Some of these estimates are more critical than others. In addition to the policies included in Note 1, “Nature of Business and Summary of Significant Accounting Policies,” to the Consolidated Financial Statements included as an exhibit in our annual report on our 2020 10-K, our critical accounting estimates are as follows:
Allowance for Loan Losses.
We maintain an allowance for loan losses to absorb probable and inherent losses in our loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated probable incurred losses in our loan portfolio. In evaluating the level of the allowance for loan loss, we consider the types of loans and the amount of loans in our loan portfolio, historical loss experience, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, prevailing economic conditions and other relevant factors determined by management. We follow all applicable regulatory guidance, including the “Interagency Policy Statement on the Allowance for Loan and Lease Losses,” issued by the Federal Financial Institutions Examination Council (FFIEC). We believe that the Bank’s Allowance for Loan Losses Policy conforms to all applicable regulatory requirements. However, based on periodic examinations by regulators, the amount of the allowance for loan losses recorded during a particular period may be adjusted.
Our determination of the allowance for loan losses is based on (1) specific allowances for specifically identified and evaluated impaired loans and their corresponding estimated loss based on likelihood of default, payment history, and net realizable value of underlying collateral. Specific allocations for collateral dependent loans are based on fair value of the underlying collateral relative to the unpaid principal balance of individually impaired loans. For loans that are not collateral dependent, the specific allocation is based on the present value of expected future cash flows discounted at the loan’s original effective interest rate through the repayment period; and (2) a general allowance on loans not specifically identified in (1) above, based on historical loss ratios, which are adjusted for qualitative and general economic factors. We continue to refine our allowance for loan losses methodology, with an increased emphasis on historical performance adjusted for applicable economic and qualitative factors.
Assessing the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans, any of which estimates may be susceptible to significant change. In our opinion, the allowance, when taken as a whole, reflects estimated probable loan losses in our loan portfolio.
Goodwill.
We account for goodwill and other intangible assets in accordance with ASC Topic 350, “Intangibles - Goodwill and Other.” The Company records the excess of the cost of acquired entities over the fair value of identifiable tangible and intangible assets acquired, less liabilities assumed, as goodwill. The Company amortizes acquired intangible assets with definite useful economic lives over their useful economic lives utilizing the straight-line method. On a periodic basis, management assesses whether events or changes in circumstances indicate that the carrying amounts of the intangible assets may be impaired. The Company does not amortize goodwill, but reviews goodwill for impairment at a reporting unit level on an annual basis, or when events or changes in circumstances indicate that the carrying amounts may be impaired. A reporting unit is
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defined as any distinct, separately identifiable component of the Company’s one operating segment for which complete, discrete financial information is available and reviewed regularly by the segment’s management. The Company has one reporting unit as of September 30, 2021, which is related to its banking activities. The Company performed the required goodwill impairment test and determined that goodwill was not impaired as of December 31, 2020.
Fair Value Measurements and Valuation Methodologies.
We apply various valuation methodologies to assets and liabilities which often involve a significant degree of judgment, particularly when liquid markets do not exist for the particular items being valued. Quoted market prices are referred to when estimating fair values for certain assets, such as most investment securities. However, for those items for which an observable liquid market does not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include loans, deposits, borrowings, goodwill, core deposit intangible assets, other assets and liabilities obtained or assumed in business combinations, and certain other financial instruments. These valuations require the use of various assumptions, including, among others, discount rates, rates of return on assets, repayment rates, cash flows, default rates, and liquidation values. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Company’s results of operations, financial condition or disclosures of fair value information.
In addition to valuation, the Company must assess whether there are any declines in value below the carrying value of assets that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statement of operations. Examples include but are not limited to; loans, investment securities, goodwill, core deposit intangible assets and deferred tax assets, among others. Specific assumptions, estimates and judgments utilized by management are discussed in detail herein in management’s discussion and analysis of financial condition and results of operations and in notes 1, 2, 3, 4 and 10 of Condensed Notes to Consolidated Financial Statements.
Income Taxes.
Amounts provided for income tax expenses are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities, which arise principally from temporary differences between the amounts reported in the financial statements and the tax basis of certain assets and liabilities, are included in the amounts provided for income taxes. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and tax planning strategies which will create taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and if necessary, tax planning strategies in making this assessment.
The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and application of specific provisions of federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be material to our consolidated results of our operations and reported earnings. We believe that the deferred tax assets and liabilities are adequate and properly recorded in the accompanying consolidated financial statements. As of September 30, 2021, management does not believe a valuation allowance related to the realizability of its deferred tax assets is necessary.
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STATEMENT OF OPERATIONS ANALYSIS
Net Interest Income. Net interest income represents the difference between the dollar amount of interest earned on interest-bearing assets and the dollar amount of interest paid on interest-bearing liabilities. The interest income and expense of financial institutions (including those of the Bank) are significantly affected by general economic conditions, competition, policies of regulatory authorities and other factors.
Interest rate spread and net interest margin are used to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on interest earning assets and the rate paid for interest-bearing liabilities that fund those assets. Net interest margin is expressed as the percentage of net interest income to average interest earning assets. Net interest margin currently exceeds interest rate spread because non-interest-bearing sources of funds (“net free funds”), principally demand deposits and stockholders’ equity, also support interest earning assets. The narrative below discusses net interest income, interest rate spread, and net interest margin for the three and nine-month periods ended September 30, 2021, and September 30, 2020, respectively.
Net interest income was $13.7 million for the three months ended September 30, 2021, and $39.3 million for the nine months ended September 30, 2021, compared to $11.9 million for the three months ended September 30, 2020 and $36.9 million for the nine months ended September 30, 2020. For the three and nine months ended September 30, 2021, net interest income benefited from: 1) the accretion of $1.9 million and $4.9 million, respectively, of deferred fees related to the SBA Paycheck Protection Program (“SBA PPP”) loans, compared to $0.6 and $1.1 million for the three and nine months ended September 30, 2020, respectively; 2) lower liability costs; and 3) organic loan growth from September 30, 2020. Net interest income for the three and nine months ended September 30, 2021 was negatively impacted by: 1) lower accretion associated with reductions in purchased credit impaired loans; 2) the impact of Federal Reserve actions to offset the impact of the pandemic in March 2020, during which it lowered overnight interest rates by 125 basis points in 6 days; and 3) market reactions to decreasing longer-term interest rates on loans, investments, and cash and cash equivalent security yields.
The net interest margin for the three-month period ended September 30, 2021, was 3.34%, compared to 3.11% for the three-month period ended September 30, 2020. The net interest margin increased due to: 1) a 29 basis point increase in SBA PPP deferred loan fee accretion and 2) 37 basis points of lower deposit costs in the three months ended September 30, 2021, compared to the three months ended September 2020. These increases were partially offset by decreases in net interest margin largely due to: 1) the impact of higher cash and cash equivalent balances, which decreased the interest margin percentage by 10 basis points; 2) 1 basis point of lower accretion associated with reductions in purchased credit impaired loans; and 3) market reactions to decreasing longer-term interest rates and the related impact on yields on loans, investments and cash and cash equivalent security yields.
The net interest margin for the nine-month period ended September 30, 2021, was 3.29%, compared to 3.36% for the nine-month period ended September 30, 2020. The decrease in net interest margin was largely due to: 1) 12 basis points of lower accretion associated with reductions in purchased credit impaired loans; 2) the impact of higher cash and cash equivalent balances, which decreased the interest margin percentage by 15 basis points; 3) the impact of Federal Reserve actions to offset the impact of the pandemic in March 2020, during which it lowered overnight interest rates by 125 basis points in 6 days; and 4) market reactions to lower yields on new originations of loans, purchases of investments and reduced yields on cash and cash equivalents. These decreases were partially offset by lower deposit rates due to management action to reduce interest rates on deposits and a 34 basis point increase in loans due to higher SBA PPP deferred loan fee accretion.
Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following net interest income analysis table presents interest income from average interest earning assets, expressed in dollars and yields, and interest expense on average interest-bearing liabilities, expressed in dollars and rates on a tax equivalent basis. Shown below is the weighted average tax equivalent yield on interest earning assets, rates paid on interest-bearing liabilities and the resultant spread at or during the three- and nine-month periods ended September 30, 2021, and September 30, 2020. Non-accruing loans have been included in the table as loans carrying a zero yield.
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NET INTEREST INCOME ANALYSIS ON A TAX EQUIVALENT BASIS
(Dollar amounts in thousands)
Three months ended September 30, 2021 compared to the three months ended September 30, 2020:
Three months ended September 30, 2021 Three months ended September 30, 2020
Average
Balance Interest
Income/
Expense Average
Yield/
Rate (1) Average
Balance Interest
Income/
Expense Average
Yield/
Rate (1)
Average interest earning assets:
Cash and cash equivalents $ 111,192 $ 50 0.18 % $ 77,774 $ 18 0.09 %
Loans 1,192,636 14,537 4.84 % 1,258,224 14,154 4.48 %
Interest-bearing deposits 1,512 8 2.10 % 3,752 23 2.44 %
Investment securities (1) 303,325 1,412 1.85 % 166,622 846 2.02 %
Other investments 14,961 168 4.46 % 15,145 177 4.65 %
Total interest earning assets (1) $ 1,623,626 $ 16,175 3.95 % $ 1,521,517 $ 15,218 3.98 %
Average interest-bearing liabilities:
Savings accounts $ 216,304 $ 95 0.17 % $ 183,381 $ 98 0.21 %
Demand deposits 392,080 280 0.28 % 285,993 231 0.32 %
Money market 276,582 193 0.28 % 255,160 280 0.44 %
CD’s 207,494 682 1.30 % 297,691 1,469 1.96 %
IRA’s 39,525 104 1.04 % 41,852 177 1.68 %
Total deposits $ 1,131,985 $ 1,354 0.47 % $ 1,064,077 $ 2,255 0.84 %
FHLB Advances and other borrowings 169,891 1,133 2.65 % 173,758 1,054 2.41 %
Total interest-bearing liabilities $ 1,301,876 $ 2,487 0.76 % $ 1,237,835 $ 3,309 1.06 %
Net interest income $ 13,688 $ 11,909
Interest rate spread 3.19 % 2.92 %
Net interest margin (1) 3.34 % 3.11 %
Average interest earning assets to average interest-bearing liabilities 1.25 1.23
(1) Fully taxable equivalent (FTE). The average yield on tax exempt securities is computed on a tax equivalent basis using a tax rate of 21.0% for the quarters ended September 30, 2021 and September 30, 2020. The FTE adjustment to net interest income included in the rate calculations totaled $1 and $0 thousand for the three months ended September 30, 2021 and September 30, 2020, respectively.
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NET INTEREST INCOME ANALYSIS ON A TAX EQUIVALENT BASIS
(Dollar amounts in thousands)
Nine months ended September 30, 2021 compared to the nine months ended September 30, 2020:
Nine months ended September 30, 2021 Nine months ended September 30, 2020
Average
Balance Interest
Income/
Expense Average
Yield/
Rate (1) Average
Balance Interest
Income/
Expense Average
Yield/
Rate (1)
Average interest earning assets:
Cash and cash equivalents $ 118,064 $ 107 0.12 % $ 42,946 $ 141 0.44 %
Loans 1,197,469 43,014 4.80 % 1,232,678 44,300 4.80 %
Interest-bearing deposits 2,227 37 2.22 % 3,967 73 2.46 %
Investment securities (1) 263,655 3,606 1.83 % 173,595 2,965 2.28 %
Other investments 15,006 510 4.54 % 15,104 533 4.71 %
Total interest earning assets (1) $ 1,596,421 $ 47,274 3.96 % $ 1,468,290 $ 48,012 4.37 %
Average interest bearing liabilities:
Savings accounts $ 211,320 $ 277 0.18 % $ 169,754 $ 348 0.27 %
Demand deposits 361,248 788 0.29 % 262,748 865 0.44 %
Money market 263,195 577 0.29 % 244,965 1,240 0.68 %
CD’s 237,706 2,592 1.46 % 326,776 5,021 2.05 %
IRA’s 40,119 355 1.18 % 42,221 568 1.80 %
Total deposits $ 1,113,588 $ 4,589 0.55 % $ 1,046,464 $ 8,042 1.03 %
FHLB Advances and other borrowings 173,889 3,400 2.61 % 185,256 3087 2.23 %
Total interest bearing liabilities $ 1,287,477 $ 7,989 0.83 % $ 1,231,720 $ 11,129 1.21 %
Net interest income $ 39,285 $ 36,883
Interest rate spread 3.13 % 3.16 %
Net interest margin (1) 3.29 % 3.36 %
Average interest earning assets to average interest bearing liabilities 1.24 1.19
(1) Fully taxable equivalent (FTE). The average yield on tax exempt securities is computed on a tax equivalent basis using a tax rate of 21.0% for the nine months ended September 30, 2021 and September 30, 2020. The FTE adjustment to net interest income included in the rate calculations totaled $3 and $1 thousand for the nine months ended September 30, 2021 and September 30, 2020, respectively.
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Rate/Volume Analysis. The following table presents the dollar amount of changes in interest income and interest expense for the components of interest earning assets and interest-bearing liabilities that are presented in the preceding table. For each category of interest earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) changes in volume, which are changes in the average outstanding balances multiplied by the prior period rate (i.e., holding the initial rate constant); and (2) changes in rate, which are changes in average interest rates multiplied by the prior period volume (i.e., holding the initial balance constant). Rate changes have been discussed previously. For the three and nine months ended September 30, 2021, compared to the same periods in 2020, the loan volume decrease is primarily due to reductions in SBA PPP loans, partially offset by the impact of organic loan growth. Investment securities volume increases are due to an increase in portfolio balances, largely due to purchases of mortgage-backed securities. The decrease in certificate volumes is due to planned runoff of brokered CDs and to a lesser extent, retail CDs, partially offset by growth in non-maturity deposits.
RATE / VOLUME ANALYSIS
(Dollar amounts in thousands)
Three months ended September 30, 2021 compared to the three months ended September 30, 2020.
Increase (decrease) due to
Volume Rate Net
Interest income:
Cash and cash equivalents $ 10 $ 22 $ 32
Loans (764) 1,147 383
Interest-bearing deposits (12) (3) (15)
Investment securities 646 (80) 566
Other investments (2) (7) (9)
Total interest earning assets (122) 1,079 957
Interest expense:
Savings accounts 16 (19) (3)
Demand deposits 79 (30) 49
Money market accounts 22 (109) (87)
CD’s (362) (425) (787)
IRA’s (9) (64) (73)
Total deposits (254) (647) (901)
FHLB Advances and other borrowings (24) 103 79
Total interest bearing liabilities (278) (544) (822)
Net interest income $ 156 $ 1,623 $ 1,779
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Nine months ended September 30, 2021 compared to the nine months ended September 30, 2020.
Increase (decrease) due to
Volume Rate Net
Interest income:
Cash and cash equivalents $ 163 $ (197) $ (34)
Loans (1,265) (21) (1,286)
Interest-bearing deposits (29) (7) (36)
Investment securities 1,344 (703) 641
Other investments (3) (20) (23)
Total interest earning assets 210 (948) (738)
Interest expense:
Savings accounts 74 (145) (71)
Demand deposits 275 (352) (77)
Money market accounts 87 (750) (663)
CD’s (1,144) (1,285) (2,429)
IRA’s (27) (186) (213)
Total deposits (735) (2,718) (3,453)
FHLB Advances and other borrowings (198) 511 313
Total interest bearing liabilities (933) (2,207) (3,140)
Net interest income $ 1,143 $ 1,259 $ 2,402
Provision for Loan Losses. We determine our provision for loan losses (“provision”) based on our desire to provide an adequate allowance for loan losses (“ALL”) to reflect probable and inherent credit losses in our loan portfolio. We continue to monitor adverse general economic conditions that could affect our commercial and agricultural portfolios in the future.
Total provision for loan losses for both the three and nine months ended September 30, 2021, was $0. The ALL and related need for provision for loan losses for both the three and nine months ended September 30, 2021, was positively impacted by reductions in both the second and third quarter in the allocation of the allowance for loan losses for general economic conditions and the impact of lower loan deferral balances associated with Section 4013 of the Cares Act, which offset increases. These positive impacts were offset by the allocation of the allowance for loan losses due to loan growth, increases in specific reserve and modest net loan charge offs. Note that in discussing ALL allocations, the entire ALL balance is available for any loan that, in management’s judgment, should be charged off. The provision for loans losses for the three and nine months ended September 30, 2020, of $1.50 million and $5.25 million, respectively, was due to loan growth, the impact of net charge-offs and increase in Q-Factors due to uncertain market conditions. Pandemic-related adverse economic impacts, including various “Stay-at-Home Orders”, were beginning to result in temporary business closures, reduced operating capacity and uncertainty regarding potential future revenue and cash flows for certain businesses, including bank borrowers.
Management believes that the provision recorded for the current year three and nine-month periods is adequate in view of the present condition of our loan portfolio and the sufficiency of collateral supporting our non-performing loans. We continually monitor non-performing loan relationships and will adjust our provision, as necessary, if changing facts and circumstances require a change in the ALL. In addition, a decline in the quality of our loan portfolio as a result of general economic conditions, factors affecting particular borrowers or our market areas, or otherwise, could all affect the adequacy of our ALL. If there are significant charge-offs against the ALL, or we otherwise determine that the ALL is inadequate, we will need to record an additional provision in the future.
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Non-interest Income . The following table reflects the various components of non-interest income for the three and nine month periods ended September 30, 2021 and 2020, respectively.
Three months ended September 30, Nine months ended September 30,
2021 2020 % Change 2021 2020 % Change
Non-interest Income:
Service charges on deposit accounts $ 463 $ 431 7.42 % $ 1,256 $ 1,336 (5.99) %
Interchange income 600 556 7.91 % 1,776 1,509 17.69 %
Loan servicing income 842 1,144 (26.40) % 2,560 3,144 (18.58) %
Gain on sale of loans 1,014 1,987 (48.97) % 4,131 4,585 (9.90) %
Loan fees and service charges 118 320 (63.13) % 547 1,041 (47.45) %
Insurance commission income — — N/M — 474 N/M
Net gains (losses) on investment securities 73 (1) N/M 344 97 254.64 %
Net gain on sale of acquired business lines — 180 N/M — 432 N/M
Settlement proceeds — — N/M — 131 N/M
Other 338 445 (24.04) % 801 929 (13.78) %
Total non-interest income $ 3,448 $ 5,062 (31.88) % $ 11,415 $ 13,678 (16.54) %
Service charges on deposit accounts increased modestly to $463 for the three months ended September 30, 2021, from $431 for the prior year quarter due to higher customer spending activity during the quarter. For the nine months ended September 30, 2021, service charges decreased to $1,256, compared to $1,336 in the comparable prior year period, due to higher average deposit balances.
Interchange income increased to $600 and $1,776 for the three and nine months ended September 30, 2021, compared to $556 and $1,509, respectively, for the similar prior year periods. Customer spending activity increased due to a stronger general economy, as our regional economies benefited from lower unemployment and were less impacted by business shutdowns as a result of the pandemic.
Loan servicing income decreased with reduced capitalization of mortgage servicing rights due to lower mortgage loan origination fees in the three- and nine-month periods ended September 30, 2021.
Gain on sale of loans decreased in the current three-month period ended September 30, 2021, compared to September 30, 2020, due to lower mortgage loan origination volumes, partially offset by a modest increase on the gain on sale of SBA loans. For the nine-month period ended September 30, 2021, gain on sale of loans decreased $454 thousand largely due to lower mortgage loan origination volumes, partially offset by gains on sale of SBA and FSA loans.
The change in loan fees and service charges for the three and nine months ended September 30, 2021, is largely due to decreases in commercial loan customer activity.
The decrease in insurance commission income is due to the sale of the Wells Insurance Agency in June 2020.
The net gains on investment securities in the three- and nine-month periods ended September 30, 2021, is largely due to unrealized gains on equity securities with readily determinable fair value recorded in the first quarter of 2021, a net realized $36 gain on sale of trust-preferred security in the second quarter of 2021, and a $42 net gain on the sale of trust-preferred securities and bank subordinated debt realized in the third quarter of 2021. In 2020, the gains in the nine-month period ended September 30, 2020, were due to the sale of $10.8 million of fixed-rate mortgage-backed securities (“MBS”) in the first quarter of 2020 and unrealized gain on equity security valuations in the second quarter of 2020.
In the third quarter of 2020, the bank recognized a $180 gain on the sale of a previously acquired wealth management business. Non-interest income for the nine-months ended September 30, 2020, also included the $252 gain on sale of Wells Insurance Agency in June 2020.
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During the quarter ended June 30, 2020, the Company recognized $131 of non-interest income related to a private mortgage-backed security claim. The $131 distribution represented a supplement to the proceeds received in March, 2017 from this security, previously owned by the Bank, and sold in 2011.
Non-interest Expense. The following table reflects the various components of non-interest expense for the three- and nine-month periods ended September 30, 2021 and 2020, respectively.
Three months ended September 30, Nine months ended September 30,
2021 2020 % Change 2021 2020 % Change
Non-interest Expense:
Compensation and related benefits $ 5,733 $ 5,538 3.52 % $ 16,802 $ 16,881 (0.47) %
Occupancy 1,313 1,396 (5.95) % 3,943 4,106 (3.97) %
Data processing 1,558 1,331 17.05 % 4,296 3,735 15.02 %
Amortization of intangible assets 399 399 — % 1,197 1,223 (2.13) %
Mortgage servicing rights expense, net 37 603 (93.86) % 28 2,330 (98.80) %
Advertising, marketing and public relations 220 260 (15.38) % 576 802 (28.18) %
FDIC premium assessment 148 188 (21.28) % 395 436 (9.40) %
Professional services 347 434 (20.05) % 1,250 1,391 (10.14) %
Gains on repossessed assets, net (3) (105) 97.14 % (150) (195) 23.08 %
Other 568 680 (16.47) % 1,670 2,138 (21.89) %
Total non-interest expense $ 10,320 $ 10,724 (3.77) % $ 30,007 $ 32,847 (8.65) %
Non-interest expense (annualized) / Average assets 2.34 % 2.62 % (10.60) % 2.34 % 2.78 % (15.80) %
Compensation expense for the three-month period ended September 30, 2021, was higher than the comparable prior year period primarily due to higher incentive compensation based on performance metrics, including items such as net income and loan growth which more than offset lower variable mortgage production compensation. Compensation expense for the nine-month period ended September 30, 2021, was lower than the comparable prior year period due to: 1) lower variable mortgage production compensation related to lower mortgage loan origination activity; 2) lower compensation due to fewer FTEs, including those related to the sale of Wells Insurance Agency in June of 2020; and 3) the closure of three branches in November 2020, partially offset by higher accrued incentive compensation as discussed above.
Data processing expense increases from the prior year quarter and year-to- date periods were due primarily to the impact of larger loan and deposit balances, and the impact of additional costs for new products offered to our customers.
Mortgage servicing rights expense, net, decreased during the three and nine months ended September 30, 2021, compared to the comparable prior year periods. This decrease is primarily due to the reversal of previously recognized impairment charges of $1.3 million, resulting largely from the impact of lower future forecasted prepayment rates. 30% of this impairment reversal occurred in the third quarter of 2021 and 70% in the first quarter of 2021. The Bank recorded MSR impairment charges of $0.3 million and $1.4 million for the three- and nine-month periods ended September 30, 2020, respectively. The remaining change is due to higher amortization in 2021.
Advertising, marketing and public relations expense decreased in both the three- and nine-month periods ended September 30, 2021, from the same periods in 2020 largely due to the pandemic related charitable contributions made in the second and third quarters of 2020 to local non-profit organizations.
The FDIC insurance premium decreased during the three months ended September 30, 2021, and nine-months ended September 30, 2021, from the comparable prior year periods due to the impact of increased capital ratios, stronger earnings performance and lower levels of non-performing assets, which more than offset the impact of a larger asset base. The Bank also realized a $56 thousand FDIC insurance credit in the first quarter of 2020.
Other expenses for the three- and nine-month periods ended September 30, 2021, decreased from the comparable prior year periods, largely due to lower loan origination and collection expenses, recognized in the similar periods in 2020.
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Income Taxes. Income tax expense was $1.8 million and $5.5 million for the three and nine months ended September 30, 2021, respectively, compared to $1.3 million and $3.3 million for the three and nine months ended September 30, 2020. The effective tax rate was 26.7% and 26.5% for the three and nine-month periods ended September 30, 2021 compared to 26.7% and 26.5% for the comparable prior year periods.
BALANCE SHEET ANALYSIS
Investment Securities. We manage our securities portfolio to provide liquidity and enhance income. Our investment portfolio is comprised of securities available for sale and securities held to maturity.
Securities available for sale, which represent the majority of our investment portfolio, were $234.4 million at September 30, 2021, compared with $144.2 million at December 31, 2020. The increase in the available for sale portfolio is due to purchases of mortgage-backed securities and corporate debt securities, which consisted of bank holding company-issued subordinated debt. The Bank sold $7.2 million of trust preferred securities and bank subordinated debt at a gain of $42 in the third quarter of 2021.
Securities held to maturity increased to $67.7 million at September 30, 2021, compared to $43.6 million at December 31, 2020. This increase was largely due to the purchase of agency mortgage-backed securities.
The amortized cost and market values of our available for sale securities by asset categories as of the dates indicated below were as follows:
Available for sale securities Amortized
Cost Fair
Value
September 30, 2021
U.S. government agency obligations $ 27,862 $ 28,410
Obligations of states and political subdivisions 140 140
Mortgage-backed securities 120,684 120,802
Corporate debt securities 40,676 41,218
Corporate asset-backed securities 34,522 34,615
Trust preferred securities 8,841 9,240
Totals $ 232,725 $ 234,425
December 31, 2020
U.S. government agency obligations $ 33,048 $ 33,365
Obligations of states and political subdivisions 140 140
Mortgage-backed securities 39,454 40,991
Corporate debt securities 17,199 17,462
Corporate asset-backed securities 36,039 35,827
Trust preferred securities 16,297 16,448
Totals $ 142,177 $ 144,233
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The amortized cost and fair value of our held to maturity securities by asset categories as of the dates noted below were as follows:
Held to maturity securities Amortized
Cost Fair
Value
September 30, 2021
Obligations of states and political subdivisions $ 4,600 $ 4,599
Mortgage-backed securities 63,139 61,268
Totals $ 67,739 $ 65,867
December 31, 2020
Obligations of states and political subdivisions $ 600 $ 602
Mortgage-backed securities 42,951 43,182
Totals $ 43,551 $ 43,784
The composition of our available for sale portfolios by credit rating as of the dates indicated below was as follows:
September 30, 2021 December 31, 2020
Available for sale securities Amortized
Cost Fair
Value Amortized
Cost Fair
Value
U.S. government agency $ 146,179 $ 146,736 $ 72,502 $ 74,356
AAA 9,706 9,840 11,142 11,088
AA 27,323 27,391 25,037 24,879
A 13,997 14,202 8,713 8,925
BBB 35,520 36,256 24,783 24,985
Non-rated — — — —
Total available for sale securities $ 232,725 $ 234,425 $ 142,177 $ 144,233
The composition of our held to maturity portfolio by credit rating as of the dates indicated was as follows:
September 30, 2021 December 31, 2020
Held to maturity securities Amortized
Cost Fair
Value Amortized
Cost Fair
Value
U.S. government agency $ 63,139 $ 61,268 $ 42,951 $ 43,182
AAA — — — —
AA 4,000 4,000 — —
A 600 599 600 602
Total $ 67,739 $ 65,867 $ 43,551 $ 43,784
As of September 30, 2021, the Bank has pledged U.S. Government Agency securities with a carrying value $0.5 million and mortgage-backed securities with a carrying value of $3.6 million as collateral against specific municipal deposits. At September 30, 2021, the Bank has pledged mortgage-backed securities with a carrying value of $0.9 million as collateral against a borrowing line of credit with the Federal Reserve Bank. However, as of September 30, 2021, there were no borrowings outstanding on this Federal Reserve Bank line of credit. As of September 30, 2021, the Bank also has mortgage-backed securities with a carrying value of $0.3 million pledged as collateral to the Federal Home Loan Bank of Des Moines.
At December 31, 2020, the Bank has pledged certain of its mortgage-backed securities with a carrying value of $1.2 million as collateral to secure a line of credit with the Federal Reserve Bank. As of December 31, 2020, there were no borrowings outstanding on this Federal Reserve Bank line of credit. As of December 31, 2020, the Bank has pledged certain of its U.S. Government Agency securities with a carrying value of $0.6 million and mortgage-backed securities with a carrying value of $3.0 million as collateral against specific municipal deposits. As of December 31, 2020, the Bank also has mortgage-backed securities with a carrying value of $0.5 million pledged as collateral to the Federal Home Loan Bank of Des Moines.
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Loans. Total loans outstanding, net of deferred loan fees and costs and unamortized discount on acquired loans, increased by $11.1 million, to $1.25 billion as of September 30, 2021, from $1.24 billion at December 31, 2020. The originated loan portfolio before SBA PPP loans increased $171.1 million in the nine month period. This increase included the repayment of $5.5 million of draws on a line of credit originated the last business day of December and repaid on the first business day of January. Total SBA PPP loans decreased $92.4 million due to debt forgiveness of $148.3 million, offset by strong new SBA PPP second round loan originations of $55.9 million. Acquired loans decreased by $69.4 million. The following table reflects the composition, or mix of our loan portfolio at September 30, 2021 and December 31, 2020:
September 30, 2021 December 31, 2020
Amount Percent Amount Percent
Real estate loans:
Commercial/Agricultural real estate
Commercial real estate $ 638,324 51.1 % $ 507,675 40.9 %
Agricultural real estate 76,634 6.1 % 68,795 5.6 %
Multi-family real estate 156,022 12.5 % 122,152 9.9 %
Construction and land development 85,538 6.9 % 98,517 8.0 %
Residential mortgage
Residential mortgage 99,781 8.0 % 131,386 10.6 %
Purchased HELOC loans 3,921 0.3 % 6,260 0.5 %
Total real estate loans 1,060,220 84.9 % 934,785 75.5 %
C&I/Agricultural operating and Consumer Installment Loans:
C&I/Agricultural operating
Commercial and industrial (“C&I”) 107,135 8.6 % 116,553 9.4 %
Agricultural operating 29,931 2.4 % 32,785 2.6 %
Consumer installment — %
Originated indirect paper 17,689 1.4 % 25,851 2.1 %
Other Consumer 9,930 0.8 % 13,213 1.1 %
Total C&I/Agricultural operating and Consumer installment Loans 164,685 13.2 % 188,402 15.2 %
Gross loans before C&I SBA PPP loans 1,224,905 98.1 % 1,123,187 90.7 %
SBA PPP loans 31,301 2.5 % 123,702 10.0 %
Gross loans $ 1,256,206 100.6 % $ 1,246,889 100.7 %
Unearned net deferred fees and costs and loans in process (3,486) (0.3) % (4,245) (0.3) %
Unamortized discount on acquired loans (4,066) (0.3) % (5,063) (0.4) %
Total loans (net of unearned income and deferred expense) 1,248,654 100.0 % 1,237,581 100.0 %
Allowance for loan losses (16,832) (17,043)
Total loans receivable, net $ 1,231,822 $ 1,220,538
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The following table summarizes SBA PPP loans by origination year at September 30, 2021:
2020 Originations 2021 Originations Total
Balance Net Deferred Fee Income Balance Net Deferred Fee Income Balance Net Deferred Fee Income
SBA PPP loans, December 31, 2020 $ 123,702 $ 2,991 $ — $ — $ 123,702 $ 2,991
2021 SBA PPP loan originations — — 47,467 1,770 47,467 1,770
Less: 2021 SBA PPP loan forgiveness and fee accretion (52,238) (1,750) — — (52,238) (1,750)
SBA PPP loans, March 31, 2021 71,464 1,241 47,467 1,770 118,931 3,011
2021 SBA PPP loan originations — — 8,323 1,715 8,323 1,715
Less: 2021 SBA PPP loan forgiveness and fee accretion (50,057) (933) (2,272) (376) (52,329) (1,309)
SBA PPP loans, June 30, 2021 21,407 308 53,518 $ 3,109 74,925 3,417
2021 SBA PPP loan originations — — 64 9 64 9
Less: 2021 SBA PPP loan forgiveness and fee accretion (18,286) (279) (25,402) (1,599) (43,688) (1,878)
SBA PPP loans, September 30, 2021 $ 3,121 $ 29 $ 28,180 $ 1,519 $ 31,301 $ 1,548
Allowance for Loan Losses. The loan portfolio is our primary asset subject to credit risk. To address this credit risk, we maintain an ALL for probable and inherent credit losses through periodic charges to our earnings. These charges are shown in our consolidated statements of operations as PLL. See “Provision for Loan Losses” earlier in this quarterly report. We attempt to control, monitor and minimize credit risk through the use of prudent lending standards, a thorough review of potential borrowers prior to lending and ongoing and timely review of payment performance. Asset quality administration, including early identification of loans performing in a substandard manner, as well as timely and active resolution of problems, further enhances management of credit risk and minimization of loan losses. Any losses that occur and that are charged off against the ALL are periodically reviewed with specific efforts focused on achieving maximum recovery of both principal and interest.
At least quarterly, we review the adequacy of the ALL. Based on an estimate computed pursuant to the requirements of ASC 450-10, “Accounting for Contingencies” and ASC 310-10, “Accounting by Creditors for Impairment of a Loan”, the analysis of the ALL consists of three components: (i) specific credit allocation established for expected losses relating to specific impaired loans for which the recorded investment in the loan exceeds its fair value; (ii) general portfolio allocation based on historical loan loss experience for significant loan categories; and (iii) general portfolio allocation based on qualitative factors such as economic conditions and other relevant factors specific to the markets in which we operate. We continue to refine our ALL methodology by introducing a greater level of granularity to our loan portfolio. We currently segregate loans into pools based on common risk characteristics for purposes of determining the ALL. The additional segmentation of the portfolio is intended to provide a more effective basis for the determination of qualitative factors affecting our ALL. In addition, management continually evaluates our ALL methodology to assess whether modifications in our methodology are appropriate in light of underwriting practices, market conditions, identifiable trends, regulatory pronouncements or other factors. We believe that any modifications or changes to the ALL methodology would be to enhance the ALL. However, any such modifications could result in materially different ALL levels in future periods.
The specific credit allocation for the ALL is based on a regular analysis of all loans that are considered impaired. In compliance with ASC 310-10, the fair value of the loan is determined based on either the present value of expected cash flows discounted at the loan’s effective interest rate, the market price of the loan, or, if the loan is collateral dependent, the fair value of the underlying collateral less the expected cost of sale for such collateral. At September 30, 2021, the Company individually evaluated loans for impairment with a recorded investment of $37.2 million, consisting of (1) $11.5 million purchased credit impaired (“PCI”) loans, with a carrying amount of $10.8 million; (2) $13.2 million TDR loans, net of TDR PCI loans; and (3) $12.5 million of substandard non-TDR, non-PCI loans. The $37.2 million total of loans individually evaluated for impairment includes $11.3 million of performing TDR loans. At December 31, 2020, the Company individually evaluated loans for impairment with a recorded investment of $43.4 million, consisting of (1) $17.9 million PCI loans, with a carrying amount of $16.9 million; (2) $15.6 million TDR loans, net of TDR PCI loans; and (3) $9.8 million of substandard non-TDR, non-PCI loans. The $43.4 million total of loans individually evaluated for impairment includes $11.7 million of performing TDR loans. At September 30, 2021, and December 31, 2020, we had 258 and 325 loans individually evaluated for impairment, respectively, all secured by real estate or personal property. Of the originated loans individually evaluated for impairment, there were 9 loans where the estimated fair value was less than their book value (i.e., we deemed impairment to exist) totaling $9.3 million for which $1.4 million in specific ALL was recorded as of September 30, 2021.
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The allowance for loan losses modestly decreased to $16.8 million at September 30, 2021, representing 1.38% of loans receivable, less the 100% SBA guaranteed PPP loans. A portion of the current loan portfolio includes loans purchased through whole bank acquisitions in recent years resulting in purchased credit impairments which are not included in the allowance for loan losses. As the originated portfolio grows and the acquired portfolio shrinks, the percentage of originated loans to total loans grows, as does the overall percentage of the allowance to total loans. The allowance for loan losses was $17.0 million at December 31, 2020, representing 1.53% of loans receivable, less the 100% SBA guaranteed PPP loans. The decrease in the allowance at September 30, 2021, was due to modest loan charge-offs.
Allowance for Loan Losses to Loans, net of SBA PPP Loans
(in thousands, except ratios)
September 30,
2021 December 31,
2020
Loans, end of period $ 1,248,654 $ 1,237,581
SBA PPP loans, net of deferred fees (29,753) (120,711)
Loans, net of SBA PPP loans and deferred fees $ 1,218,901 $ 1,116,870
Allowance for loan losses $ 16,832 $ 17,043
ALL to loans net of SBA PPP loans and deferred fees 1.38 % 1.53 %
ALL to loans, end of period 1.35 % 1.38 %
All of the nine factors identified in the FFIEC’s Interagency Policy Statement on the Allowance for Loan and Lease Losses are taken into account in determining the ALL. The impact of the factors in general categories are subject to change; thus, the allocations are management’s estimate of the loan loss categories in which the probable and inherent loss has occurred as of the date of our assessment. Of the nine factors, we believe the following have the greatest impact on our customers’ ability to repay loans and our ability to recover potential losses through collateral sales: (1) lending policies and procedures; (2) economic and business conditions; and (3) the value of the underlying collateral. As loan balances and estimated losses in a particular loan type decrease or increase and as the factors and resulting allocations are monitored by management, changes in the risk profile of the various parts of the loan portfolio may be reflected in the allocated allowance. The general component covers non-impaired loans and is based on historical loss experience adjusted for these and other qualitative factors. In addition, management continues to refine the ALL estimation process as new information becomes available. These refinements could also cause increases or decreases in the ALL. See Provision for loan losses in the Consolidated Statements of Operations (unaudited) for further details. The unallocated portion of the ALL is intended to account for imprecision in the estimation process or relevant current information that may not have been considered in the process.
Nonperforming Loans, Potential Problem Loans and Foreclosed Properties. We practice early identification of nonaccrual and problem loans in order to minimize the Bank’s risk of loss. Nonperforming loans are defined as nonaccrual loans and restructured loans that were 90 days or more past due at the time of their restructure, or when management determines that such classification is warranted. The accrual of interest income is discontinued on our loans according to the following schedule:
• Commercial/agricultural real estate loans, past due 90 days or more;
• C&I/Agricultural operating loans, past due 90 days or more;
• Closed ended consumer installment loans past due 120 days or more; and
• Residential mortgage loans and open-ended consumer installment loans past due 180 days or more.
When interest accruals are discontinued, interest credited to income is reversed. If collection is in doubt, cash receipts on non-accrual loans are used to reduce principal rather than being recorded as interest income. A TDR typically involves the granting of some concession to the borrower involving a loan modification, such as modifying the payment schedule or making interest rate changes. TDR loans may involve loans that have had a charge-off taken against the loan to reduce the carrying amount of the loan to fair market value as determined pursuant to ASC 310-10
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The following table identifies the various components of nonperforming assets and other balance sheet information as of the dates indicated below and changes in the ALL for the periods then ended:
September 30, 2021 and Nine Months Then Ended December 31, 2020 and Twelve Months Then Ended
Nonperforming assets:
Nonaccrual loans
Commercial real estate $ 5,427 $ 827
Agricultural real estate 3,567 5,084
Commercial and industrial 311 357
Agricultural operating 1,063 1,872
Residential mortgage 1,263 2,451
Consumer installment 75 156
Total nonaccrual loans $ 11,706 $ 10,747
Accruing loans past due 90 days or more 425 586
Total nonperforming loans (“NPLs”) 12,131 11,333
Other real estate owned 2 156
Other collateral owned 2 41
Total nonperforming assets (“NPAs”) $ 12,135 $ 11,530
Troubled Debt Restructurings (“TDRs”) $ 15,689 $ 18,477
Accruing TDR's $ 11,365 $ 11,742
Nonaccrual TDRs $ 4,324 $ 6,735
Average outstanding loan balance $ 1,197,470 $ 1,234,732
Loans, end of period $ 1,248,654 $ 1,237,581
Total assets, end of period $ 1,753,477 $ 1,649,095
ALL, at beginning of period $ 17,043 $ 10,320
Loans charged off:
Commercial/Agricultural real estate (251) —
C&I/Agricultural operating (7) (1,091)
Residential mortgage — (78)
Consumer installment (76) (149)
Total loans charged off (334) (1,318)
Recoveries of loans previously charged off:
Commercial/Agricultural real estate 10 150
C&I/Agricultural operating 61 44
Residential mortgage 12 20
Consumer installment 40 77
Total recoveries of loans previously charged off: 123 291
Net loans charged off (“NCOs”) (211) (1,027)
Additions to ALL via provision for loan losses charged to operations — 7,750
ALL, at end of period $ 16,832 $ 17,043
Ratios:
ALL to NCOs (annualized) 3,988.63 % 1,659.49 %
NCOs (annualized) to average loans 0.02 % 0.08 %
ALL to total loans 1.35 % 1.38 %
NPLs to total loans 0.97 % 0.92 %
NPAs to total assets 0.69 % 0.70 %
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The following table shows the detail of non-performing assets by originated and acquired portfolios:
Nonperforming Originated / Acquired Assets
(in thousands, except ratios)
September 30, 2021 December 31, 2020 September 30, 2020
Nonperforming assets:
Originated nonperforming assets:
Nonaccrual loans $ 6,408 $ 3,649 $ 3,255
Accruing loans past due 90 days or more 295 415 698
Total originated nonperforming loans (“NPL”) 6,703 4,064 3,953
Other real estate owned (“OREO”) — 63 352
Other collateral owned 2 41 56
Total originated nonperforming assets (“NPAs”) $ 6,705 $ 4,168 $ 4,361
Acquired nonperforming assets:
Nonaccrual loans $ 5,298 $ 7,098 $ 9,899
Accruing loans past due 90 days or more 130 171 252
Total acquired nonperforming loans (“NPL”) 5,428 7,269 10,151
Other real estate owned (“OREO”) 2 93 404
Other collateral owned — — —
Total acquired nonperforming assets (“NPAs”) $ 5,430 $ 7,362 $ 10,555
Total nonperforming assets (“NPAs”) $ 12,135 $ 11,530 $ 14,916
Loans, end of period $ 1,248,654 $ 1,237,581 $ 1,230,139
Total assets, end of period $ 1,753,477 $ 1,649,095 $ 1,622,593
Ratios:
Originated NPLs to total loans 0.54 % 0.33 % 0.32 %
Acquired NPLs to total loans 0.43 % 0.59 % 0.83 %
Originated NPAs to total assets 0.38 % 0.25 % 0.27 %
Acquired NPAs to total assets 0.31 % 0.45 % 0.65 %
Nonperforming assets increased by $0.6 million to $12.1 million at September 30, 2021 from December 31, 2020. This increase is largely due to a $4.5 million commercial real estate loan secured by a senior living facility, partially offset by reductions in acquired non-performing loans. Refer to the “Allowance for Loan Losses” and “Nonperforming Loans, Potential Problem Loans and Foreclosed Properties” sections above for more information related to nonperforming loans.
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Nonaccrual Loans Roll forward:
Quarter Ended
September 30, 2021 June 30, 2021 March 31, 2021 December 31, 2020 September 30, 2020
Balance, beginning of period $ 8,075 $ 8,678 $ 10,747 $ 13,154 $ 14,787
Additions 4,859 863 430 912 716
Acquired nonaccrual loans — — — — —
Charge offs (24) (58) (205) (2) (141)
Transfers to OREO — — (45) — (172)
Return to accrual status — (696) (291) — (165)
Payments received (1,202) (712) (1,935) (3,317) (1,744)
Other, net (2) — (23) — (127)
Balance, end of period $ 11,706 $ 8,075 $ 8,678 $ 10,747 $ 13,154
Nonaccrual TDR loans decreased to $4.3 million at September 30, 2021 from $6.7 million at December 31, 2020.
September 30, 2021 December 31, 2020 September 30, 2020
Number of
Modifications Recorded
Investment Number of
Modifications Recorded
Investment Number of
Modifications Recorded
Investment
Troubled debt restructurings: Accrual Status
Commercial/Agricultural real estate 12 $ 4,711 16 $ 4,695 19 $ 5,480
C&I/Agricultural operating 4 3,685 4 3,836 5 3,868
Residential mortgage 39 2,925 43 3,162 42 3,178
Consumer installment 6 44 8 49 7 53
Total loans 61 $ 11,365 71 $ 11,742 73 $ 12,579
Classified assets decreased to $27.1 million at September 30, 2021, from $28.5 million at December 31, 2020, largely due to the reduction in accruing substandard loans, partially offset by the modest increase in nonperforming assets, which are substandard assets. Nonperforming assets increased to $12.1 million or 0.69% of total assets at September 30, 2021 compared to $11.5 million or 0.70% of total assets at December 31, 2020. Included in nonperforming assets at September 30, 2021 are $5.4 million of nonperforming assets acquired during recent whole-bank acquisitions.
The table below shows a summary of criticized loans for the past five quarters. Substandard loans, largely due to reductions in non-performing loans, have decreased each quarter, except for the current quarter ended September 30, 2021. This increase was largely due to a $4.5 million commercial real estate loan secured by a senior living facility, as noted above. Special mention loans increased during the first and second quarters in 2021 due to a single hotel loan. Due to improving cash flow, this hotel loan was rated a pass loan during the quarter ended September 30, 2021. See Note 3, “Loans, Allowance for Loan Losses and Impaired Loans” for additional information.
(in thousands)
September 30,
2021 June 30,
2021 March 31,
2021 December 31,
2020 September 30,
2020
Special mention loan balances $ 2,548 $ 12,308 $ 13,659 $ 6,672 $ 7,777
Substandard loan balances 27,137 25,890 26,064 28,541 32,922
Criticized loans, end of period $ 29,685 $ 38,198 $ 39,723 $ 35,213 $ 40,699
Hotels and restaurants represent our portfolio’s two industry sectors most directly and adversely affected by the recent pandemic and related government actions. These sector loans totaled approximately $109 million and $41 million, respectively, at September 30, 2021. The weighted-average loan-to-value percentage and debt service coverage ratio on these hotel industry
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sector loans were 56% and 2.3 times, respectively. Approximately $23.8 million of restaurant sector loans are to franchise quick-service restaurants.
As of September 30, 2021, the Bank had $20.6 million of remaining loan modifications, due to pandemic-related borrower requests. Hotel industry sector loans represent approximately $19.2 million of the approved deferrals at September 30, 2021 and represented the only remaining commercial loan deferrals. Approximately $6.0 million of the hotel modifications are scheduled to resume their regular principal and interest payments in the fourth quarter, with the remaining loan scheduled to resume their regular payment in the first quarter of 2022. The hotel modifications were third deferrals under the CARES ACT. With this third deferral, the customer will make interest only payments which were funded by deposits made with the Bank at the time of modification. While the Company has no indication that any of the modified credits are specifically impaired, additional risk and uncertainty inherent in the current pandemic-affected environment have been considered. See “Allowance for Loan Losses” section above for discussion of pandemic-related qualitative factor, and related provision for loan losses.
Mortgage Servicing Rights. Mortgage servicing rights (“MSR”) assets are initially measured at fair value; assessed at least quarterly for impairment; carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value. MSR assets are amortized in proportion to and over the period of estimated net servicing income, with the amortization recorded in non-interest expense in the consolidated statement of operations. The valuation of MSRs and related amortization thereon are based on numerous factors, assumptions and judgments, such as those for: changes in the mix of loans, interest rates, prepayment speeds, and default rates. Changes in these factors, assumptions and judgments may have a material effect on the valuation and amortization of MSRs. Although management believes that the assumptions used to evaluate the MSRs for impairment are reasonable, future adjustment may be necessary if future economic conditions differ substantially from the economic assumptions used to determine the value of MSRs.
The fair market value of the Company’s MSR asset increased from $3.3 million at December 31, 2020, to $4.2 million at September 30, 2021, primarily due to higher future forecasted interest rates and resulting lower forecasted prepayment. As a result, $1.3 million of previously recorded impairments on the MSR asset was reversed during the nine-month period ended September 30, 2021.
The unpaid balances of one- to four-family residential real estate loans serviced for others as of September 30, 2021, and December 31, 2020, were $557.1 million and $553.7 million, respectively. The fair market value of the Company’s MSR asset as a percentage of its servicing portfolio at September 30, 2021, and December 31, 2020, was 0.75% and 0.59%, respectively.
Deposits. Deposits increased $113.1 million to $1.41 billion at September 30, 2021, from $1.30 billion at December 31, 2020. This growth is due to non-maturity deposit growth, split between both retail and commercial deposits. This growth was partially offset by retail certificates of deposit decreasing by $87.7 million, as the Company chose not to match higher rate local retail certificate competition. Some of the decrease in retail certificates has moved to money markets.
The following is a summary of deposits by type at September 30, 2021 and December 31, 2020, respectively:
September 30, 2021 December 31, 2020
Non-interest bearing demand deposits $ 280,611 $ 238,348
Interest bearing demand deposits 381,315 301,764
Savings accounts 229,623 196,348
Money market accounts 291,242 245,549
Certificate accounts 225,524 313,247
Total deposits $ 1,408,315 $ 1,295,256
Brokered deposits included above: $ 2,520 $ 2,516
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Federal Home Loan Bank (FHLB) advances (borrowings) and Other Borrowings. A summary of Federal Home Loan Bank (FHLB) advances and other borrowings at September 30, 2021 and December 31, 2020 is as follows:
September 30, 2021 December 31, 2020
Stated Maturity Amount Range of Stated Rates Amount Range of Stated Rates
Federal Home Loan Bank advances (1), (2), (3), (4) 2021 $ — — % — % $ 8,000 0.00 % 2.16 %
2022 11,000 2.45 % 2.45 % 15,000 2.34 % 2.45 %
2023 20,000 1.43 % 1.44 % 20,000 1.43 % 1.44 %
2024 20,530 0.00 % 1.45 % 20,530 0.00 % 1.45 %
2025 5,000 1.45 % 1.45 % 5,000 1.45 % 1.45 %
2029 42,500 1.00 % 1.13 % 42,500 1.00 % 1.13 %
2030 12,500 0.52 % 0.86 % 12,500 0.52 % 0.86 %
Subtotal 111,530 123,530
Unamortized discount on acquired notes (18) (32)
Federal Home Loan Bank advances, net $ 111,512 $ 123,498
Senior Notes (5) 2031 $ 28,856 3.50 % 3.50 % $ 28,856 3.25 % 3.50 %
Subordinated Notes (6) 2027 $ 15,000 6.75 % 6.75 % $ 15,000 6.75 % 6.75 %
2030 15,000 6.00 % 6.00 % 15,000 6.00 % 6.00 %
$ 30,000 $ 30,000
Unamortized debt issuance costs $ (456) $ (528)
Total other borrowings $ 58,400 $ 58,328
Totals $ 169,912 $ 181,826
(1) The FHLB advances bear fixed rates, require interest-only monthly payments, and are collateralized by a blanket lien on pre-qualifying first mortgages, home equity lines, multi-family loans and certain other loans which had a pledged balance of $782,715 and $723,862 at September 30, 2021 and December 31, 2020, respectively. At September 30, 2021, the Bank’s available and unused portion under the FHLB borrowing arrangement was approximately $162,875 compared to $118,391 as of December 31, 2020.
(2) Maximum month-end borrowed amounts outstanding under this borrowing agreement were $123,530 and $162,530, during the nine months ended September 30, 2021 and the twelve months ended December 31, 2020, respectively.
(3) The weighted-average interest rates on FHLB borrowings maturing within twelve months as of September 30, 2021 and December 31, 2020 were 2.45% and 1.02%, respectively.
(4) FHLB term notes totaling $55,000, with various maturity dates in 2029 and 2030, can be called or replaced by the FHLB on a quarterly basis.
(5) Senior notes, entered into by the Company in June 2019 consist of the following:
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(a) A term note, which was subsequently refinanced in October 2020, requiring quarterly interest-only payments through June 2022, and quarterly principal and interest payments thereafter. Interest is variable, based on US Prime rate with a floor rate of 3.25%.
(b) A $5,000 line of credit, maturing in August 2022, that remains undrawn upon.
(6) Subordinated notes resulted from the following:
(a) The Company’s private sale in August 2017, which bears a fixed interest rate of 6.75% for five years. In August 2022, they convert to a three-month LIBOR plus 4.90% rate, and the interest rate will reset quarterly thereafter. Interest-only payments are due quarterly.
(b) The Company’s Subordinated Note Purchase Agreement entered into with certain purchasers in August 2020, which bears a fixed interest rate of 6.00% for five years. In September 2025, the fixed interest rate will be reset quarterly to equal the three-month term Secured Overnight Financing Rate plus 591 basis points. Interest-only payments are due semi-annually each year during the fixed interest period and quarterly during the floating interest period.
FHLB advances decreased $12.0 million to $111.5 million as of September 30, 2021, compared to $123.5 million as of December 31, 2020. The Bank terminated $8.0 million of advances in the quarter ended March 31, 2021, incurring a $0.1 million prepayment penalty, as we modestly reduced excess liquidity. In the second quarter of 2021, a $4 million advance matured. The Bank has an irrevocable Standby Letter of Credit Master Reimbursement Agreement with the Federal Home Loan Bank. This irrevocable standby letter of credit (“LOC”) is supported by loan collateral as an alternative to directly pledging investment securities on behalf of a municipal customer as collateral for their interest-bearing deposit balances. The Bank’s current unused borrowing capacity, supported by loan collateral as of September 30, 2021, is approximately $162.9 million.
The Bank’s origination of SBA PPP loans allowed the Bank to gain access to the Federal Reserve’s PPPLF facility, whereby the Bank could pledge SBA PPP loans, by date of origination, up to the contractual maturity of the Bank’s SBA PPP loans with no collateral haircut. This FRB PPPLF program expired on July 30, 2021. Due to the program expiration and the strong growth in non-maturity deposits discussed above, the Bank had no outstanding borrowings under this facility at, or at any time during the quarters ended September 30, 2021, or December 31, 2020, respectively or nine months ended September 30, 2021. In July 2021, the Bank pledged these SBA PPP loans to the FHLB.
At both September 30, 2021 and December 31, 2020, the Bank had $55 million of 10-year, three-month callable advances.
See Note 7, “Federal Home Loan Bank and Federal Reserve Bank Advances and Other Borrowings” for more information.
At September 30, 2021, the Bank has pledged $782.7 million of loans to secure the current FHLB outstanding advances and letters of credit and to provide the unused borrowing capacity, compared to $723.9 million of loans pledged at December 31, 2020.
Stockholders’ Equity. Total stockholders’ equity was $165.9 million at September 30, 2021, compared to $160.6 million at December 31, 2020. The increase in stockholder’s equity was due to the Company’s net income of $15.2 million. This increase was partially offset by: 1) the repurchase of approximately 604 thousand shares of its common stock, which reduced equity by $7.7 million; 2) the payment of the annual cash dividend paid in February to common stockholders of $0.23 per share or $2.5 million; and 3) a decrease in the unrealized gain on available for sale securities of $0.26 million.
The Company repurchased all remaining authorized shares of the Company’s stock under the November 2020 share repurchase program during the three months ended September 30, 2021. On July 23, 2021, the Board of Directors adopted a new share repurchase program. Under this new share repurchase program, approximately 144 thousand shares, were repurchased during the quarter ended September 30, 2021. The Company is authorized to repurchase an additional 389 thousand shares under this July 2021 share repurchase program.
Liquidity and Asset / Liability Management . Our primary sources of funds are deposits; amortization, prepayments and maturities of outstanding loans; short-term investments; and borrowings. We use our sources of funds primarily to meet ongoing commitments, to pay non-renewing, maturing certificates of deposit and savings withdrawals, and to fund loan commitments. We have enhanced our liquidity monitoring and updated what we consider to be sources of on-balance sheet cash. We consider our interest-bearing cash and unpledged investment securities to be our sources of on-balance sheet liquidity. At September 30, 2021, our on-balance sheet liquidity ratio was 20.7%. While scheduled payments from the amortization of loans and maturing short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are
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influenced by factors partially outside of the Bank’s control, including general interest rates, economic conditions and competition. Although $198.4 million of our $225.5 million (87.99%) September 30, 2021 CD portfolio matures within the next 12 months, we have historically retained a majority of our maturing CDs. Due to strategic pricing decisions regarding rate matching based on currently liquidity levels, our retention rate may decrease in the future, although some deposits may be retained and moved to money market accounts. At September 30, 2021, the Bank had approximately $47.2 million of certificate of deposit accounts maturing in the fourth quarter of 2021, with a weighted average cost of approximately 0.8%, and approximately $155.7 million of certificate of deposit accounts maturing in 2022, with a weighted average cost of approximately 1.5%. Approximately 80% of the 2022 maturities occur in the first half of 2022. The approximate weighted average cost of new certificates in the first three quarter of 2021 was below 0.50%. Through new deposit product offerings to our branch and commercial customers, we are currently attempting to strengthen customer relationships to attract additional non-rate sensitive deposits. In our present interest rate environment, and based on maturing yields, this is intended to also reduce our cost of funds.
We maintain access to additional sources of funds including FHLB borrowings and lines of credit with the Federal Reserve Bank and correspondent banks. We utilize FHLB borrowings to leverage our capital base, to provide funds for our lending and investment activities, and to manage our interest rate risk. Our borrowing arrangement with the FHLB calls for pledging certain qualified real estate loans and borrowing up to 75% of the value of those loans, not to exceed 35% of the Bank’s total assets. As of September 30, 2021, we had approximately $162.9 million available under this arrangement, supported by loan collateral, as compared to $118.4 million at December 31, 2020. In the quarter ended June 30, 2020, the Bank’s origination of SBA PPP loans allowed the Bank to gain access to the Federal Reserve’s PPPLF facility, whereby the Bank could pledge SBA PPP loans, by date of origination, up to the contractual maturity of the Bank’s SBA PPP loans with no collateral haircut. This FRB PPPLF program expired on July 30, 2021. Due to the program expiration and the strong growth in non-maturity deposits discussed above, the Bank had no outstanding borrowings under this facility at, or at any time during the quarters ended September 30, 2021, or December 31, 2020, respectively or nine months ended September 30, 2021. In July 2021, the Bank pledged these SBA PPP loans to the FHLB. As the SBA PPP loans are forgiven, the collateral will reduce and our borrowing capacity under this facility will be reduced.
We maintain a line of credit with the Federal Reserve Bank which has a $1.0 million capacity, based on our current pledged collateral position. Additionally, we have $25.0 million of uncommitted federal funds purchased lines of credit, as well as a $5.0 million revolving line of credit which is available as needed for general liquidity purposes.
In reviewing our adequacy of liquidity, we review and evaluate historical financial information, including information regarding general economic conditions, current ratios, management goals and the resources available to meet our anticipated liquidity needs. Management believes that our liquidity is adequate. To management’s knowledge, there are no known events or uncertainties that will result, or are likely to reasonably result, in a material increase or decrease in our liquidity.
Off-Balance Sheet Liabilities . Some of our financial instruments have off-balance sheet risk. These instruments include unused commitments for lines of credit, overdraft protection lines of credit and home equity lines of credit, as well as commitments to extend credit. As of September 30, 2021, the Company had $320.1 million in unused commitments, compared to $247.3 million in unused commitments as of December 31, 2020.
Capital Resources. As of September 30, 2021, as shown in the table below, the Bank’s Tier 1 and Risk-based capital levels exceeded levels necessary to be considered “Well Capitalized” under Prompt Corrective Action provisions.
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Below are the amounts and ratios for our capital levels as of the dates noted below for the Bank:
Actual For Capital Adequacy
Purposes To Be Well Capitalized
Under Prompt Corrective
Action Provisions
Amount Ratio Amount Ratio Amount Ratio
As of September 30, 2021 (Unaudited)
Total capital (to risk weighted assets) $ 181,257 13.6 % $ 106,602 > = 8.0 % $ 133,252 > = 10.0 %
Tier 1 capital (to risk weighted assets) 164,598 12.4 % 79,951 > = 6.0 % 106,602 > = 8.0 %
Common equity tier 1 capital (to risk weighted assets) 164,598 12.4 % 59,963 > = 4.5 % 86,614 > = 6.5 %
Tier 1 leverage ratio (to adjusted total assets) 164,598 9.6 % 68,273 > = 4.0 % 85,342 > = 5.0 %
As of December 31, 2020 (Audited)
Total capital (to risk weighted assets) $ 171,702 14.7 % $ 93,381 > = 8.0 % $ 116,726 > = 10.0 %
Tier 1 capital (to risk weighted assets) 157,081 13.5 % 70,035 > = 6.0 % 93,381 > = 8.0 %
Common equity tier 1 capital (to risk weighted assets) 157,081 13.5 % 52,527 > = 4.5 % 75,872 > = 6.5 %
Tier 1 leverage ratio (to adjusted total assets) 157,081 9.9 % 63,718 > = 4.0 % 79,647 > = 5.0 %
At September 30, 2021, the Bank was categorized as “Well Capitalized” under Prompt Corrective Action Provisions, as determined by the OCC, our primary regulator.
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Below are the amounts and ratios for our capital levels as of the dates noted below for the Company:
Actual For Capital Adequacy
Purposes
Amount Ratio Amount Ratio
As of September 30, 2021 (Unaudited)
Total capital (to risk weighted assets) $ 175,558 13.2 % $ 106,602 > = 8.0 %
Tier 1 capital (to risk weighted assets) 128,899 9.7 % 79,951 > = 6.0 %
Common equity tier 1 capital (to risk weighted assets) 128,899 9.7 % 59,963 > = 4.5 %
Tier 1 leverage ratio (to adjusted total assets) 128,899 7.6 % 68,273 > = 4.0 %
As of December 31, 2020 (Audited)
Total capital (to risk weighted assets) $ 166,703 14.3 % $ 93,381 > = 8.0 %
Tier 1 capital (to risk weighted assets) 122,082 10.5 % 70,035 > = 6.0 %
Common equity tier 1 capital (to risk weighted assets) 122,082 10.5 % 52,527 > = 4.5 %
Tier 1 leverage ratio (to adjusted total assets) 122,082 7.7 % 63,718 > = 4.0 %
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.