Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-looking Statements
When used in this Quarterly Report and in other documents filed or furnished by Great Southern Bancorp, Inc. (the “Company”) with the Securities and Exchange Commission (the "SEC"), in the Company's press releases or other public or stockholder communications, and in oral statements made with the approval of an authorized executive officer, the words or phrases “may,” “might,” “could,” “should,” "will likely result," "are expected to," "will continue," "is anticipated," “believe,” "estimate," "project," "intends" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements also include, but are not limited to, statements regarding plans, objectives, expectations or consequences of announced transactions, known trends and statements about future performance, operations, products and services of the Company. The Company’s ability to predict results or the actual effects of future plans or strategies is inherently uncertain, and the Company’s actual results could differ materially from those contained in the forward-looking statements. The novel coronavirus disease, or COVID-19, pandemic is adversely affecting the Company, its customers, counterparties, employees, and third-party service providers, and the ultimate extent of the impacts on the Company’s business, financial position, results of operations, liquidity, and prospects is uncertain. Continued deterioration in general business and economic conditions, including further increases in unemployment rates, or turbulence in domestic or global financial markets could adversely affect the Company’s revenues and the values of its assets and liabilities, reduce the availability of funding, lead to a tightening of credit, and further increase stock price volatility. In addition, changes to statutes, regulations, or regulatory policies or practices as a result of, or in response to, COVID-19, could affect the Company in substantial and unpredictable ways.
Other factors that could cause or contribute to such differences include, but are not limited to: (i) expected revenues, cost savings, earnings accretion, synergies and other benefits from the Company's merger and acquisition activities might not be realized within the anticipated time frames or at all, and costs or difficulties relating to integration matters, including but not limited to customer and employee retention, might be greater than expected; (ii) changes in economic conditions, either nationally or in the Company's market areas; (iii) fluctuations in interest rates; (iv) the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses; (v) the possibility of other-than-temporary impairments of securities held in the Company's securities portfolio; (vi) the Company's ability to access cost-effective funding; (vii) fluctuations in real estate values and both residential and commercial real estate market conditions; (viii) the ability to adapt successfully to technological changes to meet customers' needs and developments in the marketplace; (ix) the possibility that security measures implemented might not be sufficient to mitigate the risk of a cyber-attack or cyber theft, and that such security measures might not protect against systems failures or interruptions; (x) legislative or regulatory changes that adversely affect the Company's business, including, without limitation, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and its implementing regulations, the overdraft protection regulations and customers' responses thereto and the Tax Cut and Jobs Act; (xi) changes in accounting policies and practices or accounting standards, including Accounting Standards Update 2016-13, Credit Losses (Topic 326), “Measurement of Credit Losses on Financial Instruments,” commonly referenced as the Current Expected Credit Loss model, which, upon adoption, is expected to result in an increase in the Company’s allowance for credit losses; (xii) monetary and fiscal policies of the Federal Reserve Board and the U.S. Government and other governmental initiatives affecting the financial services industry; (xiii) results of examinations of the Company and Great Southern Bank by their regulators, including the possibility that the regulators may, among other things, require the Company to limit its business activities, change its business mix, increase its allowance for loan losses, write-down assets or increase its capital levels, or affect its ability to borrow funds or maintain or increase deposits, which could adversely affect its liquidity and earnings; (xiv) costs and effects of litigation, including settlements and judgments; (xv) competition; (xvi) uncertainty regarding the future of LIBOR; and (xvii) natural disasters, war, terrorist activities or civil unrest and their effects on economic and business environments in which the Company operates. The Company wishes to advise readers that the factors listed above and other risks described from time to time in documents filed or furnished by the Company with the SEC could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
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The Company does not undertake-and specifically declines any obligation- to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.
Allowance for Loan Losses and Valuation of Foreclosed Assets
The Company believes that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining an allowance level believed by management to be sufficient to absorb estimated loan losses. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates of, among other things, expected default probabilities, loss once loans default, expected commitment usage, the amounts and timing of expected future cash flows on impaired loans, value of collateral, estimated losses, and general amounts for historical loss experience.
The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required which would adversely impact earnings in future periods. In addition, the Bank’s regulators could require additional provisions for loan losses as part of their examination process.
See Note 6 “Loans and Allowance for Loan Losses” included in Item 1 for additional information regarding the allowance for loan losses. Inherent in this process is the evaluation of individual significant credit relationships. From time to time certain credit relationships may deteriorate due to payment performance, cash flow of the borrower, value of collateral, or other factors. In these instances, management may revise its loss estimates and assumptions for these specific credits due to changing circumstances. In some cases, additional losses may be realized; in other instances, the factors that led to the deterioration may improve or the credit may be refinanced elsewhere and allocated allowances may be released from the particular credit. The Company uses a three-year average of historical losses for the general component of the allowance for loan loss calculation. No significant changes were made to management's overall methodology for evaluating the allowance for loan losses during the periods presented in the financial statements of this report.
In addition, the Company considers that the determination of the valuations of foreclosed assets held for sale involves a high degree of judgment and complexity. The carrying value of foreclosed assets reflects management’s best estimate of the amount to be realized from the sales of the assets. While the estimate is generally based on a valuation by an independent appraiser or recent sales of similar properties, the amount that the Company realizes from the sales of the assets could differ materially from the carrying value reflected in the financial statements, resulting in losses that could adversely impact earnings in future periods.
Carrying Value of Loans Acquired in FDIC-Assisted Transactions
The Company considers that the determination of the carrying value of loans acquired in the FDIC-assisted transactions involves a high degree of judgment and complexity. The carrying value of the acquired loans reflects management’s best ongoing estimates of the amounts to be realized on these assets. The Company determined initial fair value accounting estimates of the acquired assets and assumed liabilities in accordance with FASB ASC 805, Business Combinations . However, the amount that the Company realizes on its acquired loan assets could differ
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materially from the carrying value reflected in its financial statements, based upon the timing of collections on the acquired loans in future periods. Because of the loss sharing agreements with the FDIC on certain of these assets, the Company did not expect to incur any significant losses related to these assets. Subsequent to the initial valuation, the Company continued to monitor identified loan pools for changes in estimated cash flows projected for the loan pools, anticipated credit losses and changes in the accretable yield. Analysis of these variables requires significant estimates and a high degree of judgment. See Note 7 “FDIC-Assisted Acquired Loans” included in Item 1 for additional information regarding the TeamBank, Vantus Bank, Sun Security Bank, InterBank and Valley Bank FDIC-assisted transactions.
Goodwill and Intangible Assets
Goodwill and intangible assets that have indefinite useful lives are subject to an impairment test at least annually and more frequently if circumstances indicate their value may not be recoverable. Goodwill is tested for impairment using a process that estimates the fair value of each of the Company’s reporting units compared with its carrying value. The Company defines reporting units as a level below each of its operating segments for which there is discrete financial information that is regularly reviewed. As of September 30, 2020, the Company had one reporting unit to which goodwill has been allocated – the Bank. If the fair value of a reporting unit exceeds its carrying value, then no impairment is recorded. If the carrying value exceeds the fair value of a reporting unit, further testing is completed comparing the implied fair value of the reporting unit’s goodwill to its carrying value to measure the amount of impairment, if any. Intangible assets that are not amortized must be tested for impairment at least annually by comparing the fair values of those assets to their carrying values. At September 30, 2020, goodwill consisted of $5.4 million at the Bank reporting unit, which included goodwill of $4.2 million that was recorded during 2016 related to the acquisition of 12 branches from Fifth Third Bank. Other identifiable intangible assets that are subject to amortization are amortized on a straight-line basis over a period of seven years. At September 30, 2020, the amortizable intangible assets consisted of core deposit intangibles of $1.8 million, which are reflected in the table below. These amortizable intangible assets are reviewed for impairment if circumstances indicate their value may not be recoverable based on a comparison of fair value.
Our regular annual impairment assessment occurs in the third quarter of each year. At September 30, 2020, the Company performed this annual review, including consideration of the current circumstances brought about by the COVID-19 pandemic and its effect on the valuation of the Company and other bank holding companies. The Company concluded that no impairment of its goodwill and intangible assets had occurred at September 30, 2020. While the Company believes no impairment of its goodwill or other intangible assets existed at September 30, 2020, different conditions or assumptions used to measure fair value of reporting units, or changes in cash flows or profitability, if significantly negative or unfavorable, could have a material adverse effect on the outcome of the Company’s impairment evaluation in the future.
A summary of goodwill and intangible assets is as follows:
September 30,
2020
December 31,
2019
(In Thousands)
Goodwill – Branch acquisitions
$
5,396
$
5,396
Deposit intangibles
Boulevard Bank
61
153
Valley Bank
300
600
Fifth Third Bank
1,475
1,949
1,836
2,702
$
7,232
$
8,098
Current Economic Conditions
Changes in economic conditions could cause the value of assets and liabilities recorded in the financial statements to change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses, or capital that could negatively impact the Company’s ability to meet regulatory capital requirements and maintain sufficient liquidity.
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Following the housing and mortgage crisis and correction beginning in mid-2007, the United States entered an economic downturn. Unemployment rose from 4.7% in November 2007 to peak at 10.0% in October 2009. Since that time, economic conditions improved considerably, as indicated by higher consumer confidence levels, increased economic activity and low unemployment levels. The U.S. economy continued to operate at historically strong levels until the impact of the COVID-19 pandemic in March 2020. While the severity and extent of the COVID-19 pandemic on the global, national and regional economies is still uncertain, it will most likely have a temporary detrimental impact on the performance of our loan portfolio. Short-term modifications on loan terms to help our customers navigate through the current pandemic situation were made in accordance with guidance from the banking regulatory authorities. These modifications did not result in these loans being classified as troubled debt restructurings, potential problem loans or non-performing loans. More severely impacted industries in our portfolio include retail, motel/hotel and restaurants.
As of September 2020, the national unemployment rate declined by a 0.5 percentage point over the month to 7.9%, but was 4.4 points higher than in September 2019. Improvements in the labor market reflect the continued resumption of economic activity that had been curtailed due to the COVID-19 pandemic and efforts to contain it. During September, more significant job gains occurred in leisure and hospitality, retail trade, health care and social assistance, and professional and business services. Employment in government declined over the month, mainly in state and local government education. Unemployment rates will be volatile and dependent upon the containment of the COVID-19 virus.
The unemployment rate for the Midwest, where the Company conducts most of its business, decreased from 11.0% in June 2020 to 7.2% in September 2020. Unemployment rates for September 2020 were Arkansas at 7.3%, Colorado at 6.4%, Georgia at 6.4%, Illinois at 10.2%, Iowa at 4.7%, Kansas at 5.9%, Minnesota at 6.0%, Missouri at 4.9%, Nebraska at 3.5%, Oklahoma at 5.3%, and Texas at 8.3%. Since August 2019, the Chicago area had a decrease of 366,600 jobs, ending with an unemployment rate of 11.5% as of September 2020 making them the highest unemployment rate among the metropolitan areas in which the Company does business. While all of the company’s metropolitan areas had an increase in unemployment due to the ongoing pandemic, other than Chicago, the remaining areas are equal to or below the National unemployment rate of 7.9%.
Housing
Sales of newly built single-family homes for September 2020 were at a seasonally adjusted annual rate of 959,000 according to U.S. Census Bureau and the Department of Housing and Urban Development estimates. This is 3.5% below the revised August 2020 rate of 994,000, but is 32.1 percent above the September 2019 estimate of 726,000. The median sales price of new houses sold in September 2020 was $326,800 up from $299,400 a year earlier. The September 2020 average sales price of $405,400 was up slightly from $362,700 a year ago. The inventory of new homes for sale at the end of September would support 3.6 months’ supply at the current sales pace, down from 5.5 months in September 2019.
Existing-home sales grew for the fourth consecutive month in September, showing strong signs of a market turnaround after three straight months of sales declines caused by the ongoing pandemic, according to the National Association of Realtors (NAR). For four straight months, home sales have grown in every region compared to the previous month. Existing-home sales grew 7.1% in the Midwest to an annual rate of 1.5 million in September 2020 up 19.8% from a year ago. Total existing home sales reached a seasonally adjusted rate of 6.5 million in September 2020. Total housing inventory at the end of September 2020 totaled 1.47 million units, down 1.3% from August and down 1.82 million, or 19.2%, from the previous year period. Unsold inventory sits at a 2.7 months’ supply at the current sale pace, down from 3.0 months in August and down from 4.0 months in September 2019.
The median existing home price for all housing types in September 2020 was $311,800, up 14.8% from a year ago. This price increase marks the 103rd straight month of year-over-year gains. Median home prices increased at double-digit rates in each of the four major regions from one year ago. The median price in the Midwest was $243,100, a 14.8% increase from September 2019. First-time buyers accounted for 31% of sales in September, down from 33% in both August 2020 and September 2019.
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According to Freddie Mac, the average commitment rate for a 30-year, conventional, fixed-rate mortgage dropped to 2.88%, down from 3.13% in June 2020. The average commitment rate for all of 2019 was 3.94%, down slightly from 4.54% for 2018.
The effects of the COVID-19 pandemic on real estate markets appeared in CoStar's multifamily data with daily asking rents for apartment units declining since March 11, just as the prime leasing season began to unfold. After flattening in May, rents began to rebound in June as cities nationwide worked to reopen their economies and the national job market continued to show signs of recovering. However, U.S apartment rents have trended lower since July, led by ongoing declines in downtown rents. During the pandemic, changes in attitudes regarding working from home have changed with renters seeking more space and affordability; i.e. rents for two-bedroom units have held up better, while studios have experienced the worst losses. Net absorption surged to more than 100,000 units in the third quarter, indicating pent-up demand for new apartments still exists. With the stimulus package behind us and eviction leniency periods ending, unemployment will continue to determine the long-term outlook for apartment demand.
As of the end of September 2020, national apartment vacancy rates stood at 6.8% while our market areas reflected the following vacancy levels: Springfield, Mo. at 4.6%, St. Louis at 8.9%, Kansas City at 7.9%, Minneapolis at 6.2%, Tulsa, Okla. at 7.3%, Dallas-Fort Worth at 8.4%, Chicago at 8.0%, Atlanta at 8.7% and Denver at 7.7%.
Commercial Real Estate Other Than Housing
The full impact of the coronavirus outbreak on the U.S. Office sector remains unclear, but per CoStar, demand for office space declined steeply in the third quarter, tripling the losses posted in the second quarter. As the pandemic continues to flare in areas, many companies have extended work from home protocols till mid-2021. Co-Star’s baseline forecast calls for office-using employment totals to return to pre-pandemic levels by the end of 2022, and continue to moderately accelerate from there. Annual rent growth has been slowing over the past several quarters and was flat in the third quarter. Even before the disruption caused by the pandemic, the trend of slowing growth was expected to continue in 2020 and lingering through 2021.
The retail sector of commercial real estate remains one of the most vulnerable to the impact of the COVID-19 pandemic. Gradual store re-openings throughout the nation and the relaxation of social distancing restrictions has modestly lifted consumer confidence and given hope for stabilization in the industry throughout the remainder of 2020. However, increasing infection rates throughout many mid-western and Southern states threat the continued path to stability producing additional certainty for retailers already struggling with reduced revenues and limited liquidity. Decline in sales of soft-good department stores, retail shops and restaurants, those believed to be the most hurt by the pandemic, will affect malls, strip centers and outlet centers by subsequent increase in vacancies. The wave of retail bankruptcies is expected to continue; however, tenants with essential-oriented offerings have thus far weathered the storm and arisen as a modest source of positive demand.
Though the industrial sector may fare best among commercial real estate sectors, its operating fundamentals will not fully escape the negative impacts of the COVID-19 recession. Dampened aggregate demand and reduced export growth along with disrupted and curtailed supply chains present a headwind for port markets and industrial distribution operators. Meanwhile, labor shortages arising from mandatory construction suspensions place further pressure on industrial operators, distributors and manufacturers. Negative factors in the industry are countered somewhat with the increased activity of large tenant groups including Amazon, third party logistics providers and larger retailers.
Under CoStar’s base case forecast, the moderation in demand, taking into consideration a considerable development pipeline, may result in a vacancy rate in the mid 6% range, which is still well below the peak of 10.6% reached during the Great Recession.
The degree to which the commercial real estate sector suffers is yet unknown, as the path and progression of the pandemic, and the economy's response to such measures taken remains fluid. In addition to forced and voluntary store closures, many retailers will struggle amid near-total loss of foot traffic, declining consumer sentiment, lost wages and restrained consumer spending activity.
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Our management will continue to monitor regional, national, and global economic indicators such as unemployment, GDP, housing starts and prices, commercial real estate occupancy, absorption and rental rates, as these could significantly affect customers in each of our market areas.
COVID-19 Impact to Our Business and Response
Great Southern is actively monitoring and responding to the effects of the rapidly-changing COVID-19 pandemic. As always, the health, safety and well-being of our customers, associates and communities are the Company’s top priorities. Centers for Disease Control and Prevention (CDC) guidelines, as well as directives from federal, state and local officials, are being closely followed to make informed operational decisions. A summary of the Company’s major COVID-19 responses and actions are highlighted below.
Great Southern Associates : During this unprecedented time, the Company is working diligently with its nearly 1,200 associates to enforce CDC-advised health, hygiene and social distancing practices. A significant number of non-frontline associates continue to work from home. Teams in nearly every operational department have been split, with part of each team working at an off-site disaster recovery facility to promote social distancing and to avoid service disruptions. To date, there have been no service disruptions or reductions in staffing.
Paid time off and other benefits were enhanced and implemented to support Great Southern associates. Part-time associates were awarded paid sick benefits for the first time. Any full-time or part-time associate will receive full pay if placed under a restrictive quarantine due to COVID-19 infection or direct exposure to an infected individual. The Company’s Employee Assistance Program (EAP) was enhanced at no cost to associates and family members seeking counseling services for mental health and emotional support needs.
As a token of appreciation for our employees’ dedication over the past several months, and to help support some of the needs of our associates, in August 2020, the Company again rewarded all full-time and part-time associates with special pre-tax bonuses of $1,000 and $600, respectively. This August bonus and related benefits expense totaled $1.1 million. This is the second such bonus paid by the Company in response to the COVID-19 pandemic; the first (also totaling $1.1 million) was approved in March 2020.
Great Southern Communities : Throughout 2020, we have continued to support local COVID-19 relief efforts through contributions to food banks, local United Way agencies and other nonprofit organizations to address food insecurity and support critical health and human services. Many of our employees also volunteer their time to serve various agencies and charitable organizations in their communities.
Great Southern Customers : Taking care of customers and providing uninterrupted access to services are top priorities. As always, customers can conduct their banking business using the banking center network, online and mobile banking services, ATMs, Telephone Banking, and online account opening services. As health conditions in local markets dictate, Great Southern banking center lobbies are open following strict social distancing guidance from the CDC and local government officials. If customer lobbies are closed in a market area, then drive-thru service and in-person service by appointment are available.
As a resource to customers, a COVID-19 information center has been made available on the Company’s website, www.GreatSouthernBank.com . General information about the Company’s pandemic response, how to receive assistance, and how to avoid COVID-19 scams and fraud are included.
Impacts to Our Business Going Forward : The magnitude of the impact on the Company of the COVID-19 pandemic is not yet fully known, and will depend on the length and severity of the economic downturn brought on by the pandemic. The Company expects that the COVID-19 pandemic will continue to impact our business in future periods in one or more of the following ways, among others. Each of these factors could, individually or collectively, result in reduced net income in future periods.
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· Significantly lower market interest rates will have a negative impact on our variable rate loans indexed to LIBOR and prime
· Certain fees for deposit and loan products may be waived or reduced
· Point-of-sale fee income may decline due to a decrease in spending by our debit card customers as they deal with state and local government requirements and other restrictions and may be adversely affected by reductions in their personal income and job losses
· Non-interest expenses may increase as we continue to deal with the effects of the COVID-19 pandemic, including cleaning costs, supplies, equipment and other items
· Banking center lobbies are open, but could be closed again if the pandemic situation worsens
· Additional loan modifications may occur and borrowers may default on their loans, which may necessitate further increases to the allowance for loan losses
· The contraction in economic activity may reduce demand for our loans and for our other products and services
Paycheck Protection Program Loans
Great Southern is actively participating in the Paycheck Protection Program (PPP) through the Small Business Administration (SBA) . The PPP has been met with very high demand throughout the country, resulting in a second round of funding through an amendment to the CARES Act. As of September 30, 2020, we originated approximately 1,600 PPP loans totaling approximately $121 million. Great Southern has received $4.7 million in fees from the SBA for originating these loans based on the amount of each loan. The fees, net of origination costs, will be deferred in accordance with standard accounting practices and will be accreted to interest income on loans over the contractual life of each loan. These loans generally have a contractual maturity of two years from origination date, but may be repaid or forgiven (by the SBA) sooner. If these loans are repaid or forgiven prior to their contractual maturity date, the remaining deferred fee for such loan will be accreted to interest income on loans immediately. We expect a high percentage of these net deferred fees will accrete to interest income in the fourth quarter of 2020 and the first quarter of 2021. In the three months ended September 30, 2020, Great Southern recorded approximately $440,000 of these net deferred fees in interest income on loans.
Loan Modifications
At September 30, 2020, we had remaining 88 modified commercial loans with an aggregate principal balance outstanding of $379 million and 407 modified consumer and mortgage loans with an aggregate principal balance outstanding of $17 million. The loan modifications are within the guidance provided by the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), the federal banking regulatory agencies, the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB); therefore, they are not considered troubled debt restructurings or classified assets for regulatory purposes. At September 30, 2020, the modified loans were in the following categories (dollars in millions):
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Collateral Type
# of Loans
Modified
$ of Loans
Modified
Interest Only
3 Months
Interest Only
4-6 Months
Interest Only
7-12 Months
Full Payment Deferral
3 Months
Full Payment Deferral
6 Months
Weighted Average Loan to Value
Retail
12
$
47.8
$
—
$
5.3
$
36.1
$
2.9
$
3.5
57%
Multifamily
8
78.4
7.6
46.3
24.4
0.1
—
71%
Healthcare
7
56.3
—
9.6
11.3
—
35.4
66%
Hotel/Motel
13
105.4
20.8
34.6
10.5
—
39.5
68%
Office
9
31.3
—
24.0
4.3
3.0
—
44%
Warehouse/Other
10
15.7
3.7
—
—
—
12.0
61%
Restaurants
9
15.2
—
3.7
—
—
11.5
55%
Commercial Business
15
16.4
5.2
—
5.5
—
5.7
Land
5
12.2
11.3
—
0.9
—
—
Total Commercial
88
378.7
48.6
123.5
93.0
6.0
107.6
Residential Mortgage
53
11.0
—
—
—
2.1
8.9
68%
Consumer
354
5.8
—
—
—
0.2
5.6
Total Consumer
407
16.8
—
—
—
2.3
14.5
Total
495
$
395.5
$
48.6
$
123.5
$
93.0
$
8.3
$
122.1
During the three months ended September 30, 2020, loans with an aggregate principal balance outstanding of $602 million completed the modification period and returned to their normal payment schedule. Of the loans modified at June 30, 2020, $55.8 million in payments were received on these loans during the three months ended September 30, 2020. A portion of the loans modified at September 30, 2020 may be further modified, and new loans may be modified, within the guidance provided by the CARES Act, the federal banking regulatory agencies, the SEC and the FASB if a more severe or lengthier deterioration in economic conditions occurs in future periods.
The Company has escalated monitoring activities related to the modified loans and has also increased review and monitoring activities for certain sectors of the loan portfolio which may be currently most impacted by the COVID-19 pandemic. The retail portfolio had an outstanding balance of $388 million at September 30, 2020, which was 11% of the total loan portfolio. It is a very granular portfolio, with an average loan size of $1.6 million. Most loans are under $5 million, with 28% of the outstanding balance of the retail portfolio represented by loans in excess of $10 million. At September 30, 2020, the weighted average loan-to-value ratio of this portfolio was 61%.
The hotel/motel portfolio had an outstanding balance of $196 million at September 30, 2020, which was 5% of the total loan portfolio. The average loan size is $4.3 million, with the 20 largest loans comprising approximately 90% of the portfolio. These properties are well-diversified geographically, mainly throughout the Midwest, with most being limited-service properties. Approximately 92% of the portfolio operates under the flag of major hotel chains. At September 30, 2020, the weighted average loan-to-value ratio of this portfolio was 56%.
The restaurant portfolio had an outstanding balance of $72 million at September 30, 2020, which was 2% of the total loan portfolio. It is a very granular portfolio, with the majority of the restaurants operating in Missouri, Illinois, Iowa and Minnesota. The majority of these loans are to franchisees of top-tier quick service brands with national scale that have had the ability to stay open with delivery and drive-through service throughout the course of the pandemic. At September 30, 2020, the weighted average loan-to-value ratio of this portfolio was 59%.
Total loans outstanding (excluding FDIC-assisted acquired loans, net of discount) in the following categories at September 30, 2020, were as follows (dollars in millions):
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Collateral Type
Outstanding
Balance of
Loans of This
Collateral Type
Percentage of Loans Modified To Total Loans
of This
Collateral Type
Percentage
of Loans
Modified To
Total Loans
Percentage
of Loans of This Collateral
Type to
Total Loans
Weighted Average Loan to Value of Loans in This Collateral Type
Retail
$
388.0
12%
1%
11%
61%
Healthcare
284.3
28%
2%
8%
59%
Hotel/Motel
196.2
29%
2%
5%
56%
Multifamily
988.0
11%
3%
27%
63%
Office
274.8
11%
1%
7%
68%
Warehouse/Other
282.4
6%
<1%
8%
57%
Commercial Business (1)
242.2
6%
<1%
7%
Restaurants
72.0
23%
<1%
2%
59%
Land
67.2
18%
<1%
2%
59%
Total Commercial
2,795.1
14%
10%
76%
Residential Mortgage
619.5
2%
<1%
17%
71%
Consumer
254.1
2%
<1%
7%
Total Consumer
873.6
2%
<1%
24%
Total
$
3,668.7
11%
11%
100%
(1) The Commercial Business outstanding loan balance excludes PPP loans of $121.1 million.
General
The profitability of the Company and, more specifically, the profitability of its primary subsidiary, the Bank, depend primarily on net interest income, as well as provisions for loan losses and the level of non-interest income and non-interest expense. Net interest income is the difference between the interest income the Bank earns on its loans and investment portfolios, and the interest it pays on interest-bearing liabilities, which consists mainly of interest paid on deposits and borrowings. Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on these balances. When interest-earning assets approximate or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.
Great Southern's total assets increased $427.9 million, or 8.5%, from $5.02 billion at December 31, 2019, to $5.44 billion at September 30, 2020. Full details of the current period changes in total assets are provided in the “Comparison of Financial Condition at September 30, 2020 and December 31, 2019” section of this Quarterly Report on Form 10-Q.
Loans. Net outstanding loans increased $259.8 million, or 6.3%, from $4.15 billion at December 31, 2019, to $4.41 billion at September 30, 2020. The net increase in loans reflects reductions of $21.1 million in the FDIC-assisted acquired loan portfolios. This increase was primarily in other residential (multi-family) loans, commercial business loans, one- to four-family residential loans and commercial real estate loans. Approximately 61% of the one- to- four-family residential loan originations in the nine months ended September 30, 2020 were refinanced loans. These increases were partially offset by decreases in construction loans and consumer auto loans. The increases were primarily due to loan growth in our existing banking center network and our commercial loan production offices, and included approximately $121 million of PPP loans. Excluding FDIC-assisted acquired loans and mortgage loans held for sale, total gross loans increased $229.6 million, or 4.7%, from December 31, 2019 to September 30, 2020. As loan demand is affected by a variety of factors, including general economic conditions, and because of the competition we face and our focus on pricing discipline and credit quality, no assurances can be made regarding our future loan growth. We expect minimal loan growth for the foreseeable future due to deteriorating economic conditions resulting from the COVID-19 pandemic. The Company's strategy continues to be focused on maintaining credit risk and interest rate risk at appropriate levels.
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Recent loan growth has occurred in several loan types, primarily other residential (multi-family) loans, one- to four-family residential mortgage loans and commercial business loans and in most of Great Southern’s primary lending locations, including Springfield, St. Louis, Kansas City, Des Moines and Minneapolis, as well as our loan production offices in Atlanta, Chicago, Dallas, Denver, Omaha and Tulsa. Certain minimum underwriting standards and monitoring help assure the Company’s portfolio quality. Great Southern’s loan committee reviews and approves all new loan originations in excess of lender approval authorities. Generally, the Company considers commercial construction, consumer, and commercial real estate loans to involve a higher degree of risk compared to some other types of loans, such as first mortgage loans on one- to four-family, owner-occupied residential properties. For commercial real estate, commercial business and construction loans, the credits are subject to an analysis of the borrower’s and guarantor’s financial condition, credit history, verification of liquid assets, collateral, market analysis and repayment ability. It has been, and continues to be, Great Southern’s practice to verify information from potential borrowers regarding assets, income or payment ability and credit ratings as applicable and as required by the authority approving the loan. To minimize construction risk, projects are monitored as construction draws are requested by comparison to budget and with progress verified through property inspections. The geographic and product diversity of collateral, equity requirements and limitations on speculative construction projects help to mitigate overall risk in these loans. Underwriting standards for all loans also include loan-to-value ratio limitations, which vary depending on collateral type, debt service coverage ratios or debt payment to income ratio guidelines, where applicable, credit histories, use of guaranties and other recommended terms relating to equity requirements, amortization, and maturity. Consumer loans are primarily secured by new and used motor vehicles and these loans are also subject to certain minimum underwriting standards to assure portfolio quality. While Great Southern’s consumer underwriting and pricing standards have been fairly consistent in recent years, the Company tightened its underwriting guidelines on automobile lending beginning in the latter part of 2016. Management took this step in an effort to improve credit quality in the portfolio and reduce delinquencies and charge-offs. The underwriting standards employed by Great Southern for consumer loans include a determination of the applicant's payment history on other debts, credit scores, employment history and an assessment of ability to meet existing obligations and payments on the proposed loan. In 2019, the Company discontinued indirect auto loan originations. See “Item 1. Business – Lending Activities – General, – Commercial Real Estate and Construction Lending, and – Consumer Lending” in the Company’s December 31, 2019 Annual Report on Form 10-K.
While our policy allows us to lend up to 95% of the appraised value on one-to four-family residential properties, originations of loans with loan-to-value ratios at that level are minimal. Private mortgage insurance is typically required for loan amounts above the 80% level. Few exceptions occur and would be based on analyses which determined minimal transactional risk to be involved. We consider these lending practices to be consistent with or more conservative than what we believe to be the norm for banks our size. At September 30, 2020 and December 31, 2019, none of our owner occupied one- to four-family residential loans had loan-to-value ratios above 100% at origination. At both September 30, 2020 and December 31, 2019, an estimated 0.6% of total non-owner occupied one- to four-family residential loans had loan-to-value ratios above 100% at origination.
At September 30, 2020, troubled debt restructurings totaled $3.7 million, or 0.08% of total loans, an increase of $1.8 million from $1.9 million, or 0.05% of total loans, at December 31, 2019. Concessions granted to borrowers experiencing financial difficulties may include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. For troubled debt restructurings occurring during the nine months ended September 30, 2020, six loans totaling $149,000 were restructured into multiple new loans. For troubled debt restructurings occurring during the year ended December 31, 2019, five loans totaling $34,000 were restructured into multiple new loans. For further information on troubled debt restructurings, see Note 6 of the Notes to Consolidated Financial Statements contained in this report. In accordance with the CARES Act and guidance from the banking regulatory agencies, we made certain short-term modifications to loan terms to help our customers navigate through the current pandemic situation. Although loan modifications were made, they did not result in these loans being classified as troubled debt restructurings, potential problem loans or non-performing loans. If more severe or lengthier negative impacts of the COVID-19 pandemic occur or the effects of the SBA loan programs and other loan and stimulus programs do not enable companies and individuals to completely recover financially, this could result in longer-term modifications, which may be deemed to be troubled debt restructurings, additional potential problem loans and/or additional non-performing loans.
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Loans that were acquired through FDIC-assisted transactions, which are accounted for in pools, are currently included in the analysis and estimation of the allowance for loan losses. If expected cash flows to be received on any given pool of loans decreases from previous estimates, then a determination is made as to whether the loan pool should be charged down or the allowance for loan losses should be increased (through a provision for loan losses). Acquired loans are described in Note 7 of the Notes to Consolidated Financial Statements contained in this report. For acquired loan pools, the Company may allocate, and at September 30, 2020, has allocated, a portion of its allowance for loan losses related to these loan pools in a manner similar to how it allocates its allowance for loan losses to those loans which are collectively evaluated for impairment.
The level of non-performing loans and foreclosed assets affects our net interest income and net income. We generally do not accrue interest income on these loans and do not recognize interest income until the loans are repaid or interest payments have been made for a period of time sufficient to provide evidence of performance on the loans. Generally, the higher the level of non-performing assets, the greater the negative impact on interest income and net income.
Available-for-sale Securities. In the nine months ended September 30, 2020, available-for-sale securities increased $71.7 million, or 19.2%, from $374.2 million at December 31, 2019, to $445.9 million at September 30, 2020. The increase was primarily due to the purchase of FNMA and GNMA fixed-rate multi-family mortgage-backed securities and collateralized mortgage obligations and short-term municipal securities, partially offset by calls of municipal securities and normal monthly payments received related to the portfolio of mortgage-backed securities. The Company used increased deposits to fund this increase in investment securities.
Deposits. The Company attracts deposit accounts through its retail branch network, correspondent banking and corporate services areas, and brokered deposits. The Company then utilizes these deposit funds, along with FHLBank advances and other borrowings, to meet loan demand or otherwise fund its activities. In the nine months ended September 30, 2020, total deposit balances increased $483.7 million, or 12.2%. T ransaction account balances increased $694.3 million, or 31.0%, to $2.93 billion at September 30, 2020 , while retail certificates of deposit decreased $81.8 million, or 6.1%, to $1.27 billion at September 30, 2020 . The increases in transaction accounts were primarily a result of increased customers in the CDARS reciprocal program, money market accounts and NOW deposit accounts. Retail certificates of deposit decreased due to a decrease in retail certificates generated through the banking center network, partially offset by increases in customer deposits in the CDARS reciprocal program. Customer deposits at September 30, 2020 and December 31, 2019, totaling $56.1 million and $35.3 million, respectively, were part of the CDARS program, which allows customers to maintain balances in an insured manner that would otherwise exceed the FDIC deposit insurance limit. Brokered deposits, including CDARS program purchased funds, were $242.9 million at September 30, 2020 , a decrease of $128.8 million from $371.7 million at December 31, 2019. The brokered deposits were allowed to mature without replacement as other deposit categories increased.
Our deposit balances may fluctuate depending on customer preferences and our relative need for funding. We do not consider our retail certificates of deposit to be guaranteed long-term funding because customers can withdraw their funds at any time with minimal interest penalty. When loan demand trends upward, we can increase rates paid on deposits to attract more deposits and utilize brokered deposits to provide additional funding. The level of competition for deposits in our markets is high. It is our goal to gain deposit market share, particularly checking accounts, in our branch footprint. To accomplish this goal, increasing rates to attract deposits may be necessary, which could negatively impact the Company’s net interest margin.
Our ability to fund growth in future periods may also depend on our ability to continue to access brokered deposits and FHLBank advances. In times when our loan demand has outpaced our generation of new deposits, we have utilized brokered deposits and FHLBank advances to fund these loans. These funding sources have been attractive to us because we can create either fixed or variable rate funding, as desired, which more closely matches the interest rate nature of much of our loan portfolio. It also gives us greater flexibility in increasing or decreasing the duration of our funding. While we do not currently anticipate that our ability to access these sources will be reduced or eliminated in future periods, if this should happen, the limitation on our ability to fund additional loans could have a material adverse effect on our business, financial condition and results of operations.
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Federal Home Loan Bank Advances and Short-Term Borrowings. The Company had no Federal Home Loan Bank advances outstanding at September 30, 2020 or December 31, 2019. At September 30, 2020, there were also no overnight borrowings from the FHLBank. At December 31, 2019, there were no borrowings from the FHLBank other than overnight advances, which are included in the short term borrowings category.
Short term borrowings and other interest-bearing liabilities decreased $227.0 million from $228.2 million at December 31, 2019 to $1.2 million at September 30, 2020. The short term borrowings included overnight FHLBank borrowings of $-0- and $196.0 million at September 30, 2020 and December 31, 2019, respectively. The Company utilizes both overnight borrowings and short-term FHLBank advances depending on relative interest rates.
Securities sold under reverse repurchase agreements with customers. Securities sold under reverse repurchase agreements with customers increased $70.8 million from $84.2 million at December 31, 2019 to $155.0 million at September 30, 2020 . These balances fluctuate over time based on customer demand for this product. A large portion of this increase is related to two customers who placed additional funds in these account types.
Subordinated notes. Subordinated notes increased $74.0 million from $74.2 million at December 31, 2019 to $148.2 million at September 30, 2020 . The Company issued $75.0 million of subordinated notes in June 2020, receiving net proceeds of $73.5 million.
Net Interest Income and Interest Rate Risk Management. Our net interest income may be affected positively or negatively by changes in market interest rates. A large portion of our loan portfolio is tied to one-month LIBOR, three-month LIBOR or the "prime rate" and adjusts immediately or shortly after the index rate adjusts (subject to the effect of contractual interest rate floors on some of the loans, which are discussed below). We monitor our sensitivity to interest rate changes on an ongoing basis (see "Item 3. Quantitative and Qualitative Disclosures About Market Risk"). In addition, our net interest income has been impacted by changes in the cash flows expected to be received from acquired loan pools. As described in Note 7 of the Notes to the Consolidated Financial Statements contained in this report, the Company’s evaluation of cash flows expected to be received from acquired loan pools has been on-going and increases in cash flow expectations have been recognized as increases in accretable yield through interest income. Decreases in cash flow expectations have been recognized as impairments through the allowance for loan losses.
The current level and shape of the interest rate yield curve poses challenges for interest rate risk management. Prior to its increase of 0.25% on December 16, 2015, the FRB had last changed interest rates on December 16, 2008. This was the first rate increase since September 29, 2006. The FRB also implemented rate change increases of 0.25% on eight additional occasions beginning December 14, 2016 and through December 31, 2018, with the Federal Funds rate reaching as high as 2.50%. After December 2018, the FRB paused its rate increases and, in July, September and October 2019, implemented rate change decreases of 0.25% on each of those occasions. At December 31, 2019, the Federal Funds rate stood at 1.75%. In response to the COVID-19 pandemic, the FRB decreased interest rates on two occasions in March 2020, a 0.50% decrease on March 3 and a 1.00% decrease on March 16. At September 30, 2020, the Federal Funds rate stood at 0.25%. A substantial portion of Great Southern’s loan portfolio ($2.10 billion at September 30 , 2020 ) is tied to the one-month or three-month LIBOR index and will be subject to adjustment at least once within 90 days after September 30, 2020 . Of these loans, $2.08 billion had interest rate floors. Great Southern also has a portfolio of loans ($256 million at September 30, 2020 ) tied to a "prime rate" of interest and will adjust immediately with changes to the “prime rate” of interest. A rate cut by the FRB generally would have an anticipated immediate negative impact on the Company’s net interest income due to the large total balance of loans tied to the one-month or three-month LIBOR index and will be subject to adjustment at least once within 90 days or loans which generally adjust immediately as the Federal Funds rate adjusts. Interest rate floors may at least partially mitigate the negative impact of interest rate decreases. Loans at their floor rates are, however, subject to the risk that borrowers will seek to refinance elsewhere at the lower market rate. Because the Federal Funds rate is again very low, there may also be a negative impact on the Company's net interest income due to the Company's inability to significantly lower its funding costs in the current competitive rate environment, although interest rates on assets may decline further. Conversely, interest rate increases would normally result in increased interest rates on our LIBOR-based and prime-based loans. As of September 30, 2020 , Great Southern's interest rate risk models indicate that, generally, rising interest rates are expected to have a positive impact on the Company's net interest income,
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while declining interest rates are expected to have a negative impact on net interest income. We model various interest rate scenarios for rising and falling rates, including both parallel and non-parallel shifts in rates. The results of our modeling indicate that net interest income is not likely to be significantly affected either positively or negatively in the first twelve months following a rate change, regardless of any changes in interest rates, because our portfolios are relatively well-matched in a twelve-month horizon. In a situation where market interest rates decrease significantly in a short period of time, as they did in March 2020, our net interest margin decrease may be more pronounced in the very near term (first one to three months), due to fairly rapid decreases in LIBOR interest rates. In the subsequent months we expect that the net interest margin would stabilize and begin to improve, as renewal interest rates on maturing time deposits are expected to decrease compared to the current rates paid on those products. During the latter half of 2019 and the nine months ended September 30, 2020, we did experience some compression of our net interest margin percentage due to 2.25% of Federal Fund rate cuts during the nine month period of July 2019 through March 2020. Margin compression primarily resulted from generally slower changing average interest rates on deposits and borrowings and lower yields on loans and other interest-earning assets. LIBOR interest rates have recently decreased, putting pressure on loan yields, and strong pricing competition for loans and deposits remains in most of our markets. For further discussion of the processes used to manage our exposure to interest rate risk, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk – How We Measure the Risks to Us Associated with Interest Rate Changes.”
Non-Interest Income and Non-Interest (Operating) Expenses. The Company's profitability is also affected by the level of its non-interest income and operating expenses. Non-interest income consists primarily of service charges and ATM fees, late charges and prepayment fees on loans, gains on sales of loans and available-for-sale investments and other general operating income. Non-interest income may also be affected by the Company's interest rate derivative activities, if the Company chooses to implement derivatives. See Note 16 “Derivatives and Hedging Activities” in the Notes to Consolidated Financial Statements included in this report.
Operating expenses consist primarily of salaries and employee benefits, occupancy-related expenses, expenses related to foreclosed assets, postage, FDIC deposit insurance, advertising and public relations, telephone, professional fees, office expenses and other general operating expenses. Details of the current period changes in non-interest income and non-interest expense are provided in the “Results of Operations and Comparison for the Three and Nine Months Ended September 30, 2020 and 2019” section of this report.
Effect of Federal Laws and Regulations
General. Federal legislation and regulation significantly affect the operations of the Company and the Bank, and have increased competition among commercial banks, savings institutions, mortgage banking enterprises and other financial institutions. In particular, the capital requirements and operations of regulated banking organizations such as the Company and the Bank have been and will be subject to changes in applicable statutes and regulations from time to time, which changes could, under certain circumstances, adversely affect the Company or the Bank.
Dodd-Frank Act. In 2010, sweeping financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act implemented far-reaching changes across the financial regulatory landscape. Certain aspects of the Dodd-Frank Act have been affected by the more recently enacted Economic Growth Act, as defined and discussed below under “-Economic Growth Act.”
Capital Rules. The federal banking agencies have adopted regulatory capital rules that substantially amend the risk-based capital rules applicable to the Bank and the Company. The rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to various documents released by the Basel Committee on Banking Supervision. For the Company and the Bank, the general effective date of the rules was January 1, 2015, and, for certain provisions, various phase-in periods and later effective dates apply. The chief features of these rules are summarized below.
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The rules refine the definitions of what constitutes regulatory capital and add a new regulatory capital element, common equity Tier 1 capital. The minimum capital ratios are (i) a common equity Tier 1 (“CET1”) risk-based capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6%; (iii) a total risk-based capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. In addition to the minimum capital ratios, the rules include a capital conservation buffer, under which a banking organization must have CET1 more than 2.5% above each of its minimum risk-based capital ratios in order to avoid restrictions on paying dividends, repurchasing shares, and paying certain discretionary bonuses. The capital conservation buffer requirement began phasing in on January 1, 2016 when a buffer greater than 0.625% of risk-weighted assets was required, which amount increased an equal amount each year until the buffer requirement of greater than 2.5% of risk-weighted assets became fully implemented on January 1, 2019.
Effective January 1, 2015, these rules also revised the prompt corrective action framework, which is designed to place restrictions on insured depository institutions if their capital levels show signs of weakness. Under the revised prompt corrective action requirements, insured depository institutions are required to meet the following in order to
qualify as “well capitalized:” (i) a common equity Tier 1 risk-based capital ratio of at least 6.5%, (ii) a Tier 1 risk-based capital ratio of at least 8%, (iii) a total risk-based capital ratio of at least 10% and (iv) a Tier 1 leverage ratio of 5%, and must not be subject to an order, agreement or directive mandating a specific capital level.
Economic Growth Act. In May 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Economic Growth Act”), was enacted to modify or eliminate certain financial reform rules and regulations, including some implemented under the Dodd-Frank Act. While the Economic Growth Act maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets of more than $50 billion. Many of these amendments could result in meaningful regulatory changes.
The Economic Growth Act, among other matters, expands the definition of qualified mortgages which may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” of between 8 and 10 percent. Any qualifying depository institution or its holding company that exceeds the “Community Bank Leverage Ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be considered “well-capitalized” under the prompt corrective action rules. Effective January 1, 2020, the Community Bank Leverage Ratio was 9.0%. In April 2020, pursuant to the CARES Act, the federal bank regulatory agencies announced the issuance of two interim final rules, effective immediately, to provide temporary relief to community banking organizations. Under the interim final rules, the Community Bank Leverage Ratio requirement is a minimum of 8% for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. The Company and the Bank have chosen to not utilize the new Community Bank Leverage Ratio due to the Company’s size and complexity, including its commercial real estate and construction lending concentrations and significant off-balance sheet funding commitments.
In addition, the Economic Growth Act includes regulatory relief in the areas of examination cycles, call reports, mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
Business Initiatives
The Company’s banking center network continues to evolve. In August 2020, remodeling of the downtown office at 1900 Main in Parsons, Kansas, was completed, which included the addition of drive-thru banking lanes. With this completion, the nearby drive-thru facility was consolidated into the downtown office, leaving one location serving the Parsons market.
In the Joplin, Missouri, market, the Company purchased a banking facility in the fourth quarter of 2019 vacated by another financial institution, which included a contractual black-out period ending in April 2021. A third party vendor has been engaged by the Company to redesign this facility as a “bank of the future” prototype to incorporate evolving customer preferences. Variations of this prototype design may be utilized in other select banking centers in the Company’s footprint in the future. The Company expects the new office in Joplin to be completed in the second quarter of 2021, whereupon the nearby leased banking center at 1710 E. 32nd Street will be consolidated into this new office. There are two banking centers currently serving the Joplin market.
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The Company’s Board of Directors recently approved a new stock repurchase program, which will succeed the existing repurchase program (authorized in April 2018) following the repurchase of the remaining approximately 75,111 available shares under the existing program. The new stock repurchase program authorizes the repurchase, from time to time, of up to one million additional shares of the Company’s common stock.
Comparison of Financial Condition at September 30, 2020 and December 31, 2019
During the nine months ended September 30, 2020, the Company’s total assets increased by $427.9 million to $5.44 billion. The increase was primarily attributable to increases in loans receivable, available-for-sale investment securities, and cash equivalents.
Cash and cash equivalents were $338.3 million at September 30, 2020, an increase of $118.1 million, or 53.6%, from $220.2 million at December 31, 2019. This increase was primarily related to excess funds held at the Federal Reserve Bank after repayment of FHLBank overnight borrowings. The additional funds were primarily the result of increases in deposits.
The Company's available-for-sale securities increased $71.7 million, or 19.2%, compared to December 31, 2019. The increase was primarily due to the purchase of FNMA and GNMA fixed-rate multi-family mortgage-backed securities and short-term municipal securities, partially offset by calls of municipal securities and normal monthly payments received related to the portfolio of mortgage-backed securities. The available-for-sale securities portfolio was 8.2% and 7.5% of total assets at September 30, 2020 and December 31, 2019, respectively.
Net loans increased $259.8 million from December 31, 2019, to $4.41 billion at September 30, 2020. Excluding FDIC-assisted acquired loans and mortgage loans held for sale, total gross loans (including the undisbursed portion of loans) increased $229.6 million, or 4.7%, from December 31, 2019 to September 30, 2020. This increase was primarily in other residential (multi-family) loans ($152.4 million), commercial business loans ($126.0 million), and one- to four-family residential loans ($88.5 million). These increases were partially offset by decreases in construction loans ($117.8 million) and consumer auto loans ($52.6 million).
Total liabilities increased $406.4 million, from $4.41 billion at December 31, 2019 to $4.82 billion at September 30 , 2020 . The increase was primarily attributable to an increase in deposits, securities sold under reverse repurchase agreements and subordinated notes, partially offset by a decrease in short term borrowings.
Total deposits increased $483.7 million, or 12.2%, to $4.44 billion at September 30, 2020. T ransaction account balances increased $694.3 million to $2.93 billion at September 30, 2020 , while retail certificates of deposit decreased $81.8 million compared to December 31, 2019, to $1.27 billion at September 30, 2020 . The increase in transaction accounts was primarily a result of increases in NOW deposit accounts, money market accounts and Insured Cash Sweep (ICS) reciprocal accounts. Retail certificates of deposit decreased due to a net decrease in retail certificates generated through the banking center network, partially offset by increases in customer deposits in the CDARS reciprocal program. Customer deposits at September 30 , 2020 and December 31, 2019 totaling $56.1 million and $35.3 million, respectively, were part of the CDARS program, which allows customers to maintain balances in an insured manner that would otherwise exceed the FDIC deposit insurance limit. Brokered deposits, including CDARS program purchased funds, were $242.9 million at September 30, 2020 , a decrease of $128.8 million from $371.7 million at December 31, 2019. The brokered deposits were allowed to mature without replacement as other deposit categories increased.
The Company had no FHLBank advances outstanding at September 30, 2020 or December 31, 2019. At December 31, 2019, there were no borrowings from the FHLBank other than overnight advances, which are included in the short term borrowings category. There were no borrowings from the FHLBank outstanding at September 30, 2020.
Short term borrowings and other interest-bearing liabilities decreased $227.0 million from $228.2 million at December 31, 2019 to $1.2 million at September 30 , 2020 . There were no short term borrowings at September 30, 2020 and $196.0 million in short term borrowings included in overnight FHLBank borrowings at December 31, 2019. The Company utilizes both overnight borrowings and short term FHLBank advances depending on relative interest rates.
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Securities sold under reverse repurchase agreements with customers increased $70.8 million from $84.2 million at December 31, 2019 to $155.0 million at September 30, 2020 . These balances fluctuate over time based on customer demand for this product.
Subordinated notes increased $74.0 million from $74.2 million at December 31, 2019 to $148.2 million at September 30, 2020 . The Company issued $75.0 million of subordinated notes in June 2020, receiving net proceeds of $73.5 million.
Total stockholders' equity increased $21.5 million from $603.1 million at December 31, 2019 to $624.6 million at September 30, 2020. The Company recorded net income of $41.5 million for the nine months ended September 30, 2020. Accumulated other comprehensive income increased $23.4 million due to increases in the fair value of available-for-sale investment securities and the termination value of the cash flow hedge. In addition, total stockholders’ equity increased $1.2 million due to stock option exercises. These increases were partially offset by dividends declared on common stock of $28.6 million and repurchases of the Company’s common stock totaling $15.9 million.
Results of Operations and Comparison for the Three and Nine Months Ended September 30, 2020 and 2019
General
Net income was $13.5 million for the three months ended September 30, 2020 compared to $19.7 million for the three months ended September 30, 2019. This decrease of $6.3 million, or 31.8%, was primarily due to an increase in noninterest expense of $3.3 million, or 11.4%, an increase in provision for loan losses of $2.6 million, or 130.8%, and a decrease in net interest income of $1.8 million or 3.8%, partially offset by an increase in noninterest income of $811,000, or 9.4%, and a decrease in income tax expense of $480,000, or 11.5%.
Net income was $41.5 million for the nine months ended September 30, 2020 compared to $55.7 million for the nine months ended September 30, 2019. This decrease of $14.2 million, or 25.5%, was primarily due to an increase in provision for loan losses of $8.9 million, or 161.3%, an increase in noninterest expense of $6.5 million, or 7.7%, and a decrease in net interest income of $2.9 million, or 2.1%, partially offset by a decrease in income tax expense of $2.3 million, or 19.2%, and an increase in noninterest income of $1.8 million, or 7.9%.
Total Interest Income
Total interest income decreased $6.6 million, or 10.9%, during the three months ended September 30, 2020 compared to the three months ended September 30, 2019. The decrease was due to a $6.8 million decrease in interest income on loans, partially offset by an increase in interest income on investments and other interest-earning assets of $162,000. Interest income on loans decreased for the three months ended September 30, 2020 compared to the same period in 2019, due to lower average rates of interest on loans, partially offset by higher average balances. Interest income from investment securities and other interest-earning assets increased during the three months ended September 30, 2020 compared to the same period in 2019 primarily due to higher average balances of investment securities and other interest-earning assets, partially offset by lower average rates of interest.
Total interest income decreased $11.2 million, or 6.3%, during the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019. The decrease was due to a $12.1 million decrease in interest income on loans, partially offset by a $916,000 increase in interest income on investments and other interest-earning assets. Interest income on loans decreased for the nine months ended September 30, 2020 compared to the same period in 2019, due to lower average rates of interest on loans, partially offset by higher average balances. Interest income from investment securities and other interest-earning assets increased during the nine months ended September 30, 2020 compared to the same period in 2019 primarily due to higher average balances of investment securities and other interest-earning assets, partially offset by lower average rates of interest.
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Interest Income – Loans
During the three months ended September 30, 2020 compared to the three months ended September 30, 2019, interest income on loans decreased $10.7 million as a result of lower average interest rates on loans. The average yield on loans decreased from 5.41% during the three months ended September 30, 2019, to 4.46% during the three months ended September 30, 2020. This decrease was primarily due to decreased yields in most loan categories as a result of decreased LIBOR and Federal Funds interest rates. In addition in the 2020 period, the Company originated $121 million of PPP loans, which have a much lower yield compared to the overall loan portfolio. Interest income on loans increased $4.0 million as the result of higher average loan balances, which increased from $4.20 billion during the three months ended September 30, 2019, to $4.51 billion during the three months ended September 30, 2020. The higher average balances were primarily due to organic loan growth in commercial business loans (including the PPP loans), other residential (multi-family), and one- to four-family residential loans, partially offset by decreases in outstanding construction and consumer loans.
During the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019, interest income on loans decreased $21.5 million as a result of lower average interest rates on loans. The average yield on loans decreased from 5.41% during the nine months ended September 30, 2019, to 4.74% during the nine months ended September 30, 2020. This decrease was primarily due to decreased yields in most loan categories as a result of decreased LIBOR and Federal Funds interest rates during the nine months ended September 30, 2020. This decrease also includes PPP loans, which have a much lower yield compared to the overall loan portfolio. Interest income on loans increased $9.4 million as the result of higher average loan balances, which increased from $4.14 billion during the nine months ended September 30, 2019, to $4.38 billion during the nine months ended September 30, 2020. The higher average balances were primarily due to organic growth in commercial business loans (including the PPP loans), other residential (multi-family) loans, and one- to four-family residential loans, partially offset by decreases in outstanding construction and consumer loans.
On an on-going basis, the Company has estimated the cash flows expected to be collected from acquired loan pools. For each of the loan portfolios acquired, the cash flow estimates have increased, based on the payment histories and the collection of certain loans, thereby reducing loss expectations of certain loan pools, resulting in adjustments to be spread on a level-yield basis over the remaining expected lives of the loan pools. For the three months ended September 30, 2020 and 2019, the adjustments increased interest income by $1.2 million and $2.3 million, respectively. For the nine months ended September 30, 2020 and 2019, the adjustments increased interest income by $4.6 million and $5.2 million, respectively.
As of September 30, 2020, the remaining accretable yield adjustment that will affect interest income was $2.9 million. Of the remaining adjustments affecting interest income, we expect to recognize $932,000 of interest income during the fourth quarter of 2020. Apart from the yield accretion, the average yield on loans was 4.35% during the three months ended September 30, 2020, compared to 5.20% during the three months ended September 30, 2019, as a result of lower current market rates on adjustable rate loans and new loans originated during the year. Apart from the yield accretion, the average yield on loans was 4.60% during the nine months ended September 30, 2020, compared to 5.24% during the nine months ended September 30, 2019.
In October 2018, the Company entered into an interest rate swap transaction as part of its ongoing interest rate management strategies to hedge the risk of its floating rate loans. The notional amount of the swap was $400 million with a contractual termination date in October 2025. Under the terms of the swap, the Company received a fixed rate of interest of 3.018% and paid a floating rate of interest equal to one-month USD-LIBOR. The floating rate reset monthly and net settlements of interest due to/from the counterparty also occurred monthly. To the extent that the fixed rate exceeded one-month USD-LIBOR, the Company received net interest settlements, which were recorded as interest income on loans. If one-month USD-LIBOR exceeded the fixed rate of interest, the Company was required to pay net settlements to the counterparty and record those net payments as a reduction of interest income on loans. The Company recorded interest income related to the swap of $2.0 million and $5.6 million, respectively, in the three and nine months ended September 30, 2020. The Company recorded loan interest income related to this swap transaction of $801,000 and $1.9 million, respectively, in the three and nine months ended September 30, 2019.
58
On March 2, 2020, the Company and its swap counterparty mutually agreed to terminate the swap, effective immediately. The Company received a payment of $45.9 million, including accrued but unpaid interest, from its swap counterparty as a result of this termination. This $45.9 million, less the accrued interest portion and net of deferred income taxes, is reflected in the Company’s stockholders’ equity as Accumulated Other Comprehensive Income and a portion of it will be accreted to interest income on loans monthly through the original contractual termination date of October 6, 2025. This will have the effect of reducing Accumulated Other Comprehensive Income and increasing Interest Income and Retained Earnings over the period. In each quarterly period, commencing with the quarter ended June 30, 2020, until the original contract termination date, the Company expects to record loan interest income related to this swap transaction of approximately $2.0 million, based on the termination values of the swap.
Interest Income – Investments and Other Interest-earning Assets
Interest income on investments increased $526,000 in the three months ended September 30, 2020 compared to the three months ended September 30, 2019. Interest income increased $736,000 as a result of an increase in average balances from $342.3 million during the three months ended September 30, 2019, to $449.4 million during the three months ended September 30, 2020. Average balances of securities increased primarily due to purchases of agency multi-family mortgage-backed securities which have a fixed rate of interest with expected lives of six to twelve years. These purchased securities fit with the Company’s current asset/liability management strategies. Interest income decreased $210,000 as a result of lower average interest rates from 2.94% during the three months ended September 30, 2019, to 2.71% during the three month period ended September 30, 2020.
Interest income on investments increased $2.0 million in the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019. Interest income increased $2.5 million as a result of an increase in average balances from $310.2 million during the nine months ended September 30, 2019, to $422.7 million during the nine months ended September 30, 2020. Average balances of securities increased primarily due to purchases of agency multi-family mortgage-backed securities which have a fixed rate of interest with expected lives of six to twelve years. As noted above, these purchased securities fit with the Company’s current asset/liability management strategies. Interest income decreased $459,000 as a result of lower average interest rates from 3.10% during the nine months ended September 30, 2019, to 2.92% during the nine month period ended September 30, 2020.
Interest income on other interest-earning assets decreased $364,000 in the three months ended September 30, 2020 compared to the three months ended September 30, 2019. Interest income decreased $685,000, primarily as a result of the decrease in average interest rates to 0.09% during the three months ended September 30, 2020 compared to 2.13% during the three months ended September 30, 2019. Market interest rates earned on balances held at the Federal Reserve Bank were significantly lower in the 2020 period due to significant reductions in the federal funds rate of interest. Partially offsetting this decrease, interest income increased $321,000, primarily as a result of the increase in average balances from $79.3 million during the three months ended September 30, 2019, to $270.5 million during the three months ended September 30, 2020. Excess liquidity, after repayment of FHLBank borrowings, was maintained at the Federal Reserve Bank as a result of the significant increase in deposits during the three months ended September 30, 2020.
Interest income on other interest-earning assets decreased $1.1 million in the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019. Interest income decreased $2.1 million, primarily as a result of the decrease in average interest rates to 0.24% during the nine months ended September 30, 2020 compared to 2.32% during the nine months ended September 30, 2019. Market interest rates earned on balances held at the Federal Reserve Bank were significantly lower in the 2020 period due to significant reductions in the federal funds rate of interest. Partially offsetting this decrease, interest income increased $1.0 million, primarily as a result of the increase in average balances from $87.2 million during the nine months ended September 30, 2019, to $227.5 million during the nine months ended September 30, 2020.
59
Total Interest Expense
Total interest expense decreased $4.8 million, or 33.9%, during the three months ended September 30, 2020, when compared with the three months ended September 30, 2019, due to a decrease in interest expense on deposits of $4.7 million, or 39.8%, a decrease in interest expense on short-term borrowings and repurchase agreements of $1.1 million, or 99.3%, and a decrease in interest expense on subordinated debentures issued to capital trust of $125,000, or 49.4%, partially offset by an increase in interest expense on subordinated notes of $1.1 million, or 101.0%.
Total interest expense decreased $8.3 million, or 20.3%, during the nine months ended September 30, 2020, when compared with the nine months ended September 30, 2019, due to a decrease in interest expense on deposits of $7.1 million, or 21.1%, a decrease in interest expense on short-term borrowings and repurchase agreements of $2.2 million, or 77.0%, and a decrease in interest expense on subordinated debentures issued to capital trust of $276,000, or 35.1%, partially offset by an increase in interest expense on subordinated notes of $1.4 million, or 41.1%.
Interest Expense – Deposits
Interest expense on demand deposits decreased $893,000 due to average rates of interest that decreased from 0.54% in the three months ended September 30, 2019 to 0.33% in the three months ended September 30, 2020. Partially offsetting this decrease, interest expense on demand deposits increased $513,000, due to an increase in average balances from $1.50 billion during the three months ended September 30, 2019 to $1.96 billion during the three months ended September 30, 2020. The Company experienced increased balances in ICS reciprocal balances, money market accounts and certain types of NOW accounts.
Interest expense on demand deposits decreased $1.1 million due to average rates of interest that decreased from 0.51% in the nine months ended September 30, 2019 to 0.42% in the nine months ended September 30, 2020. Partially offsetting this decrease, interest expense on demand deposits increased $1.0 million due to an increase in average balances from $1.49 billion for the nine months ended September 30, 2019 to $1.79 billion for the nine months ended September 30, 2020. The Company experienced increased balances in ICS reciprocal balances, money market accounts and certain types of NOW accounts.
Interest expense on time deposits decreased $3.7 million as a result of a decrease in average rates of interest from 2.24% during the three months ended September 30, 2019, to 1.35% during the three months ended September 30, 2020. Interest expense on time deposits decreased $668,000 due to a decrease in average balances of time deposits from $1.73 billion during the three months ended September 30, 2019 to $1.60 billion in the three months ended September 30, 2020. A large portion of the Company’s certificate of deposit portfolio matures within six to eighteen months and therefore reprices fairly quickly; this is consistent with the portfolio over the past several years. Older certificates of deposit that renewed or were replaced with new deposits generally resulted in the Company paying a lower rate of interest due to market interest rate decreases during the latter portion of 2019 and throughout 2020. In the three months ended September 30, 2020, the decrease in average balances of time deposits was a result of decreases in both retail customer time deposits obtained through on-line channels and decreases in brokered deposits, primarily those added through the CDARS program purchased funds .
Interest expense on time deposits decreased $6.9 million as a result of a decrease in average rates of interest from 2.20% during the nine months ended September 30, 2019, to 1.66% during the nine months ended September 30, 2020. Interest expense on time deposits decreased $168,000 due to a decrease in average balances of time deposits from $1.71 billion during the nine months ended September 30, 2019 to $1.70 billion in the nine months ended September 30, 2020. A large portion of the Company’s certificate of deposit portfolio matures within six to eighteen months and therefore reprices fairly quickly; this is consistent with the portfolio over the past several years. Older certificates of deposit that renewed or were replaced with new deposits generally resulted in the Company paying a lower rate of interest due to market interest rate decreases during the latter portion of 2019 and through the first half of 2020. In the nine months ended September 30, 2020, the decrease in average balances of time deposits was a result of decreases in both retail customer time deposits obtained through on-line channels and decreases in brokered deposits, primarily those added through the CDARS program purchased funds .
60
Interest Expense – FHLBank Advances, Short-term Borrowings and Repurchase Agreements, Subordinated Debentures Issued to Capital Trusts and Subordinated Notes
FHLBank advances were not utilized during the three and nine months ended September 30, 2020 and 2019. Overnight borrowings from the FHLBank were utilized during the three and nine months ended September 30, 2019 and are included in short-term borrowings.
Interest expense on short-term borrowings and repurchase agreements decreased $766,000 due to a decrease in average rates from 1.54% in the three months ended September 30, 2019 to 0.02% in the three months ended September 30, 2020. The decrease was due to a decrease in market interest rates during the period and the lower interest rate charged on overnight FHLBank borrowings. Interest expense on short-term borrowings and repurchase agreements also decreased $349,000 due to a decrease in average balances from $289.2 million during the three months ended September 30, 2019 to $159.4 million during the three months ended September 30, 2020, which was primarily due to changes in the Company’s funding needs and the mix of funding, which can fluctuate. Overnight borrowings from the FHLBank were not utilized during the three months ended September 30, 2020.
Interest expense on short-term borrowings and repurchase agreements decreased $1.6 million due to a decrease in average rates from 1.47% in the nine months ended September 30, 2019 to 0.46% in the nine months ended September 30, 2020. The decrease was due to a decrease in market interest rates during the period and the lower interest rate charged on overnight FHLBank borrowings. Interest expense on short-term borrowings and repurchase agreements also decreased $612,000 due to a decrease in average balances from $264.1 million during the nine months ended September 30, 2019 to $195.5 million during the nine months ended September 30, 2020, which was primarily due to changes in the Company’s funding needs and the mix of funding, which can fluctuate. Overnight borrowings from the FHLBank were utilized much less often during the nine months ended September 30, 2020.
During the three months ended September 30, 2020, compared to the three months ended September 30, 2019, interest expense on subordinated debentures issued to capital trusts decreased $125,000 due to lower average interest rates. The average interest rate was 3.90% in the three months ended September 30, 2019 compared to 1.98% in the three months ended September 30, 2020. The subordinated debentures are variable-rate debentures which bear interest at an average rate of three-month LIBOR plus 1.60%, adjusting quarterly, which was 1.85% at September 30, 2020. There was no change in the average balance of the subordinated debentures between the 2019 and the 2020 periods.
During the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019, interest expense on subordinated debentures issued to capital trusts decreased $276,000 due to lower average interest rates. The average interest rate was 4.08% in the nine months ended September 30, 2019 compared to 2.65% in the nine months ended September 30, 2020. There was no change in the average balance of the subordinated debentures between the 2019 and the 2020 periods.
In August 2016, the Company issued $75.0 million of 5.25% fixed-to-floating rate subordinated notes due August 15, 2026. The notes were sold at par, resulting in net proceeds, after underwriting discounts and commissions and other issuance costs, of approximately $73.5 million. In June 2020, the Company issued $75.0 million of 5.50% fixed-to-floating rate subordinated notes due June 15, 2030. The notes were sold at par, resulting in net proceeds, after underwriting discounts and commissions and other issuance costs, of approximately $73.5 million. In both cases, these issuance costs are amortized over the expected life of the notes, which is five years from the issuance date, and therefore impact the overall interest expense on the notes. During the three months ended September 30, 2020, compared to the three months ended September 30, 2019, interest expense on subordinated notes increased $1.1 million primarily due to the higher average balances due to the issuance of new notes in the three months ended June 30, 2020. The increase of $1.3 million in the nine-month period was for the same reason as stated for the three-month period.
61
Net Interest Income
Net interest income for the three months ended September 30, 2020 decreased $1.7 million to $44.2 million compared to $45.9 million for the three months ended September 30, 2019. Net interest margin was 3.36% in the three months ended September 30, 2020, compared to 3.95% in the three months ended September 30, 2019, a decrease of 59 basis points, or 14.9%. In both three month periods, the Company’s net interest income and margin were positively impacted by the increases in expected cash flows from the FDIC-assisted acquired loan pools and the resulting increase to accretable yield, which were previously discussed in Note 7 of the Notes to Consolidated Financial Statements. The positive impact of these changes in the three months ended September 30, 2020 and 2019 were increases in interest income of $1.2 million and $2.3 million, respectively, and increases in net interest margin of 9 basis points and 20 basis points, respectively. Excluding the positive impact of the additional yield accretion, in the three months ended September 30, 2020, net interest margin decreased 48 basis points when compared to the year-ago three month period. The decrease was partially due to lower market interest rates, which caused lower LIBOR interest rates and generally resulted in lower yields on loans and other interest-earning assets. The margin decrease also resulted from an increase in interest-earning assets that were primarily at rates that were much lower than the then-current portfolio rates. Increases included $311 million in average loan balances ($120 million of which were PPP loans), $191 million in average interest-earning cash equivalents balances and $107 million in average investment securities balances. In addition, the subordinated notes issued in June 2020 reduced net interest income by approximately $1.1 million in the third quarter of 2020.
Net interest income for the nine months ended September 30, 2020 decreased $2.9 million to $132.6 million compared to $135.5 million for the nine months ended September 30, 2019. Net interest margin was 3.52% in the nine months ended September 30, 2020, compared to 3.99% in the nine months ended September 30, 2019, a decrease of 47 basis points, or 11.8%. In both nine month periods, the Company’s net interest income and margin were positively impacted by the increases in expected cash flows from the FDIC-assisted acquired loan pools and the resulting increase to accretable yield, which were previously discussed in Note 7 of the Notes to Consolidated Financial Statements. The positive impact of these changes in the nine months ended September 30, 2020 and 2019 were increases in interest income of $4.6 million and $5.2 million, respectively, and increases in net interest margin of 12 basis points and 15 basis points, respectively. Excluding the positive impact of the additional yield accretion, in the nine months ended September 30, 2020, net interest margin decreased 44 basis points when compared to the year-ago nine month period. The decrease was partially due to lower market interest rates, which caused lower LIBOR interest rates and generally resulted in lower yields on loans and other interest-earning assets. The margin decrease also resulted from an increase in average interest-earning assets that were primarily at rates that were much lower than the then-current portfolio rates, as described above.
The Company's overall average interest rate spread decreased 49 basis points, or 13.6%, from 3.61% during the three months ended September 30, 2019 to 3.12% during the three months ended September 30, 2020. The decrease was due to a 109 basis point decrease in the weighted average yield on interest-earning assets, partially offset by a 60 basis point decrease in the weighted average rate paid on interest-bearing liabilities. In comparing the two periods, the yield on loans decreased 95 basis points, the yield on investment securities decreased 23 basis points and the yield on other interest-earning assets decreased 204 basis points. The rate paid on deposits decreased 66 basis points, the rate paid on short-term borrowings and repurchase agreements decreased 152 basis points, the rate paid on subordinated debentures issued to capital trusts decreased 192 basis points, and the rate paid on subordinated notes increased five basis points.
The Company's overall average interest rate spread decreased 42 basis points, or 11.5%, from 3.66% during the nine months ended September 30, 2019 to 3.24% during the nine months ended September 30, 2020. The decrease was due to an 81 basis point decrease in the weighted average yield on interest-earning assets, partially offset by a 39 basis point decrease in the weighted average rate paid on interest-bearing liabilities. In comparing the two periods, the yield on loans decreased 67 basis points, the yield on investment securities decreased 18 basis points and the yield on other interest-earning assets decreased 208 basis points. The rate paid on deposits decreased 39 basis points, the rate paid on short-term borrowings and repurchase agreements decreased 101 basis points, the rate paid on subordinated debentures issued to capital trusts decreased 143 basis points, and the rate paid on subordinated notes increased one basis point.
62
For additional information on net interest income components, refer to the "Average Balances, Interest Rates and Yields" tables in this Quarterly Report on Form 10-Q.
Provision for Loan Losses and Allowance for Loan Losses
In the first quarter of 2020, pursuant to the CARES Act and guidance from the SEC and FASB, we elected to delay adoption of the new accounting standard (CECL) related to accounting for credit losses. Our financial statements for the three and nine months ended September 30, 2020, are prepared under the existing incurred loss methodology standard for accounting for loan losses.
Management records a provision for loan losses in an amount it believes is sufficient to result in an allowance for loan losses that will cover current net charge-offs as well as risks believed to be inherent in the loan portfolio of the Bank. The amount of provision charged against current income is based on several factors, including, but not limited to, past loss experience, current portfolio mix, actual and potential losses identified in the loan portfolio, economic conditions, and internal as well as external reviews. The levels of non-performing assets, potential problem loans, loan loss provisions and net charge-offs fluctuate from period to period and are difficult to predict.
Worsening economic conditions from the COVID-19 pandemic, higher inflation or interest rates, or other factors may lead to increased losses in the portfolio and/or requirements for an increase in loan loss provision expense. Management maintains various controls in an attempt to limit future losses, such as a watch list of possible problem loans, documented loan administration policies and loan review staff to review the quality and anticipated collectability of the portfolio. Additional procedures provide for frequent management review of the loan portfolio based on loan size, loan type, delinquencies, financial analysis, on-going correspondence with borrowers and problem loan work-outs. Management determines which loans are potentially uncollectible, or represent a greater risk of loss, and makes additional provisions to expense, if necessary, to maintain the allowance at a satisfactory level.
The provision for loan losses for the three months ended September 30, 2020 was $4.5 million compared with $2.0 million for the three months ended September 30, 2019. The provision for loan losses for the nine months ended September 30, 2020 was $14.4 million compared with $5.5 million for the nine months ended September 30, 2019. Total net charge-offs were $63,000 and $798,000 for the three months ended September 30, 2020 and 2019, respectively. During the three months ended September 30, 2020, a substantial portion of the net charge-offs were in the consumer category. Total net charge-offs were $427,000 and $3.5 million for the nine months ended September 30, 2020 and 2019, respectively. During the nine months ended September 30, 2020, a substantial portion of net charge-offs were in the consumer category. The Company experienced net recoveries in some of the other loan categories. We have seen and expect to continue to see rapid reductions in the outstanding automobile loan balance as we determined in February 2019 to cease providing indirect lending services to automobile dealerships. At September 30, 2020, indirect automobile loans totaled approximately $60 million. We expect this balance will be largely paid off in the next two years. General market conditions and unique circumstances related to specific industries and individual projects contributed to the level of provisions and charge-offs. Collateral and repayment evaluations of all assets categorized as potential problem loans, non-performing loans or foreclosed assets were completed with corresponding charge-offs or reserve allocations made as appropriate.
All FDIC-acquired loans were grouped into pools based on common characteristics and were recorded at their estimated fair values, which incorporated estimated credit losses at the acquisition date. These loan pools have been systematically reviewed by the Company to determine the risk of losses that may exceed those identified at the time of the acquisition. Techniques used in determining risk of loss are similar to those used to determine the risk of loss for the legacy Great Southern Bank portfolio, with most focus being placed on those loan pools which include the larger loan relationships and those loan pools which exhibit higher risk characteristics. Review of the acquired loan portfolio also includes review of financial information, collateral valuations and customer interaction to determine if additional reserves are warranted.
63
The Bank’s allowance for loan losses as a percentage of total loans, excluding FDIC-assisted acquired loans, was 1.24% and 1.00% at September 30, 2020 and December 31, 2019, respectively. Management considers the allowance for loan losses adequate to cover losses inherent in the Bank’s loan portfolio at September 30, 2020, based on recent reviews of the Bank’s loan portfolio and current economic conditions. If economic conditions were to deteriorate further or management’s assessment of the loan portfolio were to change, it is expected that additional loan loss provisions would be required, thereby adversely affecting the Company’s future results of operations and financial condition.
Non-performing Assets
Non-performing assets acquired through FDIC-assisted transactions, including foreclosed assets and potential problem loans, are not included in the totals or in the discussion of non-performing loans, potential problem loans and foreclosed assets below. These assets were initially recorded at their estimated fair values as of their acquisition dates and are accounted for in pools. Therefore, these loan pools are analyzed rather than the individual loans. The overall performance of the loan pools acquired in each of the five FDIC-assisted transactions has been better than original expectations as of the acquisition dates.
As a result of changes in balances and composition of the loan portfolio, changes in economic and market conditions and other factors specific to a borrower’s circumstances, the level of non-performing assets will fluctuate.
Non-performing assets, excluding all FDIC-assisted acquired assets, at September 30, 2020 were $5.5 million, a decrease of $2.7 million from $8.2 million at December 31, 2019. Non-performing assets, excluding all FDIC-assisted acquired assets, as a percentage of total assets were 0.10% at September 30, 2020 and 0.16% at December 31, 2019.
Compared to December 31, 2019, non-performing loans decreased $682,000 to $3.8 million at September 30, 2020, and foreclosed assets decreased $2.0 million to $1.6 million at September 30, 2020. Non-performing one- to four-family residential loans comprised $2.2 million, or 56.3%, of the total non-performing loans at September 30, 2020, an increase of $683,000 from December 31, 2019. Non-performing consumer loans comprised $836,000, or 21.8%, of the total non-performing loans at September 30, 2020, a decrease of $339,000 from December 31, 2019. Non-performing commercial real estate loans comprised $701,000, or 18.3%, of the total non-performing loans at September 30, 2020, an increase of $69,000 from December 31, 2019. Non-performing commercial business loans comprised $140,000, or 3.6%, of the total non-performing loans at September 30, 2020, a decrease of $1.1 million from December 31, 2019.
Non-performing Loans. Activity in the non-performing loans category during the nine months ended September 30, 2020 was as follows:
Beginning
Balance,
January 1
Additions
to Non-
Performing
Removed
from Non-
Performing
Transfers to
Potential
Problem
Loans
Transfers to
Foreclosed
Assets and
Repossessions
Charge-
Offs
Payments
Ending
Balance,
September 30
(In Thousands)
One- to four-family
construction
$
—
$
—
$
—
$
—
$
—
$
—
$
—
$
—
Subdivision construction
—
—
—
—
—
—
—
—
Land development
—
—
—
—
—
—
—
—
Commercial construction
—
—
—
—
—
—
—
—
One- to four-family
residential
1,477
1,245
—
(143
)
—
—
(419
)
2,160
Other residential
—
—
—
—
—
—
—
—
Commercial real estate
632
107
—
—
—
—
(38
)
701
Commercial business
1,235
—
—
—
—
—
(1,095
)
140
Consumer
1,175
370
—
(85
)
(89
)
(164
)
(371
)
836
Total
$
4,519
$
1,722
$
—
$
(228
)
$
(89
)
$
(164
)
$
(1,923
)
$
3,837
64
At September 30, 2020, the non-performing one- to four-family residential category included 29 loans, 12 of which were added during 2020. The largest relationship in the category totaled $276,000, or 12.8% of the total category. The non-performing commercial real estate category included three loans, one of which was added during 2020. The largest relationship in the category totaled $511,000, or 73.0% of the total category, and is primarily related to a multi-tenant building in Arkansas. The non-performing commercial business category included two loans, neither of which was added during 2020. The previous largest relationship in this category, which was added during 2018 and totaled $1.0 million, paid off during the three months ended September 30, 2020. The non-performing consumer category included 77 loans, 23 of which were added in 2020, and the majority of which are indirect and used automobile loans.
Potential Problem Loans. Compared to December 31, 2019, potential problem loans decreased $753,000, or 17.2%, to $3.6 million at September 30, 2020. This decrease was primarily due to payments of $1.6 million on potential problem loans, $119,000 in loans transferred to non-performing loans, $59,000 in loans transferred to foreclosed assets and repossessions, and $102,000 in loan write-downs, partially offset by $1.1 million in loans added to potential problem loans. Potential problem loans are loans which management has identified through routine internal review procedures as having possible credit problems that may cause the borrowers difficulty in complying with the current repayment terms. These loans are not reflected in non-performing assets, but are considered in determining the adequacy of the allowance for loan losses.
Due to the deteriorating economic conditions from COVID-19, it is possible that we could experience an increase in potential problem loans in the remainder of 2020. As noted, we experienced an increased level of loan modifications in late March through June 2020; however loan modifications were much lower at September 30, 2020 compared to June 30, 2020. In accordance with the CARES Act and guidance from the banking regulatory agencies, we made certain short-term modifications to loan terms to help our customers navigate through the current pandemic situation. Although loan modifications were made, they did not result in these loans being classified as troubled debt restructurings, potential problem loans or non-performing loans. If more severe or lengthier negative impacts of the COVID-19 pandemic occur or the effects of the SBA loan programs and other loan and stimulus programs do not enable companies and individuals to completely recover financially, this could result in longer-term modifications, which may be deemed to be troubled debt restructurings, additional potential problem loans and/or additional non-performing loans. Further actions on our part, including additions to the allowance for loan losses, could result.
Activity in the potential problem loans categories during the nine months ended September 30, 2020, was as follows:
Beginning
Balance,
January 1
Additions
to Potential
Problem
Removed
from
Potential
Problem
Transfers to
Non-
Performing
Transfers to
Foreclosed
Assets and
Repossessions
Charge-
Offs
Payments
Ending
Balance,
September 30
(In Thousands)
One- to four-family
construction
$
—
$
—
$
—
$
—
$
—
$
—
$
—
$
—
Subdivision
construction
—
24
—
—
—
—
(2
)
22
Land development
—
—
—
—
—
—
—
—
Commercial
construction
—
—
—
—
—
—
—
—
One- to four-family
residential
791
143
—
(83
)
—
—
(138
)
713
Other residential
—
—
—
—
—
—
—
—
Commercial real estate
3,078
559
—
—
—
—
(1,282
)
2,355
Commercial business
—
—
—
—
—
—
—
—
Consumer
512
401
—
(36
)
(59
)
(102
)
(178
)
538
Total
$
4,381
$
1,127
$
—
$
(119
)
$
(59
)
$
(102
)
$
(1,600
)
$
3,628
65
At September 30, 2020, the commercial real estate category of potential problem loans included two loans, one of which was added during the three months ended September 30, 2020. The largest relationship in this category (added during 2018), which totaled $1.8 million, or 76.3% of the total category, is collateralized by a mixed use commercial retail building. The other relationship in the category (previously mentioned, added this quarter), which totaled $559,000, or 23.7% of the total category, is collateralized by a restaurant building. Payments were current on both relationships at September 30, 2020. The previous other relationship in this category, which was added during 2019 and totaled $1.1 million, paid off during the quarter ended September 30, 2020. The one- to four-family residential category of potential problem loans included 17 loans. The consumer category of potential problem loans included 58 loans, the majority of which are indirect and used automobile loans.
Other Real Estate Owned and Repossessions. Of the total $3.0 million of other real estate owned and repossessions at September 30, 2020, $446,000 represents the fair value of foreclosed and repossessed assets related to loans acquired in FDIC-assisted transactions and $940,000 represents properties which were not acquired through foreclosure. The foreclosed and other assets acquired in the FDIC-assisted transactions and the properties not acquired through foreclosure are not included in the following table and discussion of other real estate owned and repossessions.
Activity in other real estate owned and repossessions during the nine months ended September 30, 2020, was as follows:
Beginning
Balance,
January 1
Additions
Sales
Capitalized
Costs
Write-
Downs
Ending
Balance,
September 30
(In Thousands)
One- to four-family construction
$
—
$
—
$
—
$
—
$
—
$
—
Subdivision construction
689
—
(455
)
126
(10
)
350
Land development
1,816
—
(365
)
—
(376
)
1,075
Commercial construction
—
—
—
—
—
—
One- to four-family residential
601
—
(601
)
—
—
—
Other residential
—
—
—
—
—
—
Commercial real estate
—
—
—
—
—
—
Commercial business
—
—
—
—
—
—
Consumer
545
957
(1,306
)
—
—
196
Total
$
3,651
$
957
$
(2,727
)
$
126
$
(386
)
$
1,621
At September 30, 2020, the land development category of foreclosed assets included two properties, the largest of which was located in the Branson, Mo. area and had a balance of $675,000, or 62.8% of the total category. The other property, which totaled 37.2% of the total category, was located in the Lake of the Ozarks, Mo. area. A portion of a land development property located in the Branson, Mo. area was sold during the three months ending March 31, 2020 for $315,000, which resulted in a write-down of $143,000. The subdivision construction category of foreclosed assets included one property located in the Branson, Mo. area and had a balance of $350,000. One property in the Branson, Mo. area was sold during the three months ended March 31, 2020, which reduced the foreclosed assets balance by $69,000 and another property in the Branson, Mo. area was sold during the three months ended June 30, 2020, which reduced the foreclosed assets balance by $260,000. Both one- to four-family residential properties of foreclosed assets sold in 2020. One sold during the three months ended March 31, 2020 for $380,000, resulting in a gain of $70,000 and the other sold during the three months ended September 30, 2020 for $419,000, resulting in a gain of $128,000. The amount of additions and sales in the consumer category are due to the volume of repossessions of automobiles, which generally are subject to a shorter repossession process. The Company experienced increased levels of delinquencies and repossessions in indirect and used automobile loans throughout 2016 and 2017. The level of delinquencies and repossessions in indirect and used automobile loans generally decreased in 2018 through 2020.
Loans Classified “Watch”
The Company reviews the credit quality of its loan portfolio using an internal grading system that classifies loans as “Satisfactory,” “Watch,” “Special Mention,” “Substandard” and “Doubtful.” Loans classified as “Watch” are being monitored because of indications of potential weaknesses or deficiencies that may require future classification as special mention or substandard. In the nine months ended September 30, 2020, loans classified as “Watch” increased $27.0 million, from $37.4 million at December 31, 2019 to $64.4 million at September 30, 2020. This increase was primarily due to the addition of two unrelated loan relationships involving five total loans. One relationship totaled $15.5 million and was collateralized by a shopping center project. The other relationship totaled $10.9 million and was collateralized by multiple indoor recreational facilities. See Note 6 for further discussion of the Company’s loan grading system.
66
Non-interest Income
For the three months ended September 30, 2020, non-interest income increased $811,000 to $9.5 million when compared to the three months ended September 30, 2019, primarily as a result of the following items:
Net gains on loan sales : Net gains on loan sales increased $1.9 million compared to the prior year period. The increase was due to an increase in originations of fixed-rate loans during the 2020 period compared to the 2019 period. Approximately 59.0% of the one- to- four-family residential loan originations in the three months ended September 30, 2020 were refinanced loans. Fixed rate single-family mortgage loans originated are generally subsequently sold in the secondary market.
Service charges, debit card and ATM fees : Service charges, debit card and ATM fees decreased $927,000 compared to the prior year period. This decrease was primarily due to a decrease in overdraft and insufficient funds fees on customer accounts. This was due to both a reduction in usage by customers and a decision near the end of the first quarter of 2020 to waive (through August 31, 2020) certain fees for customers in response to the COVID-19 pandemic. The effects of that decision were felt during the second and third quarters of 2020. In addition, the Company recorded less in debit card and ATM fees due to a reduction in debit card and ATM usage between the periods. We also saw a temporary decrease during the three months ended September 30, 2020, in our interchange income due to an adjustment by a vendor in one of their pricing models. Though a resolution was found and the income reestablished, negotiations continue to solidify longer term interchange stability.
Other income : Other income decreased $442,000 compared to the prior year period. In the 2019 period, the Company recognized approximately $510,000 in income related to origination of interest rate swaps in the Company’s back-to-back swap program with loan customers and swap counterparties.
For the nine months ended September 30, 2020, non-interest income increased $1.8 million to $25.1 million when compared to the nine months ended September 30, 2019, primarily as a result of the following items:
Net gains on loan sales : Net gains on loan sales increased $3.7 million compared to the prior year period. The increase was due to an increase in originations of fixed-rate loans during the 2020 period compared to the 2019 period. Approximately 61.2% of the one- to- four-family residential loan originations in the nine months ended September 30, 2020 were refinanced loans. As noted above, fixed rate single-family mortgage loans originated are generally subsequently sold in the secondary market.
Other income : Other income increased $452,000 compared to the prior year period. In the 2020 period, the Company recognized approximately $658,000 of additional fee income related to newly-originated interest rate swaps in the Company’s back-to-back swap program with loan customers and swap counterparties when compared to the 2019 period. The Company also recognized approximately $541,000 in income related to the exit of certain tax credit partnerships during the nine months ended September 30, 2020. In the 2019 period, the Company recognized gains totaling $677,000 from the sale of, or recovery of, receivables and assets that were acquired several years prior in FDIC-assisted transactions, with no similar sales or recoveries in the current period.
Service charges, debit card and ATM fees : Service charges, debit card and ATM fees decreased $2.3 million compared to the prior year period. This decrease was primarily due to a decrease in overdraft and insufficient funds fees on customer accounts. As noted above, a decision to waive (through August 31, 2020) certain fees for customers was made in response to the COVID-19 pandemic. In addition, the Company recorded less in debit card and ATM fees due to a reduction in debit card and ATM usage between the periods. Also, during the first quarter of 2020, $200,000 in additional expenses were netted against ATM fee income due to the conversion to a new debit card processing system. We also saw a temporary decrease during the three months ended September 30, 2020, in our interchange income due to an adjustment by a vendor in one of their pricing models. Though a resolution was found and the income reestablished, negotiations continue to solidify longer term interchange stability.
Gain (loss) on derivative interest rate products : The net loss on derivative interest rate products increased $255,000 compared to the net loss in the prior year period. In the 2020 period, the Company recognized a $424,000 decrease in the net fair value related to interest rate swaps in the Company’s back-to-back swap program with loan customers and swap counterparties compared to a $169,000 decrease in the 2019 period. As market interest rates fall this generally decreases the net fair value of
67
these back-to-back swaps. This is a non-cash item as there was no required settlement of this amount between the Company and its swap counterparties.
Non-interest Expense
For the three months ended September 30, 2020, non-interest expense increased $3.3 million to $32.0 million when compared to the three months ended September 30, 2019, primarily as a result of the following items:
Salaries and employee benefits : Salaries and employee benefits increased $2.9 million from the prior year period. The increase was partially due to annual employee compensation merit increases and increased incentives in the mortgage division, where we have added staff and variable compensation increased due to significant increases in new mortgage loan originations, much of which is sold in the secondary market as noted above. Additionally, in August 2020, the Company paid a special cash bonus to all employees totaling $1.1 million in response to the ongoing impacts of the COVID-19 pandemic.
Net occupancy expense : Net occupancy expense increased $534,000 compared to the prior year period. This was primarily related to increased depreciation on new ATM/ITMs and ATM operating software upgrades implemented during the fourth quarter of 2019. Also included in net occupancy expense for the 2020 quarter are COVID-19-related expenses for various items such as cleaning services, equipment, costs of remote work sites and other items.
Insurance : Insurance expense increased $414,000 compared to the prior year period. This increase was primarily due to an increase in FDIC deposit insurance premiums. In the 2019 period, the Bank had a credit with the FDIC for a portion of premiums previously paid to the deposit insurance fund. The deposit insurance fund balance was sufficient to cause no premium to be due for the three months ended September 30, 2019.
Expense on other real estate owned and repossessions : Expense on other real estate owned and repossessions decreased $404,000 compared to the prior year period primarily due to sales of other assets and higher expenses related to certain foreclosed assets during the prior year period. During the 2019 period, expenses related to certain foreclosed assets totaled approximately $572,000, while expenses in the 2020 period totaled approximately $278,000.
For the nine months ended September 30, 2020, non-interest expense increased $6.5 million to $92.2 million when compared to the nine months ended September 30, 2019, primarily as a result of the following items:
Salaries and employee benefits : Salaries and employee benefits increased $6.8 million in the nine months ended September 30, 2020 compared to the prior year period. The increase was partially due to annual employee compensation merit increases and increased incentives in lending, including mortgage lending activities as noted above, and operations areas. Additionally, in March 2020, the Company approved a special cash bonus to all employees totaling $1.1 million in response to the COVID-19 pandemic. In August 2020, the Company paid a second special cash bonus to all employees totaling $1.1 million in response to the pandemic.
Net occupancy expense : Net occupancy expense increased $1.2 million in the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019. This was primarily related to increased depreciation on new ATM/ITMs and ATM operating software upgrades implemented during the fourth quarter of 2019. Also included in net occupancy expense for the 2020 period are COVID-19-related expenses for various items such as cleaning services, equipment, costs to set up and operate remote work sites and other items.
Advertising : Advertising expense decreased $348,000 compared to the prior year period. This decrease was primarily due to activities related to sponsorship agreements being halted as a result of the COVID-19 pandemic.
Expense on other real estate owned and repossessions : Expense on other real estate owned and repossessions decreased $696,000 compared to the prior year period primarily due to sales of other assets and higher valuation write-downs of certain foreclosed assets during the prior year period. During the 2019 period, valuation write-downs of certain foreclosed assets totaled approximately $724,000, while valuation write-downs in the 2020 period totaled approximately $481,000.
The Company’s efficiency ratio for the three months ended September 30, 2020, was 59.64% compared to 52.63% for the same period in 2019. The efficiency ratio for the nine months ended September 30, 2020, was 58.45% compared to 53.94% for the same period in 2019. The higher efficiency ratio in the 2020 three and nine month periods were primarily due to an
68
increase in non-interest expense, along with a small decrease in total revenue. Despite this increase in non-interest expense, the Company’s ratio of non-interest expense to average assets was 2.34% and 2.33% for the three and nine months ended September 30, 2020, respectively, compared to 2.34% and 2.37% for the three and nine months ended September 30, 2019, respectively. The decrease in the current nine month ratio was primarily due to an increase in average assets in the 2020 period compared to the 2019 period, generally offset by the increase in non-interest expense. Average assets for the three months ended September 30, 2020, increased $552.9 million, or 11.3%, from the three months ended September 30, 2019, primarily due to increases in loans receivable, investment securities and interest bearing cash balances at the Federal Reserve Bank. Average assets for the nine months ended September 30, 2020, increased $457.9 million, or 9.5%, from the nine months ended September 30, 2019, primarily due to increases in loans receivable, investment securities and interest bearing cash balances at the Federal Reserve Bank.
Provision for Income Taxes
For the three months ended September 30, 2020 and 2019, the Company's effective tax rate was 21.5% and 17.5%, respectively. For the nine months ended September 30, 2020 and 2019, the Company's effective tax rate was 18.8% and 17.6%, respectively. Except for the three months ended September 30, 2020, these effective rates were lower than the statutory federal tax rate of 21%, due primarily to the utilization of certain investment tax credits and to tax-exempt investments and tax-exempt loans, which reduced the Company’s effective tax rate. The Company’s effective tax rate may fluctuate in future periods as it is impacted by the level and timing of the Company’s utilization of tax credits and the level of tax-exempt investments and loans and the overall level of pre-tax income. The Company's effective income tax rate is currently generally expected to remain below the statutory rate due primarily to the factors noted above. In 2020, the Company’s state income tax expenses have been higher than normal in various states due to the recognition of income for tax purposes related to the gain recognized on the termination of the interest rate swap. State tax expense estimates have evolved throughout the year as taxable income and apportionment between states has been analyzed. The Company currently expects its effective tax rate (combined federal and state) to be approximately 18.5% to 19.5% for the full year of 2020 and 17.5% to 18.5% in future years.
Average Balances, Interest Rates and Yields
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. Average balances of loans receivable include the average balances of non-accrual loans for each period. Interest income on loans includes interest received on non-accrual loans on a cash basis. Interest income on loans includes the amortization of net loan fees which were deferred in accordance with accounting standards. Net fees included in interest income were $1.7 million and $1.0 million for the three months ended September 30, 2020 and 2019, respectively. Net fees included in interest income were $4.4 million and $3.1 million for the nine months ended September 30, 2020 and 2019, respectively. Tax-exempt income was not calculated on a tax equivalent basis. The table does not reflect any effect of income taxes.
69
September 30,
2020 (2)
Three Months Ended
September 30, 2020
Three Months Ended
September 30, 2019
Yield/
Rate
Average
Balance
Interest
Yield/
Rate
Average
Balance
Interest
Yield/
Rate
(Dollars in Thousands)
Interest-earning assets:
Loans receivable:
One- to four-family residential
3.72
%
$
680,452
$
7,379
4.31
%
$
542,892
$
7,153
5.23
%
Other residential
4.22
989,574
11,301
4.54
814,326
11,074
5.40
Commercial real estate
4.17
1,545,358
16,850
4.34
1,471,431
19,236
5.19
Construction
4.28
649,985
7,450
4.56
730,027
10,814
5.88
Commercial business
3.70
356,505
3,663
4.09
253,225
3,316
5.20
Other loans
5.24
270,136
3,645
5.37
369,704
5,423
5.82
Industrial revenue bonds(1)
4.45
15,345
188
4.87
14,770
210
5.64
Total loans receivable
4.28
4,507,355
50,476
4.46
4,196,375
57,226
5.41
Investment securities(1)
2.99
449,383
3,060
2.71
342,277
2,534
2.94
Other interest-earning assets
0.24
270,509
63
0.09
79,344
427
2.13
Total interest-earning assets
3.96
5,227,247
53,599
4.08
4,617,996
60,187
5.17
Non-interest-earning assets:
Cash and cash equivalents
92,244
93,293
Other non-earning assets
147,084
202,361
Total assets
$
5,466,575
$
4,913,650
Interest-bearing liabilities:
Interest-bearing demand and savings
0.29
$
1,962,023
1,650
0.33
$
1,501,697
2,030
0.54
Time deposits
1.19
1,602,981
5,444
1.35
1,728,620
9,762
2.24
Total deposits
0.67
3,565,004
7,094
0.79
3,230,317
11,792
1.45
Short-term borrowings,
repurchase agreements and
other interest-bearing
liabilities
0.02
159,373
8
0.02
289,222
1,123
1.54
Subordinated debentures
issued to capital trusts
1.85
25,774
128
1.98
25,774
253
3.90
Subordinated notes
5.85
148,113
2,201
5.91
74,119
1,095
5.86
Total interest-bearing liabilities
0.85
3,898,264
9,431
0.96
3,619,432
14,263
1.56
Non-interest-bearing liabilities:
Demand deposits
888,568
670,158
Other liabilities
45,123
37,754
Total liabilities
4,831,955
4,327,344
Stockholders’ equity
634,620
586,306
Total liabilities and stockholders’ equity
$
5,466,575
$
4,913,650
Net interest income:
Interest rate spread
3.11
%
$
44,168
3.12
%
$
45,924
3.61
%
Net interest margin*
3.36
%
3.95
%
Average interest-earning assets
to average interest- bearing
liabilities
134.1
%
127.6
%
*
Defined as the Company’s net interest income divided by total average interest-earning assets.
(1)
Of the total average balances of investment securities, average tax-exempt investment securities were $67.8 million and $39.6 million for the three months ended September 30, 2020 and 2019, respectively. In addition, average tax-exempt loans and industrial revenue bonds were $19.8 million and $20.5 million for the three months ended September 30, 2020 and 2019, respectively. Interest income on tax-exempt assets included in this table was $570,000 and $660,000 for the three months ended September 30, 2020 and 2019, respectively. Interest income net of disallowed interest expense related to tax-exempt assets was $537,000 and $601,000 for the three months ended September 30, 2020 and 2019, respectively.
(2)
The yield on loans at September 30, 2020 does not include the impact of the accretable yield (income) on loans acquired in the FDIC-assisted transactions. See “Net Interest Income” for a discussion of the effect on results of operations for the three months ended September 30, 2020.
70
September 30,
2020 (2)
Nine Months Ended
September 30, 2020
Nine Months Ended
September 30, 2019
Yield/
Rate
Average
Balance
Interest
Yield/
Rate
Average
Balance
Interest
Yield/
Rate
(Dollars in Thousands)
Interest-earning assets:
Loans receivable:
One- to four-family residential
3.72
%
$
645,662
$
21,949
4.54
%
$
518,758
$
20,097
5.18
%
Other residential
4.22
917,778
32,997
4.80
815,008
33,334
5.47
Commercial real estate
4.17
1,522,825
52,820
4.63
1,424,595
55,235
5.18
Construction
4.28
665,567
24,785
4.97
704,074
31,573
6.00
Commercial business
3.70
318,657
10,215
4.28
259,021
10,066
5.20
Other loans
5.24
293,582
12,068
5.49
403,176
16,576
5.50
Industrial revenue bonds (1)
4.45
15,453
619
5.35
14,970
671
5.99
Total loans receivable
4.28
4,379,524
155,453
4.74
4,139,602
167,552
5.41
Investment securities (1)
2.99
422,696
9,226
2.92
310,227
7,201
3.10
Other interest-earning assets
0.24
227,506
405
0.24
87,193
1,514
2.32
Total interest-earning assets
3.96
5,029,726
165,084
4.38
4,537,022
176,267
5.19
Non-interest-earning assets:
Cash and cash equivalents
93,493
92,208
Other non-earning assets
155,233
191,296
Total assets
$
5,278,452
$
4,820,526
Interest-bearing liabilities:
Interest-bearing demand and
savings
0.29
$
1,792,492
5,629
0.42
$
1,491,255
5,723
0.51
Time deposits
1.19
1,701,383
21,083
1.66
1,711,692
28,121
2.20
Total deposits
0.67
3,493,875
26,712
1.02
3,202,947
33,844
1.41
Short-term borrowings, repurchase
agreements and other interest-
bearing liabilities
0.02
195,459
667
0.46
264,111
2,904
1.47
Subordinated debentures
issued to capital trusts
1.85
25,774
511
2.65
25,774
787
4.08
Subordinated notes
5.85
104,256
4,633
5.94
74,012
3,283
5.93
Total interest-bearing liabilities
0.85
3,819,364
32,523
1.14
3,566,844
40,818
1.53
Non-interest-bearing liabilities:
Demand deposits
799,594
661,446
Other liabilities
39,983
32,620
Total liabilities
4,658,941
4,260,910
Stockholders’ equity
619,511
559,616
Total liabilities and stockholders’
equity
$
5,278,452
$
4,820,526
Net interest income:
Interest rate spread
3.11
%
$
132,561
3.24
%
$
135,449
3.66
%
Net interest margin*
3.52
%
3.99
%
Average interest-earning assets
to average interest-bearing
liabilities
131.7
%
127.2
%
*
Defined as the Company’s net interest income divided by total average interest-earning assets.
(1)
Of the total average balances of investment securities, average tax-exempt investment securities were $54.8 million and $43.6 million for the nine months ended September 30, 2020 and 2019, respectively. In addition, average tax-exempt loans and industrial revenue bonds were $20.4 million and $21.1 million for the nine months ended September, 2020 and 2019, respectively. Interest income on tax-exempt assets included in this table was $1.6 million and $1.9 million for the nine months ended September 30, 2020 and 2019, respectively. Interest income net of disallowed interest expense related to tax-exempt assets was $1.5 million and $1.7 million for the nine months ended September 30, 2020 and 2019, respectively.
(2)
The yield on loans at September 30, 2020 does not include the impact of the accretable yield (income) on loans acquired in the FDIC-assisted transactions. See “Net Interest Income” for a discussion of the effect on results of operations for the nine months ended September 30, 2020.
71
Rate/Volume Analysis
The following tables present the dollar amounts of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities for the periods shown. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in rate (i.e., changes in rate multiplied by old volume) and (ii) changes in volume (i.e., changes in volume multiplied by old rate). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to volume and rate. Tax-exempt income was not calculated on a tax equivalent basis.
Three Months Ended September 30,
2020 vs. 2019
Increase (Decrease)
Total
Due to
Increase
Rate
Volume
(Decrease)
(Dollars in Thousands)
Interest-earning assets:
Loans receivable
$
(10,712
)
$
3,962
$
(6,750
)
Investment securities
(210
)
736
526
Other interest-earning assets
(685
)
321
(364
)
Total interest-earning assets
(11,607
)
5,019
(6,588
)
Interest-bearing liabilities:
Demand deposits
(893
)
513
(380
)
Time deposits
(3,650
)
(668
)
(4,318
)
Total deposits
(4,543
)
(155
)
(4,698
)
Short-term borrowings
(766
)
(349
)
(1,115
)
Subordinated debentures issued to capital trust
(125
)
—
(125
)
Subordinated notes
9
1,097
1,106
Total interest-bearing liabilities
(5,425
)
593
(4,832
)
Net interest income
$
(6,182
)
$
4,426
$
(1,756
)
Nine Months Ended September 30,
2020 vs. 2019
Increase (Decrease)
Total
Due to
Increase
Rate
Volume
(Decrease)
(Dollars in Thousands)
Interest-earning assets:
Loans receivable
$
(21,484
)
$
9,385
$
(12,099
)
Investment securities
(459
)
2,484
2,025
Other interest-earning assets
(2,143
)
1,034
(1,109
)
Total interest-earning assets
(24,086
)
12,903
(11,183
)
Interest-bearing liabilities:
Demand deposits
(1,143
)
1,049
(94
)
Time deposits
(6,870
)
(168
)
(7,038
)
Total deposits
(8,013
)
881
(7,132
)
Short-term borrowings
(1,625
)
(612
)
(2,237
)
Subordinated debentures issued to capital trust
(276
)
—
(276
)
Subordinated notes
3
1,347
1,350
Total interest-bearing liabilities
(9,911
)
1,616
(8,295
)
Net interest income
$
(14,175
)
$
11,287
$
(2,888
)
72
Liquidity
Liquidity is a measure of the Company's ability to generate sufficient cash to meet present and future financial obligations in a timely manner through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. These obligations include the credit needs of customers, funding deposit withdrawals, and the day-to-day operations of the Company. Liquid assets include cash, interest-bearing deposits with financial institutions and certain investment securities and loans. As a result of the Company’s management of the ability to generate liquidity primarily through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and meet its borrowers’ credit needs. At September 30, 2020, the Company had commitments of approximately $145.3 million to fund loan originations, $1.09 billion of unused lines of credit and unadvanced loans, and $17.9 million of outstanding letters of credit.
Loan commitments and the unfunded portion of loans at the dates indicated were as follows (in thousands):
September 30,
2020
June 30,
2020
March 31,
2020
December 31,
2019
December 31,
2018
December 31,
2017
Closed non-construction loans with unused
available lines
Secured by real estate (one- to four-family)
$
160,409
$
158,687
$
156,381
$
155,831
$
150,948
$
133,587
Secured by real estate (not one- to four-family)
19,295
16,124
16,832
19,512
11,063
10,836
Not secured by real estate - commercial business
114,519
105,071
79,117
83,782
87,480
113,317
Closed construction loans with unused
available lines
Secured by real estate (one-to four-family)
33,359
37,789
50,101
48,213
37,162
20,919
Secured by real estate (not one-to four-family)
714,566
753,589
809,436
798,810
906,006
718,277
Loan Commitments not closed
Secured by real estate (one-to four-family)
94,203
112,769
141,432
69,295
24,253
23,340
Secured by real estate (not one-to four-family)
50,264
73,103
95,652
92,434
104,871
156,658
Not secured by real estate - commercial business
800
800
—
—
405
4,870
$
1,187,415
$
1,257,932
$
1,348,951
$
1,267,877
$
1,322,188
$
1,181,804
The Company's primary sources of funds are customer deposits, FHLBank advances, other borrowings, loan repayments, unpledged securities, proceeds from sales of loans and available-for-sale securities and funds provided from operations. The Company utilizes particular sources of funds based on the comparative costs and availability at the time. The Company has from time to time chosen not to pay rates on deposits as high as the rates paid by certain of its competitors and, when believed to be appropriate, supplements deposits with less expensive alternative sources of funds.
At September 30, 2020, the Company had these available secured lines and on-balance sheet liquidity:
Federal Home Loan Bank line
$ 1,133.7 million
Federal Reserve Bank line
$ 431.5 million
Cash and cash equivalents
$ 338.3 million
Unpledged securities
$ 223.1 million
Statements of Cash Flows. During both the nine months ended September 30, 2020 and 2019, the Company had positive cash flows from operating activities, negative cash flows from investing activities and positive cash flows from financing activities.
Cash flows from operating activities for the periods covered by the Statements of Cash Flows have been primarily related to changes in accrued and deferred assets, credits and other liabilities, the provision for loan losses, depreciation and amortization, realized gains on sales of loans and the amortization of deferred loan origination fees and discounts (premiums) on loans and investments, all of which are non-cash or non-operating adjustments to operating cash flows. Net income adjusted for non-cash and non-operating items and the origination and sale of
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loans held for sale were the primary source of cash flows from operating activities. Operating activities provided cash flows of $35.8 million and $64.2 million during the nine months ended September 30, 2020 and 2019, respectively.
During the nine months ended September 30, 2020, investing activities used cash of $278.9 million, primarily due to the net origination of loans, the purchase of investment securities and the purchase of equipment, partially offset by cash proceeds from the termination of interest rate derivatives, the sale of other real estate owned and payments received on investment securities. Investing activities in the 2019 period used cash of $264.5 million, primarily due to the purchase of loans and the net origination of loans, the purchase of investment securities and the purchase of equipment, partially offset by the sale of other real estate owned, the sale of investment securities and payments received on investment securities.
Changes in cash flows from financing activities during the periods covered by the Statements of Cash Flows are due to changes in deposits after interest credited, changes in FHLBank advances and changes in short-term borrowings, as well as advances from borrowers for taxes and insurance, dividend payments to stockholders, purchases of the Company’s common stock and the exercise of common stock options. Financing activities provided cash of $361.2 million and $188.5 million during the nine months ended September 30, 2020 and 2019, respectively. In the 2020 nine-month period, financing activities provided cash primarily as a result of net increases in checking account balances, partially offset by decreases in short-term borrowings, decreases in time deposits, dividends paid to stockholders and the purchase of the Company’s common stock. Also in the 2020 period, cash was provided by the issuance of subordinated notes. In the 2019 nine-month period, financing activities provided cash primarily as a result of net increases in checking account balances and certificates of deposit, partially offset by decreases in short-term borrowings and dividends paid to stockholders.
Capital Resources
Management continuously reviews the capital position of the Company and the Bank to ensure compliance with minimum regulatory requirements, as well as to explore ways to increase capital either by retained earnings or other means.
At September 30, 2020, the Company's total stockholders' equity and common stockholders’ equity were each $624.6 million, or 11.5% of total assets, equivalent to a book value of $45.00 per common share. As of December 31, 2019, total stockholders’ equity and common stockholders’ equity were each $603.1 million, or 12.0% of total assets, equivalent to a book value of $42.29 per common share. At September 30, 2020, the Company’s tangible common equity to tangible assets ratio was 11.4%, compared to 11.9% at December 31, 2019 (See Non-GAAP Financial Measures below).
Included in stockholders’ equity at September 30, 2020 and December 31, 2019, were unrealized gains (net of taxes) on the Company’s available-for-sale investment securities totaling $24.1 million and $9.0 million, respectively. This increase in unrealized gains primarily resulted from lower market interest rates, which increased the fair value of the investment securities.
Also included in stockholders’ equity at September 30, 2020, were realized gains (net of taxes) on the Company’s cash flow hedge (interest rate swap), which was terminated in March 2020, totaling $31.5 million. This amount, plus associated deferred taxes, is expected to be accreted to interest income over the remaining term of the original interest rate swap contract, which was to end in October 2025. At September 30, 2020, the remaining pre-tax amount to be recorded in interest income was $40.8 million. The net effect on total stockholders’ equity over time will be no impact as the reduction of this realized gain will be offset by an increase in retained earnings (as the interest income flows through pre-tax income).
Banks are required to maintain minimum risk-based capital ratios. These ratios compare capital, as defined by the risk-based regulations, to assets adjusted for their relative risk as defined by the regulations. Under current guidelines banks must have a minimum common equity Tier 1 capital ratio of 4.50%, a minimum Tier 1 risk-based capital ratio of 6.00%, a minimum total risk-based capital ratio of 8.00%, and a minimum Tier 1 leverage ratio of 4.00%. To be considered "well capitalized," banks must have a minimum common equity Tier 1 capital ratio of
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6.50%, a minimum Tier 1 risk-based capital ratio of 8.00%, a minimum total risk-based capital ratio of 10.00%, and a minimum Tier 1 leverage ratio of 5.00%. On September 30, 2020, the Bank's common equity Tier 1 capital ratio was 13.3%, its Tier 1 capital ratio was 13.3%, its total capital ratio was 14.4% and its Tier 1 leverage ratio was 11.5%. As a result, as of September 30, 2020, the Bank was well capitalized, with capital ratios in excess of those required to qualify as such. On December 31, 2019, the Bank's common equity Tier 1 capital ratio was 13.1%, its Tier 1 capital ratio was 13.1%, its total capital ratio was 14.0% and its Tier 1 leverage ratio was 12.3%. As a result, as of December 31, 2019, the Bank was well capitalized, with capital ratios in excess of those required to qualify as such.
The FRB has established capital regulations for bank holding companies that generally parallel the capital regulations for banks. On September 30, 2020, the Company's common equity Tier 1 capital ratio was 11.9%, its Tier 1 capital ratio was 12.4%, its total capital ratio was 16.7% and its Tier 1 leverage ratio was 10.7%. To be considered well capitalized, a bank holding company must have a Tier 1 risk-based capital ratio of at least 6.00% and a total risk-based capital ratio of at least 10.00%. As of September 30, 2020, the Company was considered well capitalized, with capital ratios in excess of those required to qualify as such. On December 31, 2019, the Company's common equity Tier 1 capital ratio was 12.0%, its Tier 1 capital ratio was 12.5%, its total capital ratio was 15.0% and its Tier 1 leverage ratio was 11.8%. As of December 31, 2019, the Company was considered well capitalized, with capital ratios in excess of those required to qualify as such.
In June 2020, the Company further enhanced its regulatory capital position with the issuance of $75.0 million of 5.50% fixed-to-floating rate subordinated notes due June 15, 2030, which count as Tier 2 Capital in the calculation of the Total Capital Ratio. The notes will accrue interest at the fixed rate of 5.50% to but excluding June 15, 2025. From and including June 15, 2025 to but excluding the maturity date of June 15, 2030, if not redeemed by the Company, the notes will accrue interest at a floating rate.
In addition to the minimum common equity Tier 1 capital ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio, the Company and the Bank have to maintain a capital conservation buffer consisting of additional common equity Tier 1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses.
For additional information, see “Item 1. Business--Government Supervision and Regulation-Capital” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
Dividends . During the three months ended September 30, 2020, the Company declared a common stock cash dividend of $0.34 per share, or 35% of net income per diluted common share for that three month period, and paid a common stock cash dividend of $0.34 per share (which was declared in June 2020). During the three months ended September 30, 2019, the Company declared a common stock cash dividend of $0.34 per share, or 25% of net income per diluted common share for that three month period, and paid a common stock cash dividend of $0.32 per share (which was declared in June 2019). During the nine months ended September 30, 2020, the Company declared common stock cash dividends of $2.02 per share, or 69% of net income per diluted common share for that nine month period, and paid common stock cash dividends of $2.02 per share ($0.34 of which was declared in December 2019). The total dividends declared during the nine months ended September 30, 2020, consisted of regular cash dividends of $1.02 per share and a special cash dividend of $1.00 per share. During the nine months ended September 30, 2019, the Company declared common stock cash dividends of $1.73 per share, or 44% of net income per diluted common share for that nine month period, and paid common stock cash dividends of $1.71 per share. The total dividends declared during the nine months ended September 30, 2019, consisted of regular cash dividends of $0.98 per share and a special cash dividend of $0.75 per share. The Board of Directors meets regularly to consider the level and the timing of dividend payments. The $0.34 per share dividend declared but unpaid as of September 30, 2020, was paid to stockholders on October 13, 2020.
Common Stock Repurchases and Issuances . The Company has been in various buy-back programs since May 1990. During the three months ended September 30, 2020, the Company issued 2,550 shares of stock at an average price of $26.53 per share to cover stock option exercises and repurchased 206,400 shares of its common stock at an average price of $37.39 per share. During the three months ended September 30, 2019, the Company issued 12,438 shares of stock at an average price of $34.28 per share to cover stock option exercises and did not repurchase any
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shares of its common stock. During the nine months ended September 30, 2020, the Company issued 9,625 shares of stock at an average price of $33.76 per share to cover stock option exercises and repurchased 390,107 shares of its common stock at an average price of $40.67 per share. During the nine months ended September 30, 2019, the Company issued 78,896 shares of stock at an average price of $29.89 per share to cover stock option exercises and repurchased 16,040 shares of its common stock at an average price of $52.93 per share.
On April 18, 2018, the Company's Board of Directors authorized management to repurchase up to 500,000 shares of the Company's outstanding common stock, under a program of open market purchases or privately negotiated transactions. The program does not have an expiration date. Management has historically utilized stock buy-back programs from time to time as long as management believed that repurchasing the stock would contribute to the overall growth of shareholder value. The number of shares of stock that will be repurchased at any particular time and the prices that will be paid are subject to many factors, several of which are outside of the control of the Company. The primary factors, however, are the number of shares available in the market from sellers at any given time, the price of the stock within the market as determined by the market and the projected impact on the Company’s earnings per share and capital. As of September 30, 2020, there were 76,311 shares still available to be repurchased under the program.
On October 21, 2020, the Company’s Board of Directors authorized management to repurchase up to one million additional shares of the Company’s common stock under a program of open market purchases or privately negotiated transactions. The program does not have an expiration date, and will take effect after the Company completes the repurchase of the shares remaining under the 2018 stock repurchase program.
Non-GAAP Financial Measures
This document contains certain financial information determined by methods other than in accordance with accounting principles generally accepted in the United States (“GAAP”), consisting of the tangible common equity to tangible assets ratio.
In calculating the ratio of tangible common equity to tangible assets, we subtract period-end intangible assets from common equity and from total assets. Management believes that the presentation of this measure excluding the impact of intangible assets provides useful supplemental information that is helpful in understanding our financial condition and results of operations, as it provides a method to assess management’s success in utilizing our tangible capital as well as our capital strength. Management also believes that providing a measure that excludes balances of intangible assets, which are subjective components of valuation, facilitates the comparison of our performance with the performance of our peers. In addition, management believes that this is a standard financial measure used in the banking industry to evaluate performance.
This non-GAAP financial measure is supplemental and is not a substitute for any analysis based on GAAP financial measures. Because not all companies use the same calculation of non-GAAP measures, this presentation may not be comparable to similarly titled measures as calculated by other companies.
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Non-GAAP Reconciliation: Ratio of Tangible Common Equity to Tangible Assets
September 30,
December 31,
2020
2019
(Dollars in Thousands)
Common equity at period end
$
624,643
$
603,066
Less: Intangible assets at period end
7,232
8,098
Tangible common equity at period end (a)
$
617,411
$
594,968
Total assets at period end
$
5,443,010
$
5,015,072
Less: Intangible assets at period end
7,232
8,098
Tangible assets at period end (b)
$
5,435,778
$
5,006,974
Tangible common equity to tangible assets (a) / (b)
11.36
%
11.88
%
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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.