Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
ISABELLA BANK CORPORATION FINANCIAL REVIEW
(Dollars in thousands except per share amounts)
The following is management’s discussion and analysis of our financial condition and results of operations. This discussion and analysis is intended to provide a better understanding of the consolidated financial statements and statistical data included elsewhere in this Annual Report on Form 10-K.
Executive Summary
We reported net income of $19,499 and earnings per common share of $2.48 for the year ended December 31, 2021. Net income and earnings per common share for the year ended December 31, 2020 were $10,885 and $1.37, respectively. While we had a reduction in total interest income of $4,059 during 2021, compared to prior year, net interest income for the period ended December 31, 2021 increased by $2,354 from the prior year. Developments leading to the decline in gross interest income during 2021 included the lowering of interest rates, and a pause in advances to mortgage brokers. Conversely, we benefited from lower interest rates and a reduction in higher-cost borrowings as interest expense on deposits and borrowings decreased $6,413 for the year ended December 31, 2021 when compared to the same period in 2020.
The provision for loan losses decreased by $2,183 in 2021 when compared to the previous year. During 2020, increased economic and environmental risk factors, predominantly driven by COVID-19, drove a significant increase in the provision. While these risk factors remain, credit quality was strong during 2021. As of December 31, 2021, total past due and nonaccrual loans were $4,031, or 0.31% of gross loans, compared to 0.78% as of December 31, 2020. Additionally, net loan charge-offs were relatively low at $123. Strong credit quality, coupled with improvement in economic factors, such as unemployment rates, resulted in a reduction in the ALLL and a provision reversal of $518 during 2021.
Noninterest income of $13,822 for the year ended December 31, 2021 decreased $601 when compared to 2020. While service charges and fees, a component of noninterest income, increased $1,070 when compared to the previous year, 2020 also included an additional $1,022 related to gain on sale of loans and $620 related to gains from redemption of corporate owned life insurance policies. Noninterest expenses for the year ended December 31, 2021 decreased $7,539 when compared to 2020, which can be attributed to a $7,643 cost to extinguish $100,000 of FHLB advances during the fourth quarter of 2020. The remaining marginal increase of $104 can be attributed to disciplined operating expense controls.
As of December 31, 2021, total assets and assets under management were $2,032,158 and $2,827,245, respectively. Assets under management include loans sold and serviced of $278,844 and investment and trust assets managed by Isabella Wealth of $516,243, in addition to assets on our consolidated balance sheet. Loans outstanding as of December 31, 2021 totaled $1,301,037. During 2021, gross loans increased $62,726 which was largely the result of growth in the commercial and residential mortgage loan portfolios. Our securities portfolio increased $151,373 since December 31, 2020, predominantly due to purchases of treasury securities, bringing our total securities portfolio to $490,601. Total deposits increased $144,022 during the year and totaled $1,710,339 as of December 31, 2021. This growth was primarily in demand and savings deposits, driven mostly from attracting new customers and funds from the SBA PPP and government stimulus. All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a “well capitalized” institution.
Our net yield on interest earning assets (FTE) was 2.87% for 2021 which declined from 2.96% in 2020. Management implemented strategic programs focused on improving our net yield as rates declined in 2020, which included enhanced pricing related to loans and a reduced reliance on higher-cost borrowed funds and brokered deposits as funding sources. While these efforts have helped, the current interest rate environment plus the elevated cash position has had a negative impact on the yield of interest earning assets.
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Recent Events and Legislation
Impact of COVID-19: Unexpected and unprecedented changes have occurred during 2020 and 2021 as the result of COVID-19. The World Health Organization has declared the situation a global pandemic. The pandemic created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries.
The CARES Act, an unprecedented federal government support program, was enacted on March 27, 2020 in response to the COVID-19 pandemic. It is a $2 trillion stimulus package intended to provide financial relief across the country. The CARES Act included the PPP, which enabled businesses to obtain a forgivable SBA loan to meet payroll, rent, utility, and mortgage interest obligations for the 24-week period following the loan origination, and re-open quickly once the public health crisis ends. The first applications for PPP funds, with a term of two years, were accepted beginning on April 3, 2020. During 2020, we facilitated more than 950 SBA PPP loans for a total of $99,459 and had the opportunity to continue providing funding in 2021 under an additional government stimulus program. During 2021, we funded 845 SBA PPP loans for a total of $54,551 under this additional government stimulus program. Bank regulators issued an interim rule that neutralizes the regulatory capital effects by allowing a zero percent risk weight, for capital purposes, to loans originated under the PPP. The capital rule was issued April 9, 2020, with an immediate effective date.
Since 2020, many customers have expressed their general concern about the uncertain economic conditions, but it is still premature to reasonably predict the magnitude of the impact. One measure we deployed to assist our customers included changes to service charges and fees on deposit accounts. Since the COVID-19 pandemic led to an increase in the need for electronic services and products, we elected to remove select deposit account charges and fees and temporarily waive others to ease the financial stress on our customers. Other measures we have taken to assist our customers include loan programs that provide short-term payment relief. Under these programs, borrowers whose loans were in good standing as of March 1, 2020 could elect to defer full or partial payments for a period not to exceed 180 days. Loan payment deferrals totaled $306,103, or 23.8% of gross loans, as of June 30, 2020. As of September 30, 2020, active loan payment deferrals declined to $103,858, or 8.0% of gross loans, as the majority of borrowers granted loan payment deferrals had reverted back to contractual payments. As of December 31, 2020, active loan payment deferrals declined even further and totaled $6,048, or 0.5% of gross loans. As of December 31, 2021, we had active loan payment deferrals totaling $159.
Bank regulators issued a statement on March 22, 2020, and a revised statement on April 7, 2020, which provided confirmation that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers with a current payment status are not categorized as TDRs. Pursuant to this guidance, short-term loan modifications meeting this criteria were not categorized as TDR as of December 31, 2021.
In response to the COVID-19 pandemic, we temporarily closed branch lobbies, modified staffing levels, and enabled employees to work remotely during most of 2020 and into 2021. While branch operations and staffing levels have generally resumed to normal, the extent to which COVID-19 impacts our business will depend on future developments, which remain highly uncertain and cannot be predicted with any accuracy. We expect the significance of the pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain the virus and variants to the virus and the impact of actions taken in response. Uncertainty created by the pandemic is pervasive, and continues to impact our operations, customers, and various areas of risk. We continue to closely monitor external events and are in continual discussion with our customers to assess, prepare and respond to conditions as they evolve.
Subordinated Debt Issuance: On June 2, 2021, we completed a private placement of $30,000 in aggregate principal amount of 3.25% Fixed-to-Floating Rate Subordinated Notes due 2031 (the “Notes”) to various institutional investors (the “Offering”). The price for the Notes was 100% of the principal amount of the Notes. The Notes are intended to qualify as Tier 2 capital for regulatory purposes. We intend to utilize the net proceeds from the Offering for general corporate purposes, including potential repurchases of common stock and/or merger and acquisition activity. The Notes will initially bear a fixed interest rate of 3.25% until June 15, 2026, after which time until maturity on June 15, 2031, the interest rate will reset quarterly to an annual floating rate equal to the then-current 3-month SOFR plus 256 basis points. The Notes are redeemable by us at our option, in whole or in part, on or after June 15, 2026. Any such redemption will be at a redemption price equal to 100% of the principal amount of the Notes being redeemed, plus accrued and unpaid interest. The Notes are not subject to redemption at the option of the holders.
Tender Offer : On September 1, 2021, we announced the commencement of a “modified Dutch Auction” tender offer to purchase up to $20,000 in value of our common stock, or such lesser number of shares of our common stock as were properly tendered and not properly withdrawn, at a price not less than $23.00 nor greater than $27.00 per share. The tender offer expired on October 13, 2021 and resulted in the purchase of 396,576.78534 shares at a price of $27.00 per share for a total amount of
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approximately $10,708. The remainder of the $20,000 not used in the tender offer may be deployed for general corporate purposes, including potential repurchases of our common stock.
Reclassifications
Certain amounts reported in management's discussion and analysis of financial condition and results of operations for 2020 and 2019 have been reclassified to conform with the 2021 presentation.
Subsequent Events
We evaluated subsequent events after December 31, 2021 through the date our consolidated financial statements were issued for potential recognition and disclosure. No subsequent events require financial statement recognition or disclosure between December 31, 2021 and the date our consolidated financial statements were issued.
Other
We have not received, nor are aware of, any notices of regulatory actions as of March 14, 2022.
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Results of Operations
(Dollars in thousands except per share amounts)
The following table outlines the results of operations and provides certain key performance measures as of, and for the years ended, December 31:
2021 2020 2019
INCOME STATEMENT DATA
Interest income $ 60,113 $ 64,172 $ 67,306
Interest expense 7,412 13,825 17,861
Net interest income 52,701 50,347 49,445
Provision for loan losses ( 518 ) 1,665 30
Noninterest income 13,822 14,423 8,039
Noninterest expenses 43,694 51,233 43,050
Federal income tax expense (benefit) 3,848 987 1,380
Net income (loss) $ 19,499 $ 10,885 $ 13,024
PER SHARE
Basic earnings (loss) $ 2.48 $ 1.37 $ 1.65
Diluted earnings (loss) $ 2.45 $ 1.34 $ 1.61
Dividends $ 1.08 $ 1.08 $ 1.05
Tangible book value $ 21.61 $ 21.29 $ 20.45
Quoted market value
High $ 29.00 $ 24.50 $ 24.80
Low $ 19.45 $ 15.60 $ 22.01
Close (1)
$ 25.50 $ 19.57 $ 24.31
Common shares outstanding (1)
7,532,641 7,997,247 7,910,804
PERFORMANCE RATIOS
Return on average total assets 0.96 % 0.57 % 0.72 %
Return on average shareholders' equity 8.83 % 4.93 % 6.25 %
Return on average tangible shareholders' equity 11.31 % 6.34 % 8.17 %
Net interest margin yield (FTE) 2.87 % 2.96 % 3.07 %
BALANCE SHEET DATA (1)
Gross loans $ 1,301,037 $ 1,238,311 $ 1,186,570
AFS securities $ 490,601 $ 339,228 $ 429,839
Total assets $ 2,032,158 $ 1,957,378 $ 1,814,198
Deposits $ 1,710,339 $ 1,566,317 $ 1,313,851
Borrowed funds $ 99,320 $ 158,747 $ 275,999
Shareholders' equity $ 211,048 $ 218,588 $ 210,182
Gross loans to deposits 76.07 % 79.06 % 90.31 %
ASSETS UNDER MANAGEMENT (1)
Loans sold with servicing retained $ 278,844 $ 301,377 $ 259,375
Assets managed by Isabella Wealth $ 516,243 $ 443,967 $ 436,181
Total assets under management $ 2,827,245 $ 2,702,722 $ 2,509,754
ASSET QUALITY (1)
Nonperforming loans to gross loans 0.10 % 0.43 % 0.55 %
Nonperforming assets to total assets 0.08 % 0.31 % 0.40 %
ALLL to gross loans 0.70 % 0.79 % 0.67 %
CAPITAL RATIOS (1)
Shareholders' equity to assets 10.39 % 11.17 % 11.59 %
Tier 1 leverage 7.97 % 8.37 % 9.01 %
Common equity tier 1 capital 12.07 % 12.97 % 12.56 %
Tier 1 risk-based capital 12.07 % 12.97 % 12.56 %
Total risk-based capital 14.94 % 13.75 % 13.18 %
(1) At end of year
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The following table outlines our interim results of operations and key performance measures as of, and for the unaudited periods ended:
Quarter to Date
December 31
2021 September 30
2021 June 30
2021 March 31
2021
Total interest income $ 15,041 $ 15,142 $ 14,640 $ 15,290
Total interest expense 1,567 1,829 1,927 2,089
Net interest income 13,474 13,313 12,713 13,201
Provision for loan losses 81 (107) 31 (523)
Noninterest income 3,608 3,367 3,315 3,532
Noninterest expenses 11,197 11,185 10,495 10,817
Federal income tax expense 1,010 916 881 1,041
Net income $ 4,794 $ 4,686 $ 4,621 $ 5,398
PER SHARE
Basic earnings $ 0.63 $ 0.59 $ 0.58 $ 0.68
Diluted earnings 0.63 0.58 0.57 0.67
Dividends 0.27 0.27 0.27 0.27
Quoted market value (1)
25.50 26.03 23.00 21.75
Tangible book value 21.61 21.87 21.73 21.35
Quarter to Date
December 31
2020 September 30
2020 June 30
2020 March 31
2020
Total interest income $ 16,402 $ 15,700 $ 15,869 $ 16,201
Total interest expense 2,858 3,203 3,565 4,199
Net interest income 13,544 12,497 12,304 12,002
Provision for loan losses 256 516 105 788
Noninterest income 4,119 4,060 3,246 2,998
Noninterest expenses 18,638 10,950 10,700 10,945
Federal income tax expense (benefit) (508) 734 558 203
Net income (loss) $ (723) $ 4,357 $ 4,187 $ 3,064
PER SHARE
Basic earnings (loss) $ (0.10) $ 0.55 $ 0.53 $ 0.39
Diluted earnings (loss) (0.10) 0.54 0.52 0.38
Dividends 0.27 0.27 0.27 0.27
Quoted market value (1)
19.57 16.74 18.25 18.00
Tangible book value 21.29 21.75 21.52 21.10
(1) At end of period
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CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are set forth in “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. Of these significant accounting policies, we consider our policies regarding the ALLL, acquisition intangibles and goodwill, and the determination of the fair value and assessment of OTTI of investment securities to be our most critical accounting policies.
The ALLL requires our most subjective and complex judgment. Changes in economic conditions and other external factors can have a significant impact on the ALLL and, therefore, the provision for loan losses and results of operations. We have developed policies and procedures for assessing the appropriateness of the ALLL, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, and the discovery of information with respect to borrowers which is not known to us at the time of the issuance of the consolidated financial statements. For additional discussion concerning our ALLL and related matters, see “Allowance for Loan and Lease Losses” and “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
U.S. generally accepted accounting principles require that we determine the fair value of the assets and liabilities of an acquired entity, and record the fair value on the date of acquisition. We employ a variety of measures in the determination of the fair value, including the use of discounted cash flow analysis, market appraisals, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculations of the value. In other cases, where the value is not easily determined, we consult with independent experts to determine the fair value of the identified asset or liability. Once valuations have been determined, the net difference between the price paid for the acquired entity and the net value of assets acquired on our balance sheet, including identifiable intangibles, is recorded as goodwill. Acquisition intangibles and goodwill are qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired on at least an annual basis.
During the fourth quarter of 2020, we engaged a third-party valuation firm to perform a quantitative analysis of goodwill as of December 31, 2020. In determining the fair value of the Bank and Isabella Bank Corporation, the third-party firm assessed general economic conditions, industry and market considerations, the impact of recent events to financial performance, the market price of our common stock, and other relevant events. Based on the valuation prepared, it was determined that our estimated fair value of the Bank and Isabella Bank Corporation at December 31, 2020 were greater than our recorded book value and no impairment of goodwill was identified. The carrying amount of goodwill as of December 31, 2020 relied on assumptions and use of estimates pursuant to the valuation obtained. We did not observe any indications of a potential impairment to the carrying balance of goodwill during 2021. As such, a valuation was not necessary to be performed as of December 31, 2021.
AFS securities are carried at fair value with changes in the fair value included as a component of other comprehensive income. Declines in the fair value of AFS securities below their cost that are other-than-temporary are reflected as realized losses in the consolidated statements of income. We evaluate AFS securities for indications of losses that are considered other-than-temporary, if any, on a regular basis. The market values for most AFS investment securities are typically obtained from outside sources and applied to individual securities within the portfolio. Municipal securities for which no readily determinable market values are available are priced using fair value curves which most closely match the securities' characteristics.
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Average Balances, Interest Rates, and Net Interest Income
The following schedules present the daily average amount outstanding for each major category of interest earning assets, non-earning assets, interest bearing liabilities, and noninterest bearing liabilities for the last three years. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a federal income tax rate of 21%. Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in other interest earning assets.
Year Ended December 31
2021 2020 2019
Average
Balance Tax
Equivalent
Interest Average
Yield /
Rate Average
Balance Tax
Equivalent
Interest Average
Yield /
Rate Average
Balance Tax
Equivalent
Interest Average
Yield /
Rate
INTEREST EARNING ASSETS
Loans $ 1,208,141 $ 51,410 4.26 % $ 1,236,169 $ 54,102 4.38 % $ 1,162,210 $ 54,192 4.66 %
Taxable investment securities 297,357 4,920 1.65 % 229,468 5,214 2.27 % 296,758 7,185 2.42 %
Nontaxable investment securities 117,997 4,235 3.59 % 140,665 5,189 3.69 % 169,049 6,380 3.77 %
Fed funds sold 5 — 0.02 % 4 — 0.06 % 64 2 2.48 %
Other 255,246 706 0.28 % 142,717 1,026 0.72 % 38,549 1,199 3.11 %
Total earning assets 1,878,746 61,271 3.26 % 1,749,023 65,531 3.75 % 1,666,630 68,958 4.14 %
NONEARNING ASSETS
Allowance for loan losses (9,396) (8,837) (8,256)
Cash and demand deposits due from banks 29,139 24,987 20,057
Premises and equipment 24,760 25,846 27,035
Accrued income and other assets 109,625 118,195 108,073
Total assets $ 2,032,874 $ 1,909,214 $ 1,813,539
INTEREST BEARING LIABILITIES
Interest bearing demand deposits $ 345,015 $ 216 0.06 % $ 262,188 $ 357 0.14 % $ 230,570 $ 305 0.13 %
Savings deposits 558,102 616 0.11 % 456,088 1,212 0.27 % 388,821 2,572 0.66 %
Time deposits 336,094 4,610 1.37 % 387,881 7,315 1.89 % 429,745 8,731 2.03 %
Federal funds purchased and repurchase agreements 57,453 53 0.09 % 35,518 36 0.10 % 32,093 48 0.15 %
FHLB advances 69,342 1,302 1.88 % 210,451 4,905 2.33 % 272,795 6,205 2.27 %
Subordinated debt, net of unamortized issuance costs
17,000 615 3.62 % — — — % — — — %
Total interest bearing liabilities 1,383,006 7,412 0.54 % 1,352,126 13,825 1.02 % 1,354,024 17,861 1.32 %
NONINTEREST BEARING LIABILITIES
Demand deposits 416,247 320,820 237,675
Other 12,858 15,613 13,337
Shareholders’ equity 220,763 220,655 208,503
Total liabilities and shareholders’ equity $ 2,032,874 $ 1,909,214 $ 1,813,539
Net interest income (FTE) $ 53,859 $ 51,706 $ 51,097
Net yield on interest earning assets (FTE) 2.87 % 2.96 % 3.07 %
(1) Includes taxable AFS securities and equity securities
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Net interest income is the amount by which interest income on earning assets exceeds the interest expense on interest bearing liabilities. Net interest income is influenced by changes in the balance and mix of assets and liabilities, as well as market interest rates. We exert some control over these factors; however, FRB monetary policy and competition have a significant impact. For analytical purposes, net interest income is adjusted to an FTE basis by including the income tax savings from interest on tax exempt loans and nontaxable investment securities, thus making year to year comparisons more meaningful. The FTE adjustment is based on a federal income tax rate of 21%.
Volume and Rate Variance Analysis
The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows:
Volume—change in volume multiplied by the previous period's FTE rate.
Rate—change in the FTE rate multiplied by the previous period's volume.
All interest income presented in the table below is reported on a FTE basis using a federal income tax rate of 21%. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
2021 Compared to 2020
Increase (Decrease) Due to 2020 Compared to 2019
Increase (Decrease) Due to
Volume Rate Net Volume Rate Net
Changes in interest income
Loans $ (1,211) $ (1,481) $ (2,692) $ 3,341 $ (3,431) $ (90)
Taxable investment securities 1,324 (1,618) (294) (1,550) (421) (1,971)
Nontaxable investment securities (817) (137) (954) (1,050) (141) (1,191)
Fed Funds Sold — — — (1) (1) (2)
Other 529 (849) (320) 1,301 (1,474) (173)
Total changes in interest income (175) (4,085) (4,260) 2,041 (5,468) (3,427)
Changes in interest expense
Interest bearing demand deposits 90 (231) (141) 43 9 52
Savings deposits 227 (823) (596) 385 (1,745) (1,360)
Time deposits (889) (1,816) (2,705) (815) (601) (1,416)
Federal funds purchased and repurchase agreements 20 (3) 17 5 (17) (12)
FHLB advances (2,793) (810) (3,603) (1,450) 150 (1,300)
Subordinated debt, net of unamortized issuance costs
615 — 615 — — —
Total changes in interest expense (2,730) (3,683) (6,413) (1,832) (2,204) (4,036)
Net change in interest margin (FTE) $ 2,555 $ (402) $ 2,153 $ 3,873 $ (3,264) $ 609
The current low interest rate environment continues to place pressure on our net interest margin. SBA PPP fee income has supported our yield on total earning assets. Given the uncertainty in rates and the economic environment as a result of COVID-19, improvement in our net yield on interest earning assets could be gradual.
Average Yield / Rate for the Three-Month Periods Ended:
December 31
2021 September 30
2021 June 30
2021 March 31
2021 December 31
2020
Total earning assets 3.19 % 3.23 % 3.20 % 3.43 % 3.66 %
Total interest bearing liabilities 0.45 % 0.52 % 0.56 % 0.62 % 0.83 %
Net yield on interest earning assets (FTE) 2.86 % 2.85 % 2.79 % 2.98 % 3.04 %
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Quarter to Date Net Interest Income (FTE)
December 31
2021 September 30
2021 June 30
2021 March 31
2021 December 31
2020
Total interest income (FTE) $ 15,246 $ 15,452 $ 14,954 $ 15,619 $ 16,722
Total interest expense 1,567 1,829 1,927 2,089 2,858
Net interest income (FTE) $ 13,679 $ 13,623 $ 13,027 $ 13,530 $ 13,864
Allowance for Loan and Lease Losses
The viability of any financial institution is ultimately determined by its management of credit risk. Loans represent our single largest concentration of risk. The ALLL is our estimation of incurred losses within the existing loan portfolio. We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated within each loan segment. Our assessments include allocations based on specific impairment valuation allowances, historical charge-offs, internally assigned credit risk ratings, and past due and nonaccrual balances. A portion of the ALLL is not allocated to any one loan segment, but is instead a representation of other qualitative risks that reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
The following table summarizes our charge-offs, recoveries, provision for loan losses, and ALLL balances as of, and for the unaudited three month periods ended:
December 31
2021 September 30
2021 June 30
2021 March 31
2021 December 31
2020
Total charge-offs $ 149 $ 246 $ 53 $ 159 $ 111
Total recoveries 78 86 111 209 93
Net loan charge-offs (recoveries) 71 160 (58) (50) 18
Net loan charge-offs (recoveries) to average loans outstanding 0.01 % 0.01 % — % — % — %
Provision for loan losses $ 81 $ (107) $ 31 $ (523) $ 256
Provision for loan losses to average loans outstanding 0.01 % (0.01) % — % (0.04) % 0.02 %
ALLL $ 9,103 $ 9,093 $ 9,360 $ 9,271 $ 9,744
ALLL as a % of loans at end of period 0.70 % 0.73 % 0.78 % 0.78 % 0.79 %
The following table summarizes charge-off and recovery activity by loan segment for the year ended December 31, 2021:
Commercial Agricultural Residential Real Estate Consumer Total
Charge-offs $ 32 $ 77 $ 12 $ 486 $ 607
Recoveries 133 12 162 177 484
Net loan charge-offs (recoveries) $ (101) $ 65 $ (150) $ 309 $ 123
Average loans outstanding 726,272 93,931 313,906 74,032 1,208,141
Net loan charge-offs (recoveries) to average loans outstanding (0.01) % 0.07 % (0.05) % 0.42 % 0.01 %
The following table summarizes charge-offs, recoveries, and provision for loan loss activity for the years ended December 31:
2021 2020 2019 2018 2017
ALLL at beginning of period $ 9,744 $ 7,939 $ 8,375 $ 7,700 $ 7,400
Charge-offs 607 381 948 1,101 771
Recoveries 484 521 482 798 818
Provision for loan losses (518) 1,665 30 978 253
ALLL at end of period $ 9,103 $ 9,744 $ 7,939 $ 8,375 $ 7,700
Net loan charge-offs (recoveries) $ 123 $ (140) $ 466 $ 303 $ (47)
Net loan charge-offs (recoveries) to average loans outstanding 0.01 % (0.01) % 0.04 % 0.03 % — %
ALLL as a % of loans at end of period 0.70 % 0.79 % 0.67 % 0.74 % 0.71 %
ALLL as a % of nonaccrual loans 731.16 % 183.40 % 121.48 % 115.36 % 254.38 %
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While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at December 31, 2021. The COVID-19 pandemic led to the temporary and some permanent closures of businesses throughout the communities in which we serve, which also led to increased unemployment. We increased the ALLL during 2020 as a result of increased economic and environmental related risk factors, primarily driven by COVID-19. While these risk factors remain, improvement in credit quality indicators resulted in a reduction to the ALLL during 2021.
The economic impact from the COVID-19 pandemic could pose significant credit risk due to the potential inability of consumer and commercial borrowers to make contractual payments. In late March 2020, we implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. We continue to monitor the economic impact from COVID-19 as it relates to credit risk to ensure the ALLL is appropriate.
The following table illustrates the two main components of the ALLL as of:
December 31
2021 September 30
2021 June 30
2021 March 31
2021 December 31
2020
ALLL
Individually evaluated for impairment $ 578 $ 583 $ 1,201 $ 1,380 $ 911
Collectively evaluated for impairment 8,525 8,510 8,159 7,891 8,833
Total $ 9,103 $ 9,093 $ 9,360 $ 9,271 $ 9,744
ALLL to gross loans
Individually evaluated for impairment 0.04 % 0.05 % 0.10 % 0.12 % 0.07 %
Collectively evaluated for impairment 0.66 % 0.68 % 0.68 % 0.66 % 0.72 %
Total 0.70 % 0.73 % 0.78 % 0.78 % 0.79 %
The following table illustrates the amounts of the ALLL allocated to each loan segment and the percentage of these loan segments to gross loans as of December 31:
2021 2020 2019 2018 2017
ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans ALLL Allocation % of Gross Loans
Commercial $ 1,740 62.07 $ 2,162 61.10 $ 1,914 59.08 $ 2,563 58.43 $ 1,706 58.16
Agricultural 289 7.22 311 8.11 634 9.85 775 11.27 611 11.75
Residential real estate 747 25.08 1,363 24.84 2,047 25.16 1,992 24.39 2,563 24.95
Consumer 908 5.63 798 5.95 922 5.91 857 5.91 900 5.14
Total Allocated 3,684 100.00 4,634 100.00 5,517 100.00 6,187 100.00 5,780 100.00
Unallocated 5,419 — 5,110 — 2,422 — 2,188 — 1,920 —
Total $ 9,103 100.00 $ 9,744 100.00 $ 7,939 100.00 $ 8,375 100.00 $ 7,700 100.00
While we utilize our best judgment and information available, the ultimate adequacy of the ALLL is dependent upon a variety of factors beyond our control, including the performance of our borrowers, the economy, and changes in interest rates. We closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at an appropriate level.
For further discussion of the allocation of the ALLL, see “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Loans Past Due and Loans in Nonaccrual Status
Fluctuations in past due and nonaccrual status loans can have a significant impact on the ALLL. To determine the potential impact, and corresponding estimated losses, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual status loans for indications of additional deterioration.
Total Past Due and Nonaccrual Loans as of December 31
2021 2020 2019 2018 2017
Commercial $ 561 $ 2,148 $ 2,477 $ 2,722 $ 2,518
Agricultural 987 3,786 4,285 5,377 2,367
Residential real estate 2,287 3,580 4,572 3,208 4,881
Consumer 196 96 71 105 70
Total $ 4,031 $ 9,610 $ 11,405 $ 11,412 $ 9,836
Total past due and nonaccrual loans to gross loans 0.31 % 0.78 % 0.96 % 1.01 % 0.90 %
Past due and nonaccrual status loans, as a percentage of gross loans, improved throughout 2021 and continue to be at low levels as a result of strong repayment performance.
A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
Troubled Debt Restructurings
We have taken a proactive approach to modifying loans to assist borrowers who are willing to work with us, thus making them less likely to default, and to avoid foreclosure. This approach has permitted certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure. Modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. The majority of new modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed in nonaccrual status may be placed back on accrual status after six months of continued performance and achievement of current payment status.
We restructure debt with borrowers who due to financial difficulties are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, allow temporary interest-only payment structures, forgive principal, forgive interest, or grant a combination of these modifications. Typically, the modifications are for a period of three years or less. There were no TDRs that were government sponsored as of December 31, 2021 or December 31, 2020.
Losses associated with TDRs, if any, are included in the estimation of the ALLL during the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period thereafter to ensure its continued appropriateness.
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The following table provides a roll-forward of TDRs for the years ended December 31, 2020 and 2021:
Accruing Interest Nonaccrual Total
Number
of
Loans Balance Number
of
Loans Balance Number
of
Loans Balance
January 1, 2020 122 $ 21,194 9 $ 3,543 131 $ 24,737
New modifications 15 7,909 3 645 18 8,554
Principal advances (payments) — (1,690) — (148) — (1,838)
Loans paid off (30) (5,317) (2) (850) (32) (6,167)
Transfers to OREO — — (2) (356) (2) (356)
Transfers to accrual status 1 104 (1) (104) — —
December 31, 2020 108 22,200 7 2,730 115 24,930
New modifications 11 8,473 — — 11 8,473
Principal advances (payments) — (1,697) — (242) — (1,939)
Loans paid off (22) (5,739) — — (22) (5,739)
Transfers to accrual status 3 2,127 (3) (2,127) — —
Transfers to nonaccrual status (2) (88) 2 88 — —
December 31, 2021 98 $ 25,276 6 $ 449 104 $ 25,725
The following table summarizes our TDRs as of December 31:
2021 2020 2019
Accruing
Interest Nonaccrual Total Accruing
Interest Nonaccrual Total Accruing
Interest Nonaccrual Total
Current $ 25,236 $ 294 $ 25,530 $ 22,017 $ 2,421 $ 24,438 $ 20,847 $ 507 $ 21,354
Past due 30-59 days 40 85 125 183 — 183 346 — 346
Past due 60-89 days — — — — — — 1 — 1
Past due 90 days or more — 70 70 — 309 309 — 3,036 3,036
Total $ 25,276 $ 449 $ 25,725 $ 22,200 $ 2,730 $ 24,930 $ 21,194 $ 3,543 $ 24,737
2018 2017
Accruing
Interest Nonaccrual Total Accruing
Interest Nonaccrual Total
Current $ 21,794 $ 2,673 $ 24,467 $ 21,234 $ — $ 21,234
Past due 30-59 days 899 — 899 1,778 805 2,583
Past due 60-89 days 707 — 707 219 708 927
Past due 90 days or more — 878 878 53 1,400 1,453
Total $ 23,400 $ 3,551 $ 26,951 $ 23,284 $ 2,913 $ 26,197
Additional disclosures about TDRs are included in “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Impaired Loans
The following is a summary of information pertaining to impaired loans as of December 31:
2021 2020
Recorded
Balance Unpaid
Principal
Balance Valuation
Allowance Recorded
Balance Unpaid
Principal
Balance Valuation
Allowance
TDRs
Commercial real estate $ 5,707 $ 5,961 $ 9 $ 4,915 $ 5,169 $ 79
Commercial other 3,246 3,246 4 3,567 3,567 5
Agricultural real estate 9,182 9,181 — 9,667 9,667 54
Agricultural other 4,543 4,543 — 2,903 2,903 2
Residential real estate senior liens 3,047 3,203 504 3,878 4,073 692
Total TDRs 25,725 26,134 517 24,930 25,379 832
Other impaired loans
Commercial real estate 314 377 — 139 201 —
Commercial other — — — 1,200 1,200 —
Agricultural real estate 356 357 — 1,008 1,058 —
Agricultural other 108 108 — 218 218 —
Residential real estate senior liens 370 485 61 441 588 79
Home equity lines of credit 37 37 — — — —
Total other impaired loans 1,185 1,364 61 3,006 3,265 79
Total impaired loans $ 26,910 $ 27,498 $ 578 $ 27,936 $ 28,644 $ 911
We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recording of a charge-off.
Additional disclosures related to impaired loans are included in “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Nonperforming Assets
The following table summarizes our nonperforming assets as of December 31:
2021 2020 2019 2018 2017
Nonaccrual status loans $ 1,245 $ 5,313 $ 6,535 $ 7,260 $ 3,027
Accruing loans past due 90 days or more 97 — — 113 395
Total nonperforming loans 1,342 5,313 6,535 7,373 3,422
Foreclosed assets 211 527 456 355 291
Debt securities 131 230 230 230 230
Total nonperforming assets $ 1,684 $ 6,070 $ 7,221 $ 7,958 $ 3,943
Nonperforming loans as a % of total loans 0.10 % 0.43 % 0.55 % 0.65 % 0.31 %
Nonperforming assets as a % of total assets 0.08 % 0.31 % 0.40 % 0.42 % 0.20 %
The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Loans may be placed back on accrual status after six months of continued performance and achievement of current payment status. While the level of nonperforming loans has fluctuated in recent periods, it remains low in comparison to peer banks.
The following table summarizes nonaccrual loans as of December 31:
2021 2020 2019 2018 2017
Commercial $ 341 $ 1,329 $ 1,621 $ 1,757 $ 729
Agricultural 774 3,785 4,285 4,949 1,950
Residential real estate 130 199 629 554 348
Total $ 1,245 $ 5,313 $ 6,535 $ 7,260 $ 3,027
Nonaccrual loans as a % of loans at end of period 0.10 % 0.43 % 0.55 % 0.64 % 0.28 %
Included in the nonaccrual loan balances above were loans also classified as TDR as of December 31:
2021 2020 2019 2018 2017
Commercial $ 139 $ 129 $ 390 $ 160 $ 729
Agricultural 310 2,559 3,048 3,391 1,950
Residential real estate — 42 105 — 234
Total $ 449 $ 2,730 $ 3,543 $ 3,551 $ 2,913
Additional disclosures about nonaccrual status loans are included in “Note 4 – Loans and ALLL”of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Noninterest Income and Noninterest Expenses
Significant noninterest income balances are highlighted in the following table for the years ended December 31:
Change Change
2021 2020 $ % 2019 $ %
Service charges and fees
ATM and debit card fees $ 4,600 $ 3,723 $ 877 23.56 % $ 3,239 $ 484 14.94 %
Service charges and fees on deposit accounts 2,139 1,847 292 15.81 % 2,328 (481) (20.66) %
Freddie Mac servicing fee 747 625 122 19.52 % 626 (1) (0.16) %
Net OMSR income (loss) (184) 44 (228) (518.18) % (170) 214 N/M
Other fees for customer services 312 305 7 2.30 % 324 (19) (5.86) %
Total service charges and fees 7,614 6,544 1,070 16.35 % 6,347 197 3.10 %
Wealth management fees 3,071 2,578 493 19.12 % 2,792 (214) (7.66) %
Net gain on sale of mortgage loans 1,694 2,716 (1,022) (37.63) % 650 2,066 317.85 %
Earnings on corporate owned life insurance policies 800 755 45 5.96 % 764 (9) (1.18) %
Gains from redemption of corporate owned life insurance policies 271 891 (620) (69.58) % — 891 N/M
Net income (loss) on joint venture investment — 577 (577) (100.00) (3,108) 3,685 N/M
Other 372 362 10 2.76 % 594 (232) (39.06) %
Total noninterest income $ 13,822 $ 14,423 $ (601) (4.17) % $ 8,039 $ 6,384 79.41 %
ATM and debit card fees fluctuate from period to period based primarily on their usage. While we do not anticipate significant changes to our ATM and debit card fee structure, we do expect that fee income will continue to increase in 2022 as the usage of ATM and debit cards continues to increase.
Service charges and fees on deposit accounts declined in 2020 as a result of waived fees. In response to the COVID-19 pandemic, which led to an increase in the need for electronic services and products, we elected to remove select deposit account related charges and fees and temporarily waived some charges and fees to ease the financial stress of our customers. Despite some fees being removed or waived, fee income increased during 2021, but did not reach pre-pandemic levels. As such, we expect service charges and fees in 2022 to approximate pre-pandemic levels.
OMSR income results are driven, in part, by changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the servicing-retained portfolio. Increased prepayment speeds, as a result of a decline in interest rates during the first quarter of 2020, were the primary driver of the losses recognized during most of 2020. During 2021, the volume of loans serviced decreased, which decreases the value of the servicing rights, and the increased prepayment speeds continued. Both of these factors have contributed to the recognition of a loss during 2021. OMSR income during 2022 may continue to experience fluctuations and could vary from 2021 levels.
The increase in wealth management fees in 2021 was driven by a combination of the growth in the stock market and increased new business activity. During the first quarter of 2020, a decline in the stock market resulted in a decrease in the value of investment assets under management. Wealth management fees in 2022 are expected to continue to increase as a result of new business activity.
Net gain on sale of mortgage loans fluctuates as the result of changes in the amount of loans sold, loan pricing and interest rates. The amount of loans sold is driven by customer demand and balance sheet management strategies. We experienced a significant increase in loan demand during most of 2020 and into 2021 which led to an increase in the number and dollar amount of loans sold. As such, net gain on sale of mortgage loans increased significantly. In mid-2021, we decided to retain more loan originations on the balance sheet, thereby decreasing the number of mortgage loans sold, which had an impact on the net gain on loans sold in 2021. As demand is expected to decline slightly in 2022, net gain on sale of mortgage loans is not expected to exceed 2021 levels.
We recognized income during 2021 and 2020 due to the redemption of corporate owned life insurance policies in connection with the passing of retired bank employees.
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We sold our membership interest in our joint venture investment in Corporate Settlement Solutions, LLC (“CSS”) during the fourth quarter of 2020, which resulted in a $394 reduction in income. As a result of a valuation during the fourth quarter of 2019, CSS recognized a $7,133 impairment related to intangible assets as of December 31, 2019. Since we accounted for our investment in CSS under the equity method of accounting, and were a 50% owner of CSS, we reduced our investment in CSS by $3,566 during the fourth quarter of 2019.
The fluctuations in all other income are spread throughout various categories, none of which are individually significant.
Significant noninterest expense balances are highlighted in the following table for the years ended December 31:
Change Change
2021 2020 $ % 2019 $ %
Compensation and benefits $ 23,749 $ 23,772 $ (23) (0.10) % $ 23,205 $ 567 2.44 %
Furniture and equipment 5,462 5,787 (325) (5.62) % 5,866 (79) (1.35) %
Occupancy 3,661 3,557 104 2.92 % 3,418 139 4.07 %
Losses on extinguishment of debt — 7,643 (7,643) (100.00) % — 7,643 N/M
Other
Audit, consulting, and legal fees 2,066 1,836 230 12.53 % 1,884 (48) (2.55) %
ATM and debit card fees 1,810 1,441 369 25.61 % 1,210 231 19.09 %
Marketing costs 939 877 62 7.07 % 762 115 15.09 %
Memberships and subscriptions 877 740 137 18.51 % 700 40 5.71 %
Loan underwriting fees 849 825 24 2.91 % 905 (80) (8.84) %
Donations and community relations 705 723 (18) (2.49) % 1,026 (303) (29.53) %
Director fees 703 695 8 1.15 % 788 (93) (11.80) %
FDIC insurance premiums 690 612 78 12.75 % 211 401 190.05 %
All other 2,183 2,725 (542) (19.89) % 3,075 (350) (11.38) %
Total other 10,822 10,474 348 3.32 % 10,561 (87) (0.82) %
Total noninterest expenses $ 43,694 $ 51,233 $ (7,539) (14.72) % $ 43,050 $ 8,183 19.01 %
During the fourth quarter of 2020, we incurred expense of $7,643 as a result of the extinguishment of $100,000 of FHLB advances.
We have experienced an increase in the usage of ATM and debit cards which has resulted in increased income and also increased ATM and debit card expenses. Based on the anticipated continuation of increased ATM and debit card usage, we expect expenses to continue to increase in 2022.
As a result of an assessment credit of $440 received during the third quarter of 2019, FDIC insurance premiums declined in 2019 as compared to 2020 and 2021 expenses.
The fluctuations in all other noninterest expenses are spread throughout various categories, none of which are individually significant.
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Analysis of Changes in Financial Condition
The following table shows the composition and changes in our balance sheet as of December 31:
Change
2021 2020 $ %
ASSETS
Cash and cash equivalents $ 105,330 $ 246,640 $ (141,310) (57.29) %
AFS securities
Amortized cost of AFS securities 485,710 325,966 159,744 49.01 %
Unrealized gains (losses) on AFS securities 4,891 13,262 (8,371) (63.12) %
AFS securities 490,601 339,228 151,373 44.62 %
Mortgage loans AFS 1,735 2,741 (1,006) (36.70) %
Loans
Gross loans 1,301,037 1,238,311 62,726 5.07 %
Less allowance for loan and lease losses 9,103 9,744 (641) (6.58) %
Net loans 1,291,934 1,228,567 63,367 5.16 %
Premises and equipment 24,419 25,140 (721) (2.87) %
Corporate owned life insurance policies 32,472 28,292 4,180 14.77 %
Equity securities without readily determinable fair values 17,383 17,383 — — %
Goodwill and other intangible assets 48,302 48,331 (29) (0.06) %
Accrued interest receivable and other assets 19,982 21,056 (1,074) (5.10) %
TOTAL ASSETS $ 2,032,158 $ 1,957,378 $ 74,780 3.82 %
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits $ 1,710,339 $ 1,566,317 $ 144,022 9.19 %
Borrowed funds 99,320 158,747 (59,427) (37.44) %
Accrued interest payable and other liabilities 11,451 13,726 (2,275) (16.57) %
Total liabilities 1,821,110 1,738,790 82,320 4.73 %
Shareholders’ equity 211,048 218,588 (7,540) (3.45) %
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 2,032,158 $ 1,957,378 $ 74,780 3.82 %
A discussion of changes in balance sheet amounts by major categories follows:
Cash and cash equivalents
Included in cash and cash equivalents are funds held with the FRB which fluctuate from period to period. Cash levels decreased significantly during 2021 as a result of loan growth and payments for maturing long-term borrowings and other short-term liabilities. During 2021, excess funds from deposit growth were used to purchase AFS securities.
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AFS securities
The primary objective of our investing activities is to provide for safety of the principal invested. Secondary considerations include providing earnings and liquidity while managing our overall exposure to changes in interest rates. Over the last two years, the flat yield curve encouraged the use of excess funds to reduce higher-cost borrowings as opposed to investing in AFS securities. However, based on balance sheet strategies, excess funds above what is required to retire higher-cost funding sources may prudently be deployed to purchase of AFS securities in future periods.
The following is a schedule of the carrying value of AFS securities as of December 31:
2021 2020 2019
U.S. Treasury $ 209,703 $ — $ —
States and political subdivisions 121,205 143,656 169,752
Auction rate money market preferred 3,242 3,237 3,119
Mortgage-backed securities 56,148 88,652 140,204
Collateralized mortgage obligations 92,301 101,983 116,764
Corporate 8,002 1,700 —
Total $ 490,601 $ 339,228 $ 429,839
Excluding those holdings in government sponsored enterprises and municipalities within the State of Michigan, there were no investments in securities of any one issuer that exceeded 10% of shareholders’ equity during 2021, 2020, and 2019. We have a policy prohibiting investments in securities that we deem unsuitable due to their inherent credit or market risks. Prohibited investments include stripped mortgage-backed securities, zero coupon bonds, nongovernment agency asset-backed securities, and structured notes. Our holdings in mortgage-backed securities and collateralized mortgage obligations include only government agencies and government sponsored agencies as we hold no investments in private label mortgage-backed securities or collateralized mortgage obligations.
The following is a schedule of maturities of AFS securities and their weighted average yields as of December 31, 2021. Weighted average yields have been computed on an FTE basis using a tax rate of 21%. Our auction rate money market preferred investments are long-term floating rate instruments. The issuers of auction rate securities generally have the right to redeem or refinance the debt. Because of their lack of contractual maturities, auction rate money market preferred stocks are not reported by a specific maturity group. Mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group due to their variable monthly payments. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.
Maturing
Within
One Year After One
Year But
Within
Five Years After Five
Years But
Within
Ten Years After
Ten Years Securities with
Variable Monthly
Payments or
Noncontractual
Maturities
Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%)
U.S. Treasury $ — — $ 200,030 — $ 9,673 — $ — — $ — —
States and political subdivisions 16,039 2.92 56,302 2.89 20,095 3.22 28,769 3.34 — —
Mortgage-backed securities — — — — — — — — 56,148 2.19
Collateralized mortgage obligations — — — — — — — — 92,301 2.03
Auction rate money market preferred — — — — — — — — 3,242 6.27
Corporate — — — — 8,002 3.77 — — — —
Total $ 16,039 2.92 $ 256,332 0.63 $ 37,770 2.51 $ 28,769 3.34 $ 151,691 2.18
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Loans
Loans are the largest component of earning assets. The proper management of credit and market risk inherent in the loan portfolio is critical to our financial stability. To control these risks, we have adopted strict underwriting standards, lending limits to a single borrower, loan to collateral value limits, and a defined market area. We also monitor and limit loan concentrations to specific industries. We have no foreign loans and there were no concentrations greater than 10% of total loans that are not disclosed as a separate category in the following table.
The following table presents the composition of the loan portfolio for the years ended December 31:
2021 2020 2019 2018 2017
Commercial $ 807,439 $ 756,686 $ 700,941 $ 659,529 $ 634,759
Agricultural 93,955 100,461 116,920 127,161 128,269
Residential real estate 326,361 307,543 298,569 275,343 272,368
Consumer 73,282 73,621 70,140 66,674 56,123
Total $ 1,301,037 $ 1,238,311 $ 1,186,570 $ 1,128,707 $ 1,091,519
The following table presents the change in the loan portfolio categories for the years ended December 31:
2021 2020 2019
$ Change % Change $ Change % Change $ Change % Change
Commercial $ 50,753 6.71 % $ 55,745 7.95 % $ 41,412 6.28 %
Agricultural (6,506) (6.48) % (16,459) (14.08) % (10,241) (8.05) %
Residential real estate 18,818 6.12 % 8,974 3.01 % 23,226 8.44 %
Consumer (339) (0.46) % 3,481 4.96 % 3,466 5.20 %
Total $ 62,726 5.07 % $ 51,741 4.36 % $ 57,863 5.13 %
Loan demand has been negatively impacted by competition for new commercial loan opportunities while some customers hesitated to borrow due to the pandemic. While we've recently experienced an increase in commercial loan demand, advances to mortgage brokers, within the commercial loan portfolio, was the primary driver behind the growth during 2021. While we anticipate a decline in advances to mortgage brokers in 2022, we expect the commercial loan portfolio to increase with increased demand. Agricultural loans have declined over the last year due to the competitive lending environment. We expect the competitive environment for agricultural loans to remain strong. Residential mortgage lending activities have increased since mid-2020 as interest rates declined. Growth is expected to continue in both the residential mortgage and consumer loan portfolios during 2022.
Other assets
Other assets consist primarily of prepaid expenses, OMSR, and net deferred tax assets. For more information related to estimates and deferred taxes, refer to “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” and “Note 15 – Federal Income Taxes” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Deposits
Deposits are our primary source of funding. The following table presents the composition of the deposit portfolio as of December 31:
2021 2020 2019
Noninterest bearing demand deposits $ 448,352 $ 375,395 $ 249,152
Interest bearing demand deposits 364,563 302,444 229,865
Savings deposits 596,662 505,497 427,215
Certificates of deposit 297,696 358,165 365,049
Brokered certificates of deposit — 14,029 27,458
Internet certificates of deposit 3,066 10,787 15,112
Total $ 1,710,339 $ 1,566,317 $ 1,313,851
The following table presents the change in the deposit categories for the years ended December 31:
2021 2020
$ Change % Change $ Change % Change
Noninterest bearing demand deposits $ 72,957 19.43 % $ 126,243 50.67 %
Interest bearing demand deposits 62,119 20.54 % 72,579 31.57 %
Savings deposits 91,165 18.03 % 78,282 18.32 %
Certificates of deposit (60,469) (16.88) % (6,884) (1.89) %
Brokered certificates of deposit (14,029) (100.00) % (13,429) (48.91) %
Internet certificates of deposit (7,721) (71.58) % (4,325) (28.62) %
Total $ 144,022 9.19 % $ 252,466 19.22 %
Total deposits have increased over the past 12 months with significant growth in non-contractual deposits, such as demand and savings deposits. This trend is anticipated to continue into 2022 as the financial markets continue to exhibit signs of instability. We experienced a decline in certificates of deposit over the past year as a result of the low interest rate environment with customers moving their funds into demand and savings accounts. During 2020, we used excess funds to reduce higher-cost deposits, such as brokered certificates of deposit. This trend continued in 2021 as we paid off the remaining balance of brokered deposits as they matured.
The following table presents estimated balances of uninsured deposits for the years ended December 31:
2021 2020 2019 2018 2017
Uninsured deposits $ 548,213 $ 461,859 $ 336,399 $ 292,017 $ 279,037
Uninsured deposits are the portion of deposit accounts in U.S. offices that exceed the FDIC insurance limits. The balance provided above are estimates and reflect the methodologies and assumptions used for regulatory reporting of uninsured deposits. The remaining maturity of estimated uninsured certificates of deposit, by account, as of December 31, 2021 is presented in the table below. Estimated uninsured certificates of deposit is based on individual accounts and does not reflect uninsured balances by account owner.
Maturity
Within 3 months $ 14,324
Within 3 to 6 months 2,464
Within 6 to 12 months 12,900
Over 12 months 11,645
Total $ 41,333
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Borrowed Funds
Borrowed funds include FHLB advances, securities sold under agreements to repurchase, subordinated debt, and federal funds purchased. The balance of borrowed funds fluctuates from period to period based on our funding needs that arise from changes in loans, investments, and deposits. To provide balance sheet growth, we may utilize borrowings and brokered deposits to fund earning assets.
The following table presents borrowed funds balances for the years ended December 31:
2021 2020 2019
Securities sold under agreements to repurchase without stated maturity dates $ 50,162 $ 68,747 $ 30,999
FHLB advances 20,000 90,000 245,000
Subordinated debt, net of unamortized issuance costs 29,158 — —
Total $ 99,320 $ 158,747 $ 275,999
During the fourth quarter of 2020, we elected to extinguish $100,000 of FHLB advances based on our level of cash reserves and strategic initiatives. Due to a significant increase in one account during the fourth quarter of 2020, our level of securities sold under agreements to repurchase increased as of December 31, 2020. This increase was short-term and balances declined during 2021. On June 2, 2021, we completed a private placement of $30,000 in aggregate principal amount of 3.25% Fixed-to-Floating Rate Subordinated Notes due 2031 (the "Notes"). The Notes will initially bear a fixed interest rate of 3.25% until June 15, 2026, after which time until maturity on June 15, 2031, the interest rate will reset quarterly to an annual floating rate equal to the then-current 3-month SOFR plus 256 basis points. The Notes are redeemable by us at our option, in whole or in part, on or after June 15, 2026. The Notes are not subject to redemption at the option of the holders. For additional disclosure related to borrowed funds, see “Note 8 – Borrowed Funds” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
Accrued interest payable and other liabilities
Included in accrued interest payable and other liabilities are obligations related to our defined benefit pension plan and other employee benefits. For more information on the defined benefit pension plan and other employee benefits, see “Note 12 – Benefit Plans” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
Contractual Obligations and Loan Commitments
We have various financial obligations, including contractual obligations and commitments related to deposits and borrowings, which may require future cash payments. We also have loan related commitments that may impact liquidity. The commitments include unused lines of credit, commercial and standby letters of credit, and commitments to grant loans. These commitments to grant loans include residential mortgage loans with the majority committed to be sold to the secondary market. Many of these commitments historically have expired without being drawn upon and do not necessarily indicate our future cash requirements.
For additional disclosure related to Contractual Obligations and Loan Commitments, see “Note 9 – Off-Balance-Sheet Activities, Commitments and Other Matters” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Capital
Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 67,436 shares or $1,593 of common stock during 2021, and 231,393 shares or $4,185 of common stock in 2020. We offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $433 and $413 during 2021 and 2020, respectively. We also grant restricted stock awards pursuant to the RSP, effective June 24, 2020. Pursuant to this plan, we increased shareholders’ equity by $86 and $14 during 2021 and 2020.
We have publicly announced a common stock repurchase plan. Pursuant to this plan, we repurchased 135,465 shares or $3,050 of common stock during 2021 and 144,950 shares or $2,702 during 2020. As of December 31, 2021, we were authorized to repurchase up to an additional 467,491 shares of common stock.
On September 1, 2021, we announced the commencement of a “modified Dutch Auction” tender offer to purchase up to $20,000 in value of our common stock, or such lesser number of shares of our common stock as were properly tendered and not properly withdrawn, at a price not less than $23.00 nor greater than $27.00 per share. The tender offer expired on October 13, 2021 and resulted in the purchase of 396,576.78534 shares at a price of $27.00 per share for a total amount of approximately $10,708. The remainder of the $20,000 not used in the tender offer may be deployed for general corporate purposes, including potential repurchases of our common stock.
The FRB has established minimum risk-based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital.
The common equity tier 1 capital ratio has a minimum requirement of 4.50%. The minimum standard for primary, or Tier 1 capital is 6.00% and the minimum standard for total capital is 8.00%. The minimum requirements presented below include the minimum required capital levels based on the Basel III Capital Rules. Capital requirements to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. The following table sets forth these requirements and our ratios as of December 31:
2021 2020
Actual Minimum Required - BASEL III Required to be Considered Well Capitalized Actual Minimum Required - BASEL III Required to be Considered Well Capitalized
Common equity tier 1 capital 12.07 % 7.00 % 6.50 % 12.97 % 7.00 % 6.50 %
Tier 1 capital 12.07 % 8.50 % 8.00 % 12.97 % 8.50 % 8.00 %
Total capital 14.94 % 10.50 % 10.00 % 13.75 % 10.50 % 10.00 %
Tier 1 leverage 7.97 % 4.00 % 5.00 % 8.37 % 4.00 % 5.00 %
There are no significant regulatory constraints placed on our capital. At December 31, 2021, the Bank exceeded minimum capital requirements. For further information regarding the Bank’s capital requirements, see “Note 10 – Minimum Regulatory Capital Requirements” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
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Fair Value
We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. AFS securities, cash flow hedge derivative instruments and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other assets on a nonrecurring basis, such as mortgage loans AFS, impaired loans, goodwill, foreclosed assets, OMSR, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write downs of individual assets.
For further information regarding fair value measurements, see “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” and “Note 17 – Fair Value” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.
Liquidity
Liquidity is monitored regularly by our ALCO, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.
Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled $495,259 or 24.37% of assets as of December 31, 2021 as compared to $444,051 or 22.69% as of December 31, 2020. The increase in both the amount and percentage of primary liquidity is a direct result of an increase in market deposits and a deliberate reduction in non-market funding which required collateralization. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Based on these same factors, daily liquidity could vary significantly.
Deposit accounts are our primary source of funds. Our secondary sources include the ability to borrow from the FHLB, from the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. In recent periods, we have elected to use excess funds to reduce borrowings and other higher-cost funding sources. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of December 31, 2021, we had available lines of credit of $298,662.
Our stress testing of liquidity increased during 2020 and continues to evolve due to economic uncertainly as a result of COVID-19. Our liquidity position remained strong at the end of 2021 which is illustrated in the following table:
December 31
2021
Total cash and cash equivalents $ 105,330
Available lines of credit
Fed funds lines with correspondent banks 93,000
FHLB borrowings 192,260
FRB Discount Window 8,402
Other lines of credit 5,000
Total available lines of credit 298,662
Unencumbered lendable value of FRB collateral, estimated 1
350,000
Total cash and liquidity $ 753,992
(1) Includes estimated unencumbered lendable value of FHLB collateral of $280,000
The following table summarizes our sources and uses of cash for the years ended December 31:
2021 2020 $ Variance
Net cash provided by (used in) operating activities $ 25,501 $ 21,997 $ 3,504
Net cash provided by (used in) investing activities (229,635) 45,133 (274,768)
Net cash provided by (used in) financing activities 62,824 118,938 (56,114)
Increase (decrease) in cash and cash equivalents (141,310) 186,068 (327,378)
Cash and cash equivalents January 1 246,640 60,572 186,068
Cash and cash equivalents December 31 $ 105,330 $ 246,640 $ (141,310)
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Market Risk
Our primary market risks are interest rate risk and liquidity risk. IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. Managing IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital.
The FRB has adopted a policy requiring banks to effectively manage the various risks that can have a material impact on safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our Funds Management policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long-term assets, limiting the mismatch in repricing opportunities of assets and liabilities, and the frequency of measuring and reporting to our Board of Directors.
The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, loan prepayments, and funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic rate environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits.
Gap analysis, the secondary method to measure IRR, measures the cash flows and/or the earliest repricing of our interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without penalty, while commercial and agricultural loans may have prepayment penalties. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of home sales, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. A significant portion of our securities are callable or have prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of deposit have penalties that discourage early withdrawals.
We do not believe there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. We do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term, and we do not expect to make material changes to our market risk methods in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques.
Gap analysis is also utilized as a method to measure interest rate sensitivity. Interest rate sensitivity is determined by the amount of earning assets and interest bearing liabilities repricing within a specific time period, and their relative sensitivity to a change in interest rates. We strive to achieve reasonable stability in the net interest margin through periods of changing interest rates. One specific focus of interest rate sensitivity is the loan portfolio, primarily with commercial and agricultural loans.
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The following table shows the maturity of loans outstanding at December 31, 2021 based on contractual terms. Also provided are the amounts classified according to the sensitivity to changes in interest rates.
1 Year
or Less 1 to 5
Years 5 to 15
Years Over 15
Years Total
Commercial $ 165,334 $ 244,084 $ 178,898 $ 219,123 $ 807,439
Agricultural 18,375 30,980 18,480 26,120 93,955
Residential real estate 17,690 25,799 125,653 157,219 326,361
Consumer 1,886 30,470 40,926 — 73,282
Total $ 203,285 $ 331,333 $ 363,957 $ 402,462 $ 1,301,037
Fixed interest rates
Commercial $ 112,268 $ 190,942 $ 70,918 $ 10,072 $ 384,200
Agricultural 8,720 21,019 4,377 850 34,966
Residential real estate 14,517 13,740 97,648 20,668 146,573
Consumer 1,545 30,246 40,884 — 72,675
Total $ 137,050 $ 255,947 $ 213,827 $ 31,590 $ 638,414
Variable interest rates
Commercial $ 53,066 $ 53,142 $ 107,980 $ 209,051 $ 423,239
Agricultural 9,655 9,961 14,103 25,270 58,989
Residential real estate 3,173 12,059 28,005 136,551 179,788
Consumer 341 224 42 — 607
Total $ 66,235 $ 75,386 $ 150,130 $ 370,872 $ 662,623
Our primary market risk exposures related to the COVID-19 pandemic remain uncertain. A review of our market risk methods are ongoing and modeling is incorporating additional assumptions to account for this uncertainty related to this crisis. Repricing, cash flows, and prepayment projections for loans and mortgage-backed securities are not expected to behave as they would be expected to in a more stable interest rate environment. The SBA PPP loan is a newer instrument and has payment characteristics that could create uncertainty in our assumptions. Customer deposit levels may experience unusual fluctuations due to government support programs, customer and business needs, and general money supply. We continue to closely monitor customer and economic indicators to develop more precise market risk assumptions as the economic impact of the crisis continues to reveal itself.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The information presented in the section captioned “Market Risk” in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.
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