Item 2. Management’s Discussion and Analysis
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Net income in the first nine months of 2021 was $71.5 million, which increased $11.7 million, or 19.6%, from $59.7 million for the comparable period of 2020 . Diluted income per common share was $2.79 in the first nine months of 2021, up 19.7% from $2.33 in the comparable period of 2020. The increase in net income for 2021 was primarily due to growth in net interest income of $14.8 million and a decrease in provision expense of $12.8 million, offset by an increase in noninterest expense of $13.1 million. The elevated provision in 2020 was driven primarily by the economic impact of COVID-19 on the Company's loan customers using the incurred loan loss methodology. Pretax pre-provision earnings in the first nine months of 2021 were $88.7 million, an increase of $1.7 million, or 1.9%, compared to $87.1 million for the comparable period. Pretax pre-provision earnings is a non-GAAP measure calculated by adding net interest income to noninterest income and subtracting noninterest expense.
Annualized return on average total equity was 14.29% in the first nine months of 2021 versus 12.96% in the comparable period of 2020. Annualized return on average total assets was 1.57% in the first nine months of 2021 versus 1.50% for the comparable period of 2020. The Company's average equity to average assets ratio was 11.01% in the first nine months of 2021 versus 11.59% in the comparable period of 2020.
Net income in the third quarter of 2021 was $24.1 million, up $1.3 million, or 5.9%, from $22.8 million for the comparable period of 2020. Diluted earnings per common share was $0.94 in the third quarter of 2021, up 5.6% from $0.89 in the comparable period of 2020. The increase was primarily due to a $5.8 million increase in net interest income for the quarter. Additionally, the Company recording a provision for credit losses of $1.3 million for the third quarter of 2021, a decrease of $450,000, compared to provision expense of $1.8 million for the third quarter of 2020. These increases were offset by a $2.0 million, or 15.3%, decrease in noninterest income and a $2.8 million, or 12.3%, increase in noninterest expense. Pretax pre-provision earnings in the third quarter of 2021 were $30.9 million, an increase of $ 985,000, or 3.3%, compared to $29.9 million for the comparable period of 2020 .
Annualized return on average total equity was 13.90% in the third quarter of 2021 versus 14.36% in the comparable period of 2020. Annualized return on average total assets was 1.56% in the third quarter of 2021 versus 1.64% in the comparable period of 2020. The average equity to average assets ratio was 11.19% in the third quarter of 2021 versus 11.43% in the comparable period of 2020.
Total assets were $6.223 billion as of September 30, 2021 versus $5.830 billion as of December 31, 2020, an increase of $392.5 million, or 6.7%. This increase was primarily due to a $504.9 million increase in securities available-for-sale and a $307.3 million increase in cash and cash equivalents, offset by a decrease in net loans of $421.3 million. The outstanding balance of Paycheck Protection Program (PPP) loans at September 30, 2021, was $ 91.9 million versus $412.0 million at December 31, 2020. The Paycheck Protection Program has strengthened the Company’s borrowers’ balance sheets and improved their operating performance. It has further provided a valuable cash injection for all clients who participated in the program. Since the start of the pandemic, loan line utilization has declined from 48% as of March 31, 2020 to 41% as of September 30, 2021, thereby decreasing loans outstanding. Line utilization was 42% as of December 31, 2020.
Balance sheet growth was primarily funded through growth in deposits during 2021, which was driven by the deposit of PPP loan proceeds into borrower accounts and additional government stimulus payments into customer accounts, inclusive of stimulus payments received for municipal customers. Deposits increased $377.8 million while total borrowings decreased by $10.5 million since December 31, 2020. Total equity increased by $26.0 million due primarily to net income of $71.5 million, dividends declared and paid of $1.02 per share totaling $26.0 million, the day one CECL adjustment to retained earnings of $7.0 million net of tax, and a reduction to accumulated other comprehensive income of $16.8 million, driven primarily by a decrease in the fair value of available-for-sale securities.
Impact of COVID-19 . The progression of the COVID-19 pandemic in the United States has had an impact on our financial condition and results of operations as of and for the three and nine months ended September 30, 2021 and 2020, and may have a complex and significant adverse impact on the economy, the banking industry and our Company in future fiscal periods, all subject to a high degree of uncertainty. As a result of the pandemic, our financial condition, capital levels and results of operations have been and could continue to be significantly affected, as described in further detail in this section.
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Active Management of Credit Risk
The Company’s Commercial Banking and Credit Administration leadership continues to review and refine the list of industries that the company believes are most likely to be materially impacted by the potential economic impact resulting from the COVID-19 pandemic. The current assessment of impacted industries has narrowed from year end 2020 and includes only one industry, hotel and accommodation, as compared to the initial list of ten potentially affected industries disclosed in the company’s earnings release for the first quarter of 2020. The hotel and accommodation industry represents approximately 2.3%, or $94 million, of the company’s total loan portfolio. The original ten industries represented a peak of $765 million, or 18.7%, as of March 31, 2020, excluding PPP loans.
The Company’s commercial loan portfolio is highly diversified, and no industry sector represents more than 8% of the bank’s loan portfolio, net of PPP, as of September 30, 2021. Agri-business and agricultural loans represented the highest specific industry concentrations, at 8% of total loans. The Company’s Commercial Banking and Credit Administration teams continue to actively work with customers to understand their business challenges and credit needs during this time.
COVID-19 Related Loan Deferrals
Loan deferrals peaked on June 17, 2020, at $737 million, which represented 16% of the total loan portfolio. As of September 30, 2021, total deferrals attributable to COVID-19 were $22.3 million, representing three borrowers, or 0.5% of the total loan portfolio. Total deferrals as of September 30, 2021 represented a decline in deferral balances of 97.0% from peak levels in June 2020. Of the $22.3 million, two were commercial loan borrowers representing $22.3 million in loans, or 0.6% of total commercial loans, and there was one retail loan deferral with a balance less than $50,000. All COVID-19 related loan deferrals remain on accrual status, as each deferral is evaluated individually, and management has determined that all contractual cash flows are collectable at this time.
As of September 30, 2021, of the total commercial deferrals attributed to COVID-19, $8.0 million represented a second deferral action and $14.3 million represented a third deferral action. In accordance with Section 4013 of the CARES Act, these deferrals were not considered to be troubled debt restructurings. This provision was extended to January 1, 2022 under the Consolidated Appropriations Act, 2021. The third deferral action has been classified as a watch list credit and is adequately reserved for in the allowance for credit losses as of September 30, 2021. In addition, this credit was removed from COVID-19 deferral status in October 2021.
The Company’s retail loan portfolio is comprised of 1-4 family mortgage loans, home equity lines of credit and other direct and indirect installment loans. A third-party vendor manages the Company’s retail and commercial credit card program and the Company does not have any balance sheet exposure with respect to this program except for nominal recourse on limited commercial card accounts.
The Paycheck Protection Program
During the first half of 2021, the Company funded PPP loans totaling $165.1 million for its customers through the second round of the PPP program. In addition, the Bank has continued processing forgiveness applications for PPP loans made during the first and second rounds of the PPP program. As of September 30, 2021, the Bank had $91.9 million in PPP loans outstanding, net of deferred fees, consisting of $15.5 million from PPP round one and $76.4 million from PPP round two. Most of the PPP loans are for existing customers and 55% of the number of PPP loans originated are for amounts less than $50,000. As of September 30, 2021, the SBA has approved forgiveness for $538.9 million in PPP loans originated during round one and $86.0 million in PPP loans originated during round two. During 2021, the Bank has processed $320.1 million of PPP loan forgiveness. As of September 30, 2021, the Company has submitted forgiveness applications on behalf of customers in the amount of $14.6 million for PPP round one and $5.9 million for PPP round two that are awaiting SBA approval.
September 30, 2021
Originated Forgiven Outstanding (1)
Number Amount Number Amount Number Amount
PPP Round 1 2,409 $ 570,500 2,368 $ 538,910 54 $ 15,522
PPP Round 2 1,192 165,142 822 86,009 370 76,375
Total 3,601 $ 735,642 3,190 $ 624,919 424 $ 91,897
(1) Outstanding balance includes deferred loan origination fees, net of costs, and any loans repaid by borrowers.
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CRITICAL ACCOUNTING POLICIES
The Company’s accounting policies are described in Note 1 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2020.
Certain of the Company’s accounting policies are important to the portrayal of the Company’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Some of the facts and circumstances which could affect these judgments include changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for credit losses. See “Note 4 – Allowance for Credit Losses and Credit Quality” for more information on this critical accounting policy.
RESULTS OF OPERATIONS
Overview
Selected income statement information for the three and nine months ended September 30, 2021 and 2020 is presented in the following table:
Three Months Ended September 30, Nine Months Ended September 30,
(dollars in thousands) 2021 2020 2021 2020
Income Statement Summary:
Net interest income $ 45,741 $ 39,913 $ 133,081 $ 118,295
Provision for credit losses (1) 1,300 1,750 1,077 13,850
Noninterest income 11,114 13,115 35,011 35,061
Noninterest expense 25,967 23,125 79,361 66,293
Other Data:
Efficiency ratio (2) 45.67 % 43.61 % 47.21 % 43.23 %
Dilutive EPS $ 0.94 $ 0.89 $ 2.79 $ 2.33
Tangible capital ratio (3) 10.92 % 11.41 % 10.92 % 11.41 %
Net charge offs (recoveries) to average loans 0.00 % 0.00 % (0.05) % 0.12 %
Net interest margin 3.13 % 3.05 % 3.11 % 3.16 %
Net interest margin excluding PPP loans (4) 2.95 % 3.17 % 2.98 % 3.22 %
Noninterest income to total revenue 19.55 % 24.73 % 20.83 % 22.86 %
Pretax Pre-Provision Earnings (5) $ 30,888 $ 29,903 $ 88,731 $ 87,063
(1) Beginning January 1, 2021 calculation is based on the current expected credit loss methodology. Prior to January 1, 2021 calculation was based on the incurred loss methodology.
(2) Noninterest expense/net interest income plus noninterest income.
(3) Non-GAAP financial measure. The Company believes that disclosing non-GAAP financial measures provides investors with information useful to understanding the company’s financial performance. Additionally, these non-GAAP measures are used by management for planning and forecasting purposes, including measures based on “tangible common equity” which is “total equity” excluding intangible assets, net of deferred tax, and “tangible assets” which is “total assets” excluding intangible assets, net of deferred tax. See reconciliation on the next page.
(4) Non-GAAP financial measure. Calculated by subtracting the impact PPP loans had on average earnings assets, loan interest income, average interest bearing liabilities, and interest expense. Management believes this is an important measure because it provides for better comparability to prior periods, given the low fixed interest rate of 1.0% applicable to PPP loans, and because the accretion of net loan fee income can be accelerated upon borrower forgiveness and repayment by the SBA. Management is actively monitoring net interest margin on a fully tax equivalent basis with and without PPP loan impact for the duration of this program. See reconciliation on the next page.
(5) Non-GAAP financial measure. Pretax pre-provision earnings is calculated by adding net interest income to noninterest income and subtracting noninterest expense. Management believes this is an important measure because it may enable investors to identify the trends in the Company's earnings exclusive of the effects of tax and provision expense, which may vary significantly from period to period. See reconciliation on the next page.
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A reconciliation of non-GAAP measures is provided below (in thousands, except for per share data).
Three Months Ended September 30, Nine Months Ended September 30,
(dollars in thousands) 2021 2020 2021 2020
Total Equity $ 683,202 $ 636,839 $ 683,202 $ 636,839
Less: Goodwill (4,970) (4,970) (4,970) (4,970)
Plus: Deferred tax assets related to goodwill 1,176 1,176 1,176 1,176
Tangible Common Equity (A) 679,408 633,045 679,408 633,045
Total Assets $ 6,222,916 $ 5,551,108 $ 6,222,916 $ 5,551,108
Less: Goodwill (4,970) (4,970) (4,970) (4,970)
Plus: Deferred tax assets related to goodwill 1,176 1,176 1,176 1,176
Tangible Assets (B) 6,219,122 5,547,314 6,219,122 5,547,314
Tangible Capital Ratio (A/B) 10.92 % 11.41 % 10.92 % 11.41 %
Net Interest Income $ 45,741 $ 39,913 $ 133,081 $ 118,295
Noninterest Income 11,114 13,115 35,011 35,061
Noninterest Expense (25,967) (23,125) (79,361) (66,293)
Pretax Pre-Provision Earnings $ 30,888 $ 29,903 $ 88,731 $ 87,063
Impact of Paycheck Protection Program on Net Interest Margin FTE
Three Months Ended September 30, Nine Months Ended September 30,
2021 2020 2021 2020
Total Average Earnings Assets $ 5,909,834 $ 5,282,569 $ 5,825,275 $ 5,078,509
Less: Average Balance of PPP Loans (142,917) (557,290) (296,938) (339,149)
Total Adjusted Earning Assets 5,766,917 4,725,279 5,528,337 4,739,360
Total Interest Income FTE $ 50,271 $ 46,589 $ 147,351 $ 145,045
Less: PPP Loan Income (3,946) (3,294) (12,764) (6,323)
Total Adjusted Interest Income FTE 46,325 43,295 134,587 138,722
Adjusted Earning Asset Yield, net of PPP Impact 3.19 % 3.65 % 3.25 % 3.91 %
Total Average Interest Bearing Liabilities $ 3,737,707 $ 3,433,326 $ 3,728,339 $ 3,393,274
Less: Average Balance of PPP Loans (142,917) (557,290) (296,938) (339,149)
Total Adjusted Interest Bearing Liabilities 3,594,790 2,876,036 3,431,401 3,054,125
Total Interest Expense FTE $ 3,554 $ 6,066 $ 11,816 $ 24,954
Less: PPP Cost of Funds (90) (350) (555) (630)
Total Adjusted Interest Expense FTE 3,464 5,716 11,261 24,324
Adjusted Cost of Funds, net of PPP Impact 0.24 % 0.48 % 0.27 % 0.69 %
Net Interest Margin FTE, net of PPP Impact 2.95 % 3.17 % 2.98 % 3.22 %
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Net Income
Net income was $71.5 million in the first nine months of 2021 , an increase of $11.7 million, or 19.6%, versus net income of $59.7 million in the first nine months of 2020 . The increase in net income for 2021 was primarily due to growth in net interest income of $14.8 million, or 12.5%, and a decrease in provision expense of $12.8 million, offset by an increase in noninterest expense of $13.1 million. The elevated provision in the first nine months of 2020 was driven by potential negative impacts on the Company's borrowers from the economic conditions resulting from the COVID-19 pandemic, which was calculated using the incurred loss model.
Net income was $24.1 million for the three months ended September 30, 2021, an increase of $1.3 million, or 5.9%, versus net income of $22.8 million for the three months ended September 30, 2020. The increase was primarily due to the Company recording a provision for credit losses of $1.3 million for the third quarter of 2021, a decrease of $450,000 compared to provision expense of $1.8 million for the third quarter of 2020. The higher provision in the third quarter of 2020 was driven by potential negative impacts on the Company’s borrowers from the economic conditions resulting from the COVID-19 pandemic, which was calculated using the incurred loss model. In addition, net income for the three months ended September 30, 2021 was positively impacted by a $5.8 million , or 14.6%, increase in net interest income. This increase was offset by a $2.0 million, or 15.3%, decrease in noninterest income and a $2.8 million, or 12.3%, increase in noninterest expense.
We anticipate that our net income for future fiscal periods will continue to be impacted as a result of the economic developments resulting from the COVID-19 pandemic. During the first nine months of 2021 , provision expense declined relative to the first half provision expense of 2020 . This decline was a result of improving economy, the declining balances of COVID-19 loan deferrals and a one-time recovery of $1.7 million in the second quarter of 2021. However, the economic impact of the pandemic continues to evolve and, as a result, we continue to monitor the impact to customers very closely. In particular, disruption to the labor market and supply chains have had, and may continue to have, a negative impact on our customers growth plans, with a corresponding effect on loan demand.
Net interest income, excluding the impacts of PPP loans, in 2021 has been negatively impacted by net interest margin compression that has resulted from excess liquidity and a shift in the mix of earning assets from loans to investment securities and short-term investments. During 2021 , PPP loan forgiveness and continued deposit growth has contributed to the increased liquidity on the balance sheet. The combined impact of the low interest rate environment that resulted from the Federal Reserve Bank’s reductions to the target Federal Funds Rate in the first quarter of 2020, together with the Corporation’s asset sensitive balance sheet, has caused a reduction in net interest margin, excluding PPP loans, in the third quarter of 2021 when compared to the third quarter of 2020 . Loan and investment security yields have been negatively impacted by the decline in interest rates. In addition, the increase in short-term investments and investment securities has contributed to the decline in earning asset yields in 2021. Correspondingly, deposit rates have also declined but have not fully offset the earning asset compression. Net interest margin will continue to be impacted from the PPP loan program and the low fixed rate of 1.0% on these loans. Borrowers that meet the loan forgiveness requirements outlined in the SBA program will result in loan balance paydowns for the Bank and an acceleration in unamortized PPP net loan fee income accretion through the income statement, as a component of loan yields. The timing and impact to net interest margin will be contingent on how quickly the PPP loans are submitted for forgiveness by borrowers and approved for forgiveness by the SBA. In addition, loans could be repaid by borrowers in lieu of forgiveness over the course of the next few years. PPP loan income, including both interest and fees, was $12.8 million and $ 3.9 million for the nine months and three months ended September 30, 2021, respectively. PPP loan income, including both interest and fees, was $6.3 m illion and $3.3 million for the nine months and three months ended September 30, 2020, respectively.
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Net Interest Income
The following table sets forth consolidated information regarding average balances and rates:
Nine Months Ended September 30,
2021 2020
(fully tax equivalent basis, dollars in thousands) Average Balance Interest Yield (1)/
Rate Average Balance Interest Yield (1)/
Rate
Earning Assets
Loans:
Taxable (2)(3) $ 4,455,488 $ 128,828 3.87 % $ 4,339,274 $ 130,759 4.03 %
Tax exempt (1) 13,403 410 4.09 20,248 681 4.49
Investments:
Available-for-sale (1) 977,955 17,765 2.43 625,887 13,313 2.84
Short-term investments 2,273 2 0.12 32,671 67 0.27
Interest bearing deposits 376,156 346 0.12 60,429 225 0.50
Total earning assets $ 5,825,275 $ 147,351 3.38 % $ 5,078,509 $ 145,045 3.82 %
Less: Allowance for credit losses (4) (71,783) (57,111)
Nonearning Assets
Cash and due from banks 69,066 60,695
Premises and equipment 59,652 60,676
Other nonearning assets 189,472 172,187
Total assets $ 6,071,682 $ 5,314,956
Interest Bearing Liabilities
Savings deposits $ 353,058 $ 204 0.08 % $ 260,668 $ 162 0.08 %
Interest bearing checking accounts 2,334,480 4,905 0.28 1,796,270 7,683 0.57
Time deposits:
In denominations under $100,000 223,486 1,650 0.99 268,485 3,569 1.78
In denominations over $100,000 741,815 4,828 0.87 969,362 12,910 1.78
Miscellaneous short-term borrowings 500 7 1.87 40,460 458 1.51
Long-term borrowings and subordinated debentures 75,000 222 0.40 % 58,029 172 0.40
Total interest bearing liabilities $ 3,728,339 $ 11,816 0.42 % $ 3,393,274 $ 24,954 0.98 %
Noninterest Bearing Liabilities
Demand deposits 1,627,522 1,252,112
Other liabilities 47,169 53,660
Stockholders' Equity 668,652 615,910
Total liabilities and stockholders' equity $ 6,071,682 $ 5,314,956
Interest Margin Recap
Interest income/average earning assets 147,351 3.38 % 145,045 3.82 %
Interest expense/average earning assets 11,816 0.27 % 24,954 0.66 %
Net interest income and margin $ 135,535 3.11 % $ 120,091 3.16 %
(1) Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) adjustment applicable to nondeductible interest expenses. Taxable equivalent basis adjustments were $2.5 million and $1.8 million in the nine-month periods ended September 30, 2021 and 2020 , respectively.
(2) Loan fees are included as taxable loan interest income. Net loan fees attributable to PPP loans were $10.5 million and $3.7 million for the nine months ended September 30, 2021 and 2020 , respectively. All other loan fees were immaterial in relation to total taxable loan interest income for the periods presented.
(3) Nonaccrual loans are included in the average balance of taxable loans.
(4) Beginning January 1, 2021 calculation is based on the current expected credit loss methodology. Prior to January 1, 2021 calculation was based on the incurred loss methodology.
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Three Months Ended September 30, 2021 Three Months Ended September 30, 2020
(fully tax equivalent basis, dollars in thousands) Average Balance Interest Income Yield (1)/
Rate Average Balance Interest Income Yield (1)/
Rate
Earning Assets
Loans:
Taxable (2)(3) $ 4,339,792 $ 43,025 3.93 % $ 4,541,608 $ 42,056 3.68 %
Tax exempt (1) 14,312 150 4.16 15,204 130 3.40
Investments:
Available-for-sale (1) 1,201,657 6,971 2.30 637,523 4,359 2.72
Short-term investments 2,304 0 0.00 8,865 3 0.13
Interest bearing deposits 351,769 125 0.14 79,369 41 0.21
Total earning assets $ 5,909,834 $ 50,271 3.37 % $ 5,282,569 $ 46,589 3.51 %
Less: Allowance for credit losses (4) (72,157) (59,519)
Nonearning Assets
Cash and due from banks 67,715 61,656
Premises and equipment 59,824 60,554
Other nonearning assets 188,118 175,601
Total assets $ 6,153,334 $ 5,520,861
Interest Bearing Liabilities
Savings deposits $ 369,191 $ 71 0.08 % $ 282,456 $ 53 0.07 %
Interest bearing checking accounts 2,390,462 1,712 0.28 1,827,061 1,405 0.31
Time deposits:
In denominations under $100,000 211,911 457 0.86 254,315 982 1.54
In denominations over $100,000 691,143 1,239 0.71 972,436 3,501 1.43
Miscellaneous short-term borrowings 0 0 0.00 22,058 51 0.92
Long-term borrowings and subordinated debentures 75,000 75 0.40 75,000 74 0.39
Total interest bearing liabilities $ 3,737,707 $ 3,554 0.38 % $ 3,433,326 $ 6,066 0.70 %
Noninterest Bearing Liabilities
Demand deposits 1,681,565 1,401,403
Other liabilities 45,810 55,154
Stockholders' Equity 688,252 630,978
Total liabilities and stockholders' equity $ 6,153,334 $ 5,520,861
Interest Margin Recap
Interest income/average earning assets 50,271 3.37 46,589 3.51
Interest expense/average earning assets 3,554 0.24 6,066 0.46
Net interest income and margin $ 46,717 3.13 % $ 40,523 3.05 %
(1) Tax exempt income was converted to a fully taxable equivalent basis at a 21 percent tax rate. The tax equivalent rate for tax exempt loans and tax exempt securities acquired after January 1, 1983 included the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”) adjustment applicable to nondeductible interest expenses. Taxable equivalent basis adjustments were $ 976,000 and $610,000 in the three-month periods ended September 30, 2021 and September 30, 2020, respectively.
(2) Loan fees are included as taxable loan interest income. Net loan fees attributable to PPP loans were $ 3.6 million and $1.9 million for the three months ended September 30, 2021 and September 30, 2020, respectively. All other loan fees were immaterial in relation to total taxable loan interest income for the periods presented.
(3) Nonaccrual loans are included in the average balance of taxable loans.
(4) Beginning January 1, 2021 calculation is based on the current expected credit loss methodology. Prior to January 1, 2021 calculation was based on the incurred loss methodology.
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Net interest income increased $14.8 million, or 12.5%, for the nine months ended September 30, 2021 to $133.1 million compared with $118.3 million for the first nine months of 2020 . The increase in net interest income was largely driven by an increase in average earning assets of $746.8 million, due primarily to growth in investment securities of $352.1 million, growth in interest bearing deposits of $315.7 million and loan growth of $109.4 million. Average loans outstanding increased to $4.469 billion during the nine months ended September 30, 2021 compared to $4.360 billion during the the same period of 2020, with most of the growth being in fixed rate commercial loans. The average balance of PPP loans was $296.9 million for the first nine months of 2021 compared to $339.1 million for the first nine months of 2020 . The earning asset growth was funded through an increase of deposits. Average deposits increased $733.5 million to $5.280 billion during the nine months ended September 30, 2021, compared to $4.547 billion for the same period of 2020 . PPP loan proceeds to borrowers, additional economic impact payments to consumers, and stimulus payments to municipalities impacted the increase in deposits and core deposits during the first nine months of 2021, as these funds were deposited into customer checking and savings accounts at the Bank.
The tax equivalent net interest margin was 3.11% for the nine months ended September 30, 2021 compared to 3.16% during the first nine months of 2020 . The yield on earning assets totaled 3.38% during the nine months ended September 30, 2021 compared to 3.82% in the same period of 2020 . Cost of funds (expressed as a percentage of average earning assets) totaled 0.27% during the first nine months of 2021 compared to 0.66% in the same period of 2020 . The lower margin was due to lower yields on loans and securities, partially offset by a lower cost of funds. The decline in net interest margin resulted from the Federal Reserve Bank decreases in the target Federal Funds Rate by 150 basis points during the first quarter of 2020, which brought the Federal Funds Rate back to the zero-bound range of 0.00% to 0.25% and excess liquidity on the Company's balance sheet. The earning asset mix has changed during 2021 to reflect increased investment securities and interest bearing deposits, which are lower yielding assets. The Bank deployed excess liquidity of $600 million to the investment security portfolio and to interest bearing deposits as a result of lower loan growth. Additionally, the Company's net interest margin was positively impacted by 13 basis points during the first nine months of 2021 due to interest income and fees earned on PPP loans. Net interest margin excluding PPP loans was 2.98% for the nine months ended September 30, 2021.
Net interest income increased by $5.8 million, or 14.6%, for the three months ended September 30, 2021 as compared to the three months ended September 30, 2020. The increased level of net interest income during the third quarter of 2021 was largely driven by an increase in average earning assets of $627.3 million, due primarily to growth in available-for-sale securities of $564.1 million and increases in interest bearing deposits of $272.4 million. The Company deployed $600 million in excess liquidity to its investment security portfolio since late 2020 in response to the surge in deposits that begin in 2020 and has continued into 2021. This earning asset growth was funded through an increase in deposits. Average deposits increased $606.6 million to $5.344 billion for the third quarter of 2021, compared to $4.738 billion for the comparable period of 2020. During this same period, average core deposits increased $803.4 million. The Company defines "core deposits" as total deposits (including all deposits by municipalities and other government agencies), excluding brokered deposits. Short-term borrowings have decreased by $22.1 million during these comparable periods.
The Company’s net interest margin increased 8 basis points to 3.13% for the third quarter of 2021 compared to 3.05% for the third quarter of 2020. The higher margin in the third quarter of 2021 as compared to the prior year period was due to higher yields on loans due to PPP interest income and fee accretion as well as lower costs of funds. As a result of the excess liquidity on the company's balance sheet, the mix of earning assets included lower earning assets consisting of balances at the Federal Reserve Bank and the investment securities portfolio. In addition, third quarter loan yields were impacted by the lower yield on the PPP loan portfolio, offset by fees earned as a result of PPP loan forgiveness.
The Company’s net interest margin excluding PPP related net interest income was 18 basis points lower at 2.95% for the third quarter of 2021 compared to actual net interest margin of 3.13%, and reflects a 22 basis point decline from net interest margin excluding PPP loans of 3.17% in the third quarter of 2020. Cost of funds decreased to a historical low of 0.24% for the three-month period ended September 30, 2021.
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Provision for Credit Losses
The Company recorded a provision for credit losses expense of $1.3 million for the three months ended September 30, 2021 compared to a provision expense of $1.8 million during the comparable period of 2020 , a decrease of $450,000. Net recoveries were $35,000 during the three month period ended September 30, 2021 compared to net charge offs of $22,000 during the comparable period of 2020 . The Company recorded a provision for credit losses expense of $1.1 million for the nine months ended September 30, 2021 compared to a provision expense of $13.9 million during the comparable period of 2020 . The primary factor impacting the provision expense in 2020 was the potential negative impact to the Company's borrowers as a result of the economic conditions resulting from the COVID-19 pandemic. Net recoveries were $1.5 million during the nine month period ended September 30, 2021 compared to net charge offs of $3.8 million during the comparable period of 2020 . The Company adopted the CECL standard (ASU 2016-13) during the first quarter of 2021, effective January 1, 2021. Prior to this, provision expense was recorded under the incurred loss methodology. The day one impact of the adoption was an increase in the allowance for credit losses of $9.1 million, with an offset, net of taxes, to beginning stockholders’ equity.
The Company has granted COVID-19 loan deferrals to customers, which peaked on June 17, 2020 at $737 million, or 16%, of the total loan portfolio. As of September 30, 2021, COVID-19 loan deferrals have declined to $22.3 million, representing three borrowers, or 0.5% of the total loan portfolio. Two were commercial loan borrowers and there was one retail borrower with COVID-19 deferrals. In accordance with Section 4013 of the CARES Act, loan deferrals granted to customers that resulted from the impact of COVID-19 and who were not past due at December 31, 2019 were not considered troubled debt restructurings as of September 30, 2021 and December 31, 2020. This provision was extended to January 1, 2022 under the Consolidated Appropriations Act, 2021. Management continues to monitor these deferrals and has considered these credits in the September 30, 2021 and December 31, 2020 allowance for credit losses balance. The recent credit cycle has not been as negative as originally expected in the prior year, and management is comfortable with the current levels of the Company's reserve.
The provision expense in the third quarter of 2021 was driven primarily by the downgrading of two commercial loan borrowers to nonaccrual status. The balance of these loans totaled $21.2 million as of September 30, 2021. The first credit relationship of $12.0 million was downgraded due to the severe impact on the business caused by the economic conditions resulting from the COVID-19 pandemic. The borrower is a retailer of party and special event supplies. During the third quarter of 2021, the borrower’s challenges significantly worsened. As a result, loans to the borrower were downgraded and placed on nonaccrual status. Loans to this borrower are secured by a blanket lien on all assets, including buildings, inventory, accounts receivable and equipment. In addition, the exposure is supported by a partial personal guarantee. The second downgrade relates to a shared national credit participation of $9.2 million to a commercial borrower that operates grain elevators and handles feed processing and merchandising of agriculture products. Loans to this borrower are secured by a blanket lien on all assets, including buildings, inventory, accounts receivable and equipment. These downgrades resulted in an increase to the specific credit loss allocations for each credit as they are now individually analyzed credits. The loans to both borrowers are current on interest and principal payments through September 2021. The Bank believes that the allocations are adequate to cover any potential losses. Each of these downgrades resulted from a unique business challenge and management does not believe these downgrades are systemic as it relates to the Bank's broader loan portfolio.
Additional factors considered by management included key loan quality metrics, including reserve coverage of nonperforming loans and economic conditions in the Company’s markets, and changes in the facts and circumstances of watch list credits, which includes the security position of the borrower. Management’s overall view on current credit quality was also a factor in the determination of the provision for credit losses. The Company’s management continues to monitor the adequacy of the provision based on loan levels, asset quality, economic conditions and other factors that may influence the assessment of the collectability of loans.
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Noninterest Income
Noninterest income categories for the nine-month and three-month periods ended September 30, 2021 and 2020 are shown in the following table:
Nine Months Ended
September 30,
(dollars in thousands) 2021 2020 Dollar Change Percent Change
Wealth advisory fees $ 6,433 $ 5,594 $ 839 15.0 %
Investment brokerage fees 1,560 1,148 412 35.9 %
Service charges on deposit accounts 7,768 7,452 316 4.2 %
Loan and service fees 8,823 7,470 1,353 18.1 %
Merchant card fee income 2,226 1,933 293 15.2 %
Bank owned life insurance income 2,101 1,476 625 42.3 %
Interest rate swap fee income 934 4,105 (3,171) (77.2) %
Mortgage banking income 1,756 2,945 (1,189) (40.4) %
Net securities gains 797 363 434 119.6 %
Other income 2,613 2,575 38 1.5 %
Total noninterest income $ 35,011 $ 35,061 $ (50) (0.1) %
Noninterest income to total revenue 20.83 % 22.86 %
Three Months Ended
September 30,
(dollars in thousands) 2021 2020 Dollar Change Percent Change
Wealth advisory fees $ 2,177 $ 1,930 $ 247 12.8 %
Investment brokerage fees 521 421 100 23.8 %
Service charges on deposit accounts 2,756 2,491 265 10.6 %
Loan and service fees 3,005 2,637 368 14.0 %
Merchant card fee income 838 670 168 25.1 %
Bank owned life insurance income 640 932 (292) (31.3) %
Interest rate swap fee income 180 2,143 (1,963) (91.6) %
Mortgage banking income (loss) (32) 1,005 (1,037) (103.2) %
Net securities gains 0 314 (314) (100.0) %
Other income 1,029 572 457 79.9 %
Total noninterest income $ 11,114 $ 13,115 $ (2,001) (15.3) %
Noninterest income to total revenue 19.55 % 24.73 %
The Company's noninterest income decreased $50,000, or 0.1%, to $35.0 million for the nine months ended September 30, 2021 compared to $35.1 million in the prior year period. Noninterest income was positively impacted by a $1.4 million increase, or 18.1%, in loan and service fees, a $1.3 million increase, or 18.6%, in wealth management and investment brokerage fees over the corresponding prior period. Noninterest income was also positively impacted by a $625,000 increase in bank owned life insurance income and an increase in net securities gains of $434,000 due to repositioning of the available-for-sale securities portfolio in response to the steepening yield curve during the first quarter of 2021. Noninterest income was negatively impacted by a $3.2 million decrease, or 77.2%, in interest rate swap fee income, and a $1.2 million decrease, or 40.4%, in mortgage banking income. Interest rate swaps have seen a decrease in customer demand during the first three quarters of 2021 compared to the record year in 2020. Additionally, mortgage banking income has been negatively impacted by the valuation of mortgage servicing rights due to increased amortization expense in the current rate environment. The increased prepayment speeds have resulted in increased mortgage servicing asset amortization expense of $900,000 for the nine months ended September 30, 2021.
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The Company’s noninterest income decreased $2.0 million, or 15.3%, to $11.1 million for the third quarter of 2021 , compared to $13.1 million for the third quarter of 2020 . Noninterest income was positively impacted by elevated loan and service fees which increased by $368,000, or 14.0%, for these comparable periods due to increased debit card interchange fees. In addition, wealth and investment brokerage fees which increased by $347,000, or 14.8%, and service charges on deposit accounts were up $265,000, or 10.6%. Offsetting these increases were decreases of $2.0 million, or 91.6%, in interest rate swap fee income and $1.0 million, or 103.2%, in mortgage banking income. Both interest rate swap arrangements and mortgage banking have seen a decrease in demand during the third quarter of 2021 compared to the third quarter of 2020, and the carrying value of mortgage service rights has been impacted by increased prepayment speeds due to the current rate environment and appreciating single-home values. The increased prepayment speeds have resulted in increased mortgage servicing asset amortization expense of $650,000 during the third quarter of 2021 which offset mortgage banking income earned during the period.
Future noninterest income may continue to be impacted due to the effects of the COVID-19 pandemic, and the scope of any future governmental policy responses. For example, increased economic activity may result in higher merchant card fee income and higher interchange revenue that is reported in services charges on deposits accounts and loan and service fees. Conversely, increased infection rates due to COVID-19, and any governmental responses thereto, could reduce economic activity and thereby reduce these activity-driven fees.
Noninterest Expense
Noninterest expense categories for the nine-month and three-month periods ended September 30, 2021 and 2020 are shown in the following tables:
Nine Months Ended
September 30,
(dollars in thousands) 2021 2020 Dollar Change Percent Change
Salaries and employee benefits $ 44,377 $ 35,696 $ 8,681 24.3 %
Net occupancy expense 4,343 4,336 7 0.2 %
Equipment costs 4,134 4,216 (82) (1.9) %
Data processing fees and supplies 9,692 8,736 956 10.9 %
Corporate and business development 3,208 2,324 884 38.0 %
FDIC insurance and other regulatory fees 1,707 1,224 483 39.5 %
Professional fees 5,058 3,506 1,552 44.3 %
Other expense 6,842 6,255 587 9.4 %
Total noninterest expense $ 79,361 $ 66,293 $ 13,068 19.7 %
Efficiency ratio 47.21 % 43.23 %
Three Months Ended
September 30,
(dollars in thousands) 2021 2020 Dollar Change Percent Change
Salaries and employee benefits $ 14,230 $ 12,706 $ 1,524 12.0 %
Net occupancy expense 1,413 1,404 9 0.6 %
Equipment costs 1,371 1,369 2 0.1 %
Data processing fees and supplies 3,169 3,025 144 4.8 %
Corporate and business development 1,000 586 414 70.6 %
FDIC insurance and other regulatory fees 748 554 194 35.0 %
Professional fees 1,342 1,306 36 2.8 %
Other expense 2,694 2,175 519 23.9 %
Total noninterest expense $ 25,967 $ 23,125 $ 2,842 12.3 %
Efficiency ratio 45.67 % 43.61 %
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The Company’s noninterest expense increased by $13.1 million, or 19.7%, to $79.4 million in the first nine months of 2021 compared to $66.3 million in the corresponding prior year period. The increase was driven by salaries and employee benefits which increased $8.7 million, or 24.3%, primarily due to higher performance-based incentive compensation expense and health insurance costs. Professional fees increased $1.6 million, or 44.3%, driven by expenses related to the Company's implementation of Lake City Bank Digital, an innovative digital banking platform, in the first quarter of 2021, as well as an increase in legal and regulatory expense. Data processing expenses associated with the PPP digital solution totaled $578,000 during the first nine months of 2021. In addition, the Company made a $500,000 contribution to its foundation in the first quarter of 2021 which is included in corporate and business development expense.
The Company’s noninterest expense increased $2.8 million, or 12.3%, to $26.0 million in the third quarter of 2021, compared to $23.1 million in the third quarter of 2020. Salaries and employee benefits increased $1.5 million, or 12.0%, driven by higher performance-based incentive compensation expense and higher employee health insurance expense. Corporate and business development expenses increased $414,000, or 70.6%, due to the timing of planned advertising campaigns and increased business development costs, as in-person meetings with clients and prospects have resumed. FDIC insurance and other regulatory fees increased $194,000, or 35.0%, driven by the company's rapid balance sheet growth year-over-year.
The Company's efficiency ratio was 47.21% for the nine months ended September 30, 2021 compared to 43.23% in the prior period. The Company’s efficiency ratio was 45.67% for the third quarter of 2021, compared to 43.61% for the third quarter of 2020.
As previously disclosed, in the third quarter of 2019, the Bank discovered potentially fraudulent activity by a former treasury management client involving multiple banks. The former client subsequently filed several related bankruptcy cases, captioned In re Interlogic Outsourcing, Inc., et al ., which are pending in the United States Bankruptcy Court for the Western District of Michigan. On April 27, 2021, the bankruptcy court entered an order approving an amended plan of liquidation, which was filed by the former client, other debtors and bankruptcy plan proponents, and approving the consolidation of the assets in the aforementioned cases under the Khan IOI Consolidated Estate Trust. On August 9, 2021, the liquidating trustee for the bankruptcy estates filed a complaint against the Bank, and has agreed to stay prosecution of the action through December 31, 2021. The action is focused on a series of business transactions among the client, related entities, and the Bank, which the liquidating trustee alleges are voidable under applicable federal bankruptcy and state law. The complaint also addresses treatment of the Bank’s claims filed in the bankruptcy cases. Based on current information, we have determined that a loss is neither probable nor estimable at this time, and the Bank intends to vigorously defend itself against all allegations asserted in the compliant.
Future noninterest expense may continue to be impacted due to the COVID-19 pandemic. For example, continued economic reopening and growth may impact balance sheet growth and resulting revenue growth which could increase the amount the Company pays in incentive-based compensation. In addition, prolonged supply chain disruptions and increased infection rates due to COVID-19 could halt the economic recovery and result in elevated provision expense which may reduce net income and diluted earnings per share, another key performance metric that impacts the incentive-based compensation targets.
The Company’s income tax expense increased $ 2.7 million and $ 92,000 , respectively, in the nine-month and three-month periods ended September 30, 2021 compared to the same periods in 2020 . The effective tax rate was 18.5 % in the nine-month and three-month periods ended September 30, 2021, compared to 18.4% and 19.1%, respectively, for the comparable periods of 2020 . The quarter-to-date effective tax rate for 2021 decreased as compared to the prior year period primarily due a higher percentage of income being derived from tax-advantaged sources.
FINANCIAL CONDITION
Overview
Total assets of the Company were $6.223 billion as of September 30, 2021, an increase of $392.5 million, or 6.7%, when compared to $5.830 billion as of December 31, 2020. This increase was primarily due to a $307.3 million increase in cash and cash equivalents and a $504.9 million increase in securities available-for-sale, offset by a decrease in gross loans of $409.7 million, or 8.8%. The outstanding balance of Paycheck Protection Program (PPP) loans at September 30, 2021, was $91.9 million versus $412.0 million at December 31, 2020. Loans excluding PPP loans decreased by $89.6 million, or 2.1%, from $4.237 billion at December 31, 2020 to $4.148 billion at September 30, 2021. Total deposits increased $377.8 million, or 7.5%, while total borrowings decreased by $10.5 million, or 12.3%. The increase in deposits was primarily driven by growth in core deposits of $381.8 million, or 7.6%, offset by a decrease in wholesale funding of $4.0 million. Core deposits were $5.404 billion as of September 30, 2021 compared to $5.022 billion as of December 31, 2020. Additionally, commercial
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deposits increased by $203.3 million, or 10.5%, to $2.144 billion at September 30, 2021 compared to $1.940 billion at December 31, 2020. The increase in commercial and retail core deposits has resulted from proceeds from the PPP loan program, federal stimulus payments made to individuals, customer liquidity events and an increase in the savings rate during the pandemic.
Uses of Funds
Total Cash and Cash Equivalents
Total cash and cash equivalents increased by $307.3 million, or 123.0% to $557.2 million at September 30, 2021, from $249.9 million at December 31, 2020. Cash and cash equivalents at September 30, 2021 reflect repayments on loans as well as cash inflows from federal stimulus programs and an overall increase in the savings rate during the pandemic and include short-term investments. Short-term investments include cash on deposit that earns interest such as excess liquidity maintained at the Federal Reserve Bank. Cash and cash equivalents balances will vary depending on the cyclical nature of the bank’s liquidity position.
Investment Portfolio
The amortized cost and the fair value of securities as of September 30, 2021 and December 31, 2020 were as follows:
September 30, 2021 December 31, 2020
(dollars in thousands) Amortized
Cost Fair
Value Amortized
Cost Fair
Value
U.S Treasury securities $ 900 $ 900 $ 0 $ 0
U.S government sponsored agencies 118,681 116,461 36,492 36,487
Mortgage-backed securities: residential 430,388 431,833 270,231 279,503
Mortgage-backed securities: commercial 23,699 24,182 35,877 36,881
State and municipal securities 650,561 666,339 355,306 381,974
Total $ 1,224,229 $ 1,239,715 $ 697,906 $ 734,845
At September 30, 2021 and December 31, 2020, there were no holdings of securities of any one issuer, other than the U.S. government agencies and government sponsored entities, in an amount greater than 10% of stockholders’ equity. Management is aware that, as interest rates rise, any unrealized loss in the investment portfolio will increase, and as interest rates fall the unrealized gain in the investment portfolio will rise. Since the majority of the bonds in the investment portfolio are fixed-rate, with only a few adjustable-rate bonds, we would expect our investment portfolio to follow this market value pattern. This is taken into consideration when evaluating the gain or loss of investment securities in the portfolio and the potential for an allowance for credit losses.
Purchases of securities available-for-sale totaled $640.4 million in the first nine months of 2021. The purchases consisted of mortgage-backed securities issued by government sponsored entities and state and municipal securities. The investment security purchases reflect the deployment of excess liquidity to the investment portfolio. The Company deployed $100 million in December 2020, $100 million during the first quarter of 2021 and an additional $400 million during the second quarter of 2021. The deployment was due to the surge in deposits balances that began in 2020 and has continued into 2021. Paydowns from prepayments and scheduled payments of $97.5 million were received in the first nine months of 2021, and the amortization of premiums, net of the accretion of discounts, was $3.5 million. Maturities and calls of securities totaled $4.9 million in the first nine months of 2021. Proceeds from sales of securities totaled $14.0 million in the first nine months of 2021. No allowance for credit losses was recognized in the first nine months of 2021.
Purchases of securities available-for-sale totaled $89.9 million in the first nine months of 2020. The purchases consisted primarily of state and municipal securities and purchases of mortgage-backed securities issued by government sponsored entities. Paydowns from prepayments and scheduled payments of $63.0 million were received in the first nine months of 2020, and the amortization of premiums, net of the accretion of discounts, was $3.0 million. Maturities and calls of securities totaled $6.3 million in the first nine months of 2020. Proceeds from sales of securities totaled $6.4 million in the first nine months of 2020. No other-than-temporary impairment was recognized in the first nine months of 2020.
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The investment portfolio is managed by a third-party firm to provide for an appropriate balance between liquidity, credit risk, interest rate risk management and investment return and to limit the Company’s exposure to credit risk in the investment securities portfolio to an acceptable level. The Company does not trade or invest in or sponsor certain unregistered investment companies defined as hedge funds and private equity funds under what is commonly referred to as the “Volcker Rule” of the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Real Estate Mortgage Loans Held-for-Sale
Real estate mortgage loans held-for-sale decreased by $3.2 million, or 29.0%, to $8.0 million at September 30, 2021, from $11.2 million at December 31, 2020. The balance of this asset category is subject to a high degree of variability depending on, among other things, recent mortgage loan rates and the timing of loan sales into the secondary market. The Company generally sells conforming qualifying mortgage loans it originates on the secondary market. Proceeds from sales of residential mortgages totaled $98.7 million in the first nine months of 2021 compared to $90.6 million in the first nine months of 2020. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of these loans were $374.0 million and $351.0 million as of September 30, 2021 and December 31, 2020, respectively.
Loan Portfolio
The loan portfolio by portfolio segment as of September 30, 2021 and December 31, 2020 is summarized as follows:
(dollars in thousands) September 30,
2021 December 31,
2020 Current Period Change
Commercial and industrial loans $ 1,441,784 34.0 % $ 1,791,378 38.5 % $ (349,594)
Commercial real estate and multi-family residential loans 1,954,554 46.0 1,895,014 40.7 59,540
Agri-business and agricultural loans 324,080 7.6 429,644 9.2 (105,564)
Other commercial loans 83,595 2.0 94,013 2.0 (10,418)
Consumer 1-4 family mortgage loans 348,172 8.2 343,518 7.4 4,654
Other consumer loans 92,169 2.2 103,616 2.2 (11,447)
Subtotal, gross loans 4,244,354 100.0 % 4,657,183 100.0 % (412,829)
Less: Allowance for credit losses (1) (73,048) (61,408) (11,640)
Net deferred loan fees (4,901) (8,027) 3,126
Loans, net $ 4,166,405 $ 4,587,748 $ (421,343)
(1) Beginning January 1, 2021 calculation is based on the current expected credit loss methodology. Prior to January 1, 2021 calculation was based on the incurred loss methodology.
Total loans, excluding real estate mortgage loans held-for-sale and deferred fees, decreased by $412.8 million to $4.244 billion at September 30, 2021 from $4.657 billion at December 31, 2020. The decrease was primarily driven by the forgiveness of PPP loans and was also concentrated in the commercial and industrial and agribusiness categories and was driven by seasonal paydowns in these loan segments. We anticipate that the portion of our loan portfolio attributable to PPP loans will continue to decline in future quarters, as borrowers avail themselves of loan forgiveness opportunities under the PPP. Total loans excluding PPP loans decreased by $89.6 million, as of September 30, 2021 as compared to December 31, 2020. The balance of net deferred loans fees attributable to PPP loans was $2.7 million as of September 30, 2021. PPP round one and round two unamortized loan fees, net of deferred costs, were $0.1 and $2.6 million, respectively, as of September 30, 2021. Since the start of the pandemic, loan line utilization declined from 48% as of March 31, 2020 to 41% as of September 30, 2021, thereby decreasing loans outsanding.
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The following table summarizes the Company’s non-performing assets as of September 30, 2021 and December 31, 2020:
(dollars in thousands) September 30,
2021 December 31,
2020
Nonaccrual loans including nonaccrual troubled debt restructured loans $ 30,978 $ 11,986
Loans past due over 90 days and still accruing 18 116
Total nonperforming loans 30,996 12,102
Other real estate owned 316 316
Repossessions 20 6
Total nonperforming assets $ 31,332 $ 12,424
Individually analyzed loans including troubled debt restructurings $ 41,148 $ 20,177
Nonperforming loans to total loans 0.73 % 0.26 %
Nonperforming assets to total assets 0.50 % 0.21 %
Performing troubled debt restructured loans $ 4,973 $ 5,237
Nonperforming troubled debt restructured loans (included in nonaccrual loans) 6,093 6,476
Total troubled debt restructured loans $ 11,066 $ 11,713
Total nonperforming assets increased by $18.9 million, or 152.2%, to $31.3 million during the nine month period ended September 30, 2021. The ratio of nonperforming assets to total assets at September 30, 2021 increased from 0.21% at December 31, 2020 to 0.50% at September 30, 2021.
The increase in nonperforming assets was driven primarily by the downgrading of two commercial loan relationships to nonaccrual status during the third quarter of 2021, which totaled $21.2 million. The first credit relationship of $12.0 million was downgraded due to the severe impact on the business caused by the economic conditions resulting from the COVID-19 pandemic. The borrower is a retailer of party and special event supplies. During the third quarter of 2021, the borrower’s challenges significantly worsened. As a result, loans to the borrower were downgraded and placed on nonaccrual status. Loans to this borrower are secured by a blanket lien on all assets, including buildings, inventory, accounts receivable and equipment. In addition, the exposure is supported by a partial personal guarantee. The second downgrade relates to a shared national credit participation of $9.2 million to a commercial borrower that operates grain elevators and handles feed processing and merchandising of agriculture products. Loans to this borrower are secured by a blanket lien on all assets, including buildings, inventory, accounts receivable and equipment. These downgrades resulted in an increase to the specific credit loss allocations for each credit as they are now individually analyzed credits. The loans to both borrowers are current on interest and principal payments through September 2021. The Bank believes that the allocations are adequate to cover any potential losses. Each of these downgrades resulted from a unique business challenge and management does not believe these downgrades are systemic as it relates to the Bank's broader loan portfolio.
A loan is individually analyzed when full payment under the original loan terms is not expected. The analysis for smaller loans that are similar in nature and which are not in nonaccrual or troubled debt restructured status, such as residential mortgage, consumer, and credit card loans, is determined based on the class of loans. If a loan is individually analyzed, a portion of the allowance may be allocated so that the loan is reported, net, at the present value of estimated future cash flows or at the fair value of collateral if repayment is expected solely from the collateral. Total individually analyzed loans increased by $21.0 million to $41.1 million at September 30, 2021 from $20.2 million at December 31, 2020. The increase was primarily driven by the downgrading of two commercial loan relationships, discussed above.
As a result of the COVID-19 pandemic impact on the economy, we anticipate that our commercial, commercial real estate, residential and consumer borrowers may continue to encounter economic difficulties, which could lead to increases in our levels of nonperforming assets and troubled debt restructurings in future periods. Additionally, the balances of troubled debt restructurings could increase due to the expiration of relief for temporary COVID-19 related accommodations.
Loans are charged against the allowance for credit losses when management believes that the principal is uncollectible. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes will be adequate to absorb current expected credit losses relating to specifically identified loans based on an evaluation of the loans by
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management, as well as other current expected losses in the loan portfolio. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrower’s ability to repay. Management also considers trends in adversely classified loans based upon a monthly review of those credits. An appropriate level of general allowance is determined after considering the following factors: application of loss percentages using a PD/LGD approach subject to a floor, emerging market risk, commercial loan focus and large credit concentrations, new industry lending activity and current economic conditions. Federal regulations require insured institutions to classify their own assets on a regular basis. The regulations provide for three categories of classified loans: Substandard, Doubtful and Loss. The regulations also contain a Special Mention category. Special Mention applies to loans that do not currently expose an insured institution to a sufficient degree of risk to warrant classification as Substandard, Doubtful or Loss but do possess credit deficiencies or potential weaknesses deserving management’s close attention. The Company’s policy is to establish a specific allowance for credit losses for any assets where management has identified conditions or circumstances that indicate an asset is nonperforming. If an asset or portion thereof is classified as a loss, the Company’s policy is to either establish specified allowances for credit losses in the amount of 100% of the portion of the asset classified loss or charge-off such amount.
At September 30, 2021, the allowance for credit losses was 1.72% of total loans outstanding, versus 1.32% of total loans outstanding at December 31, 2020, which was calculated under the incurred loss methodology prior to January 1, 2021. The allowance for credit losses as a percentage of total loans outstanding, excluding PPP loans of $91.9 million, as of September 30, 2021, was 1.76%. This reflects a more comparable ratio to prior periods, as PPP loans are fully guaranteed by the SBA and have not been allocated for within the allowance for credit losses calculation. The allowance for credit losses at September 30, 2021 included a $9.1 million, day one impact from the adoption of CECL at January 1, 2021. At September 30, 2021, management believed the allowance for credit losses was at a level commensurate with the overall risk exposure of the loan portfolio. However, if economic conditions fail to recover or deteriorate due to the COVID-19 pandemic, certain borrowers may experience difficulty and the level of nonperforming loans, charge-offs and delinquencies could rise and require increases in the allowance for credit losses. The process of identifying credit losses is a subjective process.
The Company has a relatively high percentage of commercial and commercial real estate loans, which are extended to businesses with a broad range of revenue and within a wide variety of industries. Traditionally, this type of lending may have more credit risk than other types of lending because of the size and diversity of the credits. The Company manages this risk by utilizing conservative credit structures, by adjusting its pricing to the perceived risk of each individual credit and by diversifying the portfolio by customer, product, industry and market area.
As of September 30, 2021, based on management’s review of the loan portfolio, the Company had 88 credit relationships totaling $257.8 million on the classified loan list versus 96 credit relationships totaling $286.1 million on December 31, 2020. The decrease in classified loans for the first nine months of 2021 resulted primarily from paydowns as well as upgrades to previously classified loans on the non-individually analyzed portion of the watchlist. As of September 30, 2021, the Company had $185.6 million of assets classified as Special Mention, $72.2 million classified as Substandard, $0 classified as Doubtful and $0 classified as Loss as compared to $251.9 million, $34.2 million, $0 and $0, respectively, at December 31, 2020.
Allowance estimates are developed by management after taking into account actual loss experience adjusted for current economic conditions and a reasonably supportable forecast period. The Company has regular discussions regarding this methodology with regulatory authorities. Allowance estimates are considered a prudent measurement of the risk in the Company’s loan portfolio based upon loan segment. In accordance with CECL accounting guidance, the allowance is based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amounts. For a more thorough discussion of the allowance for credit losses methodology see the Critical Accounting Policies section of this Item 2.
The allowance for credit losses increased 19.0%, or $11.6 million, from $61.4 million at December 31, 2020 to $73.0 million at September 30, 2021. The increase included a $9.1 million adjustment on January 1, 2021 related to the day one CECL adoption. Most of the Company’s recent loan growth has been concentrated in the commercial loan portfolio, which can result in overall asset quality being influenced by a small number of credits. Management has historically considered growth and portfolio composition when determining credit loss allocations.
Prior to the pandemic, economic conditions in the Company’s markets were stable. During the past 18 months some industries have performed well during the pandemic, while others have not. The Company is monitoring industries and borrowers impacted by the pandemic as discussed. Watch list loans were $27.6 million lower at $258.5 million as of September 30, 2021 compared to $286.1 million at December 31, 2020. Watch list loans represent 6.10% of total loans at September 30, 2021 compared to 6.15% at December 31, 2020. Watch list loans excluding PPP loans, were 6.23% of total loans at
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September 30, 2021 compared to 6.75% at December 31, 2020. This reflects a more comparable ratio to prior periods, as PPP loans are fully guaranteed by the SBA and have not been allocated for within the allowance for credit losses calculation. The Company’s continued growth strategy promotes diversification among industries as well as continued focus on the enforcement of a disciplined credit culture and a conservative position in loan work-out situations.
As of September 30, 2021, total deferrals attributed to COVID-19 were $22.3 million, representing two commercial loan borrowers and a consumer loan. This represented 0.5% of the total loan portfolio and 0.6% of commercial loans.
A summary of loan deferrals attributed to COVID-19, by loan segment, as of September 30, 2021 is as follows:
(dollars in thousands) Borrowers Balance
CRE - Nonowner Occupied 1 33.4 % $ 14,347 64.3 %
CRE - Owner Occupied 1 33.3 7,954 35.6
Installment - other consumer 1 33.3 12 0.1
Total 3 100.0 % $ 22,313 100.0 %
As of September 30, 2021, one borrower with loans outstanding of $8.0 million was in their second deferral period. Additionally, one borrower with aggregate loans outstanding of $14.3 million was in their third deferral period. This borrower was removed from the deferral listing in October 2021. All COVID-19 related loan deferrals remain on accrual status, as each deferral is evaluated individually, and management has determined that all contractual cash flows are collectable at this time.
Sources of Funds
The average daily deposits and borrowings together with average rates paid on those deposits and borrowings for the nine months ended September 30, 2021 and 2020 are summarized in the following table:
Nine months ended September 30,
2021 2020
(dollars in thousands) Balance Rate Balance Rate
Noninterest bearing demand deposits $ 1,627,522 0.00 % $ 1,252,112 0.00 %
Savings and transaction accounts:
Savings deposits 353,058 0.08 260,668 0.08
Interest bearing demand deposits 2,334,480 0.28 1,796,270 0.57
Time deposits:
Deposits of $100,000 or more 741,815 0.87 969,362 1.78
Other time deposits 223,486 0.99 268,485 1.78
Total deposits $ 5,280,361 0.29 % $ 4,546,897 0.71 %
FHLB advances and other borrowings 75,500 0.41 98,489 0.85
Total funding sources $ 5,355,861 0.29 % $ 4,645,386 0.72 %
Deposits and Borrowings
As of September 30, 2021, total deposits increased by $377.8 million, or 7.5%, from December 31, 2020. Core deposits increased by $381.8 million to $5.404 billion as of September 30, 2021 from $5.022 billion as of December 31, 2020. Total brokered deposits were $11.0 million at September 30, 2021 compared to $15.0 million at December 31, 2020 reflecting a $4.0 million decrease during the first nine months of 2021. PPP loan proceeds to borrowers and government stimulus to consumers impacted the increase in deposits during 2021 as loan proceeds and stimulus payments were deposited into customer checking and savings accounts at the Bank.
Since December 31, 2020, the change in core deposits was comprised of increases in commercial deposits of $203.3 million, retail deposits of $51.4 million and public funds deposits of $127.1 million. Total public funds deposits, including public funds transaction accounts, were $1.290 billion at September 30, 2021 and $1.162 billion at December 31, 2020.
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The following table summarizes deposit composition at September 30, 2021 and December 31, 2020:
(dollars in thousands) September 30,
2021 December 31,
2020 Current
Period
Change
Retail $ 1,970,447 $ 1,919,040 $ 51,407
Commercial 2,143,576 1,940,306 203,270
Public funds 1,289,603 1,162,457 127,146
Core deposits $ 5,403,626 $ 5,021,803 $ 381,823
Brokered deposits 11,012 15,002 (3,990)
Total deposits $ 5,414,638 $ 5,036,805 $ 377,833
Total borrowings decreased by $10.5 million, or 12.3%, from December 31, 2020, due to repayment of the Company’s holding company line of credit. The Company utilizes wholesale funding, including brokered deposits and Federal Home Loan Bank advances, to supplement funding of assets, which is primarily used for loan and investment securities growth. Management anticipates that the Company’s deposit balances may fluctuate more than usual during the remainder of 2021 due to the impact of PPP loan originations, which are made to PPP loan recipient deposit accounts. The timing and use of these funds in addition to draws on unfunded commitments could impact our need to borrow throughout the year.
Capital
As of September 30, 2021, total stockholders’ equity was $683.2 million, an increase of $26.0 million, or 4.0%, from $657.2 million at December 31, 2020. Net income of $71.5 million increased equity. Offsetting the increase to stockholders’ equity was dividends declared and paid in the amount of $26.0 million, a decrease of $16.8 million in accumulated other comprehensive income, which was primarily driven by a net decrease in the fair value of available-for-sale securities, and the day one CECL adjustment, net of taxes, of $7.0 million.
The impact on equity for other comprehensive income (loss) is not included in regulatory capital. The banking regulators have established guidelines for leverage capital requirements, expressed in terms of Tier 1, or core capital, as a percentage of average assets, to measure the soundness of a financial institution. In addition, banking regulators have established risk-based capital guidelines for U.S. banking organizations. As of September 30, 2021, the Company's capital levels remained characterized as “well-capitalized”.
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The actual capital amounts and ratios of the Company and the Bank as of September 30, 2021 and December 31, 2020, are presented in the table below. Capital ratios for September 30, 2021 are preliminary until the Call Report and FR Y-9C are filed.
Actual Minimum Required For Capital Adequacy Purposes For Capital Adequacy Purposes Plus Capital Conservation Buffer Minimum Required to Be Well Capitalized Under Prompt Corrective Action Regulations
(dollars in thousands) Amount Ratio Amount Ratio Amount Ratio Amount Ratio
As of September 30, 2021:
Total Capital (to Risk Weighted Assets)
Consolidated $ 726,278 15.44 % $ 376,342 8.00 % $ 493,949 N/A N/A N/A
Bank $ 708,540 15.10 % $ 375,365 8.00 % $ 492,667 10.50 % $ 469,207 10.00 %
Tier I Capital (to Risk Weighted Assets)
Consolidated $ 667,210 14.18 % $ 282,257 6.00 % $ 399,864 N/A N/A N/A
Bank $ 649,622 13.85 % $ 281,524 6.00 % $ 398,826 8.50 % $ 375,365 8.00 %
Common Equity Tier 1 (CET1)
Consolidated $ 667,210 14.18 % $ 211,693 4.50 % $ 329,300 N/A N/A N/A
Bank $ 649,622 13.85 % $ 211,143 4.50 % $ 328,445 7.00 % $ 304,984 6.50 %
Tier I Capital (to Average Assets)
Consolidated $ 667,210 10.91 % $ 244,665 4.00 % $ 244,665 N/A N/A N/A
Bank $ 649,622 10.65 % $ 244,063 4.00 % $ 244,063 4.00 % $ 305,079 5.00 %
As of December 31, 2020:
Total Capital (to Risk Weighted Assets)
Consolidated $ 682,778 14.65 % $ 372,921 8.00 % $ 489,459 N/A N/A N/A
Bank $ 678,034 14.56 % $ 372,560 8.00 % $ 488,985 10.50 % $ 465,700 10.00 %
Tier I Capital (to Risk Weighted Assets)
Consolidated $ 624,381 13.39 % $ 279,691 6.00 % $ 396,229 N/A N/A N/A
Bank $ 619,693 13.31 % $ 279,420 6.00 % $ 395,845 8.50 % $ 372,560 8.00 %
Common Equity Tier 1 (CET1)
Consolidated $ 624,381 13.39 % $ 209,768 4.50 % $ 326,306 N/A N/A N/A
Bank $ 619,693 13.31 % $ 209,565 4.50 % $ 325,990 7.00 % $ 302,705 6.50 %
Tier I Capital (to Average Assets)
Consolidated $ 624,381 10.93 % $ 228,406 4.00 % $ 228,406 N/A N/A N/A
Bank $ 619,693 10.88 % $ 227,900 4.00 % $ 227,900 4.00 % $ 284,875 5.00 %
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FORWARD-LOOKING STATEMENTS
This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the federal securities law. Forward-looking statements are not historical facts and are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “project,” “possible,” “continue,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.
The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain and, accordingly, the reader is cautioned not to place undue reliance on any forward-looking statement made by the Company. Actual results could differ materially from those addressed in the forward-looking statements as a result of numerous factors, including, without limitation:
• the effects of future economic, business and market conditions and changes, both domestic and foreign;
• the effects of the COVID-19 pandemic, including its effects on our customers, local economic conditions, our operations and vendors, and the responses of federal, state and local governmental authorities;
• the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities and other interest sensitive assets and liabilities;
• changes in borrowers’ credit risks and payment behaviors;
• the timing and scope of any legislative and regulatory changes, including changes in tax and banking laws and regulations and their application by our regulators;
• the failure of assumptions and estimates used in our reviews of our loan portfolio, underlying the establishment of reserves for possible credit losses, our analysis of our capital position and other estimates;
• changes in the prices, values and sales volumes of residential and commercial real estate;
• changes in the scope and cost of FDIC insurance, the state of Indiana’s Public Deposit Insurance Fund and other coverages;
• the effects of disruption and volatility in capital markets on the value of our investment portfolio;
• changes in the availability and cost of credit and capital in the financial markets;
• The phase out of most LIBOR tenors by mid-2023 and establishment of a new reference rate;
• the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;
• the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth and/or expense savings from such transactions;
• governmental monetary, tax and fiscal policies and the impact the most recent election will have on these;
• changes in accounting policies, rules and practices, including as a result of adopting CECL on January 1, 2021;
• changes in technology or products that may be more difficult or costly, or less effective than anticipated, including in connection with our Lake City Bank Digital platform;
• cyber-security risks and or cyber-security damage that could result from attacks on the Company’s or third-party service providers networks or data of the Company;
• the effects of any employee or customer fraud;
• the risk of trade policy and tariffs could impact loan demand from the manufacturing sector;
• the effects of war or other conflicts, acts of terrorism or other catastrophic events, including storms, droughts, tornados and flooding, that may affect general economic conditions, including agricultural production and demand and prices for agricultural goods and land used for agricultural purposes, generally and in our markets; and
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• the risks noted in the Risk Factors discussed under Item 1A of Part 1 of our Annual Report on Form 10-K for the year ended December 31, 2020, as well as other risks and uncertainties set forth from time to time in the Company’s other filings with the SEC.
These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
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.