Item 7. Management’s Discussion and Analysis
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Cautionary Note Regarding Forward-Looking Statements
Certain matters in this Form 10-K may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of words such as “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would,” and “could.” These forward-looking statements include, but are not limited to:
• statements of our goals, intentions and expectations;
• statements regarding our business plans, prospects, growth and operating strategies;
• statements regarding the quality of our loan and investment portfolios; and
• estimates of our risks and future costs and benefits.
You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date made. These forward-looking statements are based on our current beliefs and expectations and, by their nature, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.
Important factors that could cause our actual results to differ materially from the results anticipated or projected, include, but are not limited to, the following:
• the effect of the novel coronavirus disease of 2019 ("COVID-19"), including on the Company's credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and consumer and corporate clients, including economic activity, employment levels and market liquidity;
• general economic conditions, either nationally or in our market areas, that are worse than expected;
• changes in the level and direction of loan or lease delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan and lease losses;
• our ability to access cost-effective funding;
• fluctuations in real estate values, and residential, commercial and multifamily real estate market conditions;
• demand for loans and deposits in our market area;
• our ability to implement and change our business strategies;
• competition among depository and other financial institutions and equipment financing companies;
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• the impact and intended termination of our frozen defined benefit plan;
• inflation and changes in the interest rate environment that reduce our margins and yields, our mortgage banking revenues, the fair value of financial instruments or our level of loan originations, or increase the level of defaults, losses and prepayments on loans and leases we have made and make;
• adverse changes in the securities or secondary mortgage markets;
• changes in the quality or composition of our loan, lease or investment portfolios;
• our ability to keep pace with technological changes, including our ability to identify and address cyber-security risks such as data security breaches, "denial of service" attacks, "hacking" and identity theft, and other attacks on our information technology systems or on the third-party vendors who perform several of our critical processing functions;
• the inability of third-party providers to perform as expected;
• our ability to manage market risk, credit risk and operational risk in the current economic environment;
• our ability to enter new markets successfully and capitalize on growth opportunities;
• our ability to retain key employees;
• our compensation expense associated with equity allocated or awarded to our employees;
• changes in the financial condition, results of operations or future prospects of issuers of securities that we own;
• our ability to successfully integrate into our operations any assets, liabilities, customers, systems and management personnel we may acquire and our ability to realize related revenue synergies and cost savings within expected time frames, and any goodwill charges related thereto;
• changes in consumer spending, borrowing and savings habits;
• changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; including as a result of the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act") and the Consolidated Appropriations Act, 2021 (“CAA 2021”);
• legislative or regulatory changes such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and its implementing regulations that adversely affect our business, and the availability of resources to address such changes;
• our ability to pay dividends on our common stock;
• other economic, competitive, governmental, regulatory, and technical factors affecting our operations, pricing, products and services including as a result of the CAA 2021 and recent COVID vaccination effort; and
• the other risks described elsewhere in this Form 10 K and our other reports filed with the U.S. Securities and Exchange Commission (“SEC”).
We undertake no obligation to publicly update or revise any forward-looking statements included in this report or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur and you should not put undue reliance on any forward-looking statements.
Additional factors that may affect our results are discussed under Part I, Item 1A in this document under the heading “Risk Factors.”
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General
Our principal business consists of attracting deposits from the general public, as well as brokered deposits, and investing those funds primarily in loans secured by first mortgages on owner-occupied, one- to four-family residences, a variety of consumer loans, direct financing leases, commercial and industrial loans, and loans secured by commercial and multi-family real estate. We also obtain funds by utilizing FHLB advances. Funds not invested in loans generally are invested in investment securities, including mortgage-backed and mortgage-related securities and agency and municipal bonds.
Our results of operations are primarily dependent on net interest income. Net interest income is the difference between interest income, which is the income that is earned on loans and investments, and interest expense, which is the interest that is paid on deposits and borrowings. Other significant sources of pre-tax income are service charges (mostly from service charges on deposit accounts and loan servicing fees), and fees from the sale of residential mortgage loans originated for sale in the secondary market. We may also recognize income from the sale of investment securities.
At December 31, 2020, on a consolidated basis, we had $1.1 billion in assets, $736.4 million in loans, $693.0 million in deposits and $192.7 million in stockholders’ equity. First Bank Richmond’s risk-based capital ratio at December 31, 2020 was 21.9%, exceeding the 10.0% requirement for a well-capitalized institution. For the year ended December 31, 2020, we reported net income of $10.0 million, compared with a net loss of $14.1 million for 2019.
Critical Accounting Policies
Certain accounting policies are important to the portrayal of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Management believes that its critical accounting policies include determining the allowance for loan and lease losses, the valuation of foreclosed assets, mortgage servicing rights, valuation of intangible assets and securities, deferred tax asset and income tax accounting.
Allowance for Loan and Lease Losses . We maintain an allowance for loan and lease losses to cover probable incurred credit losses at the balance sheet date. Loan and lease losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in our judgment, should be charged-off. A provision for loan and lease losses is charged to operations based on our periodic evaluation of the necessary allowance balance.
We have an established process to determine the adequacy of the allowance for loan and lease losses. The determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on other classified loans and pools of homogeneous loans, and consideration of past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors, all of which may be susceptible to significant change.
Mortgage Servicing Rights . Mortgage servicing rights, or MSRs, associated with loans originated and sold, where servicing is retained, are capitalized and included in the consolidated balance sheet. The value of the capitalized servicing rights represents the fair value of the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as a reduction in loan servicing fee income.
Securities . Under FASB Codification Topic 320 (ASC 320), Investments-Debt, investment securities must be classified as held to maturity, available for sale or trading. Management determines the appropriate classification at the time of purchase. The classification of securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and the Company has the ability to hold the securities to maturity. Securities not classified as held to maturity are classified as available for sale and are carried at fair value, with the unrealized holding gains and losses, net of tax, reported in other comprehensive income and do not affect earnings until realized.
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The fair values of our securities are generally determined by reference to quoted prices from reliable independent sources utilizing observable inputs. Certain of our fair values of securities are determined using models whose significant value drivers or assumptions are unobservable and are significant to the fair value of the securities. These models are utilized when quoted prices are not available for certain securities or in markets where trading activity has slowed or ceased. When quoted prices are not available and are not provided by third party pricing services, management judgment is necessary to determine fair value. As such, fair value is determined using discounted cash flow analysis models, incorporating default rates, estimation of prepayment characteristics and implied volatility.
We evaluate all securities on a quarterly basis, and more frequently when economic conditions warrant additional evaluations, for determining if any other-than-temporary-impairments (“OTTI”) exist pursuant to guidelines established in ASC 320. In evaluating the possible impairment of securities, consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and our ability and intent to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, we may consider whether the securities are issued by the federal government or its agencies or government sponsored agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition.
If management determines that an investment experienced an OTTI, we must then determine the amount of the OTTI to be recognized in earnings. If we do not intend to sell the security and it is more likely than not that we will not be required to sell the security before recovery of its amortized cost basis less any current period loss, the OTTI will be separated into the amount representing the credit loss and the amount related to all other factors. The amount of OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the OTTI related to other factors will be recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings will become the new amortized cost basis of the investment. If management intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current period credit loss, the OTTI will be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. Any recoveries related to the value of these securities are recorded as an unrealized gain (as accumulated other comprehensive income (loss) in stockholders’ equity) and not recognized in income until the security is ultimately sold.
From time to time we may dispose of an impaired security in response to asset/liability management decisions, future market movements, business plan changes, or if the net proceeds can be reinvested at a rate of return that is expected to recover the loss within a reasonable period of time.
Deferred Tax Asset . We have evaluated our deferred tax asset to determine if it is more likely than not that the asset will be utilized in the future. Our most recent evaluation has determined that we will more likely than not be able to utilize our remaining deferred tax asset.
Income Tax Accounting . We file a consolidated federal income tax return. The provision for income taxes is based upon income in our consolidated financial statements, rather than amounts reported on our income tax return. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on our deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.
Management Strategy
We are a community-oriented financial institution dedicated to serving the needs of customers in our primary market area. Our commitment is to offer a full array of consumer and commercial banking products and services to meet the needs of our customers. We offer mortgage lending products to qualified borrowers to give them the broadest access to home ownership in our markets. We offer commercial lending products and services tailored to complement their businesses. Our goal is to maintain asset quality while continuing to build our strong capital position while looking for growth opportunities in the markets we serve. To achieve these goals, we will focus on the following strategies:
Lending. We believe that commercial lending offers an opportunity to enhance our profitability while managing credit, interest rate and operational risk. We seek quality commercial loan opportunities in our existing markets and purchase loan participations that complement our existing portfolios. We will continue to focus our efforts on our existing markets as well as to further develop the Columbus, Ohio market through our loan production office. We anticipate that the majority of our
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commercial and multi-family real estate and commercial construction loan originations will range in size from $1.0 million to $8.0 million, while the majority of our commercial and industrial loan originations will range in size from $250,000 to $1.5 million. At December 31, 2020, our commercial loan portfolio, which includes commercial and multi-family real estate loans, commercial and industrial loans and construction loans, totaled $484.8 million, or 65.2% of total loans and leases, with approximately $144.8 million of these loans, or 19.5% of our total loans and leases, located in the Columbus, Ohio market.
Deposit Services. Deposits are our primary source of funds for lending and investment. We intend to continue to focus on increasing core deposits (which we define as all deposits except for certificates of deposit greater than $250,000 and brokered certificates of deposit) in our primary market area, with a particular emphasis on noninterest-bearing deposits. We will continue to enhance our offering of retail deposit products to maintain and increase our market share, while continuing to build our product offering of commercial deposit products to strengthen our relationships with our business customers. Core deposits represented 89.6% of our total deposits as of December 31, 2020.
Balance Sheet Growth . As a result of our efforts to build our management and infrastructure, we believe we are well-positioned to increase the size of our balance sheet without a proportional increase in overhead expense or operating risk. Accordingly, we intend to increase, on a managed basis, our assets and liabilities, particularly loans and deposits.
Asset Quality. We believe that strong asset quality is a key to long-term financial success. Our strategy for credit risk management focuses on an experienced team of credit professionals, well-defined credit policies and procedures, appropriate loan underwriting criteria and active credit monitoring. Our non-performing loans to total loans ratio was 0.65% at December 31, 2020.
Capital Position. Our policy has always been to protect the safety and soundness of First Bank Richmond through credit and operational risk management, balance sheet strength, and sound operations. The end result of these activities has been a capital ratio in excess of the well-capitalized standards set by our regulators. We believe that maintaining a strong capital position safeguards the long-term interests of First Bank Richmond.
Interest Rate Risk Management. Changes in interest rates are our primary market risk as our balance sheet is almost entirely comprised of interest-earning assets and interest-bearing liabilities. As such, fluctuations in interest rates have a significant impact not only upon our net income but also upon the cash flows related to those assets and liabilities and the market value of our assets and liabilities. In order to maintain what we believe to be acceptable levels of net interest income in varying interest rate environments, we actively manage our interest rate risk and assume a moderate amount of interest rate risk consistent with board policies.
COVID 19 Response
In response to the COVID-19 pandemic, the Company is offering a number of options designed to support our customers and the communities that we serve.
Paycheck Protection Program ("PPP"). The CARES Act was signed into law on March 27, 2020, and authorized the SBA to temporarily guarantee loans under a loan program called the Paycheck Protection Program, or PPP. As a qualified SBA lender, the Company was automatically authorized to originate PPP loans upon commencement of the program in April 2020. The SBA guarantees 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be forgiven and repaid by the SBA.
As of the conclusion of the PPP on August 8, 2020, we had funded 482 PPP loans totaling $64.9 million. Many of the PPP applications were from our existing clients but we also served those who had not had a banking relationship with us in the past. In addition to the 1% interest earned on these loans, the SBA pays us fees for processing PPP loans in the following amounts: (i) 5% for loans of not more than $350,000; (ii) 3% for loans of more than $350,000 and less than $2,000,000; and (iii) 1% for loans of at least $2,000,000. The SBA processing fees for the approved loans totaled $2.3 million for the year ended December 31, 2020. As of December 31, 2020, SBA had approved 200 loan forgiveness applications totaling $21.6 million with an additional 63 applications totaling $18.4 million pending approval.
Recent legislation reopened the PPP through March 31, 2021, by authorizing $284.5 billion in funding for eligible small businesses and non-profits. In January 2021, we began accepting and processing loan applications under this second PPP program and will continue working with clients to assist them with accessing other borrowing options, including SBA and other government sponsored lending programs, as appropriate.
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We may utilize the FRB's Paycheck Protection Program Liquidity Facility (“PPPLF”), pursuant to which the Company would pledge its PPP loans as collateral to obtain FRB non-recourse loans. The PPPLF will take the PPP loans as collateral at face value. As of December 31, 2020, we had not utilized the PPPLF.
Loan Modifications. We offer payment and financial relief programs for borrowers impacted by COVID-19, primarily through loan and lease payment deferments of principal and interest up to 90 days, although requests for payment relief during the fourth quarter of 2020 declined significantly from the second and third prior quarters of 2020. We continue to monitor our loan portfolio and strive to work with our customers and communities. Deferred loans are re-evaluated at the end of the initial deferral period and will either return to the original loan terms or be reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating is appropriate. At December 31, 2020, the number of loans and leases granted payment deferrals was 48, representing $54.7 million in loans and leases outstanding, compared to 70 loans and leases at September 30, 2020 totaling $35.3 million, and 752 loans and leases at June 30, 2020 totaling $175.1 million. The increase in the outstanding deferred loan amount was primarily attributable to four first time deferrals of large loans totaling $11.7 million in the fourth quarter. Of the loans currently deferred at December 31, 2020, ten loans, representing $11.9 million in loans and leases outstanding, were new deferrals and 38 loans, representing $42.8 million in loans and leases outstanding, were repeat deferrals. The following table summarizes information relating to loan deferments at December 31, 2020 and September 30, 2020:
December 31, 2020 September 30, 2020
($ in thousands)
Number of Loans
Balance Number of Loans
Balance
Commercial mortgage
18 $ 44,352 24 $ 27,767
Commercial and industrial
1 770 2 788
Construction and development
0 — 2 226
Multi-Family
4 8,868 2 2,105
Residential mortgage
3 163 16 3,347
Home equity
0 — 1 14
Direct financing leases
20 494 23 1,063
Consumer
2 18 0 —
Total Loans
48 $ 54,665 70 $ 35,310
The following table summarizes information relating to hospitality loan deferments (which are included in the table above) at December 31, 2020 and September 30, 2020:
December 31, 2020 September 30, 2020
($ in thousands) Number of Loans Balance Percent of total loans in category Number of loans Balance Percent of total loans in category
Restaurants 1 $ 375 6.78 % 0 $ — — %
Hotels 12 37,056 56.17 % 13 24,384 38.05 %
Total Loans 13 $ 37,431 52.35 % 13 $ 24,384 34.83 %
Branch Operations and Additional Client Support. Many of our employees continue to work remotely or have flexible work schedules, and we have established protective measures within our offices to help ensure the safety of those employees who must work on-site. We have also taken steps to resume more normal branch activities with specific guidelines in place to ensure the safety of our clients and our personnel. We continuously monitor and conform our practices based on updates from the Center for Disease Control, World Health Organization, Financial Regulatory Agencies, and local and state health departments.
We continue to work closely with our borrowers to evaluate pandemic related challenges.
Financial Condition at December 31, 2020 Compared to December 31, 2019
General. Total assets increased $98.2 million, or 10.0%, to $1.1 billion at December 31, 2020 from $986.0 million at December 31, 2019. This increase was driven by a $49.2 million, or 7.2%, increase in the loan and lease portfolio, net of
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allowance for loan and lease losses, a $39.0 million, or 17.9%, increase in investment securities and an $8.2 million, or 20.1%, increase in cash and cash equivalents. The growth in the loan portfolio occurred primarily in the PPP loan portfolio, which totaled $43.3 million at December 31, 2020. The increase in assets was funded by a $75.8 million, or 12.3%, increase in deposits and a $16.0 million, or 10.4% increase in advances from the FHLB.
Loans and Leases. Our loan and lease portfolio, net of allowance for loan and lease losses, increased $49.2 million, or 7.2%, to $736.4 million at December 31, 2020 from $687.3 million at December 31, 2019. The majority of the growth occurred in the commercial and industrial loan portfolio which increased $38.3 million or 45.3%. The growth in the commercial and industrial loan portfolio consisted of PPP loans which equaled $43.3 million at year-end 2020. We also experienced an $18.2 million, or 7.9%, increase in the commercial real estate portfolio, a $7.6 million, or 6.9%, increase in direct financing leases, and a $5.0 million, or 9.4%, increase in the construction and development portfolio. These increases were partially offset by a $4.2 million, or 3.2%, decrease in our residential mortgage portfolio as a result of selling a substantial majority of the residential loans originated during 2020 and normal paydowns and maturities. The majority of the PPP loans were generated within the western Ohio and Richmond, Indiana market area.
Nonperforming loans and leases, consisting of nonaccrual loans and leases and accruing loan and leases more than 90 days past due, total $4.8 million, or 0.64%, of total loans and leases at December 31, 2020, compared to $3.8 million, or 0.55% of total loans and leases at December 31, 2019. The increase in nonperforming loans and leases was primarily the result of a $1.1 million commercial real estate participation loan more than 90 days past due and still accruing that is working towards resolution by the lead bank.
At December 31, 2020, TDRs totaled $541,000, compared to $597,000 at December 31, 2019. The CARES Act amended generally accepted accounting principles with respect to the modification of loans to borrowers affected by the COVID-19 pandemic. Among other criteria, this guidance provided that short-term loan modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. As of December 31, 2020, the Company had outstanding 48 loan modifications qualifying under the CARES Act related to the COVID-19 pandemic with an outstanding loan balance totaling $54.7 million. Loan modifications in accordance with the CARES Act and related regulatory guidance are still subject to an evaluation in regards to determining whether or not a loan is deemed to be impaired.
Allowance for Loan and Lease Losses. Our allowance for loan and lease losses increased $3.5 million, or 49.3%, to $10.6 million at December 31, 2020 from $7.1 million at December 31, 2019. At December 31, 2020, the allowance for loan and lease losses totaled 1.42% of total loans and leases outstanding compared to 1.02% at December 31, 2019. Management expects that the vast majority of PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA within a short time frame, which in turn will reimburse the Bank for the amount forgiven. Net charge-offs during the year ended 2020 were $273,000, or 0.04% of average loans and leases outstanding compared to $1.1 million, or 0.16% of average loans and leases outstanding during 2019. The allowance for loan and lease losses to non-performing loans and leases was 220.6% at December 31, 2020, compared to 186.0% at December 31, 2019.
Management regularly analyzes conditions within its geographic markets and evaluates its loan and lease portfolio. The Company evaluated its exposure to potential loan and lease losses as of December 31, 2020, which evaluation included consideration of potential credit losses due to the deteriorating economic conditions driven by the impact of the COVID-19 pandemic. The full impact of the pandemic on the Company's deposit and loan customers is still not fully known at this time. The Company has increased its qualitative factors when determining the adequacy of its allowance for loan and lease losses. Credit metrics are being reviewed and stress testing is being performed on the loan portfolio. Potentially higher risk segments of the portfolio, such as hotels and restaurants , are being closely monitored as are loan payment deferrals.
Deposits. Total deposits increased $75.8 million, or 12.3%, to $693.0 million at December 31, 2020 from $617.2 million at December 31, 2019. This increase in deposits was due to increases in demand deposits of $93.2 million, or 35.5%, and savings accounts of $21.6 million, or 29.4%, primarily linked to overall changes in spending and savings habits by businesses and consumers due to the COVID-19 pandemic. The increase in retail deposits allowed for a decrease in brokered deposits of $33.4 million, or 58.9%, during 2020. At December 31, 2020, brokered deposits equaled 3.4% of total deposits compared to $56.7 million, or 9.2% of total deposits at December 31, 2019. At December 31, 2020, noninterest bearing deposits totaled $98.7 million, or 14.2% of total deposits, compared to $60.3 million, or 9.8%, of total deposits at December 31, 2019.
Borrowings. Total borrowings, consisting solely of FHLB advances, increased $16.0 million, or 10.4%, to $170.0 million at December 31, 2020 from $154.0 million at December 31, 2019. The increase in borrowings was used to fund both loan and lease growth as well as investment securities growth during the period.
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Stockholders’ Equity. Stockholders’ equity totaled $192.7 million as of December 31, 2020, an increase of $4.9 million, or 2.6%, from December 31, 2019. The increase in stockholders’ equity was the result of 2020 net income of $10.0 million, an increase of $4.4 million in other comprehensive income, an increase of $648,000 due to ESOP shares earned, and an increase of $811,000 due to awards made pursuant to the Company's stock-based compensation plan. These increases were partially offset by cash dividends paid in 2020 of $1.8 million, and the repurchase of common stock totaling $9.1 million. First Bank Richmond’s tangible common equity ratio and its risk-based capital ratios exceeded “well-capitalized” levels as defined by all regulatory standards as of December 31, 2020.
Comparison of Results of Operations for the Years Ended December 31, 2020 and 2019
General . We reported net income of $10.0 million for 2020 compared to a net loss of $14.1 million in 2019. The net loss for 2019 was affected by the estimated $14.3 million after-tax charge associated with the planned termination of the DB Plan, an after-tax charge of $4.9 million associated with the Company’s contribution to the Foundation which was formed in connection with our reorganization and stock offering completed on July 1, 2019, and an after-tax charge of $1.3 million related to the adoption of a nonqualified deferred compensation plan in the second quarter of 2019.
Interest Income . Total interest income for 2020 increased $784,000 or 1.9% over 2019. The increase primarily was a result of a $49.0 million increase in the average balance of loans and leases outstanding year-over-year, partially offset by a 19 basis point decrease in average yield on loans and leases, resulting in a $1.2 million increase in loan interest income. Interest on investment securities, including FHLB stock, increased $566,000, or 14.7%, due to a $82.4 million increase in the portfolio, partially offset by a 53 basis point decrease in the average yield. Interest on cash and cash equivalents decreased $1.0 million as average balances decreased $20.1 million and the yield declined 165 basis points.
Interest Expense . Total interest expense decreased $1.8 million, or 15.8% to $9.4 million during 2020 compared to $11.2 million during 2019. The primary reason for this decrease was a decrease in the average rate paid on all deposit accounts and borrowings as well as a decrease in the average balance of certificates of deposit. The average balance of savings and money market accounts increased $18.4 million, or 10.9%, to $188.4 million in 2020 compared to $169.9 million in 2019. The average rate paid on savings and money market accounts declined 16 basis points in 2020 to 0.56% from 0.72% in 2019. The average balance of interest-bearing checking accounts increased $16.1 million, or 15.8%, to $118.7 million in 2020 from $102.5 million in 2019. The average rate paid on interest-bearing checking accounts decreased 11 basis points to 0.25% in 2020 from 0.36% in 2019. The average balance of certificate of deposits declined $24.7 million, or 8.2%, to $278.0 million in 2020 from $302.7 million in 2019. The average rate paid on certificates of deposit decreased 31 basis points to 1.81% in 2020 from 2.12% in 2019. The decline in the average balance of certificate of deposit was attributable to a decrease in brokered certificates of deposit of $39.5 million, or 42.1%, to $54.4 million in 2020 from $94.0 million in 2019. The average rate paid on brokered certificates of deposit dropped 53 basis points to 1.70% in 2020 from 2.23% in 2019. The average balance of FHLB borrowings increased $30.9 million, or 21.4%, to $175.1 million in 2020 from $144.2 million in 2019. The average rate on FHLB borrowings decreased 46 basis points to 1.72% in 2020 from 2.18% in 2019. The Company increased its FHLB borrowings in 2020 to procure longer term borrowings at lower rates as a result of the drop in rates experienced in the first quarter of 2020.
Net Interest Income . Net interest income before provision for loan and lease losses increased $2.5 million, or 8.4%, to $32.9 million in 2020 compared to $30.4 million in 2019, primarily due to the increase in average earning assets exceeding the growth in interest-bearing liabilities. Our net interest margin in 2020 was 3.22%, a decrease of 12 basis points compared to 2019. The decrease in net interest margin reflects a lower overall yield on average interest-earning assets of 43 basis points in 2020 compared to 2019, while the overall rate on interest-bearing liabilities declined only 31 basis points from 2019 to 2020.
Provision for Loan and Lease Losses . The provision for loan and lease losses in 2020 was $3.8 million, a $1.2 million increase over the $2.6 million provision in 2019. The increase in the provision was due to the continued uncertainty of the economic impact of the COVID-19 pandemic on the Bank's loan and lease portfolio. Net charge-offs in 2020 were $273,000 compared to $1.1 million in 2019. Due to the increased provision expense, the allowance increased as a percentage of the total loan and lease portfolio to 1.42% at year-end 2020. Net charge-offs in 2020 equaled 0.04% of total average loans and leases outstanding compared to 0.16% of total average loans and leases outstanding in 2019.
Non-Interest Income . Total non-interest income increased $3.5 million, or 89.8%, to $7.3 million for 2020 compared to $3.9 million for 2019. The increase in total noninterest income was primarily driven by an increase in the net gain on loan and lease sales of $3.0 million, or 461.7%, to $3.6 million in 2020 from $647,000 in 2010, and by smaller increases in other loan fees and loan and lease servicing fees. These increases were partially offset by a $347,000, or 32.2%, decrease in service charges on deposit accounts in 2020 compared to 2019. The decrease in service charges on deposit accounts was the result of
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higher customer balances maintained in deposit accounts along with the waiving of overdraft fees and the waiving of certain ATM fees during a portion of 2020.
Non-Interest Expenses . Total noninterest expense decreased $27.0 million, or 53.0%, to $24.0 million during 2020 compared to 2019. The decrease primarily was the result of the $19.3 million estimated DB Plan expense, the $6.25 million expense attributable to the contribution to the Foundation, and the $1.7 million expense related to the adoption of a nonqualified deferred compensation plan incurred in 2019. Excluding these three 2019 non-recurring expenses, noninterest expenses increased $219,000 in 2020 compared to 2019.
Salaries and employee benefits decreased $156,000, or 1.1%, in 2020 compared to 2019. Pension plan expense decreased $20.1 million, or 98.1%, in 2020 compared to 2019. This was due to the recognition of the estimated $19.3 million DB Plan pre-tax expense incurred in 2019 associated with the expected termination of the DB Plan. Equipment expense increased $175,000, or 17.5%, to $1.2 million in 2020 from $1.0 million in 2019 due to additional depreciation and maintenance expense. Data processing fees increased $105,000, or 6.0%, to $1.9 million in 2020 from $1.7 million in 2019 primarily due to higher transaction volumes and additional services utilized from the Company's IT provider. Legal and professional fees increased $124,000, or 12.3%, to $1.1 million in 2020 from $1.0 million in 2019. This is primarily attributable to ongoing expenses associated with operating as a public company. Advertising expenses declined $452,000, or 54.9%, to $372,000 in 2020 from $824,000 in 2019. Much of this was attributable to sponsorships involving 501(c)(3) non-profits now being funded by the Foundation. In 2019, the Company expensed $6.25 million to fund the Foundation while in 2020 there was no comparable expense. Other expenses decreased $341,000, or 10.1%, to $3.0 million in 2020 from $3.4 million in 2019. This was primarily due to state taxes associated with the leasing portfolio decreasing by $100,000, employee expenses associated with education and travel decreasing by $140,000, and charitable contributions decreasing $185,000. Contributions in 2020 to registered 501(c)(3) organizations were primarily funded through the Foundation that was established in 2019.
Income Tax Expense . Income tax expense increased in 2020 by $7.8 million compared to 2019, reflecting a tax rate of 19.8% for 2020. This increase in income tax expense was due to pre-tax income increasing during 2020 compared to 2019 for the reasons discussed above.
Average Balances, Interest and Average Yields/Cost
The following tables set forth for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin (otherwise known as net yield on interest-earning assets), and the ratio of average interest-earning assets to average interest-bearing liabilities. Average balances have
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been calculated using quarterly balances. Non-accruing loans have been included in the table as loans carrying a zero yield. Loan fees are included in interest income on loans and are not material.
Years Ended December 31,
2020 2019 2018
Average
Balance
Outstanding Interest
Earned/
Paid Yield/
Rate Average
Balance
Outstanding Interest
Earned/
Paid Yield/
Rate Average
Balance
Outstanding Interest
Earned/
Paid Yield/
Rate
(Dollars in thousands)
Interest-earning assets:
Loans and leases receivable $ 735,959 $ 37,777 5.13 % $ 686,949 $ 36,560 5.32 % $ 613,569 $ 31,559 5.14 %
Securities 241,659 4,128 1.71 % 160,812 3,461 2.15 % 142,140 3,167 2.23 %
FHLB stock 8,803 285 3.24 % 7,256 386 5.32 % 6,686 341 5.10 %
Cash and cash equivalents and other 35,247 152 0.43 % 55,316 1,151 2.08 % 5,771 132 2.29 %
Total interest-earning assets 1,021,668 42,342 4.14 % 910,333 41,558 4.57 % 768,166 35,199 4.58 %
Interest-bearing liabilities:
Savings and money market accounts 188,379 1,062 0.56 % 169,941 1,227 0.72 % 161,111 884 0.55 %
Interest-bearing checking accounts 118,668 293 0.25 % 102,521 372 0.36 % 100,958 205 0.20 %
Certificate accounts 278,018 5,028 1.81 % 302,735 6,419 2.12 % 278,810 4,559 1.64 %
Borrowings 175,060 3,010 1.72 % 144,201 3,138 2.18 % 115,620 2,104 1.82 %
Total interest-bearing liabilities 760,125 9,393 1.24 % 719,398 11,156 1.55 % 656,499 7,752 1.18 %
Net interest income $ 32,949 $ 30,402 $ 27,447
Net earning assets $ 261,543 $ 190,935 $ 111,667
Net interest rate spread (1)
2.90 % 3.02 % 3.40 %
Net interest margin (2)
3.22 % 3.34 % 3.57 %
Average interest-earning assets to average interest-bearing liabilities 134.41 % 126.54 % 117.01 %
(1) Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate of interest-bearing liabilities.
(2) Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Analysis
The following schedule presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and that due to the changes in interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to
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rate.
Years Ended
December 31, Years Ended
December 31,
2020 vs. 2019 2019 vs. 2018
Increase/
(decrease)
due to Total
increase/ (decrease) Increase/
(decrease)
due to Total
increase/ (decrease)
Volume Rate Volume Rate
(In thousands)
Interest-earning assets:
Loans and leases receivable $ 2,624 $ (1,407) $ 1,217 $ 3,766 $ 1,235 $ 5,001
Securities 1,717 (1,050) 667 426 (132) 294
FHLB stock 83 (184) (101) 29 16 45
Cash and cash equivalents and other (417) (582) (999) 1,135 (116) 1,019
Total interest-earning assets $ 4,007 $ (3,223) $ 784 $ 5,356 $ 1,003 $ 6,359
Interest-bearing liabilities:
Savings and money market accounts $ 130 $ (295) $ (165) $ 49 $ 294 $ 343
Interest-bearing checking accounts 63 (142) (79) 3 164 167
Certificate accounts (526) (865) (1,391) 395 1,465 1,860
Borrowings 651 (779) (128) 518 516 1,034
Total interest-bearing liabilities $ 318 $ (2,081) $ (1,763) $ 965 $ 2,439 $ 3,404
Change in net interest income $ 2,547 $ 2,955
Off-Balance Sheet Activities
In the normal course of operations, we engage in a variety of financial transactions that are not recorded in our financial statements, including commitments to extend credit and unused lines of credit. These transactions involve varying degrees of off-balance sheet risks. While these contractual obligations represent our potential future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. At December 31, 2020, we had $179.9 million in loan commitments and unused lines of credit.
Liquidity
We are required to have enough cash and investments that qualify as liquid assets in order to maintain sufficient liquidity to ensure safe and sound operations. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, liquid assets have been maintained above levels believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is maintained.
Liquidity management involves the matching of cash flow requirements of customers, who may be either depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs and the ability of the Company to manage those requirements. We strive to maintain an adequate liquidity position by managing the balances and maturities of interest-earning assets and interest-bearing liabilities so that the balance in short-term investments at any given time will cover adequately any reasonably anticipated, immediate need for funds. Additionally, First Bank Richmond maintains a relationship with the FHLB of Indianapolis which could provide funds on short-term notice if needed.
Liquidity management is both a daily and long-term function of the management of our business. It is overseen by the Asset and Liability Management Committee. Excess liquidity is generally invested in short-term investments, such as overnight
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deposits and holding excess funds at the Federal Reserve Board. On a long-term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed and municipal securities. First Bank Richmond uses its sources of funds primarily to meet its ongoing commitments, pay maturing deposits, fund deposit withdrawals and fund loan commitments.
First Bank Richmond can also generate funds from borrowings, primarily FHLB advances. In addition, we have historically sold eligible long-term, fixed-rate residential mortgage loans in the secondary market in order to reduce interest rate risk and to create another source of liquidity.
Liquidity, represented by cash, cash equivalents, and investment securities, is a product of our operating, investing and financing activities. Primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans and mortgage-backed securities, maturities of investment securities and other short-term investments and funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. In addition, excess funds are invested in short-term interest-earning assets, which provide liquidity to meet lending requirements. Cash is also generated through borrowings. FHLB advances are utilized to leverage our capital base and provide funds for lending and investment activities, as well as to enhance interest rate risk management.
Funds are used primarily to meet ongoing commitments, pay maturing deposits, fund withdrawals, and to fund loan commitments. It is management’s policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that a majority of maturing deposits will remain with us.
As disclosed in our Consolidated Statements of Cash Flows in Item 8 of this Form 10-K, cash and cash equivalents increased $8.2 million to $48.8 million as of December 31, 2020, from $40.6 million at December 31, 2019. Net cash provided by operating activities was $16.6 million for the year ended December 31, 2020. Net cash of $89.3 million was used in investing activities for the year ended December 31, 2020, primarily due to the purchase of investment securities and the funding of loans. There was $80.9 million of cash provided by financing activities for the year ended December 31, 2020, which primarily consisted of an increase in deposits and additional FHLB advances, partially offset by the repurchase of common stock and payment of dividends.
Richmond Mutual Bancorporation is a separate legal entity from First Bank Richmond and must provide for its own liquidity. In addition to its own operating expenses (many of which are paid to First Bank Richmond), Richmond Mutual Bancorporation is responsible for paying for any stock repurchases, dividends declared to its stockholders and other general corporate expenses. Richmond Mutual Bancorporation’s primary source of funds are the proceeds it received and retained in connection with its recent stock offering and dividends from First Bank Richmond, which are subject to regulatory limits. At December 31, 2020, Richmond Mutual Bancorporation, on an unconsolidated basis, had $32.7 million in cash, noninterest-bearing deposits and liquid investments generally available for general corporate purposes.
Except as set forth above, management is not aware of any trends, events, or uncertainties that will have, or that are reasonably likely to have a material impact on liquidity, capital resources or operations. Further, management is not aware of any current recommendations by regulatory agencies, which, if they were to be implemented, would have this effect.
Capital Resources
First Bank Richmond is subject to minimum capital requirements imposed by the FDIC. The FDIC may require us to have additional capital above the specific regulatory levels if it believes we are subject to increased risk due to asset problems, high interest rate risk and other risks. At December 31, 2020, First Bank Richmond’s regulatory capital exceeded the FDIC regulatory requirements, and First Bank Richmond was well-capitalized under regulatory prompt corrective action standards.
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Consistent with our goals to operate a sound and profitable organization, our policy is for First Bank Richmond to maintain well-capitalized status.
Actual Required for
Adequate Capital To Be Well
Capitalized
Amount Ratio Amount Ratio Amount Ratio
At December 31, 2020 (Dollars in thousands)
Total risk-based capital (to risk weighted assets) $ 162,624 21.9 % $ 59,416 8.0 % $ 74,270 10.0 %
Tier 1 risk-based capital (to risk weighted assets) 153,325 20.6 44,562 6.0 59,416 8.0
Common equity tier 1 capital (to risk weighted assets) 153,325 20.6 33,422 4.5 48,276 6.5
Tier 1 leverage (core) capital (to adjusted tangible assets) 153,325 14.3 42,939 4.0 53,673 5.0
As of December 31, 2019
Total risk-based capital (to risk weighted assets) $ 149,137 19.5 % $ 61,304 8.0 % $ 76,629 10.0 %
Tier 1 risk-based capital (to risk weighted assets) 142,048 18.5 45,978 6.0 61,304 8.0
Common equity tier 1 capital (to risk weighted assets) 142,048 18.5 34,483 4.5 49,809 6.5
Tier 1 leverage (core) capital (to adjusted tangible assets) 142,048 14.6 39,027 4.0 48,784 5.0
Pursuant to the capital regulations of the FDIC and the other federal banking agencies, First Bank Richmond must maintain a capital conservation buffer consisting of additional common equity tier 1 (“CET1”) capital greater than 2.5% of risk-weighted assets above the required minimum levels of risk-based CET1 capital, tier 1 capital and total capital in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. At December 31, 2020, the Bank’s CET1 capital exceeded the required capital conservation buffer.
For a bank holding company with less than $3.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve Board expects the holding company’s subsidiary banks to be well capitalized under the prompt corrective action regulations. If Richmond Mutual Bancorporation was subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets, at December 31, 2020, it would have exceeded all regulatory capital requirements.
Impact of Inflation
The effects of price changes and inflation can vary substantially for most financial institutions. While management believes that inflation affects the economic value of total assets, it believes that it is difficult to assess the overall impact. Management believes this to be the case due to the fact that generally neither the timing nor the magnitude of inflationary changes in the economy coincides with changes in interest rates. Since virtually all of our assets and liabilities are monetary in nature, interest rates generally have a more significant impact on our performance than does inflation.