Item 7. Management’s Discussion and Analysis
Item 7 .
Management’s Discussion and Analysis of Financial Condition and Results of Operations .
SB Financial Group, Inc. (“SB Financial”), is a financial holding company registered with the Federal Reserve Board and subject to regulation under the Bank Holding Company Act of 1956, as amended. Through its direct and indirect subsidiaries, SB Financial is engaged in commercial and retail banking, wealth management and private client financial services.
The following discussion provides a review of the consolidated financial condition and results of operations of SB Financial and its subsidiaries (collectively, the “Company”). This discussion should be read in conjunction with the Company’s consolidated financial statements and related footnotes as of and for the years ended December 31, 2021 and 2020.
Strategic Discussion
The focus and strategic goal of the Company is to grow into and remain a top decile (>90 th percentile) independent financial services company. The Company intends to achieve and maintain that goal by executing our five key initiatives.
Increase profitability through ongoing diversification of revenue streams: For the twelve months ended December 31, 2021, the Company generated $30.7 million in noninterest income, or 44.8 percent of total operating revenue, from fee-based products. These revenue sources include fees generated from saleable residential mortgage loans, retail deposit products, wealth management services, saleable business-based loans (small business and farm service) and title agency revenue. For the twelve months ended December 31, 2020, the Company generated $30.1 million in revenue from fee-based products, or 45.6 percent of total operating revenue.
Strengthen our penetration in all markets served: Over our 119-year history of continuous operation in Northwest Ohio, we have established a significant presence in our traditional markets in Defiance, Fulton, Paulding and Williams counties in Ohio. In our newer markets of Bowling Green, Columbus, Findlay, Toledo (Ohio) and Ft. Wayne (Indiana), our current market penetration is minimal but we believe our potential for growth is significant. We have expanded and committed additional resources to our presence in the Findlay and Edgerton markets. We continue to seek to expand the presence and penetration in all of our markets.
Expand product utilization by new and existing customers: As of December 31, 2021, we operated in ten counties in Northwest Ohio and Northeast Indiana with 23 full service offices, 24 full service ATM’s and five loan production offices. Combined in the ten counties of operation, we command 4.47 percent of the deposit market share, which has steadily grown.
Deliver gains in operational excellence: Our management team believes that becoming and remaining a high-performance financial services company will depend upon seamlessly and consistently delivering operational excellence, as demonstrated by the Company’s leadership in the origination and servicing of residential mortgage loans. As of December 31, 2021, the Company serviced 8,614 residential mortgage loans with a principal balance of $1.36 billion. As of December 31, 2020, the Company serviced 8,543 loans with a principal balance of $1.30 billion.
Sustain asset quality: As of December 31, 2021, the Company’s asset quality metrics remained strong. Specifically, total nonperforming assets were $6.5 million, or 0.49 percent of total assets. Total delinquent loans at December 31, 2021 were 0.46 percent of total loans. As of December 31, 2020, the Company had total nonperforming assets of $7.3 million, or 0.58 percent of total assets. Total delinquent loans at December 31, 2020 were 0.75 percent of total loans.
The successful execution of these five strategies have enabled the Company to improve financial performance across a broad series of metrics. These metrics over the last five years are outlined in the following table. Specifically, the Company has increased total assets by $454.3 million, or 52 percent. The growth has been on both sides of the balance sheet over the five year period, with loans growing $126.1 million or 18 percent and deposits growing $383.4 million or 52.6 percent.
The Company has raised capital through the issuance of equity and debt to the market on two separate occasions during the period, which has raised equity capital significantly and expanded liquidity for potential strategic expansion. Strategic expansion has occurred with the acquisition of a small community bank, the opening of three branch offices and the acquisition of two full service title agencies.
30
Financial Highlights
Year Ended December 31,
($ in thousands, except per share data)
Earnings
2021
2020
2019
2018
2017
Interest income
$
41,904
$
42,635
$
44,400
$
39,479
$
32,480
Interest expense
4,020
6,705
9,574
6,212
4,094
Net interest income
37,884
35,930
34,826
33,267
28,386
Provision for loan losses
1,050
4,500
800
600
400
Noninterest income
30,697
30,096
18,016
16,624
17,217
Noninterest expense
44,808
43,087
37,410
34,847
31,578
Provision for income taxes
4,446
3,495
2,659
2,806
2,560
Net income
18,277
14,944
11,973
11,638
11,065
Preferred stock dividends
-
-
950
975
975
Net income available to common shareholders
18,277
14,944
11,023
10,663
10,090
Per Common Share Data
Basic earnings
$
2.58
$
1.96
$
1.71
$
1.72
$
2.10
Diluted earnings
2.56
1.96
1.51
1.51
1.74
Cash dividends declared
0.44
0.40
0.36
0.32
0.28
Total equity per share
21.05
19.39
17.53
16.36
15.03
Total tangible equity per share
17.60
16.30
15.23
15.39
13.27
Average Balances
Average total assets
$
1,322,253
$
1,161,396
$
1,027,932
$
947,266
$
854,569
Average equity
144,223
139,197
133,190
121,094
89,538
Ratios
Return on average total assets
1.38
%
1.29
%
1.16
%
1.23
%
1.29
%
Return on average equity
12.67
10.74
8.99
9.61
12.36
Cash dividend payout ratio 1
17.18
20.54
23.84
19.60
13.50
Average equity to average assets
10.91
11.99
12.96
12.78
10.48
Period End Totals
Total assets
$
1,330,854
$
1,257,839
$
1,038,577
$
986,828
$
876,627
Available-for-sale securities
263,259
149,406
100,948
90,969
82,790
Loans held for sale
7,472
7,234
7,258
4,445
3,940
Total loans & leases
822,714
872,723
825,510
771,883
696,615
Allowance for loan losses
13,805
12,574
8,755
8,167
7,930
Total deposits
1,113,045
1,049,011
840,219
802,552
729,600
Advances from FHLB
5,500
8,000
16,000
16,000
18,500
Trust preferred securities
10,310
10,310
10,310
10,310
10,310
Subordinated debt, net
19,546
-
-
-
-
Total equity
144,929
142,923
136,094
130,435
94,000
1
Cash dividends on common shares divided by net income available to common.
31
Critical Accounting Policies
The accounting and reporting policies of the Company are in accordance with generally accepted accounting principles in the United States and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the Company’s Consolidated Financial Statements for the years ended December 31, 2021 and 2020. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The Company’s financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective or complex.
Allowance for Loan Losses: The allowance for loan losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for loan losses each quarter based on changes, if any, in the nature and amount of problem assets and associated collateral, underwriting activities, loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge offs.
The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for credit losses relating to impaired loans is based on each impaired loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.
Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent, but undetected, losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the subjective nature of individual loan valuations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are also factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company’s evaluation of imprecise risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.
Goodwill and Other Intangibles: The Company records all assets and liabilities acquired in purchase acquisitions, including goodwill and other intangibles, at fair value as required. Goodwill is subject, at a minimum, to annual tests for impairment. Other intangible assets are amortized over their estimated useful lives using straight-line and accelerated methods, and are subject to impairment if events or circumstances indicate a possible inability to realize the carrying amount. The initial goodwill and other intangibles recorded and subsequent impairment analysis requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future. Events and factors that may significantly affect the estimates include, among others, customer attrition, changes in revenue growth trends, specific industry conditions and changes in competition.
Deferred Tax Liability: The Company has evaluated its deferred tax liability to determine if it is more likely than not that the liability will be realized in the future. The Company’s most recent evaluation has determined that the Company will more likely than not be able to realize the remaining deferred tax liability.
Income Tax Accounting: The Company files a consolidated federal income tax return. The provision for income taxes is based upon income in the 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 rates on the deferred tax assets and liabilities is recognized as income or expense in the period that includes the enactment date.
32
Changes in Financial Condition
Total assets at December 31, 2021, were $1.33 billion, compared to $1.26 billion at December 31, 2020. Loans (excluding loans held for sale) were $822.7 million at December 31, 2021, compared to $872.7 million at December 31, 2020. Total deposits were $1.11 billion at December 31, 2021, compared to $1.05 billion at December 31, 2020. The Company continued to experience elevated levels of liquidity as the balance sheets of both personal and business clients were supplemented by government intervention and support. The increase in liquidity by these parties has resulted in higher deposit levels, which in turn increased the overall asset size of the Company.
The following are the condensed average balance sheets of the Company for the years ending December 31 and includes the interest earned or paid, and the average interest rate, on each asset and liability:
2021
2020
2019
Average
Average
Average
Average
Average
Average
($ in thousands)
Balance
Interest
Rate
Balance
Interest
Rate
Balance
Interest
Rate
Assets
Taxable securities/cash
$
380,770
$
3,386
0.89
%
$
185,480
$
2,328
1.26
%
$
95,216
$
3,226
3.39
%
Non-taxable securities
7,802
353
4.52
%
6,625
333
5.03
%
10,108
345
3.41
%
Loans, net 1
854,521
38,165
4.47
%
880,338
39,974
4.54
%
809,651
40,829
5.04
%
Total earning assets
1,243,093
41,904
3.37
%
1,072,443
42,635
3.98
%
914,975
44,400
4.85
%
Cash and due from banks
7,290
14,553
47,135
Allowance for loan losses
(13,422
)
(10,165
)
(8,370
)
Premises and equipment
24,710
23,776
23,779
Other assets
60,582
60,789
50,413
Total assets
$
1,322,253
$
1,161,396
$
1,027,932
Liabilities
Savings and interest-bearing demand deposits
$
672,296
$
1,813
0.27
%
$
492,267
$
3,152
0.64
%
$
427,858
$
2,846
0.67
%
Time deposits
177,918
1,316
0.74
%
247,955
2,918
1.18
%
262,040
5,814
2.22
%
Repurchase agreements & other
22,821
42
0.18
%
22,832
70
0.31
%
15,288
82
0.54
%
Advances from FHLB
6,507
188
2.89
%
14,186
309
2.18
%
16,066
402
2.50
%
Trust preferred securities
10,310
199
1.93
%
10,310
256
2.48
%
10,310
430
4.17
%
Subordianted debt
12,057
462
3.83
%
Total interest-bearing liabilities
901,909
4,020
0.45
%
787,550
6,705
0.85
%
731,562
9,574
1.31
%
Demand deposits
255,908
211,004
146,401
Other liabilities
20,213
23,645
16,779
Total liabilities
1,178,030
1,022,199
894,742
Shareholders’ equity
144,223
139,197
133,190
Total liabilities and shareholders’ equity
$
1,322,253
$
1,161,396
$
1,027,932
Net interest income (tax equivalent basis)
$
37,884
$
35,930
$
34,826
Net interest income as a percent of average interest-earning assets - GAAP measure
3.05
%
3.35
%
3.81
%
Net
interest income as a percent of average interest-earning assets - Non-GAAP measure 2
3.06
%
3.36
%
3.82
%
-- Computed on a fully tax equivalent basis (FTE)
1
Nonaccruing loans and loans held for sale are included in the average balances.
2
Interest on tax exempt securities and loans is computed on a tax equivalent basis using a 21 percent statutory tax rate, and added to the net interest income. The tax equivalent adjustment was $0.15, $0.15 and $0.17 million in 2021, 2020 and 2019, respectively.
33
The following tables set forth the effect of volume and rate changes on interest income and expense for the periods indicated. For purposes of these tables, changes in interest due to volume and rate were determined as follows:
●
Volume variance - change in volume multiplied by the previous year’s rate.
●
Rate variance - change in rate multiplied by the previous year’s volume.
●
Rate/volume variance - change in volume multiplied by the change in rate. This variance allocates the volume variance and rate variance in proportion to the relationship of the absolute dollar amount of the change in each.
Total
Variance
Variance Attributable To
($ in thousands)
2021/2020
Volume
Rate
Interest income
Taxable securities
$
1,058
$
2,451
$
(1,393
)
Non-taxable securities 1
20
59
(39
)
Loans, net of unearned income and deferred fees 1
(1,809
)
(1,172
)
(637
)
Total interest income
(731
)
1,338
(2,069
)
Interest expense
Savings and interest-bearing demand deposits
(1,339
)
1,153
(2,492
)
Time deposits
(1,602
)
(824
)
(778
)
Repurchase agreements & other
(28
)
(0
)
(28
)
Advances from FHLB
(121
)
(167
)
46
Trust preferred securities
(57
)
-
(57
)
Subordinated debt
462
462
-
Total interest expense
(2,685
)
623
(3,308
)
Net interest income
$
1,954
$
715
$
1,239
1
Interest on non-taxable securities and loans has been adjusted to fully tax equivalent
The maturity distribution and weighted-average interest rates of debt securities available-for-sale at December 31, 2021, are set forth in the table below. The weighted-average interest rates are based on coupon rates for securities purchased at par value and on effective interest rates considering amortization or accretion if the securities were purchased at a premium or discount:
Maturing
($ in thousands)
Within
1 Year
Weighted
Average
Yield
1-5
Years
Weighted
Average
Yield
5-10
Years
Weighted
Average
Yield
After
10 Years
Weighted
Average
Yield
Total
Weighted
Average
Yield
Available for sale:
U.S.
Treasury and Government agencies
$
606
0.44
%
$
707
2.13
%
$
7,792
2.02
%
$
-
$
9,105
1.92
%
Mortgage-backed
securities
63
1.93
%
1,668
3.01
%
31,293
1.49
%
195,110
1.36
%
228,134
1.39
%
State
and political subdivisions
-
2,065
3.21
%
2,473
4.28
%
8,341
2.64
%
12,879
3.04
%
Other
corporate securities
-
-
13,141
3.47
%
-
13,141
3.47
%
Total
securities by maturity
$
669
0.58
%
$
4,440
2.96
%
$
54,699
2.17
%
$
203,451
1.41
%
$
263,259
1.59
%
1
Yields are presented on a tax-equivalent basis.
34
In June of 2020, we completed the acquisition of The Edon State Bank, which added approximately $50 million in deposits and $15 million in loans. Building on the success of our entry into the city of Edon, we opened an office in nearby Edgerton, Ohio in May of 2021. The Edgerton expansion has also been positive as we ended the year with over $15 million in both loans and deposits in that office.
($ in thousands)
Years
Ended December 31,
2021
2020
%
Change
Total loans
Commercial
business & agriculture
$
179,653
$
260,002
-30.9
%
Commercial
real estate
381,168
370,820
2.8
%
Residential
real estate
206,424
182,165
13.3
%
Consumer
& other
55,156
61,157
-9.8
%
Total
loans
822,401
874,144
-5.9
%
Net
deferred costs (fees)
313
(1,421
)
-122.0
%
Total
loans, net deferred costs (fees)
822,714
872,723
-5.7
%
Loans
held for sale
$
7,472
$
7,234
3.3
%
2021
2020
%
Change
Total deposits
Noninterest
bearing demand
$
247,044
$
251,649
-1.8
%
Interest-bearing
demand
195,464
176,785
10.6
%
Savings
& money market
514,033
391,028
31.5
%
Time
deposits
156,504
229,549
-31.8
%
Total
deposits
1,113,045
1,049,011
6.1
%
Total
shareholders’ equity
$
144,929
$
142,923
1.4
%
Loans held for investment decreased $50.0 million,
or 5.7 percent, to $822.7 million at December 31, 2021, which was due to a decrease in outstanding PPP loans during 2021. The Company
participated fully in the PPP initiative in both 2020 and 2021, which in total, encompassed 1,100 loans with an aggregate principal amount
of $111.4 million. At year-end 2021, the balance of PPP was down to approximately 50 loans, with an aggregate principal amount of $2 million,
as a result of SBA forgiveness of a majority of the PPP loans that we originated. Adjusted for PPP activity, loan growth compared to 2020
was up $18.5 million, or 2.3 percent. In the first quarter of 2021, the Company introduced a Private Client Residential Mortgage product.
This product, of which $76 million was originated during 2021, offset the refinance activity that occurred in our portfolio during the
year.
Concentrations of Credit Risk : The Company makes commercial, real estate and installment loans to customers located mainly in the Tri-State region of Ohio, Indiana and Michigan. Commercial loans include loans collateralized by commercial real estate, business assets and, in the case of agricultural loans, crops and farm equipment and the loans are expected to be repaid from cash flow from operations of businesses. As of December 31, 2021, commercial business and agricultural loans made up approximately 29.6 percent of the loans held for investment (“HFI”) loan portfolio while commercial real estate loans accounted for approximately 42.5 percent of the HFI loan portfolio. Residential first mortgage loans made up approximately 20.9 percent of the HFI loan portfolio and are secured by first mortgages on residential real estate, while consumer loans to individuals made up approximately 7.0 percent of the HFI loan portfolio and are primarily secured by consumer assets.
35
Maturities and Sensitivities of Loans to Changes in Interest Rates : The following table shows the maturity distribution of loans outstanding as of December 31, 2021. The amounts have been categorized between loans with a fixed or floating interest rate (floating rate loans have an adjustable interest rate that changes in accordance to a rate index).
($ in thousands)
Within
one year
After one,
but within
five years
After five,
but within
fifteen years
After
fifteen years
Total
Loans with fixed interest rates:
Commercial & industrial
$
981
$
20,715
$
28,106
$
23
$
49,825
Commercial real estate - owner occupied
168
9,567
10,302
-
35,051
Commercial real estate - nonowner occupied
6,828
14,246
13,815
162
20,037
Agricultural
122
4,094
5,557
1,362
11,135
Residential real estate
1,615
1,915
12,774
25,328
41,632
HELOC
5
-
-
-
5
Consumer
2,416
6,364
2,380
-
11,160
Total
$
12,135
$
56,901
$
72,934
$
26,875
$
168,845
Loans with floating interest rates:
Commercial & industrial
$
28,754
$
6,213
$
35,464
$
1,994
$
72,425
Commercial real estate - owner occupied
-
11,109
44,565
43,180
227,226
Commercial real estate - nonowner occupied
8,739
26,514
120,819
71,154
98,854
Agricultural
1,646
7,846
16,670
20,106
46,268
Residential real estate
4,558
485
13,294
146,455
164,792
HELOC
223
469
30,487
10,498
41,677
Consumer
990
1,324
-
-
2,314
Total
$
44,910
$
53,960
$
261,299
$
293,387
$
653,556
Total loans:
Commercial & industrial
$
29,735
$
26,928
$
63,570
$
2,017
$
122,250
Commercial real estate - owner occupied
168
20,676
54,867
43,180
118,891
Commercial real estate - nonowner occupied
15,567
40,760
134,634
71,316
262,277
Agricultural
1,768
11,940
22,227
21,468
57,403
Residential real estate
6,173
2,400
26,068
171,783
206,424
HELOC
228
469
30,487
10,498
41,682
Consumer
3,406
7,688
2,380
-
13,474
Total loans
$
57,045
$
110,861
$
334,233
$
320,262
$
822,401
Deposits increased $64.0 million, or 6.1 percent, to $1.11 billion at December 31, 2021. Deposits continued growing in 2021 on top of the over $200 million in growth experienced during 2020. Expanded government support and reduced economic activity has resulted in higher balances in client deposit accounts. During 2021, we experienced a shift in the mix of our deposit balances as more of our clients moved balances to short-term transactional accounts. Specifically, during 2021, time deposits decreased $73.0 million or 32 percent while other deposits increased $137.1 million or 17 percent.
The average amount of deposits and weighted-average rates paid are summarized as follows for the years ended December 31:
2021
2020
2019
Average
Average
Average
Average
Average
Average
($ in thousands)
Amount
Rate
Amount
Rate
Amount
Rate
Savings and interest bearing demand deposits
$
672,296
0.27
%
$
492,267
0.64
%
$
427,858
0.67
%
Time deposits
177,918
0.74
%
247,955
1.18
%
262,040
2.22
%
Non interest bearing demand deposits
255,908
-
211,004
-
146,401
-
Totals
$
1,106,122
0.28
%
$
951,226
0.64
%
$
836,299
1.04
%
36
Time deposits that exceeded the FDIC insurance limit of $250,000 are summarized as follows:
($ in thousands)
2021
2020
Three months or less
$
1,033
$
811
Over three months through six months
415
4,894
Over six months and through twelve months
3,083
1,658
Over twelve months
238
2,640
Total
$
4,769
$
10,003
Stockholders’ equity at December 31, 2021, was $144.9 million or 10.9 percent of total assets compared to $142.9 million or 11.4 percent of total assets at December 31, 2020. Retained earnings increased during the year by $15.1 million due to earnings of $18.3 million less dividends paid to common shareholders of $3.2 million. The fair market value of the bond portfolio decreased during 2021 due to the rise in interest rates, which resulted in a decrease in Other Comprehensive Income (“OCI”) of $4.1 million.
The Company continued to repurchase its own stock during the year. Specifically, the Company repurchased approximately 500,000 shares during 2021 at an average price of $18.50 per share, which was just slightly below book value. As of December 31, 2021, the Company had 495,639 shares remaining of the 750,000 shares authorized for repurchase under the Company’s existing share repurchase program which was authorized on May 25, 2021 and expires May 21, 2022.
Asset Quality
Years Ended December 31,
($ in thousands)
2021
2020
% Change
Nonaccruing loans
$
3,652
$
6,426
-43.2
%
Accruing restructured loans (TDRs)
725
810
-10.5
%
Foreclosed assets and other assets held for sale, net
2,104
23
9047.8
%
Nonperforming assets
6,481
7,259
-10.7
%
Net charge offs (recoveries)
(181
)
681
-126.6
%
Loan loss provision
1,050
4,500
-76.7
%
Allowance for loan losses
13,805
12,574
9.8
%
Nonaccruing loans/total loans
0.44
%
0.74
%
-39.7
%
Allowance/nonaccruing loans
378.01
%
195.67
%
93.2
%
Nonperforming assets/total assets
0.49
%
0.58
%
-15.6
%
Net charge offs/average loans
-0.02
%
0.08
%
-125.0
%
Allowance/loans
1.68
%
1.44
%
16.5
%
Allowance/nonperforming loans
315.40
%
173.80
%
81.5
%
Nonperforming assets consisting of loans, Other Real Estate Owned (“OREO”) and accruing TDRs totaled $6.5 million, or 0.49 percent of total assets at December 31, 2021, a decrease of $0.8 million or 10.7 percent from 2020. Net charge offs were down significantly during 2021, with total recoveries of $0.18 million, which was a $0.86 million decrease compared to total charge offs of $0.68 million for 2020. The Company’s loan loss allowance at December 31, 2021, now covers nonperforming loans at 315 percent, up from 174 percent at December 31, 2020.
37
The following schedule presents an analysis of the allowance for loan losses, average loan data and related ratios at December 31 for the years indicated:
($ in thousands)
Provision for
Loan Loss
Net (Chargeoffs)
Recoveries
Average
Loans
Ratio of annualized net
(chargeoffs)
recoveries to
average loans
December 31, 2021
Commercial & industrial
$
(1,411
)
$
227
$
160,267
0.14
%
Commercial real estate - owner occupied
505
-
118,713
0.00
%
Commercial real estate - nonowner occupied
825
-
264,980
0.00
%
Agricultural
103
-
53,122
0.00
%
Residential real estate
975
6
195,277
0.00
%
HELOC
(16
)
-
43,488
0.00
%
Consumer
69
(52
)
11,546
-0.45
%
Total
$
1,050
$
181
$
847,393
0.02
%
December 31, 2020
Commercial & industrial
$
1,757
$
(566
)
$
198,991
-0.28
%
Commercial real estate - owner occupied
721
-
104,856
0.00
%
Commercial real estate - nonowner occupied
1,128
-
269,924
0.00
%
Agricultural
62
-
51,840
0.00
%
Residential real estate
373
(42
)
185,311
-0.02
%
HELOC
203
(8
)
47,227
-0.02
%
Consumer
256
(65
)
11,595
-0.56
%
Total
$
4,500
$
(681
)
$
869,744
-0.08
%
December 31, 2019
Commercial & industrial
$
582
$
(134
)
$
139,616
-0.10
%
Commercial real estate - owner occupied
210
-
96,106
0.00
%
Commercial real estate - nonowner occupied
468
1
257,756
0.00
%
Agricultural
(48
)
-
51,836
0.00
%
Residential real estate
(325
)
(39
)
194,390
-0.02
%
HELOC
(102
)
10
47,770
0.02
%
Consumer
15
(50
)
11,862
-0.42
%
Total loans
$
800
$
(212
)
$
799,336
-0.03
%
The allowance for loan losses balance and the provision for loan losses are determined by management based upon periodic reviews of the loan portfolio. In addition, management considers the level of charge offs on loans, as well as the fluctuations of charge offs and recoveries on loans, in the factors which caused these changes. Estimating the risk of loss and the amount of loss is necessarily subjective. Accordingly, the allowance is maintained by management at a level considered adequate to cover losses that are currently anticipated based on past loss experience, economic conditions, information about specific borrower situations, including their financial position and collateral values, and other factors and estimates which are subject to change over time.
The Company has substantially increased the reserve level over the last two years. Specifically, since December 31, 2019 the allowance balance has increased from $8.8 million to $13.8 million at December 31, 2021, which is an increase of $5.0 million or 59 percent. This increase was the result of $5.6 million in provision expense during the period ($4.5 million in 2020 and $1.1 million in 2021) and minimal charge-offs, which were just $0.5 million over the two year period.
38
The following schedule provides a breakdown of the allowance for loan losses allocated by type of loan and related ratios at December 31 for the years indicated:
Allowance
Amount
Percentage
of Loans In
Each
Category to
Total Loans
Allowance
Amount
Percentage
of Loans In
Each
Category to
Total Loans
Allowance
Amount
Percentage
of Loans In
Each
Category to
Total Loans
($ in thousands)
2021
2020
2019
Commercial & industrial
$
1,890
14.9
%
$
3,074
23.4
%
$
1,883
18.3
%
Commercial real estate - owner occupied
2,588
14.5
%
2,059
12.9
%
1,220
11.9
%
Commercial real estate - nonowner occupied
4,193
31.9
%
3,392
29.5
%
2,382
32.5
%
Agricultural
599
7.0
%
496
6.3
%
434
6.2
%
Residential real estate
3,515
25.1
%
2,534
20.8
%
2,203
23.4
%
Home equity line of credit (HELOC)
631
5.1
%
647
5.3
%
454
5.8
%
Consumer
389
1.6
%
372
1.7
%
179
1.8
%
$
13,805
100.0
%
$
12,574
100.0
%
$
8,755
100.0
%
As detailed in the risk factors, the CARES Act provided for significant consumer and small business relief due to the impact of the COVID-19 pandemic. The Company provided payment relief to a number of consumer and small business customers throughout 2020 and 2021, which we believe was successful and enabled our clients to weather the pandemic effectively. All such COVID-related payment deferrals had expired or been removed by December 31, 2021 and all clients were back to contractual terms at such date.
Regulatory capital reporting is required for State Bank only, as the Company is currently exempt from quarterly regulatory capital level measurement pursuant to the Small Bank Holding Company Policy Statement. As of December 31, 2021, State Bank met all regulatory capital levels required to be considered well-capitalized (see Note 18 to the Consolidated Financial Statements).
On May 27, 2021, the Company issued and sold $20.0 million in aggregate principal amount of its 3.65% Fixed to Floating Rate Subordinated Notes due 2031 in a private placement exempt from the registration requirements under the Securities Act of 1933, as amended. The Subordinated Notes bear interest at a fixed rate of 3.65% through May 31, 2026. From June 1, 2026 to the maturity date or earlier redemption of the Subordinated Notes, the interest rate will reset quarterly to an interest rate per annum, equal to the then-current-three-month Secured Overnight Financing Rate (“SOFR”) provided by the Federal Reserve Bank of New York plus 296 basis points. The proceeds from the Subordinated Notes will be used to assist the Company in meeting various corporate obligations, including share buyback, acquisition costs and organic asset growth. The Subordinated Notes have a maturity of 10 years.
Earnings Summary – 2021 vs. 2020
Net income for 2021 was $18.3 million, or $2.56 per diluted share, compared with net income of $14.9 million, or $1.96 per diluted share, for 2020. State Bank reported net income for 2021 of $18.6 million, which was up from the $16.0 million in net income in 2020. SBFG Title reported net income for 2020 of $0.5 million, which was down from net income of $0.6 million in 2020.
Positive results for 2021 included loan growth
of $18.5 million when excluding the impact of the PPP initiative, and deposit growth of $64.0 million. The Company fully participated
in both phases of PPP, with a total of $111.4 million in loans to over 1,100 clients with revenue of $3.4 million for 2021 compared to
$1.4 million for 2020. The mortgage banking business line continued to contribute significant revenues, with residential real estate loan
production of $600.0 million for the year, resulting in $17.3 million of revenue from gains on sale. The level of mortgage origination
was down from the $694.2 million in 2020. The Company’s loans serviced for others ended the year at $1.36 billion, up from $1.30
billion at December 31, 2020.
39
Operating revenue increased by $2.6 million, or 3.9 percent, from $66.0 million in 2020 to $68.6 million in 2021 due to increased PPP fees and OMSR recapture which offset lower mortgage gain revenue. SBFG Title increased revenue by $0.1 million of $2.1 million for 2021.
Operating expense increased by $1.7 million, or 4.0 percent, from $43.1 million in 2020 to $44.8 million in 2021, due to compensation and fringe benefit cost increases and higher spend on technology/digital initiatives. These expense increases were offset by lower mortgage commission expense due to lower volume.
Results of Operations
Years Ended December 31,
($ in thousands, except per share data)
2021
2020
% Change
Total assets
$
1,330,854
$
1,257,839
5.8
%
Total investments
263,259
149,406
76.2
%
Loans held for sale
7,472
7,234
3.3
%
Loans, net of unearned income
822,714
872,723
-5.7
%
Allowance for loan losses
13,805
12,574
9.8
%
Total deposits
1,113,045
1,049,011
6.1
%
Total operating revenue 1
$
68,581
$
66,026
3.9
%
Net interest income
37,884
35,930
5.4
%
Loan loss provision
1,050
4,500
-76.7
%
Noninterest income
30,697
30,096
2.0
%
Noninterest expense
44,808
43,087
4.0
%
Net income
18,277
14,944
22.3
%
Diluted earnings per share
2.56
1.96
30.6
%
1
Operating revenue equals net interest income plus noninterest income.
Net interest income was $37.9 million for 2021 compared to $35.9 million for 2020, an increase of $2.0 million or 5.4 percent. Average earning assets increased to $1.24 billion in 2021, compared to $1.07 billion in 2020, an increase of $170.7 million or 15.9 percent due to a higher bond portfolio, which offset slightly lower loan volume. The consolidated 2021 full year net interest margin on an FTE basis decreased 30 basis points to 3.06 percent compared to 3.36 percent for the full year of 2020. PPP activity during 2021 increased margin revenue by $3.0 million for the full year of 2021.
Provision for loan losses of $1.0 million was taken in 2021 compared to $4.5 million taken for 2020. For 2021, net recoveries totaled $0.18 million, or (0.02) percent of average loans. This charge off level was significantly lower than 2020, in which net charge offs were $0.68 million or 0.08 percent of average loans.
Noninterest Income
Years Ended December 31,
($ in thousands)
2021
2020
% Change
Wealth management fees
$
3,814
$
3,245
17.5
%
Customer service fees
3,217
2,807
14.6
%
Gains on sale of residential loans & OMSR’s
17,255
25,350
-31.9
%
Mortgage loan servicing fees, net
2,940
(5,138
)
157.2
%
Gain on sale of non-mortgage loans
158
453
-65.1
%
Title Insurance income
2,089
1,913
9.2
%
Other
1,224
1,466
-16.5
%
Total noninterest income
$
30,697
$
30,096
2.0
%
40
Total noninterest income was $30.7 million for 2021 compared to $30.1 million for 2020, representing an increase of $0.6 million, or 2.0 percent, year-over-year. Although mortgage gain on sale was down from the record year in 2020 by $8.1 million, or 31.9 percent, the Company was able to offset that reduction by recapture of mortgage servicing rights of $3.9 million during 2021. The Company sold $489.4 million of originated mortgages into the secondary market in 2021, which allowed our serviced loan portfolio to grow to $1.36 billion at December 31, 2021 from $1.30 billion at December 31, 2020. The higher servicing balance of the portfolio led to the 5.6 percent increase in mortgage loan servicing income. Sales of non-mortgage loans (small business and farm credits) decreased in 2021 as compared to 2020, as SBA activity continued to be focused on the PPP initiative. The Company expanded its wealth management assets under management to $618.3 million, up $59.9 million, which resulted in a 17.5 percent increase in wealth fee income.
Noninterest Expense
Years Ended December 31,
($ in thousands)
2021
2020
% Change
Salaries & employee benefits
$
26,838
$
25,397
5.7
%
Net occupancy expense
3,048
2,891
5.4
%
Equipment expense
3,281
3,186
3.0
%
Data processing fees
2,579
3,055
-15.6
%
Professional fees
3,027
3,307
-8.5
%
Marketing expense
784
658
19.1
%
Telephone and communications
581
535
8.6
%
Postage and delivery expense
414
415
-0.2
%
State, local and other taxes
1,175
1,146
2.5
%
Employee expense
663
535
23.9
%
Other expense
2,418
1,962
23.2
%
Total noninterest expense
$
44,808
$
43,087
4.0
%
Total noninterest expense was $44.8 million for 2021 compared to $43.1 million for 2020, representing a $1.7 million, or 4.0 percent, increase year-over-year. Total full-time equivalent employees ended 2021 at 269, which was up 25 from year end 2020.
Salaries and benefits were driven by the increase in total full time employees as we filled a number of open positions during the year. We also have seen higher costs in technology as we have continued to add resources and digital options for our clients.
Earnings Summary – 2020 vs. 2019
Net income for 2020 was $14.9 million, or $1.96 per diluted share, compared with net income of $12.0 million and net income available to common of $11.0 million, or $1.51 per diluted share, for 2019. State Bank reported net income for 2020 of $16.0 million, which was up from the $12.5 million in net income in 2020. SBFG Title reported net income for 2020 of $0.6 million, which was up from the $0.3 million in 2019.
Positive results for 2020 included loan growth of $47.2 million, and deposit growth of $208.8 million. The mortgage banking business line continues to contribute significant revenues, with residential real estate loan production of $694.2 million for the year, resulting in $25.4 million of revenue from gains on sale. The level of mortgage origination was up from the $445.3 million in 2019. The Company’s loans serviced for others ended the year at $1.3 billion, up from $1.2 billion at December 31, 2019. The Company realized over $1.4 million in revenue from the PPP initiative.
Operating revenue was up compared to the prior year by $13.2 million, or 25.0 percent, which was impacted by a $3.6 million temporary OMSR impairment. Our 2020 results include the full year impact from SBFG Title with net income of $0.6 million, and SB Captive, with net income of $0.9 million. Net interest margin on a fully tax equivalent basis (“FTE”) for 2020 was 3.36 percent, down 46 basis points from 2019.
Operating expense was up compared to the prior year by $5.7 million, or 15.2 percent, due to compensation and fringe benefit cost increases as a result of higher mortgage commission levels. Operating leverage (growth in revenue divided by growth in operating expense) for the year was a positive 1.6 times.
Net charge offs for 2020 of $0.68 million resulted in a loan loss provision of $4.5 million, compared to net charge offs of $0.21 million and a $0.8 million loan loss provision in 2019.
41
Goodwill, Intangibles and Capital Purchases
The Company completed its most recent annual goodwill impairment review as of December 31, 2021. At December 31, 2021, the Company concluded that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment. The Company’s goodwill is further discussed in Note 8 to the Consolidated Financial Statements.
Management plans to continue from time to time to purchase additional premises and equipment and improve current facilities to meet the current and future needs of the Company’s customers. These purchases will include buildings, leasehold improvements, furniture and equipment. Management expects that cash on hand and cash generated from current operations will fund these capital expenditures and purchases.
Liquidity
Liquidity relates primarily to the Company’s ability to fund loan demand, meet deposit customers’ withdrawal requirements and provide for operating expenses. Sources used to satisfy these needs consist of cash and due from banks, interest-bearing deposits in other financial institutions, securities available-for-sale, loans held for sale and borrowings from various sources. These assets, excluding the borrowings, are commonly referred to as liquid assets. Liquid assets were $422.9 million at December 31, 2021, compared to $303.2 million at December 31, 2020.
The Company does not have material cash requirements for capital expenditures over the next year. Any cash needs for capital requirements would be funded by cash existing at the Company. It is not anticipated that the Company will be required to initiate external borrowings in order to fund ongoing operations.
The Company’s commercial real estate, first mortgage residential, agricultural and multi-family mortgage portfolio of $645.1 million at December 31, 2021, can and is readily used to collateralize borrowings, which is an additional source of liquidity. Management believes the Company’s current liquidity level, without these borrowings, is sufficient to meet its current and anticipated liquidity needs. At December 31, 2021, all eligible commercial real estate, residential first, multi-family mortgage and agricultural loans were pledged under a Federal Home Loan Bank (“FHLB”) blanket lien.
Significant additional off-balance-sheet liquidity is available in the form of FHLB advances, unused federal funds lines from correspondent banks and the national certificate of deposit market. Management expects the risk of changes in off-balance-sheet arrangements to be immaterial to earnings. Based on the current collateralization requirements of the FHLB, approximately $110.5 million of additional borrowing capacity existed at December 31, 2021.
At December 31, 2021 and 2020, the Company had $41.0 million in federal funds lines available. The Company also had $184.9 million in unpledged securities at December 31, 2021 available for additional borrowings.
The cash flow statements for the periods presented provide an indication of the Company’s sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. A discussion of the cash flow statements for 2021 and 2020 follows:
The Company experienced positive cash flows from
operating activities in 2021 and 2020. Net cash from operating activities was $17.3 million and $23.9 million for the years ended December
31, 2021 and 2020, respectively. Significant operating items for 2021 included gain on sale of loans of $17.4 million and net income of
$18.3 million. Cash provided by the sale of loans held for sale were $490.6 million. Cash used in the origination of loans held for sale
were $478.1 million.
The Company experienced negative cash flows from investing activities in 2021 and 2020. Net cash used in investing activities was $72.0 million and $57.2 million for the years ended December 31, 2021 and 2020, respectively. The changes for 2021 include the purchase of available-for-sale securities of $170.7 million, and net decrease in loans of $48.5 million. The changes for 2020 include the purchase of available-for-sale securities of $129.8 million and net increase in loans of $31.7 million. The Company had proceeds from repayments, maturities, sales and calls of securities of $50.5 million and $84.0 million in 2021 and 2020, respectively.
The Company experienced positive cash flows from financing activities in 2021 and 2020. Net cash from financing activities was $63.6 million and $146.9 million for the years ended December 31, 2021 and 2020, respectively. Positive cash flows of $64.0 million and $157.7 million is attributable to the change in deposits for 2021 and 2020, respectively.
42
The
Company uses an Economic Value of Equity (“EVE”) analysis to measure risk in the balance sheet incorporating all cash flows
over the estimated remaining life of all balance sheet positions. The EVE analysis calculates the net present value of the Company’s
assets and liabilities in rate shock environments that range from -100 basis points to +400 basis points. The results of this analysis
are reflected in the following table.
Economic Value of Equity
December 31, 2021
($ in thousands)
Change in rates
$ Amount
$ Change
% Change
+400 basis points
$
278,254
$
35,684
14.71
%
+300 basis points
273,190
30,620
12.62
%
+200 basis points
265,711
23,142
9.54
%
+100 basis points
256,110
13,540
5.58
%
Base Case
242,570
-
-
-100 basis points
217,281
(25,289
)
-10.43
%
Economic Value of Equity
December 31, 2020
($ in thousands)
Change in rates
$ Amount
$ Change
% Change
+400 basis points
$
243,779
$
61,586
33.80
%
+300 basis points
231,590
49,398
27.11
%
+200 basis points
217,936
35,743
19.62
%
+100 basis points
202,260
20,067
11.01
%
Base Case
182,193
-
-
-100 basis points
154,509
(27,684
)
-15.19
%