UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2020
Or
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-13368
FIRST MID BANCSHARES, INC.
(Exact name of Registrant as specified in its charter)
Delaware
37-1103704
(State or other jurisdiction of incorporation or organization)
(I.R.S. employer identification no.)
1421 Charleston Avenue
Mattoon, Illinois
61938
(Address of principal executive offices)
(Zip code)
(217) 234-7454
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Exchange Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock
FMBH
NASDAQ Global Market
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). ☐ Yes ☒ No
As of August 7, 2020 16,728,190 common shares, $4.00 par value, were outstanding.
PART I
ITEM 1. FINANCIAL STATEMENTS
First Mid Bancshares, Inc.
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except share data)
June 30, 2020
December 31,
2019
Assets
Cash and due from banks:
Non-interest bearing
$
77,392
76,498
Interest bearing
159,809
7,656
Federal funds sold
1,286
926
Cash and cash equivalents
238,487
85,080
Certificates of deposit
3,890
4,625
Investment securities:
Available-for-sale, at fair value
708,158
685,636
Held-to-maturity, at amortized cost (estimated fair value of $15,216 and $69,572 at
June 30, 2020 and December 31, 2019, respectively)
15,009
69,542
Equity securities, at fair value
97
412
Loans held for sale
5,981
1,820
Loans
3,199,281
2,693,527
Less allowance for credit losses
(38,381
)
(26,911
Net loans
3,160,900
2,666,616
Interest receivable
16,842
15,577
Other real estate owned
2,256
3,644
Premises and equipment, net
58,905
59,491
Goodwill
104,992
Intangible assets, net
25,664
28,265
Bank owned life insurance
68,084
67,225
Right of use lease assets
15,979
17,006
Other assets
33,067
29,495
Total assets
4,458,311
3,839,426
Liabilities and Stockholders’ Equity
Deposits:
817,623
633,331
2,568,204
2,284,035
Total deposits
3,385,827
2,917,366
Securities sold under agreements to repurchase
350,288
208,109
Interest payable
1,922
2,261
FHLB borrowings
103,939
113,895
Other borrowings
—
5,000
Junior subordinated debentures
18,942
18,858
Lease liabilities
16,014
17,007
Other liabilities
32,106
30,321
Total liabilities
3,909,038
3,312,817
Stockholders’ Equity:
Common stock, $4 par value; authorized 30,000,000 shares; issued 17,342,592 and
17,287,882 shares in 2020 and 2019, respectively
71,370
71,152
Additional paid-in capital
297,392
295,925
Retained earnings
179,435
166,667
Deferred compensation
2,364
2,760
Accumulated other comprehensive income
17,105
8,360
Less treasury stock at cost, 614,403 shares in 2020 and 2019
(18,393
(18,255
Total stockholders’ equity
549,273
526,609
Total liabilities and stockholders’ equity
See accompanying notes to unaudited condensed consolidated financial statements.
2
Condensed Consolidated Statements of Income (unaudited)
(In thousands, except per share data)
Three months ended June 30,
Six months ended June 30,
2020
Interest income:
Interest and fees on loans
31,382
31,539
61,409
63,643
Interest on investment securities
4,077
5,436
8,666
10,645
Interest on certificates of deposit investments
21
37
52
75
Interest on federal funds sold
4
7
Interest on deposits with other financial institutions
55
555
147
1,252
Total interest income
35,535
37,571
70,276
75,622
Interest expense:
Interest on deposits
3,105
4,940
6,966
9,318
Interest on securities sold under agreements to repurchase
158
215
352
475
Interest on FHLB borrowings
505
696
1,085
1,419
Interest on other borrowings
11
1
26
Interest on subordinated debentures
174
406
392
844
Total interest expense
3,953
6,258
8,821
12,057
Net interest income
31,582
31,313
61,455
63,565
Provision for loan losses
6,136
91
11,617
1,038
Net interest income after provision for loan losses
25,446
31,222
49,838
62,527
Other income:
Wealth management revenues
3,827
3,587
7,453
7,232
Insurance commissions
4,088
3,760
10,709
9,315
Service charges
1,111
1,959
2,889
3,761
Securities gains, net
287
218
818
272
Mortgage banking revenue, net
1,236
346
1,544
585
ATM / debit card revenue
2,239
2,202
4,226
4,218
428
447
859
877
Other
669
1,069
1,897
1,967
Total other income
13,885
13,588
30,395
28,227
Other expense:
Salaries and employee benefits
15,455
15,565
31,955
32,139
Net occupancy and equipment expense
4,141
4,543
8,383
8,998
Net other real estate owned expense
(2
188
(48
241
FDIC insurance
289
197
382
476
Amortization of intangible assets
1,290
1,823
2,585
3,179
Stationery and supplies
275
264
543
551
Legal and professional
1,489
1,304
2,887
2,498
ATM / debit card
274
829
879
1,632
Marketing and donations
314
481
795
935
2,573
4,993
5,468
7,848
Total other expense
26,098
30,187
53,829
58,497
Income before income taxes
13,233
14,623
26,404
32,257
Income taxes
3,096
3,642
6,268
7,960
Net income
10,137
10,981
20,136
24,297
Per share data:
Basic net income per common share
0.61
0.66
1.21
1.46
Diluted net income per common share
0.60
1.20
1.45
Cash dividends declared per common share
0.40
0.36
3
Condensed Consolidated Statements of Comprehensive Income (unaudited)
(in thousands)
Other Comprehensive Income
Unrealized gains (losses) on available-for-sale securities, net of taxes of ($4,938) and ($2,531) for three months ended June 30, 2020 and 2019, respectively and ($3,799) and ($5,653) for six months ended June 30, 2020 and 2019, respectively.
12,091
6,195
9,302
13,841
Amortized holding losses on held-to-maturity securities transferred from available-for- sale, net of taxes of ($5) and ($8) for three months ended June 30, 2020 and 2019, respectively and ($10) and ($17) for six months ended June 30, 2020 and June 30, 2019, respectively.
9
24
41
Less: reclassification adjustment for realized gains included in net income, net of taxes of $83 and $63 for three months ended June 30, 2020 and 2019, respectively and $237 and $79 for six months ended June 30, 2020 and 2019, respectively.
(204
(155
(581
(193
Other comprehensive income, net of taxes
11,896
6,061
8,745
13,689
Comprehensive income
22,033
17,042
28,881
37,986
Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)
For the three months ended June 30, 2020 and 2019
Common
Stock
Additional
Paid-In-
Capital
Retained
Earnings
Deferred
Compensation
Accumulated
Comprehensive
Income (Loss)
Treasury
Total
March 31, 2020
71,268
296,853
175,949
2,022
5,209
(18,250
533,051
Other comprehensive income, net of tax
Cash dividends on common stock (.40/share)
(6,651
Issuance of 13,804 common shares pursuant to the Dividend Reinvestment Plan
54
282
336
Issuance of 8,163 common shares pursuant to the Deferred Compensation Plan
33
195
228
Issuance of 3,739 common shares pursuant to the Employee Stock Purchase Plan
15
62
77
143
(143
Vested restricted shares/units compensation expense
199
March 31, 2019
71,006
294,837
144,708
2,074
1,155
(16,628
497,152
Cash dividends on common stock (.36/share)
(6,001
Issuance of 13,475 common shares pursuant to the Dividend Reinvestment Plan
419
473
Issuance of 7,398 common shares pursuant to the Deferred Compensation Plan
47
Issuance of 2,858 common shares pursuant to the Employee Stock Purchase Plan
8
56
64
131
(131
Tax benefit related to deferred compensation distributions
118
June 30, 2019
71,075
295,415
149,688
2,323
7,216
(16,759
508,958
5
For the six months ended June 30, 2020 and 2019
December 31, 2019
Cumulative change in accounting principal
(717
December 31, 2019 (as adjusted for change in accounting principal)
165,950
525,892
Issuance of 8,163 common shares pursuant to Deferred Compensation Plan
Issuance of 25,200 restricted shares pursuant to the 2017 Stock Incentive Plan
101
767
868
Issuance of 7,543 common shares pursuant to the Employee Stock Purchase Plan
30
133
163
138
(138
22
Grant of restricted units pursuant to 2017 Stock Incentive Plan
584
Release of restricted units pursuant to 2017 Stock Incentive Plan
(516
(534
December 31, 2018
70,876
293,937
131,392
2,761
(6,473
(16,629
475,864
Issuance of 7,398 common shares pursuant to Deferred Compensation Plan
248
Issuance of 25,950 restricted shares pursuant to the 2017 Stock Incentive Plan
104
760
864
88
130
(130
(52
(814
(866
246
6
Condensed Consolidated Statements of Cash Flows (unaudited)
(In thousands)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, amortization and accretion, net
5,714
5,435
Change in cash surrender value of bank owned life insurance
(859
(877
Stock-based compensation expense
404
Operating lease payments
(1,375
(1,340
Gains on investment securities, net
(818
(272
Gain on sales of repossessed assets, net
(482
63
Loss on sale of premises and equipment
(26
Gains on sale of loans held for sale, net
(1,756
(508
(Increase) decrease in accrued interest receivable
(1,265
1,231
(Decrease) increase in accrued interest payable
(211
823
Origination of loans held for sale
(90,495
(28,750
Proceeds from sale of loans held for sale
88,090
29,049
(Increase) decrease in other assets
(2,163
1,658
Decrease in other liabilities
(1,282
(141
Net cash provided by operating activities
25,229
31,970
Cash flows from investing activities:
Proceeds from maturities of certificates of deposit investments
1,715
984
Purchases of certificates of deposit investments
(980
Proceeds from sales of securities available-for-sale
1,566
20,052
Proceeds from maturities of securities available-for-sale
182,410
42,222
Proceeds from maturities of securities held-to-maturity
45,000
Purchases of securities available-for-sale
(184,751
(108,684
Net (increase) decrease in loans
(506,945
95,687
Purchases of premises and equipment
(2,543
Proceeds from sales of other real property owned
1,731
508
Net cash (used in) provided by investing activities
(461,536
48,226
Cash flows from financing activities:
Net increase in deposits
468,461
23,804
Decrease in federal funds purchased
(5,000
Increase (decrease) in repurchase agreements
142,179
(40,066
Proceeds from FHLB advances
19,000
Repayment of FHLB advances
(29,000
(24,000
Proceeds from short-term debt
Repayment of short-term debt
Repayment of long-term debt
(7,724
Proceeds from issuance of common stock
390
334
Dividends paid on common stock
(6,316
(5,528
Net cash provided by (used in) financing activities
589,714
(53,180
Increase in cash and cash equivalents
153,407
27,016
Cash and cash equivalents at beginning of period
141,400
Cash and cash equivalents at end of period
168,416
Supplemental disclosures of cash flow information
Cash paid during the period for:
Interest
9,160
11,399
(8,616
6,987
Supplemental disclosures of noncash investing and financing activities
Loans transferred to other real estate
205
1,630
Initial recognition of right-of-use assets
14,116
Initial recognition of lease liabilities
Dividends reinvested in common stock
Net tax benefit related to option and deferred compensation plans
Notes to Condensed Consolidated Financial Statements (unaudited)
Note 1 -- Basis of Accounting and Consolidation
The unaudited condensed consolidated financial statements include the accounts of First Mid Bancshares, Inc. (“Company”) formerly known as First Mid-Illinois Bancshares, Inc., and its wholly owned subsidiaries: First Mid Bank & Trust, N.A. (“First Mid Bank”), First Mid Wealth Management Company, Mid-Illinois Data Services, Inc. (“MIDS”), First Mid Insurance Group, Inc. (“First Mid Insurance”) and First Mid Captive, Inc. All significant intercompany balances and transactions have been eliminated in consolidation. The financial information reflects all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods ended June 30, 2020 and 2019, and all such adjustments are of a normal recurring nature. Certain amounts in the prior year’s consolidated financial statements may have been reclassified to conform to the June 30, 2020 presentation and there was no impact on net income or stockholders’ equity. The results of the interim period ended June 30, 2020 are not necessarily indicative of the results expected for the year ending December 31, 2020. The Company operates as a one-segment entity for financial reporting purposes. The 2019 year-end consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America.
The unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and do not include all of the information required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements and related footnote disclosures although the Company believes that the disclosures made are adequate to make the information not misleading. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2019 Annual Report on Form 10-K.
COVID-19
The COVID-19 outbreak is an unprecedented event that provides significant economic uncertainty for a broad spectrum of industries. The Company is focused on supporting its customers, communities and employees during this unique operating environment. Throughout this document, we describe the impact COVID-19 is having, actions taken as a result of COVID-19, and certain risks to the Company that COVID-19 creates or exacerbates, as well as management's outlook on the current COVID-19 situation.
Website
The Company maintains a website at www.firstmid.com. All periodic and current reports of the Company and amendments to these reports filed with the Securities and Exchange Commission (“SEC”) can be accessed, free of charge, through this website as soon as reasonably practicable after these materials are filed with the SEC.
General Litigation
The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operations and cash flows of the Company.
Loan Purchase
On April 21, 2020, First Mid Bank completed an acquisition of loans in the St. Louis metro market totaling $183 million. There were no loans purchased with deteriorated credit.
Stock Plans
At the Annual Meeting of Stockholders held April 26, 2017, the stockholders approved the First Mid-Illinois Bancshares, Inc. 2017 Stock Incentive Plan (“SI Plan”). The SI Plan was implemented to succeed the Company’s 2007 Stock Incentive Plan, which had a ten-year term. The SI Plan is intended to provide a means whereby directors, employees, consultants and advisors of the Company and its subsidiaries may sustain a sense of proprietorship and personal involvement in the continued development and financial success of the Company and its subsidiaries, thereby advancing the interests of the Company and its stockholders. Accordingly, directors and selected employees, consultants and advisors may be provided the opportunity to acquire shares of common stock of the Company on the terms and conditions established in the SI Plan.
A maximum of 149,983 shares of common stock may be issued under the SI Plan. There have been no stock options awarded under any Company plan since 2008. The Company has awarded 25,200 and 25,950 shares of restricted stock during 2020 and 2019, respectively, and 16,950 and 16,200 restricted stock units during 2020 and 2019, respectively.
Employee Stock Purchase Plan
At the Annual Meeting of Stockholders held April 25, 2018, the stockholders approved the First Mid-Illinois Bancshares, Inc. Employee Stock Purchase Plan (“ESPP”). The ESPP is intended to promote the interests of the Company by providing eligible employees with the opportunity to purchase shares of common stock of the Company at a 5% discount through payroll deductions. The ESPP is also intended to qualify as an employee stock purchase plan under Section 423 of the Internal Revenue Code.
A maximum of 600,000 shares of common stock may be issued under the ESPP. As of June 30, 2020 and 2019, 7,543 shares and 2,858 shares, respectively, were issued pursuant to the ESPP.
Captive Insurance Company
First Mid Captive, Inc. (the “Captive"), a wholly owned subsidiary of the Company which was formed and began operations in December 2019, is a Nevada-based captive insurance company. The Captive insures against certain risks unique to operations of the Company and its subsidiaries for which insurance may not be currently available or economically feasible in today's insurance marketplace. The Captive pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves. The Captive is subject to regulations of the State of Nevada and undergoes periodic examinations by the Nevada Division of Insurance. It has elected to be taxed under Section 831(b) of the Internal Revenue Code. Pursuant to Section 831(b), if gross premiums do not exceed $2,300,000, then the Captive is taxable solely on its investment income. The Captive is included in the Company's consolidated financial statements and its federal income return.
Bank Owned Life Insurance
First Mid Bank has purchased life insurance policies on certain senior management. Bank owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts that are probable at settlement.
Revenue Recognition
Accounting Standards Codification 606, Revenue from Contracts with Customers (“ASC 606”), establishes a revenue recognition model for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity's contracts to provide goods or services to customers. Most of the Company’s revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as loans and investment securities, and revenue related to mortgage servicing activities, which are subject to other accounting standards. A description of the revenue-generating activities that are within the scope of ASC 606, and included in other income in the Company’s condensed consolidated statements of income are as follows:
Trust revenues. The Company generates fee income from providing fiduciary services through its subsidiary, First Mid Wealth Management Company. Fees are billed in arrears based upon the preceding period account balance. Revenue from the farm management department is recorded when service is complete, for example when crops are sold.
Brokerage commissions. The primary non-farm brokerage revenue is recorded at the beginning of each quarter through billing to customers based on the account asset size on the last day of the previous quarter. If a withdrawal of funds takes place, a prorated refund may occur; this is reflected within the same quarter as the original billing occurred. All performance obligations are met within the same quarter that the revenue is recorded.
Insurance commissions. The Company’s insurance agency subsidiary, First Mid Insurance, receives commissions on premiums of new and renewed business policies. First Mid Insurance records commission revenue on direct bill policies as the cash is received. For agency bill policies, First Mid Insurance retains its commission portion of the customer premium payment and remits the balance to the carrier. In both cases, the entire performance obligation is held by the carriers.
Service charges on deposits. The Company generates revenue from fees charged for deposit account maintenance, overdrafts, wire transfers, and check fees. The revenue related to deposit fees is recognized at the time the performance obligation is satisfied.
ATM/debit card revenue. The Company generates revenue through service charges on the use of its ATM machines and interchange income from the use of Company issued credit and debit cards. The revenue is recognized at the time the service is used and the performance obligation is satisfied.
Other income. Treasury management fees and lock box fees are received and recorded after the service performance obligation is completed. Merchant bank card fees are received from various vendors; however, the performance obligation is with the vendors. The Company records gains on the sale of loans and the sale of OREO properties after the transactions are complete and transfer of ownership has occurred.
As each of the Company’s facilities is in markets with similar economies, no disaggregation of revenue is necessary.
Leases
Effective January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842). As of June 30, 2020, all of the Company's leases are operating leases for real estate property for bank branches, ATM locations, and office space. For leases in effect at January 1, 2019 and for leases commencing thereafter, the Company recognizes a lease liability and a right-of-use asset, based on the present value of lease payments over the lease term. The discount rate used in determining present value was the Company's incremental borrowing rate which is the FHLB fixed advance rate based on the remaining lease term as of January 1, 2019, or the commencement date for leases subsequently entered into.
Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income included in stockholders’ equity as of June 30, 2020 and December 31, 2019 are as follows (in thousands):
Unrealized Gain
(Loss) on
Securities
Net unrealized gains on securities available-for-sale
24,107
Unamortized losses on held-to-maturity securities transferred from available-for-sale
(15
Tax expense
(6,987
Balance at June 30, 2020
11,825
(50
(3,415
Balance at December 31, 2019
10
Amounts reclassified from accumulated other comprehensive income and the affected line items in the statements of income during the three and six months ended June 30, 2020 and 2019, were as follows (in thousands):
Amounts Reclassified from
Affected Line Item in the Statements of Income
Realized gains on available-for-sale securities
Tax effect
(83
(63
(237
(79
Total reclassifications out of accumulated other
comprehensive income
204
155
581
193
Net reclassified amount
See “Note 3 – Investment Securities” for more detailed information regarding unrealized losses on available-for-sale securities.
Adoption of New Accounting Guidance
Accounting Standards Update 2017-04, Intangibles-Goodwill and Other (Topic 350: Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). In January 2017, FASB issued ASU 2017-04. The amendments in this update simplify the measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under this guidance, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss should not exceed the total amount of goodwill allocated to that reporting unit. ASU
2017-04 is effective for public companies for the reporting periods beginning after December 15, 2019. The Company adopted the guidance effective January 2020. Although the Company cannot anticipate future goodwill impairment, the Company does not anticipate a material impact on the Company's financial statements. The current accounting policies and procedures of the Company have not changed, except for the elimination of Step 2 analysis.
Accounting Standards Update 2016-02, Leases (Topic 842) ("ASU 2016-02"). On February 25, 2016, FASB issued ASU 2016-02 which creates Topic 842, Leases and supersedes Topic 840, Leases. ASU 2016-02 is intended to improve financial reporting about leasing transactions, by increasing transparency and comparability among organizations. Under the new guidance, a lessee is required to record all leases with lease terms of more than 12 months on their balance sheet as lease liabilities with a corresponding right-of-use asset. ASU 2016-02 maintains the dual model for lease accounting, requiring leases to be classified as either operating or finance, with lease classification determined in a manner similar to existing lease guidance. The new guidance is effective for public companies for fiscal years beginning on or after December 15, 2018, and for private companies for fiscal years beginning on or after December 15, 2019. The Company adopted the guidance effective January 1, 2019 and recorded a right of use asset of $14.1 million and a lease liability of $14.1 million.
Accounting Standards Update 2018-13, Fair Value Measurements (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). In August 2018, FASB issued ASU 2018-13. This ASU eliminates, adds and modifies certain disclosure requirements for fair value measurements. Among the changes, an entity will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019. As ASU 2018-13 only revises disclosure requirements, it did not have a material impact on the Company’s consolidated financial statements.
Accounting Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses of Financial Instruments (“ASU 2016-13”). In June 2016, FASB issued ASU 2016-13. The provisions of ASU 2016-13 requires an entity to utilize a new impairment model known as the current expected credit loss ("CECL") model to estimate its lifetime "expected credit loss" and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The CECL model is expected to result in more timely recognition of credit losses. ASU 2016-13 also requires new disclosures for financial assets measured at amortized cost, loans and available-for sale debt securities. ASU 2016-13 is effective for annual periods beginning after December 15, 2019, including interim periods within those fiscal years. Entities will apply the standard's provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted.
Management formed an internal, cross functional committee in 2017 to evaluate implementation steps and assess the impact ASU 2016-13 would have on the Company’s consolidated financial statements. The committee assigned roles and responsibilities, key tasks to complete, and established a general time-line for implementation. The Company also engaged an outside consultant to assist with the methodology review and data validation, as well as other key aspects of implementing the standard. The committee met periodically to discuss the latest developments and ensure progress was being made. In addition, the committee kept current on evolving interpretations and industry practices related to ASU 2016-13. The committee evaluated and validated data resources and different loss methodologies. Key implementation activities for 2019 included finalization of models, establishing processes and controls, development of supporting analytics and documentation, policies and disclosure, and implementing parallel processing.
The Company adopted ASU 2016-13 using the modified retrospective method for financial assets measured at amortized cost-effective January 1, 2020. Results for the periods beginning after January 1, 2020 are presented under ASU 2016-13 while prior period amounts are reported in accordance with the previously applicable accounting standards. The Company recorded a reduction to retained earnings of approximately $717,000 upon adoption of ASU 2016-13. The transition adjustment included an increase to the allowance for credit losses on loans of $1.7 million and an increase to the allowance for credit losses on off-balance sheet credit exposure of $69,000. There was no allowance for credit losses recorded for held-to- maturity debt securities. The transition adjustment included corresponding increases in deferred tax assets.
The Company adopted ASU 2016-13 using the prospective transition approach for financial assets considered purchased credit deteriorated ("PCD") that were previously classified as purchase credit impaired ("PCI") and accounted for under ASC 310-30 effective January 1, 2020. In accordance with the standard, the Company did not reassess whether the PCI assets met the criteria of PCD assets as of the adoption date. The amortized cost of the PCD assets were adjusted to reflect the addition of $833,000 to the allowance for credit losses. The remaining noncredit discount (based on the adjusted amortized cost) will be accreted into interest income at the effective interest rate over the remaining life of the assets.
The following table illustrates the impact of ASU 2016-13 adoption (in thousands):
January 1, 2020
As reported
Pre-ASU
Impact of ASU
under ASU
2016-13
Adoption
Assets:
Construction & Land Development
1,033
1,146
(113
Farm
1,323
1,093
230
1-4 Family Residential Properties
2,142
1,386
756
Commercial Real Estate
11,739
11,198
541
Agricultural
1,023
(363
Commercial & Industrial
9,428
9,273
Consumer
1,895
1,429
466
Allowance for credit losses for all loans
28,583
26,911
1,672
Liabilities:
Allowance for credit losses on off-balance sheet exposures
69
The following table illustrates the impact of ASU 2013-13 adoption for PCD assets previously classified as PCI included in the table above (in thousands):
291
48
42
359
459
Allowance for credit losses for PCD loans
1,198
365
833
12
Note 2 -- Earnings Per Share
Basic net income per common share available to common stockholders is calculated as net income less preferred stock dividends divided by the weighted average number of common shares outstanding. Diluted net income per common share available to common stockholders is computed using the weighted average number of common shares outstanding, increased by the Company’s stock options, unless anti-dilutive. The components of basic and diluted net income per common share available to common stockholders for the three and six months ended June 30, 2020 and 2019 were as follows:
Basic Net Income per Common Share
Available to Common Stockholders:
10,137,000
10,981,000
20,136,000
24,297,000
Weighted average common shares outstanding
16,709,886
16,683,194
16,701,536
16,674,646
Basic earnings per common share
Diluted Net Income per Common Share
Net income applicable to diluted earnings per share
Dilutive potential common shares:
Restricted stock awarded
46,908
34,780
Dilutive potential common shares
Diluted weighted average common shares outstanding
16,756,794
16,717,974
16,748,444
16,709,426
Diluted earnings per common share
There were no shares not considered in computing diluted earnings per share for the three and six months ended June 30, 2020 and 2019 because they were anti-dilutive.
13
Note 3 -- Investment Securities
The amortized cost, gross unrealized gains and losses and estimated fair values for available-for-sale and held-to-maturity securities by major security type at June 30, 2020 and December 31, 2019 were as follows (in thousands):
Amortized
Cost
Gross
Unrealized
Gains
(Losses)
Fair Value
Available-for-sale:
U.S. Treasury securities and obligations of U.S.
government corporations & agencies
73,000
899
73,899
Obligations of states and political subdivisions
191,120
9,593
(16
200,697
Mortgage-backed securities: GSE residential
412,175
13,549
425,674
Other securities
7,756
160
(28
7,888
Total available-for-sale
684,051
24,201
(94
Held-to-maturity:
U.S. Treasury securities and obligations of
U.S. government corporations & agencies
207
15,216
106,428
952
(60
107,320
172,460
5,990
(17
178,433
391,307
5,331
(512
396,126
3,750
3,757
673,945
12,280
(589
99
(69
69,572
The Company also had $97,000 and $412,000 of equity securities, at fair value, as of June 30, 2020 and December 31, 2019, respectively. All of the Company's held-to-maturity securities are government agency-backed securities for which the risk of loss is minimal. As such, as of June 30, 2020, the Company did not record an allowance for credit losses on its held-to-maturity securities.
Realized gains and losses resulting from sales of securities were as follows during the three and six months ended June 30, 2020 and 2019 (in thousands):
Gross gains
Gross losses
(12
(42
14
The following table indicates the expected maturities of investment securities classified as available-for-sale presented at fair value, and held-to-maturity presented at amortized cost, at June 30, 2020 and the weighted average yield for each range of maturities (dollars in thousands):
One year
or less
After 1
through
5 years
After 5
10 years
After
ten years
U.S. government corporations and agencies
46,263
15,852
11,784
Obligations of state and political subdivisions
32,878
73,456
93,298
1,065
61,458
321,315
42,901
6,842
1,046
0
Total available-for-sale investments
140,599
417,465
149,029
Weighted average yield
2.34
%
2.59
2.41
3.68
2.50
Full tax-equivalent yield
2.60
2.78
3.05
4.99
2.79
Held to Maturity:
9,985
5,024
2.33
2.06
2.24
The weighted average yields are calculated based on the amortized cost and effective yields weighted for the scheduled maturity of each security. Tax-equivalent yields have been calculated using a 21% tax rate. With the exception of obligations of the U.S. Treasury and other U.S. government agencies and corporations, there were no investment securities of any single issuer, the book value of which exceeded 10% of stockholders' equity at June 30, 2020.
Investment securities carried at approximately $653 million and $688 million at June 30, 2020 and December 31, 2019, respectively, were pledged to secure public deposits and repurchase agreements and for other purposes as permitted or required by law.
The following table presents the aging of gross unrealized losses and fair value by investment category as of June 30, 2020 and December 31, 2019 (in thousands):
Less than 12 months
12 months or more
Fair
Value
Losses
6,519
146
15,276
15,422
1,722
8,387
(46
23,663
23,375
3,469
347
(1
3,816
67,080
(322
20,888
(190
87,968
93,924
(398
21,235
(191
115,159
14,996
(25
24,565
(44
39,561
U.S. Treasury Securities and Obligations of U.S. Government Corporations and Agencies. At June 30, 2020 and December 31, 2019, there were no available-for sale U.S. Treasury securities and obligations of U.S. government corporations and agencies in a continuous unrealized loss position for twelve months or more. At December 31, 2019, there were four held-to-maturity U.S. Treasury securities and obligations of U.S. government corporations and agencies with a fair value of $24,565,000 and unrealized losses of $44,000 in a continuous unrealized loss position for twelve months or more.
Obligations of states and political subdivisions. At June 30, 2020, there were no obligations of states and political subdivisions in a continuous loss position for twelve months or more. At December 31, 2019, there was one obligation of states and political subdivisions with a fair value of $347,000 and unrealized losses of $1,000 in a continuous unrealized loss position for twelve months or more.
Mortgage-backed Securities: GSE Residential. At June 30, 2020, there were two mortgage-backed securities with a fair value of $15,276,000 and unrealized losses of $48,000 in a continuous unrealized loss position for twelve months or more. At December 31, 2019 there were fourteen mortgage-backed securities with a fair value of $20,888,000 and unrealized losses of $190,000 in a continuous unrealized loss position for twelve months or more.
The Company does not believe any unrealized losses as of June 30, 2020 represents other than temporary impairment ("OTTI"). However, given the uncertainty of the financial markets, the Company may be required to recognize OTTI losses in future periods with respect to its available for sale investment securities portfolio. The amount and timing of any additional OTTI will depend on the decline in the underlying cash flows of the securities. Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced, and the resulting loss recognized in the period the other-than-temporary impairment is identified.
Note 4 – Loans and Allowance for Loan Losses
Loans are stated at amortized cost net of an allowance for credit losses. Amortized cost is the unpaid principal net of unearned premiums and discounts, and net deferred origination fees and costs. Deferred loan origination fees are reduced by loan origination costs and are amortized to interest income over the life of the related loan using methods that approximated the effective interest rate method. Interest on substantially all loans is credited to income based on the principal amount outstanding. A summary of loans at June 30, 2020 and December 31, 2019 follows (in thousands):
Construction and land development
181,362
94,462
Agricultural real estate
251,695
240,481
1-4 Family residential properties
341,691
336,553
Multifamily residential properties
140,415
155,132
Commercial real estate
1,125,584
997,175
Loans secured by real estate
2,040,747
1,823,803
Agricultural loans
149,072
136,023
Commercial and industrial loans
818,686
528,987
Consumer loans
81,980
83,544
All other loans
123,937
126,807
Total Gross loans
3,214,422
2,699,164
Less: Loans held for sale
3,208,441
2,697,344
Less:
Net deferred loan fees, premiums and discounts
3,817
Allowance for credit losses
38,381
Loans expected to be sold are classified as held for sale in the consolidated financial statements and are recorded at the lower of aggregate cost or fair value, taking into consideration future commitments to sell the loans. These loans are primarily for 1-4 family residential properties.
Accrued interest on loans, which is excluded from the amortized cost of the balances above, totaled $14.1 million and $12.4 million at June 30, 2020 and December 31, 2019, respectively.
16
Most of the Company’s business activities are with customers located near the Company's branch locations in Illinois and Missouri. At June 30, 2020, the Company’s loan portfolio included $400.8 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $330.5 million was concentrated in corn and other grain farming. Total loans to borrowers whose businesses are directly related to agriculture increased $24.4 million from $376.4 million at December 31, 2019 due to seasonal timing of cash flow requirements. Loans concentrated in corn and other grain farming increased $29.0 million from $301.5 million at December 31, 2019. The Company's underwriting practices include collateralization of loans, any extended period of low commodity prices, drought conditions, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry, however these could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio.
In addition, the Company has $126.5 million of loans to motels and hotels. The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region. While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in nonperforming loans to this business segment and potentially in loan losses. The Company also has $401.5 million of loans to lessors of non-residential buildings, $293.7 million of loans to lessors of residential buildings and dwellings, $117.4 million of loans to nursing care facilities, and $124.9 million of loans to other gambling industries.
The structure of the Company’s loan approval process is based on progressively larger lending authorities granted to individual loan officers, loan committees, and ultimately the board of directors. Outstanding balances to one borrower or affiliated borrowers are limited by federal regulation and most borrowers are below regulatory thresholds. The Company can occasionally have outstanding balances to one borrower up to but not exceeding the regulatory threshold should underwriting guidelines warrant. Most of the the Company’s loans are to businesses located in the geographic market areas served by the Company’s branch bank system. Additionally, a significant portion of the collateral securing the loans in the portfolio is located within the Company’s primary geographic footprint. In general, the Company adheres to loan underwriting standards consistent with industry guidelines for all loan segments.
The Company’s lending can be summarized into the following primary areas:
Commercial Real Estate Loans. Commercial real estate loans are generally comprised of loans to small business entities to purchase or expand structures in which the business operations are housed, loans to owners of real estate who lease space to non-related commercial entities, loans for construction and land development, loans to hotel operators, and loans to owners of multi-family residential structures, such as apartment buildings. Commercial real estate loans are underwritten based on historical and projected cash flows of the borrower and secondarily on the underlying real estate pledged as collateral on the debt. For the various types of commercial real estate loans, minimum criteria have been established within the Company’s loan policy regarding debt service coverage while maximum limits on loan-to-value and amortization periods have been defined. Maximum loan-to-value ratios range from 65% to 80% depending upon the type of real estate collateral, while the desired minimum debt coverage ratio is 1.20x. Amortization periods for commercial real estate loans are generally limited to twenty years. The Company’s commercial real estate portfolio is well below the thresholds that would designate a concentration in commercial real estate lending, as established by the federal banking regulators.
Commercial and Industrial Loans. Commercial and industrial loans are primarily comprised of working capital loans used to purchase inventory and fund accounts receivable that are secured by business assets other than real estate. These loans are generally written for one year or less. Also, equipment financing is provided to businesses with these loans generally limited to 80% of the value of the collateral and amortization periods limited to seven years. Commercial loans are often accompanied by a personal guaranty of the principal owners of a business. Like commercial real estate loans, the underlying cash flow of the business is the primary consideration in the underwriting process. The financial condition of commercial borrowers is monitored at least annually with the type of financial information required determined by the size of the relationship. Measures employed by the Company for businesses with higher risk profiles include the use of government- assisted lending programs through the Small Business Administration and U.S. Department of Agriculture.
Agricultural and Agricultural Real Estate Loans. Agricultural loans are generally comprised of seasonal operating lines to cash grain farmers to plant and harvest corn and soybeans and term loans to fund the purchase of equipment. Agricultural real estate loans are primarily comprised of loans for the purchase of farmland. Specific underwriting standards have been established for agricultural-related loans including the establishment of projections for each operating year based on industry developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop. Loan-to-value ratios on loans secured by farmland generally do not exceed 65% and have amortization periods limited to twenty-five years. Federal government-assistance lending programs through the Farm Service Agency are used to mitigate the level of credit risk when deemed appropriate.
17
Residential Real Estate Loans. Residential real estate loans generally include loans for the purchase or refinance of residential real estate properties consisting of one-to-four units and home equity loans and lines of credit. The Company sells most of its long-term fixed rate residential real estate loans to secondary market investors. The Company also releases the servicing of these loans upon sale. The Company retains all residential real estate loans with balloon payment features. Balloon periods are limited to five years. Residential real estate loans are typically underwritten to conform to industry standards including criteria for maximum debt-to-income and loan-to-value ratios as well as minimum credit scores. Loans secured by first liens on residential real estate held in the portfolio typically do not exceed 80% of the value of the collateral and have amortization periods of twenty-five years or less. The Company does not originate subprime mortgage loans.
Consumer Loans. Consumer loans are primarily comprised of loans to individuals for personal and household purposes such as the purchase of an automobile or other living expenses. Minimum underwriting criteria have been established that consider credit score, debt-to-income ratio, employment history, and collateral coverage. Typically, consumer loans are set up on monthly payments with amortization periods based on the type and age of the collateral.
Other Loans. Other loans consist primarily of loans to municipalities to support community projects such as infrastructure improvements or equipment purchases. Underwriting guidelines for these loans are consistent with those established for commercial loans with the additional repayment source of the taxing authority of the municipality.
Allowance for Credit Losses
The allowance for credit losses represents the Company’s best estimate of the reserve necessary to adequately account for probable losses expected over the remaining contractual life of the assets. The provision for credit losses is the charge against current earnings that is determined by the Company as the amount needed to maintain an adequate allowance for credit losses. In determining the adequacy of the allowance for credit losses, and therefore the provision to be charged to current earnings, the Company relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company’s credit exposure. The review process is directed by the overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty. Factors considered by the Company in evaluating the overall adequacy of the allowance include historical net loan losses, the level and composition of nonaccrual, past due and troubled debt restructurings, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates. The Company estimates the appropriate level of allowance for credit losses by evaluating large impaired loans separately from non-impaired loans.
Impaired loans
The Company individually evaluates certain loans for impairment. In general, these loans have been internally identified via the Company’s loan grading system as credits requiring management’s attention due to underlying problems in the borrower’s business or collateral concerns. This evaluation considers expected future cash flows, the value of collateral and also other factors that may impact the borrower’s ability to make payments when due. For loans greater than $250,000, and loans identified as troubled debt restructurings, impairment is individually measured each quarter using one of three alternatives: (1) the present value of expected future cash flows discounted at the loan’s effective interest rate; (2) the loan’s observable market price, if available; or (3) the fair value of the collateral less costs to sell for collateral dependent loans and loans for which foreclosure is deemed to be probable. A specific allowance is assigned when expected cash flows or collateral are less than the carrying amount of the loan. The carrying value of the loan reflects reductions from prior charge-offs.
Non-Impaired loans
Non-impaired loans comprise the vast majority of the Company’s total loan portfolio and include loans in accrual status and those credits not identified as troubled debt restructurings. A small portion of these loans are considered “criticized” due to the risk rating assigned reflecting elevated credit risk due to characteristics, such as a strained cash flow position, associated with the individual borrowers. Criticized loans are those assigned risk ratings of Special Mention, Substandard, or Doubtful.
18
Beginning January 1, 2020, the allowance for credit losses was estimated using the current expected credit loss model ("CECL"). The Company uses the Loss Rate method to estimate the historical loss rate for all non-impaired loans. Under this method, the allowance for credit losses is measured on a collective (pool) basis for non-impaired loans with similar risk characteristics. Historical credit loss experience provides the basis for the estimate of expected credit losses. For each pool, a historical loss rate is computed based on the average remaining contractual life of the pool. Adjustments to historical loss rates are made using qualitative factors relevant to each pool including merger & acquisition activity, economic conditions, changes in policies, procedures & underwriting, and concentrations. In addition, a twelve-month forecast, using reasonable and supportable future conditions, is prepared that is used to estimate expected changes to existing and historical conditions in the current period.
The Company also considers specific current economic events occurring globally, in the U.S. and in its local markets. In March 2020, in response to the COVID-19 outbreak, its significant disruptions in the U.S. economy and impacts on local markets, First Mid Bank offered a 90-day commercial deferral program, primarily to hotel and restaurant borrowers. In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings. These deferrals were, however, considered in the factors used to estimate the required allowance for credit losses for non-impaired loans. Other COVID-19 related impacts considered included revenue losses of businesses required to restrict or cease services, income loss to workers laid off as a result of COVID-19 restrictions, various federal and state government stimulus programs and additional deferral programs offered by First Mid Bank beginning in April 2020. Other events considered include the status of trade agreements with China, scheduled increases in minimum wage and changes to the minimum salary threshold for overtime provisions, current and projected unemployment rates, current and projected grain and oil prices and economies of local markets where customers work and operate.
Within each pool, risk elements are evaluated that have specific impacts to the borrowers within the pool. These, along with the general risks and events, and the specific lending policies and procedures by loan type described above, are analyzed to estimate the qualitative factors used to adjust the historical loss rates.
During the current period, the following assumptions and factors were considered when determining the historical loss rate and any potential adjustments by loan pool.
Construction and Land Development Loans. The average life of the construction and land development segment was determined to be twelve months. Historical losses in this segment remained very low. Current activity in this industry was deemed essential and has continued during COVID-19, however, projects may be hampered by COVID-19 restrictions which could increase costs and duration. The qualitative factor for this segment was increased to account for these potential risks.
Agricultural Real Estate Loans. The average life of the agricultural real estate segment was determined to be thirty-six months. Historical losses in the segment remain very low. Farmland values have remained steady over an extended period of time and there are no indications that this will change in the next year. More pressure on landowners to lower cash rents as farmers struggle to cover expenses is expected which would lower the return to landowners and impact the market value of the land. The qualitative factor for this segment was increased to account for this potential risk.
1- 4 Family Residential Properties Loans. The average life of the 1-4 Family Residential segment was determined to be: Residential Real Estate-non-owner occupied, sixty months; Residential Real Estate-owner occupied, sixty months; Home Equity lines of credit, thirty months. COVID-19 has impacted the finances of consumers from layoffs and furloughs resulting from employers that must reduce or suspend operations. Increased risk in this segment includes consumer ability to make mortgage and rent payments. Some of this impact has been offset by governmental actions such as stimulus payments and extended unemployment benefits. First Mid Bank has also offered short-term loan payment deferral to borrowers in this segment. The historical loss rate for this segment declined for the period but was offset by an increase in the qualitative factor to account for these potential risks.
Commercial Real Estate Loans. The average life of the commercial real estate segment was determined to be thirty-six months. This segment includes the Company's majority of exposure to the hotel industry which has been significantly impacted by COVID-19 events. Other impacted industries in this segment include restaurants and retail establishments. First Mid Bank has implemented a deferral program for borrowers in this segment in order to ease the impact to these borrowers. While there was a slight decrease in the historical loss rate, the qualitative factor for this segment was increased to account for these risks.
Agricultural Loans. The average life of the agricultural segment was determined to be eighteen months. Losses in this segment are very low and it is believed that borrowers in this segment will benefit from current governmental programs such as PPP and MFP. Many farmers are holding grain from the 2019 operating season waiting for an increase in prices, however, as of June 30, prices were down compared to the beginning of the year. It is now believed that many farmers will likely not be able to cover their operating expenses. The qualitative factor of this segment was increased to account for this new risk.
19
Commercial and Industrial Loans. The average life of the commercial and industrial segment was determined to be twenty-four months. The COVID-19 impacts include forced closures and scaled-back services for many industries within this segment including retailers, restaurants and video gaming establishments. Some of this risk is offset by government relief programs as well as, First Mid Bank's payment deferral program. In addition to an increase in the historical loss rate, the qualitative factor for this segment was increased to account for these new risks.
Consumer Loans. The average life of the consumer segment was determined to be thirty-six months. The financial status of many borrowers has been impacted by COVID-19 events including layoffs and reduced hours. Some of this impact has been offset by government stimulus programs, increased paid leave and increased and extended unemployment benefits. Additionally, First Mid Bank has offered a short-term payment deferral program. While the historical loss rate decreased for this period, the qualitative factor for the segment was increased to account for these risks.
Acquired Loans. Prior to January 1, 2020 loans acquired with evidence of credit deterioration since origination and for which it was probable that all contractually required payments would not be collected were considered purchased credit impaired at the time of acquisition. Purchase credit-impaired ("PCI") loans were accounted for under ASC 310-30, Receivables--Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"), and were initially measured at fair value, which included the estimated future credit losses expected to be incurred over the life of the loan.
Accordingly, an allowance for credit losses related to these loans was not carried over and recorded at the acquisition date. The cash flows expected to be collected were estimated using current key assumptions, such as default rates, value of underlying collateral, severity and prepayment speeds.
Subsequent to January 1, 2020, loans acquired in a business combination that have experienced more-than-insignificant deterioration in credit quality since origination are considered purchased credit deteriorated (“PCD”) loans. At the acquisition date, an estimate of expected credit losses is made for groups of PCD loans with similar risk characteristics and individual PCD loans without similar risk characteristics. This initial allowance for credit losses is allocated to individual PCD loans and added to the purchase price or acquisition date fair values to establish the initial amortized cost basis of the PCD loans. As the initial allowance for credit losses is added to the purchase price, there is no credit loss expense recognized upon acquisition of a PCD loan. Any difference between the unpaid principal balance of PCD loans and the amortized cost basis is considered to relate to noncredit factors and results in a discount or premium. Discounts and premiums are recognized through interest income on a level-yield method over the life of the loans. All loans considered to be PCI prior to January 1, 2020 were converted to PCD on that date. Accordingly, on January 1, 2020, the amortized cost basis of the PCD loans were adjusted to reflect the addition of $833,000 to the allowance for credit losses.
For acquired loans not deemed purchased credit deteriorated at acquisition, the differences between the initial fair value and the unpaid principal balance are recognized as interest income on a level-yield basis over the lives of the related loans. At the acquisition date, an initial allowance for expected credit losses is estimated and recorded as credit loss expense. The subsequent measurement of expected credit losses for all acquired loans is the same as the subsequent measurement of expected credit losses for originated loans.
The following tables present the activity in the allowance for credit losses based on portfolio segment for the three and six months ended June 30, 2020 (in thousands):
Construction
& Land
Development
Real Estate
1-4 Family
Residential
Properties
Commercial
& Industrial
Three months ended June 30, 2020
Beginning Balance
1,620
1,335
1,931
13,621
1,064
11,294
2,011
32,876
Provision for credit loss expense
738
299
483
3,118
259
(47
Loans charged off
467
311
116
963
Recoveries collected
141
100
332
Ending balance
2,358
1,634
2,486
16,272
12,360
1,948
Six months ended June 30, 2020
Impact of adopting ASU 2016-13
1,325
5,079
300
4,101
95
265
1,283
2,386
203
114
245
567
20
Prior to the adoption of ASU 2016-13, the appropriate level of the allowance for loan losses for all non-impaired loans was based on a migration analysis of net losses over a rolling twelve quarter period by loan segment. A weighted average of the net losses was determined by assigning more weight to the most recent quarters in order to recognize current risk factors influencing the various segments of the loan portfolio more prominently than past periods. Due to weakened economic conditions during historical years, the Company established qualitative factor adjustments for each of the loan segments at levels above the historical net loss averages. Some of the economic factors included the potential for reduced cash flow for commercial operating loans from reduction in sales or increased operating costs, decreased occupancy rates for commercial buildings, reduced levels of home sales for commercial land developments, the uncertainty regarding grain prices and increased operating costs for farmers, and increased levels of unemployment and bankruptcy impacting consumer’s ability to pay. Each of these economic uncertainties was taken into consideration in developing the level of the allowance for loan losses. The following tables present the activity in the allowance for credit losses based on portfolio segment for the three and six months ended June 30, 2019 and for the year ended December 31, 2019 (in thousands):
Three months ended June 30, 2019
552
1,282
1,341
10,565
1,130
10,830
1,004
26,704
187
367
335
542
(1,558
216
66
105
86
106
739
1,284
1,649
10,796
9,129
1,090
26,359
Six months ended June 30, 2019
561
1,246
1,504
11,102
951
9,893
932
26,189
178
38
326
(146
730
(546
458
161
258
485
1,110
40
185
242
Twelve months ended December 31, 2019
(153
1,268
1,827
1,053
1,394
6,433
1,478
1,743
1,828
1,253
6,326
92
356
615
Consistent with regulatory guidance, charge-offs on all loan segments are taken when specific loans, or portions thereof, are considered uncollectible. The Company’s policy is to promptly charge these loans off in the period the uncollectible loss is reasonably determined.
For all loan portfolio segments except 1-4 family residential properties and consumer, the Company promptly charges-off loans, or portions thereof, when available information confirms that specific loans are uncollectible based on information that includes, but is not limited to, (1) the deteriorating financial condition of the borrower, (2) declining collateral values, and/or (3) legal action, including bankruptcy, that impairs the borrower’s ability to adequately meet its obligations. For impaired loans that are considered solely collateral dependent, a partial charge-off is recorded when a loss has been confirmed by an updated appraisal or other appropriate valuation of the collateral.
The Company charges-off 1-4 family residential and consumer loans, or portions thereof, when the Company reasonably determines the amount of the loss. The Company adheres to timeframes established by applicable regulatory guidance which provides for the charge-down of 1-4 family first and junior lien mortgages to the net realizable value less costs to sell when the loan is 180 days past due, charge-off of unsecured open-end loans when the loan is 180 days past due, and charge down to the net realizable value when other secured loans are 120 days past due. Loans at these respective delinquency thresholds for which the Company can clearly document that the loan is both well-secured and in the process of collection, such that collection will occur regardless of delinquency status, need not be charged off.
The following table presents the amortized cost basis of collateral-dependent loans by class of loans that were individually evaluated to determine expected credit losses, and the related allowance for credit losses, as of June 30, 2020 (in thousands):
Collateral
Allowance
Business
for Credit
532
261
3,292
157
1,960
6,858
863
12,642
1,281
301
3,699
4,018
Total loans
12,943
29
16,671
1,369
Credit Quality
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, collateral support, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a continuous basis. The Company uses the following definitions for risk ratings which are commensurate with a loan considered “criticized”:
Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard. Loans classified as substandard are inadequately protected by the current sound-worthiness and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, based on currently existing factors, conditions and values, highly questionable and improbable.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered pass rated loans.
The following tables present the credit risk profile of the Company’s loan portfolio on amortized cost basis based on risk rating category and year of origination as of June 30, 2020 (in thousands):
Term Loans by Origination Year
Revolving
Risk Rating
2018
2017
2016
Prior
Construction & Land Development Loans
Pass
56,357
61,418
4,145
2,848
519
54,361
179,648
Special Mention
Substandard
308
896
61,726
3,380
909
54,417
180,934
Agricultural Real Estate Loans
44,876
42,885
43,297
18,278
15,940
69,084
234,360
3,110
387
875
11,186
16,001
487
67
249
1,021
45,176
45,995
44,171
18,639
16,882
80,519
251,382
1-4 Family Residential Property Loans
40,654
36,389
37,176
30,446
33,476
117,666
27,209
323,016
200
159
295
1,050
252
1,452
3,438
635
2,036
1,871
1,991
7,719
1,275
15,582
40,909
37,183
39,507
33,367
35,719
126,837
28,514
342,036
Commercial Real Estate Loans
111,880
206,159
174,472
197,260
174,120
355,666
1,219,557
1,857
23
4,158
1,781
4,818
2,822
15,459
1,254
1,400
3,115
4,588
19,083
29,539
114,991
206,281
180,030
202,156
183,526
377,571
1,264,555
Agricultural Loans
72,118
38,483
8,353
3,169
959
3,400
126,482
9,754
11,078
296
701
35
21,875
607
43
25
686
82,479
49,604
8,674
3,180
1,660
3,446
149,043
Commercial & Industrial Loans
362,238
148,476
100,766
84,972
55,893
138,743
891,088
1,642
33,847
58
407
37,091
1,122
2,328
1,371
208
1,638
7,049
365,002
184,651
101,333
86,401
56,508
141,333
935,228
Consumer Loans
20,116
30,739
17,657
10,147
148
78,816
72
960
1,154
2,192
156
129
140
604
1,076
20,138
30,769
17,885
10,277
1,248
1,767
82,084
Total Loans
708,239
564,549
385,866
347,120
281,055
738,929
3,052,967
13,758
48,217
5,393
3,044
8,403
17,601
96,446
3,055
3,443
4,486
7,236
6,994
29,360
55,849
725,052
616,209
395,745
357,400
296,452
785,890
3,205,262
The following tables present the credit risk profile of the Company’s loan portfolio based on risk rating category as of December 31, 2019 (in thousands):
Special
Mention
Construction & land development
93,413
413
316
94,142
231,227
6,902
2,112
240,241
1-4 Family residential property loans
314,999
5,743
15,685
336,427
1,103,543
14,156
31,951
1,149,650
1,743,182
27,214
50,064
1,820,460
129,811
3,862
2,451
136,124
Commercial & industrial loans
603,047
40,395
12,138
655,580
82,117
83,183
2,558,157
71,611
65,579
2,695,347
The following table presents the Company’s loan portfolio aging analysis at June 30, 2020 and December 31, 2019 (in
thousands):
30-59
Days Past
Due
60-89
90 Days or
More
Past Due
Total Past
Current
Receivable
> 90 Days &
Accruing
85
226
180,708
544
550
250,832
3,548
1,260
1,676
6,484
335,552
2,201
138,814
141,015
637
2,519
4,302
1,119,238
1,123,540
6,477
3,091
4,195
13,763
2,025,144
2,038,907
149,017
715
125
2,380
3,220
807,949
811,169
263
165
482
81,602
124,059
7,455
3,270
6,766
17,491
3,187,771
235
93,907
1,595
238,599
3,834
2,288
4,713
10,835
325,592
1,348
46
1,131
2,525
151,423
153,948
602
495
2,241
3,338
992,364
995,702
7,614
2,829
8,132
18,575
1,801,885
307
135,517
855
5,989
7,611
521,362
528,973
454
196
150
800
82,383
126,607
9,135
3,880
14,578
27,593
2,667,754
Impaired Loans
Within all loan portfolio segments, loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. The entire balance of a loan is considered delinquent if the minimum payment contractually required to be made is not received by the specified due date. Impaired loans, excluding certain troubled debt restructured loans, are placed on nonaccrual status. Impaired loans include nonaccrual loans and loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection. It is the Company’s policy to have any restructured loans which are on nonaccrual status prior to being modified remain on nonaccrual status until, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. If the restructured loan is on accrual status prior to being modified, the loan is reviewed to determine if the modified loan should remain on accrual status.
The Company’s policy is to discontinue the accrual of interest income on all loans for which principal or interest is ninety days past due. The accrual of interest is discontinued earlier when, in the opinion of management, there is reasonable doubt as to the timely collection of interest or principal. Once interest accruals are discontinued, accrued but uncollected interest is charged against current year income. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Interest on loans determined to be troubled debt restructurings is recognized on an accrual basis in accordance with the restructured terms if the loan is in compliance with the modified terms. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.
The following tables present impaired loans as of June 30, 2020 and December 31, 2019 (in thousands):
Recorded
Balance
Unpaid
Principal
Specific
Loans with a specific allowance:
256
4,916
5,149
5,154
5,351
182
4,254
6,861
7,337
5,904
6,408
587
14,269
14,978
15,568
16,269
788
4,087
5,673
7,653
8,789
134
18,578
21,101
23,440
25,861
1,098
Loans without a specific allowance:
369
479
3,807
4,494
3,719
4,263
283
1,583
1,721
1,724
5,643
6,767
5,960
6,507
837
609
724
817
2,892
916
3,065
288
743
391
713
7,585
11,011
7,991
10,425
Total loans:
570
297
8,723
9,643
8,873
9,614
2,243
8,007
8,920
7,625
19,912
21,745
21,528
22,776
925
809
4,904
8,565
8,569
11,854
422
525
847
26,163
32,112
31,431
36,286
The following tables present average recorded investment and interest income recognized on impaired loans for the three and six months ended June 30, 2020 and 2019 (in thousands):
For the three months ended
Average
Investment
in Impaired
Income
Recognized
590
629
854
956
9,543
2,374
4,522
32
8,256
14,414
82
20,994
68
30,064
902
5,167
9,929
457
742
27,520
41,558
For the six months ended
595
632
957
9,062
9,973
51
2,391
4,804
61
8,352
84
14,844
21,254
136
31,210
773
6,046
10,059
499
781
28,708
139
42,823
The amount of interest income recognized by the Company within the periods stated above was due to loans modified in troubled debt restructurings that remain on accrual status. The average balances of these loans included in impaired loans at June 30, 2020 and 2019, were $2.7 million and $2.8 million, respectively.
Non-Accrual Loans
The following table presents the amortized cost basis of loans on nonaccrual status and of nonaccrual loans individually evaluated for which no allowance was recorded as of June 30, 2020 and December 31, 2019 (in thousands). There were no loans past due over eighty-nine days that were still accruing.
Nonaccrual
with no
Allowance for
Credit Loss
7,299
7,379
3,137
2,127
4,412
4,351
7,307
14,361
15,387
769
1,691
4,823
8,441
521
9,356
20,440
25,118
Interest income that would have been recorded under the original terms of such nonaccrual loans totaled $1,044,000 and $1,335,000 for the six months ended June 30, 2020 and 2019, respectively.
Acquired Loans
The Company acquired certain loans considered to be credit-impaired ("PCI") in its business combinations prior to the adoption of ASU 2016-13. At acquisition, these loans evidenced deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of these loans was included in the consolidated balance sheet amounts for Loans. The amount of these loans at December 31, 2019 was as follows (in thousands):
371
2,077
2,247
4,951
Carrying amount
Allowance for loan losses
(365
Carrying amount, net of allowance
4,586
For PCI loans, the difference between contractually required payments at acquisition and the cash flow expected to be collected is referred to as the non-accretable difference. Any excess of expected cash flows over the fair value is referred to as the accretable yield. Subsequent decreases to the expected cash flows result in a provision for loan and lease losses.
Subsequent increases in expected cash flows result in a reversal of the provision for loan and lease losses to the extent of prior charges and then an adjustment to accretable yield, which had a positive impact on interest income. As of December 31, 2019, subsequent changes in expected cash flows resulted in approximately $365,000 of provision recorded and approximately $1,229,000 of provision reversed.
27
Subsequent to adoption of ASU 2016-13 on January 1, 2020, loans acquired in a business combination that have experienced more-than-insignificant deterioration in credit quality since origination are considered PCD loans. At the acquisition date, an estimate of expected credit losses is made for groups of PCD loans with similar risk characteristics and individual PCD loans without similar risk characteristics. This initial allowance for credit losses is allocated to individual PCD loans and added to the purchase price or acquisition date fair values to establish the initial amortized cost basis of the PCD loans. As the initial allowance for credit losses is added to the purchase price, there is no credit loss expense recognized upon acquisition of a PCD loan. Any difference between the unpaid principal balance of PCD loans and the amortized cost basis is considered to relate to noncredit factors and results in a discount or premium. Discounts and premiums are recognized through interest income on a level-yield method over the life of the loans. All loans considered to be PCI prior to January 1, 2020 were converted to PCD on that date.
Troubled Debt Restructuring
The balance of troubled debt restructurings ("TDRs") at June 30, 2020 and December 31, 2019 was $6.8 million and $5.8 million, respectively. There was $239,000 and $381,000 in specific reserves established with respect to these loans as of June 30, 2020 and December 31, 2019, respectively. As troubled debt restructurings, these loans are included in nonperforming loans and are classified as impaired which requires that they be individually measured for impairment. The modification of the terms of these loans included one or a combination of the following: a reduction of stated interest rate of the loan; an extension of the maturity date and change in payment terms; or a permanent reduction of the recorded investment in the loan.
The following table presents the Company’s recorded balance of troubled debt restructurings at June 30, 2020 and December 31, 2019 (in thousands).
Troubled debt restructurings:
1,843
1,905
1,873
1,746
3,716
3,651
2,673
1,349
6,839
5,803
Performing troubled debt restructurings:
1,352
1,382
1,132
2,484
2,528
81
128
2,656
2,701
The following table presents loans modified as TDRs during the six months ended June 30, 2020, as a result of various modified loan factors (in thousands). The change in the recorded investment from pre-modification to post- modification was not material.
Number of
Type of
Modifications
(b)(c)
303
(b)
1,533
(b)(c)(d)
1,579
59
2,342
70
(c)
2,744
1,720
Type of modifications:
(a) Reduction of stated interest rate of loan
Change in payment terms
Extension of maturity date
(d)
Permanent reduction of the recorded investment
28
A loan is considered to be in payment default once it is 90 days past due under the modified terms. There were no loans modified as troubled debt restructurings during the prior twelve months that experienced defaults for six months ended June 30, 2020. There were no loans modified as troubled debt restructuring during the prior twelve months that experienced defaults as of December 31, 2019.
The balance of real estate owned includes $2,256,000 and $3,644,000 of foreclosed real estate properties recorded as a result of obtaining physical possession of the property at June 30, 2020 and December 31, 2019, respectively. The recorded investment of consumer mortgage loans secured by residential real estate properties for which formal foreclosure procedures are in process was $1,146,000 and $667,000 at June 30, 2020 and December 31, 2019, respectively.
Note 5 -- Goodwill and Intangible Assets
The Company has goodwill from business combinations, intangible assets from branch acquisitions, identifiable intangible assets assigned to core deposit relationships and customer lists of First Mid Wealth Management Company and First Mid Insurance. The following table presents gross carrying value and accumulated amortization by major intangible asset class as of June 30, 2020 and December 31, 2019 (in thousands):
December 31,2019
Gross Carrying
Amortization
Goodwill not subject to amortization (effective 1/1/02)
108,752
Intangibles from branch acquisition
3,015
Core deposit intangibles
32,355
19,410
17,746
Other intangibles
16,389
4,570
16,129
3,917
160,511
30,755
160,251
28,438
The Company has mortgage servicing rights acquired in previous acquisitions. The following table summarizes the activity pertaining to mortgage servicing rights included in intangible assets as of June 30, 2020, June 30, 2019 and December 31, 2019 (in thousands):
1,444
2,101
Valuation reserve
(259
(439
(380
Mortgage servicing rights amortized
(268
(172
(411
I/O Strip
Ending Balance
900
1,636
Total amortization expense for the six months ended June 30, 2020 and 2019 was as follows (in thousands):
Three months
ended June 30,
Six months
821
953
1,664
1,933
Customer list intangibles
327
317
653
Mortgage servicing rights
142
553
268
611
Aggregate amortization expense for the current year and estimated amortization expense for each of the five succeeding years is shown in the table below (in thousands):
Aggregate amortization expense:
For period 01/01/20-6/30/20
Estimated amortization expense:
For period 7/01/20-12/31/20
2,438
For year ended 12/31/21
4,347
For year ended 12/31/22
3,981
For year ended 12/31/23
3,440
For year ended 12/31/24
2,946
For year ended 12/31/25
2,633
In accordance with the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets,” codified within ASC 350, the Company performed testing of goodwill for impairment as of June 30, 2020 and determined that, as of that date, goodwill was not impaired. Management also concluded that the remaining amounts and amortization periods were appropriate for all intangible assets.
Note 6 -- Repurchase Agreements and Other Borrowings
Securities sold under agreements to repurchase were $350.3 million at June 30, 2020, an increase of $142.2 million from $208.1 million at December 31, 2019. The increase during the first three months of 2020 was primarily due to changes in business cash flow needs. All the transactions have overnight maturities with a weighted average rate of 0.22%.
The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral pledged by the Company would be used to settle the fair value of the repurchase agreement should the Company be in default (e.g., declare bankruptcy), the Company could cancel the repurchase agreement (i.e., cease payment of principal and interest), and attempt collection on the amount of collateral value in excess of the repurchase agreement fair value. The collateral is held by a third-party financial institution in the counterparty's custodial account. The counterparty has the right to sell or repledge the investment securities. For government entity repurchase agreements, the collateral is held by the Company in a segregated custodial account under a tri-party agreement. The Company is required by the counterparty to maintain adequate collateral levels. In the event the collateral fair value falls below stipulated levels, the Company will pledge additional securities. The Company closely monitors collateral levels to ensure adequate levels are maintained, while mitigating the potential of over- collateralization in the event of counterparty default.
Collateral pledged by class for repurchase agreements are as follows (in thousands):
US Treasury securities and obligations of U.S. government corporations & agencies
69,427
77,333
2,375
Mortgage-backed securities: GSE: residential
278,741
128,401
Other Securities
2,120
FHLB borrowings were $104 million and $114 million at June 30, 2020 and December 31, 2019, respectively. At June 30, 2020 the advances were as follows:
Advance
Term (in years)
Interest Rate
Maturity Date
5,000,000
3.0
1.75%
July 31, 2020
6.0
2.30%
August 24, 2020
3.5
1.83%
February 1, 2021
5.0
1.85%
April 12, 2021
4,000,000
1.0
2.00%
May 3, 2021
7.0
2.55%
October 1, 2021
2.71%
March 21, 2022
8.0
2.40%
January 9, 2023
1.51%
July 31, 2023
0.77%
September 11, 2023
10,000,000
1.45%
December 31, 2024
0.91%
March 10, 2025
10.0
1.14%
October 3, 2029
1.15%
1.12%
1.39%
December 31, 2029
15,000,000
1.41%
Note 7 -- Fair Value of Assets and Liabilities
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:
Level 1Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities which use observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in active markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
Following is a description of the inputs and valuation methodologies used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.
Available-for-Sale Securities. The fair value of available-for-sale securities is determined by various valuation methodologies. Where quoted market prices are available in an active market, securities are classified within Level 1. If quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independent sources of market parameters, including but not limited to, yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flows. Such securities are classified in Level 2 of the valuation hierarchy. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.
Fair value determinations for Level 3 measurements of securities are the responsibility of the Treasury function of the Company. The Company contracts with a pricing specialist to generate fair value estimates on a monthly basis. The Treasury function of the Company challenges the reasonableness of the assumptions used and reviews the methodology to ensure the estimated fair value complies with accounting standards generally accepted in the United States, analyzes the changes in fair value and compares these changes to internally developed expectations and monitors these changes for appropriateness.
Derivatives. The fair value of derivatives is based on models using observable market data as of the measurement date and are therefore classified in Level 2 of the valuation hierarchy.
31
The following table presents the Company’s assets and liabilities that are measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall as of June 30, 2020 and December 31, 2019 (in thousands):
Fair Value Measurements Using
Quoted Prices in
Active Markets
for Identical
Significant
Observable
Inputs
Unobservable
(Level 1)
(Level 2)
(Level 3)
Available-for-sale securities:
U.S. Treasury securities and obligations of U.S. government
corporations and agencies
199,906
791
Mortgage-backed securities
Total available-for-sale securities
707,367
Equity securities
Derivative assets: interest rate swaps
708,297
707,409
Derivative liabilities: interest rate swaps
1,829
U.S. Treasury securities and Obligations of U.S. government
177,460
973
3,950
685,829
684,856
219
686,048
325
The change in fair value of assets measured on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2020 and 2019 is summarized as follows (in thousands):
Obligation of State and
Political Subdivisions
Three months ended
Six months ended
Beginning balance
790
968
967
Transfers into Level 3
Transfers out of Level 3
Total gains or losses:
Included in net income
Included in other comprehensive income (loss)
Purchases, issuances, sales and settlements:
Purchases
Issuances
Sales
(184
Settlements
970
Total gains or losses for the period included in net income attributable to the change in
unrealized gains or losses related to assets and liabilities still held at the reporting
date
Following is a description of the valuation methodologies used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.
Impaired Loans (Collateral Dependent). Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment and estimating fair value include using the fair value of the collateral for collateral dependent loans.
If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.
Management establishes a specific allowance for impaired loans that have an estimated fair value that is below the carrying value. The total carrying amount of loans for which a change in specific allowance has occurred as of June 30, 2020 was $9,708,000 and a fair value of $8,358,000 resulting in specific loss exposures of $1,350,000.
When there is little prospect of collecting principal or interest, loans, or portions of loans, may be charged-off to the allowance for loan losses. Losses are recognized in the period an obligation becomes uncollectible. The recognition of a loss does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off the loan even though partial recovery may be affected in the future.
Foreclosed Assets Held For Sale. Other real estate owned acquired through loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense. Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest expense. The total carrying amount of other real estate owned as of June 30, 2020 was $2,256,000. Other real estate owned included in the total carrying amount and measured at fair value on a nonrecurring basis during the period amounted to $21,000.
Mortgage Servicing Rights. As of June 30, 2020, mortgage servicing rights had a carrying value of $1,422,000 and a fair value of $899,000 resulting in a valuation reserve of $523,000. The fair value used to determine the valuation reserve for mortgage servicing rights was estimated using the discounted cash flow models. Due to the nature of the valuation inputs, the following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2020 and December 31, 2019 (in thousands):
Valuation
Technique
Unobservable Inputs
Range
(Weighted Average)
Impaired loans (collateral dependent)
8,358
Third party
valuations
Discount to reflect realizable value
0% - 40%
(20%)
Foreclosed assets held for sale
less estimated selling costs
(35%)
9.0% - 11.0%
(9.1%)
12,727
9.5% - 12.5%
(9.7%)
34
The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurements other than goodwill at June 30, 2020 and December 31, 2019 (in thousands).
The following tables present estimated fair values of the Company’s financial instruments at June 30, 2020 and December 31, 2019 in accordance with ASC 825 (in thousands):
Carrying
Amount
Level 1
Level 2
Level 3
Financial Assets
Cash and due from banks
237,201
Certificates of deposit investments
Available-for-sale securities
Held-to-maturity securities
Loans net of allowance for loan losses
3,095,700
16,482
Federal Reserve Bank stock
9,401
Federal Home Loan Bank stock
5,450
Financial Liabilities
Deposits
3,396,983
2,856,239
540,744
350,306
Federal Home Loan Bank borrowings
107,286
14,285
84,154
780
2,622,053
4,105
2,924,144
2,332,866
591,278
208,016
114,510
15,596
Note 8 -- Leases
Effective January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842). As of June 30, 2020, substantially all the Company's leases are operating leases for real estate property for bank branches, ATM locations, and office space.
These leases are generally for periods of 1 to 25 years with various renewal options. The Company elected the optional transition method permitted by Topic 842. Under this method, the Company recognizes and measures leases that exist at the application date and prior comparative periods are not adjusted. In addition, the Company elected the package of practical expedients:
1.
An entity need not reassess whether any expired or existing contracts contain leases.
2.
An entity need not reassess the lease classification for any expired or existing leases.
3.
An entity need not reassess initial direct costs for any existing leases.
The Company has also elected the practical expedient, which may be elected separately or in conjunction with the package noted above, to use hindsight in determining the lease term and in assessing the right-of-use assets. This expedient must be applied consistently to all leases. Lastly, the Company has elected to use the practical expedient to include both lease and non-lease components as a single component and account for it as a lease. In addition, The Company has elected to not include short-term leases (i.e. Leases with terms of twelve months or less) or equipment leases (primarily copiers) deemed immaterial, on the consolidated balance sheets.
For leases in effect at January 1, 2019 and for leases commencing thereafter, the Company recognizes a lease liability and a right-of-use asset, based on the present value of lease payments over the lease term. The discount rate used in determining present value was the Company's incremental borrowing rate which is the FHLB fixed advance rate based on the remaining lease term as of January 1, 2019, or the commencement date for leases subsequently entered into. The following table contains supplemental balance sheet information related to leases (dollars in thousands):
Operating lease right-of-use assets
12,805
Operating lease liabilities
12,815
Weighted-average remaining lease term (in years)
6.8
5.5
7.3
Weighted-average discount rate
2.77
3.21
3.07
Certain of the Company's leases contain options to renew the lease; however, not all renewal options are included in the calculation of lease liabilities as they are not reasonably certain to be exercised. The Company's leases do not contain residual value guarantees or material variable lease payments. The Company does not have any other material restrictions or covenants imposed by leases that would impact the Company's ability to pay dividends or cause the Company to incur additional financial obligations.
Maturities of lease liabilities were as follows (in thousands):
Year ending December 31,
1,609
2021
2,447
2022
2,183
2023
1,838
2024
1,505
Thereafter
9,389
Total lease payments
18,971
Less imputed interest
(2,957
Total lease liability
36
The components of lease expense for the six months ended June 30, 2020 and 2019 were as follows (in thousands):
Operating lease cost
736
647
1,378
1,318
Short-term lease cost
53
45
Variable lease cost
94
432
656
Total lease cost
1,101
1,694
2,019
Income from subleases
(199
(213
(392
(461
Net lease cost
638
888
1,302
1,558
As the Company elected not to separate lease and non-lease components, the variable lease cost primarily represents variable payment such as common area maintenance and copier expense. The Company does not have any material sub-lease agreements. Cash paid for amounts included in the measurement of lease liabilities was (in thousands):
Operating cash flows from operating leases
1,375
1,340
Note 9 – Derivatives
The Company utilizes an interest rate swap, designated as a fair value hedge, to mitigate the risk of changing interest rates on the fair value of a fixed rate commercial real estate loan. For derivative instruments that are designed and qualify as a fair value hedge, the gain or loss on the derivative instrument, as well as the offsetting loss or gain in the hedged asset attributable to the hedged risk, is recognized in current earnings.
Derivatives Designated as Hedging Instruments
The following table provides the outstanding notional balances and fair values of outstanding derivatives designated as hedging instruments as of June 30, 2020 and December 31, 2019 (in thousands):
Sheet
Location
Weighted
Remaining
Maturity
(Years)
Notional
Estimated
Fair Value Hedges:
Interest rate swap agreements
9.1 years
14,539
(3,763
9.3 years
14,748
(325
The effects of the fair value hedges on the Company's income statement during the six months ended June 30, 2020 and 2019 were as follows (in thousands):
Derivative
Location of Gain (Loss) on Derivatives
Interest income on loans
(78
(293
(1,462
Location of Gain (Loss) on Hedged Items
78
293
1,462
As of June 30, 2020, the following amounts were recorded on the consolidated balance sheet related to cumulative basis adjustment for fair value hedges (in thousands)
Line Item in the Balance Sheet in Which
the Hedge Item is Included
Carrying Amount of the
Hedged Asset
Cumulative Amount of Fair Value Hedging
Adjustment Included in the Carrying
Amount of the Hedged Asset
12,752
1,787
Derivatives Not Designated as Hedging Instruments
The following amounts represent the notional amounts and gross fair value of derivative contracts not designated as hedging instruments outstanding during the three months ended June 30, 2020 and 2019 (in thousands):
9.2 years
43,517
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis is intended to provide a better understanding of the consolidated financial condition and results of operations of the Company and its subsidiaries as of, and for the three and six months ended June 30, 2020 and 2019. This discussion and analysis should be read in conjunction with the consolidated financial statements, related notes and selected financial data appearing elsewhere in this report.
Forward-Looking Statements
This report may contain certain forward-looking statements, such as discussions of the Company’s pricing and fee trends, credit quality and outlook, liquidity, new business results, expansion plans, anticipated expenses, planned schedules and COVID-19. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are identified by use of the words “believe,” ”expect,” ”intend,” ”anticipate,” ”estimate,” ”project,” or similar expressions. Actual results could differ materially from the results indicated by these statements because the realization of those results is subject to many risks and uncertainties, including those described in Item 1A-“Risk Factors” and other sections of the Company’s Annual Report on Form 10-K and the Company’s other filings with the SEC, and changes in interest rates, general economic conditions and those in the Company’s market area, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios and the valuation of the investment portfolio, the Company’s success in raising capital and effecting and integrating acquisitions, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles, policies and guidelines, the severity, magnitude and duration of COVID-19 pandemic, the direct and indirect impact of such pandemic, including responses to the pandemic by the government, businesses customers' businesses, the disruption of global, national, state and local economies associated with the COVID-19 pandemic, which could affect the Company's liquidity and capital positions, impair the ability of the Company's borrowers to repay outstanding loans, impair collateral values, and further increase the allowance for credit losses, and the impact of the COVID-19 pandemic on the Company's financial results, including possible lost revenue and increased expenses (including cost of capital), as well as possible goodwill impairment charges. Furthermore, forward-looking statements speak only as of the date they are made. Except as required under the federal securities laws or the rules and regulations of the SEC, we do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise. Further information concerning the Company and its business, including a discussion of these and additional factors that could materially affect the Company’s financial results, is included in the Company’s 2019 Annual Report on Form 10-K under the headings “Item 1. Business" and “Item 1A. Risk Factors."
COVID-19 Impact
The COVID-19 outbreak is an unprecedented event that provides significant economic uncertainty for a broad spectrum of industries. The spread of this outbreak has caused significant disruptions in the U.S. economy and some of these impacts will be long lasting. As it continues to evolve it is not clear when or how the pandemic-driven contraction will recover. Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. Many of the CARES Act provisions, as well as other recent legislative and regulatory efforts, are expected to have a material impact on financial institutions. The Company's strong track record and revenue diversification provide a solid foundation for earnings and capital. The Company is focused on supporting its customers, communities and employees during this unique operating environment. Following is a description of the impact COVID-19 is having, actions taken as a result of COVID-19, and certain risks to the Company that COVID-19 creates or exacerbates, as well as management's outlook on the current COVID-19 situation.
Lending operations and accommodations to customers. Beginning in March 2020, First Mid Bank offered a 90-day commercial deferral program, primarily to hotel and restaurant borrowers. As of June 30, 2020, a total of $368 million was deferred through the program. First Mid Bank also provided a 180-day deferral program to its residential mortgage and other consumer customers. Through June 30, 2020, 230 customers, with balances totaling $3.9 million are participating in this program. In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings.
39
Beginning April 3, 2020, with the passage of the initial Paycheck Protection Program (“PPP”), administered by the Small Business Administration (“SBA”), the Company actively participated in assisting existing and new customers with applications for resources through the program. PPP loans have a two-year term and earn interest at 1%. The Company believes that most of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of June 30, 2020, the Company has approved and outstanding 2,508 PPP loans totaling $259.3 million with the SBA. It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government and as such do not represent a credit risk.
Employees. The Company has a business continuity plan in place that was executed in March 2020. Approximately half of the Company's workforce have the ability to work remotely with secure connections. In addition, various preventative and personal hygiene measures, in accordance with CDC guidelines have been implemented. To protect and ensure the safety of employees, as well as customers, all branch locations were transitioned to drive-thru use only. The Company increased the number of available sick days to every employee impacted in anyway by COVID-19 and offered financial assistance for any employee with need.
Asset impairment. The Company does not believe that any impairment exists due to COVID-19 to goodwill and other intangible assets, long-lived assets, mortgage servicing rights ("MSRs"), right of use assets, or available-for-sale investment securities at this time. While certain valuation assumptions and judgements will change to account for COVID-19 related circumstances, the Company does not expect significant changes in methodology used to determine the fair value of assets in accordance with GAAP. It is uncertain whether prolonged effects of COVID-19 will result in future impairment charges related to any of these assets.
Capital and liquidity. The Company's and First Mid Bank's capital levels are higher today than during the Great Recession of 2008. The Company could absorb approximately $140 million of total loan losses before capital levels would fall below regulatory levels considered well-capitalized. In comparison, the Company's aggregate net charge offs over the last 20 years was $30.4 million. Current capital levels also support the Company's recent loan stress testing of the most vulnerable industry sectors impacted by COVID-19. The following table shows this loan sector detail.
The following table provides information related to some of the most vulnerable sectors:
Sector Detail
($ in thousands)
% of Loan
Portfolio
LTV
DSCR
Retail
181,745
6.2
1.75x
(Merchandise $79.4 million)
Hotel
120,394
4.1
1.41x
(67% major chains)
Restaurant
78,538
2.7
89
2.02x
(79% franchise/drive-thru/limited service)
Oil Related
5,110
0.2
3.74x
The Company maintains access to multiple sources of liquidity. Currently, the Company's total liquidity sources could provide $1.5 million of total available capacity as of June 30, 2020.
Management's outlook. The Company's current financial position is strong and the fundamental earning capabilities of its currently existing operations is solid. Due to the uncertain economic outlook related to the COVID-19 crisis and the potential for loan losses and other asset impairments, it is anticipated that reserve levels will remain elevated compared to recent historical trends. All processes, procedures and internal controls are expected to continue as outlined in existing applicable policies despite remote working status of many employees. While the Company does not currently anticipate any material changes or deficiencies to its capital or liquidity sources, uncertainties about duration and overall effects on the economy could result in more adverse effects than expected.
Overview
This overview of management’s discussion and analysis highlights selected information in this document and may not contain all the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates which have an impact on the Company’s financial condition and results of operations you should carefully read this entire document.
Net income was $20,136,000 and $24,297,000 for the six months ended June 30, 2020 and 2019, respectively. Diluted net income per common share was $1.20 and $1.45 for the six months ended June 30, 2020 and 2019.
The following table shows the Company’s annualized performance ratios for six months ended June 30, 2020 and 2019, compared to the performance ratios for the year ended December 31, 2019:
Year ended
Return on average assets
0.99
1.26
1.25
Return on average common equity
7.48
9.89
9.49
Average equity to average assets
13.26
12.78
13.17
Total assets were $4.5 billion at June 30, 2020, compared to $3.8 billion as of December 31, 2019. From December 31, 2019 to June 30, 2020, cash and interest-bearing deposits increased $153.4 million, net loan balances increased $494.3 million and investment securities decreased $32.3 million. Net loan balances were $3.16 billion at June 30, 2020 compared to $2.67 billion at December 31, 2019.
Net interest margin, on a tax equivalent basis, defined as net interest income divided by average interest-earning assets, was 3.37% for the six months ended June 30, 2020, down from 3.69% for the same period in 2019. This decrease was primarily due to lower yields on loans and investments. Net interest income before the provision for loan losses was $61.5 million compared to net interest income of $63.6 million for the same period in 2019. The decrease in net interest income was primarily due to the decrease in investment securities balances and lower yields on investments and loans.
Total non-interest income of $30.4 million increased $2.2 million or 7.7% from $28.2 million for the same period last year. The increase in non-interest income resulted primarily from an increase in wealth management revenues, insurance commissions, security gains and mortgage banking revenue, offset by a decline in service charges.
Total non-interest expense of $53.8 million decreased $4.7 million or 8.0% from $58.5 million for the same period last year. The decrease was primarily due to declines in occupancy and equipment expense, FDIC insurance expense, ATM/debit card expense and acquisition costs, offset by an increase in other professional services.
Following is a summary of the factors that contributed to the changes in net income (in thousands):
Change in
Net Income
2020 versus 2019
269
(2,110
(6,045
(10,579
Other income, including securities transactions
2,168
Other expenses
4,089
4,668
546
1,692
Decrease in net income
(844
(4,161
Credit quality is an area of importance to the Company. Total nonperforming loans were $23.1 million at June 30, 2020, compared to $25.8 million at June 30, 2019 and $27.8 million at December 31, 2019. See the discussion under the heading “Loan Quality and Allowance for Loan Losses” for a detailed explanation of these balances. Repossessed asset balances totaled $2.3 million at June 30, 2020 compared to $3.6 million at June 30, 2019 and $3.7 million at December 31, 2019. The Company’s provision for loan losses for the six months ended June 30, 2020 and 2019 was $11,617,000 and $1,038,000, respectively. Total loans past due 30 days or more were 0.55% of loans at June 30, 2020 compared to 1.19% at June 30, 2019, and 1.02% of loans at December 31, 2019. Loans secured by both commercial and residential real estate comprised approximately 63.6% of the loan portfolio as of June 30, 2020 and 67.5% as of December 31, 2019
The Company’s capital position remains strong and the Company has consistently maintained regulatory capital ratios above the “well-capitalized” standards. The Company’s Tier 1 capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at June 30, 2020 and 2019 and December 31, 2019 was 14.07%, 13.92% and 14.79%, respectively. The Company’s total capital to risk weighted assets ratio calculated under the regulatory risk-based capital requirements at June 30, 2020 and 2019, and December 31, 2019 was 15.19%, 14.82% and 15.74%, respectively. The increase in these ratios from December 31, 2018 was primarily due to net income added to retained earnings.
On March 27, 2020, the federal banking regulatory agencies, issued an interim final rule which provided an option to delay the estimated impact on regulatory capital of ASU 2016-13, which was effective January 1, 2020. The initial impact of adoption of ASU 2016-13 as well as 25% of the quarterly increases in the allowance for credit losses subsequent to adoption of ASU 2016-13 ("CECL adjustments") will be delayed for two years. After two years, the cumulative amount of these adjustments will be phased out of the regulatory capital calculation over a three-year period, with 75% of the adjustments included in year three, 50% of the adjustments included in year four and 25% of the adjustments included in year five. After five years, the temporary delay of ASU 2016-13 adoption will be fully reversed. The Company has elected this option.
The Company’s liquidity position remains sufficient to fund operations and meet the requirements of borrowers, depositors, and creditors. The Company maintains various sources of liquidity to fund its cash needs. See the discussion under the heading “Liquidity” for a full listing of sources and anticipated significant contractual obligations.
The Company enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include lines of credit, letters of credit and other commitments to extend credit. The total outstanding commitments at June 30, 2020 and 2019, were $615 million and $538 million, respectively.
Federal Deposit Insurance Corporation Insurance Coverage. As a FDIC-insured institution First Mid Bank is required to pay deposit insurance premium assessments to the FDIC. Several requirements with respect to the FDIC insurance system have affected results, including insurance assessment rates.
On September 30, 2018, the Deposit Insurance Fund Reserve Ratio reached 1.36 percent. Because the reserve ratio exceeded 1.35 percent, two deposit insurance assessment changes occurred under the FDIC regulations:
•
Surcharges on large banks (total consolidated assets of less than $10 billion) ended; the last surcharge on large banks was collected on December 28, 2018.
Small banks (total consolidated assets of less than $10 billion) were awarded assessment credits for the portion of their assets that contributed to the growth in the reserve ratio from 1.15 percent to 1.35 percent, to be applied when the reserve ratio is at least 1.38 percent.
On August 20, 2019, the FDIC Board approved a Notice of Proposed Rulemaking which amended the Small Bank Credits regulation to permit credit usage when the reserve ratio is at least 1.35 percent (rather than 1.38%). Additionally, after eight quarters of credit usage, the FDIC would remit the remaining full nominal value to each bank. Eligible banks were notified in January 24, 2019 with preliminary estimate of their share of small bank assessment credits. First Mid Bank's Small Bank Credit was $931,853. A portion of the credit was applied to the second and third quarter assessments paid in 2019 and the fourth quarter assessment paid in 2020. The remaining credit of approximately $163,700 was applied to the Company's assessment for the first quarter of 2020.
The Company expensed $382,000 and $464,000 for the assessment during the first six months of 2020 and 2019, respectively. In addition to its insurance assessment, through March 29, 2019, each insured bank was subject to quarterly debt service assessments in connection with bonds issued by a government corporation that financed the federal savings and loan bailout. The Company expensed $12,000 during the first three months of 2019 for this assessment,
Basel III. In September 2010, the Basel Committee on Banking Supervision proposed higher global minimum capital standards, including a minimum Tier 1 common capital ratio and additional capital and liquidity requirements. On July 2, 2013, the Federal Reserve Board approved a final rule to implement these reforms and changes required by the Dodd-Frank Act. This final rule was subsequently adopted by the OCC and the FDIC.
The final rule includes new risk-based capital and leverage ratios:
(i) a common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The rule also establishes a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement was being phased in beginning in January 2016 at 0.625% of risk weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital level falls below the buffer amount.
The final rule also makes three changes to the proposed rule of June 2012 that impact the Company. First, the proposed rule would have required banking organizations to include accumulated other comprehensive income (“AOCI”) in common equity tier 1 capital. AOCI includes accumulated unrealized gains and losses on certain assets and liabilities that have not been included in net income. Under existing general risk-based capital rules, most components of AOCI are not included in a banking organization's regulatory capital calculations. The final rule allows community banking organizations to make a one- time election not to include these additional components of AOCI in regulatory capital and instead use the existing treatment under the general risk-based capital rules that excludes most AOCI components from regulatory capital. The Company made this election.
Second, the proposed rule would have modified the risk-weight framework applicable to residential mortgage exposures to require banking organizations to divide residential mortgage exposure into two categories in order to determine the applicable risk weight. The final rule, however, retains the existing treatment for residential mortgage exposures under the general risk- based capital rules.
Third, the proposed rule would have required banking organizations with total consolidated assets of less than $15 billion as of December 31, 2009, such as the Company, to phase out over ten years any trust preferred securities and cumulative perpetual preferred securities from its Tier 1 capital regulatory capital. The final rule, however, permanently grandfathers into Tier 1 capital of depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009 any trust preferred securities or cumulative perpetual preferred stock issued before May 19, 2010.
On March 27, 2020, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency (the "agencies") issued and interim final rule ("IFR") that delays the estimated impact on regulatory capital stemming from the implementation of ASU 2016-13 for a transition period of up to five years ("CECL IFR"). The goal of the CECL IFR is to provide regulatory relief to banking organizations that are required to adopt ASU 2016-13 as of January 1, 2020 in order to allow them to better focus on support lending to credit-worthy households and businesses. The CECL IFR is calibrated to approximate the difference in allowances under ASU 2016-13 relative to the previous incurred loss methodology for the first two years of the transition period. The cumulative difference at the end of the second year of the transition period is then phased into regulatory capital over a three-year transition period. A banking organization's five-year transition period under CECL IFR begins on the date it would have been required to adopt ASU 2016-13 under U.S. GAAP regardless of whether the banking organization uses the statutory relief offered under the CARES Act.
See discussion under the heading "Capital Resources" for a description of the Company's and First Mid Bank's risk-based capital.
Critical Accounting Policies and Use of Significant Estimates
The Company has established various accounting policies that govern the application of U.S. generally accepted accounting principles in the preparation of the Company’s consolidated financial statements. The significant accounting policies of the Company are described in the footnotes to the consolidated financial statements included in the Company’s 2019 Annual Report on Form 10-K. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and assumptions, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.
Investment in Debt and Equity Securities. The Company classifies its investments in debt and equity securities as either held-to-maturity or available-for-sale in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” which was codified into ASC 320. Securities classified as held-to-maturity are recorded at amortized cost. Available-for-sale securities are carried at fair value. Fair value calculations are based on quoted market prices when such prices are available. If quoted market prices are not available, estimates of fair value are computed using a variety of techniques, including extrapolation from the quoted prices of similar instruments or recent trades for thinly traded securities, fundamental analysis, or through obtaining purchase quotes. Due to the subjective nature of the valuation process, it is possible that the actual fair values of these investments could differ from the estimated amounts, thereby affecting the financial position, results of operations and cash flows of the Company. If the estimated value of investments is less than the cost or amortized cost, the Company evaluates whether an event or change in circumstances has occurred that may have a significant adverse effect on the fair value of the investment. If such an event or change has occurred and the Company determines that the impairment is other-than-temporary, a further determination is made as to the portion of impairment that is related to credit loss. The impairment of the investment that is related to the credit loss is expensed in the period in which the event or change occurred. The remainder of the impairment is recorded in other comprehensive income.
Allowance for Credit Losses - Held-to-Maturity Securities. Currently all the Company's held-to-maturity securities are government agency-backed securities for which the risk of loss is minimal. Accordingly, the Company does not record an allowance for credit losses on held-to-maturity securities.
Loans. Loans are reported at amortized cost. Amortized cost is the principal balance outstanding, net of purchase discounts and premiums, fair value hedge accounting adjustments and deferred loan fees and costs. Accrued interest is reported separately and is included in interest receivable in the consolidated balance sheets.
Allowance for Credit Losses - Loans. The Company believes the allowance for credit losses for loans is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of its consolidated financial statements. The allowance for credit losses for loans represents the best estimate of losses inherent in the existing loan portfolio. An estimate of potential losses inherent in the loan portfolio are determined and an allowance for those losses is established by considering factors including historical loss rates, expected cash flows and estimated collateral values. In assessing these factors, the Company uses relevant available information, from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts.
The allowance for credit losses is measured on a collective (pool) basis for non-impaired loans with similar risk characteristics. Historical credit loss experience provides the basis for the estimate of expected credit losses. Adjustments to historical loss information are made for relevant factors to each pool including merger & acquisition activity, economic conditions, changes in policies, procedures & underwriting, and concentrations. The Company estimates the appropriate level of allowance for credit losses for impaired loans by evaluating them separately. A specific allowance is assigned to an impaired loan when expected cash flows or collateral are less than the carrying amount of the loan.
Allowance for Credit Losses - Off-Balance Sheet Credit Exposures. The Company estimates expected credit losses over the contractual period that the Company is exposed to credit risk via a contractual obligation to extend credit, unless the obligation is unconditionally cancellable by the Company. The allowance for credit losses on off-balance sheet credit exposures is included in other liabilities in the consolidated balance sheets.
Other Real Estate Owned. Other real estate owned acquired through loan foreclosure is initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing the fair value when the asset is acquired, the actual fair value of the other real estate owned or foreclosed asset could differ from the original estimate. If it is determined that fair value temporarily declines subsequent to foreclosure, a valuation allowance is recorded through noninterest expense.
Operating costs associated with the assets after acquisition are also recorded as noninterest expense. Gains and losses on the disposition of other real estate owned and foreclosed assets are netted and posted to other noninterest expense.
Mortgage Servicing Rights. The Company has elected to measure mortgage servicing rights under the amortization method. Using this method, servicing rights are amortized in proportion to and over the period of estimated net servicing income. The amortized assets are assessed for impairment based on fair value at each reporting date. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type.
Impairment is recognized through a valuation reserve, to the extent that fair value is less than the carrying amount of the servicing assets. Fair value in excess of the carrying amount of servicing assets is not recognized.
Deferred Income Tax Assets/Liabilities. The Company’s net deferred income tax asset arises from differences in the dates that items of income and expense enter our reported income and taxable income. Deferred tax assets and liabilities are established for these items as they arise. From an accounting standpoint, deferred tax assets are reviewed to determine if they are realizable based on the historical level of taxable income, estimates of future taxable income and the reversals of deferred tax liabilities. In most cases, the realization of the deferred tax asset is based on future profitability. If the Company were to experience net operating losses for tax purposes in a future period, the realization of deferred tax assets would be evaluated for a potential valuation reserve.
Additionally, the Company reviews its uncertain tax positions annually under FASB Interpretation No. 48 (FIN No. 48), “Accounting for Uncertainty in Income Taxes,” codified within ASC 740. An uncertain tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely to be recognized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. A significant amount of judgment is applied to determine both whether the tax position meets the "more likely than not" test as well as to determine the largest amount of tax benefit that is greater than 50% likely to be recognized. Differences between the position taken by management and that of taxing authorities could result in a reduction of a tax benefit or increase to tax liability, which could adversely affect future income tax expense.
44
Impairment of Goodwill and Intangible Assets. Core deposit and customer relationships, which are intangible assets with a finite life, are recorded on the Company’s consolidated balance sheets. These intangible assets were capitalized as a result of past acquisitions and are being amortized over their estimated useful lives of up to 15 years. Core deposit intangible assets, with finite lives will be tested for impairment when changes in events or circumstances indicate that its carrying amount may not be recoverable. Core deposit intangible assets were tested for impairment as of June 30, 2020 as part of the goodwill impairment test and no impairment was identified.
As a result of the Company’s acquisition activity, goodwill, an intangible asset with an indefinite life, is reflected on the consolidated balance sheets. Goodwill is evaluated for impairment annually, unless there are factors present that indicate a potential impairment, in which case, the goodwill impairment test is performed more frequently than annually.
Fair Value Measurements. The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Company estimates the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, the Company estimates fair value. The Company’s valuation methods consider factors such as liquidity and concentration concerns. Other factors such as model assumptions, market dislocations, and unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded.
SFAS No. 157, “Fair Value Measurements”, which was codified into ASC 820, establishes a framework for measuring the fair value of financial instruments that considers the attributes specific to particular assets or liabilities and establishes a three-level hierarchy for determining fair value based on the transparency of inputs to each valuation as of the fair value measurement date.
The three levels are defined as follows:
Level 1 — quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 — inputs include quoted prices for similar assets and liabilities in active markets, quoted prices of identical or similar assets or liabilities in markets that are not active, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 — inputs that are unobservable and significant to the fair value measurement.
At the end of each quarter, the Company assesses the valuation hierarchy for each asset or liability measured. From time to time, assets or liabilities may be transferred within hierarchy levels due to changes in availability of observable market inputs to measure fair value at the measurement date. Transfers into or out of hierarchy levels are based upon the fair value at the beginning of the reporting period. A more detailed description of the fair values measured at each level of the fair value hierarchy can be found in Note 7 – Fair Value of Assets and Liabilities.
Results of Operations
Net Interest Income
The largest source of revenue for the Company is net interest income. Net interest income represents the difference between total interest income earned on earning assets and total interest expense paid on interest-bearing liabilities. The amount of interest income is dependent upon many factors, including the volume and mix of earning assets, the general level of interest rates and the dynamics of changes in interest rates. The cost of funds necessary to support earning assets varies with the volume and mix of interest-bearing liabilities and the rates paid to attract and retain such funds.
Net interest income is the excess of interest received from earning assets over interest paid on interest-bearing liabilities. For analytical purposes, net interest income is presented on a full tax equivalent ("TE") basis in the table that follows. The federal statutory rate in effect of 21% for 2020 and 2019 was used. The TE analysis portrays the income tax benefits associated with the tax-exempt assets. The year-to-date net yield on interest-earning assets excluding the TE adjustments of 1,056,000 and 1,085,000 for 2020 and 2019, respectively were 3.31% and 3.63% at June 30, 2020 and June 30, 2019.
The Company’s average balances, fully tax equivalent interest income and interest expense, and rates earned or paid for major balance sheet categories are set forth for the three and six months ended June 30, 2020 and 2019 in the following table (dollars in thousands):
Rate
Interest-bearing deposits with other financial
institutions
152,090
0.15
81,986
2.72
0.00
708
2.27
4,154
2.03
6,736
2.20
Taxable
507,466
2,751
2.17
632,548
4,094
Tax-exempt (1)
182,585
1,678
184,838
1,699
Loans net of unearned income (TE) (2)
3,095,468
31,566
4.10
2,563,960
31,719
4.96
Total earning assets
3,942,832
36,071
3,470,776
38,108
4.40
80,492
74,459
Premises and equipment
59,155
59,407
254,386
248,349
(36,215
(27,165
4,300,650
3,825,826
Liabilities and Stockholders' Equity
Interest-bearing deposits
Demand deposits
1,464,173
697
0.19
1,284,511
1,645
0.51
Savings deposits
465,281
98
0.08
442,772
0.14
Time deposits
541,413
2,310
1.72
658,723
3,140
1.91
Total Interest bearing deposits
2,470,867
2,386,006
0.83
301,810
0.21
153,872
0.56
FHLB advances
114,368
1.78
108,044
2.58
Federal funds purchased
115
3.49
Junior subordinated debt
18,915
3.70
29,056
5.60
Other debt
1,868
2.37
Total borrowings
436,961
848
0.78
291,637
1.81
Total interest-bearing liabilities
2,907,828
0.55
2,677,643
0.94
Non interest-bearing demand deposits
799,332
0.43
606,170
0.76
50,804
43,136
Stockholders' equity
542,686
498,877
Total liabilities & equity
32,118
31,850
Net interest spread
3.13
3.46
Impact of non interest-bearing funds
0.12
0.18
TE Net yield on interest-bearing assets
3.25
3.64
The tax-exempt income is shown on a tax equivalent basis.
Nonaccrual loans and loans held for sale are included in the average balances. Balances are net of unaccreted discount related to loans acquired.
87,957
0.34
97,019
998
0.50
4,609
7,040
2.15
525,981
6,090
2.32
594,788
7,905
2.66
178,173
3,260
3.66
200,517
2,899,259
61,781
4.29
2,593,226
63,999
4.98
3,696,977
71,332
3.88
3,493,276
76,707
4.42
86,888
69,422
59,316
59,385
252,872
248,674
(33,102
(26,991
4,062,951
3,843,766
1,364,331
1,789
0.26
1,309,927
3,267
450,381
217
0.10
439,694
555,773
4,960
1.79
639,656
5,744
Total Interest-bearing deposits
2,370,485
0.59
2,389,277
0.79
252,252
0.28
168,090
0.57
117,257
1.86
113,870
2.51
1,055
3.48
18,894
4.17
29,035
5.86
1,319
2.44
3,680
390,777
1,855
0.95
314,733
2,739
1.75
2,761,262
0.64
2,704,010
0.90
713,960
605,735
0.73
49,022
42,882
538,707
491,139
62,511
64,650
3.24
3.52
0.13
0.17
TE Net yield on interest-earning assets
3.37
3.69
Changes in net interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table summarizes the approximate relative contribution of changes in average volume and interest rates to changes in net interest income for the three and six months ended June 30, 2020, compared to the same period in 2019 (in thousands):
compared to 2019 Increase / (Decrease)
Change
Volume (1)
Rate (1)
Earning Assets:
(500
1,764
(2,264
(1,105
(107
(998
(4
(13
(5
(11
(3
(23
(34
(1,343
(738
(605
(1,815
(862
(953
Tax-exempt (2)
(21
(209
(402
Loans (2) (3)
23,931
(24,084
(2,218
15,440
(17,658
(2,037
24,932
(26,969
(5,375
14,041
(19,416
Interest-Bearing Liabilities:
(948
(2,273
(1,478
383
(1,861
(57
(108
(90
(111
(830
(533
(297
(784
(723
(61
618
(675
(123
(545
244
(435
(334
(452
Federal Funds Purchased
(232
(118
(114
(247
(205
(2,305
1,597
(3,902
(3,236
(3,221
23,335
(23,067
(2,139
14,056
(16,195
Changes attributable to the combined impact of volume and rate have been allocated proportionately to the change due to volume and the change due to rate.
The tax-exempt income is shown on a tax-equivalent basis.
Nonaccrual loans have been included in the average balances.
Tax equivalent net interest income decreased $2.1 million, or, to 3.3%, to $62.5 million for the six months ended June 30, 2020, from $64.7 million for the same period in 2019. Net interest income decreased primarily due to a decline in investment balances and decrease in rates on investments and loans. The net interest margin decreased primarily due to a lower interest rates on loans and investments.
For the six months ended June 30, 2020, average earning assets increased $203.7 million, or 5.8%, and average interest-bearing liabilities increased $57.3 million or 2.1%, compared with average balances for the same period in 2019.
The changes in average balances for these periods are shown below:
Average interest-bearing deposits with other financial institutions decreased $9.1 million or 9.3%.
Average federal funds sold increased $0.3 million or 45.5%.
Average certificates of deposits investments decreased $2.4 million or 34.5%
Average loans increased by $306 million or 11.8%.
Average securities decreased by $91.2 million or 11.5%.
Average interest-bearing customer deposits decreased by $18.8 million or 0.8%.
Average securities sold under agreements to repurchase increased by $84.2 million or 50.1%.
Average borrowings and other debt decreased by $8.1 million or 5.5%.
Net interest margin decreased to 3.37% for the first six months of 2020 from 3.69% for the first six months of 2019.
Provision for Loan Losses
The provision for loan losses for the six months ended June 30, 2020 and 2019 was $11,617,000 and $1,038,000, respectively. The increase in provision expense was primarily due to a one-time adjustment for the adoption of ASU 2016-13 $1.7 million and an increase in expected losses due to impacts of COVID-19. Net charge-offs were $1,819,000 for the six months ended June 30, 2020, compared to net charge offs of $868,000 for June 30, 2019. Nonperforming loans were $23.1 million and $25.8 million as of June 30, 2020 and 2019, respectively. For information on loan loss experience and nonperforming loans, see discussion under the “Nonperforming Loans” and “Loan Quality and Allowance for Loan Losses” sections below.
Other Income
An important source of the Company’s revenue is other income. The following table sets forth the major components of other income for the three and six months ended June 30, 2020 and 2019 (in thousands):
$ Change
% Change
240
6.7
221
3.1
328
8.7
15.0
(848
-43.3
(872
-23.2
Security gains, net
31.7
200.7
890
257.2
163.9
1.7
(19
-4.3
(18
-2.1
(400
-37.4
(70
-3.6
2.2
7.7
Following are explanations of the changes in these other income categories for the three months ended June 30, 2020 compared to the same period in 2019:
Wealth management revenues increased due to an increase in farm real estate brokerage fees offset by declines in other market-based fees.
Insurance commissions increased due to an increase in contract bond revenue offset by less commission and contingency income for the period compared to the same period last year.
Fees from service charges decreased due to a decline in overdraft fees primarily resulting from increased assistance related to COVID-19 such as stimulus payments and increased unemployment benefits and less spending during the shelter-in-place period.
Gains from the sale of securities during the second quarter of 2020 was similar compared to the same period last year.
The increase in mortgage banking income was due to an increase in mortgage refinancing activity and fees from loans sold in the secondary market. Loans sold balances were as follows:
$65.7 million (representing 419 loans) for the
$22.0 million (representing 168 loans) for the three months ended June 30, 2019
First Mid Bank generally releases the servicing rights on loans sold into the secondary market.
Revenue from ATMs and debit cards remained similar to the same period last year.
Bank owned life insurance income decreased due to a slight decline in the change in cash surrender value compared to the same period last year.
Other income declined primarily due an increase in waived fees and decreases in fees charged compared to the same period last year.
49
Following are explanations of the changes in these other income categories for the six months ended June 30, 2020 compared to the same period in 2019:
Insurance commissions increased primarily due to increases in contract bond revenue and contingency income.
Sale of securities resulted in greater net securities gains compared to the same period last year primarily due to an increase in called securities during the first quarter of 2020 resulting from the decline in interest rates.
$86.3 million (representing 570 loans) for the six months ended June 30, 2020
$34.4 million (representing 270 loans) for the six months ended June 30, 2019
Other income declined primarily due an increase in waived fees and decreases in fees charged and activity from First Mid Captive that did not occur in the same period last year, offset by fee income received from derivatives transactions.
Other Expense
The following table sets forth the major components of other expense for the three and six months ended June 30, 2020 and 2019 (in thousands):
(110
-0.7
-0.6
-8.8
(615
-6.8
-101.1
(289
-119.9
46.7
-19.7
-29.2
(594
-18.7
4.2
(8
-1.5
14.2
389
15.6
(167
-34.7
(140
-15.0
ATM/debit card expense
(555
-66.9
(753
0.0
Other operating expenses
(2,420
-48.5
(2,380
-30.3
(4,089
-13.5
(4,668
-8.0
Following are explanations for the changes in these other expense categories for the three months ended June 30, 2020 compared to the same period in 2019:
The decrease in salaries and employee benefits, the largest component of other expense, is primarily due to an increase in deferred loan origination costs, offset by increases for merit raises and applicable payroll taxes, incentive compensation and employee group insurance costs. There were 828 and 826 full-time equivalent employees at June 30, 2020 and 2019, respectively. June 30, 2020 2019
The decrease in occupancy and equipment expense was due to expenses resulting from closure of branches during the same period last year and a decrease in rent and maintenance expenses in the current year period due to these closures.
50
The decrease in net other real estate owned expense was primarily due to more gains on properties sold during 2020 than properties sold during 2019 and a decrease in property maintenance expense due to less properties currently owned.
Expense for amortization of intangible assets decreased due to less amortization for core deposit intangibles and a decrease in the amount of mortgage servicing rights impairment reserve recorded. three months ended June 30, 2020 and 2019
The decline in other operating expenses was primarily due to decreases in loan collection expense and acquisition costs offset by an increase in data processing costs and dealer referral fees.
On a net basis, all other categories of operating expenses increased slightly during the period compared to last year. The increase is primarily due to an increase in legal and professional expenses offset by a decrease in marketing and promotion expense.
Following are explanations for the changes in these other expense categories for the six months ended June 30, 2020 compared to the same period in 2019:
The decrease in salaries and employee benefits, the largest component of other expense, is primarily due to a decrease in bonus accrual due to lower expected achievement and an increase in deferred loan origination costs, offset by increases for merit raises and applicable payroll taxes and incentive compensation. There were 828 and 826 full-time equivalent employees at June 30, 2020 and 2019, respectively. June 30, 2020 2019
Expense for amortization of intangible assets decreased due to less amortization for core deposit intangibles and a decrease in the amount of mortgage servicing rights impairment reserve recorded. six months ended June 30, 2020 and 2019
On a net basis, all other categories of operating expenses increased primarily due an increase in legal and professional expenses offset by a Small Bank Assessment credit from the FDIC and a decrease in marketing and promotion expenses.
Income Taxes
Total income tax expense amounted to $6.3 million (23.7% effective tax rate) for the six months ended June 30, 2020, compared to $8.0 million (24.7% effective tax rate) for the same period in 2019.
The Company files U.S. federal and state of Illinois, Indiana, and Missouri income tax returns. The Company is no longer subject to U.S. federal or state income tax examinations by tax authorities for years before 2017.
Analysis of Balance Sheets
The Company’s overall investment objectives are to insulate the investment portfolio from undue credit risk, maintain adequate liquidity, insulate capital against changes in market value and control excessive changes in earnings while optimizing investment performance. The types and maturities of securities purchased are primarily based on the Company’s current and projected liquidity and interest rate sensitivity positions. The following table sets forth the amortized cost of the available-for-sale and held-to-maturity securities as of June 30, 2020 and December 31, 2019 (dollars in thousands)
Average Yield
88,009
1.85
175,970
2.39
2.92
2.98
7,841
4.93
4,028
3.44
Total securities
699,145
743,765
2.83
At June 30, 2020, the Company’s investment portfolio decreased by $44.6 million from December 31, 2019 primarily due to an increase in called securities following declines in interest rates. When purchasing investment securities, the Company considers its overall liquidity and interest rate risk profile, as well as the adequacy of expected returns relative to the risks assumed.
The table below presents the credit ratings as of June 30, 2020 for certain investment securities (in thousands):
Average Credit Rating of Fair Value at June 30, 2020 (1)
AAA
AA +/-
A +/-
BBB +/-
< BBB -
Not rated
U.S. Treasury securities and
obligations of U.S. government
Obligations of state and political
subdivisions
20,082
131,711
46,656
2,248
Mortgage-backed securities (2)
1,087
424,587
21,169
205,610
433,677
Equity securities:
Federal Agricultural Mtg Corp
Credit ratings reflect the lowest current rating assigned by a nationally recognized credit rating agency.
Mortgage-backed securities include mortgage-backed securities (MBS) and collateralized mortgage obligation (CMO) issues from the following government sponsored enterprises: FHLMC, FNMA, GNMA and FHLB. While MBS and CMOs are no longer explicitly rated by credit rating agencies, the industry recognizes that they are backed by agencies which have an implied government guarantee.
Other-than-temporary Impairment of Securities
Declines in the fair value, or unrealized losses, of all available for sale investment securities, are reviewed to determine whether the losses are either a temporary impairment or OTTI. Temporary adjustments are recorded when the fair value of a security fluctuates from its historical cost. Temporary adjustments are recorded in accumulated other comprehensive income and impact the Company’s equity position. Temporary adjustments do not impact net income. A recovery of available for sale security prices also is recorded as an adjustment to other comprehensive income for securities that are temporarily impaired, and results in a positive impact to the Company’s equity position.
OTTI is recorded when the fair value of an available for sale security is less than historical cost, and it is probable that all contractual cash flows will not be collected. Investment securities are evaluated for OTTI on at least a quarterly basis. In conducting this assessment, the Company evaluates a number of factors including, but not limited to:
how much fair value has declined below amortized cost;
how long the decline in fair value has existed;
the financial condition of the issuers;
contractual or estimated cash flows of the security;
underlying supporting collateral;
past events, current conditions and forecasts;
significant rating agency changes on the issuer; and
the Company’s intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.
If the Company intends to sell the security or if it is more likely than not the Company will be required to sell the security before recovery of its amortized cost basis, the entire amount of OTTI is recorded to noninterest income, and therefore, results in a negative impact to net income. Because the available for sale securities portfolio is recorded at fair value, the conclusion as to whether an investment decline is other-than-temporarily impaired, does not significantly impact the Company’s equity position, as the amount of the temporary adjustment has already been reflected in accumulated other comprehensive income/loss.
If the Company does not intend to sell the security and it is not more-likely-than-not it will be required to sell the security before recovery of its amortized cost basis, only the amount related to credit loss is recognized in earnings. In determining the portion of OTTI that is related to credit loss, the Company compares the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. The remaining portion of OTTI, related to other factors, is recognized in other comprehensive earnings, net of applicable taxes.
The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value are not necessarily favorable, or that there is a general lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. See Note 3 -- Investment Securities in the Notes to Condensed Consolidated Financial Statements (unaudited) for a discussion of the Company’s evaluation and subsequent charges for OTTI.
The loan portfolio is the largest category of the Company’s earning assets. The following table summarizes the composition of the loan portfolio at amortized cost, including loans held for sale, as of June 30, 2020 and December 31, 2019 (in thousands):
% Outstanding
5.6
7.8
8.9
10.7
12.5
4.4
5.7
35.1
36.9
63.6
67.5
4.6
5.1
25.3
19.6
2.6
3.9
4.7
100.0
Loan balances increased $509.9 million, or 18.9%. The balance of real estate loans held for sale, included in the balances shown above, amounted to $6.0 million and $1.8 million as of June 30, 2020 and December 31, 2019, respectively.
Commercial and commercial real estate loans generally involve higher credit risks than residential real estate and consumer loans. Because payments on loans secured by commercial real estate or equipment are often dependent upon the successful operation and management of the underlying assets, repayment of such loans may be influenced to a great extent by conditions in the market or the economy. The Company does not have any sub-prime mortgages or credit card loans outstanding which are also generally considered to be higher credit risk.
The following table summarizes the loan portfolio geographically by branch region as of June 30, 2020 and December 31, 2019 (dollars in thousands):
balance
loans
Central region
630,677
19.7
568,256
21.1
Sullivan region
419,916
13.1
404,169
Decatur region
695,217
21.7
602,716
22.3
Peoria region
545,280
17.0
443,526
16.5
Highland region
828,552
25.8
547,156
20.3
Southern region
85,620
129,524
4.8
Total all regions
Loans are geographically dispersed among these regions located in central and southwestern Illinois. While these regions have experienced some economic stress during 2020 and 2019, the Company does not consider these locations high risk areas since these regions have not experienced the significant declines in real estate values seen in some other areas in the United States.
The Company does not have a concentration, as defined by the regulatory agencies, in construction and land development loans or commercial real estate loans as a percentage of total risk-based capital for the periods shown above. At June 30, 2020 and December 31, 2019, the Company did have industry loan concentrations in excess of 25% of total risk-based capital in the following industries (dollars in thousands):
Other grain farming
330,452
10.31
301,469
11.18
Lessors of non-residential buildings
401,458
12.52
300,611
11.15
Lessors of residential buildings & dwellings
293,677
9.16
284,378
10.55
Other gambling industries
124,881
3.90
90,429
3.36
Hotels and motels
126,472
3.95
120,735
4.48
Nursing care facilities (skilled nursing)
117,430
92,452
3.43
The concentration of nursing care facilities was less than 25% of total risk-based capital as of December 31, 2019 however is shown for comparative purposes. The Company had no further industry loan concentrations in excess of 25% of total risk- based capital.
The following table presents the balance of loans outstanding as of June 30, 2020, by contractual maturities (in thousands):
Maturity (1)
or less(2)
Over 1 through
Over 5
years
41,759
67,998
71,177
26,273
72,509
152,600
23,072
68,823
250,141
16,957
73,652
50,406
115,257
490,968
517,315
223,318
773,950
1,041,639
115,380
28,521
5,142
189,921
543,508
77,740
6,835
60,396
14,853
18,600
30,504
74,955
554,054
1,436,879
1,214,329
Based upon remaining contractual maturity.
Includes demand loans, past due loans and overdrafts.
As of June 30, 2020, loans with maturities over one year consisted of approximately $1.9 billion in fixed rate loans and approximately $775 million in variable rate loans. The loan maturities noted above are based on the contractual provisions of the individual loans. The Company has no general policy regarding renewals and borrower requests, which are handled on a case-by-case basis.
Nonperforming Loans and Nonperforming Other Assets
Nonperforming loans include: (a) loans accounted for on a nonaccrual basis; (b) accruing loans contractually past due ninety days or more as to interest or principal payments; and (c) loans not included in (a) and (b) above which are defined as “troubled debt restructurings”. Repossessed assets include primarily repossessed real estate and automobiles.
The Company’s policy is to discontinue the accrual of interest income on any loan for which principal or interest is ninety days past due. The accrual of interest is discontinued earlier when, in the opinion of management, there is reasonable doubt as to the timely collection of interest or principal. Once interest accruals are discontinued, accrued but uncollected interest is charged against current year income. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Nonaccrual loans are returned to accrual status when, in the opinion of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal.
Restructured loans are loans on which, due to deterioration in the borrower’s financial condition, the original terms have been modified in favor of the borrower or either principal or interest has been forgiven. Repossessed assets represent property acquired as the result of borrower defaults on loans. These assets are recorded at estimated fair value, less estimated selling costs, at the time of foreclosure or repossession. Write-downs occurring at foreclosure are charged against the allowance for loan losses. On an ongoing basis, properties are appraised as required by market indications and applicable regulations.
Write-downs for subsequent declines in value are recorded in non-interest expense in other real estate owned along with other expenses related to maintaining the properties.
The following table presents information concerning the aggregate amount of nonperforming loans and repossessed assets at June 30, 2020 and December 31, 2019 (in thousands):
Nonaccrual loans
Restructured loans which are performing in accordance with revised terms
2,700
Total nonperforming loans
23,096
27,818
Repossessed assets
2,301
3,720
Total nonperforming loans and repossessed assets
25,397
31,538
Nonperforming loans to loans, before allowance for loan losses
0.72
1.03
Nonperforming loans and repossessed assets to loans, before allowance for loan losses
1.17
The $4,678,000 decrease in nonaccrual loans during 2020 resulted from the net of $3,878,000 of loans put on nonaccrual status offset by $6,294,000 of loans becoming current or paid-off, $205,000 of loans transferred to other real estate and $2,059,000 of loans charged off. The following table summarizes the composition of nonaccrual loans (in thousands):
% of Total
1.8
1.9
35.7
29.3
Multifamily Residential properties
11.0
21.6
17.3
70.3
61.2
23.6
33.6
2.0
2.1
Interest income that would have been reported if nonaccrual and restructured loans had been performing totaled $1,044,000 and $1,335,000 for the three months ended June 30, 2020 and 2019, respectively.
The $1,419,000 decrease in repossessed assets during the first six months of 2020 resulted from $222,000 of additional assets repossessed and $1,641,000 of repossessed assets sold. The following table summarizes the composition of repossessed assets (in thousands):
62.7
1,826
49.1
1-4 family residential properties
1,024
27.6
Multi-family residential properties
3.6
Total real estate
98.0
—%
76
Total repossessed collateral
Repossessed assets sold during the first six months of 2020 resulted in net gains of $157,000, of which $174,000 of net gains was related to real estate asset sales and $17,000 of net losses was related to other repossessed assets. Repossessed assets sold during the same period in 2019 resulted in net losses of $63,000, of which $77,000 of net losses was related to real estate asset sales and $14,000 of net gains was related to other repossessed assets.
Loan Quality and Allowance for Credit Losses
The allowance for credit losses represents management’s estimate of the reserve necessary to adequately account for probable losses existing in the current portfolio. The provision for loan losses is the charge against current earnings that is determined by management as the amount needed to maintain an adequate allowance for loan losses. In determining the adequacy of the allowance for loan losses, and therefore the provision to be charged to current earnings, management relies predominantly on a disciplined credit review and approval process that extends to the full range of the Company’s credit exposure. The review process is directed by overall lending policy and is intended to identify, at the earliest possible stage, borrowers who might be facing financial difficulty. Factors considered by management in evaluating the overall adequacy of the allowance include a migration analysis of the historical net loan losses by loan segment, the level and composition of nonaccrual, past due and renegotiated loans, trends in volumes and terms of loans, effects of changes in risk selection and underwriting standards or lending practices, lending staff changes, concentrations of credit, industry conditions and the current economic conditions in the region where the Company operates.
Management reviews economic factors including the potential for reduced cash flow for commercial operating loans from reduction in sales or increased operating costs, decreased occupancy rates for commercial buildings, reduced levels of home sales for commercial land developments, the uncertainty regarding grain prices, increased operating costs for farmers, and increased levels of unemployment and bankruptcy impacting consumer’s ability to pay. Each of these economic uncertainties was taken into consideration in developing the level of the reserve. Management considers the allowance for loan losses a critical accounting policy.
Management recognizes there are risk factors that are inherent in the Company’s loan portfolio. All financial institutions face risk factors in their loan portfolios because risk exposure is a function of the business. The Company’s operations (and therefore its loans) are concentrated in east central Illinois, an area where agriculture is the dominant industry. Accordingly, lending and other business relationships with agriculture-based businesses are critical to the Company’s success. At June 30, 2020, the Company’s loan portfolio included $400.8 million of loans to borrowers whose businesses are directly related to agriculture. Of this amount, $330.5 million was concentrated in other grain farming. Total loans to borrowers whose businesses are directly related to agriculture increased $24.4 million from $376.4 million at December 31, 2019 while loans concentrated in other grain farming increased $29.0 million from $301.5 million at December 31, 2019. While the Company adheres to sound underwriting practices, including collateralization of loans, any extended period of low commodity prices, drought conditions, significantly reduced yields on crops and/or reduced levels of government assistance to the agricultural industry could result in an increase in the level of problem agriculture loans and potentially result in loan losses within the agricultural portfolio. In addition, the Company has $126.5 million of loans to motels and hotels. The performance of these loans is dependent on borrower specific issues as well as the general level of business and personal travel within the region. While the Company adheres to sound underwriting standards, a prolonged period of reduced business or personal travel could result in an increase in nonperforming loans to this business segment and potentially in loan losses. The Company also has $401.5 million of loans to lessors of non-residential buildings, $293.7 million of loans to lessors of residential buildings and dwellings, and $124.9 million of loans to other gambling industries.
The structure of the Company’s loan approval process is based on progressively larger lending authorities granted to individual loan officers, loan committees, and ultimately the Board of Directors. Outstanding balances to one borrower or affiliated borrowers are limited by federal regulation; however, limits well below the regulatory thresholds are generally observed. Most of the Company’s loans are to businesses located in the geographic market areas served by the Company’s branch bank system. Additionally, a significant portion of the collateral securing the loans in the portfolio is located within the Company’s primary geographic footprint. In general, the Company adheres to loan underwriting standards consistent with industry guidelines for all loan segments.
The Company minimizes credit risk by adhering to sound underwriting and credit review policies. Management and the board of directors of the Company review these policies at least annually. Senior management is actively involved in business development efforts and the maintenance and monitoring of credit underwriting and approval. The loan review system and controls are designed to identify, monitor and address asset quality problems in an accurate and timely manner. The board of directors and management review the status of problem loans each month and formally determine a best estimate of the allowance for loan losses on a quarterly basis. In addition to internal policies and controls, regulatory authorities periodically review asset quality and the overall adequacy of the allowance for loan losses.
57
Analysis of the allowance for credit losses as of June 30, 2020 and 2019, and of changes in the allowance for the three and six months ended June 30, 2020 and 2019, is as follows (dollars in thousands):
Average loans outstanding, net of unearned income
2,703,051
Allowance-prior year end of period
Adjustment for adoption of ASU 2013-16
Allowance - beginning of period
Charge-offs:
1-4 Family residential
484
Total charge-offs
Recoveries:
1-4 Family Residential
202
Total recoveries
Net charge-offs (recoveries)
631
436
1,819
Allowance-end of period
Ratio of annualized net charge-offs to average loans
0.09
0.07
Ratio of allowance for credit losses to loans outstanding (at amortized cost)
1.04
Ratio of allowance for credit losses to nonperforming loans
166
102
The ratio of allowance for credit losses to loans outstanding was 1.20% as of June 30, 2020 compared to 1.04% as of June 30, 2019. Excluding the fully guaranteed PPP loans, the ratio of allowance for credit losses to loans outstanding was 1.30% as of June 30, 2020. The ratio of the allowance for credit losses to nonperforming loans is 166% as of June 30, 2020 compared to 102% as of June 30, 2019. The increase in this ratio is primarily due to the increase in the allowance for credit losses and a decline in nonperforming loans at June 30, 2020 compared to June 30, 2019. The increase in allowance for credit losses is primarily due to the impacts of COVID-19 on the operations and earnings of borrowers, as well as, increases in loan balances and net charge offs.
During the first six months of 2020, the Company had net charge-offs of $1,819,000 compared to net charge-offs of $868,000 in 2019. During the first six months of 2020, there were significant charge-offs of four commercial real estate loans to three borrowers totaling $482,000 and four commercial loans to a single borrower totaling $1.1 million. During the first six months of 2019, there was one significant charge off of one commercial real estate loan to a single borrower of $105,000.
Funding of the Company’s earning assets is substantially provided by a combination of consumer, commercial and public fund deposits. The Company continues to focus its strategies and emphasis on retail core deposits, the major component of funding sources. The following table sets forth the average deposits and weighted average rates for the six months ended June 30, 2020 and 2019 and for the year ended December 31, 2019 (dollars in thousands):
Demand deposits:
Non-interest-bearing
608,106
Interest-bearing
1,303,814
Savings
437,549
630,369
1.88
Total average deposits
3,084,445
0.45
2,995,012
0.63
2,979,838
The following table sets forth the high and low month-end balances for the six months ended June 30, 2020 and 2019 and for the year ended December 31, 2019 (in thousands):
High month-end balances of total deposits
3,046,212
Low month-end balances of total deposits
2,873,260
2,961,660
During the first six months of 2020, the average balance of deposits increased by $104.6 million from the average balance for the year ended December 31, 2019. Average non-interest-bearing deposits increased by $105.9 million, average interest- bearing balances increased by $60.5 million, savings account balances increased $12.8 million and balances of time deposits decreased $74.6 million.
Balances of time deposits of $100,000 or more include time deposits maintained for public fund entities and consumer time deposits. The following table sets forth the maturity of time deposits of $100,000 or more at June 30, 2020 and December 31, 2019 (in thousands):
3 months or less
64,410
81,910
Over 3 through 6 months
50,051
55,495
Over 6 through 12 months
106,808
95,725
Over 12 months
95,211
107,861
316,480
340,991
Repurchase Agreements and Other Borrowings
Securities sold under agreements to repurchase are short-term obligations of First Mid Bank. These obligations are collateralized with certain government securities that are direct obligations of the United States or one of its agencies. These retail repurchase agreements are offered as a cash management service to its corporate customers. Other borrowings consist of Federal Home Loan Bank (“FHLB”) advances, federal funds purchased, loans (short-term or long-term debt) that the Company has outstanding and junior subordinated debentures. Information relating to securities sold under agreements to repurchase and other borrowings as of June 30, 2020 and December 31, 2019 is presented below (dollars in thousands):
Federal Home Loan Bank advances:
Fixed term – due in one year or less
23,939
39,000
Fixed term – due after one year
80,000
74,895
Fed funds
473,169
345,862
Average interest rate at end of period
1.08
Maximum outstanding at any month-end:
FHLB-Overnight
25,000
59,904
66,000
8,000
Debt due in one year or less
Debt due after one year
6,549
29,126
Averages for the period (YTD):
169,437
FHLB-overnight
3,681
7,148
29,894
63,151
83,681
39,331
616
Loans due in one year or less
Loans due after one year
1,825
26,649
390,776
308,157
Average interest rate during the period
1.66
60
Securities sold under agreements to repurchase increase $142.2 million during the first six months of 2020 primarily due to the cash flow needs of various customers. FHLB advances represent borrowings by First Mid Bank to economically fund loan demand. At June 30, 2020 the fixed term advances consisted of $104 million as follows:
The Company is party to a revolving credit agreement with The Northern Trust Company in the amount of $15 million. There was no balance on this line of credit as of June 30, 2020. This loan was renewed on April 10, 2020 for one year as a revolving credit agreement. At the time of the renewal, the maximum available balance was increased to $15 million from $10 million. The interest rate is floating at 2.25% over the federal funds rate. The loan is secured by all of the stock of First Mid Bank. The Company and First Mid Bank were in compliance with the then existing covenants at June 30, 2020 and 2019, and December 31, 2019.
On February 27, 2004, the Company completed the issuance and sale of $10 million of floating rate trust preferred securities through First Mid-Illinois Statutory Trust I (“Trust I”), a statutory business trust and wholly owned unconsolidated subsidiary of the Company, as part of a pooled offering. On October 7, 2019, these trust preferred securities were redeemed, along with $310,000 in common securities issued by Trust I and held by the Company, as a result of the concurrent redemption of 100% of the Company's junior subordinated debentures due 2034 and held by Trust I, which supported the trust preferred securities. The redemption price for the junior subordinated debentures was equal to 100% of the principal amount plus accrued interest, if any, up to, but not including, the redemption date of October 7, 2019. The proceeds from the redemption of the junior subordinated debentures were simultaneously applied to redeem all of the outstanding common securities and the outstanding trust preferred securities at a price of 100% of the aggregate liquidation amount of the trust preferred securities plus accumulated but unpaid distributions up to but not including the redemption date. The redemption was made pursuant to the optional redemption provisions of the underlying indenture.
On April 26, 2006, the Company completed the issuance and sale of $10 million of fixed/floating rate trust preferred securities through First Mid-Illinois Statutory Trust II (“Trust II”), a statutory business trust and wholly owned unconsolidated subsidiary of the Company, as part of a pooled offering. The Company established Trust II for the purpose of issuing the trust preferred securities. The $10 million in proceeds from the trust preferred issuance and an additional $310,000 for the Company’s investment in common equity of Trust II, a total of $10,310 000, was invested in junior subordinated debentures of the Company. The underlying junior subordinated debentures issued by the Company to Trust II mature in 2036, bore interest at a fixed rate of 6.98% paid quarterly until June 15, 2011 and then converted to floating rate (LIBOR plus 160 basis points, 1.91% and 3.49% at June 30, 2020 and December 31, 2019, respectively). The net proceeds to the Company were used for general corporate purposes, including the Company’s acquisition of Mansfield Bancorp, Inc. in 2006.
On September 8, 2016, the Company assumed the trust preferred securities of Clover Leaf Statutory Trust I (“CLST I”), a statutory business trust that was a wholly owned unconsolidated subsidiary of First Clover Financial. The $4,000,000 of trust preferred securities and an additional $124,000 additional investment in common equity of CLST I, is invested in junior subordinated debentures issued to CLST I. The subordinated debentures mature in 2025, bear interest at three-month LIBOR plus 185 basis points (2.16% and 3.74% at June 30, 2020 and December 31, 2019, respectively) and resets quarterly.
On May 1, 2018, the Company assumed the trust preferred securities of FBTC Statutory Trust I (“FBTCST I”), a statutory business trust that was a wholly owned unconsolidated subsidiary of First BancTrust Corporation. The $6,000,000 of trust preferred securities and an additional $186,000 additional investment in common equity of FBTCST I is invested in junior subordinated debentures issued to FBTCST I. The subordinated debentures mature in 2035, bear interest at three-month LIBOR plus 170 basis points (2.01% and 3.59% at June 30, 2020 and December 31, 2019, respectively) and resets quarterly.
The trust preferred securities issued by Trust I (prior to redemption), Trust II, CLST I and FBTCST I are included as Tier 1 capital of the Company for regulatory capital purposes. On March 1, 2005, the Federal Reserve Board adopted a final rule that allows the continued limited inclusion of trust preferred securities in the calculation of Tier 1 capital for regulatory purposes. The final rule provided a five-year transition period, ending September 30, 2010, for application of the revised quantitative limits. On March 17, 2009, the Federal Reserve Board adopted an additional final rule that delayed the effective date of the new limits on inclusion of trust preferred securities in the calculation of Tier 1 capital until March 31, 2012. The application of the revised quantitative limits did not and is not expected to have a significant impact on its calculation of Tier 1 capital for regulatory purposes or its classification as well-capitalized. The Dodd-Frank Act, signed into law July 21, 2010, removes trust preferred securities as a permitted component of a holding company’s Tier 1 capital after a three-year phase-in period beginning January 1, 2013 for larger holding companies. For holding companies with less than $15 billion in consolidated assets, existing issues of trust preferred securities are grandfathered and not subject to this new restriction.
Similarly, the final rule implementing the Basel III reforms allows holding companies with less than $15 billion in consolidated assets as of December 31, 2009 to continue to count toward Tier 1 capital any trust preferred securities issued before May 19, 2010. New issuances of trust preferred securities, however, would not count as Tier 1 regulatory capital.
In addition to requirements of the Dodd-Frank Act discussed above, the act also required the federal banking agencies to adopt certain rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). This rule is generally referred to as the “Volcker Rule.” The rules permit the retention of an interest in or sponsorship of covered funds by banking entities under $15 billion in assets (such as the Company) if (1) the collateralized debt obligation was established and issued prior to May 19, 2010, (2) the banking entity reasonably believes that the offering proceeds received by the collateralized debt obligation were invested primarily in qualifying trust preferred collateral, and (3) the banking entity’s interests in the collateralized debt obligation was acquired on or prior to December 10, 2013. The Company does not currently anticipate that the Volcker Rule will have a material effect on the operations of the Company or First Mid Bank. On June 25, 2020, the agencies announced that certain restrictions under the Volcker Rule applicable to large banking entities will be eased commencing October 1, 2020.
Interest Rate Sensitivity
The Company seeks to maximize its net interest margin while maintaining an acceptable level of interest rate risk. Interest rate risk can be defined as the amount of forecasted net interest income that may be gained or lost due to changes in the interest rate environment, a variable over which management has no control. Interest rate risk, or sensitivity, arises when the maturity or repricing characteristics of interest-bearing assets differ significantly from the maturity or repricing characteristics of interest- bearing liabilities. The Company monitors its interest rate sensitivity position to maintain a balance between rate sensitive assets and rate sensitive liabilities. This balance serves to limit the adverse effects of changes in interest rates. The Company’s asset liability management committee (ALCO) oversees the interest rate sensitivity position and directs the overall allocation of funds.
In the banking industry, a traditional way to measure potential net interest income exposure to changes in interest rates is through a technique known as “static GAP” analysis which measures the cumulative differences between the amounts of assets and liabilities maturing or repricing at various intervals. By comparing the volumes of interest-bearing assets and liabilities that have contractual maturities and repricing points at various times in the future, management can gain insight into the amount of interest rate risk embedded in the balance sheet. The following table sets forth the Company’s interest rate repricing GAP for selected maturity periods at June 30, 2020 (dollars in thousands):
Rate Sensitive Within
1 years
1-2 years
2-3 years
3-4 years
4-5 years
Interest-earning assets:
Federal funds sold and other
interest-bearing deposits
161,095
1,440
980
1,470
Taxable investment securities
226,538
110,244
57,447
29,458
19,323
80,995
524,005
524,213
Nontaxable investment securities
41,213
20,362
15,575
12,327
22,300
87,482
199,259
199,258
1,381,724
612,663
361,418
323,063
398,105
128,289
3,140,062
1,812,010
744,249
435,910
364,848
439,728
296,766
4,093,511
4,028,518
Interest-bearing liabilities:
Savings and NOW accounts
357,868
123,377
561,879
1,413,255
Money market accounts
469,523
21,733
68,906
625,361
Other time deposits
363,450
112,346
27,758
14,006
11,956
529,588
Short-term borrowings/debt
Long-term borrowings/debt
42,881
10,000
15,000
40,000
122,881
121,571
1,584,010
267,456
177,868
169,116
172,066
670,857
3,041,373
3,051,237
Rate sensitive assets – rate
sensitive liabilities
228,000
476,793
258,042
195,732
267,662
(374,091
1,052,138
Cumulative GAP
704,793
962,835
1,158,567
1,426,229
Cumulative amounts as % of
total Rate sensitive assets
11.6
6.3
6.5
-9.1
Cumulative Ratio
17.2
23.5
28.3
34.8
25.7
The static GAP analysis shows that at June 30, 2020, the Company was asset sensitive, on a cumulative basis, through the twelve-month time horizon. This indicates that future decreases in interest rates could have an adverse effect on net interest income. There are several ways the Company measures and manages the exposure to interest rate sensitivity, including static GAP analysis. The Company’s ALCO also uses other financial models to project interest income under various rate scenarios and prepayment/extension assumptions consistent with First Mid Bank’s historical experience and with known industry trends. ALCO meets at least monthly to review the Company’s exposure to interest rate changes as indicated by the various techniques and to make necessary changes in the composition terms and/or rates of the assets and liabilities. The Company is currently experiencing downward pressure on asset yields resulting from the extended period of historically low interest rates and heightened competition for loans. A continuation of this environment could result in a decline in interest income and the net interest margin.
Capital Resources
At June 30, 2020, the Company’s stockholders' equity increased $22 million, or 4.3%, to $549 million from $527 million as of December 31, 2019. During the first six months of 2020, net income contributed $20.1 million to equity before the payment of dividends to stockholders. The change in market value of available-for-sale investment securities increased stockholders' equity by $8.7 million, net of tax. Dividends of $6.7 million were paid during the second quarter of 2020.
The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Bank holding companies follow minimum regulatory requirements established by the Board of Governors of the Federal Reserve System (“Federal Reserve System”), and First Mid Bank follow similar minimum regulatory requirements established for banks by the Office of the Comptroller of the Currency (“OCC”) and the Federal Deposit Insurance Corporation. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary action by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Quantitative measures established by regulatory capital standards to ensure capital adequacy require the Company and its subsidiary banks to maintain a minimum capital amounts and ratios (set forth in the table below). Management believes that, as of June 30, 2020 and December 31, 2019, the Company and First Mid Bank met all capital adequacy requirements.
As permitted by the interim final rule issued on March 27, 2020 by the federal banking regulatory agencies, the Company has elected the option to delay the estimated impact on regulatory capital of adopting ASU 2016-13, which was effective January 1, 2020. The initial impact of adoption of ASU 2016-13, as well as 25% of the quarterly increases in allowance for credit losses subsequent to adoption of ASU 2016-13 will be delayed for two years. After two years, the cumulative amount of these adjustments will be phased out of the regulatory capital calculation over a three-year period, with 75% of the adjustments included in year three, 50% of the adjustments included in year four and 25% of the adjustments included in year five. After five years, the temporary delay of ASU 2016-13 adoption will be fully reversed.
To be categorized as well-capitalized, total risk-based capital, Tier 1 risk-based capital, common equity Tier 1 risk-based capital and Tier 1 leverage ratios must be maintained as set forth in the following table (dollars in thousands):
Actual
Required Minimum For
Capital Adequacy
Purposes
To Be Well-Capitalized
Under Prompt Corrective
Action Provisions
Ratio
Total Capital (to risk-weighted
assets)
Company
471,250
15.19
325,652
> 10.50%
N/A
First Mid Bank
425,597
13.79
324,118
> 10.50
308,683
> 10.00%
Tier 1 Capital (to risk-weighted
436,254
14.07
263,623
> 8.50
390,601
12.65
262,381
246,947
> 8.00
Common Equity Tier 1 Capital
(to risk-weighted assets)
417,326
13.46
217,101
> 7.00
216,078
200,644
> 6.50
Tier 1 Capital (to average
10.43
167,304
> 4.00
9.38
166,510
208,138
> 5.00
444,305
15.74
296,378
411,196
14.65
294,703
280,670
417,394
14.79
239,925
384,285
13.69
238,569
224,536
398,536
14.12
197,585
385,285
196,469
182,435
417,395
11.20
149,044
10.37
148,268
185,335
The Company's risk-weighted assets, capital and capital ratios for June 30, 2020 are computed in accordance with Basel III capital rules which were effective January 1, 2015. See heading "Basel III" in the Overview section of this report for a more detailed description of the Basel III rules. As of June 30, 2020, the Company and First Mid Bank had capital ratios above the required minimums for regulatory capital adequacy, and First Mid Bank had capital ratios that qualified it for treatment as well-capitalized under the regulatory framework for prompt corrective action with respect to banks.
Participants may purchase Company stock under the following four plans of the Company: the Deferred Compensation Plan, the First Retirement and Savings Plan, the Dividend Reinvestment Plan, and the Stock Incentive Plan. For more detailed information on these plans, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
At the Annual Meeting of Stockholders held April 26, 2017, the stockholders approved the 2017 Stock Incentive Plan ("SI Plan"). The SI Plan was implemented to succeed the Company’s 2007 Stock Incentive Plan, which had a ten-year term. The SI Plan is intended to provide a means whereby directors, employees, consultants and advisors of the Company and its Subsidiaries may sustain a sense of proprietorship and personal involvement in the continued development and financial success of the Company and its Subsidiaries, thereby advancing the interests of the Company and its stockholders. Accordingly, directors and selected employees, consultants and advisors may be provided the opportunity to acquire shares of Common Stock of the Company on the terms and conditions established in the SI Plan.
A maximum of 149,983 shares of common stock may be issued under the SI Plan. The Company awarded 25,200 and 25,950 restricted stock awards during 2019 and 2018, respectively and 16,950 and 16,200 as stock unit awards during 2020 and 2019, respectively.
At the Annual Meeting of Stockholders held April 25, 2018, the stockholders approved the First Mid-Illinois Bancshares, Inc. Employee Stock Purchase Plan (“ESPP”). The ESPP is intended to promote the interests of the Company by providing eligible employees with the opportunity to purchase shares of common stock of the Company at a 5% discount through payroll deductions. The ESPP is also intended to qualify as an employee stock purchase plan under Section 423 of the Internal Revenue Code. A maximum of 600,000 shares of common stock may be issued under the ESPP. As of June 30, 2020, 7,543 shares were issued pursuant to the ESPP.
Stock Repurchase Program
Since August 5, 1998, the Board of Directors has approved repurchase programs pursuant to which the Company may repurchase a total of approximately $76.7 million of the Company’s common stock. During the quarter, the Company repurchased no shares. The Company has approximately $4.9 million in remaining capacity under its existing repurchase program.
Although the Company adopted the repurchase plan, the Company may make discretionary repurchases in the open market or in privately negotiated transactions from time to time. The timing, manner, price and amount of any such repurchases will be determined by the Company at its discretion and will depend upon a variety of factors including economic and market conditions, price, applicable legal requirements and other factors.
Liquidity
Liquidity represents the ability of the Company and its subsidiaries to meet all present and future financial obligations arising in the daily operations of the business. Financial obligations consist of the need for funds to meet extensions of credit, deposit withdrawals and debt servicing. The Company’s liquidity management focuses on the ability to obtain funds economically through assets that may be converted into cash at minimal costs or through other sources. The Company’s other sources of cash include overnight federal fund lines, Federal Home Loan Bank advances, deposits of the State of Illinois, the ability to borrow at the Federal Reserve Bank of Chicago, and the Company’s operating line of credit with The Northern Trust Company.
Details of the Company's liquidity sources include:
First Mid Bank has $100 million available in overnight federal fund lines, including $30 million from First Horizon Bank, N.A., $20 million from U.S. Bank, N.A., $10 million from Wells Fargo Bank, N.A., $15 million from The Northern Trust Company and $25 million from Zions Bank. Availability of the funds is subject to First Mid Bank meeting minimum regulatory capital requirements for total capital to risk-weighted assets and Tier 1 capital to total average assets. As of June 30, 2020, First Mid Bank met these regulatory requirements.
First Mid Bank can borrow from the Federal Home Loan Bank as a source of liquidity. Availability of the funds is subject to the pledging of collateral to the Federal Home Loan Bank. Collateral that can be pledged includes one-to-four family residential real estate loans and securities. At June 30, 2020, the excess collateral at the FHLB would support approximately $517.0 million of additional advances for First Mid Bank.
First Mid Bank is a member of the Federal Reserve System and can borrow funds provided that sufficient collateral is pledged.
65
In addition, as of June 30, 2020, the Company had a revolving credit agreement in the amount of $15 million with The Northern Trust Company with an outstanding balance of $0 million and $15 million in available funds. This loan was renewed on April 10, 2020 for one year as a revolving credit agreement. The interest rate is floating at 2.25% over the federal funds rate. The loan is secured by all of the stock of First Mid Bank, including requirements for operating and capital ratios. The Company and its subsidiary bank were in compliance with the then existing covenants at June 30, 2020 and 2019 and December 31, 2019.
Management continues to monitor its expected liquidity requirements carefully, focusing primarily on cash flows from:
lending activities, including loan commitments, letters of credit and mortgage prepayment assumptions;
deposit activities, including seasonal demand of private and public funds;
investing activities, including prepayments of mortgage-backed securities and call provisions on U.S. Treasury and government agency securities; and
operating activities, including scheduled debt repayments and dividends to stockholders.
The following table summarizes significant contractual obligations and other commitments at June 30, 2020 (in thousands):
Less than
More than
1 year
1-3 years
3-5 years
140,104
25,962
Debt
Other borrowing
454,227
374,227
Operating leases
2,737
4,676
3,491
9,232
Supplemental retirement
1,023,347
740,464
159,880
54,553
68,450
For the six months ended June 30, 2020, net cash of $25.2 million was provided by operating activities, $461.5 million was used in investing activities, and $589.7 million was provided by financing activities. In total, cash and cash equivalents increased by $461.5 million since year-end 2019.
Off-Balance Sheet Arrangements
First Mid Bank enters into financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include lines of credit, letters of credit and other commitments to extend credit. Each of these instruments involves, to varying degrees, elements of credit, interest rate and liquidity risk in excess of the amounts recognized in the consolidated balance sheets. The Company uses the same credit policies and requires similar collateral in approving lines of credit and commitments and issuing letters of credit as it does in making loans. The exposure to credit losses on financial instruments is represented by the contractual amount of these instruments. However, the Company does not anticipate any losses from these instruments. The off-balance sheet financial instruments whose contract amounts represent credit risk at June 30, 2020 and December 31, 2019 were as follows (in thousands):
Unused commitments and lines of credit:
92,432
122,479
Commercial operating
374,608
308,393
Home equity
38,602
38,933
97,403
103,912
603,045
573,717
Standby letters of credit
11,926
11,535
Commitments to originate credit represent approved commercial, residential real estate and home equity loans that generally are expected to be funded within ninety days. Lines of credit are agreements by which the Company agrees to provide a borrowing accommodation up to a stated amount as long as there is no violation of any condition established in the loan agreement. Both commitments to originate credit and lines of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the lines and some commitments are expected to expire without being drawn upon, the total amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments issued by the Company to guarantee the financial performance of customers to third parties. Standby letters of credit are primarily issued to facilitate trade or support borrowing arrangements and generally expire in one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending credit facilities to customers. The maximum amount of credit that would be extended under letters of credit is equal to the total off-balance sheet contract amount of such instrument. The Company's deferred revenue under standby letters of credit was nominal.
The Company is also subject to claims and lawsuits that arise primarily in the ordinary course of business. It is the opinion of management that the disposition of ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operations and cash flows of the Company.
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There has been no material change in the market risk faced by the Company since December 31, 2019. For information regarding the Company’s market risk, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
ITEM 4.
CONTROLS AND PROCEDURES
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s “disclosure controls and procedures” (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this report. Based on such evaluation, such officers have concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective. Further, there have been no changes in the Company’s internal control over financial reporting during the last fiscal quarter that have materially affected or that are reasonably likely to affect materially the Company’s internal control over financial reporting.
PART II
ITEM 1.
LEGAL PROCEEDINGS
From time to time the Company and its subsidiaries may be involved in litigation that the Company believes is a type common to our industry. None of any such existing claims are believed to be individually material at this time to the Company, although the outcome of any such existing claims cannot be predicted with certainty.
ITEM 1A. RISK FACTORS
Various risks and uncertainties, some of which are difficult to predict and beyond the Company’s control, could negatively impact the Company. As a financial institution, the Company is exposed to interest rate risk, liquidity risk, credit risk, operational risk, risks from economic or market conditions, and general business risks among others. Adverse experience with these or other risks could have a material impact on the Company’s financial condition and results of operations, as well as the value of its common stock. See the risk factors and “Supervision and Regulation” described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. In addition to the risk factors noted in the Company's Annual Report, the following should also be considered:
The ongoing COVID-19 pandemic and the measures intended to prevent its spread have had, and may continue to have a an adverse effect on the Company's operations, results of operations and financial condition, and the severity of these adverse effects depend on future developments which are highly uncertain and difficult to predict.
The global health concerns related to COVID-19 and government actions implemented to reduce the spread of the virus have had an adverse impact on the macroeconomic environment. COVID-19 has significantly increased economic uncertainty and reduced economic activity. The outbreak has resulted in authorities implementing numerous measures to try to contain the virus, such as travel bans and restrictions, quarantines, shelter in place or total lock-down orders and business limitations and shutdowns. These measures have significantly contributed to rising unemployment and negatively impacted consumer and business spending. The United States government has taken steps to mitigate some of the more severe anticipated economic effects of the virus, including the passage of the CARES Act, but there is no assurance that these steps will be effective or achieve the desired positive economic results in a timely fashion. COVID-19 has impacted, and is likely to further adversely impact, the workforce and operations of the Company, and the operations of our borrowers, customers and business partners. In particular, we may experience financial losses due to various operational factors impacting us or our borrowers, customers or business partners, including but not limited to:
credit losses resulting from financial stress being experienced by our borrowers as a result of the outbreak and related governmental actions, particularly in the hospitality, energy, retail and restaurant industries, but across other industries as well;
declines in collateral values;
third party disruptions, including outages at network providers and other suppliers;
increased cyber and payment fraud risk, as cybercriminals attempt to profit from the disruption, given increased online and remote activity; and
operational failures due to changes in our normal business practices necessitated by the outbreak and related governmental actions.
These factors may remain prevalent for a significant period and may continue to adversely affect the Company, results of operations and financial condition even after the COVID-19 outbreak has subsided. The extent to which the coronavirus outbreak impacts the Company’s operations, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. Even after the COVID-19 outbreak has subsided, we may continue to experience adverse impacts to our business as a result of the virus’s global economic impact, including the availability of credit, adverse impacts on our liquidity and any recession that has occurred or may occur in the future. There are no comparable recent events that provide guidance as to the effect the spread of COVID-19 as a global pandemic may have, and, as a result, the ultimate impact of the outbreak is highly uncertain and subject to change. The full extent of the impacts on the Company’s operations or the global economy as a whole is not yet known. However, the effects could have a material impact on the Company’s results of operations and heighten other of our known risks described in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2019.
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ISSUER PURCHASES OF EQUITY SECURITIES
Period
(a)
Number
of Shares
Purchased
Price Paid
per Share
as Part of
Publicly
Announced
Plans or
Programs
Approximate
Dollar Value
that May
Yet Be
Under the
4,945,000
See heading “Stock Repurchase Program” for more information regarding stock purchases.
DEFAULTS UPON SENIOR SECURITIES
None.
MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5.
OTHER INFORMATION
ITEM 6.
EXHIBITS
The exhibits required by Item 601 of Regulation S-K and filed herewith are listed in the Exhibit Index that precedes the Signature Page and the exhibits filed.
Exhibit
Exhibit Index to Quarterly Report on Form 10-Q Description and Filing or Incorporation Reference
10.1
First Amendment to Sixth Amended and Restate Credit Agreement by and between First Mid Bancshares, Inc. and The Northern Trust Company, dated as of April 10, 2020 (incorporated by reference to Exhibit 10.1 to First Mid Bancshares, Inc.'s Current Report on Form 8-K filed with the SEC on April 10, 2020.
31.1
Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002
31.2
32.1
Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002
32.2
101.INS
Inline XBRL Instance Document – The instance document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 (formatted as Inline XBRL and contained in Exhibits 101)
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date: August 7, 2020
Joseph R. Dively
President and Chief Executive Officer
Matthew K. Smith
Chief Financial Officer