Table of Contents
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended June 30, 2022
¨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 001-35021
EVANS BANCORP, INC.
(Exact name of registrant as specified in its charter)
New York 16-1332767
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6460 Main St. Williamsville, NY 14221
(Address of principal executive offices) (Zip Code)
(716) 926-2000
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.50 par value
EVBN
NYSE American
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 x 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 (§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 x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a 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.
Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer x
Smaller reporting company x
Emerging growth company ¨
If an emerging growth company, indicate by checkmark 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 Exchange Act).
Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common Stock, $.50 par value, 5,508,663 shares as of July 26, 2022.
INDEX
EVANS BANCORP, INC. AND SUBSIDIARIES
PART 1. FINANCIAL INFORMATION
PAGE
Item 1.
Financial Statements
Unaudited Consolidated Balance Sheets – June 30, 2022 and December 31, 2021
1
Unaudited Consolidated Statements of Income – Three months ended June 30, 2022 and 2021
2
Unaudited Consolidated Statements of Income – Six months ended June 30, 2022 and 2021
3
Unaudited Consolidated Statements of Comprehensive (Loss) Income – Three months ended June 30, 2022 and 2021
4
Unaudited Consolidated Statements of Comprehensive (Loss) Income – Six months ended June 30, 2022 and 2021
Unaudited Consolidated Statements of Changes in Stockholders’ Equity – Three months ended June 30, 2022 and 2021
5
Unaudited Consolidated Statements of Changes in Stockholders’ Equity – Six months ended June 30, 2022 and 2021
6
Unaudited Consolidated Statements of Cash Flows – Six months ended June 30, 2022 and 2021
7
Notes to Unaudited Consolidated Financial Statements
9
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
34
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
42
Item 4.
Controls and Procedures
43
PART II. OTHER INFORMATION
Legal Proceedings
44
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosure
Item 5.
Other Information
Item 6.
Exhibits
45
Signatures
46
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
UNAUDITED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2022 AND DECEMBER 31, 2021
(in thousands, except share and per share amounts)
June 30,
December 31,
2022
2021
ASSETS
Cash and due from banks
$
10,570
9,856
Interest-bearing deposits at banks
88,190
234,929
Securities:
Available for sale, at fair value (amortized cost: $438,669 at June 30, 2022;
395,620
305,959
$310,228 at December 31, 2021)
Held to maturity, at amortized cost (fair value: $7,619 at June 30, 2022;
7,702
3,165
$3,179 at December 31, 2021)
Federal Home Loan Bank common stock, at cost
2,774
3,045
Federal Reserve Bank common stock, at cost
3,059
3,039
Loans, net of allowance for loan losses of $18,819 at June 30, 2022
and $18,438 at December 31, 2021
1,595,015
1,553,467
Properties and equipment, net of accumulated depreciation of $10,852 at June 30, 2022
and $10,283 at December 31, 2021
17,282
17,789
Goodwill
12,702
Intangible assets
1,427
1,627
Bank-owned life insurance
34,614
34,295
Operating lease right-of-use asset
4,363
4,826
Other assets
35,036
25,941
TOTAL ASSETS
2,208,354
2,210,640
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Demand
550,079
492,864
NOW
265,181
259,908
Savings
1,015,511
1,019,925
Time
137,561
164,340
Total deposits
1,968,332
1,937,037
Securities sold under agreement to repurchase
5,070
4,112
Other borrowings
22,934
32,879
Operating lease liability
4,721
5,210
Other liabilities
13,598
16,536
Subordinated debt
31,024
30,974
Total liabilities
2,045,679
2,026,748
STOCKHOLDERS' EQUITY:
Common stock, $0.50 par value, 10,000,000 shares authorized; 5,532,458 and 5,482,756 shares issued at
June 30, 2022 and December 31, 2021, respectively, and 5,508,663 and 5,482,756 shares outstanding at
June 30, 2022 and December 31, 2021, respectively.
2,769
2,744
Capital surplus
80,072
78,795
Treasury stock, at cost, 23,795 and 0 shares at June 30, 2022 and
December 31, 2021, respectively
(849)
-
Retained earnings
114,982
108,024
Accumulated other comprehensive income (loss), net of tax
(34,299)
(5,671)
Total stockholders' equity
162,675
183,892
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
See Notes to Unaudited Consolidated Financial Statements
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED JUNE 30, 2022 AND 2021
Three Months Ended June 30,
INTEREST INCOME
Loans
16,828
18,513
226
19
Taxable
1,984
988
Non-taxable
59
56
Total interest income
19,097
19,576
INTEREST EXPENSE
Deposits
580
736
86
423
404
Total interest expense
1,045
1,226
NET INTEREST INCOME
18,052
18,350
PROVISION (CREDIT) FOR LOAN LOSSES
267
(760)
NET INTEREST INCOME AFTER
17,785
19,110
NON-INTEREST INCOME
Deposit service charges
703
607
Insurance service and fees
2,567
2,657
171
172
Interchange fee income
539
547
Other
632
435
Total non-interest income
4,612
4,418
NON-INTEREST EXPENSE
Salaries and employee benefits
9,436
9,365
Occupancy
1,131
1,177
Advertising and public relations
438
405
Professional services
843
989
Technology and communications
1,237
1,432
Amortization of intangibles
100
135
FDIC insurance
250
279
1,349
1,394
Total non-interest expense
14,784
15,176
INCOME BEFORE INCOME TAXES
7,613
8,352
INCOME TAX PROVISION
1,879
2,039
NET INCOME
5,734
6,313
Net income per common share-basic
1.04
1.16
Net income per common share-diluted
1.03
1.15
Weighted average number of common shares outstanding
5,512,741
5,434,803
Weighted average number of diluted shares outstanding
5,550,436
5,489,420
SIX MONTHS ENDED JUNE 30, 2022 AND 2021
Six Months Ended June 30,
32,552
35,579
296
35
3,661
1,820
105
112
36,614
37,546
1,148
1,622
89
174
824
803
2,061
2,599
34,553
34,947
488
(447)
34,065
35,394
1,395
1,179
4,866
5,159
325
335
1,031
1,037
1,426
1,274
9,043
8,984
18,906
18,409
2,311
2,364
617
668
1,715
1,948
2,411
2,696
200
270
520
579
2,564
2,607
29,244
29,541
13,864
14,837
3,382
3,672
10,482
11,165
1.90
2.06
1.89
2.04
5,503,811
5,428,356
5,548,533
5,477,567
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(in thousands)
OTHER COMPREHENSIVE (LOSS) INCOME, NET OF TAX:
Unrealized (loss) gain on available-for-sale securities:
(12,033)
1,722
Defined benefit pension plans:
Amortization of prior service cost
Amortization of actuarial loss
50
70
Total
55
75
(11,978)
1,797
COMPREHENSIVE (LOSS) INCOME
(6,244)
8,110
Six Month Ended June
Unrealized loss on available-for-sale securities
(28,738)
(2,167)
10
11
140
110
151
OTHER COMPREHENSIVE LOSS, NET OF TAX
(28,628)
(2,016)
(18,146)
9,149
UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Accumulated
Common
Capital
Retained
Comprehensive
Treasury
Stock
Surplus
Earnings
Loss
Balance, March 31, 2021
2,716
76,673
92,117
(4,532)
166,974
Net Income
Other comprehensive income
Stock compensation expense
201
Forfeitures 309 shares of restricted stock
Issued 4,611 shares under Dividend Reinvestment Plan
152
155
Issued 6,443 shares in Employee Stock Purchase Plan
203
Issued 3,753 shares in stock option exercises
Balance, June 30, 2021
2,724
77,270
98,430
(2,735)
175,689
Balance, March 31, 2022
2,762
79,396
109,366
(22,321)
169,203
Other comprehensive loss
Cash dividends
(3)
291
Issued 3,705 shares under Dividend Reinvestment Plan
141
143
Issued 6,902 shares in Employee Stock Purchase Plan
195
199
Reissued 6,660 restricted shares in stock option exercises
(115)
249
134
Issued 2,020 shares in stock option exercises
49
Repurchased 29,269 shares of common stock
(1,098)
Forfeitures 1,186 shares of restricted stock
Balance, June 30, 2022
Balance, December 31, 2020
2,708
76,394
90,522
(719)
168,905
Cash dividends ($0.60 per common share)
(3,257)
434
Issued 7,971 restricted shares, net of forfeitures
(4)
Issued 13,082 shares in stock option exercises
94
Balance, December 31, 2021
Cash dividends ($0.62 per common share)
(3,409)
624
Issued 18,244 restricted shares
(9)
Issued 20,851 shares in stock option exercises
326
336
Reissued 3,705 shares through Dividend
Reinvestment Program
Issued 6,902 shares in Employee Stock
Purchase Plan
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
OPERATING ACTIVITIES:
Interest received
35,332
34,739
Fees received
9,236
9,511
Interest paid
(2,301)
(3,381)
Cash paid to employees and vendors
(32,005)
(29,182)
Income taxes paid
(1,801)
(3,884)
Proceeds from sale of loans held for sale
3,529
Originations of loans held for sale
(3,368)
(134)
Net cash provided by operating activities
8,622
7,669
INVESTING ACTIVITIES:
Available for sales securities:
Purchases
(144,413)
(88,822)
Proceeds from sales, maturities, calls, and payments
16,198
16,532
Held to maturity securities:
(5,825)
(1,250)
Proceeds from maturities, calls, and payments
1,288
2,082
Proceeds from bank-owned life insurance claims
378
Additions to properties and equipment
(388)
(535)
Proceeds from tax credit investment
Sale of other real estate
129
Net (increase) decrease in loans
(40,854)
829
Net cash used in investing activities
(173,560)
(71,035)
FINANCING ACTIVITIES:
Repayments from long-term borrowings, net
(9,672)
(2,766)
Proceeds from short-term borrowings, net
958
295
Net increase in deposits
31,322
112,714
Dividends paid
Repurchase of treasury stock
Issuance of common stock
678
458
Reissuance of treasury stock
Net cash provided by financing activities
18,913
107,444
Net (decrease) increase in cash and cash equivalents
(146,025)
44,078
CASH AND CASH EQUIVALENTS:
Beginning of period
244,785
97,604
End of period
98,760
141,682
RECONCILIATION OF NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization
890
927
Deferred tax expense (benefit)
329
(155)
Provision (credit) for loan losses
Loss on sales of assets
22
Gain on loans sold
(62)
Changes in assets and liabilities affecting cash flow:
(2,267)
(4,340)
(2,023)
197
NET CASH PROVIDED BY OPERATING ACTIVITIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2022 AND 2021
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and reporting policies followed by Evans Bancorp, Inc. (the “Company”), a financial holding company, and its two direct, wholly-owned subsidiaries: (i) Evans Bank, National Association (the “Bank”), and the Bank’s subsidiaries, Evans National Leasing, Inc. (“ENL”), and Evans National Holding Corp. (“ENHC”); and (ii) Evans National Financial Services, LLC (“ENFS”), and ENFS’s subsidiary, The Evans Agency, LLC (“TEA”), and TEA’s subsidiaries, Frontier Claims Services, Inc. (“FCS”) and ENB Associates Inc. (“ENBA”), in the preparation of the accompanying interim unaudited consolidated financial statements conform with U.S. generally accepted accounting principles (“GAAP”) and with general practice within the industries in which it operates. Except as the context otherwise requires, the Company and its direct and indirect subsidiaries are collectively referred to in this report as the “Company.”
The Financial Accounting Standards Board (“FASB”) establishes changes to GAAP in the form of accounting standards updates (“ASUs”) to the FASB Accounting Standards Codification. The Company considers the applicability and impact of all ASUs when they are issued by FASB. ASUs adopted by the Company during the current fiscal year are not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures.
The results of operations for the six month period ended June 30, 2022 are not necessarily indicative of the results to be expected for the full year.
The accompanying unaudited consolidated financial statements should be read in conjunction with the Audited Consolidated Financial Statements and the Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2021 (the “10-K”). There have been no significant changes to the Company’s significant accounting policies as disclosed in Note 1 to the 10-K.
2. SECURITIES
The amortized cost of securities and their approximate fair value at June 30, 2022 and December 31, 2021 were as follows:
June 30, 2022
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Available for Sale:
Debt securities:
U.S. treasuries and government agencies
166,484
(16,534)
149,957
States and political subdivisions
23,676
(998)
22,688
Total debt securities
190,160
17
(17,532)
172,645
Mortgage-backed securities:
FNMA
78,044
(9,191)
68,857
FHLMC
48,272
(4,801)
43,506
GNMA
41,528
(4,352)
37,176
SBA
23,918
(1,238)
22,680
CMO
56,747
(6,035)
50,756
Total mortgage-backed securities
248,509
83
(25,617)
222,975
Total securities designated as available for sale
438,669
(43,149)
Held to Maturity:
Debt securities
(83)
7,619
Total securities designated as held to maturity
December 31, 2021
99,005
(2,386)
96,818
6,150
96
6,246
105,155
103,064
64,056
222
(1,068)
63,210
38,796
62
(424)
38,434
31,814
15
(615)
31,214
17,919
343
(54)
18,208
52,488
175
(834)
51,829
205,073
817
(2,995)
202,895
310,228
1,112
(5,381)
3,179
Available for sale securities with a total fair value of $275 million and $207 million were pledged as collateral to secure public deposits and for other purposes required or permitted by law at June 30, 2022 and December 31, 2021, respectively.
The scheduled maturities of debt and mortgage-backed securities at June 30, 2022 are summarized below. All maturity amounts are contractual maturities. Actual maturities may differ from contractual maturities because certain issuers have the right to call or prepay obligations with or without call premiums.
Estimated
cost
fair value
Debt securities available for sale:
Due in one year or less
6,856
6,830
Due after one year through five years
78,891
75,395
Due after five years through ten years
70,423
63,453
Due after ten years
33,990
26,967
Mortgage-backed securities
available for sale
Debt securities held to maturity:
6,770
6,754
514
492
349
309
69
64
Contractual maturities of the Company’s mortgage-backed securities generally exceed ten years; however, the effective lives may be significantly shorter due to prepayments of the underlying loans and due to the nature of these securities.
There were no gross realized gains or losses from sales of investment securities for the three and six month periods ended June 30, 2022 and 2021.
Management has assessed the securities available for sale in an unrealized loss position at June 30, 2022 and December 31, 2021 and determined the decline in fair value below amortized cost to be temporary. In making this determination, management considered the period of time the securities were in a loss position, the percentage decline in comparison to the securities’ amortized cost, and the financial condition of the issuer (primarily government or government-sponsored enterprises). In addition, management does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities before recovery of their amortized cost. Management believes the decline in fair value is primarily related to market interest rate fluctuations and not to the credit deterioration of the individual issuers.
The Company has not recorded any other-than-temporary impairment (“OTTI”) charges during the six month period ended June 30, 2022 and did not record any OTTI charges during 2021. The credit worthiness of the Company’s securities portfolio is largely reliant on the ability of U.S. government sponsored agencies such as Federal Home Loan Bank (“FHLB”), Federal National Mortgage Association (“FNMA”), Government National Mortgage Association (“GNMA”), and Federal Home Loan Mortgage Corporation (“FHLMC”), and municipalities throughout New York State to meet their obligations. In addition, dysfunctional markets could materially alter the liquidity, interest rate, and pricing risk of the portfolio. The stable past performance is not a guarantee for similar performance of the Company’s securities portfolio in future periods.
Information regarding unrealized losses within the Company’s available for sale securities at June 30, 2022 and December 31, 2021 is summarized below.
Less than 12 months
12 months or longer
114,660
(8,836)
30,292
(7,698)
144,952
19,891
134,551
(9,834)
164,843
61,186
(7,994)
7,416
(1,197)
68,602
36,433
(4,215)
3,050
(586)
39,483
30,915
(3,418)
6,174
(934)
37,089
21,678
(1,218)
1,002
(20)
36,694
(4,811)
5,842
(1,224)
42,536
186,906
(21,656)
23,484
(3,961)
210,390
4,050
Total temporarily impaired
securities
325,507
(31,573)
53,776
(11,659)
379,283
(43,232)
50,381
(884)
27,488
(1,502)
77,869
48,008
(903)
2,941
(165)
50,949
35,851
(423)
76
(1)
35,927
30,252
30,395
2,824
(25)
1,218
(29)
4,042
38,313
(833)
25
38,338
155,248
(2,799)
4,403
(196)
159,651
1,782
207,411
(3,686)
31,891
(1,698)
239,302
(5,384)
3. LOANS AND THE ALLOWANCE FOR LOAN LOSSES
Loan Portfolio Composition
The following table presents selected information on the composition of the Company’s loan portfolio as of the dates indicated:
Mortgage loans on real estate:
Residential mortgages
424,950
411,060
Commercial and multi-family
764,593
739,761
Construction-Residential
4,459
5,109
Construction-Commercial
100,902
98,012
Home equities
82,614
81,238
Total real estate loans
1,377,518
1,335,180
Commercial and industrial loans
236,022
237,077
Consumer and other loans
930
719
Unaccreted yield adjustments*
(636)
(1,071)
Total gross loans
1,613,834
1,571,905
Allowance for loan losses
(18,819)
(18,438)
Loans, net
* Includes net premiums and discounts on acquired loans and net deferred fees and costs on loans originated.
During 2020 the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) established a loan program administered through the U.S. Small Business Administration (“SBA”), referred to as the Paycheck Protection Program (“PPP”). PPP loans are 100% guaranteed by the SBA and are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. The outstanding balance of PPP loans of $4 million and $25 million as of June 30, 2022 and December 31, 2021, respectively, is included in commercial and industrial loans. PPP loans did not impact the Company’s allowance for loan losses as a result of the SBA guarantees. Fees collected from the SBA for these loans are deferred and amortized into interest income over the contractual period of the loan. Upon SBA forgiveness or sale of a PPP loan, unamortized fees are then recognized into interest income. PPP fees recognized into interest income in the three and six month periods ended June 30, 2022 were $0.2 million and $0.7 million, respectively compared with $2.5 million and $4.2 million in the three and six month periods ended June 30, 2021, respectively. Unamortized PPP fees were less than $0.1 million and $0.8 million at June 30, 2022 and December 31, 2021, respectively.
At June 30, 2022, the outstanding principal balance and the carrying amount of acquired credit-impaired loans totaled $0.8 million and $0.7 million, respectively. At December 31, 2021, the outstanding principal balance and carrying amount of acquired credit-impaired loans totaled $0.8 million. There were no valuation allowances for specifically identified impairment attributable to acquired credit-impaired loans at June 30, 2022 or December 31, 2021. The Company is not recording interest on the acquired credit-impaired loans due to the uncertainty of the cash flows relating to such loans.
There were $545 million and $619 million in residential and commercial mortgage loans pledged to FHLBNY to serve as collateral for potential borrowings as of June 30, 2022 and December 31, 2021, respectively.
At June 30, 2022, the Company’s FHLMC loan serving portfolio had $64 million in principal balances of residential real estate loans that were sold to FHLMC and the servicing rights are retained by the Company. No loans were sold to FHLMC by the Company during the three month or six month periods ending June 30, 2022 and 2021.
The Company may also sell certain fixed rate residential mortgages to FNMA while maintaining the servicing rights for those mortgages. At June 30, 2022, the Company’s FNMA loan servicing portfolio was $59 million in principal balances. In the three month and six month periods ended June 30, 2022, the Company sold $0.6 million and $3.5 million, respectively, of residential mortgages to FNMA. The Company did not sell any mortgages to FNMA in the three and six month periods ended June 30, 2021.
At June 30, 2022 and December 31, 2021, the Company had loan servicing portfolio principal balances of $123 million and $131 million, respectively, upon which it earned servicing fees. The fair value of the mortgage servicing rights for that portfolio was $1.1 million and $0.9 million at June 30, 2022 and December 31, 2021, respectively.
At June 30, 2022 no residential mortgages were held for sale. At December 31, 2021 there were $0.2 million of residential mortgages held for sale.
Credit Quality Indicators
The Company monitors the credit risk in its loan portfolio by reviewing certain credit quality indicators (“CQI”). The primary CQI for the commercial mortgage and commercial and industrial portfolios is the individual loan’s credit risk rating. The following list provides a description of the credit risk ratings that are used internally by the Bank when assessing the adequacy of its allowance for loan losses:
Acceptable or better
Watch
Special Mention
Substandard
Doubtful
Loss
“Special mention” and “substandard” loans are weaker credits with a higher risk of loss and are categorized as “criticized” assets.
The Company’s consumer loans, including residential mortgages and home equities, are not individually risk rated or reviewed in the Company’s loan review process. Unlike commercial customers, consumer loan customers are not required to provide the Company with updated financial information. Consumer loans also carry smaller balances. Given the lack of updated information after the initial underwriting of the loan and small size of individual loans, the Company uses delinquency status as the primary credit quality indicator for consumer loans. However, once a consumer loan is identified as impaired, it is individually evaluated for impairment.
The following tables provide data, at the class level, of credit quality indicators of certain loans for the dates specified:
Corporate Credit Exposure – By Credit Rating
Commercial Real Estate Construction
Commercial and Multi-Family Mortgages
Total Commercial Real Estate
Commercial and Industrial
Acceptable or better
64,039
538,861
602,900
161,762
Watch
17,332
155,004
172,336
56,550
Special Mention
14,443
30,153
44,596
8,439
Substandard
5,088
40,575
45,663
9,271
Doubtful/Loss
865,495
65,211
480,159
545,370
152,675
19,108
182,502
201,610
64,406
7,045
33,219
40,264
10,200
6,648
43,881
50,529
9,796
837,773
The Company continues to evaluate its loan portfolio in response to the economic impact of the COVID-19 pandemic on its clients. During 2020, the Company identified a well-defined weakness in the hotel industry and classified the loans to clients within that industry as substandard. As of June 30, 2022, the Company’s hotel loan portfolio totaled approximately $74 million, of which $54 million or 5% of total commercial loans was classified as criticized. Total criticized assets were $108 and $111 million at June 30, 2022 and at the end of the 2021, respectively.
Past Due Loans
The following tables provide an analysis of the age of the recorded investment in loans that are past due as of the dates indicated:
Current
Non-accruing
Balance
30-59 days
60-89 days
90+ days
Commercial and industrial
231,598
90
4,334
Residential real estate:
Residential
419,469
1,322
554
3,605
Construction
Commercial real estate:
Commercial
754,063
231
10,299
98,277
1,253
1,372
81,783
239
592
Consumer and other
916
12
Total Loans
1,590,565
341
1,555
1,807
20,202
1,614,470
Note: Loan balances do not include $(0.6) million of unaccreted yield adjustments as of June 30, 2022.
229,724
1,336
568
548
4,901
402,992
3,466
1,563
711,481
16,451
6,073
5,756
93,842
757
480
2,933
79,644
627
209
758
706
1,523,498
22,646
8,417
1,028
17,387
1,572,976
Note: Loan balances do not include $(1.1) million of unaccreted yield adjustments as of December 31, 2021.
The following tables present the activity in the allowance for loan losses according to portfolio segment for the three month periods ended June 30, 2022 and 2021.
Three months ended June 30, 2022
Commercial Real Estate Mortgages*
Consumer and Other
Residential Mortgages*
Home Equities
Allowance for loan
losses:
Beginning balance
3,688
12,279
2,117
490
18,618
Charge-offs
(7)
(27)
(55)
(89)
Recoveries
23
Provision
14
26
102
Ending balance
3,714
12,305
2,164
566
18,819
*Includes construction loans
Three months ended June 30, 2021
4,390
14,068
57
1,709
477
20,701
(31)
32
Provision (Credit)
(622)
(143)
(15)
(2)
3,790
13,925
58
1,694
475
19,942
* Includes construction loans
The following tables present the activity in the allowance for loan losses according to portfolio segment for the six month periods ended June 30, 2022 and 2021.
Six months ended June 30, 2022
3,309
12,367
54
2,127
581
18,438
(67)
(153)
36
400
73
92
*Includes construction loans
Six months ended June 30, 2021
4,882
13,249
1,658
20,415
(91)
65
(1,135)
676
82
(106)
The following table presents the allocation of the allowance for loan losses according to portfolio segment summarized on the basis of the Company’s impairment methodology as of June 30, 2022 and December 31, 2021:
Ending balance:
Loans acquired with deteriorated credit quality
Individually evaluated for impairment
66
227
Collectively evaluated for impairment
3,625
12,298
2,099
500
18,592
Loans:
718
4,433
14,453
3,237
981
23,104
231,589
851,042
425,454
81,633
1,590,648
429,409
345
41
495
3,209
12,022
2,118
540
17,943
5,028
11,925
2,598
1,236
20,787
232,049
825,848
412,768
80,002
1,551,386
416,169
Note: Loan balances do not include $(1.1) million of unaccreted yield adjustments as of December 31, 2021.
* Includes construction loans
Impaired Loans
The following tables provide data, at the class level, for impaired loans as of the dates indicated:
At June 30, 2022
At December 31, 2021
Recorded Investment
Unpaid Principal Balance
Related Allowance
With no related allowance recorded:
3,557
4,874
5,712
3,669
4,066
3,297
3,654
12,909
13,354
8,821
9,338
1,373
1,499
840
998
1,127
1,324
Total impaired loans
21,535
23,474
19,514
21,527
With a related allowance recorded:
1,689
1,727
154
158
245
60
717
16
1,538
109
2,246
2,327
2,032
Total:
5,284
5,870
3,914
4,311
3,357
13,080
13,551
8,992
10,055
3,054
1,156
1,433
23,781
25,801
21,546
24,126
Average Recorded Investment
Interest Income Recognized
2,834
1,071
3,534
8
3,593
10,185
107
13,671
51
1,377
1,278
787
1,444
18,717
122
21,057
1,774
5,082
814
2,211
142
2,332
8,216
4,608
6,153
3,779
4,407
10,356
3,489
929
1,553
21,049
29,273
2,896
1,123
3,440
4,508
9,076
177
13,238
63
1,383
1,076
775
1,657
17,570
21,602
1,775
4,830
163
710
2,372
2,252
8,021
29
4,671
5,953
3,603
5,218
27
9,248
3,448
917
1,766
19,822
29,623
125
Troubled debt restructurings
The following tables summarize the loans that were classified as troubled debt restructurings (“TDRs”) as of the dates indicated:
Nonaccruing
Accruing
1,327
1,228
99
567
350
2,782
402
13
389
Total TDR loans
5,428
1,808
3,620
1,003
876
127
362
3,236
478
5,718
1,515
4,203
Any TDR that is placed on non-accrual status is not reverted back to accruing status until the borrower makes timely payments as contracted for at least six months and future collection under the revised terms is probable. All of the Company’s restructurings were allowed in an effort to maximize its ability to collect on loans where borrowers were experiencing financial difficulty.
The reserve for a TDR is based upon the present value of the future expected cash flows discounted at the loan’s original effective interest rate or upon the fair value of the collateral less costs to sell, if the loan is deemed collateral dependent. This reserve methodology is used because all TDR loans are considered impaired.
The Company’s TDRs have various agreements that involve deferral of principal payments, or interest-only payments, for a period (usually 12 months or less) to allow the borrower time to improve cash flow or sell the property. Other common concessions leading to the designation of a TDR are lines of credit that are termed-out and/or extensions of maturities at rates that are less than the prevailing market rates given the risk profile of the borrower.
During 2020, federal banking regulators issued guidance that modifications made to a borrower affected by the COVID-19 pandemic and governmental shutdown orders do not need to be identified as a TDR if the loan was current at the time a modification plan was implemented.
The following tables present TDR activity by the type of concession granted to the borrower for the three month and six month periods ended June 30, 2022 and 2021.
(Recorded Investment in thousands)
Troubled Debt Restructurings by Type of Concession
Number of Contracts
Pre-Modification Outstanding Recorded Investment
Post-Modification Outstanding Recorded Investment
Commercial and Industrial:
Extension of maturity
461
Residential Real Estate & Construction
Commercial Real Estate & Construction
Residential Real Estate & Construction:
Home Equities:
Extension of maturity and
interest rate reduction
38
The general practice of the Bank is to work with borrowers so that they are able to repay their loan in full. If a borrower continues to be delinquent or cannot meet the terms of a TDR and the loan is determined to be uncollectible, the loan will be charged-off to its collateral value. A loan is considered in default when the loan is 90 days past due. Loans which were classified as TDRs during the previous 12 months which defaulted during the three month and six month periods ended June 30, 2022 and 2021 were not material.
4. COMMON EQUITY AND EARNINGS PER SHARE DATA
The common stock per share information is based upon the weighted average number of shares outstanding during each period. For the three and six month periods ended June 30, 2022 the Company had an average of 37,695 and 44,722 dilutive shares outstanding, respectively. For the three and six month periods ended June 30, 2021 the Company had an average of 54,617 and 49,211 dilutive shares outstanding, respectively.
Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive and not included in calculating diluted earnings per share. There was an average of 56,430 potentially anti-dilutive shares outstanding for the three and six month periods ended June 30, 2022 that were not included in calculating diluted earnings per share because their effect was anti-dilutive.
5. OTHER COMPREHENSIVE INCOME (LOSS)
The following tables summarize the changes in the components of accumulated other comprehensive income (loss) during the three and six month periods ended June 30, 2022 and 2021:
Balance at March 31, 2022
Net Change
Balance at June 30, 2022
Net unrealized loss on investment securities
(19,865)
(31,898)
Net defined benefit pension plan adjustments
(2,456)
(2,401)
Balance at March 31, 2021
Balance at June 30, 2021
Net unrealized gain (loss) on investment securities
(1,492)
230
(3,040)
(2,965)
Balance at December 31, 2021
(3,160)
(2,511)
Balance at December 31, 2020
2,397
(3,116)
Before-Tax Amount
Income Tax (Provision) Benefit
Net-of-Tax Amount
Unrealized gain (loss) on investment
securities:
(16,243)
4,210
2,324
(602)
Defined benefit pension plan
adjustments:
67
(17)
95
Net change
103
(28)
Other comprehensive (loss) income
(16,168)
4,190
2,427
(630)
Unrealized loss on investment
(38,780)
10,042
(2,929)
762
(6)
(5)
(35)
190
(50)
(41)
206
(38,629)
10,001
(2,723)
707
6. NET PERIODIC BENEFIT COSTS
On January 31, 2008, the Bank froze its defined benefit pension plan. The plan covered substantially all Bank employees. The plan provides benefits that are based on the employees’ compensation and years of service. Under the freeze, eligible employees will receive, at retirement, the benefits already earned through January 31, 2008, but have not accrued any additional benefits since then. As a result, service cost is no longer incurred.
The Bank uses an actuarial method of amortizing prior service cost and unrecognized net gains or losses which result from actual expense and assumptions being different than those that are projected. The amortization method the Bank used recognized the prior service cost and net gains or losses over the average remaining service period of active employees.
The Bank also maintains a nonqualified supplemental executive retirement plan covering certain members of the Company’s senior management. The Bank uses an actuarial method of amortizing unrecognized net gains or losses which result from actual expense and assumptions being different than those that are projected. The amortization method the Bank uses recognizes the net gains or losses over the average remaining service period of active employees.
The following table presents the net periodic cost for the Bank’s defined benefit pension plan and supplemental executive retirement plan for the three and six month periods ended June 30, 2022 and 2021:
Three months ended June 30,
Supplemental Executive
Pension Benefits
Retirement Plan
Service cost
33
Interest cost
40
31
Expected return on plan assets
(88)
Amortization of the net loss
24
71
Net periodic (benefit) cost
(24)
116
Six months ended June 30,
81
(176)
(177)
47
48
88
(40)
(48)
232
283
The components of net periodic benefit cost other than the service cost component are included in the line item “other expense” in the income statement.
7. REVENUE RECOGNITION OF NON-INTEREST INCOME
A description of the Company’s material revenue streams in non-interest income accounted for under ASC 606 follows:
Insurance Service and Fees: Insurance services revenue relates to various revenue streams from services provided by TEA and the Bank:
TEA earns commission revenue from selling commercial and personal property and casualty (“P&C”) insurance as well as employee benefits solutions to commercial customers.
TEA has agreements with various insurance companies to sell policies to customers on behalf of the carriers. The performance obligation for TEA is to sell annual P&C policies to commercial customers and consumers. This performance obligation is met when a new policy is sold or when an existing policy renews. The policies are generally one year terms. In the agreements with the respective insurance companies, a commission rate is agreed upon. The commission is recognized at the time of the sale of the policy or when a policy renews.
TEA has signed contracts with insurance carriers that enable TEA to sell benefit plans to commercial customers on behalf of the insurance carriers. The performance obligation for TEA is to sell the plans to commercial customers. After the initial sale when the customer signs an agreement to purchase the offered benefit plan, the performance obligation is met each month when a customer continues utilizing benefit plans from the carrier. The customer does not commit to a specific length of time with the carrier. In the agreements with the respective insurance companies, a commission rate is agreed upon. Revenue is recognized each month when the customer continues with the benefit plan sold by TEA.
TEA also earns contingent profit sharing revenue. TEA has signed written agreements with insurance carriers that document payouts to TEA based on the loss ratios of its customers. The performance obligation for TEA is to maintain a customer base with loss ratios below the agreed upon thresholds. In the contracts with the insurance companies, payout rates based on loss ratios are documented. The consideration is variable as loss ratios vary based on customer experience. TEA’s performance obligation is over the course of the year as its customers’ performance with insurance carriers is measured throughout the year as losses occur. Due to the variable nature of contingent profit sharing revenue, TEA will accrue contingent profit sharing revenue throughout the year based on recent historical results. As loss events occur and overall performance becomes known to TEA, accrual adjustments will be made until the cash is ultimately received.
Financial services commission revenue from the Bank related to wealth management such as life insurance, annuities, and mutual funds sales is also included in the “insurance service and fees” line of the income statement.
The Company earns wealth management fees from its contracts with customers for certain financial services. Fees that are transaction-based are recognized at the point in time that the transaction is executed. Other related services provided include financial planning services and the fees the Bank earns are recognized when the services are rendered.
Insurance claims services revenue is recorded at FCS.
FCS has signed agreements with insurance companies to perform claims services including investigative and adjustment services related to residential and commercial lines. The performance obligation is for FCS to investigate the insurance claims and inspecting the damage to determine the extent of the insurance company’s liability. FCS is paid based on time and materials expended to investigate the claim. The rates paid are determined in the agreement between FCS and the respective insurance companies. Upon completion of its claims inspection work, FCS bills the insurance company for services rendered and recognizes the revenue earned. FCS discontinued operations on December 31, 2021.
A disaggregation of the total insurance service and other fees for the three and six months ended June 30, 2022 and 2021 is provided in the tables below:
Commercial property and casualty insurance commissions
1,025
Personal property and casualty insurance commissions
921
Employee benefits sales commissions
217
Profit sharing and contingent revenue
191
Wealth management and other financial services
179
167
Insurance claims services revenue
78
Other insurance-related revenue
Total insurance service and other fees
1,819
1,822
1,653
1,661
443
561
619
320
347
159
8. FAIR VALUE MEASUREMENT
Fair value is defined in ASC Topic 820 “Fair Value Measurement” as 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.
There are three levels of inputs to fair value measurement:
Level 1 inputs are quoted prices for identical instruments in active markets;
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and
Level 3 inputs are unobservable inputs.
Observable market data should be used when available.
FINANCIAL INSTRUMENTS MEASURED AT FAIR VALUE ON A RECURRING BASIS
The following table presents, for each of the fair-value hierarchy levels as defined in this footnote, those financial instruments which are measured at fair value on a recurring basis as of June 30, 2022 and December 31, 2021, respectively:
Level 1
Level 2
Level 3
Fair Value
Securities available-for-sale:
US treasuries and government agencies
Securities available for sale
Fair values for available for sale securities are determined using independent pricing services and market-participating brokers. The Company utilizes a third-party for these pricing services. The third-party utilizes evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information for structured securities, cash flow and, when available, loan performance data. Because many fixed income securities do not trade on a daily basis, the third-party service provider’s evaluated pricing applications apply information as applicable through processes, such as benchmarking of like securities, sector groupings, and matrix pricing, to prepare evaluations. In addition, our third-party pricing service provider uses model processes, such as the Option Adjusted Spread model, to assess interest rate impact and develop prepayment scenarios. The models and the process take into account market convention. For each asset class, a team of evaluators gathers information from market sources and integrates relevant credit information, perceived market movements and sector news into the evaluated pricing applications and models. The third-party, at times, may determine that it does not have sufficient verifiable information to value a particular security. In these cases the Company will utilize valuations from another pricing service.
On a quarterly basis the Company reviews changes, as submitted by our third-party pricing service provider, in the market value of its securities portfolio. Individual changes in valuations are reviewed for consistency with general interest rate movements and any known credit concerns for specific securities. Additionally, on a quarterly basis the Company has its entire securities portfolio priced by a second pricing service to determine consistency with another market evaluator. If, on the Company’s review or in comparing with another servicer, a material difference between pricing evaluations were to exist, the Company may submit an inquiry to our third-party pricing service provider regarding the data used to value a particular security. If the Company determines it has market information that would support a different valuation than our third-party service provider’s evaluation it can submit a challenge for a change to that security’s valuation.
Securities available for sale are classified as Level 2 in the fair value hierarchy as the valuation provided by the third-party provider uses observable market data.
ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A NONRECURRING BASIS
The Company is required, on a nonrecurring basis, to adjust the carrying value of certain assets or provide valuation allowances related to certain assets using fair value measurements. The following table presents for each of the fair-value hierarchy levels as defined in this footnote, those financial instruments which are measured at fair value on a nonrecurring basis June 30, 2022 and December 31, 2021:
Collateral dependent impaired loans
4,743
Impaired loans
Collateral dependent loans carried at fair value have been partially charged-off or receive specific allocations of the allowance for credit losses. The Company evaluates and values collateral dependent impaired loans at the time the loan is identified as impaired, and the fair values of such loans are estimated using Level 3 inputs in the fair value hierarchy. Each loan’s collateral value has a unique appraisal and management’s discount of the value is based on factors unique to each impaired loan. The significant unobservable input in determining the fair value is management’s subjective discount on appraisals of the collateral securing the loan, which ranges from 10%-50%. Fair value is estimated based on the value of the collateral securing these loans. Collateral may consist of real estate and/or business assets including equipment, inventory and/or accounts receivable and the value of these assets is determined based on appraisals by qualified licensed appraisers hired by the Company. Appraised and reported values may be discounted based on management’s historical knowledge, changes in market conditions from the time of valuation, estimated costs to sell, and/or management’s expertise and knowledge of the client and the client’s business.
The Company has an appraisal policy in which appraisals are obtained upon a commercial loan being downgraded on the Company’s internal loan rating scale to a special mention or a substandard depending on the amount of the loan, the type of loan and the type of collateral. All impaired commercial loans are graded substandard or worse on the internal loan rating scale. For consumer loans, the Company obtains appraisals when a loan becomes 90 days past due or is determined to be impaired, whichever occurs first. Subsequent to the downgrade or reaching 90 days past due, if the loan remains outstanding and impaired for at least one year more, management may require another follow-up appraisal. Between receipts of updated appraisals, if necessary, management may perform an internal valuation based on any known changing conditions in the marketplace such as sales of similar properties, a change in the condition of the collateral, or feedback from local appraisers. Collateral dependent impaired loans had a gross value of $4.9 million, with an allowance for loan loss of $0.2 million, at June 30, 2022 compared with $5.0 million and $0.4 million, respectively, at December 31, 2021.
The table below depicts the estimated fair values of the Company’s financial instruments, including those that are not measured and reported at fair value on a recurring basis or nonrecurring basis.
Carrying
Amount
Financial assets:
Level 1:
Cash and cash equivalents
Level 2:
Available for sale securities
FHLB and FRB stock
5,833
N/A
6,084
Level 3:
Held to maturity securities
1,545,095
1,573,420
Financial liabilities:
Demand deposits
NOW deposits
Savings deposits
Securities sold under agreement to
repurchase
Other borrowed funds
22,399
32,990
31,308
32,111
Time deposits
137,259
164,574
9. SEGMENT INFORMATION
The Company comprises two primary business segments, banking and insurance agency activities. The following tables set forth information regarding these segments for the three and six month periods ended June 30, 2022 and 2021.
Banking
Insurance Agency
Activities
Net interest income
Provision for loan losses
Net interest income after
provision for loan losses
169
2,398
Other non-interest income
2,045
Amortization expense
Other non-interest expense
12,885
1,799
14,684
Income before income taxes
7,109
504
Income tax provision
1,748
131
5,361
373
Net interest income (expense)
18,353
Net interest income (expense) after
19,113
2,506
1,757
1,761
130
13,008
2,033
15,041
8,008
344
1,950
6,058
255
308
4,558
4,177
25,387
3,657
29,044
13,153
711
3,197
185
9,956
526
34,953
35,400
315
4,844
3,821
3,825
260
25,221
29,271
14,305
532
138
10,771
394
10. CONTINGENT LIABILITIES AND COMMITMENTS
The unaudited consolidated financial statements do not reflect various commitments and contingent liabilities, which arise in the normal course of business, and which involve elements of credit risk, interest rate risk and liquidity risk. These commitments and contingent liabilities consist of commitments to extend credit and standby letters of credit. A summary of the Bank’s commitments and contingent liabilities is as follows:
Commitments to extend credit
405,219
394,953
Standby letters of credit
6,018
4,636
411,237
399,589
Commitments to extend credit and standby letters of credit include some exposure to credit loss in the event of nonperformance by the customer. The Bank’s credit policies and procedures for credit commitments and financial guarantees are the same as those for extensions of credit that are recorded on the Company’s unaudited consolidated balance sheets. Because these instruments have fixed maturity dates, and because they may expire without being drawn upon, they do not necessarily represent cash requirements of the Bank. The Bank did not incur any losses on its commitments and did not record a reserve for its commitments during the first six months of 2022 or during 2021.
Certain lending commitments for construction residential mortgage loans are considered derivative instruments under the guidelines of GAAP. The changes in the fair value of these commitments, due to interest rate risk, are not recorded on the consolidated balance sheets as the fair value of these derivatives is not considered to be material.
11. RECENT ACCOUNTING PRONOUNCEMENTS
ASUs adopted by the Company during the current fiscal year are not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures. The following standard will be adopted in a future period. ASUs not listed below are not expected to have a material impact on the Company’s consolidated financial position, results of operations, cash flows or disclosures.
ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments – Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Both financial institutions and users of their financial statements expressed concern that current GAAP restricts the ability to record credit losses that are expected, but do not yet meet the “probable” threshold. The main objective of this ASU (commonly known as the Current Expected Credit Loss Impairment Model, or CECL, in the industry) is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in CECL replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The Company has contracted with a third-party software vendor to assist with the development of the Bank’s approach for determining expected credit losses under the new guidance. The Company is actively working on preliminary test calculations, data validation, as well as process and procedural documentation. While the total impact of CECL to the Company’s financial statements is unknown at this time, the Company recognizes it may be material. On October 16, 2019, the FASB affirmed its decision to amend the effective date for the amendments in CECL for smaller reporting companies to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is allowed for fiscal years beginning after December 15, 2018. The Company intends to adopt CECL effective January 1, 2023.
ASU 2022-02, Financial Instruments – Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures – This ASU eliminates the accounting guidance for troubled debt restructurings ("TDRs") in ASC 310-40, "Receivables - Troubled Debt Restructurings by Creditors" for entities that have adopted the CECL model introduced by ASU 2016-13. ASU 2022-02 also requires that public business entities disclose current-period gross charge-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, "Financial Instruments—Credit Losses—Measured at Amortized Cost". The Company intends to adopt ASU 2022-02 effective January 1, 2023.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “seek,” and similar expressions identify such forward-looking statements. These forward-looking statements include statements regarding the Company’s business plans, prospects, growth and operating strategies, statements regarding the asset quality of the Company’s loan and investment portfolios, and estimates of the Company’s risks and future costs and benefits.
These forward-looking statements are based largely on the expectations of the Company’s management and are subject to a number of risks and uncertainties, including but not limited to: adverse changes in general economic conditions, either nationally or in the Company’s market areas; increased competition among depository or other financial institutions; inflation and changes in the interest rate environment that reduce the Company’s margins or reduce the fair value of financial instruments; changes in laws or government regulations affecting financial institutions, including changes in regulatory fees, monetary policy, and capital requirements; the Company’s ability to enter new markets successfully and capitalize on growth opportunities; the Company’s ability to successfully integrate acquired entities; loan losses in excess of the Company’s allowance for loan losses; changes in accounting pronouncements and practices, as adopted by financial institution regulatory agencies, the Financial Accounting Standards Board and the Public Company Accounting Oversight Board; the impact of such changes in accounting pronouncements and practices being greater than anticipated; the ability to realize the benefit of deferred tax assets; changes in tax policies, rates and regulations of federal, state and local tax authorities; changes in consumer spending, borrowing and saving habits; changes in the Company’s organization, compensation and benefit plans; the effects of the COVID-19 pandemic, including the effects of government responses, changes in consumer behavior, and supply chain interruptions; and other factors discussed elsewhere in this Quarterly Report on Form 10-Q, as well as in the Company’s periodic reports filed with the SEC, in particular the “Risk Factors” discussed in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021. Many of these factors are beyond the Company’s control and are difficult to predict.
Because of these and other uncertainties, the Company’s actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein. Forward-looking statements speak only as of the date they are made. The Company undertakes no obligation to publicly update or revise forward-looking information, whether as a result of new, updated information, future events or otherwise, except to the extent required by law.
The Discussion and Analysis of Financial Condition and Results of Operations that follows includes comparisons to the quarter ended June 30, 2021 as well as the trailing quarter ended March 31, 2022 and balances as of December 31, 2021. Information with respect to the trailing quarter ended March 31, 2022 is included in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2022 as filed with the SEC.
PANDEMIC UPDATE
The COVID-19 pandemic has caused significant economic dislocation that has affected, and may continue to affect, the business, financial condition, and results of operations of the Company and its clients. The pandemic caused changes in the behavior of clients, businesses, and their employees, including illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in commercial activity and financial transactions, supply chain interruptions, increased unemployment, and overall economic and financial market instability. Given the ongoing and dynamic nature of the pandemic, it is difficult to predict the full impact of the pandemic on the Company’s business. The extent of such impact will depend on future developments, which are highly uncertain, including the extent to which the outbreak can be controlled and abated and when and how the economy may be fully reopened. The pandemic may adversely impact several industries within our geographic footprint and impair the ability of the Company’s clients to fulfill their contractual obligations to the Company. This could cause the Company to experience a material adverse effect on our business operations, asset valuations, financial condition, and results of operations.
APPLICATION OF CRITICAL ACCOUNTING ESTIMATES
The Company’s Unaudited Consolidated Financial Statements included in this Quarterly Report on Form 10-Q are prepared in accordance with U.S. GAAP and follow general practices within the industries in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the Company’s Unaudited Consolidated Financial Statements and Notes. These estimates, assumptions, and judgments are based on information available as of the date of the Unaudited Consolidated Financial Statements. Accordingly, as this information changes, the Unaudited Consolidated Financial Statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions, and judgments, and as such, have a greater possibility of producing results that could be materially different than originally reported.
Significant accounting policies followed by the Company are presented in Note 1 – “Organization and Summary of Significant Accounting Policies” to the Audited Consolidated Financial Statements included in Item 8 in its Annual Report on Form 10-K for the year ended December 31, 2021. These policies, along with the disclosures presented in the other Notes to the Company's Audited Consolidated Financial Statements contained in its Annual Report on Form 10-K and in this financial review, provide information on how significant assets and liabilities are presented in the Company’s Unaudited Consolidated Financial Statements and how those values are determined.
The more significant areas in which management of the Company applies critical assumptions and estimates includes the allowance for loan losses.
Allowance for Loan Losses
The allowance for loan losses (“ALLL”) represents management’s estimate of probable incurred losses in the Bank’s loan portfolio. Determining the amount of the allowance for loan losses requires significant judgment on the part of management and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, consideration of current economic trends and conditions, and other qualitative and quantitative factors, all of which may be susceptible to significant change. Qualitative loss factors are applied to each portfolio segment with the amounts determined by historical loan charge-offs of a peer group of similar-sized regional banks. It is difficult to estimate how potential changes in any one economic factor or input might affect the overall allowance because a wide variety of factors and inputs are considered in estimating the allowance and changes in those factors and inputs considered may not occur at the same rate and may not be consistent across all product types. Additionally, changes in factors and inputs may be directionally inconsistent, such that improvement in one factor may offset deterioration in others.
In estimating the ALLL on loans, management considers the sensitivity of the model and significant judgments and assumptions that could result in an amount that is materially different from management’s estimate. Given the concentration of ALLL allocation to the total commercial portfolio and the significant judgments made by management in deriving the qualitative loss factors, management analyzed the impact that changes in judgments could have. The range of impact on the ALLL allocated to the total commercial loan portfolio was between a reduction of $12.0 million and an increase of $9.8 million at June 30, 2022. The sensitivity and related range of impact is a hypothetical analysis and is not intended to represent management’s judgments or assumptions of qualitative loss factors that were utilized at June 30, 2022 in estimation of the ALLL on loans recognized on the Consolidated Balance Sheet.
If the assumptions underlying the determination of the ALLL prove to be incorrect, the ALLL may not be sufficient to cover actual loan losses and an increase to the ALLL may be necessary to allow for different assumptions or adverse developments. In addition, a problem with one or more loans could require a significant increase to the ALLL.
ANALYSIS OF FINANCIAL CONDITION
Loan Activity
Total gross loans were $1.6 billion at June 30, 2022 and December 31, 2021 compared with $1.7 billion at June 30, 2021. The year-over-year decrease is primarily due to a decrease in PPP loan balances. PPP loan balances, included in commercial and industrial loans, decreased $142 million since June 30, 2021. PPP loans totaled $4 million at June 30, 2022, compared with $25 million at December 31, 2021 and $146 million at June 30, 2021. Excluding the decrease of PPP loans, commercial and industrial loans increased $13 million year-over-year. Residential mortgages and commercial real estate loans increased year-over-year by $34 million and $6 million, respectively.
Loans secured by real estate were $1.4 billion at June 30, 2022, compared with $1.3 billion at December 31, 2021 and June 30, 2021. Residential real estate loans, including construction loans, were $429 million at June 30, 2022, $13 million or 3% higher than at December 31, 2021, and $34 million or 9% higher than at June 30, 2021. The increase in residential real estate loans reflects management’s decision to retain the majority of residential mortgages within our loan portfolio. Commercial real estate loans, including construction loans, were $865 million at June 30, 2022, $28 million or 3% higher than the balance at December 31, 2021, and $6 million or 1% higher than the balance at June 30, 2021.
In the second quarter of 2022, residential mortgage originations were $18 million compared with the previous quarter’s originations of $22 million and $33 million in the second quarter of 2021. The Company originated $40 million in residential mortgages in the first six months of 2022, compared with $65 million in the first six months of 2021. The decrease in residential mortgage originations as compared to the prior year is primarily due to customers refinancing at lower interest rates during the first six months of 2021. The Company sold $0.6 million of residential mortgages during the second quarter of 2022 compared with $2.9 million during the first quarter of 2022. During the first six months of 2022 the Company sold $3.5 million of residential mortgages. The Company did not sell any residential mortgages during the first six months of 2021. Management decides to keep or sell residential mortgage loans at the time of origination based on interest rate risk management and the risk-adjusted return of alternative investment sources such as mortgage-backed securities.
The Company has also focused on growth opportunities in commercial and industrial (“C&I”) lending as a way to diversify its overall loan portfolio. The C&I portfolio was $236 million at June 30, 2022, representing a $1 million or less than 1% decrease from December 31, 2021, and a decrease of $129 million or 35% from June 30, 2021. The decrease from prior year period is primarily the result of $142 million in SBA forgiveness of PPP loans as the program approaches conclusion. A total of $298 million of PPP loans were originated during the program, of which $95 million were originated during 2021. As of June 30, 2022, a total of $294 million of the PPP loans have been forgiven by the SBA, including $6 million that was forgiven during the second quarter of 2022. A total of $21 million has been forgiven during the first six months of 2022. C&I lending is a critical component of the Company’s strategy as C&I relationships can often include core deposits.
Credit Quality of Loan Portfolio
Non-performing loans, defined as accruing loans greater than 90 days past due and nonaccrual loans, totaled $22 million, or 1.36% of total loans outstanding at June 30, 2022, compared with $18 million, or 1.17% of total loans outstanding, as of December 31, 2021 and $24 million, or 1.43% of total loans outstanding, as of June 30, 2021. The increase in non-performing loans since the end of last year was primarily due to one commercial real estate loan of $5.5 million that moved to non-accrual status during the second quarter of 2022.
Commercial credits graded as “special mention” and “substandard,” or the criticized loan portfolio, were $108 million at June 30, 2022, a $3 million decrease from $111 million at December 31, 2021, and a $38 million decrease from $146 million at June 30, 2021. The Company continues to classify loans to clients within the hotel industry as criticized given their level of seasonality and ongoing challenges as a result of the COVID-19 pandemic. As of June 30, 2022, the Company’s hotel loan portfolio was $74 million, or approximately 7% of total commercial loans, of which $54 million of these loans are classified as criticized. The Company continues to monitor each client in that industry including on-going conversations with the borrowers. The level of criticized loans can fluctuate as new information is constantly received on the Company’s borrowers and their financial circumstances change over time. Internal risk ratings are the credit quality indicators used by the Company’s management to determine the appropriate allowance for loan losses for commercial credits. “Special mention” and “substandard” loans are weaker credits with a higher risk of loss and are categorized as “criticized” credits rather than “pass” or “watch” credits.
The Company maintains an allowance for loan losses that in management’s judgment appropriately reflects losses inherent in the loan portfolio. Loans acquired in a business combination are recorded at fair value with no carry-over of an acquired entity’s previously established allowance for credit losses. The allowance for loan losses totaled $18.8 million or 1.17% of total loans outstanding at June 30, 2022, compared with $18.4 million or 1.17% of total loans outstanding as of December 31, 2021 and $19.9 million or 1.17% of total loans outstanding at June 30, 2021. The Company recorded a $0.3 million provision for loan losses in the second quarter of 2022, compared with $0.2 million the first quarter of 2022, and a credit of $0.8 million during the second quarter of 2021. Second quarter of 2022 provision for loan losses was primarily due to the change in economic trends.
Investing Activities
Total investment securities were $403 million at June 30, 2022, compared with $309 million at December 31, 2021 and $234 million at June 30, 2021. The increases reflect the use of excess cash balances. Interest-bearing deposits at other banks, which consist of overnight funds kept at correspondent banks and the Federal Reserve, were $88 million at June 30, 2022 compared to $235 million at December 31, 2021, and $127 million at June 30, 2021. The primary objectives of the Company’s investment portfolio are to provide liquidity, provide collateral to secure municipal deposits, and maximize income while preserving safety of principal. Average investment securities and interest-bearing cash were 24% of average interest-earning assets in the second quarter of 2022, compared with 26% in the first quarter of 2022 and 15% in the second quarter of 2021.
The Company’s highest concentration in its securities portfolio was in available for sale U.S. government sponsored mortgage-backed securities which comprised 55%, 66% and 61% of total investment securities at June 30, 2022, December 31, 2021 and June 30, 2021, respectively. Tax-advantaged debt securities issued by state and political subdivisions was 2%, 3% and 4% of the total securities portfolio at June 30, 2022, December 31, 2021 and June 30, 2021, respectively. The concentration in U.S. government-sponsored agency bonds was 37%, 31% and 35% of the total securities portfolio as of June 30, 2022, December 31, 2021 and June 30, 2021, respectively.
The total net unrealized loss position of the available-for-sale investment portfolio was $43.0 million at June 30, 2022, compared with net unrealized gains of $4.3 million at December 31, 2021 and $0.3 million at June 30, 2021. The securities in an unrealized loss position at the end of the second quarter of 2022 generally reflect an increase in market interest rates. Management believes that the credit quality of the securities portfolio as a whole is strong.
The Company monitors extension and prepayment risk in the securities portfolio to limit potential exposures. The Company has no direct exposure to subprime mortgages, nor does the Company hold private mortgage-backed securities, credit default swaps, or FNMA or FHLMC preferred stock investments in its investment portfolio.
Funding Activities
Total deposits at June 30, 2022 were $2.0 billion, a $31 million or 2% increase from December 31, 2021, and an $85 million or 4% increase from June 30, 2021. The increase from June 30, 2021 largely reflects the acquisition of new commercial deposit customers. Specifically, the increase from prior year reflects increases in total demand deposits of $63 million or 13%, commercial savings of $42 million or 21%, consumer savings deposits of $21 million or 4%, municipal savings deposits of $12 million or 6%, and total NOW deposits of $4 million or 2%. These increases were offset by a decrease in time deposits of $58 million or 30%. Average demand deposits were $543 million in the second quarter of 2022, a 6% increase from $512 million in the first quarter of 2022, and a 10% increase from $494 million in the second quarter of 2021.
The Company had $23 million in other borrowings at June 30, 2022, compared with $33 million at December 31, 2021 and $41 million at June 30, 2021. This represents long-term advances from the Federal Home Loan Bank of New York (“FHLBNY”) that were acquired in the FSB acquisition. The Company’s use of its overnight line of credit with FHLBNY varies depending on its ability to fund investment and loan growth with deposits along with the line usage’s impact on interest rate risk. There were no overnight borrowings at June 30, 2022.
ANALYSIS OF RESULTS OF OPERATIONS
Average Balance Sheet
The following tables present the significant categories of the assets and liabilities of the Company, interest income and interest expense, and the corresponding yields earned and rates paid for the periods indicated. The assets and liabilities are presented as daily averages. The average loan balances include both performing and non-performing loans. Interest income on loans does not include interest on loans for which the Bank has ceased to accrue interest. Investments are included at book value. Yields are presented on a non-tax-equivalent basis.
Average
Interest
Outstanding
Earned/
Yield/
Paid
Rate
(dollars in thousands)
Interest-earning assets:
Loans, net (1)
1,591,971
4.24
%
1,718,507
4.32
Taxable securities
382,512
2.08
205,798
1.93
Tax-exempt securities
9,859
2.40
10,336
2.17
Interest bearing deposits at banks
111,457
0.81
97,168
0.08
Total interest-earning assets
2,095,799
3.65
2,031,809
3.86
Non interest-earning assets:
14,219
20,017
Premises and equipment, net
17,511
19,012
84,472
80,363
Total Assets
2,212,001
2,151,201
LIABILITIES & STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
258,197
0.09
246,565
0.11
1,020,004
348
0.14
928,375
391
0.17
143,677
176
0.49
210,287
275
0.52
25,321
0.63
41,291
84
0.82
31,010
5.47
30,908
5.24
Securities sold U/A to repurchase
6,872
0.12
4,851
Total interest-bearing liabilities
1,485,081
0.28
1,462,277
0.34
Noninterest-bearing liabilities:
542,827
493,734
17,562
23,682
2,045,470
1,979,693
Stockholders' equity
166,531
171,508
Total Liabilities and Equity
Net interest margin
3.45
3.62
Interest rate spread
3.37
3.52
(1) Included in interest earned on loans were PPP loan fees of $0.2 million and $2.5 million for the three months ended June 30, 2022 and 2021, respectively. Other loan fees included in interest earned were not material during the three months ended June 30, 2022 and 2021.
1,579,413
4.16
1,712,450
4.19
364,915
2.02
187,351
1.96
10,331
2.05
11,051
144,907
0.41
86,967
2,099,566
1,997,819
3.79
13,763
18,684
17,604
81,909
79,512
2,212,842
2,115,125
255,595
238,640
147
Regular savings
1,022,214
692
897,853
812
0.18
150,070
0.46
228,105
663
0.59
27,289
85
42,025
168
30,997
5.36
30,896
5,887
0.26
1,492,052
1,442,262
0.36
527,558
479,237
19,220
23,357
2,038,830
1,944,856
174,012
170,269
3.32
3.53
3.24
3.43
(1) Included in interest earned on loans were PPP loan fees of $0.7 million and $4.2 million for the six months ended June 30, 2022 and 2021, respectively. Other loan fees included in interest earned were not material during the six months ended June 30, 2022 and 2021.
Net income was $5.7 million, or $1.03 per diluted share, in the second quarter of 2022, compared with $4.7 million, or $0.86 per diluted share, in the first quarter of 2022 and $6.3 million, or $1.15 per diluted share, in last year’s second quarter. The increase from the sequential first quarter was largely due to higher net interest income. The change from prior year largely reflected lower PPP fees and a sizable credit in provision for loan losses during the prior year period.
Return on average equity was 13.77% for the second quarter of 2022, compared with 10.46% in the first quarter of 2022 and 14.72% in the second quarter of 2021.
Other Results of Operations – Quarterly Comparison
Net interest income increased $1.6 million, or 9%, from the sequential first quarter, but decreased $0.3 million when compared with prior-year second quarter. The increase from the first quarter of 2022 reflected higher interest income on loans of $1.1 million as a result of higher average balances and the Federal Reserve’s increase of the fed funds rate by 150 basis points since the beginning of 2022. Also contributing was higher interest income on securities of $0.3 million reflecting a $35 million increase in average balances during the second quarter of 2022. The decrease from the prior year period reflected lower interest income on loans of $1.7 million, including a decrease in PPP fees of $2.3 million partially offset by increases in interest income on investment securities of $1.0 million, interest bearing deposits at banks of $0.2 million and lower interest expense of $0.2 million. The decrease in PPP fees reflects the deceleration in the rate of remaining loan forgiveness as the program approaches its conclusion. PPP fees recognized in interest income were $0.2 million in the second quarter of 2022, $0.5 million in the first quarter of 2022 and $2.5 million in the second quarter of 2021.
Second quarter net interest margin of 3.45% increased 27 basis points from the first quarter of 2022 but decreased 17 basis points from the second quarter of 2021. The yield on loans increased 17 basis points compared with the first quarter of 2022 but decreased 8 basis points compared with the second quarter of 2021. The cost of interest-bearing liabilities was 0.28% in the second quarter of 2022 compared with 0.27% in the first quarter of 2022 and 0.34% in the second quarter of 2021.
The $0.3 million provision for loan losses in the current quarter was primarily due to a change in economic trends.
Non-interest income was $4.6 million in the second quarter of 2022, compared with $4.4 million in the first quarter of 2022 and the prior year second quarter. The increase from the sequential first quarter reflects seasonally higher policy renewals for institutional clients. The increase from prior year’s second quarter was largely due to movements in the fair value of mortgage servicing rights.
Non-interest expenses of $14.8 million in the second quarter of 2022 increased $0.3 million or 2% when compared with the first quarter of 2022 but decreased $0.4 million or 3% from last year’s second quarter. The increase from the first quarter of 2022 was due to seasonal marketing campaigns during the second quarter of 2022. The decrease from the second quarter of 2021 is primarily due to lower COVID related technology and communication expense. Salaries and employee benefits expense remained consistent when compared with prior periods. Salaries and employee benefits comprised 64% of total non-interest expense.
The Company’s GAAP efficiency ratio, or noninterest expenses divided by the sum of net interest income and noninterest income, was 65.2% in the second quarter of 2022, 69.1% in the first quarter of 2022, and 66.7% in the second quarter of 2021.
Income tax expense was $1.9 million, for an effective tax rate of 24.7%, in the second quarter of 2022 compared with 24.0% in the first quarter of 2022 and 24.4% in last year’s second quarter.
Other Results of Operations – Year-to-Date Comparison
Net interest income was $34.6 million for the first six months of 2022, a $0.4 million or 1% decrease from the first six months of 2021. The decrease in net interest income is attributable to a $3.5 million reduction in PPP fees earned during the first six months of 2022 compared to prior year period. Partially offsetting the decrease were higher interest income on investment securities of $1.8 million, interest-bearing deposits at banks of $0.3 million and lower total interest expense of $0.5 million. Average investment securities increased $177 million during the first six months of 2022 when compared to the prior year period. At June 30, 2022 total PPP loans that have not yet received SBA forgiveness was $3.5 million. SBA PPP fees are deferred and amortized into interest income over the contractual period of the loan. Upon SBA forgiveness, unamortized fees are then recognized into interest income. The Company recognized $0.7 million of amortized PPP loan fees in interest income during the six months ended June 30, 2022, compared with $4.2 million during the prior year period.
The Company’s net interest margin of 3.32% in the first six months of 2022 was 21 basis points lower than the margin in the first six months of 2021, largely reflecting changes in the composition of the Company’s earning assets. The yield on average interest-earning assets decreased 27 basis points from 3.79% to 3.52%. Average loan yields decreased 3 basis points from 4.19% to 4.16%, reflecting the reduction of PPP fees earned since the prior year, partially offset by the Federal Reserve’s increase of fed funds rate during 2022. The cost of interest-bearing liabilities was 0.28% in the first six months of 2022, 8 basis points lower than during the first six months of 2021. The rate paid on average time deposits decreased from 0.59% in the first half of 2021 to 0.46% during the first six months of 2022.
The Company recorded $0.5 million provision for loan loss in the six month period ended June 30, 2022, compared with $0.4 million release of allowance for loan losses in the six month period ended June 30, 2021 which resulted from improved macroeconomic trends recognized during the first six months of 2021. While the full impact of COVID-19 on future financial results is uncertain, the Company continues to monitor the potential impact on the ability of some clients to meet their borrowing obligations.
Non-interest income for the first six months of 2022 and 2021 was $9 million at both respective periods. During the first six months of 2022 deposit service charges and changes in the fair value of mortgage servicing rights each increased non-interest income by $0.2 million. Partially offsetting those increases was insurance service and fees revenue, the largest component of non-interest income, which decreased $0.3 million to $4.9 million as of June 30, 2022, primarily due to the discontinued operations of Frontier Claims Services, which ceased operations on December 31, 2021.
Total non-interest expense decreased to $29.2 million in the first six months of 2022, 1% lower than the six-month period ended June 30, 2021. The decrease was mostly attributable to lower technology and communications costs of $0.3 million and professional services costs of $0.2 million during the first six months of 2022 compared to the prior year period. Partially offsetting the decrease were higher salaries and employee benefits costs of $0.5 million or 3% during the first six months of 2022. Salaries and employee benefits costs were $18.9 million for the first six months of 2022 compared to $18.4 million in the prior year period.
The Company’s GAAP efficiency ratio, or noninterest expenses divided by the sum of net interest income and noninterest income, was 67.1% in the first six months of 2022, compared with 67.2% during the prior-year period.
The Company recorded income tax expense of $3.4 million for the six-month period ended June 30, 2022, compared with $3.7 million in the first six months of 2021. The effective tax rate for the first six months of 2022 was 24.4%, compared with 24.8% in the comparable 2021 period.
CAPITAL
The Company consistently maintains regulatory capital ratios significantly above the federal “well capitalized” standard, including a Tier 1 leverage ratio of 8.73% at June 30, 2022, compared with 8.57% at March 31, 2022 and 8.23% at June 30, 2021.
Book value per share was $29.53 at June 30, 2022 compared with $30.65 at March 31, 2022 and $32.28 at June 30, 2021. Reflected in the book value changes are the Federal Reserve’s aggressive interest rate hikes, that have resulted in significant changes in unrealized gains and losses on investment securities, which reduced book value per share at June 30, 2022 by $2.18 when compared with the sequential first quarter and by $5.83 from last year’s second quarter. Such unrealized gains and losses are generally due to changes in interest rates and represent the difference, net of applicable income tax effect, between the estimated fair value and amortized cost of investment securities classified as available-for-sale. The Company had no other-than-temporary impairment charges in its investment portfolio in 2022 or 2021.
The Company has also issued subordinated capital notes and junior subordinated debentures associated with trust preferred securities to provide liquidity and enhance regulatory capital ratios. The Company had $11.3 million of junior subordinated debentures associated with trust preferred securities outstanding at June 30, 2022 and December 31, 2021 which are considered Tier 1 capital and are includable in total regulatory capital. The Company had $20 million of 6.00% Fixed-to-Floating Rate Subordinated Notes due 2030 outstanding at June 30, 2022 and December 31, 2021. The Company moved $15 million of the proceeds from the sale of these notes to the Company’s Evans Bank, N.A. subsidiary as Tier 1 capital.
While we are currently classified as well capitalized, an extended economic recession could adversely impact our reported and regulatory capital ratios by credit losses. The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt. If the Company’s subsidiary bank’s capital deteriorates such that it is unable to pay dividends to the Company for an extended period of time, the Company may not be able to service its debt that was issued.
LIQUIDITY
The Bank utilizes cash flows from the investment portfolio and federal funds sold balances to manage the liquidity requirements related to loan demand and deposit fluctuations. The Bank also has many borrowing options. The Company uses the FHLBNY as its primary source of overnight funds and has long-term advance with FHLBNY. The Company’s use of its overnight line of credit with FHLBNY varies depending on its ability to fund investment and loan growth with core deposits along with the line usage’s impact on interest rate risk. The Company’s funding strategy has resulted in significant deposit growth, resulting in less usage of the FHLBNY overnight line of credit. The Company has pledged sufficient collateral in the form of residential and commercial real estate loans at FHLBNY that meets FHLB collateral requirements. As a member of the FHLB, the Bank is able to borrow funds at competitive rates. As of June 30, 2022, advances of up to $366 million could be drawn on the FHLB via an Overnight Line of Credit Agreement between the Bank and the FHLB. As of June 30, 2022, the Bank also had the ability to purchase up to $18 million in federal funds from its correspondent banks. By placing sufficient collateral in safekeeping at the Federal Reserve Bank, the Bank could borrow at the discount window. The Bank’s liquidity needs also can be met by more aggressively pursuing time deposits, or accessing the brokered time deposit market, including the Certificate of Deposit Account Registry Service (“CDARS”) network.
Cash flows from the Bank’s investment portfolio are laddered, so that securities mature at regular intervals, to provide funds from principal and interest payments at various times as liquidity needs may arise. Contractual maturities are also laddered, with consideration as to the volatility of market prices. At June 30, 2022, approximately 3% of the Bank’s securities had contractual maturity dates of one year or less and approximately 22% had maturity dates of five years or less. Additionally, mortgage-backed securities, which comprise 55% of the investment portfolio at June 30, 2022, provide consistent cash flows for the Bank.
The Company’s primary source of liquidity is dividends from the Bank. Additionally, the Company has access to capital markets as a funding source.
Management, on an ongoing basis, closely monitors the Company’s liquidity position for compliance with internal policies and believes that available sources of liquidity are adequate to meet funding needs in the normal course of business. As part of that monitoring process, management calculates the 90-day liquidity each month by analyzing the cash needs of the Bank. Included in the calculation are liquid assets and potential liabilities. Management stresses the potential liabilities calculation to ensure a strong liquidity position. Included in the calculation are assumptions of some significant deposit run-off as well as funds needed for loan closings and investment purchases. In the Company’s internal stress test at June 30, 2022, the Company had net short-term liquidity of $548 million as compared with $724 million at December 31, 2021. Available assets of $489 million, divided by public and purchased funds of $379 million, resulted in a long-term liquidity ratio of 129% at June 30, 2022, compared with 153% at December 31, 2021.
Management does not anticipate engaging in any activities, either currently or in the long term, for which adequate funding would not be available and which would therefore result in significant pressure on liquidity.
The Company believes that the Bank maintains a sufficient level of U.S. government and government agency securities and New York State municipal bonds that can be pledged as collateral for municipal deposits.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Additional information responsive to this Item is contained in the Liquidity section of Management’s Discussion and Analysis of Financial Condition and Results of Operations, which information is incorporated herein by reference.
Market risk is the risk of loss from adverse changes in market prices and/or interest rates of the Bank’s financial instruments. The primary market risk that the Company is exposed to is interest rate risk. The core banking activities of lending and deposit-taking expose the Bank to interest rate risk, which occurs when assets and liabilities reprice at different times and by different amounts as interest rates change. As a result, net interest income earned by the Bank is subject to the effects of changing interest rates. The Bank measures interest rate risk by calculating the variability of net interest income in future periods under various interest rate scenarios using projected balances for interest-earning assets and interest-bearing liabilities. Management’s philosophy toward interest rate risk management is to limit the variability of net interest income to changes in net interest rates. The balances of financial instruments used in the projections are based on expected growth from forecasted business opportunities, anticipated prepayments of loans, and expected maturities of investment securities, loans, and deposits. Management supplements the modeling technique described above with analysis of market values of the Bank’s financial instruments and changes to such market values given changes in the interest rates.
The Bank’s Asset-Liability Committee, which includes members of senior management, monitors the Bank’s interest rate sensitivity with the aid of a model that considers the impact of ongoing lending and deposit taking activities, as well as interrelationships in the magnitude and timing of the repricing of financial instruments, including the effect of changing interest rates on expected prepayments and maturities. When deemed prudent, management has taken actions, and intends to do so in the future, to mitigate exposure to interest rate risk through the use of on- or off-balance sheet financial instruments. Possible actions include, but are not limited to, changing the pricing of loan and deposit products, and modifying the composition of interest-earning assets and interest-bearing liabilities, and reliance on other financial instruments used for interest rate risk management purposes.
The following table demonstrates the possible impact of changes in interest rates on the Bank’s net interest income over a 12-month period of time:
SENSITIVITY OF NET INTEREST INCOME TO CHANGES IN INTEREST RATES
Calculated increase (decrease)
in projected annual net interest income
Changes in interest rates
+200 basis points
(1,130)
1,375
+100 basis points
2,412
3,569
-100 basis points
(3,700)
(2,183)
-200 basis points
NM
Many assumptions were utilized by management to calculate the impact that changes in interest rates may have on the Bank’s net interest income. The more significant assumptions related to the rate of prepayments of mortgage-related assets, loan and deposit volumes and pricing, and deposit maturities. The Bank assumed immediate changes in rates including 200 basis point rate changes. In the 200 basis point rate reduction scenario, the applicable rate changes may be limited to lesser amounts such that interest rates are not less than zero. The assumptions in the Company’s projections are inherently uncertain and, as a result, the Bank cannot precisely predict the impact of changes in interest rates on net interest income. Actual results may differ significantly due to the timing, magnitude, and frequency of interest rate changes in market conditions and interest rate differentials (spreads) between maturity/repricing categories, as well as any actions such as those previously described, which management may take to counter such changes. In light of the uncertainties and assumptions associated with the process, the amounts presented in the table and changes in such amounts are not considered significant to the Bank’s projected net interest income.
ITEM 4 - CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2022 (the end of the period covered by this Report). Based on that evaluation, the Company’s principal executive and principal financial officers concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2022.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No changes in the Company’s internal control over financial reporting were identified in connection with the evaluation required by paragraph (d) of Rule 13a-15 or Rule 15d-15 under the Exchange Act that occurred during the fiscal quarter ended June 30, 2022 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS
The nature of the Company’s business generates a certain amount of litigation involving matters arising in the ordinary course of business.
In the opinion of management, there are no proceedings pending to which the Company is a party or to which its property is subject, which, if determined adversely, would have a material effect on the Company’s results of operations or financial condition.
ITEM 1A – RISK FACTORS
There have been no material changes to the risk factors previously disclosed in Item 1A. Part I of the Company’s Annual Report on Form 10- K for the fiscal year ended December 31, 2021.
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
Period
Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Shares that may yet be Purchased Under the Plans or Programs
April 1, 2022 - April 30, 2022
Repurchase program(1)
300,000
Employee transactions(2)
May 1, 2022 - May 31, 2022
18,411
37.39
281,589
2,151
37.68
June 1, 2022 - June 30, 2022
10,858
37.70
270,731
29,269
37.51
(1)On February 25, 2021, the Board of Directors authorized the Company to repurchase up to 300,000 shares of the Company’s common stock (the “2021 Repurchase Program”). The 2021 Repurchase program does not expire and may be suspended or discontinued by the Board of Directors at any time. The remaining number of shares that may be purchased under the 2021 Repurchase Program as of June 30, 2022 was 270,731.
(2)The total shares purchased in the period consist of shares constructively tendered to the Company by attestation in satisfaction of the exercise price due upon exercise of options issued pursuant to the Company’s 2019 Long-Term Incentive Plan. The “average price paid per share” reported in the table above, with respect to such shares, reflects the fair market value of the Company’s common stock on the exercise date, which was the closing sales price of the Company’s common stock as reported on the NYSE American on that date.
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
(Not Applicable.)
ITEM 4 – MINE SAFETY DISCLOSURE
ITEM 5 – OTHER INFORMATION
ITEM 6 – EXHIBITS
The following exhibits are filed as a part of this report:
EXHIBIT INDEX
Exhibit No.
Name
31.1
Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Principal Executive Officer pursuant to 18 USC Section 1350 Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
Certification of Principal Financial Officer pursuant to 18 USC Section 1350 Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101
The following materials from Evans Bancorp, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, formatted in XBRL (eXtensible Business Reporting Language): (i) Unaudited Consolidated Balance Sheets – June 30, 2022 and December 31, 2021; (ii) Unaudited Consolidated Statements of Income – Three months ended June 30, 2022 and 2021; (iii) Unaudited Consolidated Statements of Income – Six months ended June 30, 2022 and 2021; (iv) Unaudited Statements of Consolidated Comprehensive Income (Loss) – Three months ended June 30, 2022 and 2021; (v) Unaudited Statements of Consolidated Comprehensive Income (Loss) – Six months ended June 30, 2022 and 2021; (vi) Unaudited Consolidated Statements of Stockholders' Equity – Three months ended June 30, 2022 and 2021; (vii) Unaudited Consolidated Statements of Stockholders' Equity – Six months ended June 30, 2022 and 2021; (viii) Unaudited Consolidated Statements of Cash Flows – Six months ended June 30, 2022 and 2021; and (ix) Notes to Unaudited Consolidated Financial Statements.
104
The cover page from the Evans Bancorp, Inc’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2022, formatted in Inline XBRL.
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.
Evans Bancorp, Inc.
DATE
July 29, 2022
/s/ David J Nasca
David J. Nasca
President and CEO
(Principal Executive Officer)
/s/ John B. Connerton
John B. Connerton
Treasurer
(Principal Financial Officer and Principal Accounting Officer)