Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒ Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2021
or
☐ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission File Number: 001-38647
FVCBankcorp, Inc.
(Exact name of registrant as specified in its charter)
Virginia
47-5020283
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
11325 Random Hills Road
Suite 240
Fairfax, Virginia
22030
(Address of principal executive offices)
(Zip Code)
(703) 436-3800
(Registrant’s telephone number, including area code)
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, $0.01 par value
FVCB
The Nasdaq Stock Market, LLC
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, 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
☒
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
13,638,934 shares of common stock, par value $0.01 per share, outstanding as of May 7, 2021
INDEX TO FORM 10-Q
PART I — FINANCIAL INFORMATION
3
Item 1. Financial Statements:
Consolidated Balance Sheets At March 31, 2021 (unaudited) and December 31, 2020
Consolidated Statements of Income For the Three Months Ended March 31, 2021 and 2020 (unaudited)
4
Consolidated Statements of Comprehensive Income For the Three Months Ended March 31, 2021 and 2020 (unaudited)
5
Consolidated Statements of Cash Flows For the Three Months Ended March 31, 2021 and 2020 (unaudited)
6
Consolidated Statements of Changes in Stockholders’ Equity For the Three Months Ended March 31, 2021 and 2020 (unaudited)
7
Notes to Consolidated Financial Statements (unaudited)
8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
36
Item 3. Quantitative and Qualitative Disclosures About Market Risk
62
Item 4. Controls and Procedures
64
PART II — OTHER INFORMATION
65
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
66
SIGNATURES
67
2
Item 1. Financial Statements
FVCBankcorp, Inc. and Subsidiary
Consolidated Balance Sheets
March 31, 2021 and December 31, 2020
(In thousands, except share data)
March 31,
December 31,
2021
2020 *
(Unaudited)
Assets
Cash and due from banks
$
16,593
20,835
Interest-bearing deposits at other financial institutions
203,285
120,228
Securities held-to-maturity (fair value of $0.3 million for both March 31, 2021 and December 31, 2020)
264
Securities available-for-sale, at fair value
135,104
126,151
Restricted stock, at cost
6,377
6,563
Loans, net of allowance for loan losses of $14.4 million and $15.0 million at March 31, 2021 and December 31, 2020, respectively
1,432,491
1,451,125
Premises and equipment, net
1,520
1,654
Accrued interest receivable
8,912
9,135
Prepaid expenses
978
621
Deferred tax assets, net
8,808
8,552
Goodwill and intangibles, net
8,277
8,357
Bank owned life insurance (BOLI)
38,425
38,178
Other real estate owned (OREO)
3,866
Operating lease right-of-use assets
10,845
11,125
Other assets
8,772
14,827
Total assets
1,884,517
1,821,481
Liabilities and Stockholders’ Equity
Liabilities
Deposits:
Noninterest-bearing
501,812
399,062
Interest-bearing checking, savings and money market
822,888
820,378
Time deposits
269,939
313,053
Total deposits
1,594,639
1,532,493
FHLB advances
25,000
Subordinated notes, net of issuance costs
44,116
44,085
Accrued interest payable
1,372
685
Operating lease liabilities
11,831
12,123
Accrued expenses and other liabilities
12,630
17,595
Total liabilities
1,689,588
1,631,981
Commitments and Contingent Liabilities
Stockholders’ Equity
2020
Preferred stock, $0.01 par value
Shares authorized
1,000,000
Shares issued and outstanding
—
Common stock, $0.01 par value
20,000,000
13,638,934
13,510,760
136
135
Additional paid-in capital
120,552
119,568
Retained earnings
73,540
67,971
Accumulated other comprehensive income, net
701
1,826
Total stockholders’ equity
194,929
189,500
Total liabilities and stockholders’ equity
See Notes to Consolidated Financial Statements.
* Derived from audited consolidated financial statements.
Consolidated Statements of Income
For the three months ended March 31, 2021 and 2020
(In thousands, except per share data)
Interest and Dividend Income
Interest and fees on loans
15,933
15,885
Interest and dividends on securities held-to-maturity
1
Interest and dividends on securities available-for-sale
717
874
Dividends on restricted stock
82
89
Interest on deposits at other financial institutions
45
81
Total interest and dividend income
16,778
16,931
Interest Expense
Interest on deposits
2,001
4,176
Interest on federal funds purchased
79
Interest on short-term debt
83
70
Interest on subordinated notes
651
395
Total interest expense
2,735
4,720
Net Interest Income
14,043
12,211
Provision for loan losses
1,066
Net interest income after provision for loan losses
11,145
Noninterest Income
Service charges on deposit accounts
243
239
Gain on sale of securities available-for-sale
97
Loss on loans held for sale
(451)
BOLI income
248
283
Other income
300
525
Total noninterest income
791
693
Noninterest Expenses
Salaries and employee benefits
4,548
4,028
Occupancy and equipment expense
807
855
Data processing and network administration
563
434
State franchise taxes
504
466
Audit, legal and consulting fees
354
225
Loan related expenses
106
211
FDIC insurance
210
165
Marketing, business development and advertising
49
103
Director fees
138
140
Postage, courier and telephone
46
44
Internet banking
133
120
Core deposit intangible amortization
80
90
Other operating expenses
344
328
Total noninterest expenses
7,882
7,209
Net income before income tax expense
6,952
4,629
Income tax expense
1,383
896
Net income
5,569
3,733
Earnings per share, basic
0.41
0.27
Earnings per share, diluted
0.38
0.26
Consolidated Statements of Comprehensive Income
(In thousands)
Other comprehensive (loss) income:
Unrealized (loss) gain on securities available for sale, net of tax benefit of $296 in 2021 and net of tax expense of $609 in 2020.
(1,281)
2,292
Unrealized gain (loss) on interest rate swaps, net of tax expense of $42 in 2021 and net of tax benefit of $124 in 2020.
156
(468)
Reclassification adjustment for gains realized in income, net of tax expense of $20 for 2020.
(77)
Total other comprehensive (loss) income
(1,125)
1,747
Total comprehensive income
4,444
5,480
Consolidated Statements of Cash Flows
Cash Flows From Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
153
159
Net amortization of premium of securities
101
Net amortization of deferred loan costs and purchase premiums
1,697
232
Net accretion of acquisition accounting adjustments
(129)
(169)
Gain on sale of available-for-sale securities
(97)
451
Payments received on loans held for sale, net
1,107
Amortization of subordinated debt issuance costs
31
20
Core deposits intangible amortization
Equity-based compensation expense
166
205
(248)
(283)
Changes in assets and liabilities:
Decrease (increase) in accrued interest receivable, prepaid expenses and other assets
6,201
(7,813)
(Decrease) increase in accrued interest payable, accrued expenses and other liabilities
(4,372)
7,713
Net cash provided by operating activities
9,237
6,515
Cash Flows From Investing Activities
Increase in interest-bearing deposits at other financial institutions
(83,057)
(44,176)
Purchases of securities available-for-sale
(21,118)
Proceeds from maturities and calls of securities available-for-sale
1,000
Proceeds from redemptions of securities available-for-sale
9,498
6,162
Net redemption (purchase) of restricted stock
186
(591)
Net decrease (increase) in loans
17,069
(11,756)
Purchases of premises and equipment, net
(19)
(165)
Net cash used in investing activities
(76,441)
(49,526)
Cash Flows From Financing Activities
Net increase in noninterest-bearing, interest-bearing checking, savings, and money market deposits
105,260
37,449
Net (decrease) increase in time deposits
(43,117)
20,879
Decrease in federal funds purchased
(10,000)
Net increase in FHLB advances
10,000
Repurchase of shares of common stock
(7,280)
Common stock issuance
819
Net cash provided by financing activities
62,962
51,253
Net (decrease) increase in cash and cash equivalents
(4,242)
8,242
Cash and cash equivalents, beginning of year
14,916
Cash and cash equivalents, end of year
23,158
Consolidated Statements of Changes in Stockholders’ Equity
Accumulated
Additional
Other
Common
Paid-in
Retained
Comprehensive
Shares
Stock
Capital
Earnings
Income
Total
Balance at December 31, 2019
13,902
139
125,779
52,470
690
179,078
Other comprehensive income
Repurchase of common stock
(487)
(5)
(7,275)
Common stock issuance for options exercised, net
37
204
Stock-based compensation expense
Balance at March 31, 2020
13,452
118,913
56,203
2,437
177,688
Balance at December 31, 2020
13,511
128
818
Balance at March 31, 2021
13,639
Notes to Unaudited Consolidated Financial Statements
Note 1.
Organization and Summary of Significant Accounting Policies
Organization
FVCBankcorp, Inc. (the Company), a Virginia corporation, was formed in 2015 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company is headquartered in Fairfax, Virginia. The Company conducts its business activities through the branch offices of its wholly owned subsidiary bank, FVCbank (the Bank). The Company exists primarily for the purposes of holding the stock of its subsidiary, the Bank.
The Bank was organized under the laws of the Commonwealth of Virginia to engage in a general banking business serving the Washington, D.C. and Baltimore metropolitan areas. The Bank commenced operations on November 27, 2007 and is a member of the Federal Reserve System (the Federal Reserve) and the Federal Deposit Insurance Corporation (FDIC). It is subject to the regulations of the Board of Governors of the Federal Reserve and the State Corporation Commission of Virginia. Consequently, it undergoes periodic examinations by these regulatory authorities.
Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and follow general practice within the banking industry. Accordingly, the unaudited consolidated financial statements do not include all the information and footnotes required by GAAP for complete financial statements; however, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s audited financial statements for the year ended December 31, 2020. Certain prior period amounts have been reclassified to conform to current period presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company. All material intercompany balances and transactions have been eliminated in consolidation.
Significant Accounting Policies
The accounting and reporting policies of the Company are in accordance with GAAP and conform to general practices within the banking industry.
Risks and Uncertainties
The COVID-19 pandemic has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company. The pandemic has caused significant disruptions to the U.S. economy and has disrupted banking and other financial activity in the areas the Company operates. While there has been no material impact to the Company’s employees to date, COVID-19 could also potentially create widespread business continuity issues for it.
The U.S. government and its agencies have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief, and Economic Stability Act (CARES Act) was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19; certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts are expected to have a material impact on our operations.
(Continued)
The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. While it is not possible to know the full universe or extent that the impact of COVID-19 and resulting measures to curtail its spread will have on the Company’s business, it is aware of the following items that are potentially material to the Company and its operations.
Financial Condition and Results of Operations
The Company’s interest income could be reduced due to COVID-19. In keeping with guidance from regulators, it is actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, the Company is unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect its borrowers’ ability to repay in future periods.
The Company’s fee income could be reduced due to COVID-19. In keeping with guidance from regulators, it is actively working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, the Company is unable to project the materiality of such an impact, but recognize the breadth of the economic impact is likely to impact its fee income in future periods.
Capital and Liquidity
While the Company believes that it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its regulatory capital ratios could be adversely impacted by future credit losses. The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt when necessary. If its capital deteriorates such that the subsidiary bank is unable to pay dividends to the Company for an extended period of time, it may not be able to service its debt.
The Company maintains access to multiple sources of liquidity. Wholesale funding markets have remained open to it, and rates for short term funding have recently been quite low. If funding costs become elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin. If an extended recession caused large numbers of its deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.
Asset Valuation
Currently, the Company does not expect COVID-19 to affect its ability to account timely for the valuation of assets on its balance sheet; however, this could change in future periods. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances such as widening credit spreads, the Company does not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.
COVID-19 could cause a decline in the Company’s stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause it to perform a goodwill impairment test and result in an impairment charge being recorded for that period. In the event that the Company concludes that all or a portion of its goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital.
9
It is possible that the lingering effects of COVID-19 could cause the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause it to perform an intangible asset impairment test and result in an impairment charge being recorded for that period. In the event that the Company concludes that all or a portion of its intangible assets are impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital.
During the fourth quarter of 2020, the Company engaged a third party specialist to perform an independent goodwill and other intangible assets valuations. Based on the qualitative analysis completed, the Company’s goodwill and other intangible assets were not impaired as of December 31, 2020. However, it is possible a triggering event could occur in the future to cause the Company reevaluate the valuation of its intangible assets.
Processes, Controls and Business Continuity Plan
The Company has invoked its Board approved Pandemic Preparedness Plan that includes a remote working strategy. The Company does not anticipate incurring additional material cost related to its continued deployment of the remote working strategy. No material operational or internal control challenges or risks have been identified to date. The Company does not anticipate significant challenges to its ability to maintain its systems and controls in light of the measures the Company has taken to prevent the spread of COVID-19. The Company does not currently face any material resource constraint through the implementation of its business continuity plans.
Lending Operations and Accommodations to Borrowers
In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in the CARES Act, the Company executed a payment deferral program for its commercial lending clients that are adversely affected by the pandemic. Depending on the demonstrated need of the client, the Company is deferring either the full loan payment or the principal component of the loan payment generally for 90 days. During the first and second quarters of 2020, the Company modified 277 loans for a total outstanding principal balance of $360.2 million, or 24.4% of the total loan portfolio. As of March 31, 2021, remaining payment deferred loans totaled $10.0 million, or 0.69% of the total loan portfolio, comprising three loans. In accordance with interagency guidance and the CARES Act issued in March 2020, these short term deferrals are not considered TDRs.
With the passage of the PPP, administered by the SBA, the Company actively participated in assisting its customers with applications for resources through the program. The majority of the PPP loans it originated have a two-year term and earn interest at 1%. The Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. At March 31, 2021, PPP loans totaled $166.6 million. The Company continues to originate PPP loans as part of the 2021 program for first and second draw loans. It is the Company’s understanding that loans funded through PPP are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan losses through a charge to earnings.
Credit
The Company is working with customers directly affected by COVID-19. It is prepared to offer short-term assistance in accordance with regulatory guidelines. As a result of the current economic environment caused by the COVID-19 virus, the Company is engaging in more frequent communications with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. Should economic conditions worsen, the Company could experience further increases in its required allowance for loan losses and record additional provision for loan loss expense. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.
10
Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASUs 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASUs have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC), such as the Company, and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company has identified a third-party vendor to assist in the measurement of expected credit losses under this standard. The implementation committee has completed the data collection process, validated the data inputs, and is in the initial phases of evaluating various allowance methodologies for certain loan segments within the Company’s loan portfolio. The Company is currently evaluating the implementation of ASU 2016-13 due to the change in implementation dates for smaller reporting companies.
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB Accounting Standards Codification (ASC) 326, “Financial Instruments - Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.
In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference London Interbank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the FASB issued ASU No. 2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No. 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU No. 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.
11
In August 2020, the FASB issued ASU No. 2020-06 “Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” The ASU simplifies accounting for convertible instruments by removing major separation models required under current GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument with no separate accounting for embedded conversion features. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. The ASU also simplifies the diluted earnings per share calculation in certain areas. In addition, the amendment updates the disclosure requirements for convertible instruments to increase the information transparency. For public business entities, excluding smaller reporting companies, the amendments in the ASU are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. For all other entities, the standard will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-06 to have a material impact on its consolidated financial statements.
Note 2.Securities
Amortized cost and fair values of securities held-to-maturity and securities available-for-sale as of March 31, 2021 and December 31, 2020, are as follows:
March 31, 2021
Gross
Amortized
Unrealized
Fair
Cost
Gains
(Losses)
Value
Held-to-maturity
Securities of state and local municipalities tax exempt
272
Total Held-to-maturity Securities
Available-for-sale
2,396
2,466
Securities of state and local municipalities taxable
747
754
Corporate bonds
13,972
155
(65)
14,062
SBA pass-through securities
121
122
Mortgage-backed securities
95,325
2,065
(1,136)
96,254
Collateralized mortgage obligations
21,055
467
(76)
21,446
Total Available-for-sale Securities
133,616
2,765
(1,277)
December 31, 2020
274
3,398
95
3,493
804
14
12,974
(237)
12,817
141
81,296
2,479
(61)
83,714
24,476
718
(26)
25,168
123,086
3,389
(324)
12
The Company had $8.2 million and $9.2 million in securities pledged with the Federal Reserve Bank of Richmond (FRB) to collateralize certain municipal deposits at March 31, 2021 and December 31, 2020, respectively.
The following table shows fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2021 and December 31, 2020, respectively. The reference point for determining when securities are in an unrealized loss position is month-end. Therefore, it is possible that a security’s market value exceeded its amortized cost on other days during the past twelve-month period. Available-for-sale and held-to-maturity securities that have been in a continuous unrealized loss position are as follows:
Less Than 12 Months
12 Months or Longer
At March 31, 2021
Losses
1,976
(24)
2,184
(41)
4,160
43,337
3,930
49,243
(1,236)
51,427
At December 31, 2020
4,240
(10)
2,000
(227)
6,240
17,504
2,098
23,842
25,842
Corporate bonds: The unrealized losses on the investments in corporate bonds were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. One of these investments carries an S&P investment grade rating of BBB+, while one has a rating of BB. The remaining nine investments do not carry a rating.
Mortgage-backed securities: The unrealized losses on the Company’s investment in eleven mortgage-backed securities were caused by interest rate increases. The contractual cash flows of those investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2021.
Collateralized mortgage obligations (CMOs): The unrealized loss associated with three CMOs was caused by interest rate increases. The contractual cash flows of these investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2021.
13
The amortized cost and fair value of securities as of March 31, 2021, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.
After 1 year through 5 years
4,020
4,044
After 5 years through 10 years
26,993
27,761
After 10 years
102,603
103,299
For the three months ended March 31, 2021 and 2020, proceeds from principal repayments of securities were $9.5 million and $6.2 million, respectively. During the three months ended March 31, 2021, proceeds from calls and maturities of securities were $ 1.0 million. There were no gross realized gains or losses during the three months ended March 31, 2021. During the three months ended March 31, 2020, proceeds from calls and maturities of securities were $1.0 million and gross realized gains were approximately $97,000. There were no realized losses on the sale of securities for the three months ended March 31, 2020.
Note 3.Loans and Allowance for Loan Losses
A summary of loan balances by type follows:
Originated
Acquired
Commercial real estate
758,069
25,714
783,783
761,876
28,149
790,025
Commercial and industrial
272,443
4,178
276,621
271,039
4,295
275,334
Commercial construction
217,819
1,368
219,187
220,845
1,474
222,319
Consumer real estate
128,447
30,770
159,217
133,940
33,932
167,872
Consumer nonresidential
13,566
28
13,594
15,802
33
15,835
1,390,344
62,058
1,452,402
1,403,502
67,883
1,471,385
Less:
Allowance for loan losses
14,336
85
14,421
14,333
625
14,958
Unearned income and (unamortized premiums), net
5,490
5,302
Loans, net
1,370,518
61,973
1,383,867
67,258
During 2018, as a result of the Company’s acquisition of Colombo Bank (Colombo), the loan portfolio was segregated between loans initially accounted for under the amortized cost method (referred to as “originated” loans) and loans acquired (referred to as “acquired” loans).
The loans segregated to the acquired loan portfolio were initially measured at fair value and subsequently accounted for under either ASC 310-30 or ASC 310-20. The outstanding principal balance and related carrying amount of acquired loans included in the consolidated balance sheets as of March 31, 2021 and December 31, 2020 are as follows:
Purchased credit impaired acquired loans evaluated individually for credit losses
Outstanding principal balance
3,828
Carrying amount
2,955
Other acquired loans
59,819
59,103
Total acquired loans
63,647
4,010
3,064
65,656
64,819
69,666
The following table presents changes during the three months ended March 31, 2021 and the year ended December 31, 2020, respectively, in the accretable yield on purchased credit impaired loans for which the Company applies ASC 310-30.
Balance at January 1, 2021
216
Accretion
(40)
Reclassification of nonaccretable difference due to improvement in expected cash flows
23
Other changes, net
17
Balance at January 1, 2020
371
(878)
691
32
15
An analysis of the allowance for loan losses for the three months ended March 31, 2021 and 2020, and for the year ended December 31, 2020, follows:
Allowance for Loan Losses
For the three months ended March 31, 2021
Commercial
Commercial and
Consumer
Real Estate
Industrial
Construction
Nonresidential
Allowance for credit losses:
Beginning Balance, January 1
9,291
2,546
1,960
471
Charge-offs
(117)
(63)
(631)
Recoveries
24
94
Provision
214
(116)
(80)
Ending Balance
9,078
2,313
1,983
652
For the three months ended March 31, 2020
6,399
1,275
2,067
417
73
10,231
(3)
(90)
(93)
19
22
1,208
(124)
(163)
72
7,607
1,170
1,904
487
58
11,226
For the year ended December 31, 2020
Beginning Balance
(115)
(254)
(410)
48
2,998
1,209
(107)
312
604
5,016
16
The following tables present the recorded investment in loans and impairment method as of March 31, 2021 and 2020, and at December 31, 2020, by portfolio segment:
Ending Balance:
Individually evaluated for impairment
1,263
1,371
Purchased credit impaired
Collectively evaluated for impairment
8,993
1,050
629
13,050
Loans Receivable
Financing receivables:
11,976
6,466
469
18,911
2,896
59
768,911
270,155
158,689
1,430,536
At March 31, 2020
298
387
872
398
10,839
1,528
4,502
820
449
7,299
3,182
372
249
3,803
758,788
101,668
220,973
181,721
10,297
1,273,447
763,498
106,542
221,793
182,419
1,284,549
1,450
25
2,100
8,666
1,096
665
12,858
13,379
7,086
254
20,719
3,007
57
773,639
268,248
167,561
1,447,602
18
Impaired loans by class excluding purchased credit impaired, at March 31, 2021 and December 31, 2020, are summarized as follows:
Impaired Loans – Originated Loan Portfolio
Unpaid
Average
Interest
Recorded
Principal
Related
Investment
Balance
Allowance
Recognized
With an allowance recorded:
4,913
4,973
96
5,009
1,286
5,070
With no related allowance:
9,924
9,928
9,929
1,553
1,554
1,379
169
250
11,727
11,732
11,558
297
Impaired Loans – Acquired Loan Portfolio
2,052
2,969
123
180
182
5,287
5,682
358
99
5,384
1,475
5,781
364
9,926
9,930
9,938
1,799
2,433
148
11,725
11,729
12,371
281
3,303
4,316
4,811
267
150
164
157
215
307
379
No additional funds are committed to be advanced in connection with the impaired loans. There were no nonaccrual loans excluded from the impaired loan disclosure.
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis typically includes larger, non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. The Company uses the following definitions for risk ratings:
Pass — Loans listed as pass include larger non-homogeneous loans not meeting the risk rating definitions below and smaller, homogeneous loans not assessed on an individual basis.
Special Mention — Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard — Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the enhanced possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful — Loans classified as doubtful include those loans which have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, improbable.
Loss — Loans classified as loss include those loans which are considered uncollectible and of such little value that their continuance as loans is not warranted. Even though partial recovery may be achieved in the future, it is neither practical nor desirable to defer writing off these loans.
Based on the most recent analysis performed, the risk category of loans by class of loans was as follows as of March 31, 2021 and December 31, 2020:
As of March 31, 2021 – Originated Loan Portfolio
Commercial Real
Consumer Real
Estate
Grade:
Pass
745,831
264,380
128,010
1,369,606
Special mention
2,314
1,596
91
4,001
Substandard
6,467
346
16,737
Doubtful
Loss
21
As of March 31, 2021 – Acquired Loan Portfolio
23,662
30,711
59,947
2,111
As of December 31, 2020 – Originated Loan Portfolio
741,570
262,355
133,750
1,374,322
10,380
1,598
93
12,071
17,109
As of December 31, 2020 – Acquired Loan Portfolio
24,696
33,844
64,342
3,453
88
3,541
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes, larger non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. At March 31, 2021, the Company had $4.0 million in loans identified as special mention within the originated loan portfolio, a decrease of $8.1 million from December 31, 2020. Special mention rated loans are loans that have a potential weakness that deserves management’s close attention. These loans do not have a specific reserve and are considered well-secured. At March 31, 2021, the Company had $16.7 million in loans identified as substandard within the originated loan portfolio, a decrease of $0.4 million from December 31, 2020. Substandard rated loans are loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. For each of these substandard loans, an impairment analysis is completed. As of March 31, 2021 specific reserves on originated and acquired loans totaling $1.4 million, has been allocated within the allowance for loan losses to supplement any shortfall of collateral.
Past due and nonaccrual loans presented by loan class were as follows at March 31, 2021 and December 31, 2020:
30-59 days past
60-89 days past
90 days or more
90 days past due
due
past due
Total past due
Current
Total loans
and still accruing
Nonaccruals
1,754
756,315
2,525
3,086
71
74
3,231
125,216
13,409
3,236
1,832
5,142
1,385,202
2,775
30,391
61,679
2,174
761,788
2,883
220,832
347
76
423
133,517
15,758
177
568
1,402,934
694
27,455
2,309
111
1,363
353
108
228
689
33,243
1,158
1,494
66,389
As of March 31, 2021 and December 31, 2020, there were no consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process. There were $169 thousand of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings were in process as of March 31, 2020.
There were overdrafts of $41 thousand and $72 thousand at March 31, 2021 and December 31, 2020, respectively, which have been reclassified from deposits to loans. At March 31, 2021 and December 31, 2020, loans with a carrying value of $190.1 million and $132.6 million, respectively, were pledged to the Federal Home Loan Bank of Atlanta (FHLB).
There were no defaults of TDRs during the twelve months since restructuring for the three months ended March 31, 2021 and 2020.
The following table presents loans designated as TDRs during the three months ended March 31, 2021:
Pre-Modification
Post-Modification
Outstanding
Number of
Troubled Debt Restructurings
Contracts
(Dollars in thousands)
There were no TDRs originated during the three months ended March 31, 2020. As of March 31, 2021, and December 31, 2020, the Company has a recorded investment in TDRs of $96 thousand and $97 thousand, respectively.
The concession made in the TDRs were related to the reduction in the stated interest rate for the remaining life of the debt.
Note 4.Derivative Financial Instruments
The Company enters into interest rate swap agreements (“swap agreements”) to facilitate the risk management strategies needed in order to accommodate the needs of its banking customers. The Company mitigates the risk of entering into these loan agreements by entering into equal and offsetting swap agreements with highly-rated third party financial institutions. These back-to-back swap agreements are free-standing derivatives and are recorded at fair value in the Company’s consolidated balance sheets (asset positions are included in other assets and liability positions are included in other liabilities) as of March 31, 2021 and December 31, 2020. The Company is party to master netting arrangements with its financial institution counterparty; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Parties to a centrally cleared over-the-counter derivative exchange daily payments that reflect the daily change in value of the derivative. These payments, commonly referred to as variation margin, are recorded as settlements of the derivatives’ mark-to-market exposure rather than collateral against the exposures, which effectively results in any centrally cleared derivative having a Level 2 fair value that approximates zero on a daily basis, and therefore, these swap agreements were not included in the offsetting table in the Fair Value Measurement section. As of March 31, 2021, the Company entered into 21 interest rate swap agreements which are collateralized with $8.7 million in cash. There were 21 interest rate swap agreements outstanding as of December 31, 2020 which were collateralized with $14.0 million in cash.
The notional amount and fair value of the Company’s derivative financial instruments as of March 31, 2021 and December 31, 2020 were as follows:
Notional Amount
Fair Value
Interest Rate Swap Agreements
Receive Fixed/Pay Variable Swaps
97,431
7,809
Pay Fixed/Receive Variable Swaps
(7,809)
97,658
13,633
(13,633)
Interest Rate Risk Management—Cash Flow Hedging Instruments
The Company uses FHLB advances and other wholesale funding from time to time as a source of funds for use in the Company’s lending and investment activities and other general business purposes. This wholesale funding exposes the Company to increased interest rate risk as a result of the variability in cash flows (future interest payments). The Company believes it is prudent to reduce this interest rate risk. To meet this objective, the Company entered into interest rate swap agreements whereby the Company reduces the interest rate risk associated with the Company’s variable rate advances (or other wholesale funding) from the designation date and going through the maturity date.
At March 31, 2021 and December 31, 2020, the information pertaining to outstanding interest rate swap agreements used to hedge variability in cash flows (FHLB advance which is included in other borrowed funds on the consolidated balance sheet) and a portion of its wholesale deposits (which is included in total deposits on the consolidated balance sheet) is as follows:
Notional amount
60,000
Weighted average pay rate
0.87
%
Weighted average receive rate
0.19
0.24
Weighted average maturity in years
1.85 years
2.10 years
Unrealized loss relating to interest rate swaps
(556)
(754)
These agreements provided for the Company to receive payments determined by a specific index (three month LIBOR) in exchange for making payments at a fixed rate. At March 31, 2021 and December 31, 2020, the unrealized loss relating to interest rate swaps designated as hedging instruments of the variability of cash flows associated with FHLB advances and wholesale deposits are reported in other comprehensive income. These amounts are subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on the advance affects earnings. The Company measures cash flow hedging relationships for effectiveness on a monthly basis, and at March 31, 2021 and December 31, 2020, the hedges were highly effective and the amount of ineffectiveness reflected in earnings was de minimus.
Note 5.Financial Instruments with Off-Balance Sheet Risk
The Company is party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments.
At March 31, 2021 and December 31, 2020, the following financial instruments were outstanding which contract amounts represent credit risk:
Commitments to grant loans
9,286
13,598
Unused commitments to fund loans and lines of credit
151,122
166,259
Commercial and standby letters of credit
9,475
5,529
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.
Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Substantially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting those commitments, if deemed necessary.
The Company maintains its cash accounts with the FRB and correspondent banks. The total amount of cash on deposit in correspondent banks exceeding the federally insured limits was $26.3 million and $25.3 million at March 31, 2021 and December 31, 2020, respectively.
Note 6.Stock-Based Compensation Plan
The Company’s Amended and Restated 2008 Option Plan (the Plan), which is stockholder-approved, was adopted to advance the interests of the Company by providing selected key employees of the Company, their affiliates, and directors with the opportunity to acquire shares of common stock. In June 2018, the stockholders approved an amendment to Plan to extend the term and increase the number of shares authorized for issuance under the Plan by 200,000 shares. The Company has granted stock options and restricted stock units under the Plan.
The maximum number of shares with respect to which awards may be made is 2,529,296 shares of common stock, subject to adjustment for certain corporate events. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant, generally vest annually over four years of continuous service and have ten year contractual terms. At March 31, 2021, 32,114 shares were available to grant under the Plan.
No options were granted during the three months ended March 31, 2021 and 2020, respectively. For the three months ended March 31, 2021, there were no shares withheld from issuance upon exercise of options in order to cover the cost of the exercise by the participant. There were 2,737 shares withheld from issuance upon exercise of options in order to cover the cost of the exercise by the participant during the three months ended March 31, 2020.
A summary of option activity under the Plan as of March 31, 2021 and changes during the three months ended is presented below:
Weighted-
Number
Remaining
Aggregate
of
Exercise
Contractual
Intrinsic
Options
Price
Term
Value (1)
Outstanding at January 1, 2021
1,727,945
8.14
3.17
Granted
Exercised
(128,608)
6.40
Forfeited or expired
(760)
10.76
Outstanding and Exercisable at March 31, 2021
1,598,577
8.28
3.16
13,125,999
(1) The aggregate intrinsic value of stock options represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31, 2021. This amount changes based on changes in the market value of the Company’s common stock.
26
The compensation cost that has been charged to income for the Plan was $166 thousand and $205 thousand for the three months ended March 31, 2021 and 2020, respectively. As of March 31, 2021, all outstanding shares of the Plan are fully vested and amortized. The total income tax benefit related to stock options exercised and recognized in the income statement for share-based compensation arrangements was $125 thousand and $76 thousand for the three months ended March 31, 2021 and 2020, respectively. 116,488 restricted stock units were granted during the three months ended March 31, 2021. There were no restricted stock units granted during the three months ended March 31, 2020.
A summary of the Company’s restricted stock unit grant activity as of March 31, 2021 is shown below.
Weighted Average
Grant Date
Nonvested at January 1, 2021
72,743
18.82
116,488
17.49
Vested
(250)
17.25
Forfeited
19.07
188,866
18.00
As of March 31, 2021, there was $3.0 million of total unrecognized compensation cost related to nonvested restricted stock units granted under the Plan. The cost is expected to be recognized over a weighted-average period of 38 months.
Note 7.Fair Value Measurements
Determination of Fair Value
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
Fair Value Hierarchy
In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 —
Valuation is based on quoted prices in active markets for identical assets and liabilities.
27
Level 2 —
Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 —
Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:
Securities available-for-sale: Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).
Cash flow hedges: The Company has interest rate swap derivatives that are designated as cash flow hedges and are recorded at fair value using published yield curve rates from a national valuation service. These observable rates and inputs are applied to a third party industry-wide valuation model, and therefore, the valuations fall into a Level 2 category.
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2021 and December 31, 2020:
Fair Value Measurements at
March 31, 2021 Using
Quoted Prices
in Active
Significant
Markets for
Identical
Observable
Unobservable
Balance as of
Inputs
Description
(Level 1)
(Level 2)
(Level 3)
Total Available-for-Sale Securities
December 31, 2020 Using
Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower of cost or market accounting or write-downs of individual assets.
The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:
Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the present value of future cash flows,observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, has the value derived by discounting comparable sales due to lack of similar properties, or is discounted by the Company due to marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach with data from comparable properties. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available, which results in a Level 3 classification of the inputs for determining fair value. OREO properties are evaluated regularly for impairment and adjusted accordingly.
29
The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis at March 31, 2021 and December 31, 2020:
Fair Value Measurements
Using
Impaired loans
5,690
Other real estate owned
6,587
The following table displays quantitative information about Level 3 Fair Value Measurements for March 31, 2021 and December 31, 2020:
Quantitative information about Level 3 Fair Value Measurements for March 31, 2021
Valuation Technique(s)
Unobservable input
Range
(Avg.)
Discounted appraised value
Marketability/Selling costs
0% - 10
(8.71)
Selling costs
10.51
Quantitative information about Level 3 Fair Value Measurements for December 31, 2020
0% - 8
(6.23)
30
The following presents the carrying amount, fair value and placement in the fair value hierarchy of the Company’s financial instruments as of March 31, 2021 and December 31, 2020. Fair values for March 31, 2021 and December 31, 2020 are estimated under the exit price notion in accordance with ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.”
Fair Value Measurements as of March 31, 2021, using
Quoted Prices in
Active Markets
Carrying
for Identical
Other Observable
Amount
Level 1
Level 2
Level 3
Financial assets:
Interest-bearing deposits at other institutions
Securities held-to-maturity
Securities available-for-sale
Restricted stock
1,442,367
Bank owned life insurance
Financial liabilities:
Checking, savings and money market accounts
1,324,700
272,710
Subordinated notes
40,889
Fair Value Measurements as of December 31, 2020, using
1,463,270
1,219,440
316,341
42,438
Note 8.Earnings Per Share
Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if contracts to issue common stock were exercised or converted into common stock, or resulted in the issuance of stock which then shared in the earnings of the Company. Holders of the Company’s restricted stock units do not have voting rights during the vesting period and therefore, restricted stock units are not included in the computation of basic earnings per share. Weighted average shares - diluted includes the potential dilution of stock options and restricted stock units as of March 31, 2021. The weighted average shares - diluted as of March 31, 2020 includes only the potential dilution of stock options.
The following shows the weighted average number of shares used in computing earnings per share and the effect of weighted average number of shares of dilutive potential common stock. Dilutive potential common stock has no effect on income available to common stockholders. There were no anti-dilutive shares for each of the periods ended March 31, 2021 and 2020.
Three Months Ended
Weighted average number of shares
13,578
13,752
Effect of dilutive securities,restricted stock units and options
958
843
Weighted average diluted shares
14,536
14,595
Basic EPS
Diluted EPS
Note 9.Accumulated Other Comprehensive Income (Loss)
Changes in accumulated other comprehensive income (AOCI) for the three months ended March 31, 2021 and 2020 are shown in the following table. The Company has two components, which are available-for-sale securities and cash flow hedges, for the periods presented.
Available-for-Sale
Cash Flow
Three Months Ended March 31, 2021
Securities
Hedges
Balance, beginning of period
2,421
(595)
Net unrealized gains (losses) during the period
Other comprehensive income (loss), net of tax
Balance, end of period
1,140
(439)
Three Months Ended March 31, 2020
753
1,824
Net reclassification adjustment for gains realized in income
2,215
2,968
(531)
The following table presents information related to reclassifications from accumulated other comprehensive income:
Amount Reclassified from AOCI
Affected Line Item
into Income
in the Consolidated
For the Three Months Ended March 31,
Statements of
Details about AOCI
Gains on sale of available-for-sale securities
(20)
77
Net of tax
Note 10.Subordinated Notes
On June 20, 2016, the Company issued $25 million of fixed-to-floating rate subordinated notes due June 30, 2026, in a private placement to accredited investors. Interest is payable at 6.00% per annum, from and including June 20, 2016 to, but excluding, June 30, 2021, payable semi-annually in arrears. From and including June 30, 2021 to the maturity date or early redemption date, the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month LIBOR rate plus 487 basis points, payable quarterly in arrears.
The Company may, at its option, beginning with the interest payment date of June 30, 2021 and on any scheduled interest payment date thereafter redeem the subordinated notes, in whole or in part, upon not fewer than 30 nor greater than 60 days’ notice to holders, at a redemption price equal to 100% of the principal amount of the subordinated notes to be redeemed plus accrued and unpaid interest to, but excluding, the date of redemption. Any partial redemption will be made pro rata among all of the holders.
On October 13, 2020, the Company completed its private placement of $20 million of its 4.875% Fixed to Floating Subordinated Notes due 2030 (the Notes) to certain qualified institutional buyers and accredited investors. The Notes have a maturity date of October 15, 2030 and carry a fixed rate of interest of 4.875% for the first five years. Thereafter, the Notes will pay interest at 3-month SOFR plus 471 basis points, resetting quarterly. The Notes include a right of prepayment without penalty on or after October 15, 2025. The Notes have been structured to qualify as Tier 2 capital for regulatory purposes. The Company plans to use the proceeds from the placement of the Notes for general corporate purposes, to include supporting capital ratios at the Company’s subsidiary, FVCbank, and potential repayment of a portion of the $25.0 million outstanding subordinated debt callable June 30, 2021.
Note 11.Revenue Recognition
The Company adopted ASU No. 2014-09 ‘‘Revenue from Contracts with Customers’’ (Topic 606) and all subsequent ASUs that modified Topic 606 in recognizing revenue. Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, gain on sale of securities, BOLI income, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as trust and asset management income, deposit related fees, interchange fees, merchant income, and insurance commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.
Service Charges on Deposit Accounts
Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and personal checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.
Fees, Exchange and Other Service Charges
Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges and are included in other income on our consolidated statements of income. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. This income is reflected in other income on the Company’s consolidated statements of income.
Other noninterest income consists of loan swap fees, insurance commissions, and other miscellaneous revenue streams not meeting the criteria above. When the Company enters into an interest rate swap agreement, the Company may receive an additional one-time payment fee which is recognized as income when received. The Company receives monthly recurring commissions based on a percentage of premiums issued and revenue is recognized when received. Any residual miscellaneous fees are recognized as they occur, and therefore, the Company determined this consistent practice satisfies the obligation for performance.
The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three months ended March 31, 2021 and 2020:
In-scope of Topic 606
Fees, Exchange, and Other Service Charges
78
160
Noninterest Income (in-scope of Topic 606)
481
330
Noninterest Income (out-scope of Topic 606)
310
363
Total Noninterest Income
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Contract Balances
A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of March 31, 2021 and 2020, the Company did not have any significant contract balances.
Contract Acquisition Costs
Under Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. The Company did not capitalize any contract acquisition cost during the three months ended March 31, 2021 or 2020.
Note 12.Supplemental Cash Flow Information
Below is additional information regarding the Company’s cash flows for the three months ended March 31, 2021 and 2020.
Supplemental Disclosure of Cash Flow Information:
Cash paid for:
Interest on deposits and borrowed funds
2,048
Income taxes
455
Noncash investing and financing activities:
Unrealized (loss) gain on securities available-for-sale
(1,577)
2,804
Unsettled purchases of available-for-sale securities
10,152
Unrealized gain (loss) on interest rate swaps
198
(592)
Right-of-use assets obtained in the exchange for lease liabilities during the current period
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Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following presents management’s discussion and analysis of our consolidated financial condition at March 31, 2021 and December 31, 2020 and the results of our operations for the three months ended March 31, 2021 and 2020. This discussion should be read in conjunction with our unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report and the audited consolidated financial statements and the notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2020. Results of operations for the three month period ended March 31, 2021 are not necessarily indicative of the results of operations for the balance of 2021, or for any other period. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Form 10-Q, as well as other periodic reports filed with the U.S. Securities and Exchange Commission, and written or oral communications made from time to time by or on behalf of FVCBankcorp, Inc. and our subsidiary (the “Company”), may contain statements relating to future events or future results of the Company that are considered “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections and statements of our beliefs concerning future events, business plans, objectives, expected operating results and the assumptions upon which those statements are based. Forward-looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and are typically identified with words such as “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “aim,” “intend,” “plan,” or words or phases of similar meaning. We caution that the forward-looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements.
The following factors, among others, could cause our financial performance to differ materially from that expressed in such forward-looking statements:
The foregoing factors should not be considered exhaustive and should be read together with other cautionary statements that are included in our Annual Report on Form 10-K for the year ended December 31, 2020, including those discussed in the section entitled “Risk Factors”. If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Form 10-Q. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We will not update the forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking statements. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence or how they will affect us.
Overview
We are a bank holding company headquartered in Fairfax County, Virginia. Our sole subsidiary, FVCbank, was formed in November 2007 as a community-oriented, locally-owned and managed commercial bank under the laws of the Commonwealth of Virginia. The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers. Our commercial relationship officers focus on attracting small and medium sized businesses, commercial real estate developers and builders, including government contractors, non-profit organizations, and professionals. Our approach to our market features competitive customized financial services offered to customers and prospects in a personal relationship context by seasoned professionals.
On October 12, 2018, we completed our acquisition of Colombo Bank (“Colombo”), which was headquartered in Rockville, Maryland, and added five banking locations in Washington, D.C., and Montgomery County and the City of Baltimore in Maryland.
Net interest income is our primary source of revenue. We define revenue as net interest income plus noninterest income. As discussed further in “Quantitative and Qualitative Disclosures About Market Risk” below, we manage our balance sheet and interest rate risk exposure to maximize, and concurrently stabilize, net interest income. We do this by monitoring our liquidity position and the spread between the interest rates earned on interest-earning assets and the interest rates paid on interest-bearing liabilities. We attempt to minimize our exposure to interest rate risk, but are unable to eliminate it entirely. In addition to managing interest rate risk, we also analyze our loan portfolio for exposure to credit risk. Loan defaults and foreclosures are inherent risks in the banking industry, and we attempt to limit our exposure to these risks by carefully underwriting and then monitoring our extensions of credit. In addition to net interest income, noninterest income is a complementary source of revenue for us and includes, among other things, service charges on deposits and loans, merchant services fee income, loan swap fees, insurance commission income, income from bank owned life insurance (“BOLI”), and gains and losses on sales of investment securities available-for-sale.
Critical Accounting Policies
General
The accounting principles we apply under U.S. generally accepted accounting principles (“GAAP”) are complex and require management to apply significant judgment to various accounting, reporting and disclosure matters. Management must use assumptions, judgments and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such judgments, assumptions and estimates may have a significant impact on the consolidated financial statements. Actual results, in fact, could differ from initial estimates.
The accounting policies we view as critical are those relating to judgments, assumptions and estimates regarding the determination of the allowance for loan losses, accounting for purchase credit-impaired loans, fair value measurements, and the valuation of other real estate owned.
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We maintain the allowance for loan losses at a level that represents management’s best estimate of known and inherent losses in our loan portfolio. We are not required to implement the provisions of the current expected credit losses accounting standard (“CECL”) until January 1, 2023, and are continuing to account for the allowance for loan losses under the incurred loss model. Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers. Unusual and infrequently occurring events, such as weather-related disasters and health related events, such as the COVID-19 pandemic and associated efforts to restrict the spread of the disease, may impact our assessment of possible credit losses. As a part of our analysis, we use comparative peer group data and qualitative factors such as levels of and trends in delinquencies, nonaccrual loans, charged-off loans, changes in volume and terms of loans, effects of changes in lending policy, experience, ability and depth of management, national and local economic trends and conditions, concentrations of credit, competition, and loan review results to support estimates.
The allowance for loan losses is based first on a segmentation of the loan portfolio by general loan type, or portfolio segments. For originated loans, certain portfolio segments are further disaggregated and evaluated collectively for impairment based on loan segments, which are largely based on the type of collateral underlying each loan. For purposes of this analysis, we categorize loans into one of five categories: commercial and industrial, commercial real estate, commercial construction, consumer residential, and consumer nonresidential loans. Typically, financial institutions use their historical loss experience and trends in losses for each loan category which are then adjusted for portfolio trends and economic and environmental factors in determining the allowance for loan losses. Since the Bank’s inception in 2007, we have experienced minimal loss history within our loan portfolio. Because of this, our allowance model uses the average loss rates of similar institutions (our custom peer group) as a baseline which is then adjusted based on our particular qualitative loan portfolio characteristics and environmental factors. The indicated loss factors resulting from this analysis are applied for each of the five categories of loans.
Our peer group is defined by selecting commercial banking institutions of similar size within Virginia, Maryland and the District of Columbia. This is known as our custom peer group. The commercial banking institutions comprising the custom peer group can change based on certain factors including but not limited to the characteristics, size, and geographic footprint of the institution. We have identified 21 banks for our custom peer group which are within $1 billion to $3 billion in total assets, the majority of whom are geographically concentrated in the Washington, D.C. metropolitan area in which we operate, as this area has experienced more stable economic conditions than many other areas of the country. These baseline peer group loss rates are then adjusted based on an analysis of our loan portfolio characteristics, trends, economic considerations and other conditions that should be considered in assessing our credit risk. Our peer loss rates are updated on a quarterly basis.
The allowance for loan losses consists of specific and general components. The specific component relates to loans that are determined to be impaired and, therefore, individually evaluated for impairment. We individually assign loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. We evaluate the impairment of certain loans on a loan by loan basis for those loans that are adversely risk rated. Measurement of impairment is based on the expected future cash flows of an impaired loan, which are discounted at the loan’s effective interest rate, or measured on an observable market value, if one exists, or the fair value of the collateral underlying the loan, discounted to consider estimated costs to sell the collateral for collateral-dependent loans. If the net collateral value is less than the loan balance (including accrued interest and any unamortized premium or discount associated with the loan) we recognize an impairment and establish a specific reserve for the impaired loan.
Credit losses are an inherent part of our business and, although we believe the methodologies for determining the allowance for loan losses and the current level of the allowance are appropriate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment. Additional provisions for such losses, if necessary, would be recorded, and would negatively impact earnings.
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Allowance for Loan Losses - Acquired Loans
Acquired loans accounted for under Accounting Standards Codification (“ASC”) 310-30
For our acquired loans, to the extent that we experience a deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans.
Acquired loans accounted for under ASC 310-20
Subsequent to the acquisition date, we establish an allowance for loan losses through a provision for loan losses based upon an evaluation process that is similar to our evaluation process used for originated loans. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other factors, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, carrying value of the loans, which includes the remaining net purchase discount or premium, and other factors that may warrant recognition in determining our allowance for loan losses.
Purchased Credit-Impaired Loans
Purchased credit-impaired (“PCI”) loans, which are the loans acquired in our acquisition of Colombo, are loans acquired at a discount (that is due, in part, to credit quality). These loans are initially recorded at fair value (as determined by the present value of expected future cash flows) with no allowance for loan losses. We account for interest income on all loans acquired at a discount (that is due, in part, to credit quality) based on the acquired loans’ expected cash flows. The acquired loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. A pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flow. The difference between the cash flows expected at acquisition and the investment in the loans, or the “accretable yield,” is recognized as interest income utilizing the level-yield method over the life of each pool. Increases in expected cash flows subsequent to the acquisition are recognized prospectively through adjustment of the yield on the pool over its remaining life, while decreases in expected cash flows are recognized as impairment through a loss provision and an increase in the allowance for loan losses. Therefore, the allowance for loan losses on these impaired pools reflect only losses incurred after the acquisition (representing the present value of all cash flows that were expected at acquisition but currently are not expected to be received). At March 31, 2021, we had specific reserves for impairment of two acquired loans within our allowance for loan losses totaling $85 thousand that had further deteriorated post acquisition.
We periodically evaluate the remaining contractual required payments due and estimates of cash flows expected to be collected. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Changes in the contractual required payments due and estimated cash flows expected to be collected may result in changes in the accretable yield and non-accretable difference or reclassifications between accretable yield and the non-accretable difference. On an aggregate basis, if the acquired pools of PCI loans perform better than originally expected, we would expect to receive more future cash flows than originally modeled at the acquisition date. For the pools with better than expected cash flows, the forecasted increase would be recorded as an additional accretable yield that is recognized as a prospective increase to our interest income on loans.
We determine the fair values of financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. Our investment securities available-for-sale are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service. This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs. Depending on the availability of observable inputs and prices, different valuation models could produce materially different fair value estimates. The values presented may not represent future fair values and may not be realizable.
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Other Real Estate Owned (“OREO”)
Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at fair value of the property, less estimated disposal costs, if any. Any excess of cost over the fair value less costs to sell at the time of acquisition is charged to the allowance for loan losses. The fair value is reviewed periodically by management and any writedowns are charged against current earnings. Accounting policy and treatment is consistent with accounting for impaired loans described above.
LIBOR and Other Benchmark Rates
In 2017, the Financial Conduct Authority (the authority that regulates London Interbank Offered Rate (“LIBOR”)) announced its intention to stop compelling banks to submit rates for the calculation of LIBOR after 2021. In December 2020, the administrator of LIBOR announced its intention to (i) cease the publication of the one-week and two-month U.S. dollar LIBOR after December 31, 2021, and (ii) cease the publication of all other tenors of U.S. dollar LIBOR (one, three, six and 12 month LIBOR) after June 30, 2023. Central banks and regulators around the world have commissioned working groups to find suitable replacements for Interbank Offered Rates (“IBOR”) and other benchmark rates and to implement financial benchmark reforms more generally. These actions have resulted in uncertainty regarding the use of alternative reference rates (“ARRs”) and could cause disruptions in a variety of markets, as well as adversely impact our business, operations and financial results.
To facilitate an orderly transition from IBORs and other benchmark rates to ARRs, we have established an enterprise-wide initiative led by senior management. The objective of this initiative is to identify, assess and monitor risks associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, achieve operational readiness and engage impacted clients in connection with the transition to ARRs.
COVID-19 Pandemic Discussion Matters
Employee Matters
As a result of the COVID-19 pandemic, a portion of our workforce continues to work remotely as we continue to service the needs of our clients in a customer secure environment. More than half of our employees have returned to our offices, under social distancing guidelines requiring employees to maintain safe distances and with more frequent cleaning of our facilities and other practices encouraging a safe work environment. Management remains connected to employees through monthly company-wide conference calls and regular notifications and updates through both email and the Company’s intranet as warranted.
Branch Hours
Branch hours and availability, which were modified early on during the onset of the pandemic in consideration of the safety of our employees and clients, were reinstated during the second quarter of 2020. All of our locations are open with advanced safety measures and are available during our normal business hours.
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Coronavirus Aid, Relief, and Economic Security Act and Consolidated Appropriations Act, 2021.
In response to the COVID-19 pandemic, the Coronovirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law on March 27, 2020 and the Consolidated Appropriations Act, 2021 (“Appropriations Act”) was signed into law on December 27, 2020. Among other things, the CARES Act and Appropriations Act include the following provisions impacting financial institutions:
Loans made under the PPP are fully guaranteed as to principal and interest by the SBA, whose guarantee is backed by the full faith and credit of the U.S. government. PPP loans afford borrowers forgiveness up to the principal amount of the PPP covered loan if the proceeds are used to retain workers and maintain payroll or make mortgage interest, lease and utility payments. The SBA will reimburse banks that participate in this program for any amount of a PPP covered loan that is forgiven. Because of the SBA guarantee, we are currently not reserving an allowance for loan losses for these loans.
We actively participated in originating PPP loans, and began processing applications at the inception of the program and through the program’s initial expiration. As of December 31, 2020, we had originated 755 applications for approximately $170.3 million, net of deferred fees and costs. We continue to originate PPP loans as part of the 2021 program for first and second draw loans, and as of March 31, 2021, we had originated an additional 393 applications for approximately $62.5 million.
Loan Portfolio Exposures
As a result of the COVID-19 pandemic, we implemented loan payment deferral programs to allow customers who were required to close or reduce business operations to defer loan principal and interest payments primarily for 90 days. During the first and second quarters of 2020, we modified 277 loans for a total outstanding principal balance of $360.2 million, or 24.4% of the total loan portfolio. On March 31, 2021, remaining payment deferred loans totaled $10.0 million, or 0.69% of the total loan portfolio, comprising three loans. One loan is a hotel participation loan totaling $9.7 million, one loan is SBA guaranteed totaling $330 thousand and the remaining loan totaling $61 thousand is a consumer unsecured loan.
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We are closely and proactively monitoring the effects of the pandemic on our loan and deposit customers and are focused on assessing risks within the loan portfolio and working with customers to minimize losses. We consider pandemic impacted loans to include commercial real estate loans made to hotels, churches, and certain retail and special purpose asset classes. During our assessment of the allowance for loan losses, we addressed the credit risks associated with these pandemic impacted segments and those loans that have requested payment deferrals. The following table shows the number of loans and outstanding loan balances by pandemic-impacted asset class as of March 31, 2021.
COVID Impacted Loans By Asset Class
Asset Class
Number of Loans
Commercial real estate - retail
104
190,308
Commercial real estate - mixed use
50
81,890
Specialty use-hotel/lodging/motel
60,972
Commercial real estate - office
109
106,957
Multi-family first lien
86
117,867
Commercial real estate - industrial
100,301
Commercial real estate - special use/church
41,535
Special purpose
29,559
Total loan categories COVID impacted
470
729,389
Other loan categories not impacted by COVID
2,807
723,013
3,277
We believe that as a result of our conservative underwriting discipline at loan origination coupled with the active dialogue we have had with our borrowers, we have the ability and necessary flexibility to assist our customers through this pandemic.
Liquidity and Backup Sources
Our primary and secondary sources of liquidity remain strong. Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $355.0 million at March 31, 2021, or 18.9% of total assets, an increase from $267.2 million, or 14.7%, at December 31, 2020. To maintain ready access to the Bank’s secured lines of credit, the Bank has pledged a portion of its commercial real estate and residential real estate loan portfolios to the Federal Home Loan Bank of Atlanta (“FHLB”) and Federal Reserve Bank of Richmond (“FRB”). Additional borrowing capacity at the FHLB at March 31, 2021 was approximately $170.4 million. Borrowing capacity with the FRB was approximately $127.0 million at March 31, 2021. We also have unsecured federal funds purchased lines of $269.0 million available to us. We anticipate maintaining liquidity at a level sufficient to protect depositors as we endure through this pandemic.
In addition to the funding sources noted above, the Federal Reserve has established a PPP Liquidity Facility (“PPPLF”), authorized under Section 13(3) of the Federal Reserve Act, that can be used to pledge PPP loans we originate as collateral under the CARES Act. Under Section 1102 of the CARES Act, a PPP loan is assigned a zero risk weighting under the risk based capital rules of the federal banking agencies. In addition, an interim rule issued on April 9, 2020 from the federal banking agencies will allow banks to neutralize the effect of PPP loans financed under the PPPLF on leverage capital ratios. We do not anticipate using this facility to provide us with additional liquidity. The interest rate on this facility is fixed at 0.35% for the term of the facility and access to the facility will end June 30, 2021.
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Share Repurchases
While our capital position remains well above the levels to be considered well capitalized for regulatory purposes, due to the heightened volatility of the stock market and uncertainty regarding the impact of COVID-19, we temporarily suspended stock repurchases on March 20, 2020. On January 21, 2021, we approved a new share repurchase program pursuant to which we may repurchase up to 1,080,860 shares of our common stock, or approximately 8% of our outstanding shares of common stock at December 31, 2020. The repurchase program will expire on December 31, 2021, subject to earlier termination of the program by the Board of Directors.
The COVID-19 pandemic has adversely impacted a broad range of industries in which our customers operate and could impair their ability to fulfill their financial obligations to us. The pandemic has caused significant disruptions to the U.S. economy and has disrupted banking and other financial activity in the areas we operate. While there has been no material impact to our employees to date, COVID-19 could also potentially create widespread business continuity issues for us.
The U.S. government and its agencies have taken several actions designed to cushion the economic fallout. Most notably, the CARES Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19; certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts are expected to have a material impact on our operations.
Our business is dependent upon the willingness and ability of our employees and customers to conduct banking and other financial transactions. While it is not possible to know the full universe or extent that the impact of COVID-19 and resulting measures to curtail its spread will have on our business, we are aware of the following items that are potentially material to us and our operations.
Our interest income could be reduced due to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.
Our fee income could be reduced due to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact is likely to impact our fee income in future periods.
While we believe that we have sufficient capital to withstand an extended economic recession brought about by COVID-19, our regulatory capital ratios could be adversely impacted by future credit losses. We rely on cash on hand as well as dividends from our subsidiary bank to service our debt when necessary. If our capital deteriorates such that our subsidiary bank is unable to pay dividends to us for an extended period of time, we may not be able to service our debt.
We maintain access to multiple sources of liquidity. Wholesale funding markets have remained open to us, and rates for short term funding have recently been quite low. If funding costs become elevated for an extended period of time, it could have an adverse effect on our net interest margin. If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding.
Currently, we do not expect COVID-19 to affect our ability to account timely for the valuation of assets on our balance sheet; however, this could change in future periods. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances such as widening credit spreads, we do not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.
COVID-19 could cause a decline in our stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform a goodwill impairment test and result in an impairment charge being recorded for that period. In the event that we conclude that all or a portion of our goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital.
It is possible that the lingering effects of COVID-19 could cause the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform an intangible asset impairment test and result in an impairment charge being recorded for that period. In the event that we conclude that all or a portion of our intangible assets are impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital.
We have invoked our Board approved Pandemic Preparedness Plan that includes a remote working strategy. We do not anticipate incurring additional material cost related to our continued deployment of the remote working strategy. No material operational or internal control challenges or risks have been identified to date. We do not anticipate significant challenges to our ability to maintain our systems and controls in light of the measures we have taken to prevent the spread of COVID-19. We do not currently face any material resource constraint through the implementation of our business continuity plans.
In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in the CARES Act, we executed a payment deferral program for our commercial lending clients that are adversely affected by the pandemic. Depending on the demonstrated need of the client, we are deferring either the full loan payment or the principal component of the loan payment generally for 90 days. During the first and second quarters of 2020, we modified 277 loans for a total outstanding principal balance of $360.2 million, or 24.4% of the total loan portfolio. As of March 31, 2021, remaining payment deferred loans totaled $10.0 million, or 0.69% of the total loan portfolio, comprising three loans. In accordance with interagency guidance and the CARES Act issued in March 2020, these short term deferrals are not considered TDRs.
With the passage of the PPP, administered by the SBA, we actively participated in assisting our customers with applications for resources through the program. The majority of the PPP loans we originated have a two-year term and earn interest at 1%. We believe that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. At March 31, 2021, PPP loans totaled $166.6 million. We continue to originate PPP loans as part of the 2021 program for first and second draw loans. It is our understanding that loans funded through PPP are fully guaranteed by the U.S. government. Should those circumstances change, we could be required to establish additional allowance for loan losses through a charge to earnings.
We are working with customers directly affected by COVID-19. We are prepared to offer short-term assistance in accordance with regulatory guidelines. As a result of the current economic environment caused by the COVID-19 virus, we are engaging in more frequent communications with borrowers to better understand their situation and the challenges faced, allowing us to respond proactively as needs and issues arise. Should economic conditions worsen, we could experience further increases in our required allowance for loan losses and record additional provision for loan loss expense. It is possible that our asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.
Results of Operations—Three Months Ended March 31, 2020 and 2019
We recorded net income of $5.6 million, or $0.38 per diluted common share, for the three months ended March 31, 2021, compared to net income of $3.7 million, or $0.26 per diluted common share for the three months ended March 31, 2020. Net interest income increased $1.8 million to $14.0 million for the three months ended March 31, 2021, compared to $12.2 million for the three months ended March 31, 2020, primarily as a result of a decrease in interest-bearing deposit expense of $2.2 million. No provision for loan losses was recorded for the three months ended March 31, 2021, compared to $1.1 million for the same period of 2020. Noninterest income increased $98 thousand to $791 thousand for the three months ended March 31, 2021 as compared to $693 thousand for 2020. Noninterest expense was $7.9 million for the three months ended March 31, 2021 compared to $7.2 million for the same three month period of 2020.
The annualized return on average assets for the three months ended March 31, 2021 and 2020 was 1.19% and 0.94%, respectively. The annualized return on average equity for the three months ended March 31, 2021 and 2020 was 11.53% and 8.29%, respectively.
Net Interest Income/Margin
Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The following table presents average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three months ended March 31, 2021 and 2020.
Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities
For the Three Months Ended March 31, 2021 and 2020
Income/
Yield/
Expense
Rate
Interest-earning assets:
Loans (1):
782,639
8,396
4.29
756,989
9,026
4.77
273,426
3,176
4.65
110,186
1,570
5.70
220,835
2,427
4.40
220,104
2,802
5.09
Consumer residential
165,211
1,676
4.06
184,010
2,122
4.61
14,199
258
7.27
10,680
129
4.81
Total loans (1)
1,456,310
4.38
1,281,969
15,649
4.88
Investment securities (2)
122,585
724
2.36
137,640
882
2.56
6,403
5.12
5,994
5.94
Loans held for sale, at fair value
0.00
10,492
236
8.99
Deposits at other financial institutions and federal funds sold
182,891
0.10
22,213
1.48
Total interest-earning assets and interest income
1,768,189
16,784
3.80
1,458,308
16,937
Noninterest-earning assets:
15,346
13,431
1,610
1,941
Accrued interest and other assets
96,226
87,560
(14,894)
(10,282)
1,866,477
1,550,958
Interest - bearing liabilities:
Interest - bearing deposits:
Interest checking
523,712
0.55
273,976
881
1.29
Savings and money markets
278,774
324
0.47
227,497
635
1.12
246,486
917
1.51
353,809
2,080
2.35
Wholesale deposits
45,778
121,047
580
1.92
Total interest - bearing deposits
1,094,750
0.74
976,329
1.72
Other borrowed funds
69,096
734
4.31
63,635
544
3.44
Total interest-bearing liabilities and interest expense
1,163,846
0.95
1,039,964
1.83
Noninterest-bearing liabilities:
Demand deposits
479,831
304,364
Other liabilities
29,625
26,476
Common stockholders’ equity
193,175
180,154
Net interest income and net interest margin
14,049
3.22
12,217
3.37
The level of net interest income is affected primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. See “Quantitative and Qualitative Disclosures About Market Risk” below for further information.
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The following table shows the effect that these factors had on the interest earned from our interest-earning assets and interest incurred on our interest-bearing liabilities for the three months ended March 31, 2021.
Rate and Volume Analysis
2021 Compared to 2020
Increase
Volume
(Decrease)
Interest income:
306
(936)
(630)
2,326
(720)
1,606
(384)
(375)
(217)
(229)
(446)
87
(2,182)
284
(96)
(62)
(158)
(13)
(7)
(236)
586
(622)
(36)
Total interest income
2,726
(2,879)
(153)
Interest expense:
782
(946)
(164)
(444)
(311)
(649)
(514)
(1,163)
(363)
(174)
(537)
(2,078)
(2,175)
190
(55)
(1,930)
(1,985)
Net interest income
2,781
(949)
Net interest income for the three months ended March 31, 2021 was $14.0 million, compared to $12.2 million for the three months ended March 31, 2020, an increase of $1.8 million, or 15.0%. The increase in net interest income was primarily a result of an increase in the volume of interest-earning assets related to organic growth of commercial and industrial loans (PPP loans are recorded within this loan type) during 2021 compared to 2020. The yield on interest-earning assets decreased 85 basis points to 3.80% for the three months ended March 31, 2021, compared to 4.65% for the same period of 2020. In addition, the cost of interest-bearing liabilities decreased 88 basis points to 0.95% for the three months ended March 31, 2021, compared to 1.83% for the same period of 2020, reflecting our efforts to decrease deposit rates to offset the repricing of our variable rate loan portfolio.
Our net interest margin, on a tax equivalent basis, for the three months ended March 31, 2021 and 2020 was 3.22% and 3.37%, respectively. The decrease in our net interest margin was primarily a result of a decrease in the yields earned on our interest-earning assets during 2021 as compared to 2020, a result of the decreased rate environment.
Net interest income, on a tax equivalent basis, is a non-GAAP financial measure that we believe provides a more accurate picture of the interest margin for comparative purposes. To derive our net interest margin on a tax equivalent basis, net interest income is adjusted to reflect tax-exempt income on an equivalent before tax basis with a corresponding increase in income tax expense. For purposes of this calculation, we use our statutory tax rates for the periods presented. This measure ensures comparability of net interest income arising from taxable and tax-exempt sources.
The following table provides a reconciliation of our GAAP net interest income to our tax equivalent net interest income.
Supplemental Financial Data and Reconciliations to GAAP Financial Measures
GAAP Financial Measurements:
Loans
Investment securities available‑for‑sale
Investment securities held‑to‑maturity
Interest‑bearing deposits
Non‑GAAP Financial Measurements:
Add: Tax benefit on tax‑exempt interest income - securities
Total tax benefit on tax-exempt interest income
Tax equivalent net interest income
Average interest-earning assets increased $309.9 million, or 21.3% to $1.77 billion for the three months ended March 31, 2021 compared to $1.46 billion for the three months ended March 31, 2020. However, because of the current low interest rate environment, total interest income on a tax equivalent basis decreased $153 thousand to $16.8 million for the three months ended March 31, 2021, compared to $16.9 million for the three months ended March 31, 2020. The increase in our earning assets was primarily driven by an increase in the average volume of loans receivable of $174.3 million, which contributed to an additional $2.5 million in interest income. This increase in interest income was reduced by a decrease in yields earned on the loan portfolio, decreasing interest income $2.2 million. Average balances of nonperforming loans, which consist of nonaccrual loans, are included in the net interest margin calculation and did not have a material impact on our net interest margin in 2021 and 2020.
Total average interest-bearing deposits increased $118.4 million to $1.09 billion for the three months ended March 31, 2021 compared to $976.3 million for the three months ended March 31, 2020. Average noninterest-bearing deposits increased $175.5 million to $479.8 million for the three months ended March 31, 2021 compared to $304.4 million for the same period in 2020. The largest increase in average interest-bearing customer deposit balances was in our interest checking, which increased $249.7 million compared to 2020. Average wholesale deposits decreased $75.3 million to $45.8 million for the first quarter of 2021 compared to $121.0 million for the first quarter of 2020. The cost of other borrowed funds, which include federal funds purchased, FHLB advances, and our subordinated notes, increased 77 basis points to 4.21% for the three months ended March 31, 2021, a result of the subordinated debt we issued during the fourth quarter of 2020 at 4.88%.
Provision Expense and Allowance for Loan Losses
Our policy is to maintain the allowance for loan losses at a level that represents our best estimate of inherent losses in the loan portfolio. Both the amount of the provision and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers. We are not required to implement the provisions of CECL until January 1, 2023, and as such we are continuing to account for the allowance for loan losses under the incurred loss model.
We recorded no provision for loan losses for the three months ended March 31, 2021 compared to a provision for loan losses of $1.1 million for the same period of 2020, which primarily reflects changes in certain qualitative factors as a result of the local economic conditions and the slight decrease in loan origination volume during the first quarter of 2021, excluding PPP loans. In addition, as previously mentioned, we evaluated our exposure to certain credit risks within industry segments in our loan portfolio that are most impacted by the pandemic. Industry subgroups such as retail, hotels, churches and other commercial real estate loans were isolated within our allowance model, in addition to those loans deferring payments, and qualitative factors were adjusted to increase the reserves for these loans as a result of their risk profiles. Specific reserves decreased $729 thousand for the three months ended March 31, 2021, a result of several watchlist credits either being paid off or sold during the first quarter of 2021. See “Asset Quality” below for additional information on the credit quality of the loan portfolio. The allowance for loan losses at March 31, 2021 was $14.4 million compared to $15.0 million at December 31, 2020. Our allowance for loan loss ratio as a percent of total loans, net of deferred fees and costs, for March 31, 2021 was 1.00% compared to 1.02% at December 31, 2020.
Noninterest income includes service charges on deposits and loans, loan swap fee income, and income from our BOLI policies, and continues to supplement our operating results. Noninterest income for the three months ended March 31, 2021 and 2020 was $791 thousand and $693 thousand, respectively. Fee income from fees on loans, service charges on deposits, and other fee income was $543 thousand for the three months ended March 31, 2021, a decrease of $221 thousand as compared to the same quarter of 2020, primarily as a result of loan swap fee income of $374 thousand recorded during the first quarter of 2020. Offsetting the decrease in loan swap fees is a one-time commission bonus earned on our minority insurance investment of $155 thousand during the first quarter of 2021.
Income from BOLI was $248 thousand and $283 thousand for the three months ended March 31, 2021 and 2020, respectively. For the three months ended March 31, 2021, we recorded no gains or losses on the sales of assets. For the three months ended March 31, 2020, we recorded gains totaling $97 thousand on the sales of $10.2 million in investment securities available-for-sale. These securities were sold as they had larger premiums susceptible to prepayment risk, decreasing future interest income. Noninterest income for the quarter ended March 31, 2020 was also impacted by losses on loans held for sale totaling $451 thousand.
Noninterest Expense
Noninterest expense includes, among other things, salaries and benefits, occupancy and equipment costs, professional fees, data processing, insurance and miscellaneous expenses. Noninterest expense was $7.9 million and $7.2 million for the three months ended March 31, 2021 and 2020, respectively.
Salaries and benefits expense increased $520 thousand to $4.5 million for the three months ended March 31, 2021 compared to $4.0 million for the same period in 2020, which was primarily related to incentive compensation during the first quarter of 2021. Data processing and network administration expense increased $129 thousand for the three months ended March 31, 2021 as compared to the same period of 2020, as planned 2020 network infrastructure upgrades were implemented during the second quarter of 2020. All other increases in noninterest expense for the quarter ended March 31, 2021 as compared to the same period of 2020 are primarily related to supporting the larger organization as a result of continued organic growth.
Income Taxes
We recorded a provision for income tax expense of $1.4 million for the three months ended March 31, 2021, compared to $896 thousand for the three months ended March 31, 2020. Our effective tax rate for the three months ended March 31, 2021 was 19.9%, compared to 19.4% for the same period of 2020. Our effective tax rates for the three months ended March 31, 2021 and 2020 were less than the statutory rate because of discrete tax benefits recorded as a result of exercises of nonqualified stock options during both 2021 and 2020.
Discussion and Analysis of Financial Condition
At March 31, 2021, total assets were $1.88 billion, an increase of 3.5%, or $63.0 million, from $1.82 billion at December 31, 2020. Total loans receivable, net of deferred fees and costs, decreased 1.3%, or $19.2 million, to $1.45 billion at March 31, 2021, from $1.47 billion at December 31, 2020. Total investment securities increased $9.0 million, or 7.1%, to $135.4 million at March 31, 2021, from $126.4 million at December 31, 2020. Total deposits increased 4.1%, or $62.1 million, to $1.59 billion at March 31, 2021, from $1.53 billion at December 31, 2020. From time to time, we may utilize other borrowed funds such as federal funds purchased and FHLB advances as an additional funding source for the Bank. At March 31, 2021 and at December 31, 2020, we had FHLB advances totaling $25.0 million.
Loans Receivable, Net
Total loans receivable, net of deferred fees and costs, were $1.45 billion at March 31, 2021, a decrease of $19.2 million, or 1.3%, compared to $1.47 billion at December 31, 2020. Loans receivable, net of deferred fees, excluding PPP loans, decreased $29.7 million during the three months ended March 31, 2021. During the first quarter of 2021, loans that paid off prior to maturity totaled $44.5 million, of which, $9.5 million were watch list credits that either paid off or were sold at a discount during the quarter, $13.5 million were related to borrowers selling the underlying collateral, and the remaining loans paid off were primarily a result of refinancing and general business activity. In addition, seasonal commercial line activity decreased $7.2 million during the first quarter of 2021. Offsetting these decreases were loan originations totaling $31.2 million (excluding PPP), of which $24.7 million funded during the quarter.
Commercial real estate loans totaled $783.8 million at March 31, 2021, compared to $790.0 million at December 31, 2020, a decrease of $6.2 million, or 0.8%. Owner-occupied commercial real estate loans were $174.5 million at March 31, 2021 compared to $182.9 million at December 31, 2020. Nonowner-occupied commercial real estate loans were $608.4 million at March 31, 2021 compared to $607.5 million at December 31, 2020. Construction loans totaled $219.2 million at March 31, 2021, or 14.2% of total loans receivable. Of the $219.2 million in construction loans, $38.2 million are collateralized by land and only $811 thousand are lot acquisition and development loans (which have a higher degree of credit risk than the remaining portion of the construction portfolio). Our commercial real estate portfolio, including construction loans, is diversified by asset type and geographic concentration. We plan to manage this portion of our portfolio in a disciplined manner. We have comprehensive policies to monitor, measure, and mitigate our loan concentrations within this portfolio segment, including rigorous credit approval, monitoring and administrative practices.
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The following table presents the composition of our loans receivable portfolio at March 31, 2021 and at December 31, 2020.
At March 31, 2021 and December 31, 2020
110,034
119,529
Paycheck protection program
166,587
155,805
Gross loans
Unearned income and (unamortized premiums)
Loans receivable, net
Asset Quality
Nonperforming assets, defined as nonaccrual loans, loans past due 90 days or more as to principal or interest and still accruing, and OREO at March 31, 2021 were $8.9 million compared to $9.5 million at December 31, 2020. Our ratio of nonperforming assets to total assets was 0.47% at March 31, 2021 compared to 0.52% at December 31, 2020. TDRs as of March 31, 2021 and December 31, 2020 totaled $96 thousand and $97 thousand, respectively, and is made up of one loan.
Nonperforming loans, which are primarily commercial real estate and commercial and industrial loans, decreased $598 thousand during the quarter ended March 31, 2021, as several loans either paid off or were sold during the quarter. Loans that we have classified as nonperforming are a result of customer specific deterioration mostly financial in nature that are not a result of economic, industry, or environmental causes that we might see as a pattern for possible future losses within our loan portfolio. For each of our criticized assets, we conduct an impairment analysis to determine the level of additional or specific reserves required for any portion of the loan that may result in a loss. As a result of the analysis completed, we have specific reserves totaling $1.4 million and $2.1 million at March 31, 2021 and December 31, 2020, respectively. Because these loans are individually evaluated for impairment, nonperforming loans are excluded from the general reserve allocation.
We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. This analysis includes, larger non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. At March 31, 2021, we had $4.0 million in loans identified as special mention, a decrease from $12.1 million from December 31, 2020. Special mention rated loans are loans that have a potential weakness that deserves management’s close attention; however, the borrower continues to pay in accordance with their contract. The decrease from December 31, 2020 was primarily related to two loans being paid off totaling $7.6 million and two loans being upgraded during the quarter. The remaining loans rated as special mention do not have a specific reserve and are considered well-secured.
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At March 31, 2021, we had $18.8 million in loans identified as substandard, a decrease of $1.8 million from December 31, 2020. The decrease in substandard loans was primarily related to two loans totaling $1.3 million which were sold at a discount, and three loans being been paid off in full during the first quarter of 2021. Substandard rated loans are loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. For each of these substandard loans, a liquidation analysis is completed. At March 31, 2021, specific reserves on originated and acquired loans totaling $1.4 million has been allocated within the allowance for loan losses to supplement any shortfall of collateral.
We recorded annualized net charge-offs to average loans receivable of 0.15% for the three months ended March 31, 2021, compared to annualized net charge-offs to average loans receivable of 0.02% for the three months ended March 31, 2020. The increase in net charge-offs during the first quarter of 2021 were primarily related to substandard loans we sold at a discount, which was estimated and included in our specific reserves as of December 31, 2020. The following tables provide additional information on our asset quality for the periods presented.
Nonperforming Assets
Nonperforming assets:
Nonaccrual loans
4,949
5,349
Loans contractually past‑due 90 days or more and still accruing
Total nonperforming loans (NPLs)
5,023
5,621
Total nonperforming assets (NPAs)
8,889
9,487
Performing troubled debt restructurings
NPLs/Total Assets
0.31
NPAs/Total Assets
0.52
NPAs and TDRs/Total Assets
0.48
0.53
Allowance for loan losses/NPLs
287.10
266.11
Nonperforming Loans by Type
385
At March 31, 2021 and December 31, 2020, there were no performing loans considered potential problem loans. Potential problem loans are defined as loans that are not included in the 90 days or more past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories. We take a conservative approach with respect to risk rating loans in our portfolio. Based upon the status as a potential problem loan, these loans receive heightened scrutiny and ongoing intensive risk management. Additionally, our loan loss allowance methodology incorporates increased reserve factors for certain loans that are adversely rated but not impaired as compared to the general portfolio.
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As previously mentioned, we have evaluated our exposure to credit risks directly related to the COVID-19 pandemic and have identified subgroups of industry segments most impacted by the pandemic. As a result of the COVID-19 pandemic, we implemented loan payment deferral programs to allow customers who were required to close or reduce business operations to defer loan principal and interest payments primarily for 90 days. As of March 31, 2021, remaining payment deferred loans totaled $10.0 million, or 0.69% of the total loan portfolio, comprising three loans. One loan is a hotel participation loan totaling $9.7 million, one loan is SBA guaranteed totaling $330 thousand and the remaining loan totaling $61 thousand is a consumer unsecured loan.
We believe that as a result of our conservative underwriting discipline at loan origination coupled with active dialogue we have with our borrowers, we have the ability and necessary flexibility to assist our customers through this pandemic.
At March 31, 2021, we had one OREO property with a fair value of $3.9 million. We are in the process of selling this property and do not expect a material gain or loss from the current fair value of the property as we recorded a $1.1 million gain on the foreclosure of the property during the year ended December 31, 2017.
Unexpected changes in economic growth could adversely affect our loan portfolio, including causing increases in delinquencies and default rates, which would adversely impact our charge-offs and provision for loan losses. Deterioration in real estate values, employment data and household incomes may also result in higher credit losses for us. Also, in the ordinary course of business, we may also be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. At March 31, 2021, our commercial real estate portfolio (including construction lending) was 69.1% of our total loan portfolio. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our business, perhaps materially, and the systems by which we set limits and monitor the level of our credit exposure to individual entities and industries, may not function as we have anticipated.
See “Critical Accounting Policies” above for more information on our allowance for loan losses methodology.
The following tables present additional information pertaining to the activity in and allocation of the allowance for loan losses by loan type and the percentage of the loan type to the total loan portfolio. The allocation of the allowance for loan losses to a category of loans is not necessarily indicative of future losses or charge-offs, and does not restrict the use of the allowance to any specific category of loans.
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Three Months Ended March 31,
Beginning balance
Loans charged off:
Total loans charged off
Recoveries:
Total recoveries
Net charge offs
(71)
Ending balance
Loans, net of deferred fees:
Balance at period end
1,446,912
1,282,142
Allowance for loan losses to loans receivable, net of fees
1.00
0.88
Net charge-offs to average loans receivable, annualized
0.15
0.02
Allocation of the Allowance for Loan Losses
Allocation
% of Total*
53.96
53.69
7.58
8.12
11.47
10.59
15.09
15.11
10.96
11.41
0.94
1.08
Total allowance for loan losses
100.00
*
Percentage of loan type to the total loan portfolio.
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Investment Securities
Our investment securities portfolio is used as a source of income and liquidity. The investment portfolio consists of investment securities available-for-sale, investment securities held-to-maturity and certificates of deposit. Investment securities available-for-sale are those securities that we intend to hold for an indefinite period of time, but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability strategy, liquidity management or regulatory capital management. Investment securities held-to-maturity for each of March 31, 2021 and December 31, 2020 totaled $264 thousand, and are those securities that we have the intent and ability to hold to maturity and are carried at amortized cost. The fair value of our investment securities available-for-sale was $135.1 million at March 31, 2021, an increase of $9.0 million or 7.1%, from $126.2 million at December 31, 2020. During the first quarter of 2021, we purchased $21.1 million in available-for-sale investment securities to invest excess liquidity and reinvest cashflows received from the investment portfolio.
As of March 31, 2021 and December 31, 2020, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency. Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk. All of our mortgage-backed securities are guaranteed by either the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association. Investment securities that were pledged to secure public deposits totaled $8.2 million and $9.2 million at March 31, 2021 and December 31, 2020, respectively.
We complete reviews for other-than-temporary impairment at least quarterly. At March 31, 2021 and December 31, 2020, only investment grade securities were in an unrealized loss position. Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment. Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government. Municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due. We do not intend to sell nor do we believe we will be required to sell any of our temporarily impaired securities prior to the recovery of the amortized cost.
No other-than-temporary impairment has been recognized for the securities in our investment portfolio as of March 31, 2021 and December 31, 2020.
We hold restricted investments in equities of the FRB, and FHLB. At March 31, 2021, we owned $1.8 million in FHLB stock and $4.4 million in FRB stock. At December 31, 2020, we owned $2.4 million in FHLB stock and $4.0 million in FRB stock.
The following table reflects the composition of our investment portfolio, at amortized cost, at March 31, 2021 and December 31, 2020.
Percent of
Held‑to‑maturity
0.21
Total held‑to‑maturity securities
Available‑for‑sale
Securities of state and local municipalities
3,143
4,202
3.41
Corporate bonds and securities
10.44
10.52
Mortgage‑backed securities
116,501
87.02
105,910
85.86
Total available‑for‑sale securities
99.79
Total investment securities
133,880
123,350
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The following table presents the amortized cost of our investment portfolio by their stated maturities, as well as the weighted average yields for each of the maturity ranges at March 31, 2021.
Investment Securities by Stated Maturity
Within One Year
One to Five Years
Five to Ten Years
Over Ten Years
Weighted
Yield
2.32
2,019
2.30
2.25
745
2.92
2.44
2.91
11,972
5.26
4.90
15,643
2.17
100,858
1.93
1.96
4,019
2.60
27,994
3.43
101,603
2.26
28,258
3.42
Deposits and Other Borrowed Funds
Total deposits were $1.59 billion at March 31, 2021, an increase of $62.1 million, or 4.1%, from $1.53 billion at December 31, 2020. Noninterest-bearing deposits totaled $501.8 million at March 31, 2021, comprising 31.5% of total deposits and increased $102.8 million, or 25.8%, compared to December 31, 2020. At March 31, 2021, deposits from municipalities which are secured by a letter of credit issued by the FHLB, represented 3.8% of our total deposits. Deposits of any individual municipality are generally limited to 5% of total assets and in the aggregate, municipalities are limited to 18% of total assets. Some of these customers utilize our treasury management services, and all maintain deposits of varying types and maturities. As such, we believe that these customers are unlikely to abruptly terminate their relationship with us. However, in the event that we were to lose all or a significant portion of the deposits of one or more of these customers, we believe that we have adequate alternative sources of liquidity to enable us to replace these funds, although the cost of such replacement sources of liquidity could be higher.
The following table provides information on our deposit composition at March 31, 2021 and December 31, 2020.
Deposit Composition
Noninterest bearing demand
Interest bearing - checking, savings and money market
0.32
Time deposits $100,000 or more
171,384
1.44
194,190
1.54
Other time deposits
98,555
0.86
118,863
The remaining maturity of time deposits at March 31, 2021 and December 31, 2020 are as follows:
Three months or less
98,253
115,707
Over three months through six months
44,688
60,490
Over six months through twelve months
54,085
53,053
Over twelve months
72,913
83,803
Wholesale deposits decreased to $35.0 million at March 31, 2021 from $50.0 million at December 31, 2020. In addition, we are a member of the IntraFi Network (“IntraFi”), which gives us the ability to offer Certificates of Deposit Account Registry Service (“CDARS”), and Insured Cash Sweep (“ICS”), products to our customers who seek to maximize Federal Deposit Insurance Corporation (“FDIC”) insurance protection. When a customer places a large deposit with us for IntraFi, funds are placed into certificates of deposit or other deposit products with other banks in the CDARS and ICS networks in increments of less than $250 thousand so that principal and interest are eligible for FDIC insurance protection. These deposits are part of our core deposit base. At March 31, 2021 and December 31, 2020, we had $137.5 million and $138.9 million, respectively, in either CDARS reciprocal or ICS reciprocal products.
The following table reports those certificates of deposit that exceed $100,000 by maturity as of March 31, 2021 and December 31, 2020.
Certificates of Deposit Over $100,000
48,562
48,388
30,546
46,739
36,941
36,327
55,335
62,736
Other borrowed funds, which include federal funds purchased, FHLB advances, and our subordinated notes, were $69.1 million at each of March 31, 2021 and December 31, 2020. For both March 31, 2021 and December 31, 2020, other borrowed funds consisted of $25.0 million in FHLB advances and $44.1 million of subordinated notes.
The following table reflects the short-term borrowings and other borrowed funds outstanding at March 31, 2021 and December 31, 2020.
Other Borrowed Funds
Other short‑term borrowed funds:
Federal funds purchased
FHLB advances - short term
1.35
1.15
Total borrowed funds and weighted average rate
Other borrowed funds:
Subordinated Debt
5.99
6.26
Total other borrowed funds and weighted average rate
69,116
69,085
4.41
Capital Resources
Capital adequacy is an important measure of financial stability and performance. Our objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.
Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profile of the financial institution. The minimum capital requirements for the Bank are: (i) a common equity Tier 1, or CET1, capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total risk based capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. Additionally, a capital conservation buffer requirement of 2.5% of risk-weighted assets is designed to absorb losses during periods of economic stress and is applicable to the Bank’s CET1 capital, Tier 1 capital and total capital ratios. Including the conservation buffer, we currently consider the Bank’s minimum capital ratios to be as follows: 7.00% for CET1; 8.50% for Tier 1 capital; and 10.50% for Total capital. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation.
On January 1, 2020, the federal banking agencies adopted a “Community Bank Leverage Ratio” (“CBLR”), which is calculated by dividing tangible equity capital by average consolidated total assets. If a “qualified community bank,” generally a depository institution or depository institution holding company with consolidated assets of less than $10 billion, opts into the CBLR framework and has a leverage ratio that exceeds the CBLR threshold, which was initially set at 9%, then such bank will be considered to have met all generally applicable leverage and risk based capital requirements under Basel III, the capital ratio requirements for “well capitalized” status under Section 38 of the Federal Deposit Insurance Act, and any other leverage or capital requirements to which it is subject. A bank or holding company may be excluded from qualifying community bank status based on its risk profile, including consideration of its off-balance sheet exposures; trading assets and liabilities; total notional derivatives exposures and such other facts as the appropriate federal banking agencies determine to be appropriate.
In April 2020, as required by the CARES Act, the federal banking agencies issued two interim final rules related to the CBLR framework. One interim final rule provides that, as of the second quarter of 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement.
At January 1, 2020, we qualified and adopted this simplified capital structure, however, there can be no assurance that satisfaction of the CBLR will provide adequate capital for our operations and growth, or an adequate cushion against increased levels of nonperforming assets or weakened economic conditions.
Shareholders’ equity at March 31, 2021 was $194.9 million, an increase of $5.4 million, compared to $189.5 million at December 31, 2020. The increase in shareholders’ equity was primarily attributable to the net income recorded for the quarter totaling $5.6 million. Common stock issued as a result of option exercises increased shareholders’ equity by $819 thousand for the three months ended March 31, 2021. Accumulated other comprehensive income decreased $1.1 million during 2021, primarily as a result of a decrease in the market value of our available-for-sale investment securities portfolio.
Total shareholders’ equity to total assets for March 31, 2021 and December 31, 2020 was 10.3% and 10.4%, respectively. Tangible book value per share (a non-GAAP financial measure which is defined in the table below) at March 31, 2021 and December 31, 2020 was $13.69 and $13.41, respectively. The Bank’s CBLR at each of March 31, 2021 and December 31, 2020 was 11.65%. Accordingly, we were considered “well capitalized” for regulatory purposes at March 31, 2021 and December 31, 2020.
As noted above, regulatory capital levels for the Bank meet those established for “well capitalized” institutions. While we are currently considered “well capitalized,” we may from time to time find it necessary to access the capital markets to meet our growth objectives or capitalize on specific business opportunities.
As the Company is a bank holding company with less than $3 billion in assets, and which does not (i) conduct significant off balance sheet activities, (ii) engage in significant non-banking activities, and (iii) have a material amount of securities registered under the Securities Exchange Act of 1934 (the Exchange Act), it is not currently subject to risk-based capital requirements adopted by the Federal Reserve, pursuant to the small bank holding company policy statement. The Federal Reserve has not historically deemed a bank holding company ineligible for application of the small bank holding company policy statement solely because its common stock is registered under the Exchange Act. There can be no assurance that the Federal Reserve will continue this practice.
The following tables shows the minimum capital requirement and our capital position at March 31, 2021 and December 31, 2020 for the Bank.
Capital Components
For Capital
Actual
Adequacy Purposes
Ratio
Leverage capital ratio
215,757
11.65
158,316
>
8.500
209,359
143,823
8.000
Tangible Book Value
Dollars in thousands, except per share data
Less: goodwill and intangibles, net
(8,277)
(8,357)
Tangible Common Equity
186,652
181,143
Book value per common share
14.29
14.03
Less: intangible book value per common share
(0.60)
(0.62)
Tangible book value per common share
13.69
13.41
60
Liquidity
Liquidity in the banking industry is defined as the ability to meet the demand for funds of both depositors and borrowers. We must be able to meet these needs by obtaining funding from depositors or other lenders or by converting non-cash items into cash. The objective of our liquidity management program is to ensure that we always have sufficient resources to meet the demands of our depositors and borrowers. Stable core deposits and a strong capital position provide the base for our liquidity position. We believe we have demonstrated our ability to attract deposits because of our convenient branch locations, personal service, technology and pricing.
In addition to deposits, we have access to the different wholesale funding markets. These markets include the brokered certificate of deposit market and the federal funds market. We are a member of the IntraFi Network, which allows banking customers to access FDIC insurance protection on deposits through our Bank which exceed FDIC insurance limits. We also have one-way authority with IntraFi for both their CDARs and ICS products which provides the Bank the ability to access additional wholesale funding as needed. We also maintain secured lines of credit with the FRB and the FHLB for which we can borrow up to the allowable amount for the collateral pledged. Having diverse funding alternatives reduces our reliance on any one source for funding.
Cash flow from amortizing assets or maturing assets also provides funding to meet the needs of depositors and borrowers.
We have established a formal liquidity contingency plan which establishes a liquidity management team and provides guidelines for liquidity management. For our liquidity management program, we first determine our current liquidity position and then forecast liquidity based on anticipated changes in the balance sheet. In this forecast, we expect to maintain a liquidity cushion. We also stress test our liquidity position under several different stress scenarios, from moderate to severe. Guidelines for the forecasted liquidity cushion and for liquidity cushions for each stress scenario have been established. We believe that we have sufficient resources to meet our liquidity needs.
Our primary and secondary sources of liquidity remain strong. Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $355.0 million at March 31, 2021, or 18.9% of total assets, an increase from $267.2 million, or 14.7%, at December 31, 2020. We held investments that are classified as held-to-maturity in the amount of $264 thousand at March 31, 2021. To maintain ready access to the Bank’s secured lines of credit, the Bank has pledged a portion of its commercial real estate and residential real estate loan portfolios to the FHLB and FRB. Additional borrowing capacity at the FHLB at March 31, 2021 was approximately $170.4 million. Borrowing capacity with the FRB was approximately $127.0 million at March 31, 2021. These facilities are subject to the FHLB and the FRB approving disbursement to us. We also have unsecured federal funds purchased lines of $269.0 million available to us. We anticipate maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth and fully comply with all regulatory requirements.
In addition to the funding facilities noted above, the Federal Reserve has established the PPPLF, authorized under Section 13(3) of the Federal Reserve Act, that can be used to pledge PPP loans we originate as collateral during the second quarter of 2020 under the CARES Act. Under Section 1102 of the CARES Act, a PPP loan is assigned a zero risk weighting under the risk based capital rules of the federal banking agencies. In addition, an interim rule issued on April 9, 2020 from the federal banking agencies will allow banks to neutralize the effect of PPP loans financed under the PPPLF on leverage capital ratios. We do not anticipate using this facility to provide us with additional liquidity. The interest rate on this facility is fixed at 0.35% for the term of the facility and access to the facility will end June 30, 2021.
Liquidity is essential to our business. Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that we may be unable to control, such as general market disruption, negative views about the financial services industry generally, or an operational problem that affects a third party or us. Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by disruptions in the capital markets or other events. As discussed under the caption “Deposits and Other Borrowed Funds” above, we have a deposit concentration related to municipalities at March 31, 2021. While we believe we have a healthy liquidity position and do not anticipate the loss of deposits of any of the significant deposit customers, any of the factors discussed above could materially impact our liquidity position in the future.
61
Financial Instruments with Off-Balance-Sheet Risk and Credit Risk
We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.
The Bank’s maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. We evaluate each customer’s credit worthiness on a case-by-case basis and require collateral to support financial instruments when deemed necessary. The amount of collateral obtained upon extension of credit is based on management’s evaluation of the counterparty. Collateral held varies but may include deposits held by us, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates up to one year or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These instruments represent obligations to extend credit or guarantee borrowings and are not recorded on the consolidated statements of financial condition. The rates and terms of these instruments are competitive with others in the market in which we do business.
Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may not be drawn upon to the total extent to which we have committed.
Standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.
With the exception of these off-balance sheet arrangements, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, changes in financial condition, revenue, expenses, capital expenditures, or capital resources, that is material to the business of the Company.
At March 31, 2021 and December 31, 2020, unused commitments to fund loans and lines of credit totaled $151.1 million and $166.3 million, respectively. Commercial and standby letters of credit totaled $9.5 million and $5.5 million at March 31, 2021 and December 31, 2020, respectively.
As a financial institution, we are exposed to various business risks, including interest rate risk. Interest rate risk is the risk to earnings and value arising from volatility in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities, changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay loans and depositors’ ability to redeem certificates of deposit before maturity, changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion, and changes in spread relationships between different yield curves, such as U.S. Treasuries and LIBOR. Our goal is to maximize net interest income without incurring excessive interest rate risk. Management of net interest income and interest rate risk must be consistent with the level of capital and liquidity that we maintain. We manage interest rate risk through an asset and liability committee (“ALCO”). ALCO is responsible for managing our interest rate risk in conjunction with liquidity and capital management.
We employ an independent consulting firm to model our interest rate sensitivity. We use a net interest income simulation model as our primary tool to measure interest rate sensitivity. Many assumptions are developed based on expected activity in the balance sheet. For maturing assets, assumptions are created for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that could reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, savings accounts as well as certificates of deposit. Based on inputs that include the current balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that market rates remain unchanged. This is considered the base case. Next, the model determines what net interest income would be based on specific changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points to 400 basis points and up 100 basis points to 400 basis points. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.
Stress testing the balance sheet and net interest income using instantaneous parallel shock movements in the yield curve of 100 to 400 basis points is a regulatory and banking industry practice. However, these stress tests may not represent a realistic forecast of future interest rate movements in the yield curve. In addition, instantaneous parallel interest rate shock modeling is not a predictor of actual future performance of earnings. It is a financial metric used to manage interest rate risk and track the movement of the Bank’s interest rate risk position over a historical time frame for comparison purposes.
At March 31, 2021, our asset/liability position was asset sensitive based on our interest rate sensitivity model in the one-year time frame and asset sensitive in the the two-year time frame. Our net interest income would increase by 2.3% in an up 100 basis point scenario and would increase by 10.7% in an up 400 basis point scenario over a one-year time frame. In the two-year time horizon, our net interest income would increase by 7.7% in an up 100 basis point scenario and would increase by 29.4% in an up 400 basis point scenario. At March 31, 2021 and December 31, 2020, all interest rate risk stress tests measures were within our board policy established limits in each of the increased rate scenarios.
Additional information on our interest rate sensitivity for a static balance sheet over a one-year time horizon as of March 31, 2021 and December 31, 2020 can be found below.
Interest Rate Risk to Earnings (Net Interest Income)
Change in interest
Percentage change in
rates (basis points)
net interest income
+400
10.68
−0.62
+300
7.94
−0.55
+200
5.06
0.63
+100
0.54
0
−100
−2.01
−0.07
−200
−4.71
−1.58
Economic value of equity (“EVE”) measures the period end market value of assets less the market value of liabilities and the change in this value as rates change. It models simultaneous parallel shifts in market interest rates, implied by the forward yield curve. The EVE model calculates the market value of capital by taking the present value of all asset cash flows less the present value of all liability cash flows.
63
The interest rate risk to capital at March 31, 2021 and December 31, 2020 is shown below and reflects that our market value of capital is in a liability position in which an increase in short-term interest rates is expected to generate lower market values of capital. At March 31, 2021 and December 31, 2020, all EVE stress tests measures were within our board policy established limits.
Interest Rate Risk to Capital
economic value of equity
8.36
6.64
7.15
6.14
5.37
4.84
2.84
2.68
-7.08
-4.15
-12.40
-3.41
The Company maintains disclosure controls and procedures (as defined in Rule 13a - 15(e) under the Exchange Act). As of the end of the period covered by this report, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was carried out under the supervision and with the participation of the Company’s management, including its chief executive officer and chief financial officer. Based on and as of the date of such evaluation, these officers concluded that the Company’s disclosure controls and procedures were effective.
The Company also maintains a system of internal accounting controls that is designed to provide assurance that assets are safeguarded and that transactions are executed in accordance with management’s authorization and are properly recorded. This system is continually reviewed and is augmented by written policies and procedures, the careful selection and training of qualified personnel and an internal audit program to monitor its effectiveness. There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that materially affected, or are likely to materially affect, our internal control over financial reporting.
Item 1.Legal Proceedings
In the ordinary course of our operations, we become party to various legal proceedings. Currently, we are not party to any material legal proceedings, and no such proceedings except as noted above are, to management’s knowledge, threatened against us.
Item 1A.Risk Factors
There have been no material changes as of March 31, 2021 in the risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2020.
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
No shares were purchased during the three months ended March 31, 2021.
Item 3.Defaults Upon Senior Securities
Item 4.Mine Safety Disclosures
None.
Item 5.Other Information
Item 6.Exhibits
31.1
Rule 13a-14(a) Certification of Principal Executive Officer
31.2
Rule 13a-14(a) Certification of Principal Financial Officer
32.1
Statement of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350
32.2
Statement of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350
The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2021, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) related notes.
The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2021, formatted in Inline Extensible Business Reporting Language (included with Exhibit 101).
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
Date: May 13, 2021
/s/ David W. Pijor
David W. Pijor
Chairman and Chief Executive Officer
(Principal Executive Officer)
/s/ Jennifer L. Deacon
Jennifer L. Deacon
Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)