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 September 30, 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 000-27719
Southern First Bancshares, Inc.
(Exact name of registrant as specified in its charter)
South Carolina
58-2459561
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
100 Verdae Boulevard, Suite 100
Greenville, S.C.
29607
(Address of principal executive offices)
(Zip Code)
864-679-9000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock
SFST
The Nasdaq Global Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 and posted 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 and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See 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: 7,913,381 shares of common stock, par value $0.01 per share, were issued and outstanding as of October 21, 2021.
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
September 30, 2021 Form 10-Q
INDEX
PART I – CONSOLIDATED FINANCIAL INFORMATION
Page
Item 1.Consolidated Financial Statements
Consolidated Balance Sheets
3
Consolidated Statements of Income
4
Consolidated Statements of Comprehensive Income
5
Consolidated Statements of Shareholders’ Equity
6
Consolidated Statements of Cash Flows
7
Notes to Unaudited Consolidated Financial Statements
8
2
PART I. CONSOLIDATED FINANCIAL INFORMATION
Item 1. CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
September 30,
December 31,
(dollars in thousands, except share data)
2021
2020
(Unaudited)
(Audited)
ASSETS
Cash and cash equivalents:
Cash and due from banks
$
17,944
12,920
Federal funds sold
47,440
21,744
Interest-bearing deposits with banks
63,149
66,023
Total cash and cash equivalents
128,533
100,687
Investment securities:
Investment securities available for sale
113,802
94,729
Other investments
2,820
3,635
Total investment securities
116,622
98,364
Mortgage loans held for sale
31,641
60,257
Loans
2,389,047
2,142,867
Less allowance for loan losses
(36,075
)
(44,149
Loans, net
2,352,972
2,098,718
Bank owned life insurance
49,521
41,102
Property and equipment, net
78,456
60,236
Deferred income taxes
16,591
9,518
Other assets
9,840
13,705
Total assets
2,784,176
2,482,587
LIABILITIES
Deposits
2,433,018
2,142,758
Federal Home Loan Bank advances and other borrowings
-
25,000
Subordinated debentures
36,079
35,998
Other liabilities
49,450
50,537
Total liabilities
2,518,547
2,254,293
SHAREHOLDERS’ EQUITY
Preferred stock, par value $.01 per share, 10,000,000 shares authorized
Common stock, par value $.01 per share, 10,000,000 shares authorized, 7,913,381 and 7,772,748 shares issued and outstanding at September 30, 2021 and December 31, 2020, respectively
79
78
Nonvested restricted stock
(1,469
(698
Additional paid-in capital
113,501
108,831
Accumulated other comprehensive income (loss)
(248
1,023
Retained earnings
153,766
119,060
Total shareholders’ equity
265,629
228,294
Total liabilities and shareholders’ equity
See notes to consolidated financial statements that are an integral part of these consolidated statements.
CONSOLIDATED STATEMENTS OF INCOME
For the three months ended September 30,
For the nine months ended September 30,
Interest income
23,063
23,042
67,938
69,963
Investment securities
355
310
926
1,090
Federal funds sold and interest-bearing deposits with banks
68
63
167
218
Total interest income
23,486
23,415
69,031
71,271
Interest expense
934
2,393
3,009
11,195
Borrowings
380
385
1,147
1,569
Total interest expense
1,314
2,778
4,156
12,764
Net interest income
22,172
20,637
64,875
58,507
Provision for (reversal of) loan losses
(6,000)
11,100
(8,200)
27,300
Net interest income after provision for loan losses
28,172
9,537
73,075
31,207
Noninterest income
Mortgage banking income
2,829
6,277
9,445
14,721
Service fees on deposit accounts
199
211
557
670
ATM and debit card income
542
465
1,532
1,258
Income from bank owned life insurance
321
270
919
810
Net lender and referral fees on PPP loans
268
2,247
Other income
348
361
1,043
1,002
Total noninterest income
4,239
7,584
13,764
20,708
Noninterest expenses
Compensation and benefits
7,468
6,666
20,974
19,450
Mortgage production costs
1,956
2,666
7,086
6,841
Occupancy
1,684
1,601
4,871
4,631
Other real estate owned (income) expenses
(3
673
Outside service and data processing costs
1,229
1,046
3,609
3,170
Insurance
244
377
807
995
Professional fees
561
395
1,479
1,270
Marketing
240
165
623
481
Other
660
594
1,861
1,687
Total noninterest expenses
14,039
14,183
41,695
39,198
Income before income tax expense
18,372
2,938
45,144
12,717
Income tax expense
4,355
721
10,438
2,990
Net income available to common shareholders
14,017
2,217
34,706
9,727
Earnings per common share
Basic
1.78
0.29
4.43
1.26
Diluted
1.75
0.28
4.36
1.24
Weighted average common shares outstanding
7,873,868
7,732,293
7,832,330
7,711,181
8,001,028
7,815,265
7,966,065
7,820,345
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three months ended
For the nine months ended
(dollars in thousands)
Net income
Other comprehensive income:
Unrealized gain on securities available for sale:
Unrealized holding gain (loss) arising during the period, pretax
(819
77
(1,609
1,472
Tax (expense) benefit
171
(17
338
(309
Other comprehensive income (loss)
(648
60
(1,271
1,163
Comprehensive income
13,369
2,277
33,435
10,890
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
Accumulated
Nonvested
Additional
other
Common stock
Preferred stock
restricted
paid-in
comprehensive
Retained
Shares
Amount
stock
capital
income (loss)
earnings
Total
June 30, 2020
7,734,644
(1,001
108,031
805
108,242
216,154
Proceeds from exercise of stock options
250
1
Issuance of restricted stock
2,700
(88
88
Compensation expense related to restricted stock, net of tax
100
Compensation expense related to stock options, net of tax
217
September 30, 2020
7,737,594
(989
108,337
865
110,459
218,749
June 30, 2021
7,899,931
(1,173
112,604
400
139,749
251,659
4,950
175
Issurance of restricted stock
8,500
(431
431
135
291
September 30, 2021
7,913,381
December 31, 2019
7,672,678
(803
106,152
(298
100,732
205,860
52,716
963
12,200
(494
494
308
728
December 31, 2020
7,772,748
117,383
2,695
2,696
23,250
(1,120
1,120
349
855
CONSOLIDATED STATEMENTS OF CASH FLOWS
Operating activities
Adjustments to reconcile net income to cash provided by (used for) operating activities:
(8,200
Depreciation and other amortization
1,621
Accretion and amortization of securities discounts and premium, net
713
497
Loss on sale of real estate owned
376
513
Gain on sale of fixed assets
(10
Net change in operating leases
266
157
Compensation expense related to stock options and restricted stock grants
1,204
1,036
Gain on sale of loans held for sale
(11,187
(14,377
Loans originated and held for sale
(406,451
(412,069
Proceeds from sale of loans held for sale
446,254
389,669
Increase in cash surrender value of bank owned life insurance
(919
(810
Increase in deferred tax asset
(6,736
(2,545
Decrease (increase) in other assets
2,698
(7,345
Increase (decrease) in other liabilities
(4,531
3,419
Net cash provided by (used for) operating activities
49,804
(3,259
Investing activities
Increase (decrease) in cash realized from:
Increase in loans, net
(246,421
(138,935
Purchase of property and equipment
(16,620
(3,696
Purchase of investment securities:
Available for sale
(37,908
(36,609
(1,000
(1,275
Payments and maturities, calls and repayments of investment securities:
16,514
17,290
1,812
5,634
Purchase of bank owned life insurance
(7,500
Proceeds from sale of fixed assets
50
Proceeds from sale of other real estate owned
1,159
Net cash used for investing activities
(289,914
(157,591
Financing activities
Increase in deposits, net
290,260
304,932
Decrease in Federal Home Loan Bank advances and other borrowings, net
(25,000
(109,946
Proceeds from the exercise of stock options
Net cash provided by financing activities
267,956
195,949
Net increase in cash and cash equivalents
27,846
35,099
Cash and cash equivalents at beginning of the period
127,816
Cash and cash equivalents at end of the period
162,915
Supplemental information
Cash paid for
Interest
5,404
14,031
Income taxes
18,357
2,544
Schedule of non-cash transactions
Foreclosure of other real estate
367
Unrealized gain (loss) on securities, net of income taxes
Right-of-use assets obtained in exchange for lease obligations:
Operating leases
4,803
2,115
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – Nature of Business and Basis of Presentation
Business Activity
Southern First Bancshares, Inc. (the “Company”) is a South Carolina corporation that owns all of the capital stock of Southern First Bank (the “Bank”) and all of the stock of Greenville First Statutory Trusts I and II (collectively, the “Trusts”). The Trusts are special purpose non-consolidated entities organized for the sole purpose of issuing trust preferred securities. The Bank's primary federal regulator is the Federal Deposit Insurance Corporation (the “FDIC”). The Bank is also regulated and examined by the South Carolina Board of Financial Institutions. The Bank is primarily engaged in the business of accepting demand deposits and savings deposits insured by the FDIC, and providing commercial, consumer and mortgage loans to the general public.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three- and nine-month period ended September 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 as filed with the U.S. Securities and Exchange Commission (“SEC”) on March 2, 2021. The consolidated financial statements include the accounts of the Company and the Bank. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation,” the financial statements related to the Trusts have not been consolidated.
Business Segments
In determining proper segment definition, the Company considers the materiality of a potential segment and components of the business about which financial information is available and regularly evaluated, relative to a resource allocation and performance assessment. The Company accounts for intersegment revenues and expenses as if the revenue/expense transactions were generated to third parties, that is, at current market prices. Please refer to “Note 10 – Reportable Segments” for further information on the reporting for the Company’s three business segments.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, real estate acquired in the settlement of loans, fair value of financial instruments, evaluating other-than-temporary-impairment of investment securities and valuation of deferred tax assets.
Risks and Uncertainties
The unprecedented and rapid spread of COVID-19 and its variants and the associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower equity market valuations and significant volatility and disruption in financial markets, and has had an adverse effect on the Company’s business, financial condition and results of operations. The ultimate extent of the impact of the COVID-19 pandemic on the Company’s business, financial condition and results of operations is currently uncertain and the timing and pace of recovery will depend on various developments and other factors, including, among others, the duration and scope of the pandemic, as well as governmental, regulatory and private sector initiatives, the effect of the continued rollout of vaccinations for the virus, whether such vaccinations will be effective against any resurgence of the virus, including any new strain of the virus, the ability for clients and businesses to return to, and remain in, their pre-pandemic routines, and the associated impacts on the economy, financial markets and our clients, employees and vendors.
The Company’s business, financial condition and results of operations generally rely upon the ability of the Bank’s borrowers to repay their loans, the value of collateral underlying the Bank’s secured loans, and demand for loans and other products and services the Bank offers, which are highly dependent on the business environment in the Bank’s primary markets where it operates and in the United States as a whole.
In addition, due to the COVID-19 pandemic, market interest rates declined significantly with the 10-year Treasury bond falling to a low of 0.52% in early August 2020 but increasing significantly since that time to near 1.50% at September 30, 2021. On March 3, 2020, the Federal Reserve reduced the target federal funds rate by 50 basis points, followed by an additional reduction of 100 basis points on March 16, 2020, making the target federal funds rate range 0% to 0.25%, and this low target rate was still in effect as of September 30, 2021. These reductions in interest rates and other effects of the COVID-19 pandemic have had, and are expected to continue to have, possibly materially, an adverse effect on Company’s business, financial condition and results of operations. For instance, the pandemic has had negative effects on the Bank’s interest income, provision for loan losses, and certain transaction-based line items of noninterest income. Other financial impacts could occur though such potential impact is unknown at this time.
As of September 30, 2021, the Company's and the Bank's capital ratios were in excess of all regulatory requirements. While management believes that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our reported and regulatory capital ratios could be adversely impacted by further credit losses.
The Company maintains access to multiple sources of liquidity, including a $15.0 million holding company line of credit with another bank which could be used to support capital ratios at the subsidiary bank. As of September 30, 2021, the $15.0 million line was unused.
Reclassifications
Certain amounts, previously reported, have been reclassified to state all periods on a comparable basis and had no effect on shareholders’ equity or net income.
Subsequent Events
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.
Newly Issued, But Not Yet Effective Accounting Standards
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. Among other things, ASU 2016-13 requires 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 form 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, ASU 2016-13 amends the accounting for credit losses on debt securities and purchased financial assets with credit deterioration. ASU 2016-13 was originally effective for all annual and interim periods beginning after December 31, 2019, with early adoption permitted for fiscal years beginning after December 15, 2018. In November 2019, the FASB issued guidance that addresses issues raised by stakeholders during the implementation of ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. The amendments affect a variety of Topics in the Accounting Standards Codification. For public business entities that meet the definition of a smaller reporting company, such as the Company, the amendments are effective for fiscal years beginning after December 15, 2022 including interim periods within those fiscal years. Early adoption is permitted in any interim period as long as the Company has adopted to amendments in ASU 2016-13. Currently, the Company is evaluating the impact of adoption on its financial statements and is considering early adoption of the ASU as of January 1, 2022. Adoption will be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company has established a team of individuals from credit, finance and risk management to evaluate the requirements of the new standard and the impact it will have on its processes.
9
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.
NOTE 2 – Investment Securities
The amortized costs and fair value of investment securities are as follows:
Amortized
Gross Unrealized
Fair
Cost
Gains
Losses
Value
US treasuries
999
1,000
US government agencies
14,503
228
14,277
SBA securities
435
10
445
State and political subdivisions
22,418
515
226
22,707
Asset-backed securities
10,526
56
13
10,569
Mortgage-backed securities
FHLMC
20,678
141
386
20,433
FNMA
39,479
325
452
39,352
GNMA
5,078
11
70
5,019
Total mortgage-backed securities
65,235
477
908
64,804
Total investment securities available for sale
114,116
1,061
1,375
6,500
6,493
504
19
485
18,614
804
30
19,388
11,587
15
73
11,529
12,157
206
47
12,316
35,893
507
91
36,309
8,179
53
23
8,209
56,229
766
161
56,834
93,434
1,586
Contractual maturities and yields on the Company’s investment securities at September 30, 2021 and December 31, 2020 are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
Less than one year
One to five years
Five to ten years
Over ten years
Yield
1.27
%
2,498
0.36
8,847
1.31
2,932
1.79
1.00
471
2.13
3,476
1.60
18,760
2.17
2.08
1,710
1.52
8,859
0.95
1.04
1,321
1.85
10,065
1.46
53,418
1.37
1.40
4,290
1.01
25,098
1.42
84,414
1.48
2,501
0.37
2,995
1.07
997
0.86
0.98
470
3,053
1.98
15,865
2.23
2.18
1,983
1.17
9,546
1.03
2,044
1.77
9,544
1.74
45,246
1.36
1.44
5,015
1.10
17,575
72,139
1.50
The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities at September 30, 2021 and December 31, 2020, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.
Less than 12 months
12 months or longer
Unrealized
#
value
losses
11,846
1,929
71
13,775
7,280
168
2,565
58
14
9,845
1,794
25
34,823
664
11,296
34
46,119
43
53,949
989
18
17,584
61
71,533
2,992
484
4,861
6,998
20,810
136
1,984
22,794
26
28,663
174
9,466
117
36
38,129
At September 30, 2021 the Company had 43 individual investments with a fair market value of $53.9 million that were in an unrealized loss position for less than 12 months and 18 individual investments with a fair market value of $17.6 million that were in an unrealized loss position for 12 months or longer. The unrealized losses were primarily attributable to changes in interest rates, rather than deterioration in credit quality. The individual securities are each investment grade securities. The Company considers the length of time and extent to which the fair value of available-for-sale debt securities have been less than cost to conclude that such securities are not other-than-temporarily impaired. The Company also considers other factors such as the financial condition of the issuer including credit ratings and specific events affecting the operations of the issuer, volatility of the security, underlying assets that collateralize the debt security, and other industry and macroeconomic conditions.
As the Company has no intent to sell securities with unrealized losses and it is not more-likely-than-not that the Company will be required to sell these securities before recovery of amortized cost, the Company has concluded that these securities are not impaired on an other-than-temporary basis.
Other investments are comprised of the following and are recorded at cost which approximates fair value.
Federal Home Loan Bank stock
1,241
3,103
1,176
129
Investment in Trust Preferred securities
403
Total other investments
The Company has evaluated the Federal Home Loan Bank (“FHLB”) stock for impairment and determined that the investment in the FHLB stock is not other than temporarily impaired as of September 30, 2021 and that ultimate recoverability of the par value of this investment is probable. All of the FHLB stock is used to collateralize advances with the FHLB.
NOTE 3 – Mortgage Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are reported as loans held for sale and carried at fair value under the fair value option with changes in fair value recognized in current period earnings. At the date of funding of the mortgage loan held for sale, the funded amount of the loan, the related derivative asset or liability of the associated interest rate lock commitment, less direct loan costs becomes the initial recorded investment in the loan held for sale. Such amount approximates the fair value of the loan. At September 30, 2021, mortgage loans held for sale totaled $31.6 million compared to $60.3 million at December 31, 2020.
Mortgage loans held for sale are considered de-recognized, or sold, when the Company surrenders control over the financial assets. Control is considered to have been surrendered when the transferred assets have been isolated from the Company, beyond the reach of the Company and its creditors; the purchaser obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets; and the Company does not maintain effective control over the transferred assets through an agreement that both entitles and obligates the Company to repurchase or redeem the transferred assets before their maturity or the ability to unilaterally cause the holder to return specific assets.
Gains and losses from the sale of mortgage loans are recognized based upon the difference between the sales proceeds and carrying value of the related loans upon sale and are recorded in mortgage banking income in the statement of income. Mortgage banking income also includes the unrealized gains and losses associated with the loans held for sale and the realized and unrealized gains and losses from derivatives.
Mortgage loans sold to investors by the Company, and which were believed to have met investor and agency underwriting guidelines at the time of sale, may be subject to repurchase or indemnification in the event of specific default by the borrower or subsequent discovery that underwriting standards were not met. The Company may, upon mutual agreement, agree to repurchase the loans or indemnify the investor against future losses on such loans. In such cases, the Company bears any subsequent credit loss on the loans. As appropriate, the Company establishes mortgage repurchase reserves related to various representations and warranties that reflect management’s estimate of losses.
12
NOTE 4 – Loans and Allowance for Loan Losses
The following table summarizes the composition of our loan portfolio. Total gross loans are recorded net of deferred loan fees and costs, which totaled $4.6 million as of September 30, 2021 and $3.9 million as of December 31, 2020.
% of Total
Commercial
Owner occupied RE
470,614
19.7
433,320
20.2
Non-owner occupied RE
628,521
26.3
585,269
27.3
Construction
87,892
3.7
61,467
2.9
Business
307,969
12.9
307,599
14.4
Total commercial loans
1,494,996
62.6
1,387,655
64.8
Consumer
Real estate
648,276
27.1
536,311
25.0
Home equity
155,049
6.5
156,957
7.3
57,419
2.4
40,525
1.9
33,307
1.4
21,419
1.0
Total consumer loans
894,051
37.4
755,212
35.2
Total gross loans, net of deferred fees
100.0
Less—allowance for loan losses
Total loans, net
Maturities and Sensitivity of Loans to Changes in Interest Rates
The information in the following tables summarizes the loan maturity distribution by type and related interest rate characteristics based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below, because borrowers have the right to prepay obligations with or without prepayment penalties.
After one
One year
but within
After five
or less
five years
years
17,069
121,176
332,369
32,463
315,742
280,316
11,666
22,095
54,131
61,534
145,862
100,573
122,732
604,875
767,389
14,126
46,753
587,397
3,099
22,683
129,267
703
1,831
54,885
8,180
21,292
3,835
26,108
92,559
775,384
148,840
697,434
1,542,773
Loans maturing after one year with:
Fixed interest rates
1,883,823
Floating interest rates
356,384
22,232
136,031
275,057
39,359
335,249
210,661
21,824
15,785
23,858
76,662
140,959
89,978
160,077
628,024
599,554
14,205
54,863
467,243
4,824
23,835
128,298
1,629
1,234
37,662
6,438
11,413
3,568
Total consumer
27,096
91,345
636,771
Total gross loan, net of deferred fees
187,173
719,369
1,236,325
1,590,171
365,523
Paycheck Protection Program (“PPP”)
On March 27, 2020, President Trump signed the Coronavirus Aid, Relief, and Economic Security Act (the “CARES” Act or the “Act”) to provide emergency assistance and health care response for individuals, families, and businesses affected by the coronavirus pandemic. The Small Business Administration (“SBA”) received funding and authority through the Act to modify existing loan programs and establish a new loan program to assist small businesses nationwide adversely impacted by the COVID-19 emergency. The Act temporarily permits the SBA to guarantee 100% of certain loans under a new program titled the “Paycheck Protection Program” and also provides for forgiveness of up to the full principal amount of qualifying loans guaranteed under the PPP.
We became an approved SBA lender in March 2020 and processed 853 loans under the PPP for a total of $97.5 million during the second quarter of 2020. On June 26, 2020, we completed the sale of our PPP loan portfolio to The Loan Source Inc., together with its servicing partner, ACAP SME LLC, receiving net lender fees of $2.2 million during the three months ended June 30, 2020.
The SBA offered a second round of PPP loans through May 31, 2021; however, we did not originate any new PPP loans. We did, however, receive referral fees of approximately $268,000 during the three months ended June 30, 2021 from The Loan Source Inc. for PPP loans they originated to our clients.
Portfolio Segment Methodology
Commercial loans are assessed for estimated losses by grading each loan using various risk factors identified through periodic reviews. The Company applies historic grade-specific loss factors to each loan class. In the development of statistically derived loan grade loss factors, the Company observes historical losses over 20 quarters for each loan grade. These loss estimates are adjusted as appropriate based on additional analysis of external loss data or other risks identified from current economic conditions and credit quality trends. The allowance also includes an amount for the estimated impairment on nonaccrual commercial loans and commercial loans modified in a troubled debt restructuring (“TDR”), whether on accrual or nonaccrual status.
For consumer loans, the Company determines the allowance on a collective basis utilizing historical losses over 20 quarters to represent its best estimate of inherent loss. The Company pools loans, generally by loan class with similar risk characteristics. The allowance also includes an amount for the estimated impairment on nonaccrual consumer loans and consumer loans modified in a TDR, whether on accrual or nonaccrual status.
Credit Quality Indicators
We manage a consistent process for assessing commercial loan credit quality by monitoring its loan grading trends and past due statistics. All loans are subject to individual risk assessment. Our risk categories include Pass, Special Mention, Substandard, and Doubtful, each of which is defined by our banking regulatory agencies. Delinquency statistics are also an important indicator of credit quality in the establishment of our allowance for loan losses.
We categorize our loans into risk categories based on relevant information about the ability of the borrower to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. A description of the general characteristics of the risk grades is as follows:
•
Pass—These loans range from minimal credit risk to average credit risk; however, still have acceptable credit risk.
Special mention—A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position at some future date.
Substandard—A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that may jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful—A doubtful loan has all of the weaknesses inherent in one classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable.
The following tables provide past due information for outstanding commercial loans and include loans on nonaccrual status as well as accruing TDRs.
Owner
Non-owner
occupied RE
Current
470,351
621,383
305,804
1,485,430
30-59 days past due
263
696
959
60-89 days past due
7,138
1,469
8,607
Greater than 90 Days
432,711
584,565
307,261
1,386,004
282
35
720
422
37
665
As of September 30, 2021 and December 31, 2020, loans 30 days or more past due represented 0.49% and 0.17% of the Company’s total loan portfolio, respectively. Commercial loans 30 days or more past due were 0.40% and 0.08% of the Company’s total loan portfolio as of September 30, 2021 and December 31, 2020, respectively.
The tables below provide a breakdown of outstanding commercial loans by risk category.
Pass
469,715
544,427
301,291
1,403,325
Special mention
333
48,540
2,651
51,524
Substandard
566
35,554
4,027
40,147
Doubtful
430,291
576,095
61,328
301,838
1,369,552
624
587
1,703
2,914
2,405
8,587
139
4,058
15,189
The Company manages a consistent process for assessing consumer loan credit quality by monitoring its loan grading trends and past due statistics. All loans are subject to individual risk assessment. The Company’s categories include Pass, Special Mention, Substandard, and Doubtful, which are defined above. Delinquency statistics are also an important indicator of credit quality in the establishment of the allowance for loan losses.
The following tables provide past due information for outstanding consumer loans and include loans on nonaccrual status as well as accruing TDRs.
647,722
153,505
33,301
891,947
1,510
40
554
534,648
156,657
753,249
332
1,331
300
1,631
Consumer loans 30 days or more past due were 0.09% of total loans as of both September 30, 2021 and December 31, 2020.
16
The tables below provide a breakdown of outstanding consumer loans by risk category.
640,595
149,136
33,120
880,270
3,326
3,162
137
6,625
2,751
7,156
530,515
152,154
21,290
744,484
1,968
1,005
3,064
3,828
3,798
38
7,664
Nonperforming assets
The following table shows the nonperforming assets and the related percentage of nonperforming assets to total assets and gross loans. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when the Company believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the contractual principal or interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received.
Following is a summary of our nonperforming assets, including nonaccruing TDRs.
7,400
1,143
195
1,461
2,536
818
547
Nonaccruing troubled debt restructurings
2,730
3,509
Total nonaccrual loans, including nonaccruing TDRs
13,878
8,069
Other real estate owned
1,169
Total nonperforming assets
9,238
Nonperforming assets as a percentage of:
0.50
Gross loans
0.58
0.43
Total loans over 90 days past due
2,296
Loans over 90 days past due and still accruing
Accruing troubled debt restructurings
4,044
4,893
17
Impaired Loans
The table below summarizes key information for impaired loans. The Company’s impaired loans include loans on nonaccrual status and loans modified in a TDR, whether on accrual or nonaccrual status. These impaired loans may have estimated impairment which is included in the allowance for loan losses. The Company’s commercial and consumer impaired loans are evaluated individually to determine the related allowance for loan losses.
Recorded investment
Impaired loans
Unpaid
with no related
with related
Related
Principal
Impaired
allowance for
Balance
loans
loan losses
1,269
9,283
8,238
838
3,333
3,303
1,834
788
Total commercial
13,885
12,810
10,138
2,672
955
3,035
2,936
2,109
828
2,190
2,049
1,992
126
5,351
5,111
4,101
1,010
210
19,236
17,921
14,239
3,682
1,165
1,753
1,649
1,497
152
76
3,212
2,188
705
1,483
366
2,892
2,449
279
2,170
897
7,998
6,425
2,620
3,805
1,339
4,362
4,031
3,108
923
190
2,371
2,096
275
163
6,995
6,537
5,204
1,333
370
14,993
12,962
7,824
5,138
1,709
The following table provides the average recorded investment in impaired loans and the amount of interest income recognized on impaired loans after impairment by portfolio segment and class.
Three months ended
Three months ended September 30, 2020
Average
Recognized
recorded
interest
investment
income
2,985
5,125
227
3,880
72
2,665
2,506
51
9,059
305
9,443
156
3,063
1,859
2,540
22
127
5,595
31
5,742
81
14,654
336
15,185
237
Nine months ended
Year ended
September 31, 2020
1,419
49
2,617
2,423
3,643
4,724
4,217
221
69
2,497
115
2,270
98
2,306
243
7,628
9,647
9,002
558
3,911
102
3,207
3,372
170
1,944
64
2,067
39
2,128
130
143
5,985
169
5,417
140
5,641
254
13,613
654
15,064
478
14,643
812
Allowance for Loan Losses
The allowance for loan losses is management’s estimate of credit losses inherent in the loan portfolio. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The Company has an established process to determine the adequacy of the allowance for loan losses that assesses the losses inherent in the portfolio. While the Company attributes portions of the allowance to specific portfolio segments, the entire allowance is available to absorb credit losses inherent in the total loan portfolio. The Company’s process involves procedures to appropriately consider the unique risk characteristics of the commercial and consumer loan portfolio segments. For each portfolio segment, impairment is measured individually for each impaired loan. The Company’s allowance levels are influenced by loan volume, loan grade or delinquency status, historic loss experience and other economic conditions.
The following table summarizes the activity related to the allowance for loan losses by commercial and consumer portfolio segments:
Three months ended September 30, 2021
occupied
Real
Home
RE
Estate
Equity
Balance, beginning of period
7,099
13,223
951
6,722
10,028
2,562
753
574
41,912
Provision for loan losses
(1,159
(1,558
149
(1,246
(598
(28
(91
(6,000
Loan charge-offs
(159
(84
(243
Loan recoveries
193
406
Net loan recoveries (charge-offs)
(30
(26
Balance, end of period
5,940
11,635
1,100
5,450
8,577
2,157
725
491
36,075
Net charge-offs (recoveries) to average loans (annualized)
(0.03
%)
Allowance for loan losses to gross loans
1.51
Allowance for loan losses to nonperforming loans
259.95
5,800
8,791
977
5,841
6,538
2,641
615
399
31,602
2,105
2,461
2,274
850
87
(375
(564
(100
(25
(1,064
581
179
(550
(14
(483
7,905
11,431
1,194
7,565
9,476
3,391
702
555
42,219
Net charge-offs to average loans (annualized)
0.09
2.03
482.43
Nine months ended September 30, 2021
8,145
12,049
1,154
7,845
10,453
3,249
747
44,149
(2,299
(509
(54
(2,256
(1,894
(1,149
(22
(158
(353
(139
(8
(658
94
253
214
196
784
95
57
(0.01
Nine months ended September 30, 2020
2,835
4,304
541
3,692
3,278
1,447
277
16,642
5,070
8,081
653
4,562
6,187
1,976
434
337
(1,508
(735
(70
(2,413
46
690
(954
(689
(32
(59
(1,723
0.11
20
The following table disaggregates the allowance for loan losses and recorded investment in loans by impairment methodology.
Allowance for loan losses
Recorded investment in loans
Individually evaluated
Collectively evaluated
23,170
11,740
34,910
1,482,186
888,940
2,371,126
24,125
11,950
27,826
14,614
42,440
1,381,230
748,675
2,129,905
29,165
14,984
NOTE 5 – Troubled Debt Restructurings
At September 30, 2021, the Company had 13 loans totaling $6.8 million compared to 20 loans totaling $8.4 million at December 31, 2020, which were considered as TDRs. The Company considers a loan to be a TDR when the debtor experiences financial difficulties and the Company grants a concession to the debtor that it would not normally consider. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of the workout plan for individual loan relationships, the Company may restructure loan terms to assist borrowers facing financial challenges in the current economic environment.
A restructuring that results in only a delay in payments that is insignificant is not considered an economic concession. In accordance with the CARES Act, the Company implemented loan modification programs in response to the COVID-19 pandemic, and the Company elected the accounting policy in the CARES Act to not apply TDR accounting to loans modified for borrowers impacted by the COVID-19 pandemic.
The following table summarizes the concession at the time of modification and the recorded investment in the Company’s TDRs before and after their modification for the nine months ended September 30, 2020. There were no new TDRs for the three months ended September 30, 2021, and new TDRs for the three months ended September 30, 2020 were immaterial. The total TDRs for the nine months ended September 30, 2021 were not material.
For the nine months ended September 30, 2020
Pre-
Post-
modification
Renewals
Reduced or
Converted
Maturity
outstanding
deemed a
deferred
to interest
date
Number
concession
payments
only
extensions
of loans
1,037
647
1,852
Total loans
3,536
As of September 30, 2021 and 2020, there were no loans modified as a TDR for which there was a payment default (60 days past due) within 12 months of the restructuring date.
21
NOTE 6 – Derivative Financial Instruments
The Company utilizes derivative financial instruments primarily to hedge its exposure to changes in interest rates. All derivative financial instruments are recognized as either assets or liabilities and measured at fair value. The Company accounts for all of its derivatives as free-standing derivatives and does not designate any of these instruments for hedge accounting. Therefore, the gain or loss resulting from the change in the fair value of the derivative is recognized in the Company’s statement of income during the period of change.
The Company enters into commitments to originate residential mortgage loans held for sale, at specified interest rates and within a specified period of time, with clients who have applied for a loan and meet certain credit and underwriting criteria (interest rate lock commitments). These interest rate lock commitments (“IRLCs”) meet the definition of a derivative financial instrument and are reflected in the balance sheet at fair value with changes in fair value recognized in current period earnings. Unrealized gains and losses on the IRLCs are recorded as derivative assets and derivative liabilities, respectively, and are measured based on the value of the underlying mortgage loan, quoted mortgage-backed securities (“MBS”) prices and an estimate of the probability that the mortgage loan will fund within the terms of the interest rate lock commitment, net of estimated commission expenses.
The Company manages the interest rate and price risk associated with its outstanding IRLCs and mortgage loans held for sale by entering into derivative instruments such as forward sales of MBS. Management expects these derivatives will experience changes in fair value opposite to changes in fair value of the IRLCs and mortgage loans held for sale, thereby reducing earnings volatility. The Company takes into account various factors and strategies in determining the portion of the mortgage pipeline (IRLCs and mortgage loans held for sale) it wants to economically hedge.
The following table summarizes the Company’s outstanding financial derivative instruments at September 30, 2021 and December 31, 2020.
Fair Value
Notional
Balance Sheet Location
Asset/(Liability)
Mortgage loan interest rate lock commitments
49,120
609
MBS forward sales commitments
34,500
(169
Total derivative financial instruments
83,620
440
107,569
2,385
75,500
(501
183,069
1,884
NOTE 7 – Fair Value Accounting
FASB ASC 820, “Fair Value Measurement and Disclosures,” defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a 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:
Level 1 – Quoted market price in active markets
Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include certain debt and equity securities that are traded in an active exchange market.
Level 2 – Significant other observable inputs
Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include fixed income securities and mortgage-backed securities that are held in the Company’s available-for-sale portfolio and valued by a third-party pricing service, as well as certain impaired loans.
Level 3 – Significant unobservable inputs
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. These methodologies may result in a significant portion of the fair value being derived from unobservable data.
The methods of determining the fair value of assets and liabilities presented in this note are consistent with our methodologies disclosed in Note 14 of the Company’s 2020 Annual Report on Form 10-K. The Company’s loan portfolio is initially fair valued using a segmented approach, using the eight categories of loans as disclosed in Note 4 – Loans and Allowance for Loan Losses. Loans are considered a Level 3 classification.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis as of September 30, 2021 and December 31, 2020.
Level 1
Level 2
Level 3
Assets
Securities available for sale
Total assets measured at fair value on a recurring basis
146,052
Liabilities
(169)
Total liabilities measured at fair value on a recurring basis
Securities available for sale:
157,371
501
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis as of September 30, 2021 and December 31, 2020.
As of September 30, 2021
2,516
16,755
Total assets measured at fair value on a nonrecurring basis
As of December 31, 2020
8,144
3,109
11,253
9,313
12,422
The Company had no liabilities carried at fair value or measured at fair value on a nonrecurring basis.
Fair Value of Financial Instruments
Financial instruments require disclosure of fair value information, whether or not recognized in the consolidated balance sheets, when it is practical to estimate the fair value. A financial instrument is defined as cash, evidence of an ownership interest in an entity or a contractual obligation which requires the exchange of cash. Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, premises and equipment and other assets and liabilities.
24
The estimated fair values of the Company’s financial instruments at September 30, 2021 and December 31, 2020 are as follows:
Carrying
Financial Assets:
Other investments, at cost
Loans1
2,335,051
2,304,092
Financial Liabilities:
2,249,961
33,773
2,085,756
2,060,698
2,008,317
FHLB and other borrowings
24,972
30,371
Carrying amount is net of the allowance for loan losses and previously presented impaired loans.
NOTE 8 – Leases
Effective January 1, 2019, the Company adopted ASU 2016-02, “Leases (Topic 842)”. As of September 30, 2021, we leased seven of our offices under various operating lease agreements. The lease agreements have maturity dates ranging from February 2022 to February 2032, some of which include options for multiple five-year extensions. The weighted average remaining life of the lease term for these leases was 7.54 years as of September 30, 2021.
The discount rate used in determining the lease liability for each individual lease was the FHLB fixed advance rate which corresponded with the remaining lease term as of January 1, 2019 for leases that existed at adoption and as of the lease commencement date for leases subsequently entered into. The weighted average discount rate for leases was 2.48% as of September 30, 2021.
The total operating lease costs were $711,000 and $616,000 for the three months ended September 30, 2021 and 2020, respectively, and $2.1 million and $1.8 million for the nine months ended September 30, 2021 and 2020, respectively. The right-of-use (ROU) asset, included in property and equipment, and lease liability, included in other liabilities, were $21.9 million and $23.0 million as of September 30, 2021, respectively, compared to $18.8 million and $19.5 million as of December 31, 2020, respectively. The ROU asset and lease liability are recognized at lease commencement by calculating the present value of lease payments over the lease term.
Maturities of lease liabilities as of September 30, 2021 were as follows:
Operating
Leases
589
2022
1,974
2023
1,939
2024
1,990
2025
2,046
Thereafter
19,287
Total undiscounted lease payments
27,825
Discount effect of cash flows
4,847
Total lease liability
22,978
NOTE 9 – Earnings Per Common Share
The following schedule reconciles the numerators and denominators of the basic and diluted earnings per share computations for the three and nine month periods ended September 30, 2021 and 2020. Dilutive common shares arise from the potentially dilutive effect of the Company’s stock options that were outstanding at September 30, 2021. The assumed conversion of stock options can create a difference between basic and dilutive net income per common share. At September 30, 2021 and 2020, there were 159,029 and 337,998 options, respectively, that were not considered in computing diluted earnings per common share because they were anti-dilutive.
Numerator:
Denominator:
Weighted-average common shares outstanding – basic
Common stock equivalents
127,160
82,972
133,735
109,164
Weighted-average common shares outstanding – diluted
Earnings per common share:
NOTE 10 – Reportable Segments
The Company’s reportable segments represent the distinct product lines the Company offers and are viewed separately for strategic planning purposes by management. The three segments include Commercial and Retail Banking, Mortgage Banking, and Corporate. The following schedule presents financial information for each reportable segment.
and Retail
Mortgage
Elimin-
Consol-
Banking
Corporate
ations
idated
ation
23,253
233
(4
23,102
313
938
2,396
Net interest income (loss)
22,315
(376
20,706
(382
1,410
1,307
Noninterest expense
11,980
103
11,445
Net income (loss) before taxes
17,745
1,106
(479
(532
3,924
(454
Income tax provision (benefit)
4,195
261
(101
(128
944
(95
Net income (loss)
13,550
845
(378
(404
2,980
(359
2,750,703
33,047
302,254
(301,828
2,411,966
66,915
254,721
(254,191
2,479,411
68,053
978
(12
70,480
791
(13
3,025
11,452
1,325
65,028
(1,131
59,028
(1,312
4,319
5,987
34,384
225
32,134
223
Net income before taxes
43,163
3,337
(1,356
5,581
8,671
(1,535
10,023
700
(285
1,491
1,821
(322
33,140
2,637
(1,071
4,090
6,850
(1,213
Commercial and retail banking. The Company’s primary business is to provide traditional deposit and lending products and services to its commercial and retail banking clients.
Mortgage banking. The mortgage banking segment provides mortgage loan origination services for loans that will be sold in the secondary market to investors.
Corporate. Corporate is comprised primarily of compensation and benefits for certain members of management and interest on parent company debt.
27
Item 2. MANAGEMENT’S DISCUSSION AND Analysis of Financial Condition and Results of Operations.
The following discussion reviews our results of operations for the three and nine month periods ended September 30, 2021 as compared to the three and nine month periods ended September 30, 2020 and assesses our financial condition as of September 30, 2021 as compared to December 31, 2020. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements and the related notes and the consolidated financial statements and the related notes for the year ended December 31, 2020 included in our Annual Report on Form 10-K for that period. Results for the three and nine month periods ended September 30, 2021 are not necessarily indicative of the results for the year ending December 31, 2021 or any future period.
Unless the context requires otherwise, references to the “Company,” “we,” “us,” “our,” or similar references mean Southern First Bancshares, Inc. and its consolidated subsidiary. References to the “Bank” refer to Southern First Bank.
Cautionary Warning Regarding forward-looking statements
This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements may relate to our financial condition, results of operations, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to:
28
If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking statements proves to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q. We make these forward-looking statements as of the date of this document and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those expressed in, or implied or projected by, the forward-looking statements, except as required by law.
OVERVIEW
Our business model continues to be client-focused, utilizing relationship teams to provide our clients with a specific banker contact and support team responsible for all of their banking needs. The purpose of this structure is to provide a consistent and superior level of professional service, and we believe it provides us with a distinct competitive advantage. We consider exceptional client service to be a critical part of our culture, which we refer to as "ClientFIRST."
At September 30, 2021, we had total assets of $2.78 billion, a 12.1% increase from total assets of $2.48 billion at December 31, 2020. The largest components of our total assets are loans which were $2.39 billion and $2.14 billion at September 30, 2021 and December 31, 2020, respectively. Our liabilities and shareholders’ equity at September 30, 2021 totaled $2.52 billion and $265.6 million, respectively, compared to liabilities of $2.25 billion and shareholders’ equity of $228.3 million at December 31, 2020. The principal component of our liabilities is deposits which were $2.43 billion and $2.14 billion at September 30, 2021 and December 31, 2020, respectively.
Like most community banks, we derive the majority of our income from interest received on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread. In addition to earning interest on our loans and investments, we earn income through fees and other charges to our clients.
29
Our net income to common shareholders was $14.0 million and $2.2 million for the three months ended September 30, 2021 and 2020, respectively. Diluted earnings per share (“EPS”) was $1.75 for the third quarter of 2021 as compared to $0.28 for the same period in 2020. The increase in net income resulted primarily from a $17.1 million decrease in loan loss provision recorded in the third quarter of 2021 compared to the same period in 2020 and a $1.5 million increase in net interest income, partially offset by a $3.3 million decrease in noninterest income.
Our net income to common shareholders was $34.7 million and $9.7 million for the nine months ended September 30, 2021 and 2020, respectively. Diluted EPS was $4.36 for the nine months ended September 30, 2021 as compared to $1.24 for the same period in 2020. The increase in net income resulted primarily from a $35.5 million decrease in loan loss provision recorded in the first nine months of 2021 compared to the same period in 2020 and a $6.4 million increase in net interest income, partially offset by a $6.9 million decrease in noninterest income and a $2.5 million increase in noninterest expense.
Our mortgage banking segment reported pre-tax income of $1.1 million and $3.3 million for the three- and nine- month periods ended September 30, 2021, compared to $3.9 million and $8.7 million for the three- and nine- month periods ended September 30, 2020. Noninterest income, which consists mainly of realized and unrealized gains associated with the fair value of commitments and loans held for sale, was $2.8 million for the third quarter of 2021 as compared to $6.3 million for the third quarter of 2020. In addition, noninterest income for the first nine months of 2021 was $9.4 million as compared to $14.7 million for the first nine months of 2020. The $3.4 million and $5.3 million decreases during the 2021 periods were driven by a decline in sales activity combined with a decrease in the fair value of derivatives associated with mortgage loan commitments. Noninterest expense consists mainly of salaries, commissions and benefits of mortgage employees, professional fees and outside services and data processing costs. Noninterest expense was $2.0 million and $7.1 million for the third quarter and first nine months of 2021, respectively, as compared to $2.7 million and $6.8 million for the third quarter and first nine months of 2020, respectively. The $709,000 decrease during the third quarter of 2021 was driven by a decrease in salaries and benefits expense primarily related to commissions paid on sales activity. The $245,000 increase during the first nine months of 2021 relates primarily to an increase in salaries and benefits expense driven by an increase in fixed salaries and other benefits costs combined with an increase in professional fees.
recent events – covid-19 pandemic
The COVID-19 pandemic has had significant impact on our business, industry and clients. Twelve months ago, unemployment rates were at historical highs, our bank lobbies were closed to guests, and the majority of our team was working remotely. As of September 30, 2021, normalcy has begun to return as unemployment rates have continued to decrease to near pre-COVID levels, our bank lobbies have re-opened, and our team members have returned to the office. Our digital technology channels are also stronger and better utilized as a result of the pandemic.
Beginning in March 2020, we began granting loan modifications or deferrals to certain borrowers affected by the pandemic on a short-term basis of three to six months. As of September 30, 2021, all of these loans are under a normal payment structure.
We continue to monitor credit risk and our exposure to increased loan losses resulting from the impact of COVID-19 on our commercial clients. In doing so, we believe that the hospitality and tourism industry is still at risk for credit loss due to reduced business and recreational travel in our regions.
Hotel portfolio as of September 30, 2021:
As of September 30, 2021 our classified asset ratio (defined as classified assets divided by the sum of tier one capital plus the allowance for loan losses) was 14.90% compared to 8.18% at December 31, 2020 and 7.00% at September 30, 2020. The increase from the prior periods was driven by the $26.2 million of hotel loans we
downgraded to substandard during the first quarter of 2021. We will continue to closely monitor these loans as we believe they currently represent our most at-risk clients.
As of September 30, 2021, all of our capital ratios, and the Bank’s capital ratios, were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by the COVID-19 pandemic, our regulatory capital ratios could be adversely impacted by further credit losses. We maintain access to multiple sources of liquidity, including a $15.0 million holding company line of credit with another bank which could be used to support capital ratios at the Bank.
results of operations
Net Interest Income and Margin
Our level of net interest income is determined by the level of earning assets and the management of our net interest margin. Our net interest income was $22.2 million for the third quarter of 2021, a 7.4% increase over net interest income of $20.6 million for the third quarter of the prior year, resulting primarily from lower deposit costs and growth in interest-earning assets, partially offset by lower yields on our interest-earning assets. In addition, our net interest margin, on a tax-equivalent basis (TE), was 3.38% for the third quarter of 2021 compared to 3.52% for the same period in 2020.
We have included a number of tables to assist in our description of various measures of our financial performance. For example, the “Average Balances, Income and Expenses, Yields and Rates” table reflects the average balance of each category of our assets and liabilities as well as the yield we earned or the rate we paid with respect to each category during the three- and nine- month periods ended September 30, 2021 and 2020. A review of this table shows that our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we direct a substantial percentage of our earning assets into our loan portfolio. Similarly, the “Rate/Volume Analysis” table demonstrates the effect of changing interest rates and changing volume of assets and liabilities on our financial condition during the periods shown. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included tables to illustrate our interest rate sensitivity with respect to interest-earning accounts and interest-bearing accounts.
The following tables entitled “Average Balances, Income and Expenses, Yield and Rates” sets forth information related to our average balance sheets, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. All investments owned have an original maturity of over one year. Nonaccrual loans are included in the following tables. Loan yields have been reduced to reflect the negative impact on our earnings of loans on nonaccrual status. The net of capitalized loan costs and fees are amortized into interest income on loans.
Average Balances, Income and Expenses, Yields and Rates
Our net interest margin (TE) decreased 14 basis points to 3.38% during the third quarter of 2021, compared to the third quarter of 2020, primarily due to a reduction in yield on our interest-earning assets, partially offset by the decreased cost of our interest-bearing liabilities. Our average interest-earning assets grew by $266.4 million during the third quarter of 2021, while the average yield on these assets decreased by 41 basis points to 3.58% during the same period. In addition, our average interest-bearing liabilities grew by $105.4 million during the third quarter of 2021, while the rate on these liabilities decreased 38 basis points to 0.30%.
The increase in average interest-earning assets for the third quarter of 2021 related primarily to an increase of $262.7 million in our average loan balances, combined with a $19.9 million increase in investment securities, partially offset by a $16.2 million decrease in federal funds sold and interest-bearing deposits with banks. The decrease in yield on our interest earning assets was driven by a 50 basis point decrease in loan yield as our loan portfolio continues to show the impact of the Federal Reserve’s aggregate 225 basis point interest rate reduction since August 2019. These rate reductions resulted in the decreased loan yield, a decrease in yield on our federal funds sold and interest bearing-deposits with banks and a decrease in yield on our investment securities.
The increase in our average interest-bearing liabilities during the third quarter of 2021 resulted primarily from a $105.2 million increase in our interest-bearing deposits, while the 38 basis point decrease in rate on our interest-bearing liabilities resulted primarily from a 38 basis point decrease in deposit rates.
Our net interest spread was 3.28% for the third quarter of 2021 compared to 3.31% for the same period in 2020. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The decrease in both the yield on our interest-earning assets and the rate on our interest-bearing liabilities resulted in a three basis point decrease in our net interest spread for the 2021 period. We anticipate continued pressure on our net interest spread and net interest margin in future periods as our loan yield continues to decline due to new and renewed loans pricing at rates lower than our current portfolio rate.
32
During the first nine months of 2021, our net interest margin (TE) improved by three basis points to 3.49%, compared to 3.46% for the first nine months of 2020, driven by the decrease in rate on our interest-bearing liabilities, partially offset by the lower yield on our interest-earning assets. Our average interest-earning assets grew by $224.4 million during the first nine months of 2021, with the average yield decreasing by 49 basis points. In addition, our average interest-bearing liabilities grew by $36.7 million during the 2021 period, while the rate on these liabilities decreased 72 basis points, resulting in the slight improvement in net interest margin.
The increase in average interest earning assets for the first nine months of 2021 related primarily to a $186.6 million increase in our average loan balances combined with a $22.4 million increase in our average investment securities. The decrease in yield on our interest-earning assets was driven by a 48 basis point decrease in our loan yield related to the interest rate reductions by the Federal Reserve.
In addition, our average interest-bearing liabilities increased by $36.7 million during the first nine months of 2021, driven by a $77.0 million increase in interest-bearing deposits, partially offset by a $40.4 million decrease in FHLB advances and other borrowings. The decrease in cost of our interest-bearing liabilities was driven by a 72 basis point decrease on our interest-bearing deposits.
Our net interest spread was 3.39% for the first nine months of 2021 compared to 3.16% for the same period of 2020. The 23 basis point increase in our net interest spread was a result of the 72 basis point decrease in cost on our interest-bearing liabilities, partially offset by the 49 basis point decrease in yield on our interest-earning assets.
33
Rate/Volume Analysis
Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following two tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.
Net interest income, the largest component of our income, was $22.2 million for the third quarter of 2021 and $20.6 million for the third quarter of 2020, a $1.5 million, or 7.4%, increase. The increase during 2021 was driven by a $1.5 million decrease in interest expense primarily due to lower rates on our interest-bearing liabilities. In addition, interest income remained stable as the increase in loan volume offset the impact of a decrease in yield across all interest earning assets.
Net interest income for the first nine months of 2021 was $64.9 million compared to $58.5 million for 2020, a $6.4 million, or 10.9%, increase. The increase in net interest income during 2021 was driven by an $8.6 million decrease in interest expense related to reduced rates on our deposit balances. In contrast, the decrease in interest income was driven by lower rates on our loan portfolio which was partially offset by growth in loan balances compared to the 2020 period.
Provision for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged as an expense on our consolidated statements of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of the allowance for loan losses. Please see the discussion included in Note 4 – Loans and Allowance for Loan Losses for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.
For the three and nine months ended September 30, 2021, we recorded a reversal of provision for loan losses expense of $6.0 million and $8.2 million which resulted in an allowance for loan losses of $36.1 million, or 1.51% of gross loans. Comparatively, our provision for loan losses was $11.1 million and $27.3 million for the three and nine months ended September 30, 2020 which resulted in an allowance for loan losses of $42.2 million, or 2.03% of gross loans. The reversal of provision expense for the 2021 periods was driven by a reduction in qualitative adjustment factors related to the overall improvement in economic and business conditions such as unemployment and hotel occupancy rates as well as a reduction in the historical loss percentages of our various loan categories due to the low charge-off percentage during the year. In addition, we downgraded a significant portion of our hotel loan portfolio during the first quarter of 2021 as we believe the tourism and hospitality industry remains at risk of credit losses due to the pandemic, which partially offset the reduction in qualitative adjustments as an increased provision was required for these loans. Our nonperforming assets and loans 30 days or more past due increased during the third quarter of 2021 due to one client relationship which includes two commercial and one consumer real estate properties. We do not believe the increase in nonperforming and past due loans is systemic or indicative of the credit quality of our remaining portfolio.
Noninterest Income
The following table sets forth information related to our noninterest income.
Noninterest income decreased $3.3 million, or 44.1%, for the third quarter of 2021 as compared to the same period in 2020. The decrease in total noninterest income resulted primarily from the following:
Partially offsetting the above decrease was an increase in ATM and debit card income of $77,000, or 16.6%, due to an increase in debit card transactions. In addition, income from bank owned life insurance increased $51,000 as we purchased an additional $7.5 million in life insurance policies earlier in the year.
Noninterest income decreased $6.9 million, or 33.5%, during the first nine months of 2021 as compared to the same period of 2020. The decrease in total noninterest income resulted primarily from decreases in mortgage banking income, service fees on deposit accounts, and net lender and referral fees on PPP loans which declined $2.0 million as we originated and sold our PPP loans to a third party during the second quarter of 2020. Partially offsetting the above decreases was a $274,000 increase in ATM and debit card income.
The following table sets forth information related to our noninterest expenses.
Noninterest expense was $14.0 million for the third quarter of 2021, a $144,000, or 10.2%, decrease from noninterest expense of $14.2 million for the third quarter of 2020. The decrease in noninterest expenses was driven primarily by the following:
Partially offsetting the above decreases were the following:
Noninterest expense was $41.7 million for the first nine months of 2021, a $2.5 million, or 6.4%, increase from the prior year. The increase in total noninterest expense resulted primarily from increases in compensation and benefits, mortgage production costs, occupancy, and outside service and data processing costs.
Our efficiency ratio was 53.2% for the third quarter of 2021 compared to 50.3% for the third quarter of 2020 and 53.0% for the first nine months of 2021 compared to 49.5% for the same period in 2020. The efficiency ratio represents the percentage of one dollar of expense required to be incurred to earn a full dollar of revenue and is computed by dividing noninterest expense by the sum of net interest income and noninterest income. The higher ratio during the third quarter of 2021, compared to the third quarter of 2020, relates primarily to the decrease in mortgage banking income, while the higher ratio for the first nine months of 2021, compared to the same period of 2020, relates to the decrease in mortgage banking income, combined with the increase in noninterest expenses.
We incurred income tax expense of $4.4 million and $721,000 for the three months ended September 30, 2021 and 2020, respectively, and $10.4 million and $3.0 million for the nine months ended September 30, 2021 and 2020, respectively. Our effective tax rate was 23.1% and 23.5% for the nine months ended September 30, 2021 and 2020, respectively. The lower tax rate for the 2021 period relates to the favorable tax impact of certain equity compensation transactions.
Balance Sheet Review
Investment Securities
At September 30, 2021, the $116.6 million in our investment securities portfolio represented approximately 4.2% of our total assets. Our available for sale investment portfolio included U.S. treasury securities, U.S. government agency securities, SBA securities, state and political subdivisions, asset-backed securities and mortgage-backed securities with a fair value of $113.8 million and an amortized cost of $114.1 million, resulting in an unrealized loss of $314,000. At December 31, 2020, the $98.4 million in our investment securities portfolio represented approximately 4.0% of our total assets, including investment securities with a fair value of $94.7 million and an amortized cost of $93.4 million for an unrealized gain of $1.3 million.
Since loans typically provide higher interest yields than other types of interest earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Average loans, excluding mortgage loans held for sale, for the nine months ended September 30, 2021 and 2020 were $2.23 billion and $2.08 billion, respectively. Before the allowance for loan losses, total loans outstanding at September 30, 2021 and December 31, 2020 were $2.35 billion and $2.04 billion, respectively.
The principal component of our loan portfolio is loans secured by real estate mortgages. As of September 30, 2021, our loan portfolio included $2.05 billion, or 85.7%, of real estate loans, compared to $1.81 billion, or 84.6%, at December 31, 2020. Most of our real estate loans are secured by residential or commercial property. We obtain a security interest in real estate, in addition to any other available collateral, in order to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans to coincide with the appropriate regulatory guidelines. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral and business types. Home equity lines of credit totaled $155.0 million as of September 30, 2021, of which approximately 50% were in a first lien position, while the remaining balance was second liens. At December 31, 2020, our home equity lines of credit totaled $157.0 million, of which approximately 45% were in first lien positions, while the remaining balance was in second liens. The average home equity loan had a balance of approximately $81,000 and a loan to value of 60% as of September 30, 2021, compared to an average loan balance of $83,000 and a loan to value of approximately 62% as of December 31, 2020. Further, 1.0% and 0.2% of our total home equity lines of credit were over 30 days past due as of September 30, 2021 and December 31, 2020, respectively. The increase in the past due percentage is related primarily to one loan.
Following is a summary of our loan composition at September 30, 2021 and December 31, 2020. During the first nine months of 2021, our loan portfolio increased by $246.2 million, or 11.5%, with a 18.4% increase in consumer loans while commercial loans increased by 7.7% during the period. The majority of the increase was in loans secured by real estate. Our consumer real estate portfolio includes high quality 1-4 family consumer real estate loans. Our average consumer real estate loan currently has a principal balance of $447,000, a term of 21 years, and an average rate of 3.51% as of September 30, 2021, compared to a principal balance of $429,000, a term of 19 years, and an average rate of 3.82% as of December 31, 2020.
Nonperforming assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure and loans on nonaccrual status. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the contractual principal or interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received. Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms and to show capacity to continue performing into the future before that loan can be placed back on accrual status. As of September 30, 2021 and December 31, 2020, we had no loans 90 days past due and still accruing.
At September 30, 2021, nonperforming assets were $13.9 million, or 0.50% of total assets and 0.58% of gross loans. Comparatively, nonperforming assets were $9.2 million, or 0.37% of total assets and 0.43% of gross loans at December 31, 2020. Nonaccrual loans increased $5.8 million during the first nine months of 2021 due primarily to $9.6 million in additions of loans on nonaccrual status, partially offset by $2.4 million of loans paid or charged off and $366,000 of loans moved to other real estate owned. The increase during the current period relates primarily to one client relationship which includes two commercial and one consumer real estate properties. On October 29, 2021 we sold the two commercial notes related to this relationship to a third-party at a discounted purchase price of $7.8 million which resulted in a combined charge-off of $812,000 on the two loans.
The amount of foregone interest income on the nonaccrual loans in the first nine months of 2021 was immaterial, while foregone interest income for the same period in 2020 was approximately $204,000. At September 30, 2021 and 2020, the allowance for loan losses represented 260.0% and 482.4% of the total amount of nonperforming loans, respectively. A significant portion, or approximately 95%, of nonperforming loans at September 30, 2021,
was secured by real estate. We have evaluated the underlying collateral on these loans and believe that the collateral on these loans is sufficient to minimize future losses.
As a general practice, most of our commercial loans and a portion of our consumer loans are originated with relatively short maturities of less than ten years. As a result, when a loan reaches its maturity we frequently renew the loan and thus extend its maturity using similar credit standards as those used when the loan was first originated. Due to these loan practices, we may, at times, renew loans which are classified as nonaccrual after evaluating the loan’s collateral value and financial strength of its guarantors. Nonaccrual loans are renewed at terms generally consistent with the ultimate source of repayment and rarely at reduced rates. In these cases, we will generally seek additional credit enhancements, such as additional collateral or additional guarantees to further protect the loan. When a loan is no longer performing in accordance with its stated terms, we will typically seek performance under the guarantee.
In addition, at September 30, 2021, 85.7% of our loans were collateralized by real estate and 95% of our impaired loans were secured by real estate. We utilize third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require us to obtain updated appraisals on an annual basis, either through a new external appraisal or an appraisal evaluation. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. As of September 30, 2021, we did not have any impaired real estate loans carried at a value in excess of the appraised value. We typically charge-off a portion or create a specific reserve for impaired loans when we do not expect repayment to occur as agreed upon under the original terms of the loan agreement.
At September 30, 2021, impaired loans totaled $17.9 million, for which $3.7 million of these loans had a reserve of approximately $1.2 million allocated in the allowance. During the first nine months of 2021, the average recorded investment in impaired loans was approximately $13.6 million. Comparatively, impaired loans totaled $13.0 million at December 31, 2020 for which $5.1 million of these loans had a reserve of approximately $1.7 million allocated in the allowance. During 2020, the average recorded investment in impaired loans was approximately $14.6 million.
We consider a loan to be a TDR when the debtor experiences financial difficulties and we provide concessions such that we will not collect all principal and interest in accordance with the original terms of the loan agreement. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. As of September 30, 2021, we determined that we had loans totaling $6.8 million that we considered TDRs compared to $8.4 million as of December 31, 2020. The decrease during the first nine months of 2021 was driven by eight client relationships with loans totaling $1.4 million that were paid off or removed from TDR status during the period.
The allowance for loan losses was $36.1 million and $42.2 million at September 30, 2021 and 2020, respectively, or 1.51% of outstanding loans at September 30, 2021 and 2.03% of outstanding loans at September 30, 2020. At December 31, 2020, our allowance for loan losses was $44.1 million, or 2.06% of outstanding loans.
During the nine months ended September 30, 2021, we charged-off $658,000 of loans and recorded $784,000 of recoveries on loans previously charged-off, for net recoveries of $126,000. Comparatively, we charged-off $2.4 million of loans and recorded $690,000 of recoveries on loans previously charged-off, resulting in net charge-offs of $1.7 million for the first nine months of 2020. The $8.1 million decrease in the allowance for loan losses during the first nine months of 2021 was driven by a reduction in qualitative adjustment factors related to the improvement in economic conditions at both the national and regional levels at September 30, 2021 and lower historical loss percentages applied to the various loan categories driven by fewer charge-offs. Partially offsetting these decreases were downgrades in our hotel loan portfolio as we believe the tourism and hospitality industry remains at risk of credit losses due to the pandemic.
Following is a summary of the activity in the allowance for loan losses.
Deposits and Other Interest-Bearing Liabilities
Our primary source of funds for loans and investments is our deposits and advances from the FHLB. In the past, we have chosen to obtain a portion of our certificates of deposits from areas outside of our market in order to obtain longer term deposits than are readily available in our local market. Our internal guidelines regarding the use of brokered CDs limit our brokered CDs to 20% of total deposits. In addition, we do not obtain time deposits of $100,000 or more through the Internet. These guidelines allow us to take advantage of the attractive terms that wholesale funding can offer while mitigating the related inherent risk.
Our retail deposits represented $2.43 billion, or 100% of total deposits at September 30, 2021. At December 31, 2020, retail deposits represented $2.12 billion, or 99.0% of our total deposits, and brokered CDs were $22.0 million, representing 1.0% of our total deposits. Our loan-to-deposit ratio was 98% at September 30, 2021 and 100% at December 31, 2020.
The following is a detail of our deposit accounts:
During the past 12 months, we continued our focus on increasing core deposits, which exclude out-of-market deposits and time deposits of $250,000 or more, in order to provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $2.37 billion and $2.01 billion at September 30, 2021, and December 31, 2020, respectively.
The following table shows the average balance amounts and the average rates paid on deposits.
During the first nine months of 2021, our average transaction account balances increased by $366.6 million, or 21.3%, from the prior year, while our average time deposit balances decreased by $131.4 million, or 41.87%.
All of our time deposits are certificates of deposits. The maturity distribution of our time deposits of $100,000 or more at September 30, 2021 was as follows:
Time deposits that meet or exceed the FDIC insurance limit of $250,000 at September 30, 2021 and December 31, 2020 were $86.5 million and $130.9 million, respectively.
Liquidity and Capital Resources
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control. We have not experienced any unusual pressure on our deposit balances or our liquidity position as a result of the COVID-19 pandemic.
At September 30, 2021 and December 31, 2020 cash and cash equivalents totaled $128.5 million and $100.7 million, respectively, or 4.6% and 4.1% of total assets, respectively. Our investment securities at September 30, 2021 and December 31, 2020 amounted to $116.6 million and $98.4 million, respectively, or 4.2% and 4.0% of total assets, respectively. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner.
Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, loan payoffs, and from additional borrowings. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. We maintain five federal funds purchased lines of credit with correspondent banks totaling $118.5 million for which there were no borrowings against the lines of credit at September 30, 2021.
We are also a member of the FHLB, from which applications for borrowings can be made. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. The unused borrowing capacity currently available from the FHLB at September 30, 2021 was $552.1 million, based primarily on the Bank’s qualifying mortgages available to secure any future borrowings. However, we are able to pledge additional securities to the FHLB in order to increase our available borrowing capacity. In addition, at September 30, 2021 and December 31, 2020 we had $243.1 million and $206.2 million, respectively, of letters of credit outstanding with the FHLB to secure client deposits.
We also have a line of credit with another financial institution for $15.0 million, which was unused at September 30, 2021. The line of credit has an interest rate of LIBOR plus 3.50% and a maturity date of December 31, 2021.
We believe that our existing stable base of core deposits, federal funds purchased lines of credit with correspondent banks, and borrowings from the FHLB will enable us to successfully meet our long-term liquidity needs. However, as short-term liquidity needs arise, we have the ability to sell a portion of our investment securities portfolio to meet those needs.
41
Total shareholders’ equity was $265.6 million at September 30, 2021 and $228.3 million at December 31, 2020. The $37.3 million increase from December 31, 2020 is primarily related to net income of $34.7 million during the first nine months of 2021, stock option exercises and equity compensation expenses of $3.9 million, partially offset by a $1.3 million decrease in other comprehensive loss.
The following table shows the return on average assets (net income divided by average total assets), return on average equity (net income divided by average equity), equity to assets ratio (average equity divided by average assets), and tangible common equity ratio (total equity less preferred stock divided by total assets) annualized for the nine months ended September 30, 2021 and the year ended December 31, 2020. Since our inception, we have not paid cash dividends.
Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.
Regulatory capital rules adopted in July 2013 and fully-phased in as of January 1, 2019, which we refer to Basel III, impose minimum capital requirements for bank holding companies and banks. The Basel III rules apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies other than “small bank holding companies,” generally holding companies with consolidated assets of less than $3 billion (such as the Company). In order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of our minimum risk-based capital requirements. This buffer must consist solely of common equity Tier 1, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer consists of an additional amount of CET1 equal to 2.5% of risk-weighted assets.
To be considered “well-capitalized” for purposes of certain rules and prompt corrective action requirements, the Bank must maintain a minimum total risked-based capital ratio of at least 10%, a total Tier 1 capital ratio of at least 8%, a common equity Tier 1 capital ratio of at least 6.5%, and a leverage ratio of at least 5%. As of September 30, 2021, our capital ratios exceed these ratios and we remain “well capitalized.”
The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements.
42
The following table summarizes the capital amounts and ratios of the Company and the minimum regulatory requirements.
The ability of the Company to pay cash dividends is dependent upon receiving cash in the form of dividends from the Bank. The dividends that may be paid by the Bank to the Company are subject to legal limitations and regulatory capital requirements. Since our inception, we have not paid cash dividends.
Effect of Inflation and Changing Prices
The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles.
Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.
Off-Balance Sheet Risk
Commitments to extend credit are agreements to lend money to a client as long as the client has not violated any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At September 30, 2021, unfunded commitments to extend credit were $574.7 million, of which $182.8 million were at fixed rates and $391.9 million were at variable rates. At December 31, 2020, unfunded commitments to extend credit were $480.1 million, of which approximately $114.6 million were at fixed rates and $365.5 million were at variable rates. A significant portion of the unfunded commitments related to consumer home equity lines of credit. We evaluate each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate.
At September 30, 2021 and December 31, 2020, there were commitments under letters of credit for $10.1 million and $8.7 million, respectively. The credit risk and collateral involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Since most of the letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements.
At September 30, 2021, there were commitments of $35.4 million related to the construction of a new headquarters building of which $18.4 million had been paid through the end of the third quarter of 2021.
Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that significantly impact earnings.
Market Risk and Interest Rate Sensitivity
Market risk is the risk of loss from adverse changes in market prices and rates, which principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.
We actively monitor and manage our interest rate risk exposure in order to control the mix and maturities of our assets and liabilities utilizing a process we call asset/liability management. The essential purposes of asset/liability management are to seek to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. Our asset/liability management committee (“ALCO”) monitors and considers methods of managing exposure to interest rate risk. We have both an internal ALCO consisting of senior management that meets at various times during each month and a board ALCO that meets monthly. The ALCOs are responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.
As of September 30, 2021, the following table summarizes the forecasted impact on net interest income using a base case scenario given upward and downward movements in interest rates of 100, 200, and 300 basis points
44
based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the Consolidated Financial Statements. Therefore, management’s assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market conditions.
Critical Accounting Policies
We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2020, as filed in our Annual Report on Form 10-K.
Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Our Critical Accounting Policies are the allowance for loan losses, fair value of financial instruments and income taxes. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations. A brief discussion of each of these areas appears in our 2020 Annual Report on Form 10-K. During the first three months of 2021, we did not significantly alter the manner in which we applied our Critical Accounting Policies or developed related assumptions and estimates.
Accounting, Reporting, and Regulatory Matters
See Note 1 – Nature of Business and Basis of Presentation in the accompanying condensed notes to consolidated financial statements included elsewhere in this report for details of recently issued accounting pronouncements and their expected impact on our consolidated financial statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
As a "smaller reporting company" as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this Item.
45
Item 4. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There has been no change in the Company’s internal control over financial reporting during the three months ended September 30, 2021, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
We are a party to claims and lawsuits arising in the course of normal business activities. Management is not aware of any material pending legal proceedings against the Company which, if determined adversely, would have a material adverse impact on the company’s financial position, results of operations or cash flows.
Item 1A. RISK FACTORS.
Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31,2020, as well as cautionary statements contained in this Quarterly Report on Form 10-Q, including those under the caption “Cautionary Warning Regarding Forward-Looking Statements” set forth in Part I, Item 2 of this Form 10-Q, risks and matters described elsewhere in this Form 10-Q, and in our other filings with the SEC.
There have been no material changes to the risk factors disclosed in Item 1A. of Part I 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.
The following table reflects share repurchase activity during the third quarter of 2021:
*On March 9, 2021, the Company announced a share repurchase plan allowing us to repurchase up to 388,612 shares of our common stock (the “Repurchase Plan”). As of September 30, 2021, we have not repurchased any of the shares authorized for repurchase under the Repurchase Plan. The Company is not obligated to purchase any such shares under the Repurchase Plan, and the Repurchase Plan may be discontinued, suspended or restarted at any time; however, repurchases under the Repurchase Plan after December 31, 2021 would require additional approval of our Board of Directors and the Federal Reserve.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
None.
Item 4. MINE SAFETY DISCLOSURES.
Not applicable.
Item 5. OTHER INFORMATION.
Item 6. EXHIBITS.
The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Index to Exhibits attached hereto and are incorporated herein by reference.
INDEX TO EXHIBITS
48
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.