COMMUNITY BANKERS TRUST CORPORATION The following discussion and analysis of the financial condition atJune 30, 2020 and results of operations ofCommunity Bankers Trust Corporation (the "Company") for the three and six months endedJune 30, 2020 should be read in conjunction with the Company's consolidated financial statements and the accompanying notes to consolidated financial statements included in this report and in the Company's Annual Report on Form 10-K for the year ended December
31, 2019. OVERVIEWCommunity Bankers Trust Corporation (the "Company") is headquartered inRichmond, Virginia and is the holding company forEssex Bank (the "Bank"), aVirginia state bank with 24 full-service offices, 18 of which are inVirginia and six of which are inMaryland . The Bank also operates two loan production offices. The Bank engages in a general commercial banking business and provides a wide range of financial services primarily to individuals, small businesses and larger commercial companies, including individual and commercial demand and time deposit accounts, commercial and industrial loans, consumer and small business loans, real estate and mortgage loans, investment services, on-line and mobile banking products, and cash management services. The Company generates a significant amount of its income from the net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest earning assets outstanding during the period and the interest rates earned thereon. The Company's cost of funds is a function of the average amount of interest bearing deposits and borrowed money outstanding during the period and the interest rates paid thereon. The mix and product type for both loans and deposits can have a significant effect on the net interest income of the Bank. For the past several years, the Bank's focus has been on maximizing that mix through branch growth and targeted product types, with lenders and other employees directly involved with customer relationships. Additionally, the quality of the interest earning assets further influences the amount of interest income lost on nonaccrual loans and the amount of additions to the allowance for loan losses. The Bank also earns noninterest income from service charges on deposit accounts and other fee or commission-based services and products, such as insurance, mortgage loans, annuities, and other wealth management products. Other sources of noninterest income can include gains or losses on securities transactions and income from bank owned life insurance (BOLI) policies. The Company's income is offset by noninterest expense, which consists of salaries and employee benefits, occupancy and equipment costs, data processing fees, professional fees, transactions involving bank-owned property, and other operational expenses. The provision for loan losses and income taxes may materially affect net income.
CAUTION ABOUT FORWARD-LOOKING STATEMENTS
The Company makes certain forward-looking statements in this report that are subject to risks and uncertainties. These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, future strategy, and financial and other goals. These forward-looking statements are generally identified by phrases such as "the Company expects," "the Company believes" or words of similar import.
These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors, including, without limitation, the effects of and changes in the following:
the quality or composition of the Company's loan or investment portfolios,
? including collateral values and the repayment abilities of borrowers and
issuers;
? assumptions that underlie the Company's allowance for loan losses;
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? general economic and market conditions, either nationally or in the Company's
market areas;
unusual and infrequently occurring events, such as weather-related disasters,
? terrorist acts or public health events (such as the current COVID-19 pandemic),
and of governmental and societal responses to them
? the interest rate environment;
? competitive pressures among banks and financial institutions or from companies
outside the banking industry;
? real estate values;
? the demand for deposit, loan, and investment products and other financial
services;
? the demand, development and acceptance of new products and services;
? the performance of vendors or other parties with which the Company does
business;
? time and costs associated with de novo branching, acquisitions, dispositions
and similar transactions;
? the realization of gains and expense savings from acquisitions, dispositions
and similar transactions;
? assumptions and estimates that underlie the accounting for purchased credit
impaired loans;
? consumer profiles and spending and savings habits;
? levels of fraud in the banking industry;
? the level of attempted cyber attacks in the banking industry;
? the securities and credit markets;
? costs associated with the integration of banking and other internal operations;
? the soundness of other financial institutions with which the Company does
business; ? inflation; ? technology; and
? legislative and regulatory requirements.
These factors and additional risks and uncertainties are described in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 and other reports filed from time to time by the Company with theSecurities and Exchange Commission . Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. 30 Table of Contents CRITICAL ACCOUNTING POLICIES The Company's financial statements are prepared in accordance with accounting principles generally accepted inthe United States (GAAP). The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when either earning income, recognizing an expense, recovering an asset or relieving a liability. For example, the Company uses historical loss factors as one factor in determining the inherent loss that may be present in its loan portfolio. Actual losses could differ significantly from the historical factors that the Company uses. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of the Company's transactions would be the same, the timing of events that would impact its transactions could change.
The following is a summary of the Company's critical accounting policies that are highly dependent on estimates, assumptions and judgments.
Allowance for Loan Losses on Loans
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 uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance is an amount that management believes is appropriate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower's ability to pay. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. The evaluation also considers the following risk characteristics of each loan portfolio:
Residential 1-4 family mortgage loans include HELOCs and single family
investment properties secured by first liens. The carry risks associated with
owner-occupied and investment properties are the continued credit-worthiness of
? the borrower, changes in the value of the collateral, successful property
maintenance and collection of rents due from tenants. The Company manages these
risks by using specific underwriting policies and procedures and by avoiding
concentrations in geographic regions.
Commercial real estate loans, including owner occupied and non-owner occupied
mortgages, carry risks associated with the successful operations of the
principal business operated on the property securing the loan or the successful
operation of the real estate project securing the loan. General market
? conditions and economic activity may impact the performance of these loans. In
addition to using specific underwriting policies and procedures for these types
of loans, the Company manages risk by avoiding concentrations to any one
business or industry, and by diversifying the lending to various lines of
businesses, such as retail, office, office warehouse, industrial and hotel.
Construction and land development loans are generally made to commercial and
residential builders/developers for specific construction projects, as well as
to consumer borrowers. These carry more risk than real estate term loans due to
the dynamics of construction projects, changes in interest rates, the long-term
? financing market and state and local government regulations. The Company
manages risk by using specific underwriting policies and procedures for these
types of loans and by avoiding concentrations to any one business or industry
and by diversifying lending to various lines of businesses, in various geographic regions and in various sales or rental price points.
Second mortgages on residential 1-4 family loans carry risk associated with the
continued credit-worthiness of the borrower, changes in value of the collateral
? and a higher risk of loss in the event the collateral is liquidated due to the
inferior lien position. The Company manages risk by using specific underwriting
policies and procedures.
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Multifamily loans carry risks associated with the successful operation of the
property, general real estate market conditions and economic activity. In
? addition to using specific underwriting policies and procedures, the Company
manages risk by avoiding concentrations to geographic regions and by
diversifying the lending to various unit mixes, tenant profiles and rental
rates.
Agriculture loans carry risks associated with the successful operation of the
business, changes in value of non-real estate collateral that may depreciate
over time and inventory that may be affected by weather, biological, price,
? labor, regulatory and economic factors. The Company manages risks by using
specific underwriting policies and procedures, as well as avoiding
concentrations to individual borrowers and by diversifying lending to various
agricultural lines of business (i.e., crops, cattle, dairy, etc.).
Commercial loans carry risks associated with the successful operation of the
business, changes in value of non-real estate collateral that may depreciate
over time, accounts receivable whose collectability may change and inventory
? values that may be subject to various risks including obsolescence. General
market conditions and economic activity may also impact the performance of
these loans. In addition to using specific underwriting policies and procedures
for these types of loans, the Company manages risk by diversifying the lending
to various industries and avoids geographic concentrations. Consumer installment loans carry risks associated with the continued
credit-worthiness of the borrower and the value of rapidly depreciating assets
? or lack thereof. These types of loans are more likely than real estate loans to
be quickly and adversely affected by job loss, divorce, illness or personal
bankruptcy. The Company manages risk by using specific underwriting policies
and procedures for these types of loans. All other loans generally support the obligations of state and political
subdivisions in the
? Company. The loans carry risks associated with the continued credit-worthiness
of the obligations and economic activity. The Company manages risk by using
specific underwriting policies and procedures for these types of loans.
While management uses the best information available to make its evaluation,
future adjustments to the allowance may be necessary if there are significant
changes in economic conditions. In addition, regulatory agencies, as an integral
part of their examination process, periodically review the Company's allowance
for loan losses, and may require the Company to make additions to the allowance
based on their judgment about information available to them at the time of their
examinations.
The allowance consists of specific, general and unallocated components. For
loans that are also classified as impaired, an allowance is established when the
collateral value (or discounted cash flows or observable market price) of the
impaired loan is lower than the carrying value of that loan. The general
component covers non-classified loans and is based on historical loss experience
adjusted for qualitative factors. The unallocated component covers uncertainties
that could affect management's estimate of probable losses.
A loan is considered impaired when, based on current information and events, it
is probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower's prior payment record, and the amount of
the shortfall in relation to the principal and interest owed. Impairment is
measured by either the present value of the expected future cash flows
discounted at the loan's effective interest rate, the loan's obtainable market
price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of smaller balance homogeneous loans are evaluated for impairment
as a pool. Accordingly, the Company does not separately analyze these individual
loans for impairment disclosures.
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Accounting for Certain Loans Acquired in a Transfer
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 310, Receivables, requires acquired loans to be recorded at fair value and prohibits carrying over valuation allowances in the initial accounting for acquired impaired loans. Loans carried at fair value, mortgage loans held for sale, and loans to borrowers in good standing under revolving credit arrangements are excluded from the scope of FASB ASC 310, which limits the yield that may be accreted to the excess of the undiscounted expected cash flows over the investor's initial investment in the loan. The excess of the contractual cash flows over expected cash flows may not be recognized as an adjustment of yield. Subsequent increases in cash flows to be collected are recognized prospectively through an adjustment of the loan's yield over its remaining life. Decreases in expected cash flows are recognized as impairments through the allowance for loan losses. The Company's acquired loans from theSuburban Federal Savings Bank (SFSB) transaction (the "PCI loans"), subject to FASB ASC Topic 805, Business Combinations, were recorded at fair value and no separate valuation allowance was recorded at the date of acquisition. FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, applies to loans acquired in a transfer with evidence of deterioration of credit quality for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. The Company is applying the provisions of FASB ASC 310-30 to all loans acquired in the SFSB transaction. The Company has grouped loans together based on common risk characteristics including product type, delinquency status and loan documentation requirements among others. The PCI loans are subject to the credit review standards described above for loans. If and when credit deterioration occurs subsequent to the date that the loans were acquired, a provision for loan loss for PCI loans will be charged to earnings for the full amount. The Company has made an estimate of the total cash flows it expects to collect from each pool of loans, which includes undiscounted expected principal and interest. The excess of that amount over the fair value of the pool is referred to as accretable yield. Accretable yield is recognized as interest income on a constant yield basis over the life of the pool. The Company also determines each pool's contractual principal and contractual interest payments. The excess of that amount over the total cash flows that it expects to collect from the pool is referred to as nonaccretable difference, which is not recorded. Judgmental prepayment assumptions are applied to both contractually required payments and cash flows expected to be collected at acquisition. Over the life of the loan or pool, the Company continues to estimate cash flows expected to be collected. Subsequent decreases in cash flows expected to be collected over the life of the pool are recognized as an impairment in the current period through the allowance for loan losses. Subsequent increases in expected or actual cash flows are first used to reverse any existing valuation allowance for that loan or pool. Any remaining increase in cash flows expected to be collected is recognized as an adjustment to the accretable yield with the amount of periodic accretion adjusted over the remaining life of the pool.
RESULTS OF OPERATIONS
Overview
Coming off a strong end to the 2019 year, the Company began the year with good momentum but was disrupted by the coronavirus (COVID-19) pandemic that set off an economic crisis. Specific events that impacted the Company's financial results for the first six months of 2020, and will impact future financial results, include government mandated business closures and stay-at-home orders, which have transformed into the highest unemployment rate seen in the Company's markets. In addition, unprecedented government stimulus programs and the uncertainties regarding how long the mandates will last have contributed to the unpredictability of the financial impacts that the Company may experience. The Company is focused on assessing the risks in its loan portfolio and working with our customers to minimize future losses. See below for additional discussion regarding trends and the potential effects of COVID-19.
During the second quarter of 2020, the Company originated loans under the
Paycheck Protection Program (PPP) of the
These PPP loans totaled$83.5 million atJune 30, 2020 and are included in commercial loans. As these loans are 100% guaranteed by the SBA, no loan loss allowance is required. The majority of the PPP loans have a two year term; however, most are expected to be forgiven by the SBA as borrowers use the funds for qualified expenses. 33 Table of Contents Net income in the second quarter of 2020 reflects an increase of$616,000 over the same period in 2019. Net income was$4.2 million in the second quarter of 2020, or earnings per share of$0.19 basic and$0.18 fully diluted. Net income for the second quarter of 2019 was$3.5 million , or$0.16 per common share, both basic and fully diluted. The increase in net income was driven by a decrease of$1.1 million in noninterest expenses, primarily from a reduction of$660,000 in salaries and employee benefits, a majority of which was associated with deferred internal costs, primarily from the origination costs of PPP loans in the second quarter of 2020. Also positively affecting year-over-year net income was a reduction of$515,000 in interest expense, which resulted in an increase of$360,000 in net interest income. Additionally, there was an increase of$165,000 in noninterest income. Offsetting these increases in net income were an increase of$775,000 in provision for loan losses and an increase of$252,000 in income tax expense.
Net income for the first six months of 2020 was$5.6 million , or$0.25 per common share, basic and fully diluted. This is a decrease of$1.5 million , or 20.9%, when compared with net income of$7.0 million , or$0.32 basic and$0.31 fully diluted earnings per share, for the first six months of 2019. The decrease was primarily the result of the provision for loan losses of$4.2 million for the first six months of 2020 compared with$125,000 for the same period in 2019. The level of provision in 2020 was recorded to reflect the business and market disruptions arising from the COVID-19 pandemic. Offsetting the decrease to net income were a decrease of$1.4 million in noninterest expenses, primarily from a reduction in salaries and employee benefits of$889,000 , due primarily to deferred internal costs as noted above, an increase of$486,000 in noninterest income, which was driven by an increase of$432,000 in mortgage loan income, an increase of$473,000 in net interest income, and a decrease of$280,000 in
income tax expense. Net Interest Income The Company's operating results depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, including securities and loans, and interest expense incurred on interest bearing liabilities, including deposits and other borrowed funds. Net interest income is affected by changes in the amount and mix of interest earning assets and interest bearing liabilities, referred to as a "volume change." It is also affected by changes in yields earned on interest earning assets and rates paid on interest bearing deposits and other borrowed funds, referred to as a "rate change."
Net interest income increased
Interest and dividend income decreased$155,000 , or 1.0%, over this time period. Interest and fees on loans increased by$372,000 . This increase was mitigated by decreases in securities income, which decreased by$257,000 , interest and fees on PCI loans, which decreased by$189,000 , and interest on deposits in other banks, which decreased by$76,000 . Interest on PCI loans was$1.1 million in the second quarter of 2020 compared with$1.3 million in the second quarter of 2019. The average balance of the PCI portfolio declined$6.2 million during the year-over-year comparison period. The increase in interest and fees on loans was generated by an increase of$134.5 million , or 13.3%, in the average balance of loans. A portion of this loan growth was a shift in the mix of earning assets, as securities average balances declined$8.5 million year over year. The average balance of total earning assets increased$152.3 million , or 11.6%, from the second quarter of 2019 to the second quarter of 2020. The yield on earning assets decreased from 4.88% in the second quarter of 2019 to 4.33% in the second quarter of 2020. The yield on earning assets was the culmination of decreases in the yield on loans, from 5.01% in the second quarter of 2019 to 4.55% in the second quarter of 2020, in the tax-equivalent yield on securities, from 3.23% in the second quarter of 2019 to 2.88% in the second quarter of 2020, and in the yield on interest bearing bank balances, from 2.41% to 0.31% year over year. The decline in interest bearing bank balances resulted in a decrease in income of$76,000 despite an increase in the average balance of$33.1 million . Interest expense decreased$515,000 , or 13.2%, when comparing the second quarter of 2020 and the second quarter of 2019. Interest expense on deposits decreased$407,000 , or 11.3%, as the cost declined from 1.41% in the second quarter of 2019 to 1.20% for the same period in 2020. The average balance of interest bearing deposits increased$46.5 million , or 4.6%. This growth was from non-maturity deposit sources. First, there was an increase of$25.7 million , or 16.5%, in the average balance of interest bearing checking accounts, which averaged$181.8 million in the second quarter of 2020. Additionally, there was an increase of$24.4 million in the average balance of savings and money market accounts from the second quarter of 2019 to the same period in 2020. Offsetting these increases was a decrease in the average balance of time deposits of$3.7 million , to$643.5 million for the second quarter of 2020. FHLB and other borrowings benefited from a decrease in cost from 2.08% in the second quarter of 2019 to 1.15% in the second quarter of 2020. This reduced interest 34 Table of Contents expense for the category by$101,000 despite an increase in the average amount outstanding of$12.8 million . The amount of liquidity in the banking system, along with lower interest rates and a shift in deposit balances, decreased the cost of interest bearing liabilities from 1.45% in the second quarter of 2019 to 1.19% in the second quarter of 2020. The tax-equivalent net interest margin decreased 29 basis points, from 3.69% in the second quarter of 2019 to 3.40% in the second quarter of 2020. Likewise, the interest spread decreased from 3.43% to 3.14% over the same time period. The decrease in the margin was precipitated by a greater decrease in the yield on earning assets of 55 basis points compared with a decline in the cost of interest bearing liabilities of 26 basis points. Net interest income was$24.6 million for the first six months of 2020. This is an increase of$473,000 , or 2.0%, from net interest income of$24.1 million for the first six months of 2019. Interest and dividend income declined by$15,000 over this time frame. Interest and dividend income was impacted by volume increases offset by a decline in yield. First, there was an increase of$1.0 million , or 4.1%, in interest and fees on loans, which increased as a result of growth of$100.4 million , or 10.0%, in the average balance of loans in 2020 over 2019. The yield on loans declined from 5.03% for the first six months of 2019 to 4.73% for the same period in 2020. Five basis points of this decrease are attributable to the addition of$83.5 million in PPP loans net of fees during the second quarter of 2020 at a rate of 1.00%. Interest and fees on PCI loans declined by$385,000 , or 15.1%. Interest on deposits in other banks declined by$103,000 . The yield on the PCI portfolio was 13.94% for the first six months of 2020 compared with 13.68% for the same period in 2019. Interest and dividends on securities declined by$561,000 in the first six months of 2020 compared with the same period in 2019. The yield on earning assets was 4.54% for the first six months of 2020, a decline of 38 basis points from 4.92% in the first six months of 2019. The yield on total loans, which includes PCI loans, declined from 5.34% for the first six months of 2019 compared to 4.99% for the same period in 2020. The return on interest bearing bank balances declined from 2.53% to 0.64%, while the tax-equivalent yield on the securities portfolio declined from 3.29% for the first six months of 2019 to 2.98% for the first six months of 2020. Interest expense of$7.1 million for the first six months of 2020 was a decrease of$488,000 , or 6.4%, from interest expense of$7.6 million for the first six months of 2019. The cost of interest bearing liabilities decreased over this time frame from 1.41% for the first six months of 2019 to 1.28% for the same period in 2020. Interest on deposits decreased$222,000 due to a decline in the rate paid from 1.36% for the first six months of 2019 to 1.27% for the first six months of 2020. The average balance of interest bearing liabilities increased over this time frame by$35.0 million . Short term borrowing expense decreased by$33,000 , and the cost of FHLB and other borrowings decreased by$233,000 , or 32.9%, as the rate paid decreased from 2.13% for the first six months of 2019 to 1.36% for the first six months of 2020. The changes noted to interest income and interest expense led to a decline in the net interest margin from 3.75% for the first six months of 2019 to 3.53% for the same period in 2020. The interest spread also declined over this time frame from 3.51% in 2019 to 3.26% in 2020. 35 Table of Contents The following tables set forth, for each category of interest-earning assets and interest bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts, and the average rate earned or paid for the three and six months endedJune 30, 2020 and 2019. The tables also set forth the average rate paid on total interest bearing liabilities, and the net interest margin on average total interest earning assets for the same periods. Except as indicated in the footnotes, no tax equivalent adjustments were made and all average balances are daily average balances. Any nonaccruing loans have been included in the tables, as loans carrying a zero yield. Three months ended June 30, 2020 Three months ended June 30, 2019 Average Average Average Interest Rates Average Interest Rates Balance Income/ Earned/ Balance Income/ Earned/ (Dollars in thousands) Sheet Expense Paid Sheet Expense Paid ASSETS: Loans$ 1,145,956 $ 13,012 4.55 %$ 1,011,448 $ 12,640 5.01 % PCI loans 29,978 1,062 14.01 36,212 1,251 13.67 Total loans 1,175,934 14,074 4.80 1,047,660 13,891 5.32 Interest bearing bank balances 52,551 41 0.31 19,436 117 2.41 Federal funds sold 210 - 0.07 799 5 2.36 Securities (taxable) 189,378 1,287 2.72 189,429 1,472 3.11 Securities (tax exempt) (1) 50,629 442 3.49 59,098 533 3.60 Total earning assets 1,468,702 15,844 4.33 1,316,422 16,018 4.88 Allowance for loan losses (12,007)
(8,820)
Non-earning assets 109,847 102,513
Total assets $ 1,566,542 $ 1,410,115
LIABILITIES AND
SHAREHOLDERS' EQUITY
Demand - interest bearing$ 181,789 98 0.22$ 156,053 86 0.22 Savings and money market 241,646 228 0.38 217,219 307 0.57 Time deposits 643,465 2,856 1.78 647,159 3,196 1.98 Total interest bearing deposits 1,066,900 3,182 1.20 1,020,431 3,589 1.41 Short-term borrowings 323 - 0.20 996 7 2.70 FHLB and other borrowings 71,685 209 1.15 58,888 310 2.08 Total interest bearing liabilities 1,138,908 3,391 1.19 1,080,315 3,906 1.45 Noninterest bearing deposits 254,216
170,783
Other liabilities 14,396 14,183
Total liabilities 1,407,520 1,265,281
Shareholders' equity 159,022 144,834
Total liabilities and
shareholders' equity $ 1,566,542 $ 1,410,115
Net interest earnings $ 12,453 $ 12,112 Interest spread 3.14 % 3.43 % Net interest margin 3.40 % 3.69 % Tax equivalent adjustment: Securities$ 93 $ 112 (1) Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 21%. 36 Table of Contents Six months ended June 30, 2020
Six months ended
Average Average
Average Interest Rates Average Interest Rates
Balance Income/ Earned/ Balance Income/ Earned/(Dollars in thousands) Sheet Expense Paid Sheet Expense Paid ASSETS: Loans$ 1,105,612 $ 26,098 4.73 %$ 1,005,168 $ 25,059 5.03 % PCI loans 30,644 2,159 13.94 36,993 2,544 13.68 Total loans 1,136,256 28,257 4.99 1,042,161 27,603 5.34 Interest bearing bank balances 34,503 110 0.64 16,920 213 2.53 Federal funds sold 176 - 0.47 429 5 2.36 Securities (taxable) 185,859 2,638 2.84 187,908 2,994 3.19 Securities (tax exempt) (1) 50,010 876 3.51 63,132 1,135 3.60 Total earning assets 1,406,804 31,881 4.54 1,310,550 31,950 4.92 Allowance for loan losses (10,314) (8,951) Non-earning assets 107,694 99,758 Total assets$ 1,504,184 $ 1,401,357 LIABILITIES AND SHAREHOLDERS' EQUITY Demand - interest bearing$ 176,034 192 0.22$ 156,908 173 0.22 Savings and money market 230,654 508 0.44
219,071 600 0.55 Time deposits 638,064 5,901 1.85 635,354 6,050 1.92 Total interest bearing deposits 1,044,752 6,601 1.27 1,011,333 6,823 1.36 Short-term borrowings 2,254 23 2.06 3,900 56 2.91
FHLB and other borrowings 69,240 475 1.36
66,012 708 2.13 Total interest bearing liabilities 1,116,246 7,099 1.28 1,081,245 7,587 1.41 Noninterest bearing deposits 215,044 165,668 Other liabilities 14,290 12,078 Total liabilities 1,345,580 1,258,991 Shareholders' equity 158,604 142,366 Total liabilities and shareholders' equity$ 1,504,184 $ 1,401,357 Net interest earnings$ 24,782 $ 24,363 Interest spread 3.26 % 3.51 % Net interest margin 3.53 % 3.75 %
Tax equivalent adjustment: Securities$ 184 $ 238
(1) Income and yields are reported on a tax equivalent basis assuming a federal
tax rate of 21%.
Provision for Loan Losses
Management actively monitors the Company's asset quality and provides specific
loss provisions when necessary. Provisions for loan losses are charged to income
to bring the total allowance for loan losses to a level deemed appropriate by
management of the Company based on such factors as historical credit loss
experience, industry diversification of the commercial loan portfolio, the
amount of nonperforming loans and related collateral, the volume growth and
composition of the loan portfolio, current economic conditions that may affect
the borrower's ability to pay and the value of collateral, the evaluation of the
loan portfolio through the internal loan review function and other relevant
factors. See Allowance for Loan Losses on Loans in the Critical Accounting
Policies section above for further discussion.
Loans are charged-off against the allowance for loan losses when appropriate.
Although management believes it uses the best information available to make
determinations with respect to the provision for loan losses, future adjustments
may be necessary if economic conditions differ from the assumptions used in
making the initial determinations.
Management also actively monitors its PCI loan portfolio for impairment and
necessary loan loss provisions. Provisions for these loans may be necessary due
to a change in expected cash flows or an increase in expected losses within
a
pool of loans.
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The Company records a separate provision for loan losses for its loan portfolio,
excluding PCI loans, and the PCI loan portfolio. There was a provision for loan
losses on the loan portfolio, excluding PCI loans, of $900,000 and $4.2 million
for the three and six months ended June 30, 2020 , respectively. There was a
provision for loan losses on the loan portfolio, excluding PCI loans, of
$125,000 for each of the three and six months ended June 30, 2019 .
The provision recorded during the first six months of 2020 was due to the
heightened risks associated with the loan portfolio that resulted from the
economic impact of the rapidly evolving effects of the COVID-19 stay-at-home
orders, business shut-downs and increased unemployment. The Company's lenders
reviewed each loan within the portfolio to identify those borrowers that
management believed to be possibly impacted by the current state of the economy.
Loans identified with increased risk were aggregated by loan type. This analysis
indicated a risk grade migration in a number of loan categories that led to a
heightened risk level in the loan portfolio. The impact of the loans' risk grade
migration was applied to the allowance for loan loss calculation, which led to
the provision for loan losses for the quarter.
Due to the COVID-19 pandemic, the Company is closely monitoring loan
concentrations in various "at risk areas" that it has deemed most likely to be
affected by the stay-at-home orders and lack of general business activity,
including a lack of travel in our geographic territory. As of June 30, 2020 ,
the Company identified the following categories of borrowers as being
potentially at risk:
Category % of Total Loans
Consumer 15.6 %
Lessors of commercial properties 17.9
Lessors of residential properties 12.8
Hotels and other lodging 5.7
Medical and care services 4.7
Food service and drinking 2.0
Retail stores 1.3
Personal services 1.1
The Company is working with borrowers who have currently expressed a need for
relief due to the effects of COVID-19. The Company granted relief in the form
of various types of payment concessions, including interest only for up to six
months or payment deferrals up to the same time frame for loans with outstanding
balances of $169.9 million at June 30, 2020 . In accordance with current
regulatory guidance, none of these loans were deemed to be TDRs, as they were
all current under their terms as of December 31, 2019 .
The Company is also helping its customers and communities by participating in
the PPP. As of June 30, 2020 , the Company originated 741 loans totaling $83.5
million net of fees, with the median size for all loans made being approximately
$35,000 . As these loans are 100% guaranteed by the SBA, no allowance for loan
losses is required.
With respect to the PCI portfolio, due to the stable nature of its performance
and its declining balances over time as the portfolio amortizes, no provision
was taken during either of the three or six months ended June 30, 2020 and 2019.
Additional discussion of loan quality is presented below.
The loan portfolio, excluding PCI loans, had net charge-offs of $481,000 in the
second quarter of 2020, compared with net recoveries of $33,000 in the second
quarter of 2019. Total charge-offs were $618,000 for the second quarter of 2020
compared with $102,000 in the second quarter of 2019. Recoveries of previously
charged-off loans were $137,000 for the second quarter of 2020 compared with
$135,000 in the second quarter of 2019.
The loan portfolio, excluding PCI loans, had net charge-offs of $391,000 for the
six months ended June 30, 2020 , compared with net charge-offs of $289,000 in the
same period of 2019. Total charge-offs were $712,000 for the six months ended
June 30, 2020 , compared with $680,000 in the same period of 2019. Recoveries of
previously charged-off loans were $321,000 for the six months ended June 30,
2020 , compared with $391,000 in the same period of 2019.
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Noninterest Income
Noninterest income of $1.6 million in the second quarter of 2020 was an increase
of $165,000 , or 11.4%, over the second quarter of 2019. Mortgage loan income
increased $273,000 , or 273.0%, from $100,000 in the second quarter of 2019 to
$373,000 in the second quarter of 2020. Other noninterest income was $296,000 in
the second quarter of 2020 compared with $222,000 in the second quarter of 2019,
an increase of $74,000 . Service charges on deposit accounts of $532,000 in the
second quarter of 2020 decreased by $175,000 , or 24.8%, year over year. This
decrease was primarily the result of reduced transaction volumes created by the
COVID-19 stay-at-home orders. Income on bank owned life insurance was $173,000
in the second quarter of 2020, a decrease of $11,000 year over year.
Noninterest income was $3.0 million for the first six months of 2020, an
increase of $486,000 , or 19.7%, over noninterest income of $2.5 million for the
first six months of 2019. Mortgage loan income was $594,000 for the first six
months of 2020, an increase of $432,000 over the same period in 2019. This
increase was created by continuity among the mortgage team, coupled with
attractive rates and increased referrals within the Bank. Other noninterest
income was $592,000 for the first six months of 2020, an increase of $194,000
over the same period in 2019. The increase was primarily the result from 2020
activity that included a $64,000 gain on the extinguishment of a FHLB borrowing
combined with $173,000 in swap fee income. Gain on sale of loans was $11,000 for
the first six months of 2020 compared with none for the same period in 2019.
Offsetting these increases to noninterest income were a decline of $112,000 in
service charges and fees, a decrease of $21,000 in securities gains and a
decline of $18,000 in income on bank owned life insurance.
Noninterest Expense
Noninterest expenses were$7.9 million for the second quarter of 2020. This is a decrease of$1.1 million from noninterest expenses of$9.0 million for the second quarter of 2019. The reason for the decrease is also the result of the large loan volume in the second quarter of 2020 that generated credits to salaries and employee benefits in accordance with ASC 310-20, Receivables, Nonrefundable Fees and Costs. These credits contributed to the majority of the$660,000 , or 12.5%, decline in salaries and employee benefits. Also decreasing for the period was other operating expenses, which decreased$147,000 , occupancy expenses, which were$141,000 lower, other real estate expenses, net, which were$109,000 lower, equipment expense, which was$49,000 lower, andFDIC assessment and data processing fees, which were both$6,000 lower. No expense category on the income statement was greater for the second quarter of 2020 compared with the same period in 2019. Noninterest expenses were$16.5 million for the six months endedJune 30, 2020 , a decrease of$1.4 million , or 7.6%, year over year. There were a number of reasons for the decrease. A portion,$559,000 , is also the result of the large loan volume in the second quarter of 2020 that generated credits to salaries and employee benefits in accordance with ASC 310-20, Receivables, Nonrefundable Fees and Costs. Salaries and employee benefits declined$889,000 , or 8.3%. The closure of two branch offices in 2019 positively influenced salaries as well as other expense categories in 2020. Also decreasing for the six month year-over-year period was occupancy expenses, which were$244,000 lower, other real estate expenses, net, which were$95,000 lower, equipment expense, which was$58,000 lower, other operating expenses, which decreased$65,000 , andFDIC assessment, which was$31,000 lower. Only data processing fees increased, and they were only$18,000 greater for the first six months of 2020 compared with the same period in 2019. Income Taxes Income tax expense was$1.0 million for the second quarter of 2020, compared with income tax expense of$791,000 for the second quarter of 2019. For the first six months of 2020 income tax expense was$1.3 million compared with$1.6 million for the first six months of 2019. The effective tax rate for the second quarter of 2020 was 20.0% compared with 18.2% for the second quarter of 2019.
For the first six months of 2020, the effective tax rate was 19.0% compared with 18.4% for the same period in 2019.
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FINANCIAL CONDITION
General
Total assets increased$184.2 million , or 12.9%, to$1.615 billion atJune 30, 2020 when compared toDecember 31, 2019 . Total loans, excluding PCI loans, were$1.165 billion atJune 30, 2020 , increasing$107.0 million , or 10.1%, from year end 2019. Total PCI loans were$29.5 million atJune 30, 2020 versus$32.5 million atDecember 31, 2019 . Loans net of fees that the Bank originated during the second quarter under the PPP were$83.5 million atJune 30, 2020 . There were 741 of these PPP loans outstanding atJune 30, 2020 , and all of these balances are included in the$263.0 million in commercial loans. Commercial loan balances, excluding PPP balances, would have declined by$11.7 million since year end 2019. Commercial real estate loans, the largest category of loans at$443.9 million , or 38.1% of gross loans outstanding, increased$47.1 million , or 11.9% year to date. Construction and land development loans, totaling$151.5 million , grew$5.0 million since year end 2019. Residential 1 - 4 family loans declined by$17.8 million during the first six months of 2020. The Company's securities portfolio, excluding restricted equity securities, increased$28.3 million since year end 2019 to$251.0 million atJune 30, 2020 .U.S. Treasury issues increased by$21.7 million during the first six months of 2020 as excess liquidity was invested short-term in very liquid and low risk instruments. Corporate securities, with balances of$19.8 million atJune 30, 2020 , increased by$13.7 million during the six month period. State, county and municipal securities, the largest investment category at$133.8 million atJune 30, 2020 , increased by$9.5 million during the first six months of 2020. Asset backed securities, consisting of student loan pools 97% guaranteed by theU.S. Government , increased by$11.5 million during the first six months of 2020 and totaled$23.2 million atJune 30, 2020 . Offsetting these increases was a decrease of$16.5 million in mortgage backed securities and a decline of$1.7 million in balances held inU.S. Government agency bonds. The Company actively manages the portfolio to improve its liquidity and maximize the return within the desired risk profile. The Company is required to account for the effect of changes in the fair value of securities available for sale (AFS) under FASB ASC 320, Investments - Debt and Equity Securities. The fair value of the AFS portfolio was$226.9 million atJune 30, 2020 and$187.0 million atDecember 31, 2019 . AtJune 30, 2020 , the Company had a net unrealized gain on the AFS portfolio of$7.3 million compared with a net unrealized gain of$3.7 million atDecember 31, 2019 . Municipal securities comprised 48.3% of the total AFS portfolio atJune 30, 2020 . These securities exhibit more price volatility in a changing interest rate environment because of their longer weighted average life, as compared to other categories contained within the rest of the portfolio. The Company had cash and cash equivalents of$85.3 million atJune 30, 2020 compared with$28.7 million at year end 2019. The six month increase was$56.6 million . The majority of this category growth occurred in interest bearing bank balances,$53.1 million since year end 2019, as large amounts of liquidity have been funneled into the banking system through the facilitation of PPP loans and stimulus checks issued by theU.S. Treasury under the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act). There were federal funds purchased of$3.3 million atJune 30, 2020 compared with$24.4 million atDecember 31, 2019 .
Interest bearing deposits atJune 30, 2020 were$1.085 billion , an increase of$100.0 million , or 10.2%, greater than atDecember 31, 2019 . Interest bearing checking accounts (formerly NOW accounts) of$195.4 million grew by$24.9 million since year end 2019. Money market deposit accounts were$148.1 million atJune 30, 2020 and grew$27.2 million , or 22.5%, during the first six months of 2020. Savings accounts totaled$108.6 million atJune 30, 2020 and grew$12.0 million for the first six months of 2020. Strong growth in these categories for the year has allowed the Bank to react to lower interest rates through proactive repricing in certificates of deposit, the highest costing deposit category. Time deposit balances combined were 46.4% of total deposits, including noninterest bearing deposits, atJune 30, 2020 , a decline from 51.3% atDecember 31, 2019 . The growth in interest bearing checking accounts, money market accounts, savings accounts and noninterest bearing deposits, which grew$164.3 million during the first six months of 2020, were associated with the$83.5 million in PPP loans net of fees originated and held atJune 30, 2020 and stimulus checks issued under the CARES Act, as well as postponed business activity that resulted from the COVID-19 stay-at-home orders. 40 Table of Contents FHLB borrowings were$68.2 million atJune 30, 2020 , compared with$68.5 million atDecember 31, 2019 . There were Federal funds purchased of$3.3 million atJune 30, 2020 , down from$24.4 million atDecember 31, 2019 . Shareholders' equity was$160.8 million atJune 30, 2020 , or 10.0% of total assets, compared with$155.5 million , or 10.9% of total assets, atDecember 31, 2019 . OnJanuary 22, 2020 , the Company announced a share repurchase program of up to 1,000,000 shares of its common stock. During the first six months of 2020, the Company repurchased 130,800 shares of common stock at a total cost of$885,665 . The Company evaluates the value of the common stock and capital for regulatory purposes when considering repurchases under the program and, as a result, is not currently making any repurchases in the current economic environment.
Asset Quality - excluding PCI loans
The allowance for loan losses represents management's estimate of the amount appropriate to provide for probable losses inherent in the loan portfolio.
Loan quality is continually monitored, and the Company's management has established an allowance for loan losses that it believes is appropriate for the risks inherent in the loan portfolio. Among other factors, management considers the Company's historical loss experience, the size and composition of the loan portfolio, the value and appropriateness of collateral and guarantors, nonperforming loans and current and anticipated economic conditions. There are additional risks of future loan losses, which cannot be precisely quantified nor attributed to particular loans or classes of loans. Because those risks include general economic trends, as well as conditions affecting individual borrowers, the allowance for loan losses is an estimate. The allowance is also subject to regulatory examinations and determination as to appropriateness, which may take into account such factors as the methodology used to calculate the allowance and size of the allowance in comparison to peer companies identified by regulatory agencies. See Allowance for Loan Losses on Loans in the Critical Accounting Policies section above for further discussion. The Company maintains a list of loans that have potential weaknesses and thus may need special attention. This loan list is used to monitor such loans and is used in the determination of the appropriateness of the allowance for loan losses. Nonperforming assets totaled$8.7 million atJune 30, 2020 and net charge-offs were$391,000 for the six months endedJune 30, 2020 . This compares with nonperforming assets of$10.8 million and net charge-offs of$879,000 for the year endedDecember 31, 2019 . Nonaccrual loans were$4.2 million atJune 30, 2020 , a$1.1 million decrease from$5.3 million atDecember 31, 2019 . The$1.1 million decrease in nonaccrual loans sinceDecember 31, 2019 was the net result of$3.7 million in additions to nonaccrual loans and$4.8 million in reductions. The increase related mainly to one construction and land development relationship totaling$1.4 million and two commercial loans totaling$1.3 million . With respect to the reductions in nonaccrual loans,$240,000 were payments to existing credits,$616,000 were charge-offs,$3.8 million were paid off, and$159,000 returned to accruing status. The allowance for loan losses, excluding PCI, equaled 289.7% of nonaccrual loans atJune 30, 2020 compared with 159.3% atDecember 31, 2019 . The ratio of nonperforming assets to loans and OREO decreased 27 basis points. The ratio was 0.74% atJune 30, 2020 versus 1.01% atDecember 31, 2019 , which was driven primarily by the decrease in nonperforming loans. In accordance with GAAP, an individual loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due in accordance with contractual terms of the loan agreement. The Company considers all troubled debt restructures and nonaccrual loans to be impaired loans. In addition, the Company reviews all substandard and doubtful loans that are not on nonaccrual status, as well as loans with other risk characteristics, pursuant to and specifically for compliance with the accounting definition of impairment as described above. These impaired loans have been determined through analysis, appraisals, or other methods used by management.
See Note 3 to the Company's financial statements for information related to the
allowance for loan losses. At
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The following table sets forth selected asset quality data, excluding PCI loans, and ratios for the dates indicated (dollars in thousands):
June 30, 2020 December 31, 2019
Nonaccrual loans $ 4,225 $ 5,292Loans past due 90 days and accruing interest -
946
Total nonperforming loans 4,225 6,238
OREO 4,486 4,527
Total nonperforming assets $ 8,711 $ 10,765
Accruing troubled debt restructure loans $ 4,898 $
4,593
Balances
Specific reserve on impaired loans 1,112
584
General reserve related to unimpaired loans 11,126
7,845
Total allowance for loan losses 12,238
8,429
Average loans during the year, net of unearned income 1,105,612 1,023,861 Impaired loans 9,123 9,885 Non-impaired loans 1,156,187 1,048,438
Total loans, net of unearned income 1,165,310
1,058,323
Ratios
Allowance for loan losses to loans 1.05 % 0.80 % Allowance for loan losses to nonaccrual loans 289.66
159.28
General reserve to non-impaired loans 0.96
0.75
Nonaccrual loans to loans 0.36
0.50
Nonperforming assets to loans and OREO 0.74
1.01
Net charge-offs to average loans 0.07
0.09
A further breakout of nonaccrual loans, excluding PCI loans, at
June 30, 2020 December 31, 2019
Mortgage loans on real estate:
Residential 14 family $ 1,697 $ 1,378
Commercial 636 1,006 Construction and land development 1,122 376
Multifamily - 2,463 Agriculture 51 - Total real estate loans 3,506 5,223 Commercial loans 707 62 Consumer installment loans 12 7 Total loans $ 4,225 $ 5,292 Asset Quality - PCI loans
Loans accounted for under FASB ASC 310-30 are generally considered accruing and
performing loans as the loans accrete interest income over the estimated life of
the loan. Accordingly, acquired impaired loans that are contractually past due
are still considered to be accruing and performing loans.
The PCI loans are subject to credit review standards for loans. If and when
credit deterioration occurs subsequent to the date that they were acquired, a
provision for credit loss for PCI loans will be charged to earnings for the full
amount. The Company makes an estimate of the total cash flows that it expects to
collect from a pool of PCI loans, which includes
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undiscounted expected principal and interest. Over the life of the loan or pool, the Company continues to estimate cash flows expected to be collected. Subsequent decreases in cash flows expected to be collected over the life of the pool are recognized as impairments in the current period through the allowance for loan losses. Subsequent increases in expected cash flows are first used to reverse any existing valuation allowance for that loan or pool. Any remaining increase in cash flows expected to be collected is recognized as an adjustment to the yield over the remaining life of the pool.
Capital Requirements
The determination of capital adequacy depends upon a number of factors, such as asset quality, liquidity, earnings, growth trends and economic conditions. The Company seeks to maintain a strong capital base exceeding regulatory minimums for well capitalized institutions to support its growth and expansion plans, provide stability to current operations and promote public confidence in the Company. Current repurchase activity under the Company's stock repurchase program was suspended effectiveApril 2, 2020 . The sole reason for this suspension was due to the uncertainties surrounding COVID-19. The Company continues to place a heightened emphasis on capital and liquidity to safeguard shareholders, its balance sheet and the needs of its customers. Management believes that the Company possesses strong capital and liquidity. The actions taken with regard to capital and liquidity as a result of the pandemic were put into effect to safeguard these areas of strength. EffectiveSeptember 2018 , theFederal Reserve raised the total consolidated asset limit in the Small Bank Holding Company Policy Statement from$1 billion to$3 billion , thereby eliminating the Company's consolidated capital reporting requirements. Therefore, the Company only reports capital information at the Bank level. Under the final rule on Enhanced Regulatory Capital Standards, commonly referred to as Basel III and which became effectiveJanuary 1, 2015 , the federal banking regulators have defined four tests for assessing the capital strength and adequacy of banks, based on four definitions of capital. "Common equity tier 1 capital" is defined as common equity, retained earnings, and accumulated other comprehensive income (AOCI), less certain intangibles. "Tier 1 capital" is defined as common equity tier 1 capital plus qualifying perpetual preferred stock, tier 1 minority interests, and grandfathered trust preferred securities. "Tier 2 capital" is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock, non-tier 1 minority interests and a limited amount of the allowance for loan losses. "Total capital" is defined as tier 1 capital plus tier 2 capital. Four risk-based capital ratios are computed using the above capital definitions, total assets and risk-weighted assets, and the ratios are measured against regulatory minimums to ascertain adequacy. All assets and off-balance sheet risk items are grouped into categories according to degree of risk and assigned a risk-weighting and the resulting total is risk-weighted assets. "Common equity tier 1 capital ratio" is common equity tier 1 capital divided by risk-weighted assets. "Tier 1 risk-based capital ratio" is tier 1 capital divided by risk-weighted assets. "Total risk-based capital ratio" is total capital divided by risk-weighted assets. The "leverage ratio" is tier 1 capital divided by total average assets. The Bank's ratio of total risk-based capital was 13.9% at each ofJune 30, 2020 andDecember 31, 2019 . The tier 1 risk-based capital ratio was 12.9% atJune 30, 2020 and 13.2% atDecember 31, 2019 . The Bank's tier 1 leverage ratio was 10.3% atJune 30, 2020 and 11.0% atDecember 31, 2019 . All capital ratios exceed regulatory minimums to be considered well capitalized.BASEL III introduced the common equity tier 1 capital ratio, which was 12.9% atJune 30, 2020 and 13.2% atDecember 31, 2019 .
Under Basel III, a capital conservation buffer of 2.5% above the minimum
risk-based capital thresholds was established. Dividend and executive
compensation restrictions begin if the Bank does not maintain the full amount of
the buffer. At
Liquidity
Liquidity represents the Company's ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest bearing deposits with banks, federal funds sold and certain investment securities. As a result of the Company's
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management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and meet its customers' credit needs.
The Company's results of operations are significantly affected by its ability to manage effectively the interest rate sensitivity and maturity of its interest earning assets and interest bearing liabilities. A summary of the Company's liquid assets atJune 30, 2020 andDecember 31, 2019 was as follows (dollars in thousands): June 30, 2020 December 31, 2019 Cash and due from banks$ 20,530 $ 16,976
Interest bearing bank deposits 64,796 11,708 Available for sale securities, at fair value, unpledged 197,631 157,225 Total liquid assets$ 282,957 $ 185,909 Deposits and other liabilities$ 1,454,223 $ 1,275,361 Ratio of liquid assets to deposits and other liabilities 19.46
% 14.58 %
The Company maintains unsecured lines of credit of varying amounts with
correspondent banks to facilitate short-term liquidity needs. The Company has a
total of
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