FIRST CAPITAL, INC. General
As the holding company for the Bank, the Company conducts its business primarily through the Bank. The Bank's results of operations depend primarily on net interest income, which is the difference between the income earned on its interest-earning assets, such as loans and investments, and the cost of its interest-bearing liabilities, consisting primarily of deposits, retail repurchase agreements and borrowings from the FHLB. The Bank's net income is also affected by, among other things, fee income, provisions for loan losses, operating expenses and income tax provisions. The Bank's results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government legislation and policies concerning monetary and fiscal affairs, housing and financial institutions and the intended actions of the regulatory authorities.
Management uses various indicators to evaluate the Company's financial condition and results of operations. Indicators include the following:
· Net income and earnings per share - Net income attributable to the Company was
for 2017.
· Return on average assets and return on average equity - Return on average
assets for 2019 was 1.26% compared to 1.19% for 2018 and 0.99% for 2017, and
return on average equity for 2019 was 11.13% compared to 11.46% for 2018 and
9.37% for 2017.
· Efficiency ratio - The Company's efficiency ratio (defined as noninterest
expenses divided by net interest income plus noninterest income) was 62.9% for
2019 compared to 64.6% for 2018 and 63.8% for 2017.
· Asset quality - Net loan charge-offs decreased from
average loans outstanding decreased from 0.17% for both 2017 and 2018 to 0.09%
for 2019. In addition, total nonperforming assets (consisting of nonperforming
loans and foreclosed real estate) decreased from
total assets, at
at
outstanding loans and 284.6% of nonperforming loans at
compared to 0.93% of total outstanding loans and 133.0% of nonperforming loans
atDecember 31, 2018 .
· Shareholder return - Total shareholder return, including the increase in the
Company's stock price from
31, 2019 and dividends of
for 2018 and 16.0% for 2017.
Management's discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of the Company and the Bank. The information contained in this section should be read in conjunction with the consolidated financial statements and the accompanying Notes to Consolidated Financial Statements
included in this report.
42
Operating Strategy
The Company is the parent company of an independent community-oriented financial
institution that delivers quality customer service and offers a wide range of
deposit, loan and investment products to its customers. The commitment to
customer needs, the focus on providing consistent customer service, and
community service and support are the keys to the Bank's past and future
success. The Company has no other material income other than that generated by
the Bank and its subsidiaries.
The Bank's primary business strategy is attracting deposits from the general
public and using those funds to originate residential mortgage loans,
multi-family residential loans, commercial real estate and business loans and
consumer loans. The Bank invests excess liquidity primarily in interest-bearing
deposits with the FHLB and other financial institutions, federal funds sold,
U.S. government and agency securities, local municipal obligations and
mortgage-backed securities.
In recent years, the Company's operating strategy has also included strategies
designed to enhance profitability by increasing sources of noninterest income
and improving operating efficiency while managing its capital and limiting its
credit risk and interest rate risk exposures. To accomplish these objectives,
the Company has focused on the following:
· Monitoring asset quality and credit risk in the loan and investment portfolios,
with an emphasis on reducing nonperforming assets and originating high-quality
commercial and consumer loans. In 2020, management will continue to focus on
maintaining the reduced level of nonperforming assets through improved collection efforts and underwriting on nonperforming loans.
· Being active in the local community, particularly through our efforts with
local schools, to uphold our high standing in our community and marketing to
our next generation of customers.
· Improving profitability by expanding our product offerings to customers and
leveraging recent investments in technology to increase the productivity and
efficiency of our staff.
· Continuing to emphasize commercial real estate and other commercial business
lending as well as consumer lending. The Bank will also continue to focus on
increasing secondary market lending as a source of noninterest income.
Management intends to continue to focus on growth in the loan portfolio and the
secondary market lending programs in and around the newest markets entered,
Bullitt County, Kentucky andClark County, Indiana .
· Growing commercial and personal demand deposit accounts which provide a
low-cost funding source.
· Continuing to evaluate vendor contracts for potential cost savings and
efficiencies.
· Continuing our capital management strategy to enhance shareholder value through
the repurchase of Company stock and the payment of dividends.
· Evaluating growth opportunities to expand the Bank's market area and market
share through acquisitions of other financial institutions or branches of other
institutions. The acquisition of Peoples in
area into
account market share among
Ridge office in
continue the enhancement and expansion of our customer relationships in these
new markets.
· Ensuring that the Company attracts and retains talented personnel and that an
optimal level of performance and customer service is promoted at all levels of
the Company.
43
Critical Accounting Policies and Estimates
The accounting and reporting policies of the Company comply withU.S. GAAP and conform to general practices within the banking industry. The preparation of financial statements in conformity withU.S. GAAP requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions, which are integral to understanding reported results. Critical accounting policies are those policies that require management to make assumptions about matters that are highly uncertain at the time an accounting estimate is made; and different estimates that the Company reasonably could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the Company's financial condition, changes in financial condition or results of operations. Most accounting policies are not considered by management to be critical accounting policies. Several factors are considered in determining whether or not a policy is critical in the preparation of financial statements. These factors include, among other things, whether the estimates are significant to the financial statements, the nature of the estimates, the ability to readily validate the estimates with other information including third parties or available prices, and sensitivity of the estimates to changes in economic conditions and whether alternative accounting methods may be utilized underU.S. GAAP.
Significant accounting policies, including the impact of recent accounting pronouncements, are discussed in Note 1 of the accompanying Notes to Consolidated Financial Statements. Those policies considered to be critical accounting policies are described below.
Allowances for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impacted loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the IDFI andFDIC , as an integral part of their examination process, periodically reviews our allowance for loan losses and may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. Note 1 and Note 4 of the accompanying Notes to Consolidated Financial Statements describe the methodology used to determine the allowance for loan losses. The Company has not made any substantive changes to its methodology for determining the allowance for loan losses during the year endedDecember 31, 2019 , but management does review (and modify as necessary) the qualitative factors used in the estimate of the allowance for loan losses on a quarterly basis. Valuation Methodologies. In the ordinary course of business, management applies various valuation methodologies to assets and liabilities that often involve a significant degree of judgment, particularly when active markets do not exist for the items being valued. Generally, in evaluating various assets for potential impairment, management compares the fair value to the carrying value. Quoted market prices are referred to when estimating fair values for certain assets, such as certain investment securities. For investment securities for which quoted market prices are not available, the Company obtains fair value measurements from an independent pricing service. However, for those items for which market-based prices do not exist and an independent pricing service is not readily available, management utilizes significant estimates and assumptions to value such items. Examples of these items include goodwill and other intangible assets, acquired loans and deposits, foreclosed and other repossessed assets, impaired loans, stock-based compensation and certain other financial investments. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Company's results of operations. Note 19 of the accompanying Notes to Consolidated Financial Statements describes the methodologies used to determine the fair value of investment securities, impaired loans, loans held for sale and foreclosed real estate. There were no changes in the valuation techniques and related inputs used during the year endedDecember 31, 2019 . 44
Results of Operations for the Year Ended
Net Income.Net income attributable to the Company was$10.3 million ($3.09 per share diluted; weighted average common shares outstanding of 3,344,072, as adjusted) for the year endedDecember 31, 2019 compared to$9.3 million ($2.77 per share diluted; weighted average common shares outstanding of 3,335,394, as adjusted) for the year endedDecember 31, 2018 . Net Interest Income. Net interest income increased$2.8 million , or 10.3%, from$27.3 million for 2018 to$30.1 million for 2019 primarily due to increases in the average balance of interest-earning assets and the interest rate spread, the difference between the average tax-equivalent yield on interest-earning assets and the average cost of interest-bearing liabilities. Total interest income increased$3.2 million for 2019 as compared to 2018. This increase was primarily a result of increases in the tax-equivalent yield on interest-earning assets from 4.01% for 2018 to 4.28% for 2019 and in the average balance of interest-earning assets from$730.5 million for 2018 to$760.8 million for 2019. The increase in the average balance of interest-earning assets in 2019 was primarily attributable to continued growth in loans and partially offset by continued declining balances in investment securities. Interest on loans increased$2.9 million as a result of the average balance of loans increasing from$423.6 million for 2018 to$465.4 million for 2019 and the average tax-equivalent yield on loans increasing from 5.39% for 2018 to 5.54% for 2019. Interest and dividends on investment securities (including FHLB stock) increased$144,000 for 2019 compared to 2018 due to an increase in the tax equivalent yield on investment securities from 2.13% in 2018 to 2.29% in 2019, partially offset by a decrease in the average balance of investment securities from$267.4 million for 2018 to$258.0 million for 2019. Other interest income increased$96,000 for 2019 as compared to 2018 primarily due to the tax equivalent yield of federal funds sold and interest-bearing deposits with banks increasing from 1.92% to 2.29% when comparing the two periods. Total interest expense increased$349,000 , from$1.6 million for 2018 to$2.0 million for 2019, due to increases in the average balance of interest-bearing liabilities from$552.2 million for 2018 to$567.6 million for 2019 and in the average cost of interest-bearing liabilities from 0.29% for 2018 to 0.35% for 2019. Included in the interest-bearing liabilities were borrowed funds with an average balance of$1.2 million for 2018 and an average cost of 1.78%. There were no borrowed funds during 2019. For further information, see "Average Balances and Yields" below. The changes in interest income and interest expense resulting from changes in volume and changes in rates for 2019 and 2018 are shown in the schedule captioned "Rate/Volume Analysis" included herein. Provision for Loan Losses. The provision for loan losses was$1.4 million for 2019 compared to$1.2 million for 2018. The consistent application of management's allowance methodology resulted in an increase in the provision for loan losses for 2019, primarily due to the loan portfolio growth during the year. Total outstanding loans increased by$33.2 million during 2019 as compared to an increase of$25.0 million during 2018. Net charge-offs decreased from$737,000 for 2018 to$429,000 for 2019, and nonperforming loans decreased from$3.1 million atDecember 31, 2018 to$1.8 million atDecember 31, 2019 . The provisions were recorded to bring the allowance to the level determined in applying the allowance methodology after reduction for net charge-offs during the year. Provisions for loan losses are charges to earnings to maintain the total allowance for loan losses at a level considered reasonable by management to provide for probable known and inherent loan losses based on management's evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specified impaired loans and economic conditions. Although management uses the best information available, future adjustments to the allowance may be necessary due to changes in economic, operating, regulatory and other conditions that may be beyond the Bank's control. While the Bank maintains the allowance for loan losses at a level that it considers adequate to provide for estimated losses, there can be no assurance that further additions will not be made to the allowance for loan losses and that actual losses will not exceed the estimated amounts. 45 Noninterest income.Noninterest income increased$758,000 to$6.9 million for 2019 due to increases in ATM and debit card fees and unrealized gains on equity securities of$248,000 and$239,000 , respectively. There was also a loss on a tax credit investment of$270,000 recorded in 2018. Those changes were partially offset by an$89,000 decrease in service charges on customer accounts during 2019. Noninterest expense.Noninterest expense increased$1.7 million , to$23.3 million for 2019 primarily due to increases in compensation and benefits expense of$1.4 million and data processing expense of$458,000 when comparing the two periods. Compensation and benefits expense increased primarily due to normal salaries and benefits increases and an increase in stock compensation expense. A significant factor in the increase in data processing expense during 2019 was the rollout of the Bank's new digital platform in the fourth quarter of 2019 and the associated costs, including termination fees from the previous platform provider. Income tax expense. Tax expense increased$593,000 for 2019 to$2.0 million primarily due to an increase in taxable income and a reduction in benefits from a tax credit entity. As a result, the effective tax rate increased from 13.1% for 2018 to 16.1% for 2019. See Note 12 of the accompanying Notes to Consolidated Financial Statements for additional details on the Company's income tax expense.
Results of Operations for the Year Ended
Net Income.Net income attributable to the Company was$9.3 million ($2.77 per share diluted; weighted average common shares outstanding of 3,335,394, as adjusted) for the year endedDecember 31, 2018 compared to$7.4 million ($2.23 per share diluted; weighted average common shares outstanding of 3,329,563, as adjusted) for the year endedDecember 31, 2017 . Net Interest Income. Net interest income increased$2.2 million , or 9.0%, from$25.0 million for 2017 to$27.3 million for 2018 primarily due to increases in the average balance of interest-earning assets and the interest rate spread, the difference between the average tax-equivalent yield on interest-earning assets and the average cost of interest-bearing liabilities. Total interest income increased$2.5 million for 2018 as compared to 2017. This increase was primarily a result of increases in the tax-equivalent yield on interest-earning assets from 3.84% for 2017 to 4.01% for 2018 and in the average balance of interest-earning assets from$708.4 million for 2017 to$730.5 million for 2018. The increase in the average balance of interest-earning assets in 2018 was primarily attributable to growth in loans and partially offset by declining balances in investment securities. Interest on loans increased$2.1 million as a result of the average balance of loans increasing from$399.8 million for 2017 to$423.6 million for 2018 and the average tax-equivalent yield on loans increasing from 5.19% for 2017 to 5.39% for 2018. Interest and dividends on investment securities (including FHLB stock) decreased$42,000 for 2018 compared to 2017 due to a decrease in the average balance of investment securities from$275.8 million for 2017 to$267.4 million for 2018. The tax equivalent yield on investment securities decreased from 2.21% for 2017 to 2.13% for 2018 primarily due to the effect of the Tax Cuts and Jobs Act ("TCJA") signed into law onDecember 22, 2017 which resulted in a decrease in the tax-effective yield on tax-exempt securities. Other interest income increased$388,000 for 2018 as compared to 2017 primarily due to the tax equivalent yield of federal funds sold and interest-bearing deposits with banks increasing from 1.13% to 1.92% when comparing the two periods as a result of increases in short-term market interest rates. Total interest expense increased$219,000 , from$1.4 million for 2017 to$1.6 million for 2018, due to increases in the average balance of interest-bearing liabilities from$541.5 million for 2017 to$552.2 million for 2018 and in the average cost of interest-bearing liabilities from 0.26% for 2017 to 0.29% for 2018. Included in the interest-bearing liabilities were borrowed funds with an average balance of$1.2 million for both 2018 and 2017 and an average cost 1.78% and 1.52%, respectively, for 2018 and 2017. For further information, see "Average Balances and Yields" below. The changes in interest income and interest expense resulting from changes in volume and changes in rates for 2018 and 2017 are shown in the schedule captioned "Rate/Volume Analysis" included herein.
46
Provision for Loan Losses. The provision for loan losses was $1.2 million for
2018 compared to $915,000 for 2017. The consistent application of management's
allowance methodology resulted in an increase in the provision for loan losses
for 2018, primarily due to the loan portfolio growth during the year and
increased net charge-offs. Total outstanding loans increased by $25.0 million
during 2018 as compared to an increase of $28.5 million during 2017. Net
charge-offs increased from $667,000 for 2017 to $737,000 for 2018 when comparing
the two periods, and nonperforming loans increased from $2.8 million at December
31, 2017 to $3.1 million at December 31, 2018 . The provisions were recorded to
bring the allowance to the level determined in applying the allowance
methodology after reduction for net charge-offs during the year.
Provisions for loan losses are charges to earnings to maintain the total
allowance for loan losses at a level considered reasonable by management to
provide for probable known and inherent loan losses based on management's
evaluation of the collectability of the loan portfolio, including the nature of
the portfolio, credit concentrations, trends in historical loss experience,
specified impaired loans and economic conditions. Although management uses the
best information available, future adjustments to the allowance may be necessary
due to changes in economic, operating, regulatory and other conditions that may
be beyond the Bank's control. While the Bank maintains the allowance for loan
losses at a level that it considers adequate to provide for estimated losses,
there can be no assurance that further additions will not be made to the
allowance for loan losses and that actual losses will not exceed the estimated
amounts.
Noninterest income.Noninterest income decreased $530,000 to $6.2 million for
2018 due to decreases in gains on the sale of loans and gains on the sale of
securities of $285,000 and $149,000 , respectively, as well as a loss on equity
securities of $207,000 and an impairment loss on a tax credit investment of
$270,000 recorded in 2018. Those charges were partially offset by a $235,000
increase in ATM and debit card fees during 2018.
Noninterest expense.Noninterest expense increased $1.4 million , to $21.6 million
for 2018 primarily due to increases in compensation and benefits expense of
$534,000 and data processing expense of $351,000 when comparing the two periods.
Net loss on foreclosed real estate and occupancy and equipment expense also
increased $160,000 and $117,000 , respectively, when comparing the two periods.
Compensation and benefits expense increased primarily due to normal salaries and
benefits increases and an increase in stock compensation expense. Data
processing expense increased primarily due to increased customer activity,
particularly related to ATM and electronic banking usage.
Income tax expense. Tax expense decreased from $3.1 million for 2017 to $1.4
million for 2018 primarily due to the TCJA and the Bank's investments in tax
credit entities during 2018. In addition, the Company recognized an additional
$290,000 in income tax expense during 2017 related to the revaluation of the
Company's net deferred tax assets at the new federal corporate tax rate of 21%.
As a result, the effective tax rate decreased from 29.4% for 2017 to 13.1%
for
2018.
47
Average Balances and Yields. The following table sets forth certain information
for the periods indicated regarding average balances of assets and liabilities,
as well as the total dollar amounts of interest income from average
interest-earnings assets and interest expense on average interest-bearing
liabilities and average yields and costs. Such yields and costs for the periods
indicated are derived by dividing income or expense by the average historical
cost balances of assets or liabilities, respectively, for the periods presented
and do not give effect to changes in fair value that are included as a separate
component of stockholders' equity. Average balances are derived from daily
balances. Tax-exempt income on loans and investment securities has been adjusted
to a tax equivalent basis using the federal marginal tax rate of 21% for 2019
and 2018 and 34% for 2017.
Year Ended December 31,
2019 2018 2017
Average Average Average
(Dollars in thousands) Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
Interest-earning assets:
Loans (1) (2)(3):
Taxable $ 461,191 $ 25,635 5.56 % $ 418,800 $ 22,693 5.42 % $ 396,898 $ 20,625 5.20 %
Tax-exempt 4,190 141 3.37 % 4,810 157 3.26 % 2,914 114 3.91 %
Total loans 465,381 25,776 5.54 % 423,610 22,850 5.39 % 399,812 20,739 5.19 %
Investment securities:
Taxable (4) 192,567 3,746 1.95 % 207,901 3,853 1.85 % 217,072 3,913 1.80 %
Tax-exempt 65,441 2,159 3.30 % 59,496 1,842 3.10 % 58,720 2,177 3.71 % Total investment securities 258,008 5,905 2.29 % 267,397 5,695 2.13 % 275,792 6,090 2.21 %
Other interest-earning assets (5) 37,387 856 2.29 % 39,485 760 1.92 % 32,799 372 1.13 % Total interest-earning assets 760,776 32,537 4.28 % 730,492 29,305 4.01 % 708,403 27,201 3.84 % Noninterest-earning assets 55,844 48,613 46,512 Total assets$ 816,620 $ 779,105 $ 754,915 Interest-bearing liabilities: Interest-bearing demand deposits$ 321,647 $ 912 0.28 %$ 307,052 $ 784 0.26 %$ 296,345 $ 599 0.20 % Savings accounts 177,648 305 0.17 % 173,693 321 0.18 % 164,859 339 0.21 % Time deposits 68,276 743 1.09 % 70,251 485 0.69 % 79,098 436 0.55 % Total deposits 567,571 1,960 0.35 % 550,996 1,590 0.29 % 540,302 1,374 0.25 % Borrowed funds 0 0 0.00 % 1,178 21 1.78 % 1,185 18 1.52 % Total interest-bearing liabilities 567,571 1,960 0.35 % 552,174 1,611 0.29 % 541,487 1,392 0.26 % Noninterest-bearing liabilities: Noninterest-bearing deposits 150,426 141,422 131,260 Other liabilities 5,834 4,736 2,798 Total liabilities 723,831 698,332 675,545 Stockholders' equity (6) 92,789 80,773 79,370 Total liabilities and stockholders' equity$ 816,620 $ 779,105 $ 754,915 Net interest income (tax equivalent basis)$ 30,577 $ 27,694 $ 25,809 Less: tax equivalent adjustment (483 ) (419 ) (779 ) Net interest income$ 30,094 $ 27,275 $ 25,030 Interest rate spread (tax equivalent basis) 3.93 % 3.72 % 3.58 % Net interest margin (tax equivalent basis) 4.02 % 3.79 % 3.64 % Ratio of average interest - earning assets to average interest-bearing liabilities 134.04 %
132.29 % 130.83 %
(1) Interest income on loans includes fee income of $1,027,000 , $984,000 and $984,000 for the years ended December 31, 2019 , 2018, and 2017, respectively.
(2) Average loan balances include loans held for sale and nonperforming loans.
(3) Interest income on loans includes net accretion on acquired loans of $44,000 , $149,000 and $124,000 for the years ended December 31, 2019 , 2018 and 2017,
respectively.
(4) Includes taxable debt securities and FHLB stock.
(5) Includes interest-bearing deposits with banks, money market funds, federal funds sold and interest-bearing time deposits.
(6) Stockholders' equity attributable to
48
Rate/Volume Analysis.The following table sets forth the effects of changing
rates and volumes on net interest income and interest expense computed on a
tax-equivalent basis. Information is provided with respect to (i) effects on
interest income attributable to changes in volume (changes in volume multiplied
by prior rate); (ii) effects attributable to changes in rate (changes in rate
multiplied by prior volume); and (iii) effects attributable to changes in rate
and volume (change in rate multiplied by changes in volume). Tax exempt income
on loans and investment securities has been adjusted to a tax-equivalent basis
using the federal marginal tax rate of 21% for 2019 and 2018 and 34% for 2017.
2019 Compared to 2018 2018 Compared to 2017
Increase (Decrease) Due to Increase (Decrease) Due to
Rate/ Rate/
Rate Volume Volume Net Rate Volume Volume Net
(In thousands)
Interest-earning assets:
Loans:
Taxable $ 586 $ 2,297 $ 59 $ 2,942 $ 875 $ 1,145 $ 48 $ 2,068
Tax-exempt 5 (20 ) (1 ) (16 ) (19 ) 74 (12 ) 43
Total loans 591 2,277 58 2,926 856 1,219 36 2,111
Investment securities:
Taxable 200 (292 ) (15 ) (107 ) 109 (164 ) (5 ) (60 )
Tax-exempt 119 186 12 317 (359 ) 29 (5 ) (335 )
Total investment securities 319 (106 ) (3 ) 210 (250 ) (135 ) (10 ) (395 )
Other interest-earning
assets 145 (41 ) (8 ) 96 259 76 53 388
Total net change in income
on interest- earning assets 1,055 2,130 47 3,232 865 1,160 79 2,104
Interest-bearing
liabilities:
Interest-bearing deposits 317 43 10 370 191 21 4 216
Borrowed funds (21 ) (21 ) 21 (21 ) 3 0 0 3
Total net change in expense
on interest- bearing
liabilities 296 22 31 349 194 21 4 219
Net change in net interest
income (tax equivalent
basis) $ 759 $ 2,108 $ 16 $ 2,883 $ 671 $ 1,139 $ 75 $ 1,885
49
Comparison of Financial Condition at
Total assets increased from
Net loans increased from$434.3 million atDecember 31, 2018 to$466.5 million atDecember 31, 2019 . The primary contributing factor to the increase in net loans was an increase of$14.1 million in commercial real estate loans. The Bank also increased commercial business loans, other consumer loans and construction loans by$9.0 million ,$7.8 million and$7.2 million , respectively, during 2019. Residential mortgage loans decreased$4.5 million during 2019 as the Bank continued to sell the majority of newly originated residential mortgage loans in the secondary market. The Bank originated$70.8 million in new residential mortgages for sale in the secondary market during 2019 compared to$54.3 million in 2018. These loans were originated and funded by the Bank for sale in the secondary market. Of the total originations for 2019,$13.7 million paid off existing loans in the Bank's portfolio. Originating mortgage loans for sale in the secondary market allows the Bank to better manage its interest rate risk, while offering a full line of mortgage products to prospective customers. Securities available for sale, at fair value, consisting primarily ofU.S. agency mortgage-backed securities and collateralized mortgage obligations,U.S. agency notes and bonds, and municipal obligations, decreased from$261.8 million atDecember 31, 2018 to$254.6 million atDecember 31, 2019 . Purchases of securities available for sale totaled$69.3 million in 2019. These purchases were more than offset by maturities of$30.6 million , principal repayments of$29.7 million and sales of$21.7 million in 2019. The Bank invests excess cash in securities that provide safety, liquidity and yield. Accordingly, we purchase mortgage-backed securities to provide cash flow for loan demand and deposit changes, we purchase federal agency notes for short-term yield and low risk, and municipals are purchased to improve our tax equivalent yield focusing on longer term profitability.
Cash and cash equivalents increased from
Foreclosed real estate decreased from
Total deposits increased
There were no outstanding borrowings at
Total stockholders' equity attributable to the Company increased$13.0 million from$85.8 million atDecember 31, 2018 to$98.8 million atDecember 31, 2019 . This increase is primarily the result of retained net income of$7.1 million and a net unrealized gain on available for sale securities of$5.6 million due to changes in the yield curve and long-term rate forecasts. As ofDecember 31, 2019 , the Company had repurchased 99,117 shares of the 240,467 shares authorized by the Board of Directors under the current stock repurchase program which was announced inAugust 2008 and 427,651 shares since the original repurchase program began in 2001. 50
Off-Balance-Sheet Arrangements
The Company is a party to financial instruments with off-balance-sheet risk including commitments to extend credit under existing lines of credit and commitments to originate loans. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements.
Off-balance-sheet financial instruments whose contract amounts represent credit and interest rate risk are summarized as follows:
At December 31,
2019 2018
(In thousands)
Commitments to originate new loans$ 14,246 $
5,876
Undisbursed portion of construction loans 23,081
26,675
Unfunded commitments to extend credit under
existing commercial and personal lines of credit 83,725
80,582 Standby letters of credit 473 1,295
The Company does not have any special purpose entities, derivative financial instruments or other forms of off-balance-sheet financing arrangements.
Commitments to originate new loans or to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Most equity line commitments are for a term of five to 10 years and commercial lines of credit are generally renewable on an annual basis. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amounts of collateral obtained, if deemed necessary by the Company upon extension of credit, are based on management's credit evaluation of the borrower. Contractual Obligations
The following table summarizes information regarding the Company's contractual
obligations as of
Payments due by period
More than
Total Less than 1 Year 1 - 3 Years 3 - 5 Years 5 Years
(In thousands)
Deposits $ 722,177 $ 687,182 $ 23,864 $ 11,131 $ 0
Operating lease obligations 5 5 0 0 0
Total contractual obligations $ 722,182 $ 687,187 $ 23,864 $ 11,131 $ 0
51
Liquidity and Capital Resources
Liquidity refers to the ability of a financial institution to generate sufficient cash flow to fund current loan demand, meet deposit withdrawals and pay operating expenses. The Bank's primary sources of funds are new deposits, proceeds from loan repayments and prepayments and proceeds from the maturity of securities. The Bank may also borrow from the FHLB. While loan repayments and maturities of securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by market interest rates, general economic conditions and competition. AtDecember 31, 2019 , the Bank had cash and interest-bearing deposits with banks (including interest-bearing time deposits) of$57.9 million and securities available for sale with a fair value of$254.6 million . If the Bank requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB, collateral eligible for repurchase agreements and unsecured federal funds purchased lines of credit with other financial institutions. The Bank must maintain an adequate level of liquidity to ensure the availability of sufficient funds to support loan growth and deposit withdrawals, to satisfy financial commitments and to take advantage of investment opportunities. AtDecember 31, 2019 , the Bank had total commitments to extend credit of$121.5 million . See Note 16 in the accompanying Notes to Consolidated Financial Statements. AtDecember 31, 2019 , the Bank had certificates of deposit scheduled to mature within one year of$33.9 million . Historically, the Bank has been able to retain a significant amount of its deposits as they mature. The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company requires funds to pay any dividends to its shareholders and to repurchase any shares of its common stock. The Company's primary source of income is dividends received from the Bank and the Captive. The amount of dividends the Bank may declare and pay to the Company in any calendar year, without the receipt of prior approval from the banking regulators, cannot exceed net income for that year to date plus retained net income (as defined) for the preceding two calendar years. AtDecember 31, 2019 , the Company (on an unconsolidated basis) had liquid assets of$3.8 million . The Bank is required to maintain specific amounts of capital pursuant to regulations. As ofDecember 31, 2019 the Bank was in compliance with all regulatory capital requirements which were effective as of such date with Tier 1 capital to average assets, Tier 1 capital to risk-weighted assets, common equity Tier 1 capital to risk-weighted assets and total risk-based capital to risk-weighted assets ratios of 10.0%, 14.0%, 14.0% and 14.9%, respectively. See Note 18 in the accompanying Notes to Consolidated Financial Statements.
Effect of Inflation and Changing Prices
The consolidated financial statements and related financial data presented in this report have been prepared in accordance withU.S. GAAP, which generally require the measurement of financial position and operating results in terms of historical dollars, without considering the changes in relative purchasing power of money over time due to inflation. The primary impact of inflation is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of the financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. Market Risk Analysis Qualitative Aspects of Market Risk. Market risk is the risk that the estimated fair value of our assets and liabilities will decline as a result of changes in interest rates or financial market volatility, or that our net income will be significantly reduced by interest rate changes. 52 The Company's principal financial objective is to achieve long-term profitability while reducing its exposure to fluctuating market interest rates by operating within acceptable limits established for interest rate risk and maintaining adequate levels of funding and liquidity. The Company has sought to reduce the exposure of its earnings to changes in market interest rates by attempting to manage the mismatch between asset and liability maturities and interest rates. In order to reduce the exposure to interest rate fluctuations, the Company has developed strategies to manage its liquidity, shorten its effective maturities of certain interest-earning assets and decrease the interest rate sensitivity of its asset base. Management has sought to decrease the average maturity of its assets by emphasizing the origination of short-term commercial and consumer loans, all of which are retained by the Company for its portfolio. The Company relies on retail deposits as its primary source of funds. Management believes the use of retail deposits, compared to brokered deposits, reduces the effects of interest rate fluctuations because they generally represent a more stable source of funds. Quantitative Aspects of Market Risk. The Company does not maintain a trading account for any class of financial instrument nor does the Company engage in hedging activities or purchase high-risk derivative instruments. Furthermore, the Company is not subject to foreign currency exchange rate risk or commodity price risk.
Potential cash flows, sales, or replacement value of many of our assets and liabilities, especially those that earn or pay interest, are sensitive to changes in the general level of interest rates. This interest rate risk arises primarily from our normal business activities of gathering deposits, extending loans and investing in investment securities. Many factors affect the Company's exposure to changes in interest rates, such as general economic and financial conditions, customer preferences, historical pricing relationships, and re-pricing characteristics of financial instruments. The Company's earnings can also be affected by the monetary and fiscal policies of theU.S. Government and its agencies, particularly the FRB. An element in the Company's ongoing process is to measure and monitor interest rate risk using a Net Interest Income at Risk simulation to model the interest rate sensitivity of the balance sheet and to quantify the impact of changing interest rates on the Company. The model quantifies the effects of various possible interest rate scenarios on projected net interest income over a one-year horizon. The model assumes a semi-static balance sheet and measures the impact on net interest income relative to a base case scenario of hypothetical changes in interest rates over twelve months and provides no effect given to any steps that management might take to counter the effect of the interest rate movements. The scenarios include prepayment assumptions, changes in the level of interest rates, the shape of the yield curve, and spreads between market interest rates in order to capture the impact from re-pricing, yield curve, option, and basis risks. Results of the Company's simulation modeling, which assumes an immediate and sustained parallel shift in market interest rates, project that the Company's net interest income could change as follows over a one-year horizon, relative to our base case scenario, based onDecember 31, 2019 and 2018 financial information. At December 31, 2019 At December 31, 2018 Immediate Change One Year Horizon One Year Horizon in the Level Dollar Percent Dollar Percent of Interest Rates Change Change Change Change (Dollars in thousands) 300bp$ 3,438 11.59 %$ 790 2.91 % 200bp 2.392 8.07 318 1.17 100bp 1,289 4.35 176 0.65 Static - - - - (100)bp (1,562 ) (5.27 ) 876 3.23 (200)bp (2,853 ) (9.62 ) 139 0.51 53 AtDecember 31, 2019 , the Company's simulated exposure to an increase in interest rates shows that an immediate and sustained increase in rates of 1.00%, 2.00% or 3.00% would increase the Company's net interest income over a one year horizon compared to a flat interest rate scenario. Alternatively, atDecember 31, 2019 , an immediate and sustained decrease in rates of 1.00% or 2.00% would decrease the Company's net interest income over a one year horizon compared to a flat interest rate scenario. AtDecember 31, 2018 , all scenarios described would have resulted in an increase of the Company's net interest income over a one year horizon compared to a flat interest rate scenario. During the year endedDecember 31, 2019 , the Company updated the discount rates and betas used in its interest rate risk model for loans and deposits to better reflect the market, and also updated the deposit decay rates based on a third-party study of customer accounts. The Company also has longer term interest rate risk exposure, which may not be appropriately measured by Net Interest Income at Risk modeling. Therefore, the Company also uses an Economic Value of Equity ("EVE") interest rate sensitivity analysis in order to evaluate the impact of its interest rate risk on earnings and capital. This is measured by computing the changes in net EVE for its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. EVE modeling involves discounting present values of all cash flows for on and off balance sheet items under different interest rate scenarios and provides no effect given to any steps that management might take to counter the effect of the interest rate movements. The discounted present value of all cash flows represents the Company's EVE and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. The amount of base case EVE and its sensitivity to shifts in interest rates provide a measure of the longer term re-pricing and option risk in the balance sheet. Results of the Company's simulation modeling, which assumes an immediate and sustained parallel shift in market interest rates, project that the Company's EVE could change as follows, relative to the Company's base case scenario, based onDecember 31, 2019 and 2018 financial information. At December 31, 2019 Immediate Change Economic Value of Equity Economic Value of Equity as a in the Level Dollar Dollar Percent Percent of Present Value of Assets of Interest Rates Amount Change Change EVE Ratio Change (Dollars in thousands) 300bp$ 203,781 $ 56,973 38.81 % 25.40 % 773 bp 200bp 187,704 40,896 27.86 23.10 543 bp 100bp 168,710 21,902 14.92 20.52 285 bp Static 146,808 - - 17.67 - bp (100)bp 123,104 (23,704 ) (16.15 ) 14.64 (303 )bp (200)bp 101,568 (45,240 ) (30.82 ) 11.89 (578 )bp At December 31, 2018 Immediate Change Economic Value of Equity Economic Value of Equity as a in the Level Dollar Dollar Percent Percent of Present Value of Assets of Interest Rates Amount Change Change EVE Ratio Change (Dollars in thousands) 300bp$ 106,468 $ 3,885 3.79 % 14.67 % 142 bp 200bp 106,176 3,593 3.50 14.31 106 bp 100bp 104,978 2,395 2.33 13.85 60 bp Static 102,583 - - 13.25 - bp (100)bp 102,230 (353 ) (0.34 ) 12.95 (30 )bp (200)bp 93,763 (8,820 ) (8.60 ) 11.63 (162 )bp 54
The previous tables indicate that atDecember 31, 2019 and 2018 the Company would expect an increase in its EVE in the event of a sudden and sustained 100, 200 or 300 basis point increase in prevailing interest rates and a decrease in its EVE in the event of a sudden and sustained 100 or 200 basis point decrease in prevailing interest rates. As previously mentioned in this report, during the year endedDecember 31, 2019 , the Company updated the discount rates and betas used in its interest rate risk model for loans and deposits to better reflect the market, and also updated the deposit decay rates based on a third-party study of customer accounts. The models are driven by expected behavior in various interest rate scenarios and many factors besides market interest rates affect the Company's net interest income and EVE. For this reason, the Company models many different combinations of interest rates and balance sheet assumptions to understand its overall sensitivity to market interest rate changes. Therefore, as with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing tables and it is recognized that the model outputs are not guarantees of actual results. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that restrict changes in interest rates on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, expected rates of prepayments on loans and early withdrawals from certificates of deposit could deviate significantly from those assumed in the modeling scenarios.
Impact of Recent Accounting Pronouncements
For a discussion of the impact of recent accounting pronouncements, see Note 1 of the accompanying Notes to Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is incorporated herein by reference to the section captioned "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk Analysis" in this Annual Report on Form 10-K.
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