AMER NAT BKSHS The purpose of this discussion is to focus on important factors affecting the financial condition and results of operations of the Company. The discussion and analysis should be read in conjunction with the Consolidated Financial Statements. Forward-Looking Statements This report contains forward-looking statements with respect to the financial condition, results of operations and business ofAmerican National Bankshares Inc. (the "Company") and its wholly owned subsidiary,American National Bank and Trust Company (the "Bank"). These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of management of the Company and on information available to management at the time these statements and disclosures were prepared. Forward-looking statements are subject to numerous assumptions, estimates, risks, and uncertainties that could cause actual conditions, events, or results to differ materially from those stated or implied by such forward-looking statements. A variety of factors, some of which are discussed in more detail in Item 1A - Risk Factors of the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 , may affect the operations, performance, business strategy, and results of the Company. Those factors include, but are not limited to, the following:
• the impact of the ongoing COVID-19 pandemic and the associated efforts to
limit the spread of the virus;
• financial market volatility, including the level of interest rates, could
affect the values of financial instruments and the amount of net interest
income earned;
• the adequacy of the level of our allowance for loan losses and the amount of
loan loss provisions required in future periods;
• general economic or business conditions, either nationally or in the market
areas in which the Company does business, may be less favorable than expected,
resulting in deteriorating credit quality, reduced demand for credit, or a
weakened ability to generate deposits;
• competition among financial institutions may increase, and competitors may
have greater financial resources and develop products and technology that
enable those competitors to compete more successfully than the Company;
• businesses that the Company is engaged in may be adversely affected by
legislative or regulatory changes, including changes in accounting standards
and tax laws;
• cybersecurity threats or attacks, the implementation of new technologies, and
the ability to develop and maintain reliable and secure electronic systems;
• the ability to retain key personnel;
• the failure of assumptions underlying the allowance for loan losses; and
• risks associated with mergers and acquisitions and other expansion activities.
COVID-19 Impact and Response InMarch 2020 , the outbreak of COVID-19 was recognized as a global pandemic. The spread of the virus has created a global health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity inthe United States and globally. Governmental responses have included orders closing businesses not deemed essential and directing individuals to restrict their movements, observe social distancing and shelter in place. These actions, together with responses to the pandemic by all parties, have resulted in rapid decreases in commercial and consumer activity, temporary closures of many businesses that have led to a loss of revenues and a rapid increase in unemployment, disrupted supply chains, market downturns and volatility, changes in consumer behavior, related emergency response legislation and an expectation that theBoard of Governors of theFederal Reserve System ("Federal Reserve") will maintain a low interest rate environment for the foreseeable future. The Company has implemented a business continuity plan and protocols to continue to maintain a high level of care for its employees, customers and communities. The Company has transitioned to a majority of its non-branch employees working remotely and assisting customers by appointment only in branches or directing them to drive-thrus or ATMs. It has cancelled all business travel, and it now holds all Company meetings through virtual platforms. InMarch 2020 (revised inApril 2020 ), the federal banking agencies issued an "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus." This was in response to the COVID-19 pandemic affecting societies and economies around the world. This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19. The guidance explains that, in consultation with theFinancial Accounting Standards Board ("FASB") staff, the federal banking agencies have concluded that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not troubled debt restructurings ("TDRs"). The Coronavirus Aid, Relief and Economic Security ("CARES") Act was passed by theU.S. Congress onMarch 27, 2020 . Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were current as ofDecember 31, 2019 are not TDRs. The Bank implemented aDisaster Assistance Program ("DAP") to provide relief to its borrowers under this guidance. ThroughJune 30, 2020 , the Bank had applied this guidance and modified loans to over 729 customers on loan balances of approximately$395 million . As ofAugust 1, 2020 , the balance of loans remaining in this program was$219 million or 10.4% of the total portfolio as of that date. The majority of modifications involved three-month deferments of principal and interest. This interagency guidance is expected to have a material impact on the Company's financial statements; however, this impact cannot be quantified at this time. The CARES Act included an allocation of$659 billion for loans to be issued by financial institutions through theSmall Business Administration ("SBA"). This program is known as the Paycheck Protection Program ("PPP"). PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and a term of two years for all but$2 million which have a five year maturity, if not forgiven, in whole or in part. Payments are deferred for the first six months of the loan. The loans are 100% guaranteed by the SBA. The SBA pays the bank a processing fee ranging from 1% to 5%, based on the size of the loan. The SBA began accepting submissions for these loans onApril 3, 2020 . As ofAugust 1, 2020 , the SBA approved approximately 2,200 applications submitted by the Bank for loans in excess of$272 million . From a funding perspective, the Bank continues to utilize core funding sources for these loans. Management believes that these sources provide sufficient and timely liquidity, both on and off the balance sheet, to support the programs and operations. Reclassification
In certain circumstances, reclassifications have been made to prior period information to conform to the 2020 presentation. There were no material reclassifications.
33
--------------------------------------------------------------------------------CRITICAL ACCOUNTING POLICIES The accounting and reporting policies followed by the Company conform withU.S. generally accepted accounting principles ("GAAP") and they conform to general practices within the banking industry. The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them, as needed. Management has discussed the Company's critical accounting policies and estimates with the Audit Committee of the Board of Directors. The Company's critical accounting policies, which are summarized below, relate to (1) the allowance for loan losses, (2) mergers and acquisitions, (3) acquired loans with specific credit-related deterioration, (4) goodwill and intangible assets, (5) deferred tax assets and liabilities, and (6) other-than-temporary impairment of securities. A summary of the Company's significant accounting policies is set forth in Note 1 to the Consolidated Financial Statements contained in the Form 10-K for the year endedDecember 31, 2019 . The financial information contained within the Company's financial 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 earning income, recognizing an expense, recovering an asset, or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Allowance for Loan Losses
The purpose of the allowance for loan losses ("ALLL") is to provide for probable losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and by recoveries of previously charged-off loans. Loan charge-offs decrease the allowance.
The goal of the Company is to maintain an appropriate, systematic, and consistently applied process to determine the amounts of the ALLL and the provision for loan loss expense.
The Company uses certain practices to manage its credit risk. These practices include (1) appropriate lending limits for loan officers, (2) a loan approval process, (3) careful underwriting of loan requests, including analysis of borrowers, cash flows, collateral, and market risks, (4) regular monitoring of the portfolio, including diversification by type and geography, (5) review of loans by the Loan Review department, which operates independently of loan production, (6) regular meetings of the Credit Committee to discuss portfolio and policy changes and make decisions on large or unusual loan requests, and (7) regular meetings of the Asset Quality Committee which reviews the status of individual loans. Risk grades are assigned as part of the loan origination process. From time to time, risk grades may be modified as warranted by the facts and circumstances surrounding the credit.
Calculation and analysis of the ALLL is prepared quarterly by the
The Company's ALLL has two basic components: the formula allowance and the specific allowance. Each of these components is determined based upon estimates and judgments.
The formula allowance uses historical loss experience as an indicator of future losses, along with various qualitative factors, including levels and trends in delinquencies, nonaccrual loans, charge-offs and recoveries, trends in volume and terms of loans, effects of changes in underwriting standards, experience of lending staff, economic conditions, portfolio concentrations, regulatory, legal, competition, quality of loan review system, and value of underlying collateral. In the formula allowance for commercial and commercial real estate loans, the historical loss rate is combined with the qualitative factors, resulting in an adjusted loss factor for each risk-grade category of loans. The period-end balances for each loan risk-grade category are multiplied by the adjusted loss factor. Allowance calculations for residential real estate and consumer loans are calculated based on historical losses for each product category without regard to risk grade. This loss rate is combined with qualitative factors resulting in an adjusted loss factor for each product category.
The specific allowance uses various techniques to arrive at an estimate of loss for specifically identified impaired loans. These include:
• The present value of expected future cash flows discounted at the loan's
effective interest rate. The effective interest rate on a loan is the rate
of return implicit in the loan (that is, the contractual interest rate
adjusted for any net deferred loan fees or costs and any premium or discount
existing at the origination or acquisition of the loan);
• The loan's observable market price; or
• The fair value of the collateral, net of estimated costs to dispose, if the
loan is collateral dependent.
The use of these computed values is inherently subjective and actual losses could be greater or less than the estimates.
No single statistic, formula, or measurement determines the adequacy of the
allowance. Management makes subjective and complex judgments about matters that
are inherently uncertain, and different amounts would be reported under
different conditions or using different assumptions. For analytical purposes,
management allocates a portion of the allowance to specific loan categories and
specific loans. However, the entire allowance is used to absorb credit losses
inherent in the loan portfolio, including identified and unidentified losses.
The relationships and ratios used in calculating the allowance, including the
qualitative factors, may change from period to period as facts and circumstances
evolve. Furthermore, management cannot provide assurance that in any particular
period the Bank will not have sizable credit losses in relation to the amount
reserved. Management may find it necessary to significantly adjust the
allowance, considering current factors at the time.
34
--------------------------------------------------------------------------------
Mergers and Acquisitions
Business combinations are accounted for under the FASB Accounting Standards
Codification ("ASC") 805, Business Combinations, using the acquisition method of
accounting. The acquisition method of accounting requires an acquirer to
recognize the assets acquired and the liabilities assumed at the acquisition
date measured at their fair values as of that date. To determine the fair
values, the Company will rely on third party valuations, such as appraisals, or
internal valuations based on discounted cash flow analysis or other valuation
techniques. Under the acquisition method of accounting, the Company will
identify the acquirer and the closing date and apply applicable recognition
principles and conditions.
Acquisition-related costs are costs the Company incurs to effect a business
combination. Those costs include advisory, legal, accounting, valuation, and
other professional or consulting fees. Some other examples of costs to the
Company include systems conversions, integration planning consultants and
advertising costs. The Company will account for acquisition-related costs as
expenses in the periods in which the costs are incurred and the services are
received, with one exception. The costs to issue debt or equity securities will
be recognized in accordance with other applicable GAAP. These
acquisition-related costs have been and will be included within the consolidated
statements of income classified within the noninterest expense caption.
Acquired Loans with Specific Credit-Related Deterioration
Acquired loans with specific credit deterioration are accounted for by the Company in accordance with ASC 310-30, Receivables -Loans and Debt Securities Acquired with Deteriorated Credit Quality. Certain acquired loans, those for which specific credit-related deterioration, since origination, is identified, are recorded at fair value reflecting the present value of the amounts expected to be collected. Income recognition on these loans is based on a reasonable expectation about the timing and amount of cash flows to be collected. In accounting for purchased credit impaired loans, such loans are not classified as nonaccrual when they become 90 days past due. They are considered to be accruing because their interest income relates to the accretable yield and not to contractual interest payments.
The Company performs its annual analysis as ofJune 30 each fiscal year. Recently adopted ASU 2017-04 simplifies the accounting for goodwill impairment by requiring impairment charges to be based on the first step in the previous two-step impairment test. Under the new guidance, if a reporting unit's carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. The standard eliminates the prior requirement to calculate a goodwill impairment charge using Step 2, which requires an entity to calculate any impairment charge by comparing the implied fair value of goodwill with its carrying amount. No indicators of impairment were identified during the six months endedJune 30, 2020 or 2019.
Deferred Tax Assets and Liabilities
The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is "more likely than not" that all or a portion of the deferred tax asset will not be realized. "More likely than not" is defined as greater than a 50% chance. Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed.
Other-than-temporary Impairment of Securities
Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (1) the Company intends to sell the security or (2) it is more-likely-than-not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more-likely-than-not that it will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. Non-GAAP Presentations Non-GAAP presentations are provided because the Company believes these may be valuable to investors. These include (1) the analysis of net interest income presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets and (2) the calculation of the efficiency ratio.
Internet Access to Corporate Documents
The Company provides access to itsSecurities and Exchange Commission ("SEC") filings through a link on the Investor Relations page of the Company's website at www.amnb.com. Reports available include annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the reports are filed electronically with theSEC . The information on the Company's website is not incorporated into this report or any other filing the Company makes with theSEC . TheSEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with theSEC at www.sec.gov. Completed Acquisition OnApril 1, 2019 , the Company announced the completion of its acquisition ofHomeTown Bankshares Corporation ("HomeTown"). The combination deepens the Company's footprint in theRoanoke, Virginia metropolitan area and creates a presence in theNew River Valley with an office inChristiansburg, Virginia . After completion of the merger and with two office consolidations and one office closure, the Company has seven offices in the combinedRoanoke/New River Valley market area. As a result of the merger, the holders of shares of HomeTown common stock received 0.4150 shares of the Company's common stock for each share of HomeTown common stock held immediately prior to the effective date of the merger. Following completion of the merger, HomeTown's subsidiary bank,HomeTown Bank , was merged with and into the Bank. 35 --------------------------------------------------------------------------------
RESULTS OF OPERATIONS Executive Overview
Second quarter 2020 financial highlights include the following:
• Earnings produced a return on average assets of 0.80% for the second quarter
of 2020, compared to 1.37% in the previous quarter and (0.20%) for the same
quarter in the prior year.
• PPP loans drove the
quarter. At
categories offset some of the growth during the quarter. In addition, average
deposits grew 12.3% during the quarter, as proceeds from PPP funding
contributed to significant deposit growth.
• Net interest margin was 3.22% for the quarter, down from 3.52% in the first
quarter of 2020 and down from 3.82% in the same quarter of the prior year.*
• Noninterest revenues decreased
previous quarter, and increased
quarter in the prior year.
• Noninterest expense decreased
previous quarter, and decreased
same quarter in the prior year.
• The second quarter provision for loan losses totaled
compares to a provision of
recovery of
for loan losses as a percentage of loans held for investment increased to
0.88% at period end. Excluding PPP loans, the allowance as a percentage of
loans increased to 1.00% at period end.
• Nonperforming assets as a percentage of total assets remained stable at 0.16%
at
• Annualized net charge-offs were 0.06% for the second quarter of 2020, compared
to zero for the corresponding quarter in the prior year and up from 0.01% for
the first quarter of 2020.
*Refer to the Non-GAAP Financial Measures section within this section for further information on these non-GAAP financial measurements.
Net Interest Income Net interest income is the difference between interest income on earning assets, primarily loans and securities, and interest expense on interest bearing liabilities, primarily deposits and other funding sources. Fluctuations in interest rates as well as volume and mix changes in earning assets and interest bearing liabilities can materially impact net interest income. The following discussion of net interest income is presented on a taxable equivalent basis to facilitate performance comparisons among various taxable and tax-exempt assets, such as certain state and municipal securities. A tax rate of 21% was used in adjusting interest on tax-exempt assets to a fully taxable equivalent basis. Net interest income divided by average earning assets is referred to as the net interest margin. The net interest spread represents the difference between the weighted rate earned on average earning assets and the weighted rate paid on average interest-bearing liabilities
Three months ended
Net interest income on a taxable equivalent basis decreased$759,000 or 3.6% for the second quarter of 2020 compared to the same quarter of 2019. The largest cause of the year-over-year decrease was the five reductions of the federal funds rate over the period totaling 225 basis points, partially offset by PPP lending. Average loan balances for the 2020 quarter were up$233,715,000 or 12.8% over the 2019 quarter, primarily due to PPP lending. These loans had a balance of$272 million atJune 30, 2020 , earn 1% interest and generated fee income that is being accreted over the life of the loans. The accretion attributed to the yield on the PPP portfolio but the increased average loan volume earning a much lower rate decreased yields for the second quarter of 2020. Loan yields for the quarter were 81 basis points lower than the 2019 quarter. For the second quarter of 2020, the Company's yield on interest-earning assets was 3.70%, compared to 4.58% for the second quarter of 2019. The cost of interest-bearing liabilities was 0.74% compared to 1.10%. The interest rate spread was 2.96% compared to 3.48%. The net interest margin, on a fully taxable equivalent basis, was 3.22% compared to 3.82%, a decrease of 60 basis points. The decrease in net interest margin was driven by declining interest rates and the impact of lower rates on the PPP lending. The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the three months endedJune 30, 2020 and 2019. Nonaccrual loans are included in average balances. Interest income on nonaccrual loans is only recognized when the loan returns to accrual status or at full payment of principal. 36 --------------------------------------------------------------------------------
Net Interest Income Analysis (dollars in thousands)
Three Months Ended June 30,
Average Balance Income/Expense Yield/Rate
2020 2019 2020 2019 2020 2019
Loans:
Commercial $ 513,765 $ 321,263 $ 4,377 $ 3,899 3.43 % 4.87 %
Real estate 1,529,723 1,485,665 16,901 18,578 4.42 5.00
Consumer 9,343 12,188 149 201 6.41 6.61
Total loans 2,052,831 1,819,116 21,427 22,678 4.18 4.99
Securities:
U.S. Treasury 2,250 - 9 - 1.60 -
Federal agencies and GSEs 47,197 140,516 284 858 2.41 2.44
Mortgage-backed and CMOs 203,268 127,718 1,059 809 2.08 2.53
State and municipal 42,742 68,185 288 480 2.70 2.82
Other securities 20,202 18,087 272 233 5.39 5.15
Total securities 315,659 354,506 1,912 2,380 2.42 2.69
Deposits in other banks 157,508 37,651 33 258 0.08 2.75
Total interest-earning assets 2,525,998 2,211,273 23,372
25,316 3.70 4.58
Non-earning assets 229,472 222,675
Total assets $ 2,755,470 $ 2,433,948
Deposits:
Demand $ 371,451 $ 335,879 115 112 0.12 0.13
Money market 554,318 448,722 591 1,394 0.43 1.25
Savings 192,354 179,375 24 98 0.05 0.22
Time 446,307 499,637 1,748 1,916 1.58 1.54
Total deposits 1,564,430 1,463,613 2,478 3,520 0.64 0.96
Customer repurchase agreements 43,716 35,657 66 140 1.61 1.57
Other short-term borrowings - 7,627 - 38 - 1.99
Long-term borrowings 35,575 36,301 493 524 5.54 5.77
Total interest-bearing
liabilities 1,643,721 1,543,198 3,037 4,222 0.74 1.10
Noninterest bearing demand
deposits 760,901 559,944
Other liabilities 22,797 23,525
Shareholders' equity 328,051 307,281
Total liabilities and
shareholders' equity $ 2,755,470 $ 2,433,948
Interest rate spread 2.96 % 3.48 %
Net interest margin 3.22 % 3.82 %
Net interest income (taxable equivalent basis) 20,335 21,094
Less: Taxable equivalent
adjustment 75 105
Net interest income $ 20,260 $ 20,989
37
--------------------------------------------------------------------------------
Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
Three Months Ended June 30,
2020 vs. 2019
Change
Increase Attributable to
(Decrease) Rate Volume
Interest income
Loans:
Commercial $ 478 $ (1,393 ) $ 1,871
Real estate (1,677 ) (2,215 ) 538
Consumer (52 ) (6 ) (46 )
Total loans (1,251 ) (3,614 ) 2,363
Securities:
U.S. Treasury 9 9 -
Federal agencies and GSEs (574 ) (12 ) (562 )
Mortgage-backed and CMOs 250 (163 ) 413
State and municipal (192 ) (20 ) (172 )
Other securities 39 11 28
Total securities (468 ) (175 ) (293 )
Deposits in other banks (225 ) (436 ) 211
Total interest income (1,944 ) (4,225 ) 2,281
Interest expense
Deposits:
Demand 3 (8 ) 11
Money market (803 ) (1,074 ) 271
Savings (74 ) (81 ) 7
Time (168 ) 40 (208 )
Total deposits (1,042 ) (1,123 ) 81
Customer repurchase agreements (74 ) (100 ) 26
Other short-term borrowings (38 ) (19 ) (19 )
Long-term borrowings (31 ) (21 ) (10 )
Total interest expense (1,185 ) (1,263
) 78
Net interest income (taxable equivalent basis)
Six months ended
Net interest income on a taxable equivalent basis increased$4,050,000 or 11.2% for the six months endedJune 30, 2020 compared to the same period in 2019. This improvement in net interest income was primarily related to an increase in earning asset balances for the 2020 period compared to the 2019 period. Average loan balances for the 2020 period were up$354,537,000 or 22.3% over the 2019 period, primarily due to PPP lending and the HomeTown acquisition. Loan yields for thesix months endedJune 30, 2020 were 43 basis points lower than the 2019 period. The impact of PPP loans earning 1% further compounded the downward pressure imposed by theFederal Reserve's interest rate cuts during the twelve months endedJune 30, 2020 . For the six months endedJune 30, 2020 , the Company's yield on interest-earning assets was 3.95%, compared to 4.41% for the prior year period. The cost of interest-bearing liabilities was 0.87% compared to 1.06%. The interest rate spread was 3.08% compared to 3.35%. The net interest margin, on a fully taxable equivalent basis, was 3.36% compared to 3.67%, a decrease of 31 basis points. The decrease in net interest margin was driven by declining interest rates. The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the six months endedJune 30, 2020 and 2019. Nonaccrual loans are included in average balances. Interest income on nonaccrual loans is only recognized when the loan returns to accrual status or at full payment of principal. 38 --------------------------------------------------------------------------------
Net Interest Income Analysis (dollars in thousands)
Six Months Ended June 30,
Average Balance Income/Expense Yield/Rate
2020 2019 2020 2019 2020 2019
Loans:
Commercial $ 423,343 $ 293,575 $ 7,919 $ 6,790 3.76 % 4.66 %
Real estate 1,509,520 1,285,842 34,564 31,294 4.58 4.87
Consumer 9,692 8,601 307 276 6.37 6.47
Total loans 1,942,555 1,588,018 42,790 38,360 4.41 4.84
Securities:
U.S. Treasury 5,650 - 44 - 1.56 -
Federal agencies and GSEs 75,254 139,993 861 1,708 2.29 2.44
Mortgage-backed and CMOs 200,521 119,754 2,202 1,502 2.20 2.51
State and municipal 41,784 73,362 576 1,018 2.76 2.78
Other securities 19,486 16,090 537 411 5.51 5.11
Total securities 342,695 349,199 4,220 4,639 2.46 2.66
Deposits in other banks 115,209 38,670 297 524 0.52 2.73
Total interest-earning assets 2,400,459 1,975,887 47,307
43,523 3.95 4.41
Non-earning assets 223,072 174,270
Total assets $ 2,623,531 $ 2,150,157
Deposits:
Demand $ 351,404 $ 287,424 238 126 0.14 0.09
Money market 534,828 422,359 1,779 2,548 0.67 1.22
Savings 185,625 156,843 77 107 0.08 0.14
Time 458,140 431,900 3,696 3,211 1.62 1.50
Total deposits 1,529,997 1,298,526 5,790 5,992 0.76 0.93
Customer repurchase agreements 42,617 39,161 195
311 0.92 1.60
Other short-term borrowings 2 3,865 - 39 0.50 2.02
Long-term borrowings 35,565 32,142 999 908 5.62 5.65
Total interest-bearing
liabilities 1,608,181 1,373,694 6,984 7,250 0.87 1.06
Noninterest bearing demand
deposits 667,632 490,263
Other liabilities 21,906 19,992
Shareholders' equity 325,812 266,208
Total liabilities and
shareholders' equity $ 2,623,531 $ 2,150,157
Interest rate spread 3.08 % 3.35 %
Net interest margin 3.36 % 3.67 %
Net interest income (taxable
equivalent basis) 40,323 36,273
Less: Taxable equivalent
adjustment 144 216
Net interest income $ 40,179 $ 36,057
39
--------------------------------------------------------------------------------
Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
Six Months Ended June 30,
2020 vs. 2019
Change
Increase Attributable to
(Decrease) Rate Volume
Interest income
Loans:
Commercial $ 1,129 $ (1,472 ) $ 2,601
Real estate 3,270 (1,933 ) 5,203
Consumer 31 (4 ) 35
Total loans 4,430 (3,409 ) 7,839
Securities:
U.S. Treasury 44 44 -
Federal agencies and GSEs (847 ) (100 ) (747 )
Mortgage-backed and CMOs 700 (207 ) 907
State and municipal (442 ) (7 ) (435 )
Other securities 126 34 92
Total securities (419 ) (236 ) (183 )
Deposits in other banks (227 ) (668 ) 441
Total interest income 3,784 (4,313 ) 8,097
Interest expense
Deposits:
Demand 112 80 32
Money market (769 ) (1,334 ) 565
Savings (30 ) (47 ) 17
Time 485 283 202
Total deposits (202 ) (1,018 ) 816
Customer repurchase agreements (116 ) (141 ) 25
Other short-term borrowings (39 ) (20 ) (19 )
Long-term borrowings 91 (5 ) 96
Total interest expense (266 ) (1,184
) 918
Net interest income (taxable equivalent basis)
Noninterest Income
Three months ended
For the quarter endedJune 30, 2020 , noninterest income increased$153,000 or 4.2% compared to the comparable 2019 quarter. Details of individual accounts are shown in the table below. Three Months Ended June 30, (Dollars in thousands) 2020 2019 $ Change % Change Noninterest income: Trust fees$ 953 $ 933 $ 20 2.1 % Service charges on deposit accounts 541 724 (183 ) (25.3 ) Other fees and commissions 951 1,015 (64 ) (6.3 ) Mortgage banking income 893 586 307 52.4 Securities gains, net - 147 (147 ) (100.0 ) Brokerage fees 172 186 (14 ) (7.5 ) Loss from SBICs (119 ) (137 ) 18 (13.1 ) Losses on premises and equipment, net - (87 ) 87 (100.0 ) Other 444 315 129 41.0 Total noninterest income$ 3,835 $ 3,682 $ 153 4.2 Service charge income decreased$183,000 in the second quarter of 2020 compared to the second quarter of 2019, and other fees and commissions decreased$64,000 . Due to the actions taken to combat COVID-19 such as stay-at-home orders and restaurant and retail changes, debit card income decreased as consumers did not spend at the same levels in the second quarter of 2020 as 2019. The Company saw decreases in overdraft and related fees, another component of service charge income, caused by consumer spending decreases during the same period. Mortgage banking income increased$307,000 in the 2020 quarter compared to the 2019 quarter, primarily due to increased volume of applications for purchases and refinancing as rates hit historical lows in 2020. Net securities gains decreased$147,000 in the 2020 quarter compared to the same quarter in 2019. 40 --------------------------------------------------------------------------------
Six months ended
For the six months endedJune 30, 2020 , noninterest income increased$1,197,000 or 16.8% compared to the comparable 2019 period. Details of individual accounts are shown in the table below. Six Months Ended June 30, (Dollars in thousands) 2020 2019 $ Change % Change Noninterest income: Trust fees$ 1,965 $ 1,847 $ 118 6.4 % Service charges on deposit accounts 1,262 1,318 (56 ) (4.2 ) Other fees and commissions 1,892 1,723 169 9.8 Mortgage banking income 1,442 992 450 45.4 Securities gains, net 814 470 344 73.2 Brokerage fees 383 333 50 15.0 Income (loss) from SBICs (64 ) 31 (95 ) (306.5 ) Losses on premises and equipment, net (82 ) (87 ) 5 (5.7 ) Other 718 506 212 41.9 Total noninterest income$ 8,330 $ 7,133 $ 1,197 16.8 Trust fees increased$118,000 for the six months endedJune 30, 2020 compared to the same period in 2019. Other fees and commissions increased$169,000 in the 2020 period compared to the 2019 period, mostly on the strength of debit card fee revenue in the first quarter. Mortgage banking income increased$450,000 for the six months endedJune 30, 2020 compared to the 2019 period. The increase in 2020 is a result of historically low rates in the first six months of 2020 resulting in increased application volume for new purchases and refinancing of existing loans. Net securities gains increased$344,000 in the 2020 period compared to the same period in 2019. Noninterest Expense
Three months ended
For the three months endedJune 30, 2020 , noninterest expense decreased$13,884,000 or 52.8%. Details of individual accounts are shown in the table below. Three Months Ended June 30, (Dollars in thousands) 2020 2019 $ Change % Change Noninterest Expense Salaries$ 4,805 $ 7,048 $ (2,243 ) (31.8 )% Employee benefits 1,386 1,425 (39 ) (2.7 ) Occupancy and equipment 1,327 1,431 (104 ) (7.3 ) FDIC assessment 176 169 7 4.1 Bank franchise tax 425 412 13 3.2 Core deposit intangible amortization 417 458 (41 ) (9.0 ) Data processing 785 717 68 9.5 Software 403 321 82 25.5 Other real estate owned, net 15 (44 ) 59 134.1 Merger related expenses - 10,871 (10,871 ) (100.0 ) Other 2,693 3,508 (815 ) (23.2 ) Total noninterest expense$ 12,432 $ 26,316 $ (13,884 ) (52.8 ) Salaries expense decreased$2,243,000 in the 2020 quarter as compared to the 2019 quarter. Total full-time equivalent employees ("FTEs") were 345 at the end of the second quarter of 2020, down from 371 at the end of the second quarter of 2019, for a decrease of 26 FTEs. Contributing to the decrease was a reduction in salary expenses of$1.6 million for the deferral of loan costs related to PPP originations. These costs were deferred at loan origination and are being amortized to interest income over the remaining lives of the loans, which for the majority of PPP loans was 24 months at origination date. These costs are amortized against the related loan fees received from the origination of the PPP loans in interest income. Recognition of the deferred costs and related fees will be accelerated upon forgiveness or repayment of the PPP loans. Occupancy and equipment expense decreased$104,000 in the 2020 quarter compared to the 2019 quarter. Merger related expenses, which are related to the HomeTown acquisition and are nonrecurring in nature, totaled$10,871,000 during the second quarter of 2019. 41
--------------------------------------------------------------------------------
Six months ended
For the six months endedJune 30, 2020 , noninterest expense decreased$11,479,000 or 30.8%. Details of individual accounts are shown in the table below. Six Months Ended June 30, (Dollars in thousands) 2020 2019 $ Change % Change Noninterest Expense Salaries$ 10,864 $ 11,712 $ (848 ) (7.2 )% Employee benefits 2,687 2,655 32 1.2 Occupancy and equipment 2,693 2,515 178 7.1 FDIC assessment 271 294 (23 ) (7.8 ) Bank franchise tax 851 702 149 21.2 Core deposit intangible amortization 844 513 331 64.5 Data processing 1,548 1,249 299 23.9 Software 759 645 114 17.7 Other real estate owned, net 6 (31 ) 37 119.4 Merger related expenses - 11,322 (11,322 ) (100.0 ) Other 5,243 5,669 (426 ) (7.5 ) Total noninterest expense$ 25,766 $ 37,245 $ (11,479 ) (30.8 ) Salaries expense decreased$848,000 for the six months endedJune 30, 2020 compared to the 2019 period. Total FTEs were 345 at the end of the second quarter of 2020, down from 371 at the end of the second quarter of 2019, for a decrease of 26 FTEs. Contributing to the decrease was a reduction in salary expenses of$1.6 million for the deferral of loan costs related to PPP originations in the second quarter of 2020. Occupancy and equipment expense increased$178,000 for the six months endedJune 30, 2020 compared to the 2019 period, primarily due to the HomeTown acquisition in the second quarter of 2019. Core deposit intangible amortization increased$331,000 in the 2020 period compared to the same period in 2019 due to the HomeTown acquisition. Merger related expenses, which are related to the HomeTown acquisition and are nonrecurring in nature, totaled$11,322,000 during the 2019 period. Non-GAAP Financial Measures The efficiency ratio is calculated by dividing noninterest expense excluding (1) gains or losses on the sale of other real estate owned ("OREO"), (2) core deposit intangible amortization and (3) merger related expense by net interest income including tax equivalent income on nontaxable loans and securities and noninterest income and excluding (a) gains or losses on securities and (b) gains or losses on sale or disposal of premises and equipment. The efficiency ratio for the 2020 quarter was 49.74% compared to 60.94% for the 2019 quarter. The improved ratio resulted from a myriad of factors, with lower noninterest expenses having the greatest impact. This includes the previously discussed deferral of$1.6 million of PPP loan origination costs in the second quarter of 2020. Other expenses were down in 2020 due to the pandemic while 2019 included other miscellaneous costs related to the assimilation of HomeTown into the Company. The efficiency ratio is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be construed as such. Management believes, however, such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The Company, in referring to its net income, is referring to income under GAAP. The components of the efficiency ratio calculation are summarized in the following table (dollars in thousands): Three Months Ended June 30, Six Months Ended June 30, 2020 2019 2020 2019 Efficiency Ratio Noninterest expense$ 12,432 $ 26,316 $ 25,766 $ 37,245 Add: gain on sale of OREO 8 76 35 78 Subtract: core deposit intangible amortization (417 ) (458 ) (844 ) (513 ) Subtract: merger related expense - (10,871 ) - (11,322 )$ 12,023 $ 15,063 $ 24,957 $ 25,488 Net interest income$ 20,260 $ 20,989 $ 40,179 $ 36,057 Tax equivalent adjustment 75 105 144 216 Noninterest income 3,835 3,682 8,330 7,133 Subtract: gain on securities - (147 ) (814 ) (470 ) Add: loss on fixed assets - 87 82 87$ 24,170 $ 24,716 $ 47,921 $ 43,023 Efficiency ratio 49.74 % 60.94 % 52.08 % 59.24 % 42
--------------------------------------------------------------------------------
Net interest margin is calculated by dividing tax equivalent net interest income
by total average earning assets. Because a portion of interest income earned by
the Company is nontaxable, the tax equivalent net interest income is considered
in the calculation of this ratio. Tax equivalent net interest income is
calculated by adding the tax benefit realized from interest income that is
nontaxable to total interest income then subtracting total interest expense. The
tax rate utilized in calculating the tax benefit for both the 2020 and 2019
quarters is 21%. The reconciliation of tax equivalent net interest income, which
is not a measurement under GAAP, to net interest income, is reflected in the
table below (dollars in thousands):
Three Months Ended June 30, Six Months Ended June 30,
2020 2019 2020 2019
Reconciliation of Net Interest Income to
Tax-Equivalent Net Interest Income
Non-GAAP measures:
Interest income - loans $ 21,427 $ 22,678 $ 42,790 $ 38,360
Interest income - investments and other 1,945 2,638 4,517 5,163
Interest expense - deposits (2,478 ) (3,520 ) (5,790 ) (5,992 )
Interest expense - customer repurchase
agreements (66 ) (140 ) (195 ) (311 )
Interest expense - other short-term
borrowings - (38 ) - (39 )
Interest expense - long-term borrowings (493 ) (524 ) (999 ) (908 )
Total net interest income $ 20,335 $ 21,094 $ 40,323 $ 36,273
Less non-GAAP measures:
Tax benefit realized on non-taxable
interest income - loans $ (48 ) $ (49 ) $ (90 ) $ (93 )
Tax benefit realized on non-taxable
interest income - municipal securities (27 ) (56 ) (54 ) (123 )
GAAP measures $ 20,260 $ 20,989 $ 40,179 $ 36,057
Income Taxes
The effective tax rate for the second quarter of 2020 was 20.60% compared to
(24.77)% for the second quarter of 2019. The income tax benefit in the second
quarter of 2019 was due to a pretax loss of $1,635,000 resulting primarily from
$10,871,000 of merger related expense during the quarter. The effective tax rate
for the six months ended June 30, 2020 and 2019 was 17.66% and 19.63%,
respectively. The decreased rate for the 2020 period compared to the rate for
the 2019 period is a result of tax benefits recognized. As a result of the
enactment of the CARES Act in the first quarter of 2020, the Company recognized
a tax benefit for the net operating loss ("NOL") five-year carryback provision
for the NOL acquired in the HomeTown merger. An income tax benefit was realized
for the difference between the current corporate income tax rate of 21% and the
higher federal corporate tax rate of 35% prior to 2018.
The effective tax rate is ordinarily lower than the statutory rate of 21% due to
the benefit of tax-exempt interest, tax-exempt changes in the cash surrender
value of bank owned life insurance and excess tax benefits recognized on the
exercise of stock options and the vesting of restricted stock.
Fair Value Impact to Net Interest Margin
The Company's fully taxable equivalent net interest margin includes the impact of acquisition accounting fair value adjustments. The net accretion impact for the three and six months endedJune 30, 2020 and 2019, as well as the remaining estimated net accretion impact are reflected in the following table (dollars in thousands): Loan Deposit Borrowings Accretion Accretion Amortization Total For the three months ended June 30, 2020$ 775 $ 47 $ (21 )$ 801 For the three months ended June 30, 2019 995 144
(21 ) 1,118
For the six months ended June 30, 2020 1,681 120 (42 ) 1,759 For the six months ended June 30, 2019 1,276 144
(47 ) 1,373
For the remaining six months of 2020 (estimated) 1,094 61 (42 ) 1,113 For the years ending (estimated): 2021 1,876 78 (102 ) 1,852 2022 1,199 50 (102 ) 1,147 2023 750 30 (102 ) 678 2024 454 5 (102 ) 357 2025 360 2 (102 ) 260 Thereafter (estimated) 1,928 3 (743 ) 1,188
Impact of Inflation and Changing Prices
The majority of assets and liabilities of a financial institution are monetary
in nature and therefore differ greatly from most commercial and industrial
companies that have significant investments in fixed assets or inventories. The
most significant effect of inflation is on noninterest expense, which tends to
rise during periods of inflation. Changes in interest rates have a greater
impact on a financial institution's profitability than do the effects of higher
costs for goods and services. Through its balance sheet management practices,
the Company has the ability to react to those changes and measure and monitor
its interest rate and liquidity risk. Price inflation has been consistently
modest over the past several years.
43
--------------------------------------------------------------------------------CHANGES IN FINANCIAL POSITION BALANCE SHEET ANALYSIS Securities The securities portfolio generates income, plays a major role in the management of interest rate sensitivity, provides a source of liquidity, and is used to meet collateral requirements. The securities portfolio consists primarily of high credit quality investments, mostly federal agency, mortgage-backed, and state and municipal securities. The available for sale securities portfolio was$322,523,000 atJune 30, 2020 , compared to$379,195,000 atDecember 31, 2019 , a decrease of$56,672,000 or 14.9%. AtJune 30, 2020 , the available for sale portfolio had an amortized cost of$311,788,000 , resulting in a net unrealized gain of$10,735,000 . AtDecember 31, 2019 , the available for sale portfolio had an amortized cost of$375,494,000 , resulting in a net unrealized gain of$3,701,000 . The Company had no remaining equity securities atJune 30, 2020 . During the six months endedJune 30, 2019 , the Company recognized a$330,000 change in the fair value of equity securities. During the six months endedJune 30, 2020 , the Company sold$5,000,000 in par value bonds and realized a net gain of$814,000 . This compares to the six months endedJune 30, 2019 , when the Company sold$29,878,000 in par value bonds and realized a net gain of$127,000 . The Company had no remaining equity securities atJune 30, 2020 . During the six months endedJune 30, 2019 , the Company sold$317,000 in equity securities at fair value. The Company is cognizant of the continuing historically low and currently steady rate environment and has elected to execute an asset liability strategy of purchasing high quality taxable securities with relatively low optionality and short and overall balanced duration. Loans The loan portfolio consists primarily of commercial and residential real estate loans, commercial loans to small and medium-sized businesses, construction and land development loans, and home equity loans. AtJune 30, 2020 , the commercial real estate portfolio included concentrations of$77,291,000 ,$45,604,000 and$178,142,000 in hotel, restaurants, and retail, respectively. These concentrations total 14.4% of total loans. Total loans were$2,101,711,000 atJune 30, 2020 , compared to$1,830,815,000 atDecember 31, 2019 , an increase of$270,896,000 or 14.8%. AtJune 30, 2020 , PPP loans, which are in the commercial loan category, totaled$271,854,000 . Declines in other categories offset some of the total loan growth during the period. Average loans were$2,052,831,000 for the second quarter of 2020, compared to$1,819,116,000 for the second quarter of 2019, an increase of$233,715,000 or 12.8%, primarily related to PPP lending. Loans held for sale totaled$2,845,000 atJune 30, 2020 and$2,027,000 atDecember 31, 2019 . Secondary loan production volume was$66,905,000 for the six month period endedJune 30, 2020 and$43,495,000 for the same period of 2019. These loans were approximately 60% purchase and 40% refinancing. Management of the loan portfolio is organized around portfolio segments. Each segment is comprised of various loan types that are reflective of operational and regulatory reporting requirements. The following table presents the Company's loan portfolio by segment as ofJune 30, 2020 andDecember 31, 2019 (dollars in thousands): June 30, 2020 December 31, 2019 Commercial$ 566,859 $ 339,077 Commercial real estate: Construction and land development 141,392 137,920 Commercial real estate 978,768 899,199 Residential real estate: Residential 291,242 324,315 Home equity 114,397 119,423 Consumer 9,053 10,881 Total loans$ 2,101,711 $ 1,830,815 Provision for Loan Losses The Company had a provision for loan losses of$5,712,000 for the six month period endedJune 30, 2020 , compared to a provision of$6,000 for the same period endedJune 30, 2019 . The increase over the prior year period reflects an increase in allowance requirements in response to the declining and uncertain economic landscape caused by the COVID-19 pandemic. Net charge-offs for the six months endedJune 30, 2020 were$357,000 compared to$25,000 for the 2019 period. 44
--------------------------------------------------------------------------------
Allowance for Loan Losses The purpose of the ALLL is to provide for probable losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and by recoveries of previously charged-off loans. Loan charge-offs decrease the allowance. AtJune 30, 2020 , the ALLL was$18,507,000 , compared to$13,152,000 atDecember 31, 2019 . The ALLL as a percentage of total loans at such dates was 0.88% and 0.72%, respectively. Management will continue to evaluate the adequacy of the Company's allowance for loan losses as more economic data becomes available and as changes within the Company's portfolio are known. The effects of the pandemic may require the Company to fund additional increases in the allowance for loan losses in future periods. As part of the Company's methodology to evaluate the adequacy of its ALLL, the Company computed its ASC 450 loan balance by reducing total loans by acquired loans and loans that were evaluated for impairment individually. The FASB ASC 450 loan loss reserve balance is the total ALLL reduced by allowances associated with these other pools of loans. The general allowance, ASC 450 (FAS 5) reserves to FASB ASC 450 loans, was 1.00% atJune 30, 2020 , compared to 0.87% atDecember 31, 2019 . On a dollar basis, the reserve was$17,969,000 atJune 30, 2020 , compared to$12,684,000 atDecember 31, 2019 . This segment of the allowance represents by far the largest portion of the loan portfolio and the largest aggregate risk. The specific allowance, ASC 310-40 (FAS 114) reserves to FASB ASC 310-40 loans, was 8.87% atJune 30, 2020 , compared to 10.51% atDecember 31, 2019 . On a dollar basis, the reserve was$286,000 atJune 30, 2020 , compared to$230,000 atDecember 31, 2019 . There is ongoing turnover in the composition of the impaired loan population, which increased by a net$1,027,000 overDecember 31, 2019 . The specific allowance does not include reserves related to acquired loans with deteriorated credit quality. This reserve was$252,000 atJune 30, 2020 compared to$238,000 atDecember 31, 2019 . This is the only portion of the reserve related to purchased credit impaired loans. Cash flow expectations for these loans are reviewed on a quarterly basis and unfavorable changes in those estimates relative to the initial estimates can result in the need for additional loan loss provision. The following table presents the Company's loan loss and recovery experience for the periods indicated (dollars in thousands): Six Months Year Ended Ended June 30, December 31, 2020 2019 Balance at beginning of period$ 13,152
Charge-offs:
Construction and land development - - Commercial real estate - 6 Residential real estate 61 20 Home equity 1 50 Total real estate 62 76 Commercial and industrial 411 12 Consumer 76 245 Total charge-offs 549 333 Recoveries: Construction and land development 1 - Commercial real estate 57 9 Residential real estate 24 40 Home equity 9 18 Total real estate 91 67 Commercial and industrial 26 13 Consumer 75 144 Total recoveries 192 224 Net charge-offs 357 109 Provision for loan losses 5,712 456 Balance at end of period$ 18,507 $ 13,152 45
--------------------------------------------------------------------------------
Asset Quality Indicators
The following table provides qualitative indicators relevant to the Company's loan portfolio for the six month period and year indicated below.
Asset Quality Ratios
June 30, 2020 December 31, 2019
Allowance to loans (1) 0.88 % 0.72 %
ASC 450 (FAS 5) ALLL to ASC 450 loans (2) 1.00 0.87
Net charge-offs to allowance (3) 3.86
0.83
Net charge-offs to average loans (3) 0.04
0.01
Nonperforming assets to total assets 0.16
0.15
Nonperforming loans to loans 0.15
0.13
Provision to net charge-offs (3) 1,600.00
418.35
Provision to average loans (3) 0.59
0.03
Allowance to nonperforming loans 572.97 570.59 __________________________
(1) - Excluding PPP loans, 1.01%
(2) - Excluding PPP loans, 1.17%
(3) - Annualized.
Nonperforming Assets (Loans and Other Real Estate Owned and Repossessions)
Nonperforming loans include loans on which interest is no longer accrued and accruing loans that are contractually past due 90 days or more. Nonperforming loans include loans originated and loans acquired exclusive of PCI loans.
Nonperforming loans to total loans were 0.15% at
Nonperforming assets include nonperforming loans, OREO and repossessions. Nonperforming assets represented 0.16% and 0.15% of total assets atJune 30, 2020 andDecember 31, 2019 , respectively. As ofJune 30, 2020 , there was no increase in nonperforming assets as a result of the pandemic. The Company continues to monitor the significant impact to its borrowers caused by COVID-19 and anticipates increases in nonperforming assets as a result, but the total cannot be determined at this time. In most cases, it is the policy of the Company that any loan that becomes 90 days past due will automatically be placed on nonaccrual loan status, accrued interest reversed out of income, and further interest accrual ceased. Any payments received on such loans will be credited to principal. In some cases a loan in process of renewal may become 90 days past due. In these instances the loan may still be accruing because of a delayed renewal process in which the customer has not been billed. In accounting for acquired impaired loans, such loans are not classified as nonaccrual when they become 90 days past due. They are considered to be accruing because their interest income relates to the accretable yield and not to contractual interest payments. Loans will only be restored to full accrual status after six consecutive months of payments that were each less than 30 days delinquent. The Company strictly adheres with this policy before restoring a loan to normal accrual status.
The following table presents the Company's nonperforming assets as of
Nonperforming Assets
December 31,
June 30, 2020 2019
Nonaccrual loans:
Real estate $ 2,594 $ 1,083
Commercial 260 857
Consumer 1 4
Total nonaccrual loans 2,855 1,944
Loans past due 90 days and accruing interest:
Real estate 362 309
Commercial 13 52
Total past due 90 days and accruing interest 375 361
Total nonperforming loans 3,230 2,305
Other real estate owned 984 1,308
Repossessions (included in other assets) 362 -
Total nonperforming assets $ 4,576 $ 3,613
46--------------------------------------------------------------------------------
Impaired Loans 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. The following table shows loans that were considered impaired, exclusive of purchased credit impaired loans, as ofJune 30, 2020 andDecember 31, 2019 (dollars in thousands): Impaired Loans June 30, 2020 December 31, 2019 Accruing $ 917 $ 969 Nonaccruing 2,302 1,223 Total impaired loans $ 3,219 $ 2,192 Troubled Debt Restructurings TDRs exist whenever the Company makes a concession to a customer based on the customer's financial distress that would not have otherwise been made in the normal course of business.
There were
InMarch 2020 (revised inApril 2020 ), the federal banking agencies issued an "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus." This was in response to the COVID-19 pandemic affecting societies and economies around the world. This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19. The guidance explains that, in consultation with the FASB staff, the federal banking agencies have concluded that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not TDRs. The CARES Act was passed by theU.S. Congress onMarch 27, 2020 . Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were current as ofDecember 31, 2019 are not TDRs. The Bank implemented a DAP to provide relief to its borrowers under this guidance. ThroughJune 30, 2020 , the Bank had applied this guidance and modified loans to over 729 customers on loan balances of approximately$395 million . As ofAugust 1, 2020 , the balance of loans under this program was$219 million , or 10.4% of the total portfolio as of that date. The majority of modifications involved three-month deferments of principal and interest. This interagency guidance is expected to have a material impact on the Company's financial statements; however, this impact cannot be quantified at this time. Other Real Estate Owned Other real estate owned was$984,000 and$1,308,000 as ofJune 30, 2020 andDecember 31, 2019 , respectively. OREO is initially recorded at fair value, less estimated costs to sell, at the date of foreclosure. Loan losses resulting from foreclosure are charged against the ALLL at that time. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the new cost basis or fair value, less estimated costs to sell with any additional write-downs charged against earnings. For significant assets, these valuations are typically outside annual appraisals. The following table shows the Company's OREO as ofJune 30, 2020 andDecember 31, 2019 (dollars in thousands): Other Real Estate Owned June 30, 2020 December 31, 2019 Construction and land development $ 484 $ 600 1-4 family residential 237 285 Commercial real estate 263 423 $ 984 $ 1,308 Deposits The Company's deposits consist primarily of checking, money market, savings, and consumer and commercial time deposits. Total deposits were$2,431,776,000 atJune 30, 2020 compared to$2,060,547,000 atDecember 31, 2019 , an increase of$371,229,000 or 18.0%. Customer deposits of loan proceeds from the PPP that remained atJune 30, 2020 accounted for a a significant amount of the increase. Average interest bearing deposits were$1,564,430,000 for the second quarter of 2020, compared to$1,463,613,000 for the second quarter of 2019, an increase of$100,817,000 or 6.9%. Average noninterest bearing deposits for the 2020 quarter were$760,901,000 , compared to$559,944,000 for the 2019 quarter, an increase of$200,957,000 or 35.9%. The Company's primary focus on the liability side of the balance sheet is growing core deposits and their affiliated relationships. The challenge is to fund the Bank in a cost effective and competitive manner. The Company's cost of deposits for the second quarter of 2020 was 0.64%, down from 0.96% for the second quarter of 2019. Shareholders' Equity The Company's capital management strategy is to be classified as "well capitalized" under regulatory capital ratios and provide as high as possible total return to shareholders. The Company's capital strategy has not changed in response to COVID-19 except to suspend the stock repurchase program for the near term.
Shareholders' equity was
The Company paid cash dividends of$0.54 per share during the first six months of 2020 while the aggregate basic and diluted earnings per share for the same period was$1.28 . 47
-------------------------------------------------------------------------------- EffectiveJanuary 1, 2015 , the Company and the Bank became subject to the rules implementing the Basel III capital framework and certain related provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Basel III Capital Rules"). The Basel III Capital Rules require the Company and the Bank to comply with the following minimum capital ratios: (i) a ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%), (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%), and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets. The phase-in of the capital conservation buffer requirement began onJanuary 1, 2016 , at 0.625% of risk-weighted assets, increasing by the same amount each year until it was fully implemented at 2.5% onJanuary 1, 2019 . In addition, to be well capitalized under the "prompt corrective action" regulations pursuant to Section 38 of the Federal Deposit Insurance Act, the Bank must have the following minimum capital ratios: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%. OnAugust 28, 2018 , theFederal Reserve issued an interim final rule required by the Economic Growth, Regulatory Relief, and Consumer Protection Act ("EGRRCPA") that expands the applicability of theFederal Reserve's Small Bank Holding Company Policy Statement ("SBHC Policy Statement") to bank holding companies with total consolidated assets of less than$3 billion (up from the prior$1 billion threshold). Under the SBHC Policy Statement, qualifying bank holding companies, such as the Company, have additional flexibility in the amount of debt they can issue and are also exempt from the Basel III Capital Rules. However, the Company does not currently intend to issue a material amount of debt or take any other action that would cause its capital ratios to fall below the minimum ratios required by the Basel III Capital Rules. The SBHC Policy Statement does not apply to the Bank, and the Bank must comply with theBasel III Capital Rules. OnSeptember 17, 2019 , the federal banking agencies jointly issued a final rule required by the EGRRCPA that will permit qualifying banks and bank holding companies that have less than$10 billion in consolidated assets to elect to opt into the Community Bank Leverage Ratio ("CBLR") framework. Under the final rule, banks and bank holding companies that opt into the CBLR framework and maintain a CBLR of greater than 9% would not be subject to other risk-based and leverage capital requirements under the Basel III Capital Rules and will be deemed to have met the well capitalized ratio requirements under the "prompt corrective action" framework. In addition, a community bank that falls out of compliance with the framework will have a two-quarter grace period to come back into full compliance, provided its leverage ratio remains above 8%, and will be deemed well-capitalized during the grace period. The CBLR framework was first available for banking organizations to use in theirMarch 31, 2020 regulatory reports. OnApril 6, 2020 , the federal bank regulatory agencies announced the issuance of two interim final rules that make changes to the CBLR framework and implement Section 4012 of the CARES Act. One interim final rule provides that, as of the second quarter of 2020, a banking organization with a leverage ratio of 8% or greater (and that meets the other existing qualifying criteria) may elect to use the CBLR framework. This rule also establishes a two-quarter grace period for a qualifying community banking organization whose leverage ratio falls below 8% so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition back to the leverage ratio requirement of 9%. Under this rule, the required leverage ratio will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. This rule also maintains a two-quarter grace period for a qualifying community banking organization whose leverage ratio falls no more than 1% below the applicable ratio. This transition will allow community banking organizations to focus on supporting lending to creditworthy households and businesses given the recent strains on theU.S. economy caused by COVID-19. The Company and the Bank do not currently expect to opt into the CBLR framework. The following table provides information on the regulatory capital ratios for the Company and the Bank atJune 30, 2020 andDecember 31, 2019 . Management believes, as ofJune 30, 2020 , that the Company and the Bank more than satisfy all capital adequacy requirements to which they are subject. Percentage At June 30, 2020 Percentage At December 31, 2019 Risk-Based Capital Ratios: Company Bank Company Bank Common equity tier 1 capital ratio 11.68 % 12.61 % 11.56 % 12.38 % Tier 1 capital ratio 13.09 12.61 12.98 12.38 Total capital ratio 14.41 13.56 14.04 13.06 Leverage Capital Ratio: Tier 1 leverage ratio 9.82 9.46 10.75 10.25 Stock Repurchase Program OnJanuary 19, 2018 , the Company filed a Form 8-K with theSEC to announce the approval by its Board of Directors of a stock repurchase program. The program authorized the repurchase of up to 300,000 shares of the Company's common stock over a two-year period that ended onDecember 31, 2019 .
On
No shares of the Company's common stock were repurchased during the three months endedJune 30, 2020 . In the six month period endedJune 30, 2020 , the Company repurchased 140,526 shares at an average cost of$35.44 per share, for a total cost of$4,981,000 . The Company did not repurchase any shares in the six month period endedJune 30, 2019 . This program has been suspended for the near term in an effort to conserve capital in response to COVID-19. 48 --------------------------------------------------------------------------------
Liquidity
Liquidity is the ability of the Company to convert assets into cash or cash
equivalents without significant loss and to raise additional funds by increasing
liabilities in a timely manner. Liquidity management involves maintaining the
Company's ability to meet the daily cash flow requirements of its customers,
whether they are borrowers requiring funds or depositors desiring to withdraw
funds. Additionally, the Company requires cash for various operating needs
including dividends to shareholders, the servicing of debt, and the payment of
general corporate expenses. The Company manages its exposure to fluctuations in
interest rates through policies approved by the Asset Liability Committee
("ALCO") and Board of Directors, both of which receive periodic reports of the
Company's interest rate risk and liquidity position. The Company uses a computer
simulation model to assist in the management of the future liquidity needs of
the Company.
Liquidity sources include on balance sheet and off balance sheet sources.
Balance sheet liquidity sources include cash, amounts due from banks, loan repayments, and increases in deposits. The Company also maintains a large, high quality, very liquid bond portfolio, which is generally 50% to 60% unpledged and would, accordingly, be available for sale if necessary.
Off balance sheet sources include lines of credit from the
The Company has a line of credit with the FHLB, equal to 30% of the Bank's assets, subject to the amount of collateral pledged. Under the terms of its collateral agreement with the FHLB, the Company provides a blanket lien covering all of its residential first mortgage loans, second mortgage loans, home equity lines of credit, and commercial real estate loans. In addition, the Company pledges as collateral its capital stock in and deposits with the FHLB. The Company had$205,000,000 outstanding in letters of credit atJune 30, 2020 and$170,000,000 outstanding atDecember 31, 2019 . These letters of credit provide the Bank with alternate collateral for securing public entity deposits aboveFDIC insurance levels, thereby providing less need for collateral pledging from the securities portfolio, and thereby maximizing on balance sheet liquidity.
Short-term borrowings are discussed in Note 8 and long-term borrowings are discussed in Note 9 in the Consolidated Financial Statements included in this report.
The Company has federal funds lines of credit established with one correspondent bank in the amount of$50,000,000 and another correspondent bank in the amount of$10,000,000 , and has access to theFederal Reserve Bank of Richmond's discount window. The Company has a relationship with Promontory Network, the sponsoring entity for the Certificate of Deposit Account Registry Service® ("CDARS"). Through CDARS, the Company is able to provide deposit customers with access to aggregateFDIC insurance in amounts exceeding$250,000 . This gives the Company the ability, as and when needed, to attract and retain large deposits from insurance conscious customers. With CDARS, the Company has the option to keep deposits on balance sheet or sell them to other members of the network. Additionally, subject to certain limits, the Bank can use CDARS to purchase cost-effective funding without collateralization and in lieu of generating funds through traditional brokered CDs or the FHLB. In this manner, CDARS can provide the Company with another funding option. Thus, CDARS serves as a deposit-gathering tool and an additional liquidity management tool. Under the EGRRCPA signed into law onMay 24, 2018 , a well-capitalized bank with a CAMELS rating of 1 or 2 may hold reciprocal deposits up to the lesser of 20 percent of its total liabilities or$5 billion without those deposits being treated as brokered deposits. Deposits through the CDARS program as ofJune 30, 2020 andDecember 31, 2019 , were$14,397,000 and$14,864,000 , respectively. COVID-19 and the participation in the PPP and the DAP programs could significantly impact the Company's liquidity. The participation in the PPP program generated average deposit growth of 12.3% during the the second quarter of 2020. The ability to retain these funds as the economic impact of COVID-19 and its effect on our customers continue into the third and fourth quarters are unknown. Management believes that the resources available to the Company will provide sufficient and timely liquidity, both on and off the balance sheet to support the programs and operations. Off-Balance Sheet Activities The Company enters into certain financial transactions in the ordinary course of performing traditional banking services that result in off-balance sheet transactions. Other than subsidiaries to issue trust preferred securities, the Company does not have any off-balance sheet subsidiaries. Off-balance sheet transactions atJune 30, 2020 and atDecember 31, 2019 were as follows (dollars in thousands):June 30, 2020 December 31, 2019
Commitments to extend credit
12,821 13,611
Mortgage loan rate-lock commitments 35,707 10,791
Commitments to extend credit to customers represent legally binding agreements
with fixed expiration dates or other termination clauses. Since many of the
commitments are expected to expire without being funded, the total commitment
amounts do not necessarily represent future funding requirements. Standby
letters of credit are conditional commitments issued by the Company guaranteeing
the performance of a customer to a third party. Those guarantees are primarily
issued to support public and private borrowing arrangements.
49--------------------------------------------------------------------------------
© Edgar Online, source
