LANDMARK BANCORP, INC. Overview.Landmark Bancorp, Inc. is a financial holding company incorporated under the laws of theState of Delaware and is engaged in the banking business through its wholly-owned subsidiary,Landmark National Bank , and in the insurance business through its wholly-owned subsidiary,Landmark Risk Management, Inc. References to the "Company," "we," "us," and "our" refer collectively toLandmark Bancorp, Inc. ,Landmark National Bank andLandmark Risk Management, Inc. The Company is listed on the Nasdaq Global Market under the symbol "LARK." The Bank is dedicated to providing quality financial and banking services to its local communities. Our strategy includes continuing a tradition of holding and acquiring quality assets while growing our commercial, commercial real estate and agriculture loan portfolios. We are committed to developing relationships with our borrowers and providing a total banking service. The Bank is principally engaged in the business of attracting deposits from the general public and using such deposits, together with borrowings and other funds, to originate one-to-four family residential real estate, construction and land, commercial real estate, commercial, agriculture, municipal and consumer loans. Although not our primary business function, we do invest in certain investment and mortgage-related securities using deposits and other borrowings as funding sources.Landmark Risk Management, Inc. , which was formed and began operations onMay 31, 2017 , is aNevada -based captive insurance company that provides property and casualty insurance coverage to the Company and the Bank for which insurance may not be currently available or economically feasible in the insurance marketplace.Landmark Risk Management, Inc. is subject to the regulations of theState of Nevada and undergoes periodic examinations by theNevada Division of Insurance . As ofMay 31, 2019 ,Landmark Risk Management, Inc. exited the pool resources relationship of which it was previously a member. Management expects that it will join a new pool during 2020 and resume providing insurance to the Company and the Bank at that time. Our results of operations depend generally on net interest income, which is the difference between interest income from interest-earning assets and interest expense on interest-bearing liabilities. Net interest income is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. In addition, we are subject to interest rate risk to the degree that our interest-earning assets mature or reprice at different times, or at different speeds, than our interest-bearing liabilities. Our results of operations are also affected by non-interest income, such as service charges, loan fees, gains from the sale of newly originated loans, gains or losses on investments and certain other non-interest related items. Our principal operating expenses, aside from interest expense, consist of compensation and employee benefits, occupancy costs, professional fees, federal deposit insurance costs, data processing expenses and provision for loan losses.
We are significantly impacted by prevailing economic conditions, including federal monetary and fiscal policies, and federal regulations of financial institutions. Deposit balances are influenced by numerous factors such as competing investments, the level of income and the personal rate of savings within our market areas. Factors influencing lending activities include the demand for housing and the interest rate pricing competition from other lending institutions.
Currently, our business consists of ownership of the Bank, with its main office
in
Significant Developments - Impact of COVID-19. The COVID-19 pandemic inthe United States has had and continues to have a complex and significant adverse impact on the economy, the banking industry and the Company, all subject to a high degree of uncertainty for future periods. Effects on Our Market Areas. Our commercial and consumer banking products and services are offered primarily inKansas , where individual and governmental responses to the COVID-19 pandemic led to a broad curtailment of economic activity beginning inMarch 2020 . The Governor ofKansas issued a series of orders, including an order that, subject to limited exceptions, all individuals stay at home and non-essential businesses cease all activities, which order was effectiveMarch 28, 2020 . This stay at home order was lifted onMay 3, 2020 , with economic and social gatherings reopening in a phased-in approach since then. The Bank and its branches have remained open during these orders because banks have been deemed essential businesses. The re-opening of the economy inKansas has resulted in increased cases of COVID-19, and additional restrictions have been put in place to slow the spread. The Bank is currently serving its customers through its digital banking platforms and drive-thru services, while branch lobbies are open by appointment only. Based on the current environment, it is unclear how theState of Kansas will continue to change or relax its stay-at-home and social distancing policies. 26 Acrossthe United States , as a result of stay-at-home orders, many states have experienced a dramatic increase in unemployment levels as a result of the curtailment of business activities. The unemployment rate inKansas was 10.0 percent inMay 2020 , which is an increase from 3.1% inDecember 2019 as a result of economic impacts of the COVID-19 pandemic. Policy and Regulatory Developments. Federal, state and local governments and regulatory authorities have enacted and issued a range of policy responses to the COVID-19 pandemic, including the following:
? The
0.5% on
current range of 0.0 - 0.25%.
? On
Economic Security Act ("CARES Act"), which established a
economic stimulus package, including cash payments to individuals,
supplemental unemployment insurance benefits and a
administered through the
as the Paycheck Protection Program ("PPP"). Under the PPP, small businesses,
sole proprietorships, independent contractors and self-employed individuals
could apply for loans from existing SBA lenders and other approved regulated
lenders that enroll in the program, subject to numerous limitations and
eligibility criteria. The Bank is participating as a lender in the PPP. On or
about
for the PPP was exhausted. On
funding for PPP loans was authorized, with such funds available for PPP loans
beginning on
institutions the option to temporarily suspend certain requirements under GAAP
related to TDRs for a limited period of time to account for the effects of
COVID-19. See footnotes 3 and 11 of the financial statements for additional
information.
? On
Statement on Loan Modifications and Reporting for Financial Institutions,
which, among other things, encouraged financial institutions to work prudently
with borrowers who are or may be unable to meet their contractual payment
obligations because of the effects of COVID-19, and stated that institutions
generally do not need to categorize COVID-19-related modifications as TDRs and
that the agencies will not direct supervised institutions to automatically
categorize all COVID-19 related loan modifications as TDRs. See footnotes 3
and 11 of the financial statements for additional information.
? On
supporting small and midsized business, as well as state and local governments
impacted by COVID-19. The
Lending Program, which establishes two new loan facilities intended to
facilitate lending to small and midsized businesses: (1) the Main Street New
Loan Facility ("MSNLF"), and (2) the Main Street Expanded Loan Facility
("MSELF"). MSNLF loans are unsecured term loans originated on or after April
8, 2020, while MSELF loans are provided as upsized tranches of existing loans
originated before
to
employees or
confirm that they are seeking financial support because of COVID-19 and that
they will not use proceeds from the loan to pay off debt. The
also stated that it would provide additional funding to banks offering PPP
loans to struggling small businesses. Lenders participating in the PPP will be
able to exclude loans financed by the facility from their leverage ratio. In
addition, the
support state and local governments with up to
the
appropriated by the CARES Act. The facility will make short-term financing
available to cities with a population of more than one million or counties
with a population of greater than two million. The
both the size and scope of its Primary and Secondary Market Corporate Credit
Facilities to support up to
This will allow companies that were investment grade before the onset of
COVID-19 but then subsequently downgraded after
to the facility. Finally, the
Asset-Backed Securities Loan Facility will be scaled up in scope to include
the triple A-rated tranche of commercial mortgage-backed securities and newly
issued collateralized loan obligations. The size of the facility is
billion.
? In addition to the policy responses described above, the federal bank
regulatory agencies, along with their state counterparts, have issued a stream
of guidance in response to the COVID-19 pandemic and have taken a number of
unprecedented steps to help banks navigate the pandemic and mitigate its
impact. These include, without limitation: requiring banks to focus on
business continuity and pandemic planning; adding pandemic scenarios to stress
testing; encouraging bank use of capital buffers and reserves in lending
programs; permitting certain regulatory reporting extensions; reducing margin
requirements on swaps; permitting certain otherwise prohibited investments in
investment funds; issuing guidance to encourage banks to work with customers
affected by the pandemic and encourage loan workouts; and providing credit
under the Community Reinvestment Act ("CRA") for certain pandemic-related
loans, investments and public service. Moreover, because of the need for
social distancing measures, the agencies revamped the manner in which they
conducted periodic examinations of their regulated institutions, including
making greater use of off-site reviews. The
guidance encouraging banking institutions to utilize its discount window for
loans and intraday credit extended by its Reserve Banks to help households and
businesses impacted by the pandemic and announced numerous funding facilities.
The
of participating in the PPP and the
and Money Market Mutual Fund Liquidity Facility.
27
Effects on Our Business. The COVID-19 pandemic and the specific developments
referred to above have had, and are expected to continue to have, a significant
impact on our business. In particular, we anticipate that a significant portion
of the Bank's borrowers in the retail, restaurant, hospitality and agriculture
industries will continue to endure significant economic distress, which may
cause them to draw on their existing lines of credit and adversely affect their
ability to repay existing indebtedness, and the COVID-19 pandemic is expected to
adversely impact the value of collateral. These developments, together with
economic conditions generally, are also expected to impact our commercial real
estate portfolio, particularly with respect to real estate with exposure to
these industries, our one-to-four family residential real estate loan business
and loan portfolio, and the value of certain collateral securing our loans. As a
result, we anticipate that our financial condition, capital levels and results
of operations will be significantly adversely affected, as described in further
detail below.
Our Response. We have taken numerous steps in response to the COVID-19 pandemic, including the following:
? We established a pandemic response team, which has been meeting as needed
since mid-March to address changes resulting from the COVID-19 pandemic. We
have a significant portion of our associates working from home and for those
that remain in our bank facilities have enhanced safety precautions in place
for their safety. We have repositioned associates to support our customer care
- call center to handle increased volumes of customer requests and to support
our customers' access to our digital banking platforms.
? As a preferred lender with the SBA, we were able and prepared to immediately
respond to help existing and new clients access the PPP authorized by the
CARES Act. As of
? As of
short-term repayment plans on 13 one-to-four family residential mortgage loans
totaling
forbearance and modifications to those impacted by COVID-19. With the safety
and well-being of our customers and associates foremost in mind, we limited
access to our bank lobbies while keeping our drive-thru lanes open and
encouraging our customers to use our online and mobile banking applications or
call our customer care center.
? In
currently have no plans to change our dividend strategy given our current
capital and liquidity positions. However, while we have achieved a strong
capital base and expect to continue operating profitably, this is dependent
upon the projected length and depth of any economic recession and effects on
our operations, profitability and capital positions in future periods. In
addition, as disclosed in our Annual Report on Form 10-K for the year ended
(including for dividends and repurchases of stock) or pay discretionary
bonuses to executive officers without restriction if we do not maintain
greater than 2.5% in Common Equity Tier 1 Capital attributable to a capital
conservation buffer.
Critical Accounting Policies. Critical accounting policies are those which are both most important to the portrayal of our financial condition and results of operations and require our management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our critical accounting policies relate to the allowance for loan losses, the valuation of investment securities, accounting for income taxes and the accounting for goodwill, all of which involve significant judgment by our management. Information about our critical accounting policies is included under Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2019 filed with theSecurities and Exchange Commission onMarch 12, 2020 . 28 Summary of Results. During the second quarter of 2020, we recorded net earnings of$5.1 million , which was an increase of$2.5 million , or 96.3%, from the$2.6 million of net earnings in the second quarter of 2019. During the first six months of 2020, we recorded net earnings of$8.5 million , which was an increase of$3.7 million , or 77.1%, from the$4.8 million of net earnings in the first six months of 2019. The increase in net earnings was primarily driven by higher gains on sales of loans as low mortgage rates have fueled a robust housing market and refinancing activity.
The following table summarizes earnings and key performance measures for the periods presented.
(Dollars in thousands, except
per share amounts) Three months ended June 30, Six months ended June 30,
2020 2019 2020 2019
Net earnings:
Net earnings $ 5,100 $ 2,598 $ 8,463 $ 4,781
Basic earnings per share (1) $ 1.13 $ 0.57 $ 1.87 $ 1.04
Diluted earnings per share (1) $ 1.13 $ 0.56 $ 1.86 $ 1.04
Earnings ratios:
Return on average assets (2) 1.86 % 1.05 % 1.62 % 0.98 %
Return on average equity (2) 18.03 % 10.61 % 15.22 % 10.08 %
Equity to total assets 10.48 % 10.27 % 10.48 % 10.27 %
Net interest margin (2) 3.72 % 3.43 %
3.69 % 3.42 %
Dividend payout ratio 17.70 % 33.90 % 21.51 % 36.70 %
(1) Per share values for the periods endedJune 30, 2019 have been adjusted to give effect to the 5% stock dividend paid duringDecember 2019 . (2) Ratios have been annualized and are not necessarily indicative of the results for the entire year.
Interest Income. Interest income of$9.6 million for the quarter endedJune 30, 2020 increased$348,000 , or 3.7%, as compared to the same period of 2019. Interest income on loans increased$887,000 , or 12.9%, to$7.8 million for the quarter endedJune 30, 2020 , compared to the same period of 2019 due primarily to an increase in our average loan balances, which increased from$512.2 million in the second quarter of 2019 to$674.1 million in the second quarter of 2020. Our average loan balances benefited from the$130.1 million of PPP loans we originated in the second quarter of 2020. While the maturities of PPP loans are two or five years, we anticipate a significant amount will be forgiven prior to the end of 2020 which will increase the yield on these loans and reduce the balances. Partially offsetting the higher average balances were lower yields on loans, which decreased from 5.39% in the second quarter of 2019 to 4.64% in the second quarter of 2020. TheFederal Reserve decreased the target federal funds interest rate by a total of 75 basis points in the second half of 2019. In addition, in response to the COVID-19 pandemic, theFederal Reserve decreased the target federal funds interest rate by a total of 150 basis points inMarch 2020 . These decreases impacted yields on loans between 2019 and 2020. In addition, the yield on PPP loans is lower than our typical commercial loans, resulting in a lower average yield on loans in the second quarter of 2020. We anticipate that our yield on loans will be adversely affected in future periods as a result originating PPP loans and the impact of loans repricing lower in the current rate environment. Interest income on investment securities decreased$539,000 , or 22.3%, to$1.9 million for the second quarter of 2020, as compared to$2.4 million in the same period of 2019. The decrease in interest income on investment securities was the result of lower average balances, which decreased from$388.7 million in the second quarter of 2019 to$313.9 million in the second quarter of 2020, and lower rates, which decreased from 2.72% in the second quarter of 2019 to 2.67% in the second quarter of 2020. Interest income of$19.0 million for the six months endedJune 30, 2020 increased$782,000 , or 4.3%, as compared to the same period of 2019. Interest income on loans increased$1.6 million , or 11.6%, to$14.9 million for the six months endedJune 30, 2020 , compared to the same period of 2019 due primarily to an increase in our average loan balances, which increased from$502.0 million during the first six months of 2019 to$610.5 million during the first six months of 2020. Partially offsetting the higher average balances were lower yields on loans, which decreased from 5.36% in the six months endedJune 30, 2019 to 4.91% during the six months endedJune 30, 2020 . Our average loan balances and yields were impacted by the same factors described in the quarter-to-quarter comparison above. Interest income on investment securities decrease$770,000 , or 15.9%, to$4.1 million for the first six months of 2020, as compared to$4.8 million in the same period of 2019. The decrease in interest income on investment securities was the result of lower average balances, which decreased from$389.1 million in the first six months of 2019 compared to$337.6 million in the first six months of 2020, and lower rates, which decreased from 2.74% in the first six months of 2019 to 2.67% in the first six months of 2020. Interest Expense. Interest expense during the quarter endedJune 30, 2020 decreased$1.2 million , or 65.5%, to$626,000 as compared to the same period of 2019. Interest expense on interest-bearing deposits decreased$919,000 , or 66.6%, to$461,000 for the quarter endedJune 30, 2020 as compared to the same period of 2019. Our total cost of interest-bearing deposits decreased from 0.86% in the second quarter of 2019 to 0.28% in the second quarter of 2020 as a result of lower rates paid on money market and checking accounts, as the rates reprice based on market indexes, and lower rates on our certificates of deposit. Partially offsetting the lower interest expense rates was an increase in average interest-bearing deposit balances, which increased from$642.1 million in the second quarter of 2019 to$654.4 million in the second quarter of 2020. For the second quarter of 2020, interest expense on borrowings decreased$267,000 , or 61.8%, to$165,000 as compared to the same period of 2019 due to a decrease in our average outstanding borrowings, which decreased from$60.6 million in the second quarter of 2019 to$39.0 million in the same period of 2020, and lower rates, which decreased from 2.86% in the second quarter of 2019 to 1.70% in
the same period of 2020. 29 Interest expense during the six months endedJune 30, 2020 decreased$1.7 million , or 47.4%, to$1.8 million as compared to the same period of 2019. Interest expense on interest-bearing deposits decreased$1.3 million , or 46.7%, to$1.4 million for the six months endedJune 30, 2020 as compared to the same period of 2019. The decrease in interest expense on interest-bearing deposits was the result of lower rates paid on money market and checking accounts, as the rates reprice based on market indexes, and lower rates on our certificates of deposit. Partially offsetting the lower interest expense was an increase in average interest-bearing deposit balances, which increased from$645.5 million in the first six months of 2019 to$649.6 million in the same period of 2020. The average rate of interest-bearing deposits decreased 0.40% to 0.45% for the first six months of 2020 as compared to 0.85% in the same period of 2019. For the first six months of 2020, interest expense on borrowings decreased$391,000 , or 49.6%, to$398,000 as compared to the same period of 2019, due to a decrease in our average outstanding borrowings, which decreased from$54.2 million in the first six months of 2019 to$40.1 million in the first six months of 2020. Also contributing to the lower average outstanding borrowings were lower average rates on our borrowings, which decreased to 2.00% for the first six months of 2020 compared to 2.93% for the same period of 2019. Net Interest Income. Net interest income increased$1.5 million , or 20.5%, to$9.0 million for the second quarter of 2020 compared to the same period of 2019. The increase in net interest income was primarily a result of an increase of 10.9% in average interest-earning assets, from$901.2 million in the second quarter of 2019 to$999.3 million for the same period of 2020. The increase average interest-earning assets was primarily due to growth in our average loan balances. Our net interest margin, on a tax-equivalent basis, increased from 3.43% during the second quarter of 2019 to 3.72% in the same period of 2020. Net interest income increased$2.4 million , or 16.6%, to$17.1 million for the first six months of 2020 compared to the same period of 2019. The increase was primarily a result of a 7.1% increase in average interest-earning assets, from$892.2 million in the first six months of 2019 to$955.9 million in the first six months of 2020. The increase average interest-earning assets was primarily due to growth in our average loan balances. Net interest margin, on a tax-equivalent basis, increased from 3.42% in the first six months of 2019 to 3.69% in the same period of 2020. As a result of the COVID-19 pandemic, we have originated approximately$130.1 million of PPP loans fromApril 3, 2020 throughJune 30, 2020 . These loans have an interest rate of 1.00% plus the amortization of the origination fee which resulted in a yield of 2.60% on PPP loans in the second quarter of 2020. The maturity date of these loans is two or five years unless the borrower's loan is forgiven, in which case the loan may be repaid sooner. While the cost of our funds is lower than the yield on these loans, the interest rate spread is lower than we generally have received. As a result of the origination of PPP loans, to the extent PPP loans we originate are not forgiven. our net interest income may increase in future periods, but our net interest margin will likely decline. In addition, the COVID-19 pandemic has slowed our origination of new loans, excluding PPP loans, which may lead to lower net interest income and net interest margin in future periods. The decline in market interest rates will also likely adversely impact our net interest income and net interest margin as a result of lower yields on loans and investment securities exceeding the benefit of a lower cost of funds.
See the Average Assets/Liabilities and Rate/Volume tables at the end of Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional details on asset yields, liability rates and net interest margin.
Provision for Loan Losses. We maintain, and our Board of Directors monitors, an allowance for losses on loans. The allowance is established based upon management's periodic evaluation of known and inherent risks in the loan portfolio, review of significant individual loans and collateral, review of delinquent loans, past loss experience, adverse situations that may affect the borrowers' ability to repay, current and expected market conditions, and other factors management deems important. Determining the appropriate level of reserves involves a high degree of management judgment and is based upon historical and estimated losses in the loan portfolio and the collateral value or discounted cash flows of specifically identified impaired loans. Additionally, allowance policies are subject to periodic review and revision in response to a number of factors, including current market conditions, actual loss experience and management's expectations. During the second quarter of 2020, we recorded a provision for loan losses of$400,000 compared to$400,000 in the second quarter of 2019. We recorded net loan charge-offs of$132,000 during the second quarter of 2020 compared to net loan charge-offs of$72,000 during the second quarter of 2019. 30 During the first six months of 2020, we recorded a provision for loan losses of$1.6 million compared to$600,000 during the same period of 2019. We recorded net loan charge-offs of$320,000 during the six months endedJune 30, 2020 compared to$99,000 during the same period of 2019. The increase in our provision for loan losses during 2020 was primarily due to the estimated economic impact of the COVID-19 pandemic. If the COVID-19 pandemic causes economic declines in excess of our estimations, or if the pandemic lasts longer than currently projected, our provision for loan losses may remain elevated or increase in future periods. We expect to see higher loan delinquencies and defaults in future periods as a result of the COVID-19 pandemic. We will continue to monitor our allowance for loan losses in light of changing economic conditions related to COVID-19.
For further discussion of the allowance for loan losses, refer to the "Asset Quality and Distribution" section below.
Non-interest Income. Total non-interest income was$7.0 million in the second quarter of 2020, an increase of$3.0 million , or 74.8%, from the same period in 2019, primarily as a result of an increase of$3.1 million in gains on sales of loans. Our gains on sales of loans increased as our originations of secondary market one-to-four family residential real estate loans increased due to the decline in mortgage interest rates that have fueled a robust housing market and refinancing activity. We anticipate our origination levels to remain elevated for some time as a result of the current interest rates; however, the impact of the COVID-19 pandemic may slow these volumes if our borrowers are impacted by the economic slowdown. Partially offsetting this increase is a decrease of$177,000 in fees and services charges due to lower overdraft fees and a decrease of$61,000 in other non-interest income which was primarily due to losses on the sale of real estate owned. The second quarter of 2019 included losses on sales of investment securities totaling$146,000 . Total non-interest income was$12.3 million in the first half of 2020, an increase of$5.1 million , or 70.1%, from the first half of 2019. The increase in non-interest income was primarily due to an increase of$3.2 million in gains on sales of loans, driven by higher volumes of secondary market one-to-four family residential real estate loans originated. Also contributing to the increase in non-interest income was$1.8 million of gains on sales of investment securities due to approximately$45 million of mortgage-backed investment securities sold during the first six months of 2020. We sold higher coupon mortgage-backed investment securities after comparing the market prices to the risks of accelerating prepayment speeds due to decreasing interest rates. A loss of$146,000 was recorded on sales of investment securities during the six months endedJune 30, 2019 . Non-interest Expense. Non-interest expense totaled$9.1 million for the second quarter of 2020, an increase of$1.2 million , or 14.5%, from$8.0 million for the second quarter of 2019. The increase was primarily due to increases of$1.0 million in compensation and benefits as a result of the addition of bank employees and increased compensation costs. Also contributing to the increase were increases of$133,000 in amortization of intangibles resulting from accelerated prepayments on mortgage servicing rights. Non-interest expense totaled$17.2 million for the first six months of 2020, an increase of$1.5 million or 9.8%, from$15.7 million for the first six months of 2019. The increase was primarily due to increases of$1.4 million in compensation and benefits as a result of the addition of bank employees and increased compensation costs. Also contributing to the increase was an increase of$146,000 in amortization of intangibles resulting from accelerated prepayments on mortgage servicing rights. Partially offsetting that increase was a decline of$125,000 in professional fees due primarily to a decrease in costs associated with an external audit of our internal controls over financial reporting that will no longer be required for the Company based on the fact that the Company will no longer qualify as an accelerated filer for its Form 10-K for the year endingDecember 31, 2020 based on the change in the definition of accelerated filer. Income Tax Expense. During the second quarter of 2020, we recorded income tax expense of$1.4 million , compared to$506,000 during the same period of 2019. Our effective tax rate increased from 16.3% in the second quarter of 2019 to 21.2% in the second quarter of 2020, primarily due to an increase in earnings before income taxes while our tax-exempt income declined over the comparable periods.
We recorded income tax expense of$2.2 million for the first six months of 2020 compared to$847,000 in the same period of 2019. Our effective tax rate increased from 15.0% in the first half of 2019 to 20.3% in the first half of 2020 primarily due to an increase in earnings before income taxes while our tax-exempt income declined over the comparable periods. 31
Financial Condition. Economic conditions inthe United States deteriorated during the first six months of 2020 as the impact of COVID-19 caused portions of the economy to shut down. OnMarch 28, 2020 , a stay at home order was issued for the entire state ofKansas , which expanded previously issued local orders. This stay at home order was lifted onMay 3, 2020 with a phased approach to reopening theKansas economy. TheState of Kansas and the geographic markets in which the Company operates have been significantly impacted by this pandemic. The Company's allowance for loan losses atJune 30, 2020 included estimates of the economic impact of COVID-19 on our loan portfolio. COVID-19 will likely continue to cause an increase in our delinquent and non-accrual loans as the economic slowdown impacts our customers. However, our loan portfolio is diversified across various types of loans and collateral throughout the markets in which we operate. Aside from a few problem loans that management is working to resolve, our asset quality has remained strong over the past few years. While we anticipate further increases in problem assets as a result of COVID-19, management believes its efforts to run a high quality financial institution with a sound asset base will continue to create a strong foundation for continued growth and profitability in the future. The table below shows additional information on the diversification of industry types within our commercial real estate and commercial loan categories: (dollars in thousands) As ofJune 30, 2020 Loan Percent of balance total loans Commercial real estate loans:
Real estate rental and leasing - owner occupied
6.1 %
Real estate rental and leasing - non-owner occupied
4.5 % Accomodations and hotels 15,132 2.2 % Retail 9,054 1.3 %
Health care and social assistance 9,727
1.4 %
Restaurants 5,702
0.8 %
Construction and specialty contractors 4,286
0.6 %
Educational services 4,661 0.7 %
Other 21,196 3.0 %Total commercial real estate loans$ 144,249
20.6 % Commercial loans: Finance and insurance 17,766 2.5 %
Auto and equipment leasing 17,429
2.5 %
Wholesale 14,761
2.1 %
Construction and specialty contractors 11,532
1.6 %
Retail 8,337 1.2 %
Restaurants 7,013 1.0 %Real estate rental and leasing 3,115
0.4 %
Other 37,436 5.3 %
Total commercial loans $ 117,389 16.7 %
Asset Quality and Distribution. Our primary investing activities are the
origination of one-to-four family residential real estate, construction and
land, commercial real estate, commercial, agriculture, municipal and consumer
loans and the purchase of investment securities. Total assets increased $120.5
million , or 12.1%, to $1.1 billion at June 30, 2020 , compared to $998.5 million
at December 31, 2019 . Investment securities available for sale decreased $56.2
million , or 15.5%, to $306.8 million at June 30, 2020 , from $363.0 million at
December 31, 2019 primarily due to the result of the strategic sale of agency
mortgage-backed investment securities during the first quarter of 2020. Net
loans increased $157.4 million , or 29.6%, to $689.6 million at June 30, 2020 ,
compared to $532.2 million at year-end 2019. Our loan growth during the second
quarter of 2020 was primarily due to the origination of PPP loans. We anticipate
that loan growth will slow down in the future for our commercial and commercial
real estate portfolios as a result of COVID-19 and the related decline in
economic conditions in our market areas.
The allowance for loan losses is established through a provision for loan losses
based on our evaluation of the risk inherent in the loan portfolio and changes
in the nature and volume of our loan activity. This evaluation, which includes a
review of all loans with respect to which full collectability may not be
reasonably assured, considers the fair value of the underlying collateral,
economic conditions, historical loan loss experience, level of classified loans
and other factors that warrant recognition in providing for an appropriate
allowance for loan losses. At June 30, 2020 our allowance for loan losses
totaled $7.7 million , or 1.11% of gross loans outstanding, compared to $6.5
million , or 1.20% of gross loans outstanding, at December 31, 2019 . The
allowance for loan losses to gross loans outstanding declined as a result of
originating $130.1 million of PPP loans which are guaranteed by the SBA and have
no allowance allocated as of June 30, 2020 .
32
As ofJune 30, 2020 andDecember 31, 2019 , approximately$26.0 million and$18.1 million , respectively, of loans were considered classified and assigned a risk rating of special mention, substandard or doubtful. The increase in classified loans was primarily due to the impact of COVID-19 and weakness in the agriculture industry which deteriorated further due to the pandemic. These ratings indicate that these loans were identified as potential problem loans having more than normal risk which raised doubts as to the ability of the borrower to comply with present loan repayment terms. Even though borrowers were experiencing moderate cash flow problems as well as some deterioration in collateral value, management believed the allowance for loan losses was sufficient to cover the risks and probable incurred losses related to such loans atJune 30, 2020 andDecember 31, 2019 , respectively. Loans past due 30-89 days and still accruing interest totaled$4.2 million , or 0.60% of gross loans, atJune 30, 2020 , compared to$3.4 million , or 0.64% of gross loans, atDecember 31, 2019 . AtJune 30, 2020 ,$8.2 million in loans were on non-accrual status, or 1.18% of gross loans, compared to$5.5 million , or 1.03% of gross loans, atDecember 31, 2019 . Non-accrual loans typically consist of loans 90 or more days past due and certain impaired loans. No loans were 90 days delinquent and accruing interest atJune 30, 2020 orDecember 31, 2019 . Our impaired loans totaled$11.9 million atJune 30, 2020 compared to$8.7 million atDecember 31, 2019 . The difference in the Company's non-accrual loan balances and impaired loan balances atJune 30, 2020 andDecember 31, 2019 was related to TDRs that were accruing interest but still classified as impaired. AtJune 30, 2020 , the Company had eight loan relationships consisting of sixteen outstanding loans that were classified as TDRs. One commercial loan relationship with five loans was classified as a TDR during the three months and six months endedJune 30, 2020 . No loan restructurings were classified as TDRs during
the first six months of 2019.
As ofJune 30, 2020 , the Company had restructured 135 loans totaling$54.7 million as a result of the COVID-19 pandemic. These loans are not classified as TDRs based on the CARES Act and regulatory guidance as the modifications were directly related to the impact of COVID-19. As ofJune 30, 2020 , these loans were all performing based on the terms of their restructurings. As ofJuly 31, 2020 , 57 loans with outstanding loan balances of$18.4 million had reached the end of their initial deferral periods and returned to their respective contractual payment terms. Additionally, as of the same date, only 2 borrowers with aggregate loans outstanding of$3.8 million were granted a second deferral. The following table presents additional information on these commercial and commercial real estate loan modifications by industry type: (dollars in thousands) As of June 30, 2020 Commercial Other Total COVID-19 real estate Commercial loans modificatons Real estate rental and leasing - owner occupied$ 3,079 $ 91$ 2,606 $ 5,776 Real estate rental and leasing - non-owner occupied 8,511 - 4,720 13,231 Accommodations and hotels 9,920 - - 9,920 Manufacturing 558 2,208 598 3,364 Restaurants 3,779 820 - 4,599
Healthcare and social assistance 2,275 313
653 3,241 Educational services 2,009 - 1,089 3,098 Construction and specialty contractors 97 379 261 737 Other 3,558 2,917 4,269 10,744
Total COVID-19 loan modifications
Consistent with the CARES Act and regulatory guidance, the Company entered into short-term forbearance plans or short-term repayment plans on thirteen one-to-four family residential mortgage loans totaling$1.5 million as ofJune 30, 2020 . These modifications are not included in the table above. As part of our credit risk management, we continue to manage the loan portfolio to identify problem loans and have placed additional emphasis on commercial real estate and construction and land relationships. We are working to resolve the remaining problem credits or move the non-performing credits out of the loan portfolio. AtJune 30, 2020 , we had$314,000 of real estate owned compared to$290,000 atDecember 31, 2019 . As ofJune 30, 2020 , real estate owned consisted of undeveloped land and residential real estate. The Company is currently marketing all of the remaining properties in real estate owned. Liability Distribution. Our primary ongoing sources of funds are deposits, FHLB borrowings, proceeds from principal and interest payments on loans and investment securities and proceeds from the sale of mortgage loans and investment securities. While maturities and scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates and economic conditions. We experienced an increase of$109.2 million , or 13.1%, in total deposits during the first six months of 2020, to$944.2 million atJune 30, 2020 , from$835.0 million atDecember 31, 2019 . The increase in deposits was primarily due to increased balances of non-interest bearing, money market and checking and savings deposit accounts. This increase in deposits was primarily related to PPP funds, government stimulus payments and customers increasing liquidity. This increase was partially offset by lower balances of time deposit accounts. 33 Non-interest-bearing deposits atJune 30, 2020 , were$277.6 million , or 29.4% of deposits, compared to$182.7 million , or 21.9% of deposits, atDecember 31, 2019 . Money market and checking deposit accounts were 45.7% of our deposit portfolio and totaled$431.8 million atJune 30, 2020 , compared to$405.7 million , or 48.6% of deposits, atDecember 31, 2019 . Savings accounts increased to$116.3 million , or 12.3% of deposits, atJune 30, 2020 , from$99.5 million , or 11.9% of deposits, atDecember 31, 2019 . Certificates of deposit totaled$118.5 million , or 12.6% of deposits, atJune 30, 2020 , compared to$147.1 million , or 17.6% of deposits, atDecember 31, 2019 . Certificates of deposit atJune 30, 2020 , scheduled to mature in one year or less, totaled$96.4 million . Historically, maturing deposits have generally remained with the Bank, and we believe that a significant portion of the deposits maturing in one year or less will remain with us upon maturity in
some type of deposit account.
Total borrowings decreased$2.4 million to$39.8 million atJune 30, 2020 , from$42.2 million atDecember 31, 2019 . The decrease in total borrowings was primarily due to a decrease in our other borrowings, consisting of repurchase agreements, from$17.5 million atDecember 31, 2019 to$10.2 million atJune 30, 2020 . Partially offsetting that decrease was$8.0 million of FHLB advances we borrowed during the second quarter of 2020 as a result of special rate PPP funding offered by the FHLB. Cash Flows. During the six months endedJune 30, 2020 , our cash and cash equivalents increased by$4.5 million . Our operating activities used cash of$2.5 million during the first six months of 2020 primarily as a result of the origination of loans held for sale. Our investing activities used net cash of$95.7 million during the first six months of 2020, primarily as a result of funding PPP loans. Financing activities provided net cash of$102.7 million during the first six months of 2020, primarily as a result of an increase in deposits. Liquidity. Our most liquid assets are cash and cash equivalents and investment securities available for sale. The levels of these assets are dependent on the operating, financing, lending and investing activities during any given period. These liquid assets totaled$325.0 million atJune 30, 2020 and$376.7 million atDecember 31, 2019 . During periods in which we are not able to originate a sufficient amount of loans and/or periods of high principal prepayments, we generally increase our liquid assets by investing in short-term, high-grade investments. Liquidity management is both a daily and long-term function of our strategy. Excess funds are generally invested in short-term investments. Excess funds are typically generated as a result of increased deposit balances, while uses of excess funds are generally deposit withdrawals and loan advances. In the event we require funds beyond our ability to generate them internally, additional funds are generally available through the use of FHLB advances, a line of credit with the FHLB, other borrowings or through sales of investment securities. AtJune 30, 2020 , we had an outstanding FHLB advance of$8.0 million and no borrowings against our line of credit with the FHLB. AtJune 30, 2020 , we had collateral pledged to the FHLB that would allow us to borrow an additional$67.2 million , subject to FHLB credit requirements and policies. AtJune 30, 2020 , we had no borrowings through theFederal Reserve discount window, while our borrowing capacity with theFederal Reserve was$107.3 million . We also have various other federal funds agreements, both secured and unsecured, with correspondent banks totaling approximately$30.0 million in available credit under which we had no outstanding borrowings atJune 30, 2020 . AtJune 30, 2020 , we had subordinated debentures totaling$21.7 million and other borrowings of$10.2 million , which consisted of$10.2 million in repurchase agreements. The Company also has available a$7.5 million line of credit from an unrelated financial institution maturing onNovember 1, 2020 , with an interest rate that adjusts daily based on the prime rate less 0.25%. This line of credit has covenants specific to capital and other financial ratios, with which the Company was in compliance atJune 30, 2020 .
We have been actively monitoring our liquidity since the COVID-19 pandemic
began. This includes enhanced monitoring of cash levels and unfunded loan
commitments. We also increased our borrowing capacity at the
Off Balance Sheet Arrangements. As a provider of financial services, we routinely issue financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by us generally to guarantee the payment or performance obligation of a customer to a third party. While these standby letters of credit represent a potential outlay by us, a significant amount of the commitments may expire without being drawn upon. We have recourse against the customer for any amount the customer is required to pay to a third party under a standby letter of credit. The letters of credit are subject to the same credit policies, underwriting standards and approval process as loans made by us. Most of the standby letters of credit are secured, and in the event of nonperformance by the customers, we have the right to the underlying collateral, which could include commercial real estate, physical plant and property, inventory, receivables, cash and marketable securities. The contract amount of these standby letters of credit, which represents the maximum potential future payments guaranteed by us, was$2.1 million atJune 30, 2020 . 34
At
Capital. Current regulatory capital regulations require financial institutions (including banks and bank holding companies) to meet certain regulatory capital requirements. The Company and the Bank are subject to the Basel III Rules that implemented the Basel III regulatory capital reforms from theBasel Committee on Banking Supervision and certain changes required by theDodd-Frank Wall Street Reform and Consumer Protection Act. The Basel III Rules are applicable to allU.S. banks that are subject to minimum capital requirements, as well as to bank and savings and loan holding companies other than "small bank holding companies" (generally, non-public bank holding companies with consolidated assets of less than$3.0 billion ).
The Basel III Rules require a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, a Tier 1 capital to risk-weighted assets minimum ratio of 6.0%, a Total Capital to risk-weighted assets minimum ratio of 8.0%, and a Tier 1 leverage minimum ratio of 4.0%. A capital conservation buffer, equal to 2.5% common equity Tier 1 capital, is also established above the regulatory minimum capital requirements (other than the Tier 1 leverage ratio). As ofJune 30, 2020 andDecember 31, 2019 , the Bank met the capital requirements to be deemed "well capitalized," which is the highest rating available under the regulatory capital regulations framework for prompt corrective action. Management believed that as ofJune 30, 2020 , the Company and the Bank met all capital adequacy requirements to which we are subject. We believe the Company has adequate capital to withstand the impact of the COVID-19 pandemic and any economic downturn on our asset quality and net earnings. The Company performs stress tests on the loan portfolio to measure the impact of severe economic recessions on its capital levels to help it monitor capital levels in connection with the COVID-19 pandemic.
Dividends. During the quarter ended
The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations. In addition, under the Basel III Rules, financial institutions have to maintain greater than 2.5% in common equity Tier 1 capital attributable to the capital conservation buffer in order to pay dividends and make other capital distributions. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as ofJune 30, 2020 . The National Bank Act imposes limitations on the amount of dividends that a national bank may pay without prior regulatory approval. Generally, the amount is limited to the bank's current year's net earnings plus the adjusted retained earnings for the two preceding years. As ofJune 30, 2020 , approximately$18.6 million was available to be paid as dividends to the Company by the Bank without prior regulatory approval. Additionally, our ability to pay dividends is limited by the subordinated debentures that are held by three business trusts that we control. Interest payments on the debentures must be paid before we pay dividends on our capital stock, including our common stock. We have the right to defer interest payments on the debentures for up to 20 consecutive quarters. However, if we elect to defer interest payments, all deferred interest must be paid before we may pay dividends on our capital stock. 35
Average Assets/Liabilities. The following tables reflect the tax-equivalent yields earned on average interest-earning assets and costs of average interest-bearing liabilities for the periods indicated (derived by dividing income or expense by the monthly average balance of assets or liabilities, respectively) as well as "net interest margin" (which reflects the effect of the net earnings balance) for the periods shown:
Three months ended Three months ended
(Dollars in thousands) June 30, 2020 June 30, 2019
Average Average Average
Average balance Interest yield/rate balance Interest yield/rate
Assets
Interest-earning assets:
Interest-bearing deposits at banks $ 11,299 $ 4 0.14 % $ 298 $ 5 6.73 %
Investment securities (1) 313,872 2,087 2.67 % 388,681 2,638 2.72 %
Loans receivable, net (2) 674,149 7,772 4.64 % 512,242 6,886 5.39 %
Total interest-earning assets 999,320 9,863 3.97 % 901,221 9,529 4.24 %
Non-interest-earning assets 98,083 93,393
Total $ 1,097,403 $ 994,614
Liabilities and Stockholders' Equity
Interest-bearing liabilities:
Money market and checking $ 412,894 $ 139 0.14 %$ 375,590 $ 712 0.76 % Savings accounts 112,994 10 0.04 % 97,760 9 0.04 % Time deposit 128,545 312 0.98 % 168,729 659 1.57 % Total deposits 654,433 461 0.28 % 642,079 1,380 0.86 %
FHLB advances and other borrowings 38,964 165 1.70 % 60,585 432 2.86 % Total interest-bearing liabilities 693,397 626 0.36 % 702,664 1,812 1.03 % Non-interest-bearing liabilities 290,535
193,777
Stockholders' equity 113,471 98,173
Total $ 1,097,403 $ 994,614
Interest rate spread (3) 3.61 % 3.21 %
Net interest margin (4) $ 9,237 3.72 % $ 7,717 3.43 %Tax-equivalent interest - imputed 222 236 Net interest income$ 9,015 $ 7,481 Ratio of average interest-earning assets to average interest-bearing liabilities 144.1 % 128.3 %
(1) Income on tax exempt securities is presented on a fully tax-equivalent basis,
using a 21% federal tax rate.
(2) Includes loans classified as non-accrual. Income on tax-exempt loans ispresented on a fully tax-equivalent basis, using a 21% federal tax rate. (3) Interest rate spread represents the difference between the average yield
earned on interest-earning assets and the average rate paid on
interest-bearing liabilities. (4) Net interest margin represents annualized, tax-equivalent net interest income
divided by average interest-earning assets.
36
Six months ended Six months ended
(Dollars in thousands) June 30, 2020 June 30, 2019
Average Average Average
Average balance Interest yield/rate balance Interest yield/rate
Assets
Interest-earning assets:
Interest-bearing deposits at banks $ 7,765 $ 15 0.39 %$ 1,074 $ 19 3.57 % Investment securities (1) 337,568 4,484 2.67 % 389,059 5,280 2.74 % Loans receivable, net (2) 610,529 14,904 4.91 % 502,040 13,353 5.36 % Total interest-earning assets 955,862 19,403 4.08 % 892,173 18,652 4.22 % Non-interest-earning assets 95,079 93,074 Total$ 1,050,941 $ 985,247 Liabilities and Stockholders' Equity Interest-bearing liabilities: Money market and checking $ 402,961$ 653 0.33 %$ 379,254 $ 1,394 0.74 % Savings accounts 107,366 19 0.04 % 96,959 17 0.04 % Time deposit 139,292 772 1.11 % 169,332 1,300 1.55 % Total deposits 649,619 1,444 0.45 % 645,545 2,711 0.85 %
FHLB advances and other borrowings 40,052 398 2.00 % 54,230 789 2.93 % Total interest-bearing liabilities 689,671 1,842 0.54 % 699,775 3,500 1.01 % Non-interest-bearing liabilities 249,150
189,857
Stockholders' equity 112,120 95,615
Total $ 1,050,941 $ 985,247
Interest rate spread (3) 3.54 % 3.21 %
Net interest margin (4) $ 17,561 3.69 % $ 15,152 3.42 %Tax-equivalent interest - imputed 444 475 Net interest income$ 17,117 $ 14,677 Ratio of average interest-earning assets to average interest-bearing liabilities 138.6 % 127.5 %
(1) Income on tax exempt securities is presented on a fully tax-equivalent basis,
using a 21% federal tax rate.
(2) Includes loans classified as non-accrual. Income on tax-exempt loans ispresented on a fully tax-equivalent basis, using a 21% federal tax rate. (3) Interest rate spread represents the difference between the average yield
earned on interest-earning assets and the average rate paid on
interest-bearing liabilities. (4) Net interest margin represents annualized, tax-equivalent net interest income
divided by average interest-earning assets.
37
Rate/Volume Table. The following table describes the extent to which changes in
tax-equivalent interest income and interest expense for major components of
interest-earning assets and interest-bearing liabilities affected the Company's
interest income and expense for the periods indicated. The table distinguishes
between (i) changes attributable to rate (changes in rate multiplied by prior
volume), (ii) changes attributable to volume (changes in volume multiplied by
prior rate), and (iii) net change (the sum of the previous columns). The net
changes attributable to the combined effect of volume and rate that cannot be
segregated have been allocated proportionately to the change due to volumeand the change due to rate. (Dollars in thousands) Three months endedJune 30 ,
Six months ended June 30,
2020 vs 2019 2020 vs 2019
Increase/(decrease) attributable to Increase/(decrease) attributable to
Volume Rate Net Volume Rate Net
Interest income:
Interest-bearing
deposits at banks $ (1 ) $ - $ (1 ) $ (5 ) $ 1 $ (4 )
Investment securities (503 ) (48 ) (551 ) (667 ) (129 ) (796 )
Loans 1,583 (697 ) 886 2,536 (985 ) 1,551
Total 1,079 (745 ) 334 1,864 (1,113 ) 751
Interest expense:
Deposits 27 (946 ) (919 ) 17 (1,284 ) (1,267 )
Borrowings (125 ) (142 ) (267 ) (177 ) (214 ) (391 )
Total (98 ) (1,088 ) (1,186 ) (160 ) (1,498 ) (1,658 )
Net interest income $ 1,177 $ 343 $ 1,520 $ 2,024 $ 385 $ 2,409 © Edgar Online, source
