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, 2020 , 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 the Company's allowance for loan losses, the
• amount of loan loss provisions required in future periods, and the failure of
assumptions underlying the allowance for loan losses;
• 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;
• the ability to recruit and retain key personnel;
• cybersecurity threats or attacks, the implementation of new technologies, and
the ability to develop and maintain reliable and secure electronic systems;
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 created a global health crisis that resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity inthe United States and globally. Governmental responses 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, resulted in rapid decreases in commercial and consumer activity, temporary closures of many businesses that 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. In 2020, the Company implemented a business continuity plan and protocols to continue to maintain a high level of care for its employees, customers and communities. The Company 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. In the first quarter of 2021, the Company was encouraged by the optimism surrounding the potential end of the pandemic and prospects for the economy with continued stimulus support. InApril 2021 , the majority of remaining remote workers returned to the office, and the Company fully opened branch lobbies to customers with prudent safety protocols. The Company remains focused on supporting and protecting its employees, customers, and communities while creating shareholder value. During the first quarter of 2021, the Bank continued to assist borrowers through theDisaster Assistance Program ("DAP") adopted inMarch 2020 in response to the federal banking agencies issuance of the "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 encouraged 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 explained 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"). OnMarch 31, 2021 , the balance of loans remaining in this program was$19.3 million , or less than 1.0% of the total portfolio, compared to$30.0 million , or 1.5%, atDecember 31, 2020 . AtMarch 31, 2021 ,$16.4 million of the$19.3 million was the result of second and third interest deferrals. The majority of the remaining modifications involved six-month deferments of interest. 32
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The Company continued to participate in theSmall Business Administration ("SBA") Paycheck Protection Program ("PPP") under the Coronavirus Aid, Relief, and Economic Security ("CARES") Act in the first quarter of 2021. During the quarter, there were 805 loans processed for approximately$80.7 million from the second round of the program. The loans are 100% guaranteed by the SBA and therefore do not have a related allowance. The SBA pays the Bank a processing fee based on the size of the loan which is amortized to income over the life of the loan or until the loan is forgiven or otherwise repaid. In addition to the new loans,$105.1 million of first round loans from 2020 were forgiven in first quarter 2021 compared to$56.4 million in the fourth quarter of 2020. Total outstanding net PPP loans were$183.8 million and$211.3 million atMarch 31, 2021 andDecember 31, 2020 , respectively. Reclassification
In certain circumstances, reclassifications have been made to prior period information to conform to the 2021 presentation. There were no material reclassifications.
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, 2020 . 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, and charge-offs and recoveries; trends in
volume and terms of loans; effects of changes in risk selection, underwriting
standards, and lending policies; experience of lending staff; national,
regional, and local economic trends and conditions; portfolio concentrations;
regulatory and legal factors; 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.
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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.
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.
Recently adopted Accounting Standards Update 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 impairment charge will be limited to the amount of goodwill allocated to that reporting unit. 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. The Company performs its annual analysis as ofJune 30 each fiscal year, as well as when an event triggering impairment may have occurred. Due to the COVID-19 pandemic market conditions, the Company determined a triggering event occurred during the first quarter of 2020 and performed an assessment for each quarter end of 2020 starting with the first quarter. The assessments determined the fair value exceeded the carrying value and did not indicate impairment. Due to improving economic conditions, no assessment was deemed necessary atMarch 31, 2021 . The impact of COVID-19 on market conditions and other changes in the economic environment, operations, or other adverse events could result in future impairment charges which could have a material adverse impact on the Company's operating results. 34
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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. 35
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Table of Contents RESULTS OF OPERATIONS Executive Overview
First quarter 2021 financial highlights include the following:
• Earnings produced a return on average assets (annualized) of 1.49% for the
first quarter of 2021, compared to 1.18% in the previous quarter and 1.37%
for the same quarter in the prior year.
• Average deposits grew 1.8% during the quarter and 24.8% over the samequarter of 2020; the cost of interest-bearing deposits decreased to 0.30% in
the first quarter, compared to 0.43% in the previous quarter and 0.89% in
the same quarter of the prior year.
• Fully taxable equivalent net interest margin was 3.20% for the quarter, down
from 3.22% in the fourth quarter of 2020 and from 3.52% in the same quarter
of the prior year.*
• Noninterest revenues increased
previous quarter, and increased
quarter in the prior year.
• Noninterest expense decreased
previous quarter, and increased
same quarter in the prior year.
• The Company had no provision for loan losses in the first quarter of 2021,
compared to a provision of
provision of
net charge-offs were 0.00% for the first quarter of 2021, down from 0.01%
for the corresponding quarter in the prior year and 0.05% for the fourth
quarter of 2020.
• Nonperforming assets as a percentage of total assets were 0.10% at
2021, down from 0.12% at December 31, 2020 and 0.16% at March 31, 2020 .
*Refer to the Non-GAAP Financial Measures within this section for further information on this non-GAAP financial measurement.
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 increased$2,495,000 , or 12.5%, for the first quarter of 2021 compared to the same quarter of 2020. The increase in net interest income from the same quarter in the prior year was attributable to the PPP and reduced deposit costs from a significantly lower rate environment. Average loan balances for the 2021 quarter were up$188,122,000 , or 10.3%, over the 2020 quarter, primarily due to PPP lending. These loans had a net balance of$183,783,000 atMarch 31, 2021 , earn 1% interest, and generate fee income that is being accreted over the life of the loans. The interest income from the total PPP portfolio generated$526,000 in revenues for the first quarter of 2021. Total net PPP fees recognized in net interest income during the first quarter of 2021 were$2,854,000 , enhanced by the accelerated amortization of fees and costs on the forgiveness of$105,100,000 in PPP loans. Loan yields for the quarter were 24 basis points lower than the 2020 quarter. For the first quarter of 2021, the Company's yield on interest-earning assets was 3.46%, compared to 4.21% for the first quarter of 2020. The cost of interest-bearing liabilities was 0.40% compared to 1.01%. The interest rate spread was 3.06% compared to 3.20%. The net interest margin, on a fully taxable equivalent basis, was 3.20% compared to 3.52%, a decrease of 32 basis points. The decrease in net interest margin was driven by declining interest rates and the impact of lower rates on the PPP lending. 36
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The following presentation is an analysis of net interest income and related yields and rates, on a taxable equivalent basis, for the three months endedMarch 31, 2021 and 2020. 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.
Net Interest Income Analysis (dollars in thousands)
Three Months Ended March 31,
Average Balance Income/Expense Yield/Rate
2021 2020 2021 2020 2021 2020
Loans:
Commercial $ 464,677 $ 332,920 $ 5,790 $ 3,543 5.05 % 4.28 %
Real estate 1,548,091 1,489,319 16,390 17,663 4.23 4.74
Consumer 7,635 10,042 127 157 6.75 6.29
Total loans 2,020,403 1,832,281 22,307 21,363 4.43 4.67
Securities:
U.S. Treasury 15,303 9,049 12 36 0.31 1.59
Federal agencies and GSEs 105,337 103,311 305 576 1.16 2.23
Mortgage-backed and CMOs 258,003 197,774 973 1,144 1.51 2.31
State and municipal 58,493 40,825 315 288 2.15 2.82
Other securities 21,624 18,771 275 264 5.09 5.63
Total securities 458,760 369,730 1,880 2,308 1.64 2.50
Deposits in other banks 335,128 72,909 77 264 0.09 1.46
Total interest-earning assets 2,814,291 2,274,920 24,264
23,935 3.46 4.21
Non-earning assets 212,661 216,671
Total assets $ 3,026,952 $ 2,491,591
Deposits:
Demand $ 450,953 $ 331,357 40 123 0.04 0.15
Money market 683,948 515,339 276 1,188 0.16 0.93
Savings 227,404 178,896 7 53 0.01 0.12
Time 378,113 469,973 964 1,948 1.03 1.67
Total deposits 1,740,418 1,495,565 1,287 3,312 0.30 0.89
Customer repurchase agreements 43,746 41,519 11 129 0.11 1.25
Other short-term borrowings - 3 - - - 1.01
Long-term borrowings 35,640 35,554 483 506 5.41 5.69
Total interest-bearing
liabilities 1,819,804 1,572,641 1,781 3,947 0.40 1.01
Noninterest-bearing demand
deposits 842,121 574,362
Other liabilities 22,796 21,015
Shareholders' equity 342,231 323,573
Total liabilities and
shareholders' equity $ 3,026,952 $ 2,491,591
Interest rate spread 3.06 % 3.20 %
Net interest margin 3.20 % 3.52 %
Net interest income (taxable equivalent basis) 22,483 19,988
Less: Taxable equivalent
adjustment 60 69
Net interest income $ 22,423 $ 19,919
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Changes in Net Interest Income (Rate/Volume Analysis)
(in thousands)
Three Months Ended March 31,
2021 vs. 2020
Change
Increase Attributable to
(Decrease) Rate Volume
Interest income
Loans:
Commercial $ 2,247 $ 677 $ 1,570
Real estate (1,273 ) (1,950 ) 677
Consumer (30 ) 10 (40 )
Total loans 944 (1,263 ) 2,207
Securities:
U.S. Treasury (24 ) (40 ) 16
Federal agencies and GSEs (271 ) (282 ) 11
Mortgage-backed and CMOs (171 ) (463 ) 292
State and municipal 27 (79 ) 106
Other securities 11 (27 ) 38
Total securities (428 ) (891 ) 463
Deposits in other banks (187 ) (431 ) 244
Total interest income 329 (2,585 ) 2,914
Interest expense
Deposits:
Demand (83 ) (117 ) 34
Money market (912 ) (1,210 ) 298
Savings (46 ) (57 ) 11
Time (984 ) (653 ) (331 )
Total deposits (2,025 ) (2,037 ) 12
Customer repurchase agreements (117 ) (124 ) 7
Long-term borrowings (24 ) (25 ) 1
Total interest expense (2,166 ) (2,186
) 20
Net interest income (taxable equivalent basis)
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Table of Contents Noninterest Income
Three months ended
For the quarter ended
Three Months Ended March 31,
(Dollars in thousands)
2021 2020 $ Change % Change
Noninterest income:
Trust fees $ 1,206 $ 1,012 $ 194 19.2 %
Service charges on deposit accounts 622 721 (99 ) (13.7 )
Other fees and commissions 1,139 941 198 21.0
Mortgage banking income 1,318 549 769 140.1
Securities gains, net - 814 (814 ) (100.0 )
Brokerage fees 218 211 7 3.3
Income from Small Business Investment Companies 428 55 373 678.2
Income from insurance investments 788 48 740 1,541.7
Losses on premises and equipment, net (49 ) (82 ) 33 (40.2 )
Other 252 226 26 11.5
Total noninterest income $ 5,922 $ 4,495 $ 1,427 31.7
Trust fees increased $194,000 for the three months ended March 31, 2021 compared
to the same period in 2020 as a result of growth in clients and growth in market
value. Service charge income decreased $99,000 in the first quarter of 2021
compared to the first quarter of 2020 due to decreased consumer activity in the
wake of the COVID-19 pandemic. Other fees and commissions increased $198,000 in
the 2021 period compared to the 2020 period due to increased usage of debit
cards. Mortgage banking income increased $769,000 in the 2021 quarter compared
to the 2020 quarter, primarily due to increased volume of applications for
purchases and refinancing as rates have hit historical lows. Income from Small
Business Investment Companies and income from insurance investments increased
$373,000 and $740,000 , respectively, during three months ended March 31,
2021 compared to the same period in 2020. Income from Small Business Investment
Companies are not predictable. The increase in income from insurance investments
was primarily the result of an additional distribution in 2020 not received
until 2021. There were no net securities gains in the 2021 quarter compared to
$814,000 in the same quarter in 2020.
Noninterest Expense
Three months ended
For the three months ended
Three Months Ended March 31,
(Dollars in thousands)
2021 2020 $ Change % Change
Noninterest Expense
Salaries and employee benefits $ 7,518 $ 7,360 $ 158 2.1 %
Occupancy and equipment 1,533 1,366 167 12.2
FDIC assessment 224 95 129 135.8
Bank franchise tax 438 426 12 2.8
Core deposit intangible amortization 381 427 (46 ) (10.8 )
Data processing 778 763 15 2.0
Software 329 356 (27 ) (7.6 )
Other real estate owned, net 117 (9 ) 126 (1,400.0 )
Other 2,747 2,550 197 7.7
Total noninterest expense $ 14,065 $ 13,334 $ 731 5.5
Salaries and employee benefits increased $158,000 in the 2021 quarter as
compared to the 2020 quarter. Total full-time equivalent employees ("FTEs") were
340 at end of the first quarter of 2021, down from 355 at the end of the same
quarter of 2020. However, salaries and employee benefits expenses were impacted
by increased incentive compensation and mortgage commissions due to the uptick
in mortgage banking resulting from the low rate environment. The increase in
occupancy and equipment expense in the first quarter of 2021 compared to the
first quarter of 2020 reflects additional depreciation from the 2020 ATM project
and expenses related to the opening of a new branch. The Federal Deposit
Insurance Corporation ("FDIC") assessment expense in the 2020 quarter was
positively impacted by the Small Bank Assessment Credit, which reduced insurance
expense $75,000 . Net expense on other real estate owned was $117,000 in
the three months ended March 31, 2021 compared to a net gain of $9,000 in the
same period in 2020. Other expenses increased $197,000 compared to the same
quarter of 2020 as a result of additional shipping, printing and data processing
expenses.
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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 2021 quarter was 47.70% compared to 54.46% for the 2020 quarter. 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 information. 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 March 31,
2021 2020
Efficiency Ratio
Noninterest expense $ 14,065 $ 13,334
Add/subtract: gain/loss on sale of OREO, net of write-downs (111 ) 27
Subtract: core deposit intangible amortization (381 ) (427 )
$ 13,573 $ 12,934
Net interest income $ 22,423 $ 19,919
Tax equivalent adjustment 60 69
Noninterest income 5,922 4,495
Subtract: gain on securities - (814 )
Add: loss on fixed assets 49 82
$ 28,454 $ 23,751
Efficiency ratio 47.70 % 54.46 %
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 2021 and 2020
periods 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 March 31,
2021 2020
Reconciliation of Net Interest Income to Tax-Equivalent
Net Interest Income
Non-GAAP measures:
Interest income - loans $ 22,307 $ 21,363
Interest income - investments and other 1,957 2,572
Interest expense - deposits (1,287 ) (3,312 )
Interest expense - customer repurchase agreements (11 ) (129 )
Interest expense - long-term borrowings (483 ) (506 )
Total net interest income $ 22,483 $ 19,988
Less non-GAAP measures:
Tax benefit realized on non-taxable interest income -
loans $ (34 ) $ (42 ) Tax benefit realized on non-taxable interest income - municipal securities
(26 ) (27 )
GAAP measures net interest income $ 22,423 $ 19,919
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Income Taxes
The effective tax rate for the first quarter of 2021 was 20.95% compared to
15.65% for the first quarter of 2020. The decreased rate for first quarter of
2020 was a result of tax benefits recognized in 2020. 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 Bankshares Corporation merger completed in
April 2019 . 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 months endedMarch 31, 2021 and 2020, 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 March 31, 2021$ 952 $ 22 $ (26 )$ 948 For the three months ended March 31, 2020 905 73 (21 ) 957 For the remaining nine months of 2021 (estimated) 1,320 56 (77 ) 1,299 For the years ending (estimated): 2022 1,255 50 (102 ) 1,203 2023 761 30 (102 ) 689 2024 513 5 (102 ) 416 2025 402 2 (102 ) 302 2026 286 1 (102 ) 185 Thereafter (estimated) 1,174 2 (640 ) 536
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.
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Table of Contents 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$482,143,000 atMarch 31, 2021 , compared to$466,091,000 atDecember 31, 2020 , an increase of$16,052,000 , or 3.4%. AtMarch 31, 2021 , the available for sale portfolio had an amortized cost of$477,926,000 , resulting in a net unrealized gain of$4,217,000 . AtDecember 31, 2020 , the available for sale portfolio had an amortized cost of$455,992,000 , resulting in a net unrealized gain of$10,099,000 .
During the three months ended
The Company is cognizant of the continuing historically low and steady rate environment and has elected to execute an asset liability strategy of purchasing high quality taxable securities with relatively low optionality and moderate 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. AtMarch 31, 2021 , the commercial real estate portfolio included concentrations of$74,760,000 ,$43,720,000 and$195,656,000 in hotel, restaurants, and retail loans, respectively. These concentrations total 15.9% of total loans, excluding loans in process. Total loans were$1,978,640,000 atMarch 31, 2021 , compared to$2,015,056,000 atDecember 31, 2020 , a decrease of$36,416,000 , or 1.8%. AtMarch 31, 2021 , net PPP loans, which are in the commercial loan category, totaled$183,783,000 , compared to$211,275,000 atDecember 31, 2020 . Average loans were$2,020,403,000 for the first quarter of 2021, compared to$1,832,281,000 for the first quarter of 2020, an increase of$188,122,000 , or 10.3%, primarily related to PPP lending. Loans held for sale totaled$17,929,000 atMarch 31, 2021 and$15,591,000 atDecember 31, 2020 . Secondary loan production volume was$41,186,000 for the three month period endedMarch 31, 2021 and$25,745,000 for the same period of 2020. These loans were approximately 30% purchase and 70% refinancing for the quarter endedMarch 31, 2021 , compared to 40% purchase and 60% refinancing for the year endedDecember 31, 2020 . Management of the loan portfolio is organized around portfolio segments. Each segment is comprised of various loan types that are reflective of operational and regulatory reporting requirements. The following table presents the Company's loan portfolio by segment as ofMarch 31, 2021 andDecember 31, 2020 (dollars in thousands): December 31, March 31, 2021 2020 Commercial$ 447,109 $ 491,256 Commercial real estate: Construction and land development 159,801
140,071
Commercial real estate - owner occupied 364,549
373,680
Commercial real estate - non-owner occupied 628,742 627,569 Residential real estate: Residential 266,595 269,137 Home equity 100,643 104,881 Consumer 11,201 8,462 Total loans, net of deferred fees and costs$ 1,978,640 $ 2,015,056 Provision for Loan Losses There was no provision expense for the first quarter of 2021, compared to$585,000 for the previous quarter and$953,000 for the same period in the previous year. The first quarter of 2021 warranted a significantly lower provision than fourth quarter based on loan activity, an improving economy, ongoing low charge-off and delinquency rates, and overall strong asset quality metrics. However, the economy continues to recover from the effects of the pandemic, and risk levels in general remain elevated, particularly in certain industry segments. Net recoveries for the three months endedMarch 31, 2021 were$13,000 compared to net charge-offs of$40,000 for the same 2020 period. 42
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Table of Contents 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. AtMarch 31, 2021 , the ALLL was$21,416,000 , compared to$21,403,000 atDecember 31, 2020 . The ALLL as a percentage of total loans at such dates was 1.08% and 1.06%, respectively. Management will continue to evaluate the adequacy of the Company's ALLL as more economic data becomes available and as changes within the Company's portfolio are known. The effects of the pandemic may require adjustments in the ALLL 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 1.17% atMarch 31, 2021 , compared to 1.16% atDecember 31, 2020 . On a dollar basis, the reserve was$20,551,000 atMarch 31, 2021 , compared to$20,534,000 atDecember 31, 2020 . 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 1.00% atMarch 31, 2021 , compared to 1.06% atDecember 31, 2020 . On a dollar basis, the reserve was$27,000 atMarch 31, 2021 , compared to$30,000 atDecember 31, 2020 . There is ongoing turnover in the composition of the impaired loan population, which decreased by a net$109,000 overDecember 31, 2020 . The specific allowance does not include reserves related to acquired loans with deteriorated credit quality. This reserve was$838,000 atMarch 31, 2021 compared to$839,000 atDecember 31, 2020 . This is the only portion of the reserve related to purchased credit impaired loans. Cash flow expectations for these loans are reviewed on a quarterly basis and unfavorable changes in those estimates relative to the initial estimates can result in the need for additional loan loss provision. The following table presents the Company's loan loss and recovery experience for the periods indicated (dollars in thousands): Three Months Year Ended Ended March December 31, 31, 2021 2020 Balance at beginning of period$ 21,403
Charge-offs:
Construction and land development - - Commercial real estate - owner occupied 3 17 Commercial real estate - non-owner occupied - 165 Residential real estate - 90 Home equity - 27 Total real estate 3 299 Commercial and industrial - 505 Consumer 19 202 Total charge-offs 22 1,006 Recoveries: Construction and land development - 2 Commercial real estate - owner occupied 2 12 Commercial real estate - non-owner occupied - 50 Residential real estate 2 63 Home equity 3 22 Total real estate 7 149 Commercial and industrial 9 65 Consumer 19 127 Total recoveries 35 341 Net charge-offs (recoveries) (13 ) 665 Provision for loan losses - 8,916 Balance at end of period$ 21,416 $ 21,403 43
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Table of Contents Asset Quality Indicators
The following table provides qualitative indicators relevant to the Company's loan portfolio for the three month-period and year indicated below.
Asset Quality Ratios
March 31, 2021 December 31, 2020
Allowance to loans (1) 1.08 % 1.06 %
ASC 450 (FAS 5) ALLL to ASC 450 loans (2) 1.17 1.16
Net charge-offs to allowance (3) (0.24 )
3.11
Net charge-offs to average loans (3) -
0.03
Nonperforming assets to total assets 0.10
0.12
Nonperforming loans to loans 0.13
0.13
Provision to net charge-offs (3) -
1,340.75
Provision to average loans (3) -
0.44
Allowance to nonperforming loans 861.81 793.88 __________________________
(1) - Excluding PPP loans, 1.19% at both
(2) - Excluding PPP loans, 1.31% at
(3) - Annualized
Nonperforming Assets (Loans and Other Real Estate Owned)
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 purchased credit impaired loans.
Nonperforming loans to total loans were 0.13% at
Nonperforming assets include nonperforming loans, OREO and repossessions. Nonperforming assets represented 0.10% and 0.12% of total assets atMarch 31, 2021 andDecember 31, 2020 , respectively. The Company continues to monitor the impact to its borrowers caused by COVID-19. 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,
March 31, 2021 2020
Nonaccrual loans:
Real estate $ 2,248 $ 2,328
Commercial 68 100
Consumer 7 6
Total nonaccrual loans 2,323 2,434
Loans past due 90 days and accruing interest:
Real estate 162 262
Total nonperforming loans 2,485 2,696
Other real estate owned 443 958
Total nonperforming assets $ 2,928 $ 3,654
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Table of Contents 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 ofMarch 31, 2021 andDecember 31, 2020 (dollars in thousands): Impaired Loans March 31, 2021 December 31, 2020 Accruing $ 737 $ 758 Nonaccruing 2,006 2,094 Total impaired loans $ 2,743 $ 2,852
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
During the first quarter of 2021, the Bank continued to assist borrowers through the DAP. OnMarch 31, 2021 , the balance of loans remaining in this program was$19.3 million , or less than 1.0% of the total portfolio, compared to$30.0 million , or 1.5%, atDecember 31, 2020 . AtMarch 31, 2021 ,$16.4 million of the$19.3 million was the result of second and third interest deferrals. The majority of the remaining modifications involved six-month deferments of interest. Other Real Estate Owned Other real estate owned was$443,000 and$958,000 as ofMarch 31, 2021 andDecember 31, 2020 , 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 ofMarch 31, 2021 andDecember 31, 2020 (dollars in thousands): Other Real Estate Owned March 31, 2021 December 31, 2020 Construction and land development $ 213 $
443
Commercial real estate - owner occupied 230 230 Residential real estate - 237 Home equity - 48 Total other real estate owned $ 443 $ 958 Deposits The Company's deposits consist primarily of checking, money market, savings, and consumer and commercial time deposits. Total deposits were$2,632,534,000 atMarch 31, 2021 compared to$2,611,330,000 atDecember 31, 2020 , an increase of$21,204,000 , or 0.8%. The growth during the first quarter of 2021 is a result of continued higher than average cash balances being maintained by customers as elevated savings rates and liquidity patterns continue. This pattern has been prevalent since the second quarter of 2020 and is consistent with trends with other commercial banks. Average interest-bearing deposits were$1,740,418,000 for the first quarter of 2021, compared to$1,495,565,000 for the first quarter of 2020, an increase of$244,853,000 , or 16.4%. Average noninterest-bearing deposits for the 2021 quarter were$842,121,000 , compared to$574,362,000 for the 2020 quarter, an increase of$267,759,000 , or 46.6%. The Company's primary focus on the liability side of the balance sheet is growing core deposits and their affiliated relationships. The Company's cost of interest-bearing deposits for the first quarter of 2021 was 0.30%, down from 0.89% for the first quarter of 2020. 45
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Table of Contents 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.
Shareholders' equity was
The Company paid cash dividends of$0.27 per share during the first three months of 2021 while the aggregate basic and diluted earnings per share for the same period was$1.03 . 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. 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. The first lowered the required leverage ratio to 8% for the remainder of 2020 while the second provides a transition back to the 9% requirement. 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 CBLR framework was first available for banking organizations to use in theirMarch 31, 2020 regulatory reports. 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 atMarch 31, 2021 andDecember 31, 2020 . Management believes, as ofMarch 31, 2021 , that the Company and the Bank more than satisfy all capital adequacy requirements to which they are subject. Percentage At March 31, 2021 Percentage At December 31, 2020 Risk-Based Capital Ratios: Company Bank Company Bank Common equity tier 1 capital ratio 12.74 % 13.30 % 12.36 % 12.86 % Tier 1 capital ratio 14.16 13.30 13.78 12.86 Total capital ratio 15.56 14.40 15.18 13.97 Leverage Capital Ratio: Tier 1 leverage ratio 9.56 8.97 9.48 8.85 Stock Repurchase Program
On
During the three month period ended
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.
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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$245,000,000 outstanding in letters of credit atMarch 31, 2021 andDecember 31, 2020 . 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 7 and long-term borrowings are discussed in Note 8 in the Consolidated Financial Statements included in this report.
The Company has federal funds lines of credit established with correspondent banks in the amount of$60,000,000 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 EGRRCPA, a well-capitalized bank with a CAMELS rating of 1 or 2 may hold reciprocal deposits up to the lesser of 20% of its total liabilities or$5 billion without those deposits being treated as brokered deposits. Deposits through the CDARS program as ofMarch 31, 2021 andDecember 31, 2020 , were$550,000 and$4,342,000 , respectively. COVID-19 and the participation in the PPP and the DAP programs could significantly impact the Company's liquidity. Average deposits grew 24.8% in the first quarter of 2021 compared to the same quarter of 2020, partially due to customer deposits of loan proceeds from participation in the PPP. Customers have continued to maintain higher cash balances through the first quarter of 2021 as future liquidity needs remain uncertain. This buildup of cash reserves primarily accounts for the significant increase over the same period of 2020. Management believes that the resources available to the Company will provide sufficient and timely liquidity, both on and off the balance sheet, to support its programs and operations.
Off-Balance Sheet Activities
The Company enters into certain financial transactions in the ordinary course of performing traditional banking services that result in off-balance sheet transactions. Other than subsidiaries to issue trust preferred securities, the Company does not have any off-balance sheet subsidiaries. Off-balance sheet transactions atMarch 31, 2021 and atDecember 31, 2020 were as follows (dollars in thousands): March 31, 2021 December 31, 2020 Commitments to extend credit$ 508,610 $ 503,272 Standby letters of credit 14,606 17,355 Mortgage loan rate-lock commitments 24,722 26,883 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. 47
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