FARMERS & MERCHANTS BANCORP, INC. NOTE 9 PROPOSED BUSINESS COMBINATION (Continued)
Subject to the terms of the Agreement, which has been unanimously approved by the Board of Directors of each company, PFSB shareholders will elect to receive either 1.776 shares of FMAO stock or$41.20 per share in cash for each PFSB share owned, subject to adjustment based upon 1,833,999 shares of FMAO to be issued in the merger. AtMarch 31, 2021 , PFSB reported 2,470,032 shares of common stock outstanding. Based on FMAO's closing share price as ofMay 3, 2021 of$24.22 , the implied aggregate acquisition value equals$103.7 million . In 2021, the Company incurred$523.5 thousand of third-party acquisition related costs. These expenses are comprised of consulting fees of$160.8 thousand and other general and administrative expense of$362.7 thousand in the Company's consolidated statement of income for the nine months endedSeptember 30, 2021 . During the most recent quarter, the Company incurred$275.4 thousand of third-party acquisition related costs. These expenses are comprised of consulting fees of$69.0 thousand and other general and administrative expense of$206.3 thousand in the Company's consolidated statement of income for the three months endedSeptember 30, 2021 .
NOTE 10 RECENT ACCOUNTING PRONOUNCEMENTS
InJune 2016 , theFinancial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." This ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The ASU was effective forSEC filers for fiscal years, and interim periods within those fiscal years, beginning afterDecember 15, 2019 (i.e.,January 1, 2020 , for calendar year entities). FASB subsequently approved a delay in adoption for Smaller Reporting Companies. The Company has completed an analysis to determine that it qualifies as aSmaller Reporting Company . As such, adoption can be postponed until periods beginning afterDecember 15, 2022 (i.e.,January 1, 2023 , for calendar year entities). Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning afterDecember 15, 2018 . The Company has contracted with an external advisor and has formed a committee to determine the methodology to be used. Most importantly, the Company is gathering as much data as possible to enable management to review scenarios and determine which calculations will produce the most reliable results. The Company began working with the third-party service provider to review parallel reports starting inJune 2019 . The Company has not adopted ASU 2016-13 in calendar year 2021 and management is currently evaluating when or if they would elect to early adopt ASU 2016-13. 47
--------------------------------------------------------------------------------
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW The first nine months of 2021 has been a time of expansion and handling one-time events impacting both revenue and expense. A great deal of the focus for 1st quarter remained with COVID-19 related items. While much of the forgiveness from the Paycheck Protection Program (PPP) was received in 4th quarter 2020, we continued to work with our remaining customers to process the forgiveness requests and payments. At the same time, we began the requests for additional funding under the additional PPP opportunities. Farmers & Merchant's (F&M) Commercial Division saw PPP loan activity begin to slow in the 2nd quarter. F&M shifted to working with our PPP Second Draw clients and the forgiveness process. F&M is very proud of the PPP program and the impact it has had on our clients and their employees. The PPP program at F&M has impacted 18,094 jobs. Most COVID-19 restrictions were lifted in the second quarter and many of the F&M client base returned to full schedules. F&M did assist clients with deferrals or modifications that were negatively impacted by COVID-19. As of the end of the third quarter, only two loans are currently under principal deferrals. One of these loans will resume principal payments in October while the second loan will resume principal payments inJuly 2022 . The Bank received approximately$2.4 million in accelerated net fee income from the most recent round (2021 originations) of PPP loans during the third quarter. The activities surrounding the originations and forgiveness of PPP loans account for a portion of the one-time events occurring in 2021. Acquisition costs are categorized as one-time when looking at the individual acquisition. Two actual acquisitions had associated costs with them in the first nine months of 2021. The acquisition ofOssian Financial Services, Inc (Ossian) had expenses of$2.1 million during the first nine months of 2021 and Perpetual Federal Savings (Perpetual) total$523.5 thousand so far in 2021. The Company is excited to have expanded its coverage inIndiana with the new offices of Ossian andBluffton . As ofMay 1st , Ossian has been included in the Company's financials with system software conversion occurred mid-May. The Company has obtained regulatory approvals for the Perpetual deal and has completed the transaction onOctober 1st with system software conversion occurring mid-October. Each acquisition involves a different structure. Ossian was an all cash deal. Perpetual was a stock and cash deal. Additional detail can be found in the financial statements presented. These two acquisitions will account for expansion of both our footprint and our assets by over half a billion dollars by year end 2021. F&M Commercial Banking Division continues to see good loan demand and most of this activity is spread throughout the three state footprint, including the Loan Production Offices (LPO) inMuncie, Indiana ;Oxford, Ohio ; andWest Bloomfield, Michigan . The loan environment remains very competitive and we are seeing both lower rates and longer amortizations than what we have historically seen. Commercial clients continue to remain very challenged in the availability of workforce. Commercial clients have a seen some of the supply chain challenges lessen, but some areas of material availability and price remain very concerning for our clients. Credit quality of the portfolio remains solid and we are able to analyze most of the commercial portfolio as CPAs have mostly caught up on FYE 2020 reporting. The 2021 planting season for our market area was favorable as crops were planted timely. The growing conditions through most of our market area has been favorable with average to above average yields anticipated. Commodity prices have fallen from their earlier highs but remain at a profitable level. The outlook for our grain farmers is optimistic for 2021. The livestock industry in our portfolio has been stable. Agri-business is stable and will benefit as farm profits are positive. Concerns in the supply chain exist as they do in other industries. The agriculture portfolio remains healthy and concerns manageable. Home loan rates remain low though the volume of refinancing loans has slowed as compared to the same time in 2020. Turn times have become more manageable and the Bank focused on home equity lines as an opportunity for growth. Limited inventory and the demand for homes remain strong. During the quarter, 247 loans including home equity and lines of credit were closed totaling$30.3 million which compares to 541 loans and$70.6 million the previous year. The third quarter gain on 1-4 family mortgage sales was down by approximately 67% compared to third quarter 2020. On a year to date basis, the gain on 1-4 family mortgage sales was down$75 thousand from a year ago. The median home-sale price did increase 14% inthe United States during Q3 according to Housing Wire. Increased lumber prices have impacted the remodeling and new build; however, we have seen input prices begin to decrease. Additional expenses that would categorize closely to one-time events, were the divestiture of four offices. Three of the offices were in communities of which two offices were present. The review of our office structure spurred from the Company's strategic plan focusing on improving operating efficiency. Office closure expenses of$406 thousand have been included in the Company's consolidated statements of income for 2021. During fourth quarter, the last office closure expense should be realized. Total savings is expected to be over$760 thousand , netting a year one savings overall and 48 --------------------------------------------------------------------------------
significant savings going forward. This will allow the Company to use the savings to fund expansion and transformation of existing offices. ATM's remain at the locations and all have ceased operations as of the end of the second quarter 2021.
The Company formed a "Pandemic" committee at the beginning of the COVID-19 situation in 2020 inthe United States . The committee was tasked with researching, monitoring and implementing best practices as it relates to the protection of our employees, customers, shareholders and communities at large. We continue to rely on the committee and follow the directives issued as it remains in place today. With offices in three states, we adhere to the guidelines provided and continue to follow quarantine protocols as it relates to exposure and positive tests. We currently require masking of employees along with social distancing. The Company has offered an employee incentive for vaccinations of COVID-19 and/or the flu. Our meetings have fluctuated between in person and virtual as we monitor the risks of spread. We have participated in the government programs made available to our customers and ourselves. COVID-19 has become a routine part of our business and is a standard consideration in each decision we make. Therefore, we have determined a separate section as it relates to COVID-19 is no longer necessary in our reporting. Our PPP loan balances are under$10 million and will no longer have a significant impact on our financials. Our committee remains intact, and we will report on any new programs we may participate in. Overall, COVID-19 has increased the speed of adoption of our digital strategy and has changed the physical location of our team members. Departments are now separated to reduce the risk of a whole department being exposed and the utilization of remote work has increased. At the same time, the Company recognizes the importance of social interaction and will continue to explore the best way to bring people together in a safe environment. During the summer, the Bank hosted employee outings to two local zoos. The events were well received and attended. As we prepare for the holidays and budget for 2022, remain assured COVID -19 has influenced our actions and it has heightened our awareness of risks that must be considered and lessened in all future decisions. Net interest earnings increased by$5.8 million as compared to first nine months of 2020. The improvement was due to growth in the balance sheet as the Company continues to operate in the low rate environment preceded by the national prime rate drop of 150 basis points in the first quarter of 2020. The year to date net interest margin increased 9 basis points to 3.36% as compared to year to dateJune 30, 2021 . The asset yield increased by 9 basis points on a year to date basis and 32 basis points when comparing to prior quarter. Cost of funds decreased 1 basis point on a year to date basis and increased 1 basis point when comparing the third quarter's cost to second quarter 2021. The increase in net interest margin and asset yield is attributable to the accelerated net fee income realized with the payoff or forgiveness of PPP loans. Further discussion of the balance sheet composition movements and the impact on the earnings can be viewed in the Material Results of Operations section that follows. Net income improved 18.7% in comparing the first nine months 2021 to first nine months 2020 and earnings per share increased 17.5% in the same comparison. The higher net income was mainly driven by two factors: higher interest income and lower interest expense. Interest income on a year to date basis increased 4.5% or$2.4 million compared to 2020. As mentioned previously, interest expense decreased by 40.9% and$3.4 million on a year to date basis compared to first nine months 2020 on 23.1% higher average balances in 2021. Noninterest income, which also played a large part in the improved earnings, increased 17.3% and$1.9 million over the same period 2020. Gain on sales of both 1-4 family mortgage loans and fixed rate agricultural loans along with interchange fees on debit card transactions were the biggest contributors. 1-4 family mortgage activity remains strong though has slowed compared to the last three quarters of 2020. We expect additional slowing the last quarter of the year as refinancing has slowed, housing prices have increased, and inventory of available homes is low throughout most of the Bank's market area. The Company has worked diligently to manage during volatile times and the increase in our size and footprint has helped establish diversity of revenue streams and insulated our earnings. While we report and recognize the many one-time costs incurred by our strategic focus, we continue to realize the long-term benefits of our strategies. Our historical prudent approach to lending has continued to demonstrate its benefits in our credit quality. Past dues over 30 days as ofSeptember 30, 2021 were 0.11% of total loans outstanding. The relationships we have with our customers, employees, shareholders and communities has allowed our belief in our mission to "help people live their best lives" be realized. The light at the end of the tunnel is beginning to widen and the Company remains well capitalized and plans to continue in our strategic vision of expansion. The last two years has shown us the benefits from such growth are real. NATURE OF ACTIVITIESFarmers & Merchants Bancorp, Inc. (the "Company") is a financial holding company incorporated under the laws ofOhio in 1985. Our subsidiaries areThe Farmers & Merchants State Bank (the "Bank"), a community bank operating inNorthwest Ohio since 1897, andFarmers & Merchants Risk Management, Inc. , a captive insurance company formed inDecember 2014 49 --------------------------------------------------------------------------------
and located in
Our executive offices are located at307 North Defiance Street ,Archbold, Ohio 43502, and our telephone number is (419) 446-2501. The Bank operates twenty-nine full-service banking offices throughoutNorthwest Ohio andNortheast Indiana and a drive-up facility inArchbold . The Bank also operates three Loan Production Offices (LPOs), one in each state ofOhio ,Indiana andMichigan . As ofJune 30, 2021 , the Bank discontinued operations in four offices, three inOhio and one inIndiana . Existing customers of those offices will continue to be serviced by other nearby offices.The Farmers & Merchants State Bank engages in general commercial banking and savings business including commercial, agricultural and residential mortgage, consumer and credit card lending activities. The largest segment of the lending business relates to commercial, both real estate and non-real estate. The type of commercial business ranges from small business to multi-million dollar companies. The loans are a reflection of business located within the Banks' market area. Because the Bank's offices are located inNorthwest Ohio andNortheast Indiana , a substantial amount of the loan portfolio is comprised of loans made to customers in the farming industry for such items as farm land, farm equipment, livestock and operating loans for seed, fertilizer, and feed. Other types of lending activities include loans for home improvements, and loans for the purchase of autos, trucks, recreational vehicles, motorcycles, and other consumer goods. The Bank also provides checking account services, as well as savings and time deposit services such as certificates of deposits. In addition, Automated Teller Machines (ATMs) or Interactive Teller Machines (ITMs) are provided at most branch locations along with other independent locations in the market area. ITMs operate as an ATM with the addition of remote teller access to assist the user. The Bank has custodial services for Individual Retirement Accounts (IRAs) and Health Savings Accounts (HSAs). The Bank provides on-line banking access for consumer and business customers. For consumers, this includes bill-pay, on-line statement opportunities and mobile banking. For business customers, it provides the option of electronic transaction origination such as wire and Automated Clearing House (ACH) file transmittal. In addition, the Bank offers remote deposit capture or electronic deposit processing and merchant credit card services. Mobile banking was added in 2012 and has been widely accepted and used by consumers. Upgrades to our digital products and services continue to occur in both retail and business lines. The Bank continues to offer new suites of products as customer preferences change and the Bank adapts and adopts new technologies. The Bank continues to offer products that also meet the needs of our more traditional customers. The Bank has established underwriting policies and procedures which facilitate operating in a safe and sound manner in accordance with supervisory and regulatory guidance. Within this sphere of safety and soundness, the Bank's practice has been to not promote innovative, unproven credit products which may not be in the best interest of the Bank or its customers. The Bank does offer a hybrid mortgage loan. Hybrid loans are loans that start out as a fixed rate mortgage but after a set number of years automatically adjust to an adjustable rate mortgage. The Bank offers a three year fixed rate mortgage after which the interest rate will adjust annually. The majority of the Bank's adjustable rate mortgages are of this type. In order to offer longer term fixed rate mortgages, the Bank does participate in the Freddie Mac, Farmer Mac and Small Business Lending programs. The Bank also normally retains the servicing rights on these partially or 100% sold loans. In order for the customer to participate in these programs they must meet the requirements established by those agencies. In addition, the Bank does sell some of its longer term fixed rate agricultural mortgages into the secondary market with the aid of brokers. The Bank does not have a program to fund sub-prime loans. Sub-prime loans are characterized as a lending program or strategy that targets borrowers who pose a significantly higher risk of default than traditional retail banking customers. All loan requests are reviewed as to credit worthiness and are subject to the Bank's underwriting guidelines as to secured versus unsecured credit. Secured loans are in turn subject to loan to value (LTV) requirements based on collateral types as set forth in the Bank's Loan Policy. In addition, credit scores of those seeking consumer credit are reviewed and if they do not meet the Bank's Loan Policy guidelines an additional officer approval is required.
Consumer Loans:
• Maximum loan to value (LTV) for cars, SUVs, and trucks is 110%
depending on whether direct or indirect.
• Loans above 100% are generally the result of additional charges for
extended warranties and/or insurance coverage for wage or
death.
• Boats, campers, motorcycles, RV's and Motor Coaches range from 80%-90%
based on age of vehicle.
• 1st or 2nd mortgages on 1-4 family homes range from 75%-90% with
"in-house" first real estate mortgages requiring private mortgage
insurance (PMI) on those exceeding 80% LTV. Exception for 1st lien
home equity loans which do not require PMI or exceeding 80% LTV.
• Raw land LTV maximum ranges from 65%-75% depending on whether or not
the property has been improved.
50
--------------------------------------------------------------------------------
Commercial/Agriculture: Accounts Receivable:
Up to 80% LTV less retainages and greater than 90 days.
Inventory:
• Agriculture:
o Livestock and grain up to 80% LTV, crops (insured) up to 75%
and Warehouse Receipts up to 87%.
• Commercial:
o Maximum LTV of 50% on raw and finished goods.
• Floor plan:
o New/used vehicles to 100% of wholesale.
o New/Used recreational vehicles and manufactured homes to 80% of wholesale.
Equipment:
• New NTE 80% of invoice, used NTE 50% of listed book or 75% of
appraised value.
• Restaurant equipment up to 35% of market value.
• Heavy trucks, titled trailers NTE 75% LTV and aircraft up to 75% of
appraised value.
Real Estate:
• Maximum LTVs range from 70%-80% depending on type. • Maximum LTV on non-traditional loan up to 85%. F&M Investment Services, the brokerage department of the Bank, opened for business inApril 1999 . Securities are offered throughRaymond James Financial Services, Inc. In November of 2020, FM Investment Services purchased the assets and clients of Adams County Financial Resources (ACFR) which is discussed in further detail in Note 2 to the Company's financial statements. Securities are offered throughRaymond James Financial Services, Inc. In December of 2014, the Company became a financial holding company within the meaning of the Bank Holding Company Act of 1956 as amended (the "Act"), in order to provide the flexibility to take advantage of the expanded powers available to a financial holding company under the Act. Our subsidiary bank is in turn regulated and examined by theOhio Division of Financial Institutions and theFederal Deposit Insurance Corporation . The activities of our bank subsidiary are also subject to other federal and state laws and regulations. The Company also formed a captive insurance company (the "captive") inDecember 2014 which is located inNevada and regulated by the State ofNevada Division of Insurance . The Bank's primary market includes communities located in theOhio counties ofDefiance ,Fulton ,Hancock ,Henry ,Lucas ,Williams ,Wood and in theIndiana counties ofAdams ,Allen ,DeKalb ,Jay ,Steuben andWells . In our banking activities, we compete directly with other commercial banks, credit unions, farm credit services, and savings and loan institutions in each of our operating localities. In a number of our locations, we compete against entities which are much larger than us. The primary factors in competing for loans and deposits are the rates charged as well as location and quality of the services provided. AtSeptember 30, 2021 , we had 366 full time equivalent employees. The employees are not represented by a collective bargaining unit. We provide our employees with a comprehensive benefit program, some of which is contributory. We consider our employee relations to be good.
RECENT REGULATORY DEVELOPMENTS
The Bank remains attentive to the current regulatory environment in light of the regulatory agencies' risk-based approach to examinations. Regulatory changes and the complexity of new and amended rules have resulted in challenges and uncertainties which could pose an increased risk of noncompliance. Various significant mortgage rules require monitoring by means of testing, validation of results, additional training, and further research or consultation to assist with ongoing compliance. The global spread of the Coronavirus (COVID-19) and resulting declaration of a world-wide pandemic have impacted the financial services industry and banking operations inthe United States (US) and world-wide. The financial services sector is identified as a Critical Infrastructure Sector by theDepartment of Homeland Security during the COVID-19 response efforts. How basic business operations can be conducted has undergone a rapid and dramatic change. At the same time continuity of business operations involves promoting safety and security of customers and employees, providing a quality customer experience, and maintaining effective delivery systems and channels of communication. Regulatory guidance has been issued to manage and mitigate the unprecedented impact of the COVID-19 pandemic on business operations. Regulatory agencies promote prudent and practical efforts to assist customers and communities during this national emergency. Such assistance to alleviate the financial impact on affected customers involved modification of loan terms for existing borrowers, waiver of 51
-------------------------------------------------------------------------------- certain fees and charges, providing small dollar loans, and offering forbearance and payment deferrals on mortgage loan obligations due to financial hardship. Legislation enacted inMarch 2020 has provided the Families First Coronavirus Response Act (FFCRA) and CARES Act. The FFCRA which was effective throughDecember 31, 2020 , provided for a paid leave for employees (of employers with fewer than 500 employees) who had to quarantine due to the coronavirus, were caring for a sick family member, or caring for a child out of school. It significantly expanded existing protections currently available to employees who take leave to care for a sick family member. The CARES Act, among other matters, resulted in expansion of SBA Lending Programs; provided for a financial election to suspend GAAP principles and regulatory determinations for COVID-19 related loan modifications that would otherwise be deemed Trouble Debt Restructuring; gave theFDIC authority to establish a temporary Debt Guarantee Program for bank liabilities; delayed Current Expected Credit Losses (CECL) compliance; reduced the Community Bank Leverage Ratio to 8% to eliminate risk-based capital compliance for banks under$10 billion ; required credit furnishers that agree to deferred loan payments, forbearance on a delinquent account, or any other relief during the national emergency to report accounts as current to Credit Reporting Agencies; and defined forbearance requirements and terms for single family and multi-family loans backed by federal government agencies or government sponsored entities due to COVID-19 financial hardship. Of immediate and significant importance was the rollout of the SBA Paycheck Protection Program (PPP). The PPP authorized lending of up to$350 billion in 100% guaranteed 7(a) loans to cover payroll costs, interest on mortgage payments, rent obligations, and utilities. The PPP provided a guaranteed loan for which a portion of the loan up to or equal to 8 weeks of covered payroll and specific operating expenses can be forgiven. The maximum loan size was capped at the lessor of 250% of the average monthly payroll costs or$10 million . InApril 2020 , legislation known as the Paycheck Protection Program and Health Care Enhancement Act provided additional funding to replenish and supplement key programs under the CARES Act. Included in this legislation was the extension of the PPP with an additional$320 billion in funding. At least$60 billion of this funding was to be set aside for small and midsize banks and community lenders. Since April, the SBA has issued various Interim Final Rules to supplement and clarify matters involving the PPP. The Paycheck Protection Program Flexibility Act of 2020 (PPPFA) was enacted in earlyJune 2020 . This provided more flexibility to Borrowers regarding use of PPP loan funds. Certain provisions were retroactive to the date of the CARES Act and all PPP loans. Among these provisions were the extension of the covered period of the loan, extension of the forgiveness period, deferral of payments based on the loan forgiveness period, reduction in the minimum that must be spent for payroll costs, extended date by which employees must be rehired, and removal of restrictions on payroll tax deferral. The term for subsequent PPO loans made after enactment of the PPPFA was extended to five years from two. A primary focus is now directed to aiding PPP borrowers in navigating the loan forgiveness process. FFCRA requirements to provide paid leave to employees ended onDecember 31, 2020 . Due to the extended duration of the COVID-19 pandemic, employers subject to FFCRA could voluntarily extend the paid leave option untilMarch 31, 2021 . If the employer has elected to voluntarily apply the FFCRA extension, employees eligible for leave in 2020 and did not use the leave may take the leave in 2021. Under the American Rescue Plan of 2021 enacted inMarch 2021 , for those employers who voluntarily extend the paid leave option, paid leave was reset startingApril 1, 2021 . If employees previously exhausted their paid leave under FFCRA, they may be entitled to an additional 10 days/80 hours for use. Additionally, the PPP was reauthorized with passage of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act. It was originally intended to run throughMarch 31, 2021 and was subsequently extended toMay 31, 2021 . Under the new legislation,$284 billion in funding for first and second-time PPP loan borrowers was provided to the SBA. Three categories of businesses are eligible to apply for PPP: 1) qualified business that did not receive a PPP loan during the first funding round; 2) previous PPP loan recipients who need a second loan and meet certain criteria; previous PPP loan recipients who returned all or a portion of their original loans and want to apply to additional funding. To be eligible, any business applying for PPP must have been in operation since at leastFebruary 15, 2020 . Specific eligibility criteria apply to first-time PPP borrowers and previous PPP loan recipients. For 2021, PPP provides expanded coverage for expenditures in addition to covered payroll and specific operating expenses. For second-time loan recipients, the maximum loan amount was reduced from$10 million to$2 million . A loan recipient is eligible for full loan forgiveness if at least 60% of the loan amount is spent on payroll costs. Funds must be spent over a covered period of the loan recipients' choosing between eight and 24 weeks after loan origination to be eligible for forgiveness. Depending on the continued duration of COVID-19 spread, further legislation and regulatory guidance may continue due to the economic impact on customers, businesses, communities, and industry sectors. The Coronavirus Response and Relief Supplemental Appropriations Act, passed byCongress inDecember 2020 , extended certain provisions of the CARES Act affecting the Company into 2021. Key banking provisions under this legislation include the following: • Provided an additional$284.6 billion in Paycheck Protection Program (PPP) funding for loans to small businesses, including for borrowers who have previously received a PPP loan.
• A one-page simplified forgiveness process for PPP loans under
52
--------------------------------------------------------------------------------
• Clarification to various CARES Act provisions, the tax treatment of
PPP expenses, lender responsibilities for agent fees, andlender "hold
harmless" protections under the PPP and other laws.
• A further delay in Troubled Debt Restructuring (TDR) accounting until
60 days after the termination of the national emergency, or
2022. During third quarter 2021, there was one loan modification for
$3.1 million that would have been previously treated as TDR under the guidance in ASC 310-40. • A further optional delay in Current Expected Credit Loss (CECL) accounting untilJanuary 1, 2022 . • A new round of Economic Impact Payments (EIPs) for consumers, with aggressive distribution timelines and new exemptions from garnishments. • Significant added support for Community Development Financial Institutions (CDFIs) and Minority Depository Institutions (MDIs).
• Funding for agricultural support programs and for renter assistance programs.
• Termination of existing Federal Reserve emergency lending authority
under the CARES Act, while preserving the Fed's general 13(3)
emergency authority existing prior to that Act.
In December 2020 , new Qualified Mortgage (QM) Definition rules were issued by
the Consumer Financial Protection Bureau . One set of rules revised the General
QM definition and another set added the definition of a Seasoned QM Loan. Both
QM Loan rules had an effective date of March 1, 2021 . The revised General QM
rule replaced the General QM loans definition of a 43% debt-to-income (DTI)
limit with a focus on the loan pricing and whether the Annual Percentage Rate
exceeds the average prime offer rate by less than 2.25 percentage points.
Compliance with the revised General QM Loan rule had a mandatory compliance date
of July 1, 2021 . The existing Temporary Government Sponsored Entity (GSE) QM
option was set to expire as of the mandatory compliance date for the revised
General QM Rule. Subsequently, the CFPB issued a final rule published in the
Federal Register on April 30, 2021 which delayed and extended the mandatory
compliance date for the revised General QM rule to October 1, 2022 . At the
present time, the Company has the option to comply with either the original
DTI-based General QM Loan definition or the revised price-based new General QM
Loan definition. Since the Company sells fixed rate consumer mortgage loans to
the Federal Home Loan Mortgage Corporation, it must remain attentive to their
current loan underwriting requirements and how they evolve in the extended
interim period.
With regard to all regulatory matters, the Bank remains committed in making good
faith efforts to comply with technical requirements of the laws, rules,
regulations, and guidance from both federal and state agencies which govern its
activities.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted inthe United States of America , and the Company follows general practices within the financial services industry in which it operates. At times the application of these principles requires management to make assumptions, estimates and judgments that affect the amounts reported in the financial statements and accompanying notes. These assumptions, estimates and judgments are based on information available as of the date of the financial statements. As this information changes, the financial statements could reflect different assumptions, estimates and judgments. Certain policies inherently have a greater reliance on assumptions, estimates and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Examples of critical assumptions, estimates and judgments are when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not required to be recorded at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability must be recorded contingent upon a future event. These policies, along with the disclosures presented in the notes to the condensed consolidated financial statements and in the management discussion and analysis of the financial condition and results of operations, provide information on how significant assets and liabilities are valued and how those values are determined for the financial statements. Based on the valuation techniques used and the sensitivity of financial statement amounts to assumptions, estimates, and judgments underlying those amounts, management has identified the determination of the ALLL, the valuation of its Mortgage Servicing Rights and the valuation of real estate acquired through or in lieu of loan foreclosures ("OREO Property") as the accounting areas that require the most subjective or complex judgments, and as such could be the most subject to revision as new information becomes available. OREO Property held for sale is initially recorded at fair value at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of cost or fair value minus estimated costs to sell. Costs of holding foreclosed real estate are charged to expense in the current period, except for significant property improvements, which are capitalized. Valuations are periodically performed by management and a write-down is recorded by a charge to non-interest expense if the carrying value exceeds the fair value minus estimated costs to sell. 53 -------------------------------------------------------------------------------- The net income from operations of foreclosed real estate held for sale is reported either in noninterest income or noninterest expense depending upon whether the property is in a gain or loss position overall. AtSeptember 30, 2021 OREO property holdings were$167 thousand . OREO totaled$71 thousand and$206 thousand as ofDecember 31, 2020 andSeptember 30, 2020 respectively. The ALLL and ACL represents management's estimate of probable credit losses inherent in the Bank's loan portfolio, unfunded loan commitments, and letters of credit at the report date. The ALLL methodology is regularly reviewed for its appropriateness and is approved annually by the Board of Directors. This written methodology is consistent with Generally Accepted Accounting Principles which provides for a consistently applied analysis. The Bank's methodology provides an estimate of the probable credit losses either by calculating a specific loss per credit or by applying a composite of historical factors over a relevant period of time with current internal and external factors which may affect credit collectability. Such factors which may influence estimated losses are the conditions of the local and national economy, local unemployment trends, and abilities of lending staff, valuation trends of fixed assets, and trends in credit delinquency, classified credits, and credit losses. Inherent in most estimates is imprecision. The Bank's ALLL may include a margin for imprecision with an unallocated portion. Bank regulatory agencies and external auditors periodically review the Bank's methodology and adequacy of the ALLL. Any required changes in the ALLL or loan charge-offs by these agencies or auditors may have a material effect on the ALLL. For more information regarding the estimates and calculations used to establish the ALLL please see Note 4 to the consolidated financial statements provided herewith. The Bank is also required to estimate the value of its mortgage servicing rights. The Bank's mortgage servicing rights relating to fixed rate single-family mortgage loans that it has sold without recourse but services for others for a fee represent an asset on the Bank's balance sheet. The valuation is completed by an independent third party. The expected and actual rates of mortgage loan prepayments are the most significant factors driving the potential for the impairment of the value of mortgage servicing assets. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced. The Bank's mortgage servicing rights relating to loans serviced for others represent an asset. This asset is initially capitalized and included in other assets on the Company's consolidated balance sheet. The mortgage servicing rights are then amortized as noninterest expense in proportion to, and over the period of the estimated future net servicing income of the underlying mortgage servicing rights. There are a number of factors, however, that can affect the ultimate value of the mortgage servicing rights to the Bank. The expected and actual rates of mortgage loan prepayments are the most significant factors driving the potential for the impairment of the value of mortgage servicing assets. Increases in mortgage loan prepayments reduce estimated future net servicing cash flows because the life of the underlying loan is reduced, meaning that the present value of the mortgage servicing rights is less than the carrying value of those rights on the Bank's balance sheet. Therefore, in an attempt to reflect an accurate expected value to the Bank of the mortgage servicing rights, the Bank receives a valuation of its mortgage servicing rights from an independent third party. The independent third party's valuation of the mortgage servicing rights is based on relevant characteristics of the Bank's loan servicing portfolio, such as loan terms, interest rates and recent national prepayment experience, as well as current national market interest rate levels, market forecasts and other economic conditions. For purposes of determining impairment, the mortgage servicing assets are stratified into like groups based on loan type, term, new versus seasoned and interest rate. Management, with the advice from its third-party valuation firm, reviewed the assumptions related to prepayment speeds, discount rates, and capitalized mortgage servicing income on a quarterly basis. Changes are reflected in the following quarter's analysis related to the mortgage servicing asset. In addition, based upon the independent third party's valuation of the Bank's mortgage servicing rights, management then establishes a valuation allowance by each stratum, if necessary, to quantify the likely impairment of the value of the mortgage servicing rights to the Bank. The estimates of prepayment speeds and discount rates are inherently uncertain, and different estimates could have a material impact on the Bank's net income and results of operations. The valuation allowance is evaluated and adjusted quarterly by management to reflect changes in the fair value of the underlying mortgage servicing rights based on market conditions. The accuracy of these estimates and assumptions by management and its third party valuation specialist can be directly tied back to the fact that management has only been required to record minor valuation allowances through its income statement over time based upon the valuation of each stratum of servicing rights.
MATERIAL CHANGES IN FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The Company plans to continue in its growth mode in 2021 led by loan growth from
within our newer markets. The Bank is focused on funding the loan growth with
the least expensive source of deposits, sale of securities or borrowings.
Growing deposits will also be a focus especially in our newer markets. The Bank
offers the Insured Cash Sweep ("ICS") product
54
--------------------------------------------------------------------------------
accessed through the Promontory network of financial institutions which helps to
reduce the amount of pledged securities. This has provided more availability for
runoff of securities by the Bank if warranted to fund loan growth.
Liquidity in terms of cash and cash equivalents ended $17.6 million lower as of
September 30, 2021 than it was at yearend December 31, 2020 . An increase in
deposits helped to fund the $190.5 million increase in net loans since yearend
2020. All loan portfolios with the exception of the agricultural real estate
portfolio increased compared to December 31, 2020 .
In comparing to the same prior year period, the September 30, 2021 (net of
deferred fees and cost) loan balances of $1.5 billion accounted for $131.7
million or 9.7% increase when compared to 2020's $1.4 billion . The year over
year improvement was made up of a combined increase of 4.9% in commercial and
industrial related loans (comprised of 22.5% in commercial real estate loans and
a decrease of 17.6% in non-real estate commercial loans). PPP loans of
approximately $9.8 million and $87.2 million are included in the non-real estate
commercial portfolio as of September 30, 2021 and September 30, 2020 ,
respectively. Consumer real estate loans increased by 15.2%, consumer loans by
4.0% and other loans by 244.4%. Agricultural related loans decreased 4.8% year
over year (comprised of 7.0% in agricultural real estate and offset by an
increase of 2.2% in non-real estate agricultural loans). The Company credits the
growth not only to the OFSI acquisition but also to the strong team of lenders
focused on providing customers valuable localized services and thereby
increasing our market share.
The chart below shows the breakdown of the loan portfolio category as of
(In Thousands)
September 30, 2021 September 30, 2020 September 30, 2019
Amount Amount Amount
Consumer Real Estate $ 202,370 $ 175,595 $ 158,458
Agricultural Real Estate 179,051 192,577 200,625
Agricultural 105,722 103,476 110,405
Commercial Real Estate 727,418 593,936 501,095
Commercial and Industrial 194,286 235,793 130,228
Consumer 55,619 53,455 49,718
Other 31,096 9,030 8,167
Total Loans, net $ 1,495,562 $ 1,363,862 $ 1,158,696
The following is a contractual maturity schedule by major category of loans
excluding fair value adjustments as of
(In Thousands)
After One
Within Year Within After
One Year Five Years Five Years
Consumer Real Estate $ 8,137 $ 31,278 $ 163,269
Agricultural Real Estate 5,947 2,730 171,167
Agricultural 61,331 32,014 12,266
Commercial Real Estate 28,764 323,045 377,209
Commercial and Industrial 67,459 94,500 33,473
Consumer 5,078 36,199 14,249
Other 247 1,101 29,746
While the security portfolio has been utilized to fund loan growth for the last
three years, additional sources have been cultivated during 2019, 2020, and
2021. The security portfolio increased $118.9 million in the first nine months
of 2021 from yearend 2020 and $167.7 million from September 2020 . The amount of
pledged investment securities decreased by $6.1 million as compared to yearend
and $9.9 million as compared to September 30, 2020 . Liquidity is improved with
the additional option of selling unpledged investment securities if needed to
fund loan growth or other initiatives. As of
55
--------------------------------------------------------------------------------For the Bank, an additional$6.7 million is also available from theFederal Home Loan Bank based on current amounts of pledged collateral. At the present time, only 1-4 family and home equity portfolios are pledged. Additional borrowings would be available if additional portfolios (i.e. commercial real estate) were pledged. OnJuly 30, 2021 , the Company announced the completion of a private placement of$35 million aggregate principal amount of its 3.25% fixed-to-floating rate subordinated notes dueJuly 30, 2031 (the "Notes") to various accredited investors (the "Offering"). The price for the Notes was 100% of the principal amount of the Notes. The Notes are intended to qualify as Tier 2 capital for regulatory purposes. The Company intends to use the net proceeds from the Offering for general corporate purposes, including financing acquisitions and organic growth.
With the exception of FHLB stocks, carried at cost, which is shown as other securities, all of the Company's security portfolio is categorized as "available-for-sale" and as such is recorded at fair value.
Management feels confident that liquidity needs for future growth can be met through additional maturities and/or sales from the security portfolio, increased deposits and additional borrowings. For short term needs, the Bank has$163.2 million of unsecured borrowing capacity through its correspondent banks.
Overall total assets increased 16.2% since yearend 2020 and grew 21.5% since
Deposits accounted for the largest growth within liabilities, up 16.9% or$270.1 million since yearend and 26.3% or$388.9 million overSeptember 30, 2020 balances. The OFSI acquisition contributed$116.0 million to the overall increase in the deposit balances compared to yearend andSeptember 30, 2020 . As stated previously, the growth of deposits correlated to a flight to safety as the stock market continues to experience some volatility. Core deposits continue to drive the increase which provide the opportunity to generate additional noninterest income. This growth aided the increased liquidity position and funded the loan growth for the periods along with usage of excess Federal Funds sold for daily borrowings. Shareholders' equity increased by$5.6 million as of the third quarter of 2021 compared to yearend 2020. Earnings exceeded dividend declarations during the nine months endedSeptember 30, 2021 . Accumulated other comprehensive income decreased in unrealized gain position by$4.8 million fromDecember 2020 to an unrealized gain of$901 thousand onSeptember 30, 2021 . Dividends declared increased$0.01 from the last four quarters to$0.18 per share. Compared toSeptember 30, 2020 , shareholders' equity increased 6.0% or$14.4 million . Profits were higher year to dateSeptember 2021 than year to dateSeptember 2020 by$2.5 million . Basel III regulatory capital requirements became effective in 2016.The Bank and Company include a capital conservation buffer as a part of the transition provision. For calendar year 2016, the applicable required capital conservation buffer percentage of 0.625% was the base above which institutions avoid limitations on distributions and certain discretionary bonus payments. For the calendar year 2017, the applicable required capital conservation buffer percentage was 1.25%. For 2018, the capital conservation buffer percentage increased to 1.875%. The total buffer requirement increased to 2.5% for calendar year 2019. As ofSeptember 30, 2021 , the Company and the Bank are both positioned well above the 2019 requirement.
The Bank continues to be well-capitalized in accordance with Federal regulatory capital requirements as the capital ratios below show:
Tier I Leverage Ratio 8.30 % Risk Based Capital Tier I 11.25 %Total Risk Based Capital 12.31 % Stockholders' Equity/Total Assets 10.81 % Capital Conservation Buffer 4.31 % 56
--------------------------------------------------------------------------------
MATERIAL CHANGES IN RESULTS OF OPERATIONS
Comparison of Results of Interest Earnings and Expenses for three month periods
ended
Interest Income
When comparing third quarter 2021 to third quarter 2020, average loan balances with the acquisition of OFSI grew$131.8 million with PPP loans decreasing$64.6 million . This represented a 9.7% increase in a one-year time period. Interest income on loan balances experienced an increase of$2.6 million as compared to the quarter endedSeptember 30, 2020 . Net fee income for the PPP loans is recognized on a straight line basis over 24 months for the first draw and 60 months for the second draw and will be accelerated upon payoff. PPP loan income for the quarter included interest income of$56.7 thousand and net fee income of$2.5 million compared to$219.7 thousand of loan interest income and$416.9 thousand of net fee income for 2020. The available-for-sale securities portfolio increased in average balances by$144.0 million when comparing to the previous year while the income increased$176 thousand over third quarter. Federal funds sold and interest-bearing deposits increased in average balances by$103.6 million as compared to the same quarter in 2020 with increased income of$68 thousand for the current quarter. Refer to Note 2 Business Combination and Asset Purchase for information on assets acquired from OFSI. The overall total average balance of the Bank's earning assets increased and interest income for the quarter comparisons was higher for third quarter 2021 by 16.4% or$2.8 million as compared to third quarter 2020. A low prime lending rate has contributed to the decrease in rate yield. Annualized yield, for the quarter endedSeptember 30, 2021 , was 3.53% as compared to 4.25% for the quarter endedSeptember 30, 2020 . The following charts demonstrate the value of increased loan balances in the balance sheet mix, as well as the impact on the changes in interest rates. The yields on tax-exempt securities and the portion of the tax-exempt IDB loans included in loans have been tax adjusted based on a 21% tax rate in the charts to follow. (In Thousands) Quarter to Date Ended September 30, 2021 Annualized Yield/Rate Interest Earning Assets: Average Balance Interest/Dividends September 30, 2021 September 30, 2020 Loans $ 1,490,988 $ 18,766 5.04 % 4.76 % Taxable investment securities 398,060 1,177 1.18 % 1.58 % Tax-exempt investment securities 17,293 75 2.20 % 2.10 % Fed funds sold & other 187,398 104 0.22 % 0.17 % Total Interest Earning Assets $ 2,093,739 $ 20,122 3.85 % 4.04 % Change inInterest Income Quarter to DateSeptember 30, 2021 Compared to September 30, 2020 (In Thousands) Change Due Change Due Interest Earning Assets: Total Change to Volume to Rate Loans$ 2,585 $ 1,570 $ 1,015 Taxable investment securities 209 603 (394 ) Tax-exempt investment securities (33 ) (46 )
13
Fed funds sold & other 68 45
23
Total Interest Earning Assets
657 Interest Expense Adding to the higher interest income for the quarter was the decrease in interest expense in 2021 of$597 thousand or 26.3% compared to third quarter 2020. Since 2020, average interest-bearing deposit balances have increased$259.9 million or 22.1% and the Company recognized$643 thousand less in interest expense for the most recent quarter. The prime rate dropped 150 basis points in March of 2020 and management has adjusted deposit rates accordingly. Interest expense on 57 -------------------------------------------------------------------------------- FHLB borrowings was down$144 thousand in the third quarter 2021 over the same time frame in 2020 due to borrowings taken on from the Limberlost acquisition being repaid in addition to the related fair value amortization completed inApril 2021 . Interest expense on fed funds purchased and securities sold under agreement to repurchase was down$9 thousand compared to second quarter 2020. Interest expense on subordinated notes was$199 thousand for the most recent quarter. Refer to Note 8 for additional information on subordinated notes. Liabilities assumed from OFSI can be seen in Note 2. (In Thousands) Quarter to Date Ended September 30, 2021 Annualized Yield/Rate Interest Bearing Liabilities: Average Balance Interest
$ 1,181,103 $ 560 0.19 % 0.35 %
Other time deposits 252,966 661 1.05 % 1.65 %
Other borrowed money 17,868 87 1.95 % 4.88 %
Fed funds purchased &
securities
sold under agreement to
repurchase 29,729 165 2.22 % 2.31 %
Subordinated notes 23,807 199 3.34 % 0.00 %
Total Interest Bearing
Liabilities $ 1,505,473 $ 1,672 0.45 % 0.74 %
Change in Interest Expense Quarter to Date September 30, 2021 Compared to
September 30, 2020
(In Thousands)
Change Due Change Due
Interest Bearing Liabilities: Total Change to Volume to Rate
Savings deposits $ (238 ) $ 232 $ (470 )
Other time deposits (405 ) (24 ) (381 )
Other borrowed money (144 ) (13 ) (131 )
Fed funds purchased & securities
sold under agreement to repurchase (9 ) (2 ) (7 )
Subordinated notes 199 199 $ -
Total Interest Bearing Liabilities $ (597 )
(989 )
Overall, net interest spread for the third quarter 2021 was 10 basis points
higher than last year. As the following chart indicates, the decline in yields
on interest earning assets was less than the decline in the cost of funds when
comparing to the same period a year ago.
September 30, 2021 September 30, 2020 September 30, 2019
Interest/Dividend income/yield 3.85 % 4.04 % 4.74 %
Interest Expense/cost 0.45 % 0.74 % 1.55 %
Net Interest Spread 3.40 % 3.30 % 3.19 %
Net Interest Margin 3.53 % 3.51 % 3.60 %
Net Interest Income
Net interest income increased $3.4 million for the third quarter 2021 over the
same time frame in 2020 with the increase in interest income of $2.8 million
combined with the lower interest expense of $597 thousand , as previously
mentioned. As the new loans added in 2020 and 2021 generate more income,
management expects the benefits of the Company's strategy of repositioning the
balance sheet to continue to increase net interest income. In terms of net
interest margin rate, the Bank recognizes competition for deposits may again
increase and put pressure on the margin which may lead to a tightening.
58
--------------------------------------------------------------------------------
Comparison of Noninterest Results of Operations for three month periods ended
Provision Expense The ALLL has a direct impact on the provision expense. The increase in the ALLL is funded through recoveries and provision expense. The following tables both deal with the allowance for credit losses. The first table breaks down the activity within ALLL for each loan portfolio class and shows the contribution provided by both the recoveries and the provision along with the reduction of the allowance caused by charge-offs. The second table discloses how much of the ALLL is attributed to each class of the loan portfolio, as well as the percent that each particular class of the loan portfolio represents to the entire loan portfolio in the aggregate. The consumer loan portfolio accounted for the largest component of charge-offs and recoveries for third quarter of 2021 and 2020. The commercial real estate portfolio is currently creating a large impact on the ALLL due to the loan growth. Total provision for loan losses was$1.3 million lower for the third quarter 2021 as compared to the same quarter 2020. Provision for loan loss has stabilized during the third quarter of 2021. There is still some uncertainty related to COVID-19 and its effects on the ability of individuals, businesses and other entities to meet their financial obligation; therefore, it is prudent to incorporate the impact of COVID-19 in the evaluation of the adequacy of Allowance for Loan and Lease Losses (ALLL). The restaurant and hospitality sectors have been hit especially hard. Risk in the Consumer and 1-4 Family Portfolio has increased but the full impact still remains unknown. Increases to the Bank's ALLL for the third quarter of 2021, centered around current customers and businesses that are particularly vulnerable and qualitative factors were adjusted accordingly. Management continues to monitor asset quality, making adjustments to the provision as necessary. Loan charge-offs were$24 thousand higher in third quarter 2021 than the same quarter 2020. Recoveries were$13 thousand higher in third quarter 2021 as compared to third quarter 2020. Combined net charge-offs were$11 thousand higher in third quarter 2021 than the same time period 2020. Past due loans, which include no deferrals related to COVID-19, increased$1.3 million atSeptember 30, 2021 as compared toSeptember 30, 2020 . Approximately 75% of the change is attributed to the increase of past due balances in the consumer real estate and commercial and industrial portfolios. 59 -------------------------------------------------------------------------------- The following table breaks down the activity within the ALLL for each loan portfolio class and shows the contribution provided by both recoveries and the provision, along with the reduction of the allowance caused by charge-offs. The time period covered is for three months endedSeptember 30, 2021 , 2020, and 2019. (In Thousands) Three Months Ended Three Months Ended Three Months Ended September 30, 2021 September 30, 2020 September 30, 2019 Loans, net $ 1,495,562 $ 1,363,862 $ 1,158,696 Daily average of outstanding loans $ 1,490,988 $
1,359,156 $ 1,126,173
Allowance for Loan Losses - July
1, $ 15,087 $ 9,933 $ 6,683
Loans Charged off:
Consumer Real Estate 2 - 39
Agriculture Real Estate - - -
Agricultural 1 - 22
Commercial Real Estate - - -
Commercial and Industrial 5 - 55
Consumer 95 79 103
103 79 219
Loan Recoveries:
Consumer Real Estate 3 2 -
Agriculture Real Estate - - -
Agricultural 1 - 1
Commercial Real Estate 3 2 2
Commercial and Industrial 9 10 13
Consumer 39 28 32
55 42 48
Net Charge Offs 48 37 171
Provision for loan loss 659 1,987 247
Acquisition provision for loan
loss - - -
Allowance for Loan & Lease
Losses - September 30, 15,698 11,883 6,759
Allowance for Unfunded Loan
Commitments
& Letters of Credit -
September 30, 1,039 633 430
Total Allowance for Credit
Losses - September 30, $ 16,737 $ 12,516 $ 7,189
Ratio of net charge-offs to
average
Loans outstanding 0.00 % 0.00 % 0.02 %
Ratio of the Allowance for Loan
Loss to
Nonperforming Loans* 251.26 % 151.01 % 173.25 %
* Nonperforming loans are defined as all loans on nonaccrual, plus any
loans 90 days past due not on nonaccrual.
The Bank uses the following guidelines as stated in policy to determine when to
realize a charge-off of a loan, whether partial loan balance or full loan
balance. The Bank is also following the guidelines established under the CARES
Act. A charge down in whole or in part is realized when unsecured consumer
loans, credit card credits and overdraft lines of credit reach 90 days
delinquency. At 120 days delinquent, secured consumer loans are charged down to
the value of the collateral, if repossession of the collateral is assured and/or
in the process of repossession. Consumer mortgage loan deficiencies are charged
down upon the sale of the collateral or sooner upon the recognition of
collateral deficiency. Commercial and agricultural credits are charged down at
120 days delinquency, unless an established and approved work-out plan is in
place or litigation of the credit will likely result in recovery of the loan
balance. Upon notification of bankruptcy, unsecured debt is charged off.
Additional charge-offs may be realized as further unsecured positions are
recognized.
Loans classified as nonaccrual were lower as of
60
--------------------------------------------------------------------------------
commercial and industrial portfolios decreased a combined $852 thousand . The
agricultural real estate and agricultural portfolios increased a combined $393
thousand as compared to September 30, 2020 .
In determining the allocation for impaired loans, the Bank applies the appraised
market value of the collateral securing the asset, reduced by applying a
discount for estimated costs of collateral liquidation. In some instances where
the discounted market value is less than the loan amount, a specific impairment
allocation is assigned, which may be reduced or eliminated by the write down of
the credit's active principal outstanding balance.
For the majority of the Bank's impaired loans, including all collateral
dependent loans, the Bank will apply the appraised market value methodology.
However, the Bank may also utilize a measurement incorporating the present value
of expected future cash flows discounted at the loan's effective rate of
interest. To determine appraised market value, collateral asset values securing
an impaired loan are periodically evaluated. Maximum time of re-evaluation is
every 12 months for chattels and titled vehicles and every two years for real
estate. In this process, third party evaluations are obtained and heavily relied
upon. Until such time that updated appraisals are received, the Bank may
discount the collateral value used.
The following table presents the balances for allowance for loan losses by loan
type for nine months ended
(In Thousands) (In Thousands)
September 30, 2021 September 30, 2020
% of Loan % of Loan
Balance at End of Period Applicable To: Amount Category Amount Category
Consumer Real Estate $ 796 13.53 % $ 530 12.87 %
Agricultural Real Estate 926 11.97 % 762 14.12 %
Agricultural 687 7.07 % 669 7.59 %
Commercial Real Estate 8,365 48.64 % 5,735 43.55 %
Commercial and Industrial 3,814 15.07 % 3,272 17.95 %
Consumer 606 3.72 % 604 3.92 %
Unallocated 504 0.00 % 311 0.00 %
Allowance for Loan & Lease Losses 15,698 11,883
Off Balance Sheet Commitments 1,039 633
Total Allowance for Credit Losses $ 16,737 $ 12,516
Noninterest Income
Noninterest income was down $641 thousand for the third quarter 2021 over the
same time frame in 2020. The Company has seen a decrease in its mortgage
production volume and the gain on the sale of these loans was $715 thousand
lower for the third quarter 2021 over the same period in 2020. Loan originations
on loans held for sale for the third quarter 2021 were $21.7 million with
proceeds from sale at $26.8 million for 2021 compared to 2020's third quarter
activity of $63.5 million in originations and $68.9 million in sales. Loan
originations driven by the refinance activity associated with the reduction in
interest rates has slowed. The mortgages sold were both 1-4 family and
agricultural real estate loans originated for sale.
Combined service fees increased by $74 thousand as compared to third quarter
2020. Debit card income increased by $156 thousand and bank owned life insurance
cash surrender value increased $76 thousand . Also contributing to the increase
was service charge income and overdraft and returned check charges which
increased $41 and $90 thousand respectively compared to third quarter 2020.
Service fee income for 1-4 family and agricultural real estate loans increased
by $33 thousand while servicing rights income decreased $346 thousand .
61
--------------------------------------------------------------------------------
The impact of mortgage servicing rights, both to income and expense, is shown in
the following table which reconciles the value of mortgage servicing rights. The
capitalization runs through noninterest income while the amortization thereof is
included in non-interest expense. For the third quarter of 2021 and 2020,
mortgage servicing rights caused a net $22 and $287 thousand in income,
respectively. The first nine months of 2021 and 2020, mortgage servicing rights
caused a net $165 and $398 thousand of income, respectively. The lower
capitalized additions for 2021 are attributed to a lower loan origination level
of 1-4 families. A low interest rate environment has helped to generate the
mortgage refinance activity. For loans of 15 years and less, the value was
1.160% in the third quarter 2021 versus 0.975% in third quarter 2020. For loans
over 15 years, the value was 1.355% versus a lower 1.109% for the same periods
respectively. The carrying value is greater than the market value of $3.5
million which created the need to establish a $388 thousand valuation allowance
during 2021.
Three Months Nine Months
(In Thousands) (In Thousands)
2021 2020 2021 2020
Beginning Balance $ 3,146 $ 2,740 $ 3,320 $ 2,629
Capitalized Additions 236 583 1,091 1,182
Amortization (214 ) (296 ) (926 ) (784 )
Ending Balance, September 30, 3,168 3,027 3,485 3,027
Valuation Allowance (71 ) -
(388 ) -
Mortgage Servicing Rights net,
Noninterest Expense For the third quarter 2021, noninterest expenses were$2.0 million higher than for the same quarter in 2020. Salaries, wages, and employee benefits (includes normal merit increases, restricted stock expense, incentive payout and all employee benefits) increased$395 thousand in total. This was comprised of increased salaries of$340 thousand and increased benefits of$55 thousand with$153 thousand acquisition related. Consulting fees increased$51 thousand over third quarter 2020 with$79 thousand related to the acquisition of Ossian and Perpetual.FDIC assessment expenses were up$102 thousand due to the increased assessment base. During the third quarter 2021, the Bank also recognized a loss of$189 thousand which is included in the Net (Gain) Loss on Sale of Other Assets Owned line of the consolidated statement of income for the sale of buildings. Data processing increased$1.1 million over third quarter 2020 with$893 thousand acquisition related. Other general and administrative expenses increased$165 thousand as compared to third quarter 2020 with$267 thousand acquisition related while the remainder was primarily attributable to the Company's overall growth for the year.
Income Taxes
Income tax expense was$337 thousand higher for the third quarter 2021 compared to the same quarter in 2020. Effective tax rates were 21.53% and 22.59% for third quarter 2021 and 2020 respectively. The lower effective income tax rate for third quarter 2021 accounted for a decrease of$80 thousand of income tax expense. Increased earnings equaled an increase in income tax expense of$417 thousand . Net Income Results overall, net income in the third quarter of 2021 was up$1.5 million as compared to the same quarter last year. Third quarter 2021 included a decrease of$1.3 million of loan loss provision as compared to third quarter 2020. The Company has done an exceptional job of growing loans while keeping past dues low. The Company remains strong, stable, and well capitalized and has the capacity to continue to cover the increased costs of expansion. 62
--------------------------------------------------------------------------------
Comparison of Results of Interest Earnings and Expenses for nine month periods
ended
Interest Income Higher loan balances of$107.6 million led to an improvement in the interest income for the first nine months of 2021 as compared to the first nine months of 2020. PPP average loan balances decreased approximately$12.6 million year over year. Interest income in total rose 4.6% or$2.4 million with interest income from loans accounting for 99.7% of the increase. Contributing to the overall increase was also a decrease in securities income of$27 thousand and an increase from Fed Funds sold and interest-bearing deposits of$33 thousand over 2020. The asset yield decreased by 60 basis points to 3.70% for the first nine months of 2021 compared to the first nine months of 2020's 4.30%.
PPP loan interest income recognized was
The average interest earning asset base was
The yields on tax-exempt securities and the portion of the tax-exempt IDB loans
included in loans have been tax adjusted based on a 21% tax rate in the charts
to follow.
(In Thousands)
Year to Date Ended September 30, 2021 Annualized Yield/Rate
Interest Earning Assets: Average Balance
Interest/Dividends
$ 1,413,625 $ 50,637 4.78 % 4.93 %
Taxable investment securities 363,284 3,286 1.21 % 2.06 %
Tax-exempt investment securities 18,387 252 2.31 % 2.28 %
Fed funds sold & other 171,015 242 0.19 % 0.37 %
Total Interest Earning Assets $ 1,966,311 $ 54,417 3.70 % 4.30 %
Change in Interest Income Year to Date September 30, 2021 Compared to
September 30, 2020
(In Thousands)
Change Due Change Due
Interest Earning Assets: Total Change to Volume to Rate
Loans $ 2,381 $ 3,980 $ (1,599 )
Taxable investment securities 66 2,390 (2,324 )
Tax-exempt investment securities (93 ) (123 ) 30
Fed funds sold & other 33 262
(229 )
Total Interest Earning Assets
Interest Expense Interest expense was lower for the first nine months of 2021 compared to the first nine months of 2020. At$5.0 million , the first nine months of 2021 was down$3.4 million as compared to the same time period 2020 or 40.9%. The average balance of interest-bearing liabilities was higher by$236.9 million in 2021 than the first nine months of 2020. Interest bearing deposits increased$236.6 million . The remainder is comprised of an increase in subordinated notes of$8.0 million offset by a decrease in Fed Funds purchased and securities sold under agreement to repurchase of$3.2 million and other borrowed money of$4.5 million . Refer to Note 8 for additional information on subordinated notes. The higher balance coupled with the slight variation of the balance sheet mix and lower interest rates, resulted in a 48 basis points decrease in the cost of funds at 0.47% for the first nine months of 2021 as compared to 2020's 0.95%.
The change chart below shows the decreased cost was driven more by rate than volume.
63
--------------------------------------------------------------------------------
(In Thousands)
Year to Date Ended September 30, 2021 Annualized Yield/Rate
Interest Bearing
Liabilities: Average Balance Interest September 30, 2021 September 30, 2020
Savings deposits $ 1,106,674 $ 1,700 0.20 % 0.51 %
Other time deposits 248,426 2,137 1.15 % 1.88 %
Other borrowed money 17,859 424 3.17 % 4.49 %
Fed funds purchased &
securities
sold under agreement to
repurchase 29,973 494 2.20 % 2.44 %
Subordinated notes 8,023 199 3.31 % 0.00 %
Total Interest Bearing
Liabilities $ 1,410,955 $ 4,954 0.47 % 0.95 %
Change in Interest Expense Year to Date September 30, 2021 Compared to
September 30, 2020
(In Thousands)
Change Due Change Due
Interest Bearing Liabilities: Total Change to Volume to Rate
Savings deposits $ (1,537 ) $ 979 $ (2,516 )
Other time deposits (1,645 ) (286 ) (1,359 )
Other borrowed money (330 ) (153 ) (177 )
Fed funds purchased & securities
sold under agreement to repurchase (111 ) (57 ) (54 )
Subordinated notes 199 199 -
Total Interest Bearing Liabilities
(4,106 )
Net Interest Income
Overall, net interest spread figures for the first nine months of 2021 were down
from 2020 by 12 basis points and down 28 basis points from 2019. Net interest
margin for the first nine months of 2021 was lower than the same periods of 2020
and 2019. As the chart below illustrates, lower yields on loan and investment
income were only partially offset by lower interest expense resulting in total
net interest margin down 25 basis points since the first nine months of 2020 and
under the first nine months of 2019 by 52 basis points.
September 30, 2021 September 30, 2020 September 30, 2019
Interest/Dividend income/yield 3.70 % 4.30 % 4.93 %
Interest Expense/cost 0.47 % 0.95 % 1.42 %
Net Interest Spread 3.23 % 3.35 % 3.51 %
Net Interest Margin 3.36 % 3.61 % 3.88 %
Net interest income was up $5.8 million in the first nine months of 2021 over
the same time frame in 2020 due to the increase in interest income and lower
interest expense as previously mentioned. As the new loans added in 2020 and
2021 generate more income, management expects the benefits of the Company's
strategy of repositioning the balance sheet to continue to widen this margin as
measured in dollars. In terms of net interest margin rate, the Bank recognizes
competition for deposits may again increase and put pressure on the margin which
may lead to a tightening.
Comparison of Results of Noninterest Earnings and Expenses for nine month
periods ended
Provision Expense
Total provision for loan losses was$2.0 million lower for the first nine months 2021 than for the first nine months 2020 attributable primarily to the lessened uncertainties associated with COVID-19 and its effects on the ability of individuals, businesses and other entities to meet their financial obligations. Therefore, it is prudent to incorporate the impact of COVID-19 in the evaluation of the adequacy of Allowance for Loan and Lease Losses (ALLL). The restaurant and hospitality sectors have been hit especially hard. Risk in the Consumer and 1-4 Family Portfolio has increased but the full impact remains 64 -------------------------------------------------------------------------------- unknown. Increases to the Bank's ALLL for the first nine months of 2021, centered around current customers and businesses that are particularly vulnerable and qualitative factors were adjusted accordingly. Management continues to monitor asset quality, making adjustments to the provision as necessary. Loan charge-offs were$674 thousand higher in the first nine months of 2021 compared to the same period 2020. Recoveries were$31 thousand higher in the first nine months of 2021 as compared to first nine months of 2020. Combined net charge-offs were$643 thousand higher in the nine months endedSeptember 2021 as compared to the same time period 2020. Management continues to evaluate the potential financial implications resulting from COVID-19 and adjusts ALLL qualitative factors as necessary. The following table breaks down the activity within the ALLL for each loan portfolio class and shows the contribution provided by both recoveries and the provision, along with the reduction of the allowance caused by charge-offs. The time period covered is for nine months endedSeptember 30, 2021 , 2020, and 2019. (In Thousands) Nine Months Ended Nine Months Ended Nine Months Ended September 30, 2021 September 30, 2020 September 30, 2019 Loans, net $ 1,495,562 $ 1,363,862 $ 1,158,696 Daily average of outstanding loans $ 1,413,625 $
1,305,998 $ 1,113,892
Allowance for Loan Losses -
January 1, $ 13,672 $ 7,228 $ 6,775
Loans Charged off:
Consumer Real Estate 2 35 95
Agriculture Real Estate - - -
Agricultural 143 - 22
Commercial Real Estate - 8 -
Commercial and Industrial 814 165 55
Consumer 195 272 382
1,154 480 554
Loan Recoveries:
Consumer Real Estate 9 7 -
Agriculture Real Estate - - -
Agricultural 7 - 3
Commercial Real Estate 8 7 7
Commercial and Industrial 19 19 21
Consumer 137 116 97
180 149 128
Net Charge Offs 974 331 426
Provision for loan loss 3,000 4,986 410
Acquisition provision for loan
loss - - -
Allowance for Loan & Lease
Losses - September 30, 15,698 11,883 6,759
Allowance for Unfunded Loan
Commitments
& Letters of Credit -
September 30, 1,039 633 430
Total Allowance for Credit
Losses - September 30, $ 16,737 $ 12,516 $ 7,189
Ratio of net charge-offs to
average
Loans outstanding 0.07 % 0.03 % 0.04 %
Ratio of the Allowance for Loan
Loss to
Nonperforming Loans* 251.26 % 151.01 % 173.25 %
* Nonperforming loans are defined as all loans on nonaccrual, plus any
loans 90 days past due not on nonaccrual.
In comparing past due balances of loans 30+ days, September 30, 2021 balances
were $1.6 million as compared to September 30, 2020 balances of $324 thousand .
Net charge-offs were higher at $974 thousand for the first nine months of 2021
compared to the first nine months of 2020's $331 thousand .
65
--------------------------------------------------------------------------------
Noninterest Income Noninterest income for the first nine months of 2021 increased over the first nine months of 2020 by$1.9 million . Gain on sale of loans showed a$695 thousand increase over the first nine months of 2020 with the surge in refinance activity due to interest rate reductions. Combined service fees increased by$1.2 million with increased debit card income of$778 thousand which included a Mastercard growth credit of$151 thousand , servicing fee income on 1-4 family and agricultural real estate loans of$176 thousand and bank owned life insurance cash surrender value increases of$209 thousand . Service charge income increased by$146 thousand while overdraft and returned check income decreased by$46 thousand . Servicing rights income and release fees decreased compared to 2020 by$91 thousand and$93 thousand , respectively. The Company did sell some of its available-for-sale securities in first nine months of both years and recognized a gain of$293 thousand in 2021 and$270 thousand in 2020.
Noninterest Expense
Through the first nine months of 2021, noninterest expenses were$6.7 million higher than in the first nine months of 2020. 2021 included$2.7 million of third party acquisition related costs incurred with the Ossian and Perpetual transactions. The nine months of 2021 included an increase of$1.0 million in salaries and wages in addition to an increase of$1.1 million in employee benefits. The addition of the acquired offices, normal merit increases, a one time expense for 2020 employer pension match and increased employer taxes have impacted 2021. The increases were offset by decreased restricted stock expense and medical costs. 2021 included acquisition costs of$694 thousand in the employee benefits line of the Company's consolidated statement of income. Data processing fees, which included a credit for product upgrades in the amount of$100 thousand , were$1.1 million higher than last year with$939 thousand attributed to the acquisitions. A seven year contract extension was signed in the third quarter of 2016 which has helped reduce the expense while adding new products and services to better align with our customers' expectations in the coming years. Consulting fees increased$312 thousand with$416 thousand acquisition related. The increase inFDIC assessments for 2021 was due to Small Bank Credits being applied in 2020 and an increase in the assessment base. 2021 included a loss on the sale of buildings in the amount of$406 thousand . General and administrative expenses were up$1.5 million over the first nine months of 2020. Acquisition costs of$604 thousand were included in this line for 2021. One of the largest increases was for provision for unfunded loans for$244 thousand which was partially related to the decreased balances on lines of credit due to PPP. Loan and collection expense increased$259 thousand while legal fees increased$420 thousand over 2020 with$402 thousand related to the acquisitions. Audit, accounting and exam fees increased$149 thousand compared to 2020 with$44 thousand attributed to the acquisitions.
Income Taxes
Income tax expense was$583 thousand higher for the first nine months of 2021 compared to the first nine months of 2020. Effective tax rates were 20.20% and 20.43% for the first nine months of 2021 and 2020 respectively. The slightly lower effective tax rate for the first nine months of 2021 equaled a decrease in income tax expense of$45 thousand with an increase of$628 thousand driven from increased earnings. Net Income Overall, net income through the first nine months of 2021 was up$2.5 million as compared to the first nine months of 2020. Decreased interest expense of$3.4 million , decreased loan loss provision of$2.0 million and increased loan interest income of$2.4 million were the largest contributors to the increased net income for 2021. 66
--------------------------------------------------------------------------------
FORWARD LOOKING STATEMENTS Statements contained in this portion of the Company's report may be forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements may be identified by the use of words such as "intend," "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." Such forward-looking statements are based on current expectations, but actual results may differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents filed by the Company with theSecurities and Exchange Commission from time to time. Other factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of theU.S. Government , including policies of theU.S. Treasury and theFederal Reserve Board , the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Bank's market area, changes in relevant accounting principles and guidelines and other factors over which management has no control, including, but not limited to, the ongoing impact of the COVID-19 pandemic. The forward-looking statements are made as of the date of this report, and the Company assumes no obligation to update the forward-looking statements or to update the reasons why actual results differ from those projected in the forward-looking statements. 67
--------------------------------------------------------------------------------
© Edgar Online, source
