CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report, including information included or incorporated by reference in this report, contains statements which constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of our company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words "may," "approximately," "is likely," "would," "could," "should," "will," "expect," "anticipate," "predict," "project," "potential," "continue," "assume," "believe," "intend," "plan," "forecast," "goal," and "estimate," as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitation, those described under the heading "Risk Factors" in our Annual Report on Form 10-K for the year endedDecember 31, 2020 as filed with theU.S. Securities and Exchange Commission (the "SEC") onMarch 12, 2021 and the following:
? The impact of the outbreak of the novel coronavirus, or COVID-19, on our
business, including the impact of the actions taken by governmental authorities
to try and contain the virus or address the impact of the virus on the United
States economy (including, without limitation, the CARES Act; the Consolidated
Appropriations Act, 2021; and the American Rescue Plan Act of 2021), and the
resulting effect of these items on our operations, liquidity and capital
position, and on the financial condition of our borrowers and other customers;
? credit losses as a result of, among other potential factors, declining real
estate values, increasing interest rates, increasing unemployment, or changes
in customer payment behavior or other factors;
? the amount of our loan portfolio collateralized by real estate and weaknesses
in the real estate market;
? restrictions or conditions imposed by our regulators on our operations;
? the adequacy of the level of our allowance for loan losses and the amount of
loan loss provisions required in future periods;
? examinations by our regulatory authorities, including the possibility that the
regulatory authorities may, among other things, require us to increase our
allowance for loan losses, write-down assets, or take other actions;
? risks associated with actual or potential information gatherings,
investigations or legal proceedings by customers, regulatory agencies or
others;
? reduced earnings due to higher other-than-temporary impairment charges
resulting from additional decline in the value of our securities portfolio,
specifically as a result of increasing default rates, and loss severities on
the underlying real estate collateral;
? increases in competitive pressure in the banking and financial services
industries;
? changes in the interest rate environment which could reduce anticipated or
actual margins;
? changes in political or social conditions or the legislative or regulatory
environment, including governmental initiatives affecting the financial
services industry, including as a result of the 2020 presidential and
congressional elections;
? general economic conditions resulting in, among other things, a deterioration
in credit quality;
? changes occurring in business conditions and inflation;
? changes in access to funding or increased regulatory requirements with regard
to funding; 28
? cybersecurity risk related to our dependence on internal computer systems and
the technology of outside service providers, as well as the potential impacts
of third party security breaches, which subject us to potential business
disruptions or financial losses resulting from deliberate attacks or
unintentional events; ? changes in deposit flows; ? changes in technology;
? our current and future products, services, applications and functionality and
plans to promote them;
? changes in monetary and tax policies, including potential changes in tax laws
and regulations;
? changes in accounting standards, policies, estimates and practices;
? our assumptions and estimates used in applying critical accounting policies,
which may prove unreliable, inaccurate or not predictive of actual results;
? the rate of delinquencies and amounts of loans charged-off;
? the rate of loan growth in recent years and the lack of seasoning of a portion
of our loan portfolio;
? our ability to maintain appropriate levels of capital, including levels of
capital required under the capital rules implementing Basel III;
? our ability to successfully execute our business strategy;
? our ability to attract and retain key personnel;
? our ability to retain our existing customers, including our deposit
relationships;
? adverse changes in asset quality and resulting credit risk-related losses and
expenses;
? the potential effects of events beyond our control that may have a
destabilizing effect on financial markets and the economy, such as epidemics
and pandemics (including COVID-19), war or terrorist activities, disruptions in
our customers' supply chains, disruptions in transportation, essential utility
outages or trade disputes and related tariffs;
? disruptions due to flooding, severe weather or other natural disasters; and
? other risks and uncertainties detailed in Part I, Item 1A of our Annual Report
on Form 10-K for the year ended
other filings with theSEC . Because of these and other risks and uncertainties, our actual future results may be materially different from the results indicated by any forward-looking statements. For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see "Risk Factors" under Part I, Item 1A of our Annual Report on Form 10-K for the year endedDecember 31, 2020 . In addition, our past results of operations do not necessarily indicate our future results. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. All forward-looking statements in this report are based on information available to us as of the date of this report. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required
by applicable law. Overview
The following discussion describes our results of operations for the three months endedMarch 31, 2021 as compared to the three-month period endedMarch 31, 2020 and analyzes our financial condition as ofMarch 31, 2021 as compared toDecember 31, 2020 . Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section, we have included a discussion of this process, as well as several tables describing our allowance for loan losses and the allocation of this allowance among our various categories of loans. 29
In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this non-interest income, as well as our non-interest expense, in the following discussion.
The following discussion and analysis identify significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.
Unless the context requires otherwise, references to the "Company," "we," "us,"
"our," or similar references mean
Recent Events - COVID-19 Pandemic
Our financial performance generally, and in particular the ability of our borrowers to repay their loans, the value of collateral securing those loans, as well as demand for loans and other products and services we offer, is highly dependent on the business environment in our primary markets where we operate and inthe United States as a whole. The COVID-19 pandemic continues to create extensive disruptions to the global economy and financial markets and to businesses and the lives of individuals throughout the world. The impact of the COVID-19 pandemic is fluid and continues to evolve. The unprecedented and rapid spread of COVID-19 and its associated impacts on trade (including supply chains and export levels), travel, employee productivity, unemployment, consumer spending, and other economic activities has resulted in less economic activity, lower bank equity market valuations and significant volatility and disruption in financial markets. In addition, due to the COVID-19 pandemic, market interest rates declined significantly, with the 10-yearTreasury bond falling to a low of 0.52% in earlyAugust 2020 , but increasing significantly since that time to 1.74% atMarch 31, 2021 . InMarch 2020 , theFederal Open Market Committee reduced the targeted federal funds interest rate range to 0% to 0.25% percent, and this low rate was still in effect as ofMarch 31, 2021 . Furthermore, one-month to three-yearTreasury yields ranged from 0.01% to 0.35% atMarch 31, 2021 . These reductions in interest rates and the other effects of the COVID-19 pandemic have had, and are expected to continue to have, possibly materially, an adverse effect on our business, financial condition and results of operations. For instance, the pandemic has had negative effects on the Bank's net interest margin, provision for loan losses, deposit service charges, salaries and benefits, occupancy expense, and equipment expense. The ultimate extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is currently uncertain and will depend on various developments and other factors, including the effect of governmental and private sector initiatives, the effect of the recent rollout of vaccinations for the virus, whether such vaccinations will be effective against any resurgence of the virus, including any new strains, and the ability for customers and businesses to return to their pre-pandemic routine. Our business, financial condition and results of operations generally rely upon the ability of our borrowers to repay their loans, the value of collateral underlying our secured loans, and demand for loans and other products and services we offer, which are highly dependent on the business environment in our primary markets where we operate and inthe United States as a whole. We are focused on servicing the financial needs of our commercial and consumer customers with flexible loan payment arrangements, including short-term loan modifications or forbearance payments and reducing or waiving certain fees on deposit accounts. Future governmental actions may require these and other types of customer-related responses. Beginning inMarch 2020 , we proactively offered payment deferrals for up to 90 days to our loan customers regardless of the impact of the pandemic on their business or personal finances. We continue to consider potential deferrals with respect to certain customers, which we evaluate on a case-by-case basis. Loans on which payments have been deferred declined to$8.7 million atMarch 31, 2021 from$16.1 million atDecember 31, 2020 and from$118.3 million atMarch 31, 2020 . At its peak, which occurred during the second quarter of 2020, we granted payment deferments on loans totaling$206.9 million . As a result of payments being resumed at the conclusion of their payment deferral period, loans for which payments were being deferred decreased from the peak of$206.9 million to$175.0 million atJune 30, 2020 , to$27.3 million atSeptember 30, 2020 , to$16.1 million atDecember 31, 2020 , and to$8.7 million atMarch 31, 2021 . We had no loans remaining on initial deferral status in which both principal and interest were deferred atDecember 31, 2020 andMarch 31, 2021 . The$16.1 million in deferrals atDecember 31, 2020 consisted of seven loans on which only principal was being deferred. We had three loans totaling$8.7 million in continuing deferral status in which only principal is being deferred atMarch 31, 2021 . Two of the continuing deferrals atMarch 31, 2021 totaling$4.5 million are in the retail industry segment identified by us as one of the industry segments most impacted by the COVID-19 pandemic; the other continuing deferral totaling$4.2 million is a mixed use office space that we do not consider to be in an industry segment most impacted by the COVID-19 pandemic. Some of these deferments were to businesses that temporarily closed or reduced operations and some were requested as a pre-cautionary measure to conserve cash. 30 We are also a small business administration approved lender and participated in the Paycheck Protection Program, or PPP, established under the CARES Act. We had PPP loans totaling$64.1 million gross of deferred fees and costs and$61.8 million net of deferred fees and costs atMarch 31, 2021 . We had PPP loans totaling$43.3 million gross of deferred fees and costs and$42.2 million net of deferred fees and costs atDecember 31, 2020 . The PPP deferred fees net of deferred costs will be recognized as interest income over the remaining life of the PPP loans. Our asset quality metrics as ofMarch 31, 2021 remained sound. The non-performing asset ratio was 0.37% of total assets with the nominal level of$5.6 million in non-performing assets atMarch 31, 2021 compared to 0.50% and$7.0 million atDecember 31, 2020 . Loans past due 30 days or more represented 0.04% of the loan portfolio atMarch 31, 2021 compared to 0.23% atDecember 31, 2020 . The ratio of classified loans plus OREO and repossessed assets increased to 9.90% of total bank regulatory risk-based capital atMarch 31, 2021 from 6.89% atDecember 31, 2020 due to one loan relationship, which was impacted by the COVID-19 pandemic. During the three months endedMarch 31, 2021 , we experienced net loan charge-offs of$8 thousand and net overdraft recoveries of$5 thousand . AtMarch 31, 2021 , our non-performing assets were not yet materially impacted by the economic pressures of the COVID-19 pandemic. As we closely monitor credit risk and our exposure to increased loan losses resulting from the impact of COVID-19 on our customers, we evaluated and identified our exposure to certain industry segments most impacted by the COVID-19 pandemic as ofMarch 31, 2021 :
Industry Segments Outstanding % of Loan Avg. Loan Avg. Loan to (Dollars in millions) Loan Balance Portfolio Size
Value Hotels$ 33.2 3.8 %$ 2.4 69 % Restaurants$ 22.2 2.6 %$ 0.7 72 % Assisted Living $ 8.8 1.0 %$ 1.5 47 % Retail$ 82.4 9.5 %$ 0.7 57 % We are also monitoring the impact of the COVID-19 pandemic on the operations and value of our investments. We mark to market our publicly traded investments and review our investment portfolio for impairment at, a minimum, quarterly. We do not consider any securities in our investment portfolio to be other-than-temporarily impaired atMarch 31, 2021 . However, because of changing economic and market conditions affecting issuers, we may be required to recognize future impairments on the securities we hold as well as reductions in other comprehensive income. We cannot currently determine the ultimate impact of the pandemic on the long-term value of our portfolio. Our capital remained strong and exceeded the well-capitalized regulatory requirements atMarch 31, 2021 . Total shareholders' equity declined$3.6 million or 2.7% to$132.7 million atMarch 31, 2021 from$136.3 million atDecember 31, 2020 . The$3.6 million decline was due to a$6.2 million reduction in accumulated other comprehensive income partially offset by a$2.4 million increase in retention of earnings less dividends paid. The decline in accumulated other comprehensive income was due to an increase in longer-term market interest rates, which resulted in a reduction in the net unrealized gains in our investment securities portfolio. In 2018, theFederal Reserve increased the asset size to qualify as a small bank holding company. As a result of this change, we are generally not subject to theFederal Reserve capital requirements unless advised otherwise. The Bank remains subject to capital requirements including a minimum leverage ratio and a minimum ratio of "qualifying capital" to risk weighted assets. These requirements are essentially the same as those that applied to the Company prior to the change in the definition of a small bank holding company. Each of the regulatory capital ratios for the Bank exceeds the well capitalized minimum levels currently required by regulatory statute atMarch 31, 2021 andDecember 31, 2020 . Refer to the Liquidity and Capital Resources section for more details. 31 Prompt Corrective Action Excess Capital $s of
Dollars in thousands (PCA) Requirements PCA Requirements Well Adequately Well Adequately Capital Ratios Actual Capitalized Capitalized Capitalized CapitalizedMarch 31, 2021 Leverage Ratio 8.73 % 5.00 % 4.00 %$ 52,529 $ 66,594
Common Equity Tier 1 Capital Ratio 13.20 % 6.50 %
4.50 % 62,377 80,985 Tier 1 Capital Ratio 13.20 % 8.00 % 6.00 % 48,421 67,029 Total Capital Ratio 14.34 % 10.00 % 8.00 % 40,375 58,984 December 31, 2020 Leverage Ratio 8.84 % 5.00 % 4.00 %$ 52,270 $ 65,893
Common Equity Tier 1 Capital Ratio 12.83 % 6.50 %
4.50 % 59,406 78,169 Tier 1 Capital Ratio 12.83 % 8.00 % 6.00 % 45,334 64,097 Total Capital Ratio 13.94 % 10.00 % 8.00 % 36,961 55,723
Based on our strong capital, conservative underwriting, and internal stress testing, we expect to remain well capitalized throughout the COVID-19 pandemic. However, the Bank's reported regulatory capital ratios could be adversely impacted by future credit losses related to the COVID-19 pandemic. We recognize that we face extraordinary circumstances, and we intend to monitor developments and potential impacts on our capital. We believe that we have ample liquidity to meet the needs of our customers and to manage through the COVID-19 pandemic through our low cost deposits; our ability to borrow against approved lines of credit (federal funds purchased) from correspondent banks; and our ability to obtain advances secured by certain securities and loans from theFederal Home Loan Bank .
Critical Accounting Policies
We have adopted various accounting policies that govern the application of accounting principles generally accepted inthe United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our unaudited consolidated financial statements as ofMarch 31, 2021 and our notes included in the consolidated financial statements in our Annual Report on Form 10-K for the year endedDecember 31, 2020 as filed with theSEC onMarch 12, 2021 . Certain accounting policies inherently involve a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported, which could have a material impact on the carrying values of our assets and liabilities and our results of operations. We consider these accounting policies and estimates to be critical accounting policies. We have identified the determination of the allowance for loan losses, goodwill and other intangibles, income taxes, deferred tax assets, and deferred tax liabilities, other-than-temporary impairment, business combinations, and method of accounting for loans acquired to be the accounting areas that require the most subjective or complex judgments and, as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate and/or market interest rates. Therefore, management has reviewed and approved these critical accounting policies and estimates and has discussed these policies with ourAudit and Compliance Committee . A brief discussion of each of these areas appears in our 2020 Annual Report on Form 10-K. During the first three months of 2021, we did not significantly alter the manner in which we applied our Critical Accounting Policies or developed related assumptions and estimates.
There have been no significant changes to the Company's critical accounting
policies as disclosed in the Company's Annual Report on Form 10-K for the year
ended
32
Comparison of Results of Operations for Three Months Ended
Net Income
Our net income for the three months endedMarch 31, 2021 was$3.3 million , or$0.43 diluted earnings per common share, as compared to$1.8 million , or$0.24 diluted earnings per common share, for the three months endedMarch 31, 2020 . The$1.5 million increase in net income between the two periods is primarily due to a$1.2 million increase in net interest income, a$368 thousand increase in non-interest income, and an$898 thousand reduction in provision for loan losses partially offset by a$502 thousand increase in non-interest expense and$453 thousand increase in income tax expense. The increase in net interest income results from an increase of$261.8 million in average earning assets partially offset by a 32 basis point decline in the net interest margin between the two periods. The increase in non-interest income is primarily related to increases in investment advisory fees and non-deposit commissions of$243 thousand , ATM/debit card income of$116 thousand , gains on sale of assets of$77 thousand , and$100 thousand from the collection of a summary judgment related to a loan charged off at a bank, which we subsequently acquired. The reduction in provision for loan losses is primarily related to an increase in the qualitative factors in our allowance for loan losses methodology related to the economic uncertainties caused by the COVID-19 pandemic during the first three months of 2020. The increase in non-interest expense is primarily related to increased salaries and employee benefits expense of$311 thousand , increased occupancy expense of$87 thousand , and increasedFDIC assessment of$127 thousand . Our effective tax rate was 21.49% during the first quarter of 2021 compared to 19.62% during the first quarter of 2020. Net Interest Income Net interest income is our primary source of revenue. Net interest income is the difference between income earned on assets and interest paid on deposits and borrowings used to support such assets. Net interest income is determined by the rates earned on our interest-earning assets and the rates paid on our interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing liabilities, and the degree of mismatch and the maturity and repricing characteristics of our interest-earning assets and interest-bearing liabilities. Please refer to the table at the end of this Item 2 (Management's Discussion and Analysis of Financial Condition and Results of Operations) for the average yields on assets and average rates on interest-bearing liabilities during the three-month periods endedMarch 31, 2021 and 2020, along with average balances and the related interest income and interest expense amounts. Net interest income increased$1.2 million , or 12.2%, to$10.6 million for the three months endedMarch 31, 2021 from$9.4 million for the three months endedMarch 31, 2020 . Our net interest margin declined by 32 basis points to 3.20% during the three months endedMarch 31, 2021 from 3.52% during the three months endedMarch 31, 2020 . Our net interest margin, on a taxable equivalent basis, was 3.23% for the three months endedMarch 31, 2021 compared to 3.55% for the three months endedMarch 31, 2020 . Average earning assets increased$261.8 million , or 24.3%, to$1.3 billion for the three months endedMarch 31, 2021 compared to$1.1 billion in the same period of 2020. The increase in net interest income was primarily due to a higher level of average earning assets partially offset by lower net interest margin. The increase in average earning assets was due to increases in loans, securities, and other short-term investments primarily due to Non-PPP loan growth, PPP loans, organic deposit growth, and excess liquidity from PPP loan proceeds and other stimulus funds related to the COVID-19 pandemic. The decline in net interest margin was primarily due to theFederal Reserve reducing the target range of the federal funds rate two times totaling 150 basis points during the first quarter of 2020 and the excess liquidity generated from PPP loan proceeds and other stimulus funds related to the COVID-19 pandemic being deployed in lower yielding securities and other short-term investments. Lower market rates, the competitive loan pricing environment, and the COVID-19 pandemic put downward pressure on our net interest margin during 2020 and the first three months of 2021. Average loans increased$132.7 million , or 17.6%, to$886.4 million for the three months endedMarch 31, 2021 from$753.7 million for the same period in 2020. Average PPP loans increased$55.5 million and average Non-PPP loans increased$77.2 million to$55.5 million and$830.8 million , respectively, for the three months endedMarch 31, 2021 . We had no PPP loans atMarch 31, 2020 . Average loans represented 66.2% of average earning assets during the three months endedMarch 31, 2021 compared to 70.0% of average earning assets during the same period in 2020. The decline in average loans as a percentage of average earning assets was primarily due to increases in deposits of$238.7 million and securities sold under agreements to repurchase of$8.4 million . The growth in our deposits and securities sold under agreements to repurchase was higher than the growth in our loans, which resulted in the excess funds being deployed in our securities portfolio and other short-term investments and to reduce the amount of ourFederal Home Loan Bank advances. The yield on loans declined 39 basis points to 4.32% during the three months endedMarch 31, 2021 from 4.71% during the same period in 2020. The yield on PPP loans was 4.99% and the yield on Non-PPP loans was 4.28% during the three months endedMarch 31, 2021 . Average securities and average other short-term investments for the three months endedMarch 31, 2021 increased$87.0 million and$42.1 million , respectively, from the prior year period. The yield on our securities portfolio declined to 1.88% for the three months endedMarch 31, 2021 from 2.42% for the same period in 2020 while the yield on our other short-term investments declined to 0.17% for the three months endedMarch 31, 2021 from 1.70% for the same period in 2020. These declines were primarily related to theFederal Reserve reducing the target range of the federal funds rate as described above. The yield on earning assets for the three months endedMarch 31, 2021 and 2020 was 3.40% and 4.00%, respectively. The cost of interest-bearing liabilities was at 29 basis points during the three months endedMarch 31, 2021 compared to 69 basis points during the same period in 2020. 33 We continue to focus on growing our pure deposits (demand deposits, interest-bearing transaction accounts, savings deposits, money market accounts, and IRAs) as these accounts tend to be low-cost deposits and assist us in controlling our overall cost of funds. During the three months endedMarch 31, 2021 , these deposits averaged 89.2% of total deposits as compared to 85.6% during the same period of 2020. This increase was due to PPP loan proceeds, other stimulus funds related to the COVID-19 pandemic, and organic growth.
Provision and Allowance for Loan Losses
We account for our allowance for loan losses under the incurred loss model. As discussed above, the CECL model will become effective for us onJanuary 1, 2023 . AtMarch 31, 2021 , the allowance for loan losses was$10.6 million , or 1.22% of total loans (excluding loans held-for-sale), compared to$10.4 million or 1.23% of total loans (excluding loans held-for-sale) atDecember 31, 2020 , and$7.7 million , or 1.03% of total loans (excluding loans held-for-sale), atMarch 31, 2020 . Excluding PPP loans and loans held-for-sale, the allowance for loan losses was 1.31% of total loans atMarch 31, 2021 compared to 1.30% of total loans atDecember 31, 2020 . The increase in the allowance for loan losses is primarily related to an increase in the qualitative factors in our allowance for loan losses methodology related to loan growth and economic uncertainties caused
by the COVID-19 pandemic.
Loans that we acquired in our acquisition of Cornerstone Bancorp, otherwise referred to herein as Cornerstone, in 2017 as well as in our acquisition ofSavannah River Financial Corp. , otherwise referred to herein as Savannah River, in 2014 are accounted for under FASB ASC 310-30. These acquired loans were initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. The credit component on loans related to cash flows not expected to be collected is not subsequently accreted (non-accretable difference) into interest income. Any remaining portion representing the excess of a loan's or pool's cash flows expected to be collected over the fair value is accreted (accretable difference) into interest income. AtMarch 31, 2021 andDecember 31, 2020 , the remaining credit component on loans attributable to acquired loans in the Cornerstone and Savannah River transactions was$229 thousand and$264 thousand , respectively. Our provision for loan losses was$177 thousand for the three months endedMarch 31, 2021 compared to$1.1 million during the same period in 2020. The decline in the provision for loan losses is primarily related to an increase during the first three months of 2020 in the qualitative factors in our allowance for loan losses methodology related to the deteriorating economic conditions and economic uncertainties caused by the COVID-19 pandemic. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, the knowledge and depth of lending personnel, economic conditions (local and national) that may affect the borrower's ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider qualitative factors such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, and concentrations of credit. During the first quarter of 2020, we added a new qualitative factor related to the economic uncertainties caused by the COVID-19 pandemic. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period, especially considering the uncertainties related to the COVID-19 pandemic. We perform an analysis quarterly to assess the risk within the loan portfolio. The portfolio is segregated into similar risk components for which historical loss ratios are calculated and adjusted for identified changes in current portfolio characteristics. Historical loss ratios are calculated by product type and by regulatory credit risk classification (See Note 4 to the Consolidated Financial Statements). The annualized weighted average loss ratios over the last 36 months for loans classified as substandard, special mention and pass have been approximately 0.02%, 0.02% and 0.01%, respectively. The allowance consists of an allocated and unallocated allowance. The allocated portion is determined by types and ratings of loans within the portfolio. The unallocated portion of the allowance is established for losses that exist in the remainder of the portfolio and compensates for uncertainty in estimating the loan losses. The allocated portion of the allowance is based on historical loss experience as well as certain qualitative factors as explained above. The qualitative factors have been established based on certain assumptions made as a result of the current economic conditions and are adjusted as conditions change to be directionally consistent with these changes. The unallocated portion of the allowance is composed of factors based on management's evaluation of various conditions that are not directly measured in the estimation of probable losses through the experience formula or specific allowances. The overall risk as measured in our three-year lookback, both quantitatively and qualitatively, does not encompass a full economic cycle. Net charge-offs in the 2009 to 2011 period averaged 63 basis points annualized in our loan portfolio. Over the most recent three-year period, our net charge-offs have experienced a modest net recovery. We currently believe the unallocated portion of our allowance represents potential risk associated throughout a full economic cycle; however, the COVID-19 pandemic and the government and economic responses thereto may materially affect the risk within our loan portfolios. 34 We have a significant portion of our loan portfolio with real estate as the underlying collateral. AtMarch 31, 2021 andDecember 31, 2020 , approximately 86.3% and 87.5%, respectively, of the loan portfolio had real estate collateral. The reduction in the percent of our loan portfolio with real estate as the underlying collateral is due to the increase in PPP loans, which increased to$61.8 million atMarch 31, 2021 from$42.2 atDecember 31, 2020 . When loans, whether commercial or personal, are granted, they are based on the borrower's ability to generate repayment cash flows from income sources sufficient to service the debt. Real estate is generally taken to reinforce the likelihood of the ultimate repayment and as a secondary source of repayment. We work closely with all our borrowers that experience cash flow or other economic problems, and we believe that we have the appropriate processes in place to monitor and identify problem credits. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period. The allowance is also subject to examination and testing for adequacy by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions. Such regulatory agencies could require us to adjust our allowance based on information available to them at the time
of their examination. Non-performing assets were$5.6 million (0.37% of total assets) atMarch 31, 2021 as compared to$7.0 million (0.50% of total assets) atDecember 31, 2020 . This decrease was related to a$1.3 million reduction in loans past due 90 days and still accruing. Total loans past due declined to$317 thousand , or 0.04% of total loans, atMarch 31, 2021 compared to$1.9 million , or 0.23% of total loans, atDecember 31, 2020 . While we believe the non-performing assets to total assets ratios are favorable in comparison to current industry results (both nationally and locally), we continue to monitor the impact of the COVID-19 pandemic on our customer base of local businesses and professionals. There were 19 loans totaling$4.5 million (0.52% of total loans) included in non-performing status (non-accrual loans and loans past due 90 days and still accruing) atMarch 31, 2021 . The largest loan included in non-accrual status is in the amount of$1.7 million and is secured by commercial real estate located inNorth Augusta, South Carolina . The average balance of the remaining 18 loans is approximately$158 thousand with a range between$0 and$1.2 million , and the majority of these loans are secured by first mortgage liens. Furthermore, we had$1.5 million in accruing trouble debt restructurings, or TDRs, atMarch 31, 2021 compared to$1.6 million atDecember 31, 2020 . We consider a loan impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due, including both principal and interest, according to the contractual terms of the loan agreement. Nonaccrual loans and accruing TDRs are considered impaired. AtMarch 31, 2021 , we had 21 impaired loans totaling$6.0 million compared to 23 impaired loans totaling$6.1 million atDecember 31, 2020 . These loans were measured for impairment under the fair value of collateral method or present value of expected cash flows method. For collateral dependent loans, the fair value of collateral method is used and the fair value is determined by an independent appraisal less estimated selling costs. AtMarch 31, 2021 , we had loans totaling$317 thousand that were delinquent 30 days to 89 days representing 0.04% of total loans compared to$665 thousand or 0.08% of total loans atDecember 31, 2020 . During the ongoing COVID-19 pandemic and because of our proactive offering of payment deferrals, loans on which payments have been deferred declined to$8.7 million atMarch 31, 2021 , from$16.1 million atDecember 31, 2020 , from$27.3 million atSeptember 30, 2020 , from$175.0 million atJune 30, 2020 and from$118.3 million atMarch 31, 2020 . The$16.1 million in deferrals atDecember 31, 2020 consist of seven loans on which only principal is being deferred. We had three loans totaling$8.7 million in continuing deferral status in which only principal is being deferred atMarch 31, 2021 . Two of the continuing deferrals atMarch 31, 2021 totaling$4.5 million are in the retail industry segment identified by us as one of the industry segments most impacted by the COVID-19 pandemic; the other continuing deferral totaling$4.2 million is a mixed use office space that we do not consider to be in an industry segment most impacted by the COVID-19 pandemic. Some of these deferments were to businesses that temporarily closed or reduced operations and some were requested as a pre-cautionary measure to conserve cash. We proactively offered initial deferrals to our customers regardless of the impact of the pandemic on their business or personal finances. We obtained additional information from customers who requested second or continuing deferrals and we performed additional analyses to justify the need for the second or continuing deferral requests. Our management continuously monitors non-performing, classified and past due loans to identify deterioration regarding the condition of these loans and given the ongoing and uncertain impact of the COVID-19 pandemic, we will continue to monitor our loan portfolio for potential risks. 35
The following table summarizes the activity related to our allowance for loan losses for the periods indicated:
Allowance for Loan Losses Three Months Ended March 31, (Dollars in thousands) 2021 2020 Average loans outstanding (including loans held-for-sale)$ 886,379 $ 753,659 Loans outstanding at period end (excluding loans held-for-sale)$ 869,066 $ 749,529 Non-performing assets: Nonaccrual loans$ 4,521 $ 1,739 Loans 90 days past due still accruing
- 168 Foreclosed real estate 1,070 1,481 Repossessed-other 7 - Total non-performing assets $
5,598
Beginning balance of allowance$ 10,389 $ 6,627 Loans charged-off: Commercial - - Real Estate - Construction - -
Real Estate Mortgage - Residential - - Real Estate Mortgage - Commercial
- - Consumer - Home Equity - - Consumer - Other 25 23 Total loans charged-off 25 23 Recoveries: Commercial 1 - Real Estate - Construction - -
Real Estate Mortgage - Residential - - Real Estate Mortgage - Commercial
4 6 Consumer - Home Equity 1 1 Consumer - Other 16 8 Total recoveries 22 15 Net loan charge offs 3 8 Provision for loan losses 177 1,075 Balance at period end$ 10,563 $ 7,694 Net charge offs to average loans (annualized) 0.00 % 0.00 % Allowance as percent of total loans 1.22 % 1.03 % Non-performing assets as % of total assets 0.37 % 0.29 % Allowance as % of non-performing loans 233.6 % 403.5 % 36
The following allocation of the allowance to specific components is not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses in the portfolio.
Composition of the Allowance for Loan Losses
(Dollars in thousands) March 31, 2021 December 31, 2020 % of % of allowance in allowance in Amount Category Amount Category
Commercial, Financial and Agricultural$ 758 7.2 %$ 778 7.5 % Real Estate - Construction 134 1.3 % 145 1.4 % Real Estate Mortgage: Residential 480 4.5 % 541 5.2 % Commercial 8,137 77.0 % 7,855 75.6 % Consumer: Home Equity 309 2.9 % 324 3.1 % Other 124 1.2 % 125 1.2 % Unallocated 621 5.9 % 621 6.0 % Total$ 10,563 100.0 %$ 10,389 100.0 % Accrual of interest is discontinued on loans when management believes, after considering economic and business conditions and collection efforts that a borrower's financial condition is such that the collection of interest is doubtful. A delinquent loan is generally placed in nonaccrual status when it becomes 90 days or more past due. At the time a loan is placed in nonaccrual status, all interest, which has been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain.
Non-interest Income and Non-interest Expense
Non-interest income during the three months endedMarch 31, 2021 was$3.3 million compared to$2.9 million during the same period in 2020. Deposit service charges declined$153 thousand during the three months endedMarch 31, 2021 compared to the same period in 2020 primarily due to lower overdraft fees. Mortgage banking income increased by$8 thousand to$990 thousand during the three months endedMarch 31, 2021 from$982 thousand during the same period in 2020. While mortgage banking income was approximately equal to last year's first quarter result, the gain-on-sale margin of 2.32% in the first quarter of 2021 was limited as we worked on certain loans not yet sold, in an effort to resolve processing and delivery issues. As we work to improve our mortgage processing and delivery efficiency, we anticipate the gain-on-sale margin will recover to more normal levels, which for the Company would be approximately 3.00% to 3.25%. Mortgage production during the three months endedMarch 31, 2021 was$42.7 million compared to$35.3 million during the same period in 2020. Investment advisory fees increased$243 thousand to$877 thousand during the three months endedMarch 31, 2021 from$634 thousand during the same period in 2020. Total assets under management increased to$519.3 million atMarch 31, 2021 compared to$319.7 million atMarch 31, 2020 . Management continues to focus on increasing both the mortgage banking income as well as the investment advisory fees and commissions. Gain on sale of other assets was$77 thousand during the three months endedMarch 31, 2021 compared to$6 thousand during the same period
in 2020.
Non-interest income, other increased$199 thousand during the three months endedMarch 31, 2021 compared to the same period in 2020 primarily due to$100 thousand received from the collection of a summary judgment related to a loan charged off at a bank, which the company subsequently acquired and due to a$116 thousand increase in ATM debit card income, partially offset by a$29 thousand reduction in income on bank owned life insurance. The following is a summary of the components of other non-interest income for the periods indicated: Three months ended (Dollars in thousands) March 31, 2021 2020 ATM debit card income$ 628 $ 512 Income on bank owned life insurance 167 196 Rental income 70 66 Other service fee and safe deposit box fees 62 59 Wire transfer fees 26 20 Other 153 54 Total$ 1,106 $ 907 37
Non-interest expense increased$502 thousand during the three months endedMarch 31, 2021 to$9.5 million compared to$9.0 million during the same period in 2020. Salary and benefit expense increased$311 thousand to$6.0 million during the three months endedMarch 31, 2021 from$5.7 million during the same period in 2020. This increase is primarily a result of the normal salary adjustments and increased mortgage and financial planning and investment advisory commissions. We had 243 full time equivalent employees atMarch 31, 2021 compared to 242 atMarch 31, 2020 . Occupancy expense increased$87 thousand to$730 thousand during the three months endedMarch 31, 2021 compared to$643 thousand during the same period in 2020.FDIC assessments increased$127 thousand due to a higher assessment rate in 2021 related to a decrease in our leverage ratio and an increase in our assessment base due to higher average assets as well as$39 thousand of small bank assessment credits utilized in the three months endedMarch 31, 2020 . The reduction in our leverage ratio and the increase in our assessment base were partially related to PPP loans and the excess liquidity generated from PPP loan proceeds and other stimulus funds related to the COVID-19 pandemic. Furthermore, we receivedFDIC small bank assessment credits during the three months endedMarch 31, 2020 compared to none during the same period in 2021. TheFDIC small bank assessment credits were fully utilized during the first quarter of 2020. The following is a summary of the components of other non-interest expense for the periods indicated: (Dollars in thousands) Three months ended March 31, 2021 2020 Data processing$ 856 $ 777 Telephone 89 81 Correspondent services 70 66 Insurance 79 78 Legal and professional fees 263 255 Director fees 95 82 Shareholder expense 49 50 Dues 40 37 Loan closing costs/fees 50 70 Other 329 392$ 1,920 $ 1,888 Income Tax Expense We incurred income tax expense of$891 thousand and$438 thousand for the three months endedMarch 31, 2021 and 2020, respectively. Our effective tax rate was 21.5% and 19.6% for the three months endedMarch 31, 2021 and 2020, respectively. Financial Position
Assets totaled$1.5 billion atMarch 31, 2021 and$1.4 billion atDecember 31, 2020 . Loans (excluding loans held-for-sale) increased$24.9 million to$869.1 million atMarch 31, 2021 from$844.2 million atDecember 31, 2020 . Total loan production excluding PPP loans and a PPP related credit facility was$40.2 million during the three months endedMarch 31, 2021 compared to$33.5 million during the same period in 2020. Loans held-for-sale declined to$23.5 million atMarch 31, 2021 from$45.0 million atDecember 31, 2020 due to an improvement in the number of loans purchased by investors. Mortgage production was$42.7 million during the three months endedMarch 31, 2021 compared to$35.3 million during the same period in 2020. The loan-to-deposit ratio (including loans held-for-sale) atMarch 31, 2021 andDecember 31, 2020 was 70.2% and 74.8%, respectively. The loan-to-deposit ratio (excluding loans held-for-sale) atMarch 31, 2021 andDecember 31, 2020 was 68.4% and 71.0%, respectively. Investment securities increased to$407.5 million atMarch 31, 2021 from$361.9 million atDecember 31, 2020 . Other short-term investments increased to$88.4 million atMarch 31, 2021 from$46.1 million atDecember 31, 2020 . The increases in investments and other short-term investments are primarily due to organic deposit growth and excess liquidity from customer's PPP loan proceeds and other stimulus funds related to the COVID-19 pandemic. 38 Non-PPP loans increased$5.3 million to$807.2 million atMarch 31, 2021 from$801.9 million atDecember 31, 2020 . PPP loans increased$19.6 million to$61.8 million atMarch 31, 2021 from$42.2 million atDecember 31, 2020 . PPP loans totaled$64.1 million gross of deferred fees and costs and$61.8 million net of deferred fees and costs atMarch 31, 2021 . During 2020, we originated 843 PPP loans totaling$51.2 million gross of deferred fees and costs and$49.8 million net of deferred fees and costs. Furthermore, during 2020, we facilitated the origination of 111 PPP loans totaling$31.2 million related to our customers with a third party prior to establishing our own PPP platform. During 2020, 159 PPP loans totaling$8.0 million were forgiven through the SBA PPP forgiveness process. As ofMay 3, 2021 , 552 PPP loans originated by the Company totaling$27.3 million , gross of deferred fees, had been forgiven. An additional 208 loans totaling$5.8 million are in process of being forgiven. As ofMay 3, 2021 , we originated 563 PPP loans in 2021, totaling$36.7 million , gross of deferred fees, under The Consolidated Appropriations Act, 2021. The$2.2 million in PPP deferred fees net of deferred costs atMarch 31, 2021 will be recognized as interest income over the remaining life of the PPP loans. One of our goals as a community bank has been, and continues to be, to grow our assets through quality loan growth by providing credit to small and mid-size businesses and individuals within the markets we serve. We remain committed to meeting the credit needs of our local markets. The following table shows the composition of the loan portfolio by category at the dates indicated: (Dollars in thousands) March 31, 2021 December 31, 2020 Amount Percent Amount Percent Commercial, financial & agricultural$ 110,776 12.7 %$ 96,688 11.5 % Real estate: Construction 104,065 12.0 % 95,282 11.3 % Mortgage - residential 38,947 4.5 % 43,928 5.2 % Mortgage - commercial 582,083 67.0 % 573,258 67.9 % Consumer: Home Equity 25,068 2.9 % 26,442 3.1 % Other 8,127 0.9 % 8,559 1.0 % Total gross loans 869,066 100.0 % 844,157 100.0 % Allowance for loan losses (10,563 ) (10,389 ) Total net loans$ 858,503 $ 833,768 In the context of this discussion, a real estate mortgage loan is defined as any loan, other than loans for construction purposes and advances on home equity lines of credit, secured by real estate, regardless of the purpose of the loan. Advances on home equity lines of credit are included in consumer loans. We follow the common practice of financial institutions in our market areas of obtaining a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase the magnitude of the real estate loan components. We generally limit the loan-to-value ratio to 80%. Deposits increased$82.0 million to$1.3 billion atMarch 31, 2021 compared to$1.2 billion atDecember 31, 2020 . Our pure deposits, which are defined as total deposits less certificates of deposits, increased$84.1 million to$1.143 billion atMarch 31, 2021 from$1.059 billion atDecember 31, 2020 . We continue to focus on growing our pure deposits as a percentage of total deposits in order to better manage our overall cost of funds. We had no brokered deposits and no listing services deposits atMarch 31, 2021 . Our securities sold under agreements to repurchase, which are related to our customer cash management accounts, increased$19.4 million to$60.3 million atMarch 31, 2021 from$40.9 million atDecember 31, 2020 . This increase was due to seasonality in our cash management accounts. Total shareholders' equity declined$3.6 million , or 2.7%, to$132.7 million atMarch 31, 2021 from$136.3 million atDecember 31, 2020 . The$3.6 million decline was due to a$6.2 million reduction in accumulated other comprehensive income partially offset by a$2.4 million increase in retention of earnings less dividends paid. The decline in accumulated other comprehensive income was due to an increase in longer-term market interest rates, which resulted in a reduction in the net unrealized gains in our investment securities portfolio. In late 2019, we obtained approval of a share repurchase plan of up to 200,000 shares of our outstanding common stock; however, no share repurchases were made under this repurchase plan prior to its expiration onDecember 31, 2020 . OnApril 12, 2021 , we announced that our Board of Directors approved the repurchase of up to 375,000 shares of our common stock (the "2021 repurchase plan"), which represents approximately 5% of our 7,524,944 shares outstanding as ofMarch 31, 2021 . The approved 2021 repurchase plan provides us with some flexibility in managing our capital going forward. 39 Market Risk Management Market risk reflects the risk of economic loss resulting from adverse changes in market prices and interest rates. The risk of loss can be measured in either diminished current market values or reduced current and potential net income. Our primary market risk is interest rate risk. We have established an Asset/Liability Management Committee (the "ALCO") to monitor and manage interest rate risk. The ALCO monitors and manages the pricing and maturity of our assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on our net interest income. The ALCO has established policy guidelines and strategies with respect to interest rate
risk exposure and liquidity. A monitoring technique employed by us is the measurement of our interest sensitivity "gap," which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Simulation modeling is performed to assess the impact varying interest rates and balance sheet mix assumptions will have on net interest income. We model the impact on net interest income for several different changes, to include a flattening, steepening and parallel shift in the yield curve. For each of these scenarios, we model the impact on net interest income in an increasing and decreasing rate environment of 100 and 200 basis points. We also periodically stress certain assumptions such as loan prepayment rates, deposit decay rates and interest rate betas to evaluate our overall sensitivity to changes in interest rates. Policies have been established in an effort to maintain the maximum anticipated negative impact of these modeled changes in net interest income at no more than 10% and 15%, respectively, in a 100 and 200 basis point change in interest rates over a 12-month period. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available-for-sale, replacing an asset or liability at maturity or by adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in the same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates. Neither the "gap" analysis or asset/liability modeling are precise indicators of our interest sensitivity position due to the many factors that affect net interest income including, the timing, magnitude and frequency of interest rate changes as well as changes in the volume and mix of earning assets and interest-bearing liabilities. Based on the many factors and assumptions used in simulating the effect of changes in interest rates, the following table estimates the hypothetical percentage change in net interest income atMarch 31, 2021 andDecember 31, 2020 over the subsequent 12 months. AtMarch 31, 2021 andDecember 31, 2020 , we were slightly liability sensitive over the first three month period and over the balance of a 12-month period are asset sensitive on a cumulative basis. As a result, our modeling reflects slight exposure to falling rates and our rising rate exposure trends from neutral to slightly liability sensitive as rates move higher over the first 12 months. This negative impact of rising rates reverses and net interest income is favorably impacted over a 24-month period. In a declining rate environment, the model reflects a decline in net interest income. This primarily results from the current level of interest rates being paid on our interest bearing transaction accounts as well as money market accounts. The interest rates on these accounts are at a level where they cannot be repriced in proportion to the change in interest rates. The increase and decrease of 100 and 200 basis points, respectively, reflected in the table below assume a simultaneous and parallel change in interest rates along the entire yield curve.
Net Interest Income Sensitivity
Hypothetical percentage change in Change in short-term interest rates net interest income March 31, 2021 December 31, 2020 +200bp -1.39 % -0.73 % +100bp -0.32 % +0.08 % Flat - - -100bp -4.18 % -3.37 % -200bp -6.89 % -3.58 % We perform a valuation analysis projecting future cash flows from assets and liabilities to determine the Present Value of Equity ("PVE") over a range of changes in market interest rates. The sensitivity of PVE to changes in interest rates is a measure of the sensitivity of earnings over a longer time horizon. AtMarch 31, 2021 andDecember 31, 2020 , the PVE exposure in a plus 200 basis point increase in market interest rates was estimated to be 6.25% and 11.47%, respectively. The PVE exposure in a down 100 basis point decrease was estimated to be (9.01)% atMarch 31, 2021 compared to (14.32)% atDecember 31, 2020 . 40
Liquidity and Capital Resources
Liquidity management involves monitoring sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity represents our ability to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of the investment portfolio is very predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to nearly the same degree of control. Asset liquidity is provided by cash and assets which are readily marketable, or which can be pledged, or which will mature in the near future. Liability liquidity is provided by access to core funding sources, principally the ability to generate customer deposits in our market area. In addition, liability liquidity is provided through the ability to borrow against approved lines of credit (federal funds purchased) from correspondent banks and to borrow on a secured basis through securities sold under agreements to repurchase. The Bank is a member of the FHLB and has the ability to obtain advances for various periods of time. These advances are secured by eligible securities pledged by the Bank or assignment of eligible loans within the Bank's portfolio. As ofMarch 31, 2021 , we have not experienced any unusual pressure on our deposit balances or our liquidity position as a result of the COVID-19 pandemic. We had no brokered deposits and no listing services deposits atMarch 31, 2021 . We believe that we have ample liquidity to meet the needs of our customers and to manage through the COVID-19 pandemic through our low cost deposits; our ability to borrow against approved lines of credit (federal funds purchased) from correspondent banks; and our ability to obtain advances secured by certain securities and loans from theFederal Home Loan Bank . We generally maintain a high level of liquidity and adequate capital, which along with continued retained earnings, we believe will be sufficient to fund the operations of the Bank for at least the next 12 months. Shareholders' equity declined to 8.9% of total assets atMarch 31, 2021 from 9.8% atDecember 31, 2020 primarily due to PPP loans and excess liquidity from customer's PPP loans,other stimulus funds related to the COVID-19 pandemic, and due to a$6.2 million reduction in accumulated other comprehensive income. The Bank maintains federal funds purchased lines in the total amount of$60.0 million with two financial institutions, although these were not utilized atMarch 31, 2021 ; and$10 million through the Federal Reserve Discount Window. The FHLB ofAtlanta has approved a line of credit of up to 25% of the Bank's assets, which, when utilized, is collateralized by a pledge against specific investment securities and/or eligible loans.
Through the operations of our Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. AtMarch 31, 2021 , we had issued commitments to extend unused credit of$141.7 million , including$41.6 million in unused home equity lines of credit, through various types of lending arrangements. AtDecember 31, 2020 , we had issued commitments to extend unused credit of$142.6 million , including$42.3 million in unused home equity lines of credit, through various types of lending arrangements. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes. We regularly review our liquidity position and have implemented internal policies establishing guidelines for sources of asset-based liquidity and evaluate and monitor the total amount of purchased funds used to support the balance sheet and funding from noncore sources. Although uncertain, we may encounter stress on liquidity management as a direct result of the COVID-19 pandemic and the Bank's participation in the PPP as a participating lender. We had PPP loans totaling$64.1 million gross of deferred fees and costs and$61.8 million net of deferred fees and costs atMarch 31, 2021 compared to$43.3 million gross of deferred fees and costs and$42.2 million net of deferred fees and costs atDecember 31, 2020 . As customers manage their own liquidity stress, we could experience an increase in the utilization of existing lines of credit. Regulatory capital rules adopted inJuly 2013 and fully-phased in as ofJanuary 1, 2019 , which we refer to Basel III, impose minimum capital requirements for bank holding companies and banks. In 2018, theFederal Reserve increased the asset size to qualify as a small bank holding company. As a result of this change, we generally are not subject to theFederal Reserve capital requirements unless advised otherwise. The Bank remains subject to capital requirements including a minimum leverage ratio and a minimum ratio of "qualifying capital" to risk weighted assets. These requirements are essentially the same as those that applied to us prior to the change in the definition of a small bank holding company. 41
Specifically, the Bank is required to maintain he following minimum capital requirements:
? a Common Equity Tier 1 risk-based capital ratio of 4.5%;
? a Tier 1 risk-based capital ratio of 6%;
? a total risk-based capital ratio of 8%; and
? a leverage ratio of 4%. Under the final Basel III rules, Tier 1 capital was redefined to include two components: Common Equity Tier 1 capital and additional Tier 1 capital. The highest form of capital, Common Equity Tier 1 capital, consists solely of common stock (plus related surplus), retained earnings, accumulated other comprehensive income, otherwise referred to as AOCI, and limited amounts of minority interests that are in the form of common stock. Additional Tier 1 capital is primarily comprised of noncumulative perpetual preferred stock, Tier 1 minority interests and grandfathered trust preferred securities (as discussed below). Tier 2 capital generally includes the allowance for loan losses up to 1.25% of risk-weighted assets, qualifying preferred stock, subordinated debt and qualifying tier 2 minority interests, less any deductions in Tier 2 instruments of an unconsolidated financial institution. Cumulative perpetual preferred stock is included only in Tier 2 capital, except that the Basel III rules permit bank holding companies with less than$15 billion in total consolidated assets to continue to include trust preferred securities and cumulative perpetual preferred stock issued beforeMay 19, 2010 in Tier 1 Capital (but not in Common Equity Tier 1 capital), subject to certain restrictions. AOCI is presumptively included in Common Equity Tier 1 capital and often would operate to reduce this category of capital. When implemented, Basel III provided a one-time opportunity at the end of the first quarter of 2015 for covered banking organizations to opt out of much of this treatment of AOCI. We made this opt-out election and, as a result, retained our pre-existing treatment for AOCI. In addition, in order to avoid restrictions on capital distributions or discretionary bonus payments to executives, under Basel III, a covered banking organization must maintain a "capital conservation buffer" on top of its minimum risk-based capital requirements. This buffer must consist solely of Tier 1 Common Equity, but the buffer applies to all three measurements (Common Equity Tier 1, Tier 1 capital and total capital). The 2.5% capital conservation buffer was phased in incrementally over time, and became fully effective for us onJanuary 1, 2019 , resulting in the following effective minimum capital plus capital conservation buffer ratios: (i) a Common Equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%. InNovember 2019 , the federal banking regulators published final rules implementing a simplified measure of capital adequacy for certain banking organizations that have less than$10 billion in total consolidated assets. Under the final rules, which went into effect onJanuary 1, 2020 , depository institutions and depository institution holding companies that have less than$10 billion in total consolidated assets and meet other qualifying criteria, including a leverage ratio of greater than 9%, off-balance-sheet exposures of 25% or less of total consolidated assets and trading assets plus trading liabilities of 5% or less of total consolidated assets, are deemed "qualifying community banking organizations" and are eligible to opt into the "community bank leverage ratio framework." A qualifying community banking organization that elects to use the community bank leverage ratio framework and that maintains a leverage ratio of greater than 9% is considered to have satisfied the generally applicable risk-based and leverage capital requirements under the Basel III rules, discussed above, and, if applicable, is considered to have met the "well capitalized" capital ratio requirements for purposes of its primary federal regulator's prompt corrective action rules, outlined below. The final rules include a two-quarter grace period during which a qualifying community banking organization that temporarily fails to meet any of the qualifying criteria, including the greater than 9% leverage capital ratio requirement, is generally still deemed "well capitalized" so long as the banking organization maintains a leverage capital ratio greater than 8%. A banking organization that fails to maintain a leverage capital ratio greater than 8% is not permitted to use the grace period and must comply with the generally applicable requirements under the Basel III rules and file the appropriate regulatory reports. We did not elect to use the community bank leverage ratio framework but may make such
an election in the future. 42 As outlined above, we are generally not subject to theFederal Reserve capital requirements unless advised otherwise because we qualify as a small bank holding company. Our Bank remains subject to capital requirements including a minimum leverage ratio and a minimum ratio of "qualifying capital" to risk weighted assets. As ofMarch 31, 2021 , the Bank met all capital adequacy requirements under the rules on a fully phased-in basis. Prompt Corrective Action Excess Capital $s of Dollars in thousands (PCA) Requirements PCA Requirements Well Adequately Well Adequately Capital Ratios Actual Capitalized Capitalized Capitalized Capitalized March 31, 2021 Leverage Ratio 8.73 % 5.00 % 4.00 %$ 52,529 $ 66,594
Common Equity Tier 1 Capital Ratio 13.20 % 6.50 %
4.50 % 62,377 80,985 Tier 1 Capital Ratio 13.20 % 8.00 % 6.00 % 48,421 67,029 Total Capital Ratio 14.34 % 10.00 % 8.00 % 40,375 58,984 December 31, 2020 Leverage Ratio 8.84 % 5.00 % 4.00 %$ 52,270 $ 65,893
Common Equity Tier 1 Capital Ratio 12.83 % 6.50 %
4.50 % 59,406 78,169 Tier 1 Capital Ratio 12.83 % 8.00 % 6.00 % 45,334 64,097 Total Capital Ratio 13.94 % 10.00 % 8.00 % 36,961 55,723 The Bank's risk-based capital ratios of leverage ratio, Tier 1, and total capital were 8.73%, 13.20% and 14.34%, respectively, atMarch 31, 2021 as compared to 8.84%, 12.83%, and 13.94%, respectively, atDecember 31, 2020 . The Bank's Common Equity Tier 1 ratio atMarch 31, 2021 was 13.20% and atDecember 31, 2020 was 12.83%. Under the Basel III rules, we anticipate that the Bank will remain a well capitalized institution for at least the next 12 months. Furthermore, based on our strong capital, conservative underwriting, and internal stress testing, we expect to remain well capitalized throughout the COVID-19 pandemic. However, the Bank's reported and regulatory capital ratios could be adversely impacted by future credit losses related to the COVID-19 pandemic. As a bank holding company, our ability to declare and pay dividends is dependent on certain federal and state regulatory considerations, including the guidelines of theFederal Reserve . TheFederal Reserve has issued a policy statement regarding the payment of dividends by bank holding companies. In general, theFederal Reserve's policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization's capital needs, asset quality and overall financial condition. TheFederal Reserve's policies also require that a bank holding company serve as a source of financial strength to its subsidiary bank(s) by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. In addition, under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect our ability to pay dividends or otherwise engage in capital distributions. Our Board of Directors approved a cash dividend for the first quarter of 2021 of$0.12 per common share. This dividend is payable onMay 18, 2021 to shareholders of record of our common stock as ofMay 4, 2021 . As we are a legal entity separate and distinct from the Bank and do not conduct stand-alone operations, our ability to pay dividends depends on the ability of the Bank to pay dividends to us, which is also subject to regulatory restrictions. As aSouth Carolina -chartered bank, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. Unless otherwise instructed by theSouth Carolina Board of Financial Institutions , the Bank is generally permitted under South Carolina State banking regulations to pay cash dividends of up to 100% of net income in any calendar year without obtaining the prior approval of theSouth Carolina Board of Financial Institutions . TheFDIC also has the authority under federal law to enjoin a bank from engaging in what in its opinion constitutes an unsafe or unsound practice in conducting its business, including the payment of a dividend under certain circumstances. Average Balances, Income Expenses and Rates. The following table depicts, for the periods indicated, certain information related to our average balance sheet and our average yields on assets and average costs of liabilities. Such yields are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been derived from daily averages. 43 FIRST COMMUNITY CORPORATION Yields on Average Earning Assets and Rates on Average Interest-Bearing Liabilities Three months ended March 31, 2021 Three months ended March 31, 2020 Average Interest Yield/ Average Interest Yield/ Balance Earned/Paid Rate Balance Earned/Paid Rate Assets Earning assets Loans PPP loans$ 55,540 $ 684 4.99 % $ - $ - NA Non-PPP loans 830,839 8,767 4.28 % 753,659 8,827 4.71 % Total Loans 886,379 9,451 4.32 % 753,659 8,827 4.71 % Securities 373,340 1,734 1.88 % 286,332 1,726 2.42 % Other short-term investments 79,334 33 0.17 % 37,251 157 1.70 % Total earning assets 1,339,053 11,218 3.40 % 1,077,242 10,710 4.00 % Cash and due from banks 18,429 15,032 Premises and equipment 34,351 35,002
Goodwill and other intangibles 15,726
16,063 Other assets 38,124 39,691 Allowance for loan losses (10,424 ) (6,680 ) Total assets$ 1,435,259 $ 1,176,350 Liabilities Interest-bearing liabilities Interest-bearing transaction accounts$ 277,476 $
58 0.08 %$ 216,198 $ 103 0.19 % Money market accounts 254,412 141 0.22 % 198,292 350 0.71 % Savings deposits 125,981 19 0.06 % 103,776 29 0.11 % Time deposits 160,321 301 0.76 % 169,397 537 1.27 % Other borrowings 78,266 132 0.68 % 70,332 274 1.57 %
Total interest-bearing liabilities 896,456
651 0.29 % 757,995 1,293 0.69 % Demand deposits 389,891 281,714 Other liabilities 13,332 13,178 Shareholders' equity 135,580 123,463
Total liabilities and shareholders' equity$ 1,435,259 $ 1,176,350 Cost of deposits, including demand deposits 0.17 % 0.42 % Cost of funds, including demand deposits
0.21 % 0.50 % Net interest spread 3.11 % 3.31 % Net interest income/margin$ 10,567 3.20 %$ 9,417 3.52 %
Net interest income/margin (tax equivalent)$ 10,675 3.23 %$ 9,495 3.55 %
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