FIRST NATIONAL CORPORATION Cautionary Statement Regarding Forward-Looking Statements
First National Corporation (the Company) makes forward-looking statements in this Form 10-Q that are subject to risks and uncertainties. These forward-looking statements include, but are not limited to, statements regarding profitability, liquidity, adequacy of capital, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and the impact of the Company's acquisitions ofThe Bank of Fincastle (Fincastle ) and the SmartBank loan portfolio, including the expected benefits of the acquisition ofFincastle (Merger) and the potential impact of the acquisitions on the Company's andFirst Bank's (the Bank) financial and other goals. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or other similar words or terms are intended to identify forward-looking statements. These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:
• the ability of the Company and the Bank to realize the anticipated benefits of
the Merger, including expected revenue synergies and cost savings that may not
be fully realized or realized within the expected time frame;
• expected revenue synergies and cost savings from the Merger that may not be
fully realized or realized within the expected time frame;
• revenues following the Merger that may be lower than expected;
• customer and employee relationships and business operations as a result of
disruptions caused by the Merger;
• the effects of the COVID-19 pandemic, including its potential adverse effect
on economic conditions and the Company's employees, customers, credit quality,
and financial performance;
• general business conditions, as well as conditions within the financial
markets;
• general economic conditions, including unemployment levels, inflation and
slowdowns in economic growth;
• the Company's branch and market expansions, technology initiatives and other
strategic initiatives?
• the impact of competition from banks and non-banks, including financial
technology companies (Fintech)?
• the composition of the loan and deposit portfolio, including the types of
accounts and customers, may change, which could impact the amount of net
interest income and noninterest income in future periods, including revenue
from service charges on deposits?
• limited availability of financing or inability to raise capital?
• reliance on third parties for key services?
• the Company's credit standards and its on-going credit assessment processes
might not protect it from significant credit losses?
• the quality of the loan portfolio and the value of the collateral securing
those loans?
• demand for loan products;
• deposit flows;
• the level of net charge-offs on loans and the adequacy of the allowance for
loan losses?
• the concentration in loans secured by real estate may adversely affect
earnings due to changes in the real estate markets?
• the value of securities held in the Company's investment portfolio?
• legislative or regulatory changes or actions, including the effects of changes
in tax laws?
• accounting principles, policies and guidelines and elections made by the
Company thereunder?
• cyber threats, attacks or events?
• the ability to maintain adequate liquidity by retaining deposit customers and
secondary funding sources, especially if the Company's reputation would become
damaged?
• monetary and fiscal policies of the
of those policies on interest rates and business in the Company's markets;
• changes in interest rates could have a negative impact on the Company's net
interest income and an unfavorable impact on the Company's customers' ability
to repay loans?
geopolitical conditions, including acts or threats of terrorism, international
• hostilities, or actions taken by the
acts or threats of terrorism and/or military conflicts, which could impact
business and economic conditions in the
• other factors identified in Item 1A. Risk Factors of the Company's Form 10-K
for the year ending December 31, 2021 .
Because of these and other uncertainties, actual results may be materially
different from the results indicated by these forward-looking statements. In
addition, past results of operations do not necessarily indicate future results.
The following discussion and analysis of the financial condition at March 31,
2022 and statements of income of the Company for the three months ended March
31, 2022 and 2021 should be read in conjunction with the consolidated financial
statements and related notes included in Part I, Item 1, of this Form 10-Q and
in Part II, Item 8, of the Form 10-K for the period ending December 31, 2021 .
The statements of income for thethree months ended March 31, 2022 may not be
indicative of the results to be achieved for the year.
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Table of Contents Executive Overview The Company
•First Bank (the Bank). The Bank owns: •First Bank Financial Services, Inc. •Bank of Fincastle Services, Inc. •ESF, LLC •Shen-Valley Land Holdings, LLC •First National (VA) Statutory Trust II (Trust II)
•
II, the Trusts)
First Bank Financial Services, Inc. invests in entities that provide title
insurance and investment services. Bank of Fincastle Services, Inc. owns an
entity that provides mortgage services. Shen-Valley Land Holdings, LLC and ESF,
LLC were formed to hold other real estate owned and future office sites. The
Trusts were formed for the purpose of issuing redeemable capital securities,
commonly known as trust preferred securities and are not included in the
Company's consolidated financial statements in accordance with authoritative
accounting guidance because management has determined that the Trusts qualify as
variable interest entities.
Products, Services, Customers and Locations
The Bank offers loan, deposit, and wealth management products and services. Loan products and services include consumer loans, residential mortgages, home equity loans, and commercial loans. Deposit products and services include checking accounts, treasury management solutions, savings accounts, money market accounts, certificates of deposit, and individual retirement accounts. Wealth management services include estate planning, investment management of assets, trustee under an agreement, trustee under a will, individual retirement accounts, and estate settlement. Customers include small and medium-sized businesses, individuals, estates, local governmental entities, and non-profit organizations. The Bank's office locations are well-positioned in attractive markets along theInterstate 81 ,Interstate 66 , andInterstate 64 corridors in theShenandoah Valley , theRoanoke Valley , central regions ofVirginia , and the city ofRichmond . Within these markets, there are diverse types of industry including medical and professional services, manufacturing, retail, warehousing, Federal government, hospitality, and higher education. The Bank's products and services are delivered through 20 bank branch offices, a loan production office and customer service centers in two retirement villages. For the location and general character of each of these offices, see Item 2 of Form 10-K. Many of the Bank's services are also delivered through the Bank's mobile banking platform, its website, www.fbvirginia.com, and a network of ATMs located throughout its market area.
Revenue Sources and Expense Factors
The primary source of revenue is from net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense and typically represents between 70% and 80% of the Company's total revenue. Interest income is determined by the amount of interest-earning assets outstanding during the period and the interest rates earned on those assets. The Bank's interest expense is a function of the amount of interest-bearing liabilities outstanding during the period and the interest rates paid. In addition to net interest income, noninterest income is the other source of revenue for the Company. Noninterest income is derived primarily from service charges on deposits, fee income from wealth management services, and ATM and check card fees. Primary expense categories are salaries and employee benefits, which comprised 59% of noninterest expenses for the three months endedMarch 31, 2022 , followed by occupancy and equipment expense, which comprised 13% of noninterest expenses. The provision for loan losses is also typically a primary expense of the Bank. The provision is determined by factors that include net charge-offs, asset quality, economic conditions, and loan growth. Changing economic conditions caused by inflation, recession, unemployment, or other factors beyond the Company's control have a direct correlation with asset quality, net charge-offs, and ultimately the required provision for loan losses. 36
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Overview of Quarterly Financial Performance
Net income increased by$1.3 million to$3.7 million , or$0.60 per diluted share, for the three months endedMarch 31, 2022 , compared to$2.4 million , or$0.50 per diluted share, for the same period in 2021. Return on average assets was 1.06% and return on average equity was 13.40% for the first quarter of 2022, compared to 1.00% and 11.53%, respectively, for the same period in 2021.
The increase in net income resulted primarily from a
The$3.0 million increase in net interest income resulted from a$2.9 million increase in total interest income and a$107 thousand decrease in total interest expense. Although the net interest margin decreased by 8-basis points to 3.19%, net interest income increased as the impact of the lower net interest margin was offset by a$415.1 million , or 44%, increase in average earning assets, and$367 thousand of accretion of loan discounts, net of premium amortization, on acquired loans. Total interest expense decreased by$107 thousand , or 18%, primarily from a decrease in interest expense on deposits as the Bank lowered interest rates paid on deposit accounts. The merger ofThe Bank of Fincastle with and intoFirst Bank onJuly 1, 2021 and growth in deposits contributed to the increase in average earning assets. There was no provision for loan losses for the first quarter of 2022. During the quarter, a$173 thousand increase in the general reserve component of the allowance for losses was offset by a$55 thousand decrease in the specific reserve component of the allowance for loan losses and$118 thousand of net recoveries of loans previously charged off. The allowance for loan losses totaled$5.8 million , or 0.70% of total loans atMarch 31, 2022 , compared to 0.69% of total loans atDecember 31, 2021 . There was also no provision for loan losses for the same period of 2021. The$568 thousand increase in noninterest income was primarily a result of increases in service charges on deposits, ATM and check card fees, income from bank-owned life insurance and fees for other customer services. The merger withFincastle contributed to increases in all noninterest income categories, except for wealth management fees, which increased$160 thousand , or 25%. The$2.0 million increase in noninterest expense was primarily attributable to the acquisition ofFincastle and the acquisition of the loan portfolio, branch assets and addition of the employees from SmartBank. Merger expenses totaled$20 thousand and$405 thousand for the three-month periods endingMarch 31, 2022 , and 2021, respectively.
For a more detailed discussion of the Company's quarterly performance, see "Net Interest Income," "Provision for Loan Losses," "Noninterest Income," "Noninterest Expense" and "Income Taxes" below.
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Acquisition of
OnJuly 1, 2021 , the Company completed the acquisition ofThe Bank of Fincastle for an aggregate purchase price of$33.8 million of cash and stock. The Company paid cash consideration of$6.8 million and issued 1,348,065 shares of its common stock to the shareholders ofFincastle . Upon completion of the transaction,Fincastle was merged with and intoFirst Bank . At the time of closing of the acquisition,The Bank of Fincastle had six bank branch offices operating in theRoanoke Valley region ofVirginia and reported total assets of$267.9 million , total loans of$194.5 million and total deposits of$236.3 million . For the three months endedMarch 31, 2022 , the Company recorded merger related expenses of$20 thousand in connection with the acquisition ofFincastle . After the merger, the former Fincastle branches continued to operate asThe Bank of Fincastle , a division ofFirst Bank , until the systems were converted onOctober 16, 2021 . All branch offices have been operating asFirst Bank since the system conversion. Purchased performing loans were recorded at fair value, including a credit discount. The fair value discount will be accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan losses on the purchased loans is expected in future periods as the accretion decreases the fair value discount amount. A provision may also be required for any deterioration in these loans in future periods. The Company expects cost savings to be realized asFincastle's operations are fully integrated during 2022.
Acquisition of SmartBank Loan Portfolio
OnSeptember 30, 2021 , the Bank acquired$82.0 million of loans and certain fixed assets from SmartBank related to itsRichmond area branch, located inGlen Allen, Virginia .First Bank paid cash consideration of$83.7 million for the loans and fixed assets. Additionally, an experienced team of bankers based out of the SmartBank location have transitioned to become employees ofFirst Bank .First Bank did not assume any deposit liabilities from SmartBank in connection with the transaction, and SmartBank closed their branch operation onDecember 31, 2021 .First Bank assumed the facility lease and acquired the remaining assets at the branch onDecember 31, 2021 and now operates a loan production office in the location of the former SmartBank branch. The Company incurred expenses totaling$101 thousand related to the acquisition of loans and fixed assets of SmartBank in the fourth quarter of 2021. Purchased performing loans were recorded at fair value, including a credit discount. The fair value discount will be accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan losses may be required as fair value discounts accrete to lower amounts than the required reserves for purchased loans and for any deterioration in these loans in future periods. Non-GAAP Financial Measures This report refers to the efficiency ratio, which is computed by dividing noninterest expense, excluding amortization of intangibles, net gains on disposal of premises and equipment, and merger related expenses, by the sum of net interest income on a tax-equivalent basis and noninterest income, excluding securities gains. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be construed as such. Management believes, however, such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The Company, in referring to its net income, is referring to income under GAAP. The components of the efficiency ratio calculation are summarized in the following table (dollars in thousands). Efficiency Ratio Three Months Ended March 31, 2022 March 31, 2021 Noninterest expense $ 8,644 $ 6,650 Add/(Subtract): other real estate owned (expense)/income, net (28 ) - Subtract: amortization of intangibles (4 ) (14 ) Subtract: loss on disposal of premises and equipment, net 0 - Subtract: merger related expenses (20 ) (405 ) $ 8,592 $ 6,231 Tax-equivalent net interest income $ 10,634 $ 7,568 Noninterest income 2,711 2,143 Subtract: gain on disposal of premises and equipment, net - (12 ) Subtract: securities gains, net - (37 ) $ 13,345 $ 9,662 Efficiency ratio 64.38 % 64.49 % 38
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This report also refers to net interest margin, which is calculated by dividing
tax equivalent net interest income by total average earning assets. Because a
portion of interest income earned by the Company is nontaxable, the tax
equivalent net interest income is considered in the calculation of this ratio.
Tax equivalent net interest income is calculated by adding the tax benefit
realized from interest income that is nontaxable to total interest income then
subtracting total interest expense. The tax rate utilized in calculating the tax
benefit for both 2022 and 2021 is 21%. The reconciliation of tax equivalent net
interest income, which is not a measurement under GAAP, to net interest income,
is reflected in the table below (in thousands).
Reconciliation of Net Interest Income to
Tax-Equivalent Net Interest Income
Three Months Ended
March 31, 2022 March 31, 2021
GAAP measures:
Interest income - loans $ 9,496 $ 7,143
Interest income - investments and other 1,528 952
Interest expense - deposits (340 ) (363 )
Interest expense - subordinated debt (69 ) (154 )
Interest expense - junior subordinated debt (67 ) (66 )
Total net interest income $ 10,548 $ 7,512
Non-GAAP measures: Tax benefit realized on non-taxable interest income - loans
$ 8 $ 8
Tax benefit realized on non-taxable interest income - municipal securities
81 48
Total tax benefit realized on non-taxable interest income
$ 89 $ 56
Total tax-equivalent net interest income $ 10,637 $ 7,568
Critical Accounting Policies
General
The Company's consolidated financial statements and related notes are prepared
in accordance with GAAP. The financial information contained within the
statements is, to a significant extent, financial information that is based on
measures of the financial effects of transactions and events that have already
occurred. A variety of factors could affect the ultimate value that is obtained
either when earning income, recognizing an expense, recovering an asset, or
relieving a liability. The Bank uses historical losses as one factor in
determining the inherent loss that may be present in the loan portfolio. Actual
losses could differ significantly from the historical factors used. In addition,
GAAP itself may change from one previously acceptable method to another.
Although the economics of transactions would be the same, the timing of events
that would impact transactions could change.
Presented below is a discussion of those accounting policies that management
believes are the most important (Critical Accounting Policies) to the portrayal
and understanding of the Company's financial condition and results of
operations. The Critical Accounting Policies require management's most
difficult, subjective, and complex judgments about matters that are inherently
uncertain. In the event that different assumptions or conditions were to
prevail, and depending upon the severity of such changes, the possibility of
materially different financial condition or results of operations is a
reasonable likelihood.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have
occurred through a provision for loan losses charged to earnings. Loan losses
are charged against the allowance when management determines that the loan
balance is uncollectible. Subsequent recoveries, if any, are credited to the
allowance. For further information about the Company's loans and the allowance
for loan losses, see Notes 3 and 4 to the Consolidated Financial Statements
included in this Form 10-Q.
The allowance for loan losses is evaluated on a quarterly basis by management
and is based upon management's periodic review of the collectability of the
loans in light of historical experience, the nature and volume of the loan
portfolio, adverse situations that may affect the borrower's ability to repay,
estimated value of any underlying collateral, and prevailing economic
conditions. This evaluation is inherently subjective as it requires estimates
that are susceptible to significant revision as more information becomes
available.
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The Company performs regular credit reviews of the loan portfolio to review credit quality and adherence to underwriting standards. The credit reviews consist of reviews by its internal credit administration department and reviews performed by an independent third party. Upon origination, each loan is assigned a risk rating ranging from one to nine, with loans closer to one having less risk. This risk rating scale is the Company's primary credit quality indicator. The Company has various committees that review and ensure that the allowance for loans losses methodology is in accordance with GAAP and loss factors used appropriately reflect the risk characteristics of the loan portfolio. The allowance represents an amount that, in management's judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Management's judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower's ability to repay and the value of the collateral, overall portfolio quality, and review of specific potential losses. The evaluation also considers the following risk characteristics of each loan portfolio class:
• 1-4 family residential mortgage loans carry risks associated with the
continued creditworthiness of the borrower and changes in the value of the
collateral.
• Real estate construction and land development loans carry risks that the
project may not be finished according to schedule, the project may not be
finished according to budget, and the value of the collateral may, at any
point in time, be less than the principal amount of the loan. Construction
loans also bear the risk that the general contractor, who may or may not be a
loan customer, may be unable to finish the construction project as planned
because of financial pressure or other factors unrelated to the project.
• Other real estate loans carry risks associated with the successful operation
of a business or a real estate project, in addition to other risks associated
with the ownership of real estate, because repayment of these loans may be
dependent upon the profitability and cash flows of the business or project.
• Commercial and industrial loans carry risks associated with the successful
operation of a business because repayment of these loans may be dependent upon
the profitability and cash flows of the business. In addition, there is risk
associated with the value of collateral other than real estate which may
depreciate over time and cannot be appraised with as much reliability.
• Consumer and other loans carry risk associated with the continuedcreditworthiness of the borrower and the value of the collateral, if any.
Consumer loans are typically either unsecured or secured by rapidly
depreciating assets such as automobiles. These loans are also likely to be
immediately and adversely affected by job loss, divorce, illness, personal
bankruptcy, or other changes in circumstances. Other loans included in this
category include loans to states and political subdivisions.
The allowance for loan losses consists of specific and general components. The
specific component relates to loans that are classified as impaired, and is
established when the discounted cash flows, fair value of collateral less
estimated costs to sell, or observable market price of the impaired loan is
lower than the carrying value of that loan. For collateral dependent loans, an
updated appraisal is ordered if a current one is not on file. Appraisals are
typically performed by independent third-party appraisers with relevant industry
experience. Adjustments to the appraised value may be made based on recent sales
of like properties or general market conditions among other considerations.
The general component covers loans that are not considered impaired and is based
on historical loss experience adjusted for qualitative factors. The historical
loss experience is calculated by loan type and uses an average loss rate during
the preceding twelve quarters. The qualitative factors are assigned by
management based on delinquencies and asset quality, national and local economic
trends, effects of the changes in the value of underlying collateral, trends in
volume and nature of loans, effects of changes in the lending policy, the
experience and depth of management, concentrations of credit, quality of the
loan review system, and the effect of external factors such as competition and
regulatory requirements. The factors assigned differ by loan type. The general
allowance estimates losses whose impact on the portfolio has yet to be
recognized by a specific allowance. Allowance factors and the overall size of
the allowance may change from period to period based on management's assessment
of the above described factors and the relative weights given to each factor.
For further information regarding the allowance for loan losses, see Note 4 to
the Consolidated Financial Statements included in this Form 10-Q.
Loans acquired from Fincastle and SmartBank were recorded at fair value. There
was $350 thousand of allowance for loan losses attributable to purchased loans
at March 31, 2022 .
Loans Acquired in a Business Combination
Acquired loans are classified as either (i) purchased credit-impaired (PCI) loans or (ii) purchased performing loans and are recorded at fair value on the date of acquisition.
PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Corporation will not collect all contractually required principal and interest payments. When determining fair value, PCI loans are aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the "nonaccretable difference." Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the "accretable yield" and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. There were no acquire d loans classified as PCI in the acquisition of theFincastle and the Smartbank loan portfolios.
Goodwill arises from business combinations and is determined as the excess fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date.Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed. The Company has selectedJune 30 as the date to perform the annual impairment test. Intangible assets with finite useful lives are amortized over their estimated useful lives to their estimated residual values.Goodwill is the only intangible asset with an indefinite life on the balance sheet. Other intangible assets consist of core deposit intangible assets arising from whole bank and branch acquisitions and are amortized on an accelerated method over their estimated useful lives, which range from 6 to 10 years. 40
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Table of Contents Lending Policies General In an effort to manage risk, the Bank's loan policy gives loan amount approval limits to individual loan officers based on their position within the Bank and level of experience. The Management Loan Committee can approve new loans up to the Bank's legal lending limit. The Board Loan Committee reviews all loans greater than$1.0 million . The Board Loan Committee currently consists of six directors, five of which are non-management directors. The Board Loan Committee approves the Bank's Loan Policy and reviews risk management reports, including watch list reports and concentrations of credit. The Board Loan Committee meets at least two times per quarter and the Chairman of the Committee then reports to the Board of Directors. Residential loan originations are primarily generated by mortgage loan officer solicitations and referrals by employees, real estate professionals, and customers. Commercial real estate loan originations and commercial and industrial loan originations are primarily obtained through direct solicitation and additional business from existing customers. All completed loan applications are reviewed by the Bank's loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment, and credit history of the applicant. The Bank also participates in commercial real estate loans and commercial and industrial loans originated by other financial institutions that are typically outside its market area. In addition, the Bank has purchased consumer loans originated by other financial institutions that are typically outside its market area. Loan quality is analyzed based on the Bank's experience and credit underwriting guidelines depending on the type of loan involved. Except for loan participations with other financial institutions, real estate collateral is valued by independent appraisers who have been pre-approved by the Board Loan Committee. As part of the ongoing monitoring of the credit quality of the Company's loan portfolio, certain appraisals are analyzed by management or by an outsourced appraisal review specialist throughout the year in order to ensure standards of quality are met. The Company also obtains an independent review of loans within the portfolio on an annual basis to analyze loan risk ratings and validate specific reserves on impaired loans. In the normal course of business, the Bank makes various commitments and incurs certain contingent liabilities which are disclosed but not reflected in its financial statements, including commitments to extend credit. AtMarch 31, 2022 , commitments to extend credit, stand-by letters of credit, and rate lock commitments totaled$195.6 million .
Construction and Land Development Lending
The Bank makes local construction loans, including residential and land
acquisition and development loans. These loans are secured by the property under
construction and the underlying land for which the loan was obtained. The
majority of these loans mature in one year. Construction lending entails
significant additional risks, compared with residential mortgage lending.
Construction and land development loans sometimes involve larger loan balances
concentrated with single borrowers or groups of related borrowers. Another risk
involved in construction and land development lending is the fact that loan
funds are advanced upon the security of the land or property under construction,
which value is estimated based on the completion of construction. Thus, there is
risk associated with failure to complete construction and potential cost
overruns. To mitigate the risks associated with this type of lending, the Bank
generally limits loan amounts relative to the appraised value and/or cost of the
collateral, analyzes the cost of the project and the creditworthiness of its
borrowers, and monitors construction progress. The Bank typically obtains a
first lien on the property as security for its construction loans, typically
requires personal guarantees from the borrower's principal owners, and typically
monitors the progress of the construction project during the draw period.
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1-4 Family Residential Real Estate Lending
1-4 family residential lending activity may be generated by Bank loan officer solicitations and referrals by real estate professionals and existing or new bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment, and credit history of the applicant. Residential mortgage loans generally are made on the basis of the borrower's ability to make payments from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In addition to the Bank's underwriting standards, loan quality may be analyzed based on guidelines issued by a secondary market investor. The valuation of residential collateral is generally provided by independent fee appraisers who have been approved by the Board Loan Committee. In addition to originating mortgage loans with the intent to sell to correspondent lenders or broker to wholesale lenders, the Bank also originates and retains certain mortgage loans in its loan portfolio.
Commercial Real Estate Lending
Commercial real estate loans are secured by various types of commercial real estate typically in the Bank's market area, including multi-family residential buildings, office and retail buildings, hotels, industrial buildings, and religious facilities. Commercial real estate loan originations are primarily obtained through direct solicitation of customers and potential customers. The valuation of commercial real estate collateral is provided by independent appraisers who have been approved by the Board Loan Committee. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy in general. The Bank's commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower's creditworthiness, prior credit history, and reputation. The Bank typically requires personal guarantees of the borrowers' principal owners and considers the valuation of the real estate collateral.
Commercial and Industrial Lending
Commercial and industrial loans generally have a higher degree of risk than
loans secured by real estate, but typically have higher yields. Commercial and
industrial loans typically are made on the basis of the borrower's ability to
make repayment from cash flow from its business. The loans may be unsecured or
secured by business assets, such as accounts receivable, equipment, and
inventory. As a result, the availability of funds for the repayment of
commercial business loans is substantially dependent on the success of the
business itself. Furthermore, any collateral for commercial business loans may
depreciate over time and generally cannot be appraised with as much reliability
as real estate.
Also included in this category are loans originated under the SBA's PPP. PPP
loans are fully guaranteed by the SBA, and in some cases borrowers may be
eligible to obtain forgiveness of the loans, in which case loans would be repaid
by the SBA.
Consumer Lending
Loans to individual borrowers may be secured or unsecured, and include unsecured
consumer loans and lines of credit, automobile loans, deposit account loans, and
installment and demand loans. These consumer loans may entail greater risk than
residential mortgage loans, particularly in the case of consumer loans which are
unsecured or secured by rapidly depreciating assets such as automobiles. In such
cases, any repossessed collateral for a defaulted consumer loan may not provide
an adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss, or depreciation. Consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness, or
personal bankruptcy. Furthermore, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered on such loans.
The underwriting standards employed by the Bank for consumer loans include a
determination of the applicant's payment history on other debts and an
assessment of ability to meet existing obligations and payments on a proposed
loan. The stability of the applicant's monthly income may be determined by
verification of gross monthly income from primary employment, and additionally
from any verifiable secondary income.
Also included in this category are loans purchased through a third-party lending
program. These portfolios include consumer loans and carry risks associated with
the borrower, changes in the economic environment, and the vendor itself. The
Company manages these risks through policies that require minimum credit scores
and other underwriting requirements, robust analysis of actual performance
versus expected performance, as well as ensuring compliance with the Company's
vendor management program.
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Table of Contents Results of Operations General Net interest income represents the primary source of earnings for the Company. Net interest income equals the amount by which interest income on interest-earning assets, predominantly loans and securities, exceeds interest expense on interest-bearing liabilities, including deposits, other borrowings, subordinated debt, and junior subordinated debt. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, are the components that impact the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets. The provision for loan losses, noninterest income, and noninterest expense are the other components that determine net income. Noninterest income and expense primarily consists of income from service charges on deposit accounts, revenue from wealth management services, ATM and check card income, revenue from other customer services, income from bank owned life insurance, general and administrative expenses, amortization expense, and other real estate owned expense. Net Interest Income For the three-month period endingMarch 31, 2022 , net interest income increased$3.0 million , or 40%, compared to the same period of 2021. The increase resulted from a$2.9 million , or 36% increase in total interest and dividend income and a$107 thousand , or 18%, decrease in total interest expense. Net interest income was favorably impacted by a$415.1 million , or 44%, increase in average earning assets, which was partially offset by an 8-basis point decrease in the net interest margin to 3.19% when comparing the periods. The acquisition ofThe Bank of Fincastle onJuly 1, 2021 and an increase in average deposit balances resulted in growth of average earning assets. The decrease in the net interest margin was primarily attributable to the change in the composition of average earning assets. Average loans, which was the highest yielding category, decreased to 61% of average earning assets for the first quarter of 2022, compared to 68% for the first quarter of 2021. Although average loans increased$193.3 million , lower yielding categories experienced higher growth, as average securities increased$187.2 million and Federal funds sold and interest-bearing deposits in other banks combined increased$34.6 million . Accretion of PPP income, net of costs, and accretion of discounts on purchased loans, net of premiums, were included in interest and fees on loans. Accretion of PPP income totaled$323 thousand in the first quarter of 2022, compared to$599 thousand for the same period of 2021. Accretion of discounts on purchased loans totaled$367 thousand in the first quarter of 2022. There were no purchased loans in the first quarter of 2021, and as a result, there was no accretion of discounts on purchased loans during the period. Total interest expense decreased by$107 thousand , or 18%, comparing the three month period endingMarch 31, 2022 to the same period of 2021, which also contributed to the increase in net interest income. Interest expense on deposits decreased$23 thousand , or 6%, from a 8-basis point decrease in the cost of interest-bearing deposits and was partially offset by a 46% increase in average interest-bearing deposit balances. The decrease in the cost of interest-bearing deposits was attributable to a reduction in interest rates paid on checking, money market and time deposits. Interest expense on subordinated debt also decreased by$85 thousand , or 55%, due to theJanuary 1, 2022 repayment of$5.0 million of subordinated debt. 43
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The following tables show interest income on earning assets and related average
yields as well as interest expense on interest-bearing liabilities and related
average rates paid for the periods indicated (dollars in thousands):
Average Balances, Income and Expenses, Yields and Rates (Taxable Equivalent
Basis)
Three Months Ended
March 31, 2022 March 31, 2021
Interest Average Interest
Average Balance Income/Expense Yield/Rate Balance Income/Expense Yield/Rate
Assets
Securities:
Taxable $ 284,016 $ 1,132 1.62 % $ 123,201 $ 717 2.36 %
Tax-exempt (1) 61,308 386 2.55 % 34,947 228 2.65 %
Restricted 1,825 21 4.72 % 1,848 22 4.94 %
Total securities $ 347,149 $ 1,539 1.80 % $ 159,996 $ 967 2.45 %
Loans: (2)
Taxable $ 824,988 $ 9,477 4.66 % $ 630,463 $ 7,113 4.58 %
Tax-exempt (1) 2,223 27 4.49 % 3,423 38 4.49 %
Total loans $ 827,211 $ 9,504 4.66 % $ 633,886 $ 7,151 4.58 %
Federal funds sold - - 0.00 % 134 - 0.10 %
Interest-bearing deposits with other
institutions 177,951 70 0.16 % 143,183 33 0.90 %
Total earning assets $ 1,352,311 $ 11,113 3.33 % $ 937,199 $ 8,151 3.53 %
Less: allowance for loan losses (5,766 ) (7,484 )
Total non-earning assets 83,979 58,609
Total assets $ 1,430,524 $ 988,324
Liabilities and Shareholders' Equity
Interest bearing deposits:
Checking $ 289,475 $ 100 0.14 % $ 227,691 $ 117 0.21 %
Regular savings 206,798 25 0.05 % 126,213 19 0.06 %
Money market accounts 246,958 52 0.08 % 155,314 43 0.11 %
Time deposits:
$100,000 and over 64,515 83 0.52 % 42,586 98 0.93 %
Under $100,000 78,124 78 0.41 % 55,851 85 0.62 %
Brokered 562 2 1.94 % 594 1 0.66 %
Total interest-bearing deposits $ 886,432 $ 340 0.16 % $ 608,249 $ 363 0.24 %
Federal funds purchased - - - % 2 - 0.47 %
Subordinated debt 6,244 69 4.50 % 9,992 154 6.23 %
Junior subordinated debt 9,279 67 2.91 % 9,279 66 2.91 %
Total interest-bearing liabilities $ 901,955 $ 476 0.21 % $ 627,522 $ 583 0.38 %
Non-interest bearing liabilities
Demand deposits 411,576 272,026
Other liabilities 4,171 3,068
Total liabilities $ 1,317,702 $ 902,616
Shareholders' equity 112,822 85,708
Total liabilities and Shareholders'
equity $ 1,430,524 $ 988,324
Net interest income $ 10,637 $ 7,568
Interest rate spread 3.12 % 3.15 %
Cost of funds 0.15 % 0.26 %
Interest expense as a percent of
average earning assets 0.14 % 0.25 %
Net interest margin 3.19 % 3.27 %
(1) Income and yields are reported on a taxable-equivalent basis assuming a
federal tax rate of 21%. The tax-equivalent adjustment was
thousand for the three months ended
(2) Loans on non-accrual status are reflected in the balances.
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Table of Contents Provision for Loan Losses There was no provision for loan losses recorded for the first quarter of 2022. During the quarter, the general reserve component of the allowance for losses increased$173 thousand and was offset by a$55 thousand decrease in the specific reserve component and$118 thousand of net recoveries of loans previously charged off. The increase in the general reserve resulted from loan growth which was partially offset by an adjustment to a qualitative factor related to economic conditions. The allowance for loan losses totaled$5.8 million , or 0.70% of total loans atMarch 31, 2022 , compared to$5.7 million , or 0.69% of total loans atDecember 31, 2021 , and$7.5 million , or 1.17% of total loans atMarch 31, 2021 . There was no provision for loan losses for the same period of 2021. A provision for loan losses was not recorded for the first quarter of 2021 as an increase in the general reserve component of the allowance for loan losses was offset by a decrease in the specific reserve component. The general reserve component of the allowance for loan losses increased primarily from the impact of an increase in loan balances during the quarter. The decrease in the specific reserve component of the allowance for loan losses resulted from a decrease in a reserve on a loan evaluated in a prior period. There were no changes to qualitative factors during the first quarter of 2021. Noninterest Income Noninterest income increased$568 thousand , or 27%, to$2.7 million for the three-month period endedMarch 31, 2022 , compared to the same period of 2021. Wealth management fees increased$160 thousand , or 25%, and was attributable to an increase in assets under management from growth in account values and from an increase in the number of clients served by the wealth management division. Service charges on deposits increased$167 thousand , or 38%, ATM and check card fees increased$149 thousand , or 25%, income from bank-owned life insurance increased$31 thousand , or 27%, and fees for other customer services increased$51 thousand , or 28%, comparing the same periods. The increases were primarily attributable to the acquisition ofFincastle . 45
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Table of Contents Noninterest Expense Noninterest expense increased$2.0 million , or 30%, to$8.6 million for the three-month period endedMarch 31, 2022 , compared to the same period one year ago. The increase was primarily attributable to a$1.6 million , or 44%, increase in salaries and employee benefits, a$125 thousand , or 28%, increase in occupancy expense, a$128 thousand , or 30%, increase in equipment expense, an$83 thousand , or 120%, increase inFDIC assessment, and a$227 thousand , or 38%, increase in other operating expense. The increases were primarily attributable to the increase in the number of employees, branch offices and customers that resulted from the acquisition ofFincastle and the acquisition of the loan portfolio, branch assets and addition of the employees from SmartBank. The increased expenses were partially offset by a$404 thousand decrease in legal and professional fees, which was attributable to merger related costs in the first quarter of 2021. Merger expenses totaled$20 thousand and$405 thousand for the three-month periods endingMarch 31, 2022 and 2021, respectively. Income Taxes Income tax expense increased$317 thousand for the first quarter of 2022, compared to the same period one year ago. The Company's income tax expense differed from the amount of income tax determined by applying theU.S. federal income tax rate to pretax income for the three months endedMarch 31, 2022 and 2021. The difference was a result of net permanent tax deductions, primarily comprised of tax-exempt interest income and income from bank owned life insurance. A more detailed discussion of the Company's tax calculation is contained in Note 11 to the Consolidated Financial Statements included in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 . 46
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Table of Contents Financial Condition General Total assets increased$28.2 million to$1.4 billion atMarch 31, 2022 , compared toDecember 31, 2021 . The increase was primarily attributable to an$11.2 million , or 1.4%, increase in loans, net of allowance for loan losses, and a$48.2 million , or 144.1%, increase in securities held to maturity. These increases were partially offset by a decrease in interest-bearing deposits in banks of$27.5 million , or 17.5%, during the first quarter of 2022.
At
Total shareholders' equity decreased$10.5 million to$106.6 million atMarch 31, 2022 , compared to$117.0 million atDecember 31, 2021 . This was primarily attributable to a$13.7 million decrease in accumulated other comprehensive (loss) income (AOCI). The decrease in AOCI is related to unrealized losses in the securities portfolio stemming from market rate increases during the first quarter. This decrease was partially offset by a$2.9 million increase in retained earnings. The Company's capital ratios continued to exceed the minimum capital requirements for regulatory purposes. Loans Loans, net of the allowance for loan losses, increased$11.2 million to$830.6 million atMarch 31, 2022 , compared to$819.4 million atDecember 31, 2021 . Commercial real estate and commercial and industrial loans increased by$19.4 million and$3.9 million , respectively, during the first quarter of 2022. Construction loans, consumer and other loans, and residential real estate loans decreased by$6.4 million ,$3.8 million and$1.6 million , respectively during the first quarter of 2022. The Bank actively participated as a lender in theU.S. Small Business Administration's ("SBA") Paycheck Protection Program ("PPP") to support local small businesses and non-profit organizations by providing forgivable loans. Loan fees received from the SBA are accreted by the Bank into income evenly over the life of the loans, net of loan origination costs, through interest and fees on loans. PPP loans totaled$2.5 million atMarch 31, 2022 , with$52 thousand scheduled to mature in the second and third quarters of 2022, and$2.4 million scheduled to mature in the first and second quarters of 2026. The Company believes the majority of these loans will ultimately be forgiven and repaid by the SBA in accordance with the terms of the program. It is the Company's understanding that loans funded through the PPP program are fully guaranteed by theU.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan losses through additional provision for loan losses charged to earnings. The Bank recognized$323 thousand and$599 thousand of accretion on deferred PPP income, net of origination costs, through interest and fees on loans for the three month periods endedMarch 31, 2022 and 2021, respectivley. The total amount of deferred PPP income, net of origination costs, that has not yet been recognized through interest and fees on loans totaled$44 thousand atMarch 31, 2022 . During the fourth quarter of 2020, the Bank modified terms of certain loans for customers that continued to be negatively impacted by the pandemic. The loan modifications lowered borrower loan payments by allowing interest only payments for periods ranging between 6 and 24 months. All loans modified were in the lodging sector of the Bank's commercial real estate loan portfolio and totaled$8.9 million atMarch 31, 2022 . All modified loans were performing under their modified terms atMarch 31, 2022 . The Company, through its banking subsidiary, grants mortgage, commercial, and consumer loans to customers. The Bank segments its loan portfolio into real estate loans, commercial and industrial loans, and consumer and other loans. Real estate loans are further divided into the following classes: Construction andLand Development ; 1-4 Family Residential; and Other Real Estate Loans. Descriptions of the Company's loan classes are as follows: Real Estate Loans - Construction andLand Development : The Company originates construction loans for the acquisition and development of land and construction of commercial buildings, condominiums, townhomes, and one-to-four family residences. Real Estate Loans - 1-4 Family: This class of loans includes loans secured by one-to-four family homes. In addition to traditional residential mortgage loans secured by a first or junior lien on the property, the Bank offers home equity lines of credit. Real Estate Loans - Other: This loan class consists primarily of loans secured by various types of commercial real estate typically in the Bank's market area, including multi-family residential buildings, office and retail buildings, industrial and warehouse buildings, hotels, and religious facilities. Commercial and Industrial Loans: Commercial loans may be unsecured or secured with non-real estate commercial property. The Company's banking subsidiary makes commercial loans to businesses located within its market area and also to businesses outside of its market area through loan participations with other financial institutions. Loans originated under the SBA's PPP are also included in this loan class. Consumer and Other Loans: Consumer loans include all loans made to individuals for consumer or personal purposes. They include new and used automobile loans, unsecured loans, and lines of credit. The Company's banking subsidiary makes consumer loans to individuals located within its market area. The Bank has also made loans to individuals outside of its market area through the purchase of loans from another financial institution. Other loans in this category include loans to state and political subdivisions. A substantial portion of the loan portfolio is represented by residential and commercial loans secured by real estate throughout the Bank's market area. The ability of the Bank's debtors to honor their contracts may be impacted by the real estate and general economic conditions in this area. 47
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Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances less the allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued and credited to income based on the unpaid principal balance. Loan origination fees, net of certain origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. Interest income includes amortization of purchase premiums and discounts, recognized evenly over the life of the loans. A loan's past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on non-accrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. Loans greater than 90 days past due and still accruing totaled$53 thousand atMarch 31, 2022 . There were no loans greater than 90 days past due and still accruing atDecember 31, 2021 . For those loans that are carried on non-accrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. These policies are applied consistently across the loan portfolio. All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. When a loan is returned to accrual status, interest income is recognized based on the new effective yield to maturity of the loan.
Any unsecured loan that is deemed uncollectible is charged-off in full. Any secured loan that is considered by management to be uncollectible is partially charged-off and carried at the fair value of the collateral less estimated selling costs. This charge-off policy applies to all loan segments.
Impaired Loans A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value (net of selling costs), and the probability of collecting scheduled principal and interest payments when due. Additionally, management generally evaluates substandard and doubtful loans greater than$250 thousand for impairment. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair market value of the collateral, net of selling costs, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company typically does not separately identify individual consumer, residential, and certain small commercial loans that are less than$250 thousand for impairment disclosures, except for troubled debt restructurings (TDRs) as noted below. The recorded investment in impaired loans totaled$2.1 million and$2.2 million atMarch 31, 2022 andDecember 31, 2021 , respectively.
Troubled Debt Restructurings (TDR)
In situations where, for economic or legal reasons related to a borrower's financial condition, management grants a concession to the borrower that it would not otherwise consider, the related loan is classified as a TDR. TDRs are considered impaired loans. Upon designation as a TDR, the Company evaluates the borrower's payment history, past due status, and ability to make payments based on the revised terms of the loan. If a loan was accruing prior to being modified as a TDR and if the Company concludes that the borrower is able to make such payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the loan will remain on an accruing status. If a loan was on non-accrual status at the time of the TDR, the loan will remain on non-accrual status following the modification and may be returned to accrual status based on the policy for returning loans to accrual status as noted above. There were$1.6 million in loans classified as TDRs as ofMarch 31, 2022 and$1.6 million as ofDecember 31, 2021 . Asset Quality Management classifies non-performing assets as non-accrual loans and OREO. OREO represents real property taken by the Bank when its customers do not meet the contractual obligation of their loans, either through foreclosure or through a deed in lieu thereof from the borrower and properties originally acquired for branch operations or expansion but no longer intended to be used for that purpose. OREO is recorded at the lower of cost or fair value, less estimated selling costs, and is marketed by the Bank through brokerage channels. The Bank had$1.8 million in assets classified as OREO atMarch 31, 2022 andDecember 31, 2021 . Non-performing assets totaled$3.9 million and$4.2 million atMarch 31, 2022 andDecember 31, 2021 , representing approximately 0.27% and 0.30% of total assets, respectively. Non-performing assets consisted of OREO and non-accrual loans atMarch 31, 2022 andDecember 31, 2021 . Non-performing assets included$1.8 million in properties formerly classified as bank premises by theBank of Fincastle which are now classified as held for sale. 48
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AtMarch 31, 2022 , 1% of non-performing assets were commercial real estate loans, 38% were commercial and industrial loans, and 16% were residential real estate loans. Additionally, 45% was related to properties acquired from theBank of Fincastle which will not be used in the Company's operations and are classified as held for sale. Non-performing assets could increase due to other loans identified by management as potential problem loans. Other potential problem loans are defined as performing loans that possess certain risks, including the borrower's ability to pay and the collateral value securing the loan, that management has identified that may result in the loans not being repaid in accordance with their terms. Other potential problem loans totaled$311 thousand and$1.1 million atMarch 31, 2022 andDecember 31, 2021 , respectively. The amount of other potential problem loans in future periods may be dependent on economic conditions and other factors influencing a customers' ability to meet their debt requirements. Loans greater than 90 days past due and still accruing totaled$53 thousand atMarch 31, 2022 . There were no loans greater than 90 days past due and still accruing atDecember 31, 2021 . The allowance for loan losses represents management's analysis of the existing loan portfolio and related credit risks. The provision for loan losses is based upon management's current estimate of the amount required to maintain an adequate allowance for loan losses reflective of the risks in the loan portfolio. The allowance for loan losses totaled$5.8 million atMarch 31, 2022 and$5.7 million December 31, 2021 , representing 0.70% and 0.69% of total loans, respectively. For further discussion regarding the allowance for loan losses, see "Provision for Loan Losses" above. Recoveries of loan losses of$4 thousand ,$5 thousand ,$2 thousand ,$140 thousand , and$73 thousand were recorded in the construction and land development, 1-4 family residential, other real estate, commercial and industrial loan classes, and consumer and other loans classes respectively, during the three months endedMarch 31, 2022 . There was no provision for loan loss recorded atMarch 31, 2022 . For more detailed information regarding the (recovery of) provision for loan losses, see Note 4 to the Consolidated Financial Statements. Impaired loans totaled$2.1 million and$2.3 million atMarch 31, 2022 andDecember 31, 2021 , respectively. There was no related allowance for loan losses recorded for these loans atMarch 31, 2022 . The related allowance for loan losses provided for these loans totaled$55 thousand atDecember 31, 2021 . The average recorded investment in impaired loans during the three months endedMarch 31, 2022 and the year endedDecember 31, 2021 was$2.3 million and$4.5 million , respectively. Included in the impaired loans total are loans classified as TDRs totaling$1.6 million atMarch 31, 2022 andDecember 31, 2021 . Loans classified as TDRs represent situations in which a modification to the contractual interest rate or repayment structure has been granted to address a financial hardship. As ofMarch 31, 2022 , none of these TDRs were performing under the restructured terms and all were considered non-performing assets. Management believes, based upon its review and analysis, that the Bank has sufficient reserves to cover losses inherent within the loan portfolio. For each period presented, the provision for loan losses charged to expense was based on management's judgment after taking into consideration all factors connected with the collectability of the existing portfolio. Management considers economic conditions, historical loss factors, past due percentages, internally generated loan quality reports, and other relevant factors when evaluating the loan portfolio. There can be no assurance, however, that an additional provision for loan losses will not be required in the future, including as a result of changes in the qualitative factors underlying management's estimates and judgments, changes in accounting standards, adverse developments in the economy, on a national basis or in the Company's market area, loan growth, or changes in the circumstances of particular borrowers. For further discussion regarding the allowance for loan losses, see "Critical Accounting Policies" above. 49
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Table of Contents Securities The securities portfolio plays a primary role in the management of the Company's interest rate sensitivity and serves as a source of liquidity. The portfolio is used as needed to meet collateral requirements, such as those related to secure public deposits and balances with theReserve Bank . The investment portfolio consists of held to maturity, available for sale, and restricted securities. Securities are classified as available for sale or held to maturity based on the Company's investment strategy and management's assessment of the intent and ability to hold the securities until maturity. Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Company has the ability at the time of purchase to hold the investment securities to maturity, they are classified as investment securities held to maturity and are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Investment securities which the Company may not hold to maturity are classified as investment securities available for sale, as management has the intent and ability to hold such investment securities for an indefinite period of time, but not necessarily to maturity. Securities available for sale may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, general liquidity needs and other similar factors and are carried at estimated fair value. Restricted securities, includingFederal Home Loan Bank ,Federal Reserve Bank , andCommunity Bankers' Bank stock, are generally viewed as long-term investments because there is minimal market for the stock and are carried at cost. Securities atMarch 31, 2022 totaled$366.5 million , an increase of$43.6 million , or 14.0%, from$322.9 million atDecember 31, 2021 . Investment securities are comprised ofU.S. agency and mortgage-backed securities, obligations of state and political subdivisions, corporate debt securities, and restricted securities. As ofMarch 31, 2022 , neither the Company nor the Bank held any derivative financial instruments in their respective investment security portfolios. Gross unrealized gains in the available for sale portfolio totaled$288 thousand and$2.0 million atMarch 31, 2022 andDecember 31, 2021 , respectively. Gross unrealized losses in the available for sale portfolio totaled$18.9 million and$2.6 million atMarch 31, 2022 andDecember 31, 2021 , respectively. Gross unrealized gains in the held to maturity portfolio totaled$12 thousand and$242 thousand atMarch 31, 2022 andDecember 31, 2021 , respectively. Gross unrealized losses in the held to maturity portfolio totaled$3.4 million and$66 thousand atMarch 31, 2022 andDecember 31, 2021 . Investments in an unrealized loss position were considered temporarily impaired atMarch 31, 2022 andDecember 31, 2021 . The change in the unrealized gains and losses of investment securities fromDecember 31, 2021 toMarch 31, 2022 was related to changes in market interest rates and was not related to credit concerns of the issuers. AtMarch 31, 2022 , the securities portfolio was comprised of$284.9 million of securities available for sale and$81.6 million of securities held to maturity compared to$289.5 million and$33.4 million atDecember 31, 2021 , respectively. Securities held to maturity increased by$48.2 million during the first quarter of 2022 as a part of the Company's strategy to mitigate the risk of potential fluctuations in value and the related impact on shareholders' equity. Deposits AtMarch 31, 2022 , deposits totaled$1.3 billion , an increase of$44.1 million , from$1.2 billion atDecember 31, 2021 . There was a slight change in the deposit mix when comparing the periods. AtMarch 31, 2022 , noninterest-bearing demand deposits, savings and interest-bearing demand deposits, and time deposits composed 32%, 57%, and 11% of total deposits, respectively, compared to 33%, 55%, and 12% atDecember 31, 2021 . Liquidity Liquidity represents the ability to meet present and future financial obligations through either the sale or maturity of existing assets or with borrowings from correspondent banks or other deposit markets. The Company classifies cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, investment securities, and loans maturing within one year as liquid assets. As part of the Bank's liquidity risk management, stress tests and cash flow modeling are performed quarterly. As a result of the Bank's management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Bank maintains overall liquidity sufficient to satisfy its depositors' requirements and to meet its customers' borrowing needs. AtMarch 31, 2022 , cash, interest-bearing and noninterest-bearing deposits with banks, securities, and loans maturing within one year totaled$235.3 million . AtMarch 31, 2022 , 9.8% or$81.7 million of the loan portfolio matured within one year. Non-deposit sources of available funds totaled$247.1 million atMarch 31, 2022 , which included$147.7 million of secured funds available fromFederal Home Loan Bank of Atlanta (FHLB),$48 million of secured funds available through the Federal Reserve Discount Window, and$51.0 million of unsecured federal funds lines of credit with other correspondent banks. 50
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Table of Contents Capital Resources The adequacy of the Company's capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Company's asset and liability levels and consistent with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses. The Company meets eligibility criteria of a small bank holding company in accordance with theFederal Reserve Board's Small Bank Holding Company Policy Statement issued inFebruary 2015 and is not obligated to report consolidated regulatory capital. EffectiveJanuary 1, 2015 , the Bank became subject to capital rules adopted by federal bank regulators implementing the Basel III regulatory capital reforms adopted by theBasel Committee on Banking Supervision (the Basel Committee), and certain changes required by the Dodd-Frank Act. The minimum capital level requirements applicable to the Bank under the final rules are as follows: a new common equity Tier 1 capital ratio of 4.5%; a Tier 1 capital ratio of 6%; a total capital ratio of 8%; and a Tier 1 leverage ratio of 4% for all institutions. The final rules also established a "capital conservation buffer" above the new regulatory minimum capital requirements. The capital conservation buffer was phased-in over four years and, as fully implemented effectiveJanuary 1, 2019 , requires a buffer of 2.5% of risk-weighted assets. This results in the following minimum capital ratios beginning in 2019: a common equity Tier 1 capital ratio of 7.0%, a Tier 1 capital ratio of 8.5%, and a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions. Management believes, as ofMarch 31, 2022 andDecember 31, 2021 , that the Bank met all capital adequacy requirements to which it is subject, including the capital conservation buffer.
The following table shows the Bank's regulatory capital ratios at
First Bank Total capital to risk-weighted assets 14.44 % Tier 1 capital to risk-weighted assets 13.79 %
Common equity Tier 1 capital to risk-weighted assets 13.79 % Tier 1 capital to average assets
8.61 %
Capital conservation buffer ratio(1) 6.44 %
(1) Calculated by subtracting the regulatory minimum capital ratio requirements
from the Company's actual ratio for Common equity Tier 1, Tier 1, and Total
risk based capital. The lowest of the three measures represents the Bank's
capital conservation buffer ratio.
The prompt corrective action framework is designed to place restrictions on
insured depository institutions if their capital levels begin to show signs of
weakness. Under the prompt corrective action requirements, which are designed to
complement the capital conservation buffer, insured depository institutions are
required to meet the following capital level requirements in order to qualify as
"well capitalized:" a common equity Tier 1 capital ratio of 6.5%; a Tier 1
capital ratio of 8%; a total capital ratio of 10%; and a Tier 1 leverage ratio
of 5%. The Bank met the requirements to qualify as "well capitalized" as of
March 31, 2022 and December 31, 2021 .
On September 17, 2019 the FDIC finalized a rule that introduces an optional
simplified measure of capital adequacy for qualifying community banking
organizations (i.e., the community bank leverage ratio (CBLR) framework), as
required by the Economic Growth Act. The CBLR framework is designed to reduce
burden by removing the requirements for calculating and reporting risk-based
capital ratios for qualifying community banking organizations that opt into the
framework.
In order to qualify for the CBLR framework, a community banking organization
must have a tier 1 leverage ratio greater than 9%, less than $10 billion in
total consolidated assets, and limited amounts of off-balance sheet exposures
and trading assets and liabilities. The CARES Act temporarily lowered the tier 1
leverage ratio requirement to 8% until December 31, 2020 . A qualifying community
banking organization that opts into the CBLR framework and meets all
requirements under the framework will be considered to have met the
"well-capitalized" ratio requirements under the prompt corrective action
regulations and will not be required to report or calculate risk-based capital.
Although, the Company did not opt into the CBLR framework at March 31, 2022 , it
may opt into the CBLR framework in a future quarterly period.
During the fourth quarter of 2019, the Board of Directors of the Company
authorized a stock repurchase plan pursuant to which the Company was authorized
to repurchase up to $5.0 million of the Company's outstanding common stock
through December 31, 2020 . During 2020, the Company repurchased and retired
129,035 shares at an average price paid per share of $16.05 , for a total of $2.1
million . The Company's stock repurchase plan was suspended in the second quarter
of 2020, and remained suspended until it ended on December 31, 2020 . The
Company has not authorized another stock repurchase plan as of March 31, 2022 .
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Table of Contents Contractual Obligations There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2021 .
Off-Balance Sheet Arrangements
The Company, through the Bank, is a party to credit related financial instruments with risk not reflected in the consolidated financial statements in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank's exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance sheet instruments. Commitments to extend credit, which amounted to$167.1 million atMarch 31, 2022 , and$161.4 million atDecember 31, 2021 , are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Bank, is based on management's credit evaluation of the customer. Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized as deemed necessary and may or may not be drawn upon to the total extent to which the Bank is committed. Commercial and standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments if deemed necessary. AtMarch 31, 2022 andDecember 31, 2021 , the Bank had$17.6 million and$18.9 million in outstanding standby letters of credit, respectively.
At
OnApril 21, 2020 , the Company entered into interest rate swap agreements related to its outstanding junior subordinated debt. The Company uses derivatives to manage exposure to interest rate risk through the use of interest rate swaps. Interest rate swaps involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date with no exchange of underlying principal amounts. The interest rate swaps qualified and are designated as cash flow hedges. The Company's cash flow hedges effectively modify the Company's exposure to interest rate risk by converting variable rates of interest on$9.0 million of the Company's junior subordinated debt to fixed rates of interest. The cash flow hedges end and the junior subordinated debt matures betweenJune 2034 andOctober 2036 . The cash flow hedges' total notional amount is$9.0 million . AtMarch 31, 2022 , the cash flow hedges had a fair value of$1.6 million , which is recorded in other assets. The net gain/loss on the cash flow hedges is recognized as a component of other comprehensive (loss) income and reclassified into earnings in the same period(s) during which the hedged transactions affect earnings. The Company's derivative financial instruments are described more fully in Note 16 to the Consolidated Financial Statements.
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