FIRST NORTHERN COMMUNITY BANCORP Introduction
This overview highlights selected information in this Annual Report on Form 10-K and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources, and critical accounting estimates, you should carefully read this entire Annual Report on Form 10-K. For a discussion of changes in results of operations comparing the years endedDecember 31, 2019 and 2018, for the Company and its subsidiary, see Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year endedDecember 31, 2019 , filed with theSEC onMarch 5, 2020 . Our subsidiary,First Northern Bank of Dixon , is aCalifornia state-chartered bank that derives most of its revenues from lending and deposit taking in theSacramento Valley region ofNorthern California . Interest rates, business conditions and customer confidence all affect our ability to generate revenues. In addition, the regulatory environment and competition can challenge our ability to generate those revenues.
Financial highlights for 2020 include:
The Company reported net income of$12.2 million for 2020, a 17.4% decrease compared to net income of$14.7 million for 2019. Net income per common share for 2020 was$0.90 , a decrease of 18.2% compared to net income per common share of$1.10 for 2019. Net income per common share on a fully diluted basis was$0.90 for 2020, a decrease of 16.7% compared to net income per common share on a fully diluted basis of$1.08 for 2019. Net interest income totaled$47.4 million for 2020, an increase of 0.5% from$47.1 million in 2019, primarily due to increases in interest income on loans and a decrease in interest expense on deposits, which was partially offset by decreases in interest income on due from bank balances, investment securities, and other earning assets. Provision for loan losses totaled$3.1 million in 2020, compared to no provision for loan losses in 2019. The increase was largely driven by increases in qualitative factors due to declines in the general economic environment as a result of the coronavirus pandemic. Non-interest income totaled$7.8 million in 2020, an increase of 8.5% from$7.2 million in 2019. Gain on sale of loans held-for sale and gain on sale of available-for-sale securities increased in 2020 compared to 2019, which was partially offset by a decrease in service charges on deposit accounts and other non-interest income. The decrease in service charges on deposit accounts was primarily a result of the COVID-19 pandemic and the Bank's decision to waive overdraft/NSF fees for all business and consumer customers for an initial period of 60 days which began in March and was later extended into the third quarter. The auto-waiver period expired onAugust 1, 2020 . This assistance resulted in increased fee waiver activity, reducing reported service charge income. Non-interest expenses totaled$35.5 million for 2020, up 4.5% from$33.9 million in 2019. The increase was primarily due to increases in salaries and employee benefits due to increased staffing levels, occupancy and equipment expense due to the full year rent expense and other expenses associated with the opening of an administrative office space and a branch in the second half of 2019, and other expenses. The decrease was partially offset by a decrease in data processing expenses primarily due to costs incurred in 2019 that were not repeated in 2020, associated with outsourcing of core processing and network infrastructure to third parties, and other real estate owned expense primarily due to a write-down on other real estate owned in 2019, that was not repeated in 2020.
The Company reported total assets of
Investments increased to$435.1 million as ofDecember 31, 2020 , a 26.9% increase from$342.9 million as ofDecember 31, 2019 .U.S. Treasury securities totaled$38.9 million as ofDecember 31, 2020 , down 10.1% from$43.3 million as ofDecember 31, 2019 ; securities ofU.S. government agencies and corporations totaled$106.5 million , up 97.7% from$53.9 million as ofDecember 31, 2019 ; obligations of state and political subdivisions totaled$32.9 million , up 21.6% from$27.0 million as ofDecember 31, 2019 ; collateralized mortgage obligations totaled$73.5 million , down 7.5% from$79.4 million as ofDecember 31, 2019 ; and mortgage-backed securities totaled$183.3 million , up 31.6% from$139.3 million as ofDecember 31, 2019 . Loans (including loans held-for-sale), net of allowance, increased to$885.0 million as ofDecember 31, 2020 , a 14.5% increase from$773.0 million as ofDecember 31, 2019 . Commercial loans totaled$255.9 million as ofDecember 31, 2020 , up 141.1% from$106.1 million as ofDecember 31, 2019 ; commercial real estate loans were$454.1 million , up 0.5% from$451.8 million as ofDecember 31, 2019 ; agriculture loans were$95.0 million , down 17.9% from$115.8 million as ofDecember 31, 2019 ; residential mortgage loans were$64.5 million , down 0.7% from$64.9 million as ofDecember 31, 2019 ; residential construction loans were$4.2 million , down 72.2% from$15.2 million as ofDecember 31, 2019 ; and consumer loans totaled$19.5 million , down 27.4% from$26.8 million as ofDecember 31, 2019 . 30 -------------------------------------------------------------------------------- Table of Contents Deposits increased to$1.48 billion as ofDecember 31, 2020 , a 29.8% increase from$1.14 billion as ofDecember 31, 2019 . FHLB advances totaling$5.0 million as ofDecember 31, 2020 , compared to no FHLB advances as ofDecember 31, 2019 . The$5.0 million advance is a short-term borrowing with a 0% interest rate that was received through the FHLB's COVID-19 Relief and Recovery Advances Program.
Stockholders' equity increased to
Recent Developments Related to COVID-19
SinceMarch 13, 2020 ,the United States has been operating under a state of emergency declared byPresident Trump in response to the spread of the coronavirus and the COVID-19 disease which it causes. OnMarch 4, 2020 ,California GovernorGavin Newsom declared a similar state-wide emergency. Also, early in March, a number of county and other local health agencies inCalifornia declared emergencies and issued "stay-at-home" ordinances for all persons other than workers at "essential businesses". Later in 2020, theCalifornia state government adopted a four-phase reopening plan. The ability of a county to move into a phase with fewer restrictions on social and economic activities is dependent upon the county's compliance with parameters such as the county's case rate, test positivity rate, and a health equity metric. As of this time, theCalifornia state government, as well as the county health departments in our market area, continue to limit business re-openings in certain sectors and/or with capacity and other restrictions. DuringMarch 2020 and continuing thereafter, the pandemic and governmental responses have resulted in recessionary economic, labor and financial market conditions acrossthe United States and in our markets inCalifornia , including dramatic increases in unemployment. In response, the FRB reduced its federal funds rate by 1.5 percentage points to the current target range of .00 to .25 percent. In addition, in lateMarch 2020 , theU.S. government enacted the CARES Act, a$2.2 trillion economic stimulus package, the largest inU.S. history, plus an additional$900 billion stimulus package inDecember 2020 , in an effort to lessen the impact of the pandemic on consumers and businesses. These developments have had an impact on our business. Our commercial real estate loan portfolio exposure to industries most affected by the stay-at-home order and subsequent limitations on business activities includes 6.2% to retail properties and business; 1.5% to restaurants; and 1.1% to the hospitality/hotel sector atDecember 31, 2020 . Loans to these customers are generally secured by real estate with relatively low loan-to-value ratios and strong guarantors. There is concern that borrowers will draw on their credit lines to support cashflow disruptions caused by the continuing restrictions on business activities. Most of the Bank's optional advance lines of credit are "controlled" with advances supported by certain assets pledged to the Bank for repayment or specific budgeted expense. The Bank monitors credit line advances daily and has not noted any significant, unusual loan advances as ofDecember 31, 2020 . We have also granted customer relief in a variety of ways, including extended grace periods on residential and commercial mortgages, commercial loans, and automobile loan and lease payments, refraining from reporting payment deferrals to credit bureaus and waiving or refunding certain fees. The Bank, in the first part ofApril 2020 , commenced participation in the PPP of the SBA which is aimed at providing relief from the pandemic to small businesses through loans by banks guaranteed by the SBA. In the initial phase of the program, the Bank approved approximately 650 applications for loans under the PPP covering approximately$184 million in funding. The program was suspended after the initial Congressional appropriation of$349 billion was exhausted. A second phase of the program, involving a Congressional appropriation of some$310 billion , was initiated onApril 27, 2020 . The Bank approved approximately 670 applications for PPP loans in this second phase, covering approximately$51 million in funding. A total of approximately$235 million in PPP loans were originated by the Bank in 2020. These PPP loan originations resulted in approximately$7.8 million in SBA processing fees which will be recognized as an adjustment to the effective yield over the loans projected life. A total of approximately$5.9 million of PPP processing fees was recognized in interest income for the year endedDecember 31, 2020 . In 2020, the Bank received$80 million in payoffs and reimbursements from the SBA for the amounts forgiven pursuant to the terms of the PPP. The Bank had PPP loans totaling$155 million as ofDecember 31, 2020 . The Company expects that a significant portion of the PPP loans remaining will be forgiven during 2021 under the terms of the program, as borrowers satisfy the requirement of applying at least 60% of the loan proceeds to support their payroll expenses. Loans which do not qualify for the forgiveness will remain on the Bank's books, subject to the SBA's guarantee.First Northern Bank has continued to actively assist our communities by providing temporary loan relief under Section 4013 of the CARES Act to customers who have been adversely impacted by the pandemic. This relief has included loan modifications which provided temporary forbearance programs (both full payment deferrals and interest only payments). The Bank provided temporary forbearance relief for borrowers over the course of 2020 totaling approximately$102 million , resulting in the net deferral of interest income of approximately$1.2 million for the year endedDecember 31, 2020 . For loans that were provided full payment deferrals under Section 4013, the Bank made a policy election to cease recognizing interest income during the term of the payment suspension. Upon completion of the payment forbearance period, and resumption of performance under the original loan terms, the foregone interest is capitalized as deferred interest and recognized as a yield adjustment over the remaining loan term. Loans on interest-only plans continued to accrue interest income given continued payment performance over the course of the forbearance period. A majority of loans completed their forbearance period during the fourth quarter of 2020.
Two
loans totaling$7.0 million were on an interest only forbearance plan and one loan totaling$0.8 million was on a principal and interest forbearance plan atDecember 31, 2020 . 31 -------------------------------------------------------------------------------- Table of Contents Although banks inCalifornia are defined as "essential businesses" under theCalifornia governmental actions and thus are allowed to remain open, some of our employees have elected to work remotely, a majority of whom would normally be working in our branches or offices. In our branches and offices we continue to enforce the use of face coverings, social distancing and using proper hygiene practices.
Critical Accounting Policies and Estimates
The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States . The preparation of these consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, income and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to the allowance for loan losses, other real estate owned, investments, and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements: Allowance for Loan Losses The Company believes the allowance for loan losses accounting policy is critical because the loan portfolio represents the largest asset on the consolidated balance sheet, and there is significant judgment used in determining the adequacy of the allowance for loan losses. The Company maintains an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance.
A
provision for loan losses is based on the Company's periodic evaluation of the
factors mentioned below, as well as other pertinent factors. The allowance for
loan losses consists of an allocated component and a general component. The
components of the allowance for loan losses represent an estimate. The
allocated component of the allowance for loan losses reflects expected losses
resulting from analyses developed through specific credit allocations for
individual loans and historical loss experience for each loan category. The
specific credit allocations are based on regular analyses of all loans where the
internal credit rating is at or below a predetermined classification. These
analyses involve a high degree of judgment in estimating the amount of loss
associated with specific loans, including estimating the amount and timing of
future cash flows and collateral values. The historical loan loss element is
determined using analysis that examines loss experience.
The allocated component of the allowance for loan losses also includes
consideration of concentrations and changes in portfolio mix and volume. The
general portion of the allowance reflects the Company's estimate of probable
inherent but undetected losses within the portfolio due to uncertainties in
economic conditions, delays in obtaining information, including unfavorable
information about a borrower's financial condition, the difficulty in
identifying triggering events that correlate perfectly to subsequent loss rates,
and risk factors that have not yet manifested themselves in loss allocation
factors. Uncertainty surrounding the strength and timing of economic cycles
also affects estimates of loss. There are many factors affecting the allowance
for loan losses; some are quantitative while others require qualitative
judgment. Although the Company believes its process for determining the
allowance adequately considers all of the potential factors that could
potentially result in credit losses, the process includes subjective elements
and may be susceptible to significant change. To the extent actual outcomes
differ from Company estimates, additional provision for credit losses could be
required that could adversely affect earnings or financial position in future
periods.
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 amounts due according
to the contractual terms of the loan agreement, including scheduled interest
payments. For a loan that has been restructured in a troubled debt
restructuring, the contractual terms of the loan agreement refer to the
contractual terms specified by the original loan agreement, not the contractual
terms specified by the restructuring agreement. An impaired loan is measured
based upon the present value of future cash flows discounted at the loan's
effective rate, the loan's observable market price, or the fair value of
collateral if the loan is collateral dependent. If the measurement of the
impaired loan is less than the recorded investment in the loan, an impairment is
recognized by a charge to the allowance for loan losses.
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Other-than-temporary Impairment in Debt Securities
Debt securities with fair values that are less than amortized cost are
considered impaired. Impairment may result from either a decline in the
financial condition of the issuing entity or, in the case of fixed interest rate
debt securities, from rising interest rates. At each consolidated financial
statement date, management assesses each debt security in an unrealized loss
position to determine if impaired debt securities are temporarily impaired or if
the impairment is other than temporary. This assessment includes consideration
regarding the duration and severity of impairment, the credit quality of the
issuer and a determination of whether the Company intends to sell the security,
or if it is more likely than not that the Company will be required to sell the
security before recovery of its amortized cost basis less any current-period
credit losses. Other-than-temporary impairment is recognized in earnings if one
of the following conditions exists: 1) the Company's intent is to sell the
security; 2) it is more likely than not that the Company will be required to
sell the security before the impairment is recovered; or 3) the Company does not
expect to recover its amortized cost basis. If, by contrast, the Company does
not intend to sell the security and will not be required to sell the security
prior to recovery of the amortized cost basis, the Company recognizes only the
credit loss component of other-than-temporary impairment in earnings. The
credit loss component is calculated as the difference between the security's
amortized cost basis and the present value of its expected future cash flows.
The remaining difference between the security's fair value and the present value
of the future expected cash flows is deemed to be due to factors that are not
credit related and is recognized in other comprehensive income.
Fair Value Measurements
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a non-recurring basis, such as loans held-for-sale, loans held-for-investment and certain other assets. These non-recurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally corresponds with the Company's quarterly valuation process. For additional discussion, see Note 13 to the Consolidated Financial Statements in this Form 10-K.
Share-Based Payment
The Company determines the fair value of stock options at grant date using the Black-Scholes-Merton pricing model that takes into account the stock price at the grant date, the exercise price, the expected dividend yield, stock price volatility, and the risk-free interest rate over the expected life of the option. The Black-Scholes-Merton model requires the input of highly subjective assumptions including the expected life of the stock-based award and stock price volatility. The estimates used in the model involve inherent uncertainties and the application of Management's judgment. As a result, if other assumptions had been used, our recorded stock-based compensation expense could have been materially different from that reflected in these financial statements. The fair value of non-vested restricted common shares generally equals the stock price at grant date. In addition, we estimate the expected forfeiture rate and only recognize expense for those share-based awards expected to vest. If our actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different. For additional discussion, see Note 15 to the Consolidated Financial Statements in this Form 10-K.
Accounting for Income Taxes
Income taxes reported in the consolidated financial statements are computed
based on an asset and liability approach. We recognize the amount of taxes
payable or refundable for the current year, and deferred tax assets and
liabilities for the expected future tax consequences that have been recognized
in the financial statements. Under this method, deferred tax assets and
liabilities are determined based on the differences between the consolidated
financial statements and tax basis of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
We record net deferred tax assets to the extent it is more-likely-than-not that
they will be realized. In evaluating our ability to recover the deferred tax
assets, Management considers all available positive and negative evidence,
including scheduled reversals of deferred tax liabilities, projected future
taxable income, tax planning strategies and recent financial operations. In
projecting future taxable income, Management develops assumptions including the
amount of future state and federal pretax operating income, the reversal of
temporary differences, and the implementation of feasible and prudent tax
planning strategies. These assumptions require significant judgment about the
forecasts of future taxable income and are consistent with the plans and
estimates being used to manage the underlying business. The Company files
consolidated federal and combined state income tax returns.
A "more-likely-than-not" recognition threshold must be met before a tax benefit
can be recognized in the consolidated financial statements. For tax positions
that meet the more-likely-than-not threshold, an enterprise may recognize only
the largest amount of tax benefit that is greater than fifty percent likely of
being realized upon ultimate settlement with the taxing authority. To the
extent tax authorities disagree with these tax positions, our effective tax
rates could be materially affected in the period of settlement with the taxing
authorities. For additional discussion, see Note 18 to the Consolidated
Financial Statements in this Form 10-K.
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Mortgage Servicing Rights
Transfers and servicing of financial assets and extinguishments of liabilities
are accounted for and reported based on consistent application of a
financial-components approach that focuses on control. Transfers of financial
assets that are sales are distinguished from transfers that are secured
borrowings. Retained servicing rights on loans sold are measured by allocating
the previous carrying amount of the transferred assets between the loans sold
and retained interest, if any, based on their relative fair value at the date of
transfer. Fair values are estimated using discounted cash flows based on a
current market interest rate. The Company recognizes a gain and a related asset
for the fair value of the rights to service loans for others when loans are
sold.
The recorded value of mortgage servicing rights is included in other assets on
the Consolidated Balance Sheets initially at fair value, and is amortized in
proportion to, and over the period of, estimated net servicing revenues. The
Company assesses capitalized mortgage servicing rights for impairment based upon
the fair value of those rights at each reporting date. For purposes of
measuring impairment, the rights are stratified based upon the product type,
term and interest rates. Fair value is determined by discounting estimated net
future cash flows from mortgage servicing activities using discount rates that
approximate current market rates and estimated prepayment rates, among other
assumptions. The amount of impairment recognized, if any, is the amount by
which the capitalized mortgage servicing rights for a stratum exceeds their fair
value. Impairment, if any, is recognized through a valuation allowance for each
individual stratum.
Impact of Recently Issued Accounting Standards
The CARES Act was passed byCongress and signed into law onMarch 27, 2020 . Section 4013 of the CARES Act stipulates that a financial institution may elect to not apply GAAP requirements to loan modifications related to the COVID-19 pandemic that would otherwise be categorized as a TDR, and suspends the determination of loan modifications related to the COVID-19 pandemic from being treated as TDR's. The relief from TDR guidance applies to modifications of loans that were not more than 30 days past due as ofDecember 31, 2019 , and modifications that occur beginning onMarch 1, 2020 , until the earlier of: sixty days after the date on which the national emergency related to the COVID-19 outbreak is terminated orDecember 31, 2020 . The suspension of TDR accounting and reporting guidance may not be applied to any adverse impact on the credit of a borrower that is not related to the COVID-19 pandemic. InDecember 2020 , the Consolidated Appropriations Act, 2021 was signed into law. Section 541 of this legislation, "Extension of Temporary Relief From Troubled Debt Restructurings and Insurer Clarification," extends Section 4013 of the CARES Act to the earlier ofJanuary 1, 2022 or 60 days after the termination of the national emergency declared relating to COVID-19. Future TDRs are indeterminable and will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic. OnApril 3, 2020 , theSEC Office of the Chief Accountant issued a public statement communicating that for eligible entities that elect to apply Section 4013 of the CARES Act, theSEC staff would not object that this is in accordance with GAAP for the periods for which such elections are available. InJune 2020 , theAmerican Institute of Certified Public Accountants published Q&A Section 2130.41 regarding a technical question regarding the recognition of interest income on Section 4013 loans which provided multiple permitted policy elections regarding the recognition of interest on Section 4013 restructured loans. The Bank has continued to actively assist its communities by providing temporary loan relief under Section 4013 of the CARES Act. This relief included loan modifications which include forbearance programs (both full payment deferrals and interest only payments) to customers who have been negatively impacted by the pandemic. For loans that have been provided temporary full payment deferrals, the Bank has made a policy election to cease recognition of interest income during the term of the payment deferrals (generally three to six months). Upon completion of the forbearance period, the foregone interest over the deferral period is capitalized as deferred interest and recognized as an adjustment to the effective interest rate over the remaining life of the loan using the effective yield method. Loans that were provided interest only payment relief will continue to accrue interest over the interest-only period provided that the loans continue to perform as agreed. This policy election does not impact the Bank's existing policies regarding non-accrual determinations if reasonable doubt exists as to the full and timely collection of interest or principal or when a loan becomes contractually past due by ninety days or more with respect to interest or principal regardless of whether a loan was modified under Section 4013 of the CARES Act. OnMarch 22, 2020 , the federal bank regulatory agencies issued joint guidance advising that the agencies have confirmed with the staff of theFinancial Accounting Standards Board that short-term modifications due to COVID-19, made on a good faith basis to borrowers who were current prior to relief, are not TDRs. The CARES Act also provided relief from TDR classification for certain COVID-19 loan modifications. The Bank elected not to classify modifications that meet the criteria under either the CARES Act or the criteria specified by the regulatory agencies as TDRs. 34 -------------------------------------------------------------------------------- Table of Contents InMarch 2020 , the FASB issued ASU 2020-02, Financial Instruments-Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant toSEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842). This ASU adds anSEC paragraph pursuant to the issuance ofSEC Staff Accounting Bulletin No. 119 on loan losses to the FASB Codification Topic 326. This ASU also updates theSEC section of the Codification for the change in the effective date of Topic 842. This ASU is effective upon addition to the FASB Codification. The Company adopted ASU 2016-02, Leases (Topic 842) onJanuary 1, 2019 . ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) is effective onJanuary 1, 2023 for smaller reporting companies with less than$250 million in public float as defined in theSEC's rules (such as the Company). While the Company is currently unable to reasonably estimate the impact of adopting ASU 2016-13, it expects that the impact of adoption will be significantly influenced by the composition, characteristics and quality of the Company's loan and securities portfolios as well as the prevailing economic conditions and forecasts as of the adoption date. InMarch 2020 , the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. The amendments in ASU 2020-03 make narrow-scope improvements to various aspects of the financial instruments guidance, including the current expected credit losses (CECL) standard issued in 2016. The ASU is part of the FASB's ongoing Codification improvement project aimed at clarifying specific areas of accounting guidance to help avoid unintended application. The items addressed in that project generally are not expected to have a significant effect on current accounting practice or create a significant administrative cost for most entities. Effective dates for each amendment vary. The Company does not expect the adoption of this update to have a significant impact on its financial statements. InMarch 2020 , the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848). This ASU provides temporary optional guidance to ease the potential burden in accounting for reference rate reform. This ASU provides optional expedients and exceptions for contracts, hedging relationships, and other transactions that reference LIBOR or other reference rates expected to be discontinued because of reference rate reform. This ASU is effective for all entities as ofMarch 12, 2020 throughDecember 31, 2022 . The Company is in the process of evaluating the provisions of this ASU, but does not expect it to have a material impact on our consolidated financial statements. InJanuary 2021 , the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope. This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includesMarch 12, 2020 , or prospectively to new modifications from any date within the interim period that includes or is subsequent toJanuary 7, 2021 , up to the date that financial statements are available to be issued. An entity may elect to apply ASU 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includesMarch 12, 2020 , and to new eligible hedging relationships entered into after the beginning of the interim period that includesMarch 12, 2020 . The Company is in the process of evaluating the provisions of this ASU, but does not expect it to have a material impact on our consolidated financial statements. 35 -------------------------------------------------------------------------------- Table of Contents STATISTICAL INFORMATION AND DISCUSSION The following statistical information and discussion should be read in conjunction with the Selected Financial Data included in Part II (Item 6) and the audited consolidated financial statements and accompanying notes included in Part II (Item 8) of this Annual Report on Form 10-K. The following tables present information regarding the consolidated average assets, liabilities and stockholders' equity, the amounts of interest income from average earning assets and the resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include non-performing loans. Interest income includes proceeds from loans on non-accrual status only to the extent cash payments have been received and applied as interest income. Tax-exempt income is not shown on a tax equivalent basis. Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential (Dollars in thousands) 2020 2019 2018 Average Average Average Balance Percent Balance Percent Balance Percent ASSETS Cash and Due From Banks$ 221,140 14.3 %$ 127,977 10.2 %$ 139,957 11.5 % Certificates of Deposit 19,210 1.2 % 12,538 1.0 % 4,160 0.3 % Investment Securities 358,005 23.2 % 319,418 25.5 % 293,259 24.1 % Loans (1) 894,626 57.9 % 741,466 59.3 % 739,243 60.6 % Stock in Federal Home Loan Bank and other equity securities, at cost 6,509 0.4 % 6,405 0.5 % 5,884 0.5 % Other Real Estate Owned - - 840 0.1 % 185 0.0 % Other Assets 46,388 3.0 % 41,899 3.4 % 36,460 3.0 % Total Assets$ 1,545,878 100.0 %$ 1,250,543 100.0 %$ 1,219,148 100.0 % LIABILITIES & STOCKHOLDERS' EQUITY Deposits: Demand$ 577,559 37.3 %$ 408,551 32.7 %$ 394,106 32.3 % Interest-Bearing Transaction Deposits 356,867 23.1 % 308,917 24.7 % 307,727 25.2 % Savings and MMDAs 387,490 25.0 % 334,672 26.8 % 333,788 27.4 % Time Certificates 54,147 3.5 % 58,128 4.6 % 67,177 5.5 % Federal Home Loan Bank Advances 5,656 0.4 % - - - - Other Liabilities 19,493 1.3 % 16,313 1.3 % 11,743 1.0 % Stockholders' Equity 144,666 9.4 % 123,962 9.9 % 104,607 8.6 % Total Liabilities and Stockholders' Equity$ 1,545,878 100.0 %$ 1,250,543 100.0 %$ 1,219,148 100.0 %
(1) Average balances for loans include loans held-for-sale and non-accrual loans
and are net of the allowance for loan losses.
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Net Interest Earnings
Average Balances, Yields and Rates
(Dollars in thousands)
2020 2019 2018
Yields Yields Yields
Interest Earned/ Interest Earned/ Interest Earned/
Average Income/ Rates Average Income/ Rates Average Income/ Rates
Assets Balance Expense Paid Balance Expense Paid Balance Expense Paid
Total Loans,
Including
Loan Fees(1) $ 894,626 $ 40,569 4.53 % $ 741,466 $ 39,097 5.27 % $ 739,243 $ 37,189 5.03 %
Due From
Banks 188,021 582 0.31 % 98,593 2,148 2.18 % 114,350 2,163 1.89 %
Certificates
of Deposit 19,210 438 2.28 % 12,538 355 2.83 % 4,160 104 2.50 %
Investment
Securities:
Taxable 336,586 6,406 1.90 % 306,473 6,637 2.17 % 283,500 5,500 1.94 %
Non-taxable
(2) 21,419 498 2.33 % 12,945 300 2.32 % 9,759 143 1.47 %
Total
Investment
Securities 358,005 6,904 1.93 % 319,418 6,937 2.17 % 293,259 5,643 1.92 %
Other
Earning
Assets 6,509 371 5.70 % 6,405 456 7.12 % 5,884 518 8.80 %
Total
Earning
Assets $ 1,466,371 $ 48,864 3.33 % $ 1,178,420 $ 48,993 4.16 % $ 1,156,896 $ 45,617 3.94 %
Cash and Due
from Banks 33,119 29,384 25,607
Other Real
Estate Owned - 840 185
Interest
Receivable
and Other
Assets 46,388 41,899 36,460
Total Assets $ 1,545,878 $ 1,250,543 $ 1,219,148 (1) Average balances for loans include loans held-for-sale and non-accrual loans
and are net of the allowance for loan losses, but non-accrued interest
thereon is excluded. Includes amortization of deferred loan fees and costs.
(2) Interest income and yields on tax-exempt securities are not presented on a
taxable equivalent basis.
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Continuation of
Net Interest Earnings
Average Balances, Yields and Rates
(Dollars in thousands)
2020 2019 2018
Yields Yields Yields
Liabilities and Interest Earned/ Interest Earned/ Interest Earned/Stockholders' Average Income/ Rates Average
Income/ Rates Average Income/ Rates Equity
Balance Expense Paid Balance Expense Paid Balance Expense PaidInterest-Bearing
Deposits:
Interest-Bearing
Transaction Deposits$ 356,867 $ 358 0.10 %$ 308,917 $ 505 0.16 %$ 307,727 $ 428 0.14 % Savings and MMDAs 387,490 786 0.20 % 334,672 981 0.29 % 333,788 559 0.17 % Time Certificates 54,147 340 0.63 % 58,128 373 0.64 % 67,177 281 0.42 % Total Interest-Bearing Deposits 798,504 1,484 0.19 % 701,717 1,859 0.26 % 708,692 1,268 0.18 % Demand Deposits 577,559 408,551 394,106 Total Deposits 1,376,063$ 1,484 0.11 % 1,110,268$ 1,859 0.17 % 1,102,798$ 1,268 0.11 % Federal Home Loan Bank Advances 5,656 - - Interest payable and Other Liabilities 19,493 16,313 11,743 Stockholders' Equity 144,666 123,962 104,607 Total Liabilities and Stockholders' Equity$ 1,545,878 $ 1,250,543 $ 1,219,148 Net Interest Income and Net Interest Margin (1)$ 47,380 3.23 %$ 47,134 4.00 %$ 44,349 3.83 % Net Interest Spread (2) 3.14 % 3.90 % 3.76 %
(1) Net interest margin is computed by dividing net interest income by total average interest-earning assets.
(2) Net interest spread represents the average yield earned on interest-earning
assets less the average rate paid on interest-bearing liabilities.
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Table of Contents
Analysis of Changes
in Interest Income and Interest Expense
(Dollars in thousands)
Following is an analysis of changes in interest income and expense (dollars in thousands) for 2020 over 2019. Changes not solely due to interest rate or volume have been allocated proportionately to interest rate and volume.
2020 Over 2019
Interest
Volume Rate Change
Increase (Decrease) in Interest Income:
Loans$ 7,409 $ (5,937 ) $ 1,472 Due From Banks 1,091 (2,657 ) (1,566 ) Certificates of Deposit 162 (79 ) 83 Investment Securities - Taxable 628 (859 )
(231 )
Investment Securities - Non-taxable 197 1 198
Other Earning Assets 7 (92 ) (85 )
9,494 (9,623 ) (129 )
Increase (Decrease) in Interest Expense:
Deposits:
Interest-Bearing Transaction Deposits 66 (213 ) (147 )
Savings and MMDAs 137 (332 ) (195 )
Time Certificates (27 ) (6 ) (33 )
176 (551 ) (375 )
Increase in Net Interest Income: $ 9,318 $ (9,072 ) $ 246
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INVESTMENT PORTFOLIO
Composition of Investment Securities The mix of investment securities held by the Company at
2020 2019 2018
Investment securities available-for-sale (at fair value): U.S. Treasury Securities$ 38,891 $ 43,255 $ 50,682 Securities ofU.S. Government Agencies and Corporations 106,558 53,912 42,076 Obligations of State and Political Subdivisions 32,882 27,031 19,168 Collateralized Mortgage Obligations 73,460 79,420 63,799 Mortgage-Backed Securities 183,289 139,279 138,912 Total Investments$ 435,080 $ 342,897 $ 314,637 Maturities of Investment Securities The following table summarizes the contractual maturity (dollars in thousands) and projected yields of the Company's investment securities as ofDecember 31, 2020 . The yields on tax-exempt securities are shown on a tax equivalent basis. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. In addition, factors such as prepayments and interest rates may affect the yield on carrying value of mortgage related securities. Period to Maturities After One But After Five But Within One Year Within Five Years Within Ten Years Amount Yield Amount Yield Amount Yield Investment securities available-for-sale (at fair value): U.S. Treasury Securities$ 11,140 1.67 %$ 27,751 1.77 % $ - - Securities of U.S. Government Agencies and Corporations 3,544 1.76 % 48,060 0.96 % 53,853 1.09 % Obligations of State and Political Subdivisions 1,763 3.14 % 4,403 3.00 % 5,398 3.75 % Collateralized Mortgage Obligations - - 2,346 2.02 % 7,064 1.92 % Mortgage-Backed Securities 11 2.12 % 8,650 2.02 % 67,918 2.03 % TOTAL$ 16,458 1.85 %$ 91,210 1.43 %$ 134,233 1.72 % After Ten Years Total Amount Yield Amount Yield Investment securities available-for-sale (at fair value): U.S. Treasury Securities $ - -$ 38,891 1.74 % Securities ofU.S. Government Agencies and Corporations 1,101 2.35 % 106,558 1.07 % Obligations of State & Political Subdivisions 21,318 2.78 % 32,882 2.99 % Collateralized Mortgage Obligations 64,050 1.84 % 73,460 1.86 % Mortgage-Backed Securities 106,710 1.10 % 183,289 1.49 % TOTAL$ 193,179 1.54 %$ 435,080 1.58 % 40
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LOAN PORTFOLIO
Composition of Loans
The mix of loans, net of deferred origination fees and costs and allowance for
loan losses and excluding loans held-for-sale, at December 31 , for the previous
five fiscal years is as follows (dollars in thousands):
December 31,
2020 2019 2018
Balance Percent Balance Percent Balance Percent
Commercial $ 255,926 28.7 % $ 106,140 13.6 % $ 125,177 16.1 %
Commercial Real
Estate 454,053 50.8 % 451,774 58.0 % 420,106 54.2 %
Agriculture 95,048 10.6 % 115,751 14.8 % 123,626 15.9 %
Residential Mortgage 64,497 7.2 % 64,943 8.3 % 51,064 6.6 %
Residential
Construction 4,223 0.5 % 15,212 1.9 % 20,124 2.6 %
Consumer 19,467 2.2 % 26,825 3.4 % 35,397 4.6 %
893,214 100.0 % 780,645 100.0 % 775,494 100.0 %
Allowance for loan
losses (15,416 ) (12,356 ) (12,822 )
Net deferred
origination fees and
costs (1,968 ) 584 721
TOTAL $ 875,830 $ 768,873 $ 763,393
2017 2016
Balance Percent Balance Percent
Commercial $ 135,015 18.0 % $ 126,311 18.6 %
Commercial Real Estate 398,346 53.2 % 344,210 50.6 %
Agriculture 113,555 15.2 % 101,905 15.0 %
Residential Mortgage 42,081 5.6 % 40,237 5.9 %
Residential Construction 21,299 2.8 % 23,650 3.5 %
Consumer 38,900 5.2 % 43,250 6.4 %
749,196 100.0 % 679,563 100.0 %
Allowance for loan losses (11,133 ) (10,899 )
Net deferred origination fees and costs 1,049 1,106
TOTAL $ 739,112 $ 669,770
As shown in the comparative figures for loan mix during 2020 and 2019, total
loans increased as a result of increases in commercial and commercial real
estate loans, which was partially offset by decreases in agriculture,
residential mortgage, residential construction and consumer loans. The increase
in commercial loans was primarily due to PPP loans totaling approximately $155
million at December 31, 2020 .
Included in net deferred origination fees at December 31, 2020 was approximately
$1.9 million in unearned PPP loan fees. The Company received a total of
approximately $7.8 million in processing fees from the SBA during 2020. These
fees are required to be recognized as an adjustment to the effective yield over
the life of the loan. During 2020, the Company recognized approximately $5.9
million of these processing fees, which are included as a component of interest
income on loans. The balance of approximately $1.9 million will be recognized
over the remaining life of the PPP loans.
Commercial loans are primarily for financing the needs of a diverse group of
businesses located in the Bank's market area. Commercial real estate loans
generally fall into two categories, owner-occupied and non-owner occupied. Real
estate construction loans are generally for financing the construction of
single-family residential homes for individuals and builders we believe are
well-qualified. These loans are secured by real estate and have short
maturities. Residential mortgage loans, which are secured by real estate,
include owner-occupied and non-owner occupied properties in the Bank's market
area. Loans are considered agriculture loans when the primary source of
repayment is from the sale of an agricultural or agricultural-related product or
service. Such loans are secured and/or unsecured to producers and processors of
crops and livestock. The Bank also makes loans to individuals for investment
purposes.
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Table of Contents
Maturities and Sensitivities of Loans to Changes in Interest Rates
Loan maturities of the loan portfolio at
Variable
Maturing Fixed Rate Rate Total
Within one year $ 17,849 $ 56,933 $ 74,782
After one year through five years 243,625 42,984 286,609
After five years 145,188 386,635 531,823
Total $ 406,662 $ 486,552 $ 893,214 Non-Accrual, Past Due, OREO and Restructured Loans It is generally the Company's policy to discontinue interest accruals once a loan is past due for a period of 90 days as to interest or principal payments. When a loan is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and an appropriate period of performance has been demonstrated. The following tables summarize the Company's non-accrual loans by loan category (dollars in thousands), net of guarantees of theState of California andU.S. Government , including its agencies and its government-sponsored agencies atDecember 31, 2020 , 2019, 2018, 2017, and 2016. AtDecember 31, 2020
At
Gross Guaranteed Net Gross Guaranteed Net
Commercial $ 363 $ 63 $ 300 $ 266 $ 170 $ 96
Commercial real estate 4,875 34 4,841 466 45 421
Agriculture 9,130 - 9,130 - - -
Residential mortgage 153 - 153 172 - 172
Residential construction - - - - - -
Consumer 690 - 690 253 - 253
Total non-accrual loans $ 15,211 $ 97 $ 15,114 $ 1,157 $ 215 $ 942
At December 31, 2018 At December 31, 2017
Gross Guaranteed Net Gross Guaranteed Net
Commercial $ 750 $ 300 $ 450 $ 1,057 $ 32 $ 1,025
Commercial real estate 381 56 325 1,724 70 1,654
Agriculture 4,830 776 4,054 - - -
Residential mortgage 100 - 100 781 - 781
Residential construction - - - - - -
Consumer 191 - 191 205 - 205
Total non-accrual loans $ 6,252 $ 1,132 $ 5,120 $ 3,767 $ 102 $ 3,665
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Table of Contents
At December 31, 2016
Gross Guaranteed Net
Commercial $ 5,000 $ 2,000 $ 3,000
Commercial real estate 540 81 459
Agriculture - - -
Residential mortgage 654 - 654
Residential construction - - -
Consumer 103 - 103
Total non-accrual loans $ 6,297 $ 2,081 $ 4,216
Non-accrual loans amounted to $15,211,000 at December 31, 2020 , and were
comprised of four commercial loans totaling $363,000 , three commercial real
estate loans totaling $4,875,000 , three agriculture loans totaling $9,130,000 ,
one residential mortgage loan totaling $153,000 and five consumer loans totaling
$690,000 . Non-accrual loans amounted to $1,157,000 at December 31, 2019 , and
were comprised of three commercial loans totaling $266,000 , two commercial real
estate loans totaling $466,000 , one residential mortgage loan totaling $172,000
and four consumer loans totaling $253,000 .
If interest on non-accrual loans had been accrued, such interest income would
have approximated $1,038,000 and $139,000 during the years ended December 31,
2020 and 2019, respectively. The increase in lost interest was primarily due to
two commercial real estate loans comprising one relationship and three
agriculture loans and one consumer loan comprising one relationship that were
placed on non-accrual in 2020. Income actually recognized for these loans
approximated $71,000 and $475,000 for the years ended December 31, 2020 and
2019, respectively.
Loans for which it is probable that payment of interest and principal will not
be made in accordance with the contractual terms of the loan agreement are
considered impaired. Non-performing impaired loans are non-accrual loans and
loans that are 90 days or more past due and still accruing. Total
non-performing impaired loans at December 31, 2020 and 2019, consisting of loans
on non-accrual status totaled $15,211,000 and $1,157,000 , respectively. A
restructuring of a loan can constitute a troubled debt restructuring if the
Company for economic or legal reasons related to the borrower's financial
difficulties grants a concession to the borrower that it would not otherwise
consider. A loan that is restructured in a troubled debt restructuring is
considered an impaired loan. Performing impaired loans, which consisted of
loans modified as troubled debt restructurings, totaled $2,260,000 and
$3,318,000 at December 31, 2020 and 2019, respectively. The Company expects to
collect all principal and interest due from performing impaired loans. These
loans are not on non-accrual status. No assurance can be given that the
existing or any additional collateral will be sufficient to secure full recovery
of the obligations owed under these loans.
The Company had no loans 90 days past due and still accruing as of the periods
ended
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As the following table illustrates, total non-performing assets, which consists
of loans on non-accrual status, loans past due 90-days and still accruing and
Other Real Estate Owned ("OREO") net of guarantees of the State of California
and U.S. Government , including its agencies and its government-sponsored
agencies, increased $14,172,000 , or 1504.5%, to $15,114,000 from December 31,
2019 to December 31, 2020 . Non-performing assets net of guarantees represent
0.9% and 0.1% of total assets at December 31, 2020 and 2019, respectively. The
Bank's management believes that the $15,211,000 in non-accrual loans were
appropriately reflected at their fair value at December 31, 2020 . However, no
assurance can be given that the existing or any additional collateral will be
sufficient to secure full recovery of the obligations owed under these loans.
At December 31, 2020 At
Gross Guaranteed Net Gross Guaranteed Net
(dollars in
thousands)
Non-accrual loans $ 15,211 $ 97 $ 15,114 $ 1,157 $ 215 $ 942
Loans 90 days past
due and still
accruing - - - - - -
Total non-performing
loans 15,211 97 15,114 1,157 215 942
Other real estate
owned - - - - - -
Total non-performing
assets 15,211 97 15,114 1,157 215 942 Non-performing loans (net of guarantees) to total loans 1.7 % 0.1 % Non-performing assets (net of guarantees) to total assets 0.9 % 0.1 % Allowance for loan and lease losses to non-performing loans (net of guarantees) 102.0 %
1,311.7 %
At December 31, 2018 At December 31, 2017
Gross Guaranteed Net Gross Guaranteed Net
(dollars in
thousands)
Non-accrual loans $ 6,252 $ 1,132 $ 5,120 $ 3,767 $ 102 $ 3,665
Loans 90 days past
due and still
accruing - - - 45 - 45
Total non-performing
loans 6,252 1,132 5,120 3,812 102 3,710
Other real estate
owned 1,092 - 1,092 - - -
Total non-performing
assets 7,344 1,132 6,212
3,812 102 3,710
Non-performing loans
(net of guarantees)
to total loans 0.7 % 0.5 %
Non-performing assets
(net of guarantees)
to total assets 0.5 % 0.3 %
Allowance for loan
and lease losses to
non-performing loans
(net of guarantees) 250.4 % 300.1 %
At December 31, 2016
Gross Guaranteed Net
(dollars in thousands)
Non-accrual loans $ 6,297 $ 2,081 $ 4,216
Loans 90 days past due and still accruing - - -
Total non-performing loans 6,297 2,081 4,216
Other real estate owned - - -
Total non-performing assets 6,297 2,081 4,216
Non-performing loans (net of guarantees) to total
loans 0.6 %
Non-performing assets (net of guarantees) to total assets
0.4 %
Allowance for loan and lease losses to
non-performing loans (net of guarantees) 258.5 %
OREO consists of property that the Company has acquired by deed in lieu of
foreclosure or through foreclosure proceedings, and property that the Company
does not hold title to but is in actual control of, known as in-substance
foreclosure. The estimated fair value of the property is determined prior to
transferring the balance to OREO. The balance transferred to OREO is the
estimated fair value of the property less estimated cost to sell. Impairment
may be deemed necessary to bring the book value of the loan equal to the
appraised value. Appraisals or loan officer evaluations are then conducted
periodically thereafter charging any additional impairment to the appropriate
expense account. The Company had no OREO as of the years ended December 31,
2020 and 2019.
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Potential Problem Loans
The Company manages asset quality and credit risk by maintaining diversification
in its loan portfolio and through review processes that include analysis of
credit requests and ongoing examination of outstanding loans and delinquencies,
with particular attention to portfolio dynamics and loan mix. The Company
strives to identify loans experiencing difficulty early enough to correct the
problems, to record charge-offs promptly based on realistic assessments of
collectability and current collateral values and to maintain an adequate
allowance for loan losses at all times. Asset quality reviews of loans and
other non-performing assets are administered using credit risk rating standards
and criteria similar to those employed by state and federal banking regulatory
agencies. The federal banking regulatory agencies utilize the following
definitions for assets adversely classified for supervisory purposes:
"Substandard Assets: a substandard asset is inadequately protected by the
current sound worth and paying capacity of the obligor or of the collateral
pledged, if any. Assets so classified must have a well-defined weakness or
weaknesses that jeopardize the liquidation of the debt. They are characterized
by the distinct possibility that the institution will sustain some loss if the
deficiencies are not corrected." "Doubtful Assets: An asset classified doubtful
has all the weaknesses inherent in one classified substandard with the added
characteristic that the weaknesses make collection or liquidation in full, on
the basis of currently existing facts, conditions, and values, highly
questionable and improbable. OREO and loans rated Substandard and Doubtful are
deemed "classified assets." This category, which includes both performing and
non-performing assets, receives an elevated level of attention regarding
collection.
Commercial loans, whether secured or unsecured, generally are made to support
the short-term operations and other needs of small businesses. These loans are
generally secured by the receivables, equipment, and other real property of the
business and are susceptible to the related risks described above. Problem
commercial loans are generally identified by periodic review of financial
information that may include financial statements, tax returns, and payment
history of the borrower. Based on this information, the Company may decide to
take any of several courses of action, including demand for repayment, requiring
the borrower to provide a significant principal payment and/or additional
collateral or requiring similar support from guarantors. Notwithstanding, when
repayment becomes unlikely based on the borrower's income and cash flow,
repossession or foreclosure of the underlying collateral may become necessary.
Collateral values may be determined by appraisals obtained through
Bank-approved, licensed appraisers, qualified independent third parties,
purchase invoices, or other appropriate documentation. Appropriate valuations
are obtained at origination of the credit and periodically thereafter (generally
every 3-12 months depending on the collateral type and market conditions), once
repayment is questionable, and the loan has been deemed classified.
Commercial real estate loans generally fall into two categories, owner-occupied
and non-owner occupied. Loans secured by owner occupied real estate are
primarily susceptible to changes in the market conditions of the related
business. This may be driven by, among other things, industry changes,
geographic business changes, changes in the individual financial capacity of the
business owner, general economic conditions, and changes in business cycles.
These same risks apply to commercial loans whether secured by equipment,
receivables, or other personal property or unsecured. Problem commercial real
estate loans are generally identified by periodic review of financial
information that may include financial statements, tax returns, payment history
of the borrower, and site inspections. Based on this information, the Company
may decide to take any of several courses of action, including demand for
repayment, requiring the borrower to provide a significant principal payment
and/or additional collateral or requiring similar support from guarantors.
Notwithstanding, when repayment becomes unlikely based on the borrower's income
and cash flow, repossession or foreclosure of the underlying collateral may
become necessary. Losses on loans secured by owner-occupied real estate,
equipment, or other personal property generally are dictated by the value of
underlying collateral at the time of default and liquidation of the collateral.
When default is driven by issues related specifically to the business owner,
collateral values tend to provide better repayment support and may result in
little or no loss. Alternatively, when default is driven by more general
economic conditions, underlying collateral generally has devalued more and
results in larger losses due to default. Loans secured by non-owner occupied
real estate are primarily susceptible to risks associated with swings in
occupancy or vacancy and related shifts in lease rates, rental rates or room
rates. Most often, these shifts are a result of changes in general economic or
market conditions or overbuilding and resultant over-supply of space. Losses
are dependent on the value of underlying collateral at the time of default.
Values are generally driven by these same factors and influenced by interest
rates and required rates of return as well as changes in occupancy costs.
Collateral values may be determined by appraisals obtained through
Bank-approved, licensed appraisers, qualified independent third parties, sales
invoices, or other appropriate means. Appropriate valuations are obtained at
origination of the credit and periodically thereafter (generally every 3-12
months depending on the collateral type and market conditions), once repayment
is questionable, and the loan has been deemed classified.
Agricultural loans, whether secured or unsecured, generally are made to
producers and processors of crops and livestock. Repayment is primarily from
the sale of an agricultural product or service. Agricultural loans are
generally secured by inventory, receivables, equipment, and other real
property. Agricultural loans primarily are susceptible to changes in market
demand for specific commodities. This may be exacerbated by, among other
things, industry changes, changes in the individual financial capacity of the
business owner, general economic conditions and changes in business cycles, as
well as changing weather conditions. Problem agricultural loans are generally
identified by periodic review of financial information that may include
financial statements, tax returns, crop budgets, payment history, and crop
inspections. Based on this information, the Company may decide to take any of
several courses of action, including demand for repayment, requiring the
borrower to provide a significant principal payment and/or additional collateral
or requiring similar support from guarantors. Notwithstanding, when repayment
becomes unlikely based on the borrower's income and cash flow, repossession or
foreclosure of the underlying collateral may become necessary. Collateral
values may be determined by appraisals obtained through Bank-approved, licensed
appraisers, qualified independent third parties, purchase invoices, or other
appropriate documentation. Appropriate valuations are obtained at origination
of the credit and periodically thereafter (generally every 3-12 months depending
on the collateral type and market conditions), once repayment is questionable,
and the loan has been deemed classified.
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Residential mortgage loans, which are secured by real estate, are primarily
susceptible to three risks; non-payment due to diminished or lost income,
over-extension of credit, a lack of borrower's cash flow to sustain payments,
and shortfalls in collateral value. In general, non-payment is due to loss of
employment and follows general economic trends in the marketplace, particularly
the upward movement in the unemployment rate, loss of collateral value, and
demand shifts. Problem residential mortgage loans are generally identified via
payment default. Based on this information, the Company may decide to take any
of several courses of action, including demand for repayment, requiring the
borrower to provide a significant principal payment and/or additional collateral
or requiring similar support from guarantors. Notwithstanding, when repayment
becomes unlikely based on the borrower's income and cash flow, repossession or
foreclosure of the underlying collateral may become necessary. Collateral
values may be determined by appraisals obtained through Bank-approved, licensed
appraisers, qualified independent third parties, purchase invoices, or other
appropriate documentation. Appropriate valuations are obtained at origination
of the credit and periodically thereafter (generally every 3-12 months depending
on the collateral type and market conditions), once repayment is questionable,
and the loan has been deemed classified.
Construction loans, whether owner occupied or non-owner occupied residential
development loans, are not only susceptible to the related risks described above
but the added risks of construction itself, including cost over-runs,
mismanagement of the project, or lack of demand and market changes experienced
at time of completion. Again, losses are primarily related to underlying
collateral value and changes therein as described above. Problem construction
loans are generally identified by periodic review of financial information that
may include financial statements, tax returns and payment history of the
borrower. Based on this information, the Company may decide to take any of
several courses of action, including demand for repayment, requiring the
borrower to provide a significant principal payment and/or additional collateral
or requiring similar support from guarantors, or repossession or foreclosure of
the underlying collateral. Collateral values may be determined by appraisals
obtained through Bank-approved, licensed appraisers, qualified independent third
parties, purchase invoices, or other appropriate documentation. Appropriate
valuations are obtained at origination of the credit and periodically thereafter
(generally every 3-12 months depending on the collateral type and market
conditions), once repayment is questionable, and the loan has been deemed
classified.
Consumer loans, whether unsecured or secured, are primarily susceptible to four
risks: non-payment due to diminished or lost income, over-extension of credit, a
lack of borrower's cash flow to sustain payments, and shortfall in collateral
value. In general, non-payment is due to loss of employment and will follow
general economic trends in the marketplace, particularly the upward movements in
the unemployment rate, loss of collateral value, and demand shifts. Problem
consumer loans are generally identified via payment default. Based on this
information, the Company may decide to take any of several courses of action,
including demand for repayment, requiring the borrower to provide a significant
principal payment and/or additional collateral or requiring similar support from
guarantors. Notwithstanding, when repayment becomes unlikely based on the
borrower's income and cash flow, repossession or foreclosure of the underlying
collateral may become necessary. Collateral values may be determined by
appraisals obtained through Bank-approved, licensed appraisers, qualified
independent third parties, purchase invoices, or other appropriate
documentation. Appropriate valuations are obtained at origination of the credit
and periodically thereafter (generally every 3-12 months depending on the
collateral type and market conditions), once repayment is questionable, and the
loan has been deemed classified.
Once a loan becomes delinquent or repayment becomes questionable, a Company
collection officer will address collateral shortfalls with the borrower and
attempt to obtain additional collateral or a principal payment. If this is not
forthcoming and payment of principal and interest in accordance with the
contractual terms of the loan agreement becomes unlikely, the Company will
consider the loan to be impaired and will estimate its probable loss, using the
present value of future cash flows discounted at the loan's effective interest
rate, the loan's observable market price, or the fair value of the collateral if
the loan is collateral dependent. For collateral dependent loans, the Company
will utilize a recent valuation of the underlying collateral less estimated
costs of sale, and charge-off the loan down to the estimated net realizable
amount. Depending on the length of time until final collection, the Company may
periodically revalue the estimated loss and take additional charge-offs or
specific reserves as warranted. Revaluations may occur as often as every 3-12
months depending on the underlying collateral and volatility of values. Final
charge-offs or recoveries are taken when the collateral is liquidated and the
actual loss is confirmed. Unpaid balances on loans after or during collection
and liquidation may also be pursued through legal action and attachment of wages
or judgment liens on the borrower's other assets.
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Excluding the non-performing loans cited previously, loans totaling $11,878,000
and $8,749,000 were classified as substandard or doubtful loans, representing
potential problem loans at December 31, 2020 and 2019, respectively. In
Management's opinion, the potential loss related to these problem loans was
sufficiently covered by the Bank's existing loan loss reserve (Allowance for
Loan Losses) at December 31, 2020 and 2019. The ratio of the Allowance for Loan
Losses to total loans at December 31, 2020 and 2019 was 1.73% and 1.58%,
respectively.
SUMMARY OF LOAN LOSS EXPERIENCE
The Company's allowance for credit losses is maintained at a level considered
adequate to provide for losses that can be estimated based upon specific and
general conditions. These include conditions unique to individual borrowers, as
well as overall credit loss experience, the amount of past due, non-performing
loans and classified loans, recommendations of regulatory authorities,
prevailing economic conditions and other factors. A portion of the allowance is
specifically allocated to classified loans whose full collectability is
uncertain. Such allocations are determined by Management based on loan-by-loan
analyses. In addition, loans with similar characteristics not usually
criticized using regulatory guidelines are analyzed based on the historical loss
rates and delinquency trends, grouped by the number of days the payments on
these loans are delinquent. Last, allocations are made to non-criticized and
classified commercial loans and residential real estate loans based on
historical loss rates, and other statistical data. The remainder of the
allowance is considered to be unallocated. The unallocated allowance is
established to provide for probable losses that have been incurred as of the
reporting date but not reflected in the allocated allowance. It addresses
additional qualitative factors consistent with Management's analysis of the
level of risks inherent in the loan portfolio, which are related to the risks of
the Company's general lending activity. Included in the unallocated allowance
is the risk of losses that are attributable to national or local economic or
industry trends which have occurred but have yet been recognized in past loan
charge-off history (external factors). The external factors evaluated by the
Company include: economic and business conditions, external competitive issues,
and other factors. Also included in the unallocated allowance is the risk of
losses attributable to general attributes of the Company's loan portfolio and
credit administration (internal factors). The internal factors evaluated by the
Company include: loan review system, adequacy of lending Management and staff,
loan policies and procedures, problem loan trends, concentrations of credit, and
other factors. By their nature, these risks are not readily allocable to any
specific loan category in a statistically meaningful manner and are difficult to
quantify. Management assigns a range of estimated risk to the qualitative risk
factors described above based on Management's judgment as to the level of risk
and assigns a quantitative risk factor from the range of loss estimates to
determine the appropriate level of the unallocated portion of the allowance.
Management considered the $15,416,000 allowance for credit losses to be adequate
as a reserve against losses as of December 31, 2020 .
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Analysis of the Allowance for Loan Losses
(Dollars in thousands)
2020 2019 2018 2017 2016
Balance at Beginning of Year $ 12,356 $ 12,822 $ 11,133 $ 10,899 $ 9,251
Provision for Loan Losses 3,050 - 2,100 600 1,800
Loans Charged-Off:
Commercial (212 ) (638 ) (509 ) (681 ) (446 )
Commercial Real Estate - - (142 ) - (15 )
Agriculture - (98 ) - - -
Residential Mortgage - - - (121 ) (13 )
Residential Construction - - - - -
Consumer (15 ) (43 ) (34 ) (33 ) (65 )
Total Charged-Off (227 ) (779 ) (685 ) (835 ) (539 )
Recoveries:
Commercial 201 209 46 302 37
Commercial Real Estate - - - - -
Agriculture - - - - 81
Residential Mortgage - 74 34 96 1
Residential Construction - 21 131 5 5
Consumer 36 9 63 66 263
Total Recoveries 237 313 274 469 387
Net Recoveries (Charge-offs) 10 (466 ) (411 ) (366 ) (152 )
Balance at End of Year $ 15,416 $ 12,356 $ 12,822 $ 11,133 $ 10,899
Ratio of Net Recoveries
(Charge-Offs)
During the Year to Average
Loans
Outstanding During the Year 0.00 % (0.06 %) (0.05 %) (0.05 %) (0.02 %)
Allowance as a percentage of
Total Loans 1.73 % 1.58 % 1.65 % 1.49 % 1.60 %
Allowance as a percentage of
Non-performing loans, net of
guarantees 102.0 % 1,311.7 % 250.4 % 300.1 % 258.5 %
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Allocation of the Allowance for Loan LossesThe Allowance for Loan Losses has been established as a general component available to absorb probable inherent losses throughout the loan portfolio.
The
following table is an allocation of the Allowance for Loan Losses balance on the dates indicated (dollars in thousands):
December 31, 2020 December 31, 2019 December 31, 2018
Allocation of Allocation of Allocation of Allowance as Loans as a %
Allowance for Allowance as Loans as a Allowance for Allowance as a Loans as a Allowance for a % of
Loan Losses a % of Total % of Total Loan Losses % of Total % of Total Loan Losses of Total Total Loans,
Balance Allowance Loans, net Balance Allowance Loans, net Balance Allowance net
Loan Type:
Commercial $ 2,252 14.6 % 28.7 % $ 2,354 19.1 % 13.6 % $ 3,198 25.0 % 16.1 %
Commercial Real Estate 7,915 51.3 % 50.8 % 6,846 55.4 % 58.0 % 5,890 45.9 % 54.2 %
Agriculture 3,834 25.0 % 10.6 % 2,054 16.6 % 14.8 % 1,632 12.7 % 15.9 %
Residential Mortgage 635 4.1 % 7.2 % 466 3.8 % 8.3 % 643 5.0 % 6.6 %
Residential Construction 128 0.8 % 0.5 % 201 1.6 % 1.9 % 318 2.5 % 2.6 %
Consumer 214 1.4 % 2.2 % 236 1.9 % 3.4 % 279 2.2 % 4.6 %
Unallocated 438 2.8 % - 199 1.6 % - 862 6.7 % -
Total $ 15,416 100.0 % 100.0 % $ 12,356 100.0 % 100.0 % $ 12,822 100.0 % 100.0 %
December 31, 2017 December 31, 2016
Allocation of Allocation of
Allowance Allowance Allowance Allowance
for Loan as a % of Loans as a % for Loan as a % of Loans as a %
Losses Total of Total Losses Total of Total
Balance Allowance Loans, net Balance Allowance Loans, net
Loan Type:
Commercial $ 2,625 23.7 % 18.0 % $ 3,571 32.8 % 18.3 %
Commercial Real Estate 5,460 49.0 % 53.2 % 3,910 35.9 % 50.9 %
Agriculture 1,547 13.9 % 15.2 % 1,262 11.6 % 15.0 %
Residential Mortgage 628 5.6 % 5.6 % 660 6.0 % 5.9 %
Residential Construction 360 3.2 % 2.8 % 440 4.0 % 3.5 %
Consumer 342 3.1 % 5.2 % 498 4.6 % 6.4 %
Unallocated 171 1.5 % - 558 5.1 % -
Total $ 11,133 100.0 % 100.0 % $ 10,899 100.0 % 100.0 %
The Bank believes that any breakdown or allocation of the allowance into loan
categories lends an appearance of exactness, which does not exist, because the
allowance is available for all loans. The allowance breakdown shown above is
computed taking actual experience into consideration but should not be
interpreted as an indication of the specific amount and allocation of actual
charge-offs that may ultimately occur.
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Deposits
The following table sets forth the average amount and the average rate paid on
each of the listed deposit categories (dollars in thousands) during the periods
specified:
2020 2019 2018
Average Average Average
Amount Average Rate Amount Average Rate Amount Average Rate
Deposit Type:
Non-interest-Bearing
Demand$ 577,559 -$ 408,551 -$ 394,106 -
Interest-Bearing
Demand (NOW)$ 356,867 0.10 %$ 308,917 0.16 %$ 307,727 0.14 % Savings and MMDAs$ 387,490 0.20 %$ 334,672 0.29 %$ 333,788 0.17 % Time$ 54,147 0.63 %$ 58,128 0.64 %$ 67,177 0.42 %
The following table sets forth by time remaining to maturity the Bank's time
deposits over
Three months or less$ 5,110
Over three months through twelve months 5,877
Over twelve months 3,656 Total$ 14,643 Short-Term Borrowings Short-term borrowings totaling$5,000,000 as ofDecember 31, 2020 consisted of an advance with the FHLB through its COVID-19 Relief and Recovery Advances Program. The advance matures in 0.4 years and has a 0% interest rate. The advance is secured under terms of a blanket collateral agreement by a pledge of FHLB stock and certain other qualifying collateral such as commercial and mortgage loans. Average outstanding balances of short-term borrowings were$5,656,000 and$0 during 2020 and 2019, respectively. As ofDecember 31, 2020 , the Company had a remaining collateral borrowing capacity with the FHLB of$292,046,000 and, at such date, also had unsecured formal lines of credit totaling$122,000,000 with correspondent banks. The Company had no short-term borrowings as ofDecember 31, 2019 .
The Company had no Federal Funds purchased during the years ended
Long-Term Borrowings
The Company had no long-term borrowings at December 31, 2020 and 2019. There
were no average outstanding balances of long-term borrowings during 2020 and
2019.
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Supplemental Compensation Plans
The Company and the Bank maintain an unfunded non-contributory defined benefit
pension plan ("Salary Continuation Plan") and related split dollar plan for a
select group of highly compensated employees. Eligibility to participate in the
Salary Continuation Plan is limited to a select group of management or highly
compensated employees of the Bank that are designated by the Board.
Additionally, the Company and the Bank adopted a supplemental executive
retirement plan ("SERP") in 2006. The SERP is intended to integrate the various
forms of retirement payments offered to executives. There are currently three
participants in the SERP. At December 31, 2020 , the accrued benefit liability
was $7,127,000 , of which $4,173,000 was recorded in interest payable and other
liabilities and $2,954,000 was recorded in accumulated other comprehensive
income (loss), net, in the Consolidated Balance Sheets. At December 31, 2019 ,
the accrued benefit liability was $5,871,000 , of which $3,891,000 was recorded
in interest payable and other liabilities and $1,980,000 was recorded in
accumulated other comprehensive income (loss), net, in the Consolidated Balance
Sheets.
The Company and the Bank maintain an unfunded non-contributory defined benefit
pension plan ("Directors' Retirement Plan") and related split dollar plan for
the directors of the Bank. At December 31, 2020 , the accrued benefit liability
was $831,000 , of which $757,000 was recorded in interest payable and other
liabilities and $74,000 was recorded in accumulated other comprehensive income
(loss), net, in the Consolidated Balance Sheets. At December 31, 2019 , the
accrued benefit liability was $820,000 , of which $798,000 was recorded in
interest payable and other liabilities and $22,000 was recorded in accumulated
other comprehensive income (loss), net, in the Consolidated Balance Sheets.
For additional information, see Note 17 to the Consolidated Financial Statements in this Form 10-K.
Overview
Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
Net income for the year ended December 31, 2020 , was $12.2 million , representing
a decrease of $2.6 million , or 17.4%, compared to net income of $14.7 million
for the year ended December 31, 2019 . The decrease in net income was
principally attributable to a $3.1 million increase in provision for loan loss
and $1.5 million increase in non-interest expenses, which was partially offset
by a $0.4 million decrease in interest expense, $0.6 million increase in
non-interest income, and $1.2 million decrease in provision for income taxes.
Total assets increased by $362.8 million , or 28.1%, to $1.66 billion as of
December 31, 2020 , compared to $1.29 billion at December 31, 2019 . The increase
in total assets was primarily due to a $155.7 million increase in cash and cash
equivalents, $92.2 million increase in investment securities, and $112.0 million
increase in net loans (including loans held-for-sale). Total deposits increased
$339.5 million , or 29.8%, to $1.48 billion as of December 31, 2020 , compared to
$1.14 billion at December 31, 2019 .
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Results of Operations
Net Interest Income
Net interest income is the excess of interest and fees earned on the Bank's
loans, investment securities, federal funds sold and banker's acceptances over
the interest expense paid on deposits, mortgage notes and other borrowed funds
which are used to fund those assets. Net interest income is primarily affected
by the yields and mix of the Bank's interest-earning assets and interest-bearing
liabilities outstanding during the period. The $129,000 decrease in the Bank's
interest and dividend income in 2020 from 2019 was driven by decreased interest
rates, which was partially offset by increased volumes. Decreasing interest
rates drove decreases in interest income from loans, due from bank balances, and
investment securities by $5,937,000 , $2,736,000 , and $858,000 , respectively.
This was partially offset by increasing volume growth that drove increases in
interest income from loans, due from bank balances, and investment securities by
$7,409,000 , $1,253,000 , and $825,000 , respectively. Also included in interest
income on loans in 2020 was approximately $5.9 million in PPP loan fees
recognized. The $375,000 decrease in the Bank's interest expense on deposits
was primarily driven by a $551,000 decrease due to decreasing interest rates,
which was partially offset by a $176,000 increase driven by volume growth. See
"Analysis of Changes in Interest Income and Interest Expense" set forth on page
39 of this Annual Report on Form 10-K for a discussion of the effects of
interest rates and loan/deposit volume on net interest income.
The Federal Reserve influences the general market rates of interest, including
the deposit and loan rates offered by many financial institutions. Our loan
portfolio is significantly affected by changes in the prime interest rate. The
prime interest rate, which is the rate offered on loans to borrowers with strong
credit, was 4.75% at December 31, 2019 . In March 2020 , the prime rate decreased
150 basis points to 3.25%, where it remained through December 31, 2020 . The
effective federal funds rate, which is the cost of immediately available
overnight funds, was at a target range of 1.50 % to 1.75% at December 31, 2019 .
In March 2020 , the target range for the federal funds rate decreased 150 basis
points to 0% to 0.25% where it remained through December 31, 2020 . The decrease
in the target range for the federal funds rate in March 2020 was largely an
emergency measure by the Federal Reserve aimed at blunting the economic impact
of COVID-19.
We are primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This lower-cost funding base is expected to have a positive impact on our net interest income and net interest margin in a rising interest rate environment.
The nature and impact of future changes in interest rates and monetary policy on the business and earnings of the Company cannot be predicted. For additional information, see "The Effects of Changes or Increases in, or Supervisory Enforcement of, Banking or Other Laws and Regulations or Governmental Fiscal or Monetary Policies Could Adversely Affect Us" in "Risk Factors (Item 1A) of this Report on Form 10-K. Interest income on loans for 2020 was up 3.8% from 2019, increasing from$39,097,000 to$40,569,000 . The increase in interest income on loans was primarily due to the recognition of processing fees from the SBA related to the origination of the PPP loans. The Company received a total of approximately$7.8 million in processing fees from the SBA during 2020. These fees are required to be recognized as an adjustment to the effective yield over the life of the loan. In 2020 the Bank recognized$5.9 million of these processing fees which are included as a component of interest income on loans. The remaining balance of approximately$1.9 million will be recognized over the remaining life of the PPP loans. The increase in interest income on loans was offset by a 74 basis point decrease in loan yields compared to 2019. The decrease in loan yields compared to the prior period is due to several factors: adjustable rate loans re-pricing at lower rates as a result of recent declines in interest rates and related indices, which is mitigated to some extent by the inclusion of interest rate floors on the majority of our variable rate loans; the accommodation of certain fixed rate loan customers to re-price their existing loans at lower rates to retain existing relationships in a competitive rate environment; an increase in non-accrual loan balances; our policy election to cease interest recognition for loans provided temporary full payment deferrals during the term of the forbearance period (generally ranging from three to six months) under Section 4013 of the CARES Act (see Note 1 of the Notes to Condensed Consolidated Financial Statements) and the origination of$235 million of PPP loans at an interest rate of 1%. The Bank provided temporary forbearance relief for borrowers over the course of 2020 totaling approximately$102 million , resulting in the net deferral of interest income of approximately$1.2 million for the year endedDecember 31, 2020 . A majority of loans completed its forbearance period during the fourth quarter of 2020. Two loans totaling$7.0 million were on an interest only forbearance plan and one loan totaling$0.8 million was on a principal and interest forbearance plan atDecember 31, 2020 . Interest income on interest-bearing due from banks for 2020 was down 72.9% from 2019, decreasing from$2,148,000 to$582,000 . The decrease in interest income on interest-bearing due from banks was the result of a 187 basis point decrease in yield on interest-bearing due from banks, which was partially offset by a 90.7% increase in average balances of interest-bearing due from banks. The decrease in yield was primarily due to the decrease in the effective federal funds rate as discussed above. 52 -------------------------------------------------------------------------------- Table of Contents Interest income on certificates of deposit for 2020 was up 23.4% from 2019, increasing from$355,000 to$438,000 . The increase in interest income on certificates of deposit was the result of a 53.2% increase in average balances of certificates of deposit, which was partially offset by a 55 basis point decrease in yield on certificates of deposit. Interest income on investment securities for 2020 was down 0.48% from 2019, decreasing from$6,937,000 to$6,904,000 . The decrease in interest income on investment securities was the result of a 24 basis point decrease in investment securities yields, which was partially offset by a 12.1% increase in average investment securities volume. The Bank deployed excess liquidity into the investment portfolio over the course of 2020, although reinvestment rates were generally lower than existing yields in the portfolio, which decreased overall portfolio yields. Investment securities yields were 1.93% and 2.17% for 2020 and 2019, respectively. Interest expense on deposits for 2020 was down 20.2% from 2019, decreasing from$1,859,000 to$1,484,000 . The decrease in interest expense on deposits was the result of a 7 basis point decrease in interest rates paid on interest-bearing deposits, which was partially offset by a 13.8% increase in average balances of interest-bearing deposits. The mix of deposits for the previous three years was as follows (dollars in thousands): 2020 2019 2018 Average Average Average Balance Percent Balance Percent Balance Percent Non-interest-Bearing Demand$ 577,559 42.0 %$ 408,551 36.9 %$ 394,106 35.7 % Interest-Bearing Demand (NOW) 356,867 25.9 % 308,917 27.8 % 307,727 27.9 % Savings and MMDAs 387,490 28.2 % 334,672 30.1 % 333,788 30.3 % Time 54,147 3.9 % 58,128 5.2 % 67,177 6.1 % Total$ 1,376,063 100.0 %$ 1,110,268 100.0 %$ 1,102,798 100.0 % The Bank's net interest margin (net interest income divided by average earning assets) was 3.23% in 2020 and 4.00% in 2019. The net spread between the rate for total earning assets and the rate for interest-bearing deposits and borrowed funds decreased 76 basis points from 2019 to 2020. The decrease in the net spread was primarily due to an overall decrease in interest rates on earning assets, coupled with an increase in average due from banks as a percentage of total average earning assets, which was partially offset by a decrease in interest rates on interest-bearing deposits. Provision for Loan Losses The provision for loan losses is established by charges to earnings based on management's overall evaluation of the collectability of the loan portfolio. Based on this evaluation, the provision for loan losses increased to$3,100,000 in 2020 from no provision in 2019, primarily due to increases in qualitative factors adversely affecting our loan portfolio resulting from the downturn in economic conditions associated with the COVID-19 pandemic. Also driving the increase was a specific reserve on one loan totaling$2.1 million atDecember 31, 2020 . The amount of loans charged-off decreased in 2020 to$227,000 from$779,000 in 2019, and recoveries decreased to$237,000 in 2020 from$313,000 in 2019. The ratio of the Allowance for Loan Losses to total loans atDecember 31, 2020 was 1.73% compared to 1.58% atDecember 31, 2019 . The ratio of the Allowance for Loan Losses to total non-accrual loans and loans past due 90 days or more, net of guarantees was 102.0% atDecember 31, 2020 , compared to 1311.70% atDecember 31, 2019 . The decrease was primarily due to the increase in nonaccrual loans, net of guarantees totaling$14.2 million . 53
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Non-Interest Income and Expenses
Non-interest income consisted primarily of service charges on deposit accounts,
net gain on sale of available-for-sale securities, net realized gains on loans
held-for-sale, debit card income and other income. Service charges on deposit
accounts decreased $608,000 in 2020 over 2019. The decrease in service charges
on deposit accounts was primarily a result of the COVID-19 pandemic and the
Bank's decision to waive overdraft/NSF fees for all business and consumer
customers for an initial period of 60 days which began in March and was later
extended into the third quarter. The auto-waiver period expired on August 1,
2020 . This assistance resulted in increased fee waiver activity, reducing
reported service charge income. Net gains on sale of available-for-sale
securities increased $299,000 in 2020 over 2019 primarily due to the sale of
municipal securities in 2020. Net realized gains on loans held-for-sale
increased $1,633,000 in 2020 over 2019. The increase in gains on sales of loans
held-for-sale was primarily due to an increase in loan origination volumes as a
result of the decline in interest rates and uptick in refinancing activity
during 2020. Other income decreased $726,000 in 2020 over 2019. The decrease
was primarily due to a gain on sale of land recognized in 2019 that was not
repeated during 2020, decrease in mortgage brokerage income due to decreased
mortgage brokerage volume, and decrease in loan servicing income due to
impairment expense recognized on mortgage servicing rights asset.
Non-interest expenses consisted primarily of salaries and employee benefits,
occupancy and equipment expense, data processing expense and other expenses.
Non-interest expenses increased to $35,477,000 in 2020 from $33,940,000 in 2019,
representing an increase of $1,537,000 , or 4.5%.
Following is an analysis of the increase or decrease in the components of non-interest expenses (dollars in thousands) during the periods specified:
2020 over 2019
Amount Percent
Salaries and Employee Benefits $ 1,133 5.2 %
Occupancy and Equipment 505 16.0 %
Data Processing (129 ) (4.6 %)
Stationery and Supplies (8 ) (2.7 %)
Advertising (16 ) (3.7 %)
Directors Fees 27 9.4 %
OREO Expense and Impairment (305 ) (100.3 %)
Other Expense 330 7.0 %
Total $ 1,537 4.5 %
The increase in salaries and employee benefits in 2020 was primarily due to a 7%
increase in regular salaries, a 17% increase in commissions and an 11% increase
in group insurance, which was partially offset by a 20% decrease in profit
sharing expense. The increase in regular salaries expense and group insurance
was primarily due to increased staffing levels and salary increases. The
increase in commissions was primarily due to an increase in mortgage
originations due to the decline in interest rates and uptick in refinancing
activity in 2020. The decrease in profit sharing expense was primarily due to
the decrease in income before tax compared to 2019. The increase in occupancy
and equipment expense was primarily due to a full year of rent expense and other
expenses associated with the opening of an administrative office space in the
third quarter of 2019, and a new branch in the fourth quarter of 2019. The
decrease in data processing expense was primarily due to costs incurred in 2019
that was not repeated in 2020 associated with outsourcing core processing and
network infrastructure to third parties. The decrease in other real estate
owned expense was primarily due to a writedown on an other real estate owned
property in 2019 that was not repeated in 2020. The increase in other expenses
was primarily due to a increases in FDIC assessments and loan collection
expenses.
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Income Taxes
The provision for income taxes is primarily affected by the tax rate, the level
of earnings before taxes and the level of tax-exempt income. In 2020, tax
expense decreased to $4,501,000 from $5,670,000 in 2019, due to a decrease in
income before taxes. Non-taxable municipal bond income was $498,000 and
$300,000 for the years ended December 31, 2020 and 2019, respectively.
Liquidity
Liquidity is defined as the ability to generate cash at a reasonable cost to
fulfill lending commitments and support asset growth, while satisfying the
withdrawal demands of deposit customers and any debt repayment requirements.
The Bank's principal sources of liquidity are core deposits and loan and
investment payments and proceeds of sale and prepayments. Providing a secondary
source of liquidity is the available-for-sale investment portfolio. The Company
held $435,080,000 in total investment securities at December 31, 2020 . Under
certain deposit, borrowing, and other arrangements, the Company must hold and
pledge investment securities as collateral. At December 31, 2020 , such
collateral requirements totaled approximately $41,916,000 . As a smaller source
of liquidity, the Bank can utilize existing credit arrangements.
The Company's primary source of liquidity on a stand-alone basis is dividends
from the Bank. As discussed in Part I (Item 1) of this Annual Report on Form
10-K, dividends from the Bank are subject to regulatory and corporate law
restrictions.
Liquidity risk can result from the mismatching of asset and liability cash
flows, or from disruptions in the financial markets. The Bank experiences
seasonal swings in deposits, which impact liquidity. Management has sought to
address these seasonal swings by scheduling investment maturities and developing
seasonal credit arrangements with the Federal Home Loan Bank , Federal Reserve
Bank and Federal Funds lines of credit with correspondent banks. In addition,
the ability of the Bank's real estate department to originate and sell loans
into the secondary market has provided another tool for the management of
liquidity. As of December 31, 2020 , the Company has not created any special
purpose entities to securitize assets or to obtain off-balance sheet funding.
The liquidity position of the Bank is managed daily, thus enabling the Bank to
adapt its position according to market fluctuations. Liquidity is measured by
various ratios, the most common of which is the ratio of net loans (including
loans held-for-sale) to deposits. This ratio was 59.9% on December 31, 2020 ,
and 67.9% on December 31, 2019 . At December 31, 2020 and 2019, the Bank's ratio
of core deposits to total assets was 88.4% and 86.9%, respectively. Core
deposits include demand deposits, interest-bearing transaction deposits, savings
and money market deposit accounts, and time deposits $250,000 or less. Core
deposits are important in maintaining a strong liquidity position as they
represent a stable and relatively low-cost source of funds. Management believes
that the Bank's liquidity position was adequate in 2020. This is best
illustrated by the change in the Bank's net non-core ratio, which explains the
degree of reliance on non-core liabilities to fund long-term assets. At
December 31, 2020 , the Bank's net core funding dependence ratio, the difference
between non-core funds, time deposits $250,000 or more and brokered time
deposits under $250,000 , and short-term investments to long-term assets, was
(18.64)% as of December 31, 2020 , and (7.96%) as of December 31, 2019 . This
ratio indicated at December 31, 2020 , the Bank did not significantly rely upon
non-core deposits and borrowings to fund the Bank's long-term assets, namely
loans and investments. The Bank believes that by maintaining adequate volumes
of short-term investments and implementing competitive pricing strategies on
deposits, it can ensure adequate liquidity to support future growth. The Bank
also believes that its liquidity position remains strong to meet both present
and future financial obligations and commitments, events or uncertainties that
have resulted or are reasonably likely to result in material changes with
respect to the Bank's liquidity.
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Commitments
The following table details the amounts and expected maturities of commitments
as of
Maturities by period
Less than 1 More than 5
Commitments Total year 1-3years 3-5 years years
Commitments to extend credit Commercial$ 96,675 $ 70,405 $ 15,664 $ 4,411 $ 6,195 Commercial Real Estate 5,409 524 - - 4,885 Agriculture 28,411 24,574 730 53 3,054 Residential Mortgage 216 - - 216 - Residential Construction 1,327 97 - - 1,230 Consumer 57,059 20,317 7,449 7,869 21,424 Commitments to sell loans 1,052 1,052 - - - Standby Letters of Credit 1,731 1,731 - - - Total$ 191,880 $ 118,700 $ 23,843 $ 12,549 $ 36,788 Commitments to extend credit 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Off-Balance Sheet Arrangements The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. These loans have been sold to third parties without recourse, subject to customary default, representations and warranties, recourse for breaches of the terms of the sales contracts and payment default recourse.
Financial instruments, whose contract amounts represent credit risk at
2020 2019
Undisbursed loan commitments $ 189,097 $ 198,534
Standby letters of credit 1,731 2,455
Commitments to sell loans 1,052 1,240
$ 191,880 $ 202,229
The Bank expects its liquidity position to remain strong in 2021, as the Bank
expects to continue to grow into existing markets. Our liquidity position is
continuously monitored and adjustments are made to balance between sources and
uses of funds as deemed appropriate. The Bank believes that it has the means to
provide adequate liquidity for funding normal operations in 2021.
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Capital
The Company believes a strong capital position is essential to the Company's
continued growth and profitability. A solid capital base provides depositors
and shareholders with a margin of safety, while allowing the Company to take
advantage of profitable opportunities, support future growth and provide
protection against any unforeseen losses.
At December 31, 2020 , stockholders' equity totaled $150.7 million , an increase
of $17.7 million from $132.9 million at December 31, 2019 . The increase was
primarily due to net income of $12.2 million . Also affecting capital in 2020
was paid-in capital in the amount of $0.7 million resulting from employee stock
purchases and stock plan accruals. See "Business - Capital Standards" in Part
I, Item 1 of this report on Form 10-K, for additional information.
The capital of the Company and the Bank historically have been maintained at a
level that is in excess of regulatory guidelines for a "well capitalized"
institution. The policy of annual stock dividends has, over time, allowed the
Company to match capital and asset growth through retained earnings and a
managed program of geographic growth.
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