MACATAWA BANK CORPORATION Macatawa Bank Corporation is aMichigan corporation and a registered bank holding company. It wholly-ownsMacatawa Bank and Macatawa Statutory Trust II.Macatawa Bank is aMichigan chartered bank with depository accounts insured by theFDIC . The Bank operates twenty-six branch offices and a lending and operational service facility, providing a full range of commercial and consumer banking and trust services inKent County ,Ottawa County , and northernAllegan County, Michigan . Macatawa Statutory Trust II is a grantor trust and issued$20.0 million of pooled trust preferred securities. Macatawa Statutory Trust II is not consolidated in our Consolidated Financial Statements. For further information regarding consolidation, see the Notes to Consolidated Financial Statements. AtSeptember 30, 2020 , we had total assets of$2.51 billion , total loans of$1.54 billion , total deposits of$2.17 billion and shareholders' equity of$233.9 million . For the three months endedSeptember 30, 2020 , we recognized net income of$7.1 million compared to$8.2 million for the same period in 2019. For the nine months endedSeptember 30, 2020 , we recognized net income of$21.2 million compared to$23.8 million for the same period in 2019. The Bank was categorized as "well capitalized" under regulatory capital standards atSeptember 30, 2020 .
We paid a dividend of
InDecember 2019 , news began to surface regarding an influenza pandemic inChina , known as the novel coronavirus, or COVID-19. InJanuary 2020 ,the United States restricted entry to anyone traveling fromChina . InFebruary 2020 , the pandemic spread broadly and swiftly throughoutEurope and theMiddle East . Cases began to surface inthe United States inFebruary 2020 and accelerated in earlyMarch 2020 . TheFederal Reserve reduced the overnight federal funds rate by 50 basis points onMarch 3, 2020 and by another 100 basis points onMarch 15, 2020 and announced the resumption of quantitative easing. During the week ofMarch 9, 2020 , individual states began implementing restrictions and promoting "social distancing." These restrictions included closure of schools, restrictions on the number of public gatherings, restrictions on businesses, including closures and mandatory work at home orders and other measures.Congress passed a number of measures in lateMarch 2020 , designed to infuse cash into the economy to offset the negative impacts of business closings and restrictions. InMichigan , beginningMarch 24, 2020 , GovernorGretchen Whitmer issued a series of executive orders, which severely limited economic activity inMichigan , requiring businesses not deemed to be essential, to severely limit or shut down operations. Under later executive orders,Governor Whitmer a phased reopening of businesses, subject to stringent health and safety requirements and strict social distancing measures. As ofSeptember 30, 2020 , most businesses inMichigan were allowed to be open in some capacity under the executive orders, subject to stringent health and safety requirements, strict social distancing measures and nonsurgical face mask requirements.Congress passed a number of measures in lateMarch 2020 , designed to infuse cash into the economy to offset the negative impacts of business closings and restrictions. The COVID-19 pandemic is a highly unusual, unprecedented and evolving public health and economic crisis and may have a negative material impact on the Company's business, financial condition and results of operations and has had, and is likely to continue to have, a negative impact on many of our customers' business, financial condition and results of operations. Additionally, the negative consequences of the unprecedented economic shutdown nationally and inMichigan is likely to result in a higher level of future delinquencies, loan impairments and loan losses and require additional provisions for loan losses, which will have a negative impact on our results of operations. The Company quickly responded to the changing environment by successfully executing its business continuity plan including implementing work from home arrangements and limiting branch activities. As ofSeptember 30, 2020 , branches were fully open with additional health and safety requirements to comply withGovernor Whitmer's then-current executive orders, including, among other things, daily deep cleaning, nonsurgical face mask requirements and strict social distancing measures. OnOctober 2 , and 12, 2020, theMichigan Supreme Court issued decisions invalidating all ofGovernor Whitmer's executive orders effective immediately. In response,Governor Whitmer , acting through various state agencies, has sought to substantially re-implement the requirements of the executive orders by way of state agency emergency orders. Also, certain county and municipal governments have issued emergency orders seeking to keep elements of the executive orders in place. Legal challenges to these orders may occur. Finally, theMichigan legislature has passed legislation - whichGovernor Whitmer is expected to sign and enact into law - codifying certain elements of the executive orders. The patchwork implementation of state agency and local government executive orders - coupled with the possibility of legal challenges to these orders - creates uncertainty as to legal requirements applicable to businesses, institutions and individuals inMichigan . This uncertainty may have a negative impact on the business, financial condition, and results of operations of the Company and its customers. OnMarch 22, 2020 , the federal banking agencies issued an "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus". This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19. The guidance goes on to explain that in consultation with the FASB staff that the federal banking agencies conclude that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not Troubled Debt Restructurings ("TDRs"). The Coronavirus Aid, Relief and Economic Security ("CARES") Act was passed byCongress onMarch 27, 2020 . Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were current as ofDecember 31, 2019 are not TDRs. ThroughSeptember 30, 2020 , the Bank had applied this guidance and modified 726 individual loans with aggregate principal balances totaling$337.2 million . The majority of these modifications involved three-month extensions. -38-
--------------------------------------------------------------------------------
Index
BySeptember 30, 2020 , most of these modifications had expired, other than those receiving a second short-term modification as allowed under the guidance. AtSeptember 30, 2020 , there were 26 such loans under COVID-19 modifications, totaling$79.9 million . This is down from a quarter end peak of$297.3 million atJune 30, 2020 . The table below shows the number and balances of loans with such modifications as of the last three quarter end dates (dollars in thousands): Number of COVID-19 Outstanding Balance of Modifications COVID-19 Modifications March 31, 2020 176 $ 87,917 June 30, 2020 599 297,269 September 30, 2020 26 79,894 The CARES Act, as amended, included an allocation of$659 billion for loans to be issued by financial institutions through theSmall Business Administration ("SBA") Paycheck Protection Program ("PPP"). PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and a term of two years (loans made beforeJune 5, 2020 ) or five years (loans made on or afterJune 5, 2020 ), if not forgiven, in whole or in part. Payments are deferred until either the date on which the SBA remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10 month period. The loans are 100% guaranteed by the SBA. ThroughSeptember 30, 2020 , the Bank had originated 1,738 PPP loans totaling$346.7 million in principal, with an average loan size of$200,000 . Fees totaling$10.0 million were collected from the SBA for these loans in the nine months endedSeptember 30, 2020 . These fees are deferred and amortized into interest income over the contractual period of 24 months or 60 months, as applicable. Upon SBA forgiveness, unamortized fees are then recognized into interest income. Participation in the PPP had a significant impact on the Bank's asset mix and net interest income in the second and third quarters of 2020 and will continue to impact both asset mix and net interest income for the remainder of 2020. The PPP program expired onAugust 8, 2020 . We are in an asset-sensitive position, so decreases in short-term interest rates have a net negative impact on our net interest income as our interest-earning assets will reprice faster than our interest-bearing liabilities. Given our asset-sensitivity, several years ago we established floors on our variable rate loans to help offset the negative impact of declining interest rates on net interest income. The benefit of these floors has become more evident in the second and third quarters of 2020 and will be in future quarters if theFederal Reserve maintains short-term interest rates at the low level established inMarch 2020 . Additionally, our PPP loan origination activity should provide some offsetting positive impact on earnings in the remainder of 2020, considering interest income on the loans and the processing fees paid by the SBA. The processing fees, alone, on the PPP loans originated in 2020 amount to$10.0 million , of which$938,000 was recognized in the second quarter of 2020 and$1.2 million was recognized in the third quarter of 2020. We expect the majority of the remaining fees will be recognized in the fourth quarter of 2020 and early 2021 as the related loans are forgiven by the SBA. This expectation is subject to change due to borrower behavior, changing SBA requirements and processes related to loan forgiveness and other relevant factors. While the effects of COVID-19 are likely to have a far-reaching, long-lasting effect on the global, national, andMichigan economies, we believe we have sufficient capital and financial strength, as well as liquidity resources to mitigate the effects of the COVID-19 pandemic on our operations and financial condition, while continuing to serve our communities and protect shareholder value.
RESULTS OF OPERATIONS
Summary: Net income for the three months endedSeptember 30, 2020 was$7.1 million , compared to$8.2 million for the same period in 2019. Net income per share on a diluted basis for the three months endedSeptember 30, 2020 was$0.21 compared to$0.24 for the same period in 2019. Net income for the nine months endedSeptember 30, 2020 was$21.2 million , compared to$23.8 million for the same period in 2019. Net income per share on a diluted basis for the nine months endedSeptember 30, 2020 was$0.62 compared to$0.70 for the same period in 2019. The decrease in earnings in both the three and nine months endedSeptember 30, 2020 compared to the same periods in 2019 was due primarily to decreased net interest income and higher provision for loan losses. Net interest income decreased to$14.7 million in the three months endedSeptember 30, 2020 compared to$15.8 million in the same period in 2019. Net interest income decreased to$45.0 million in the nine months endedSeptember 30, 2020 compared to$47.8 million in the nine months endedSeptember 30, 2019 . These decreases in net interest income were primarily attributable to the decreases in short-term interest rates instituted by theFederal Reserve starting inJuly 2019 and throughMarch 2020 . The provision for loan losses was$500,000 for the three months endedSeptember 30, 2020 , compared to$0 for the same period in 2019. The provision for loan losses was$2.2 million for the nine months endedSeptember 30, 2020 , compared to a negative$450,000 for the same period in 2019. We were in a net loan recovery position for the three months endedSeptember 30, 2020 , with$203,000 in net loan recoveries, compared to$259,000 in net loan recoveries in the same period in 2019. We were in a net loan charge-off position for the nine months endedSeptember 30, 2020 , with$2.8 million in net loan charge-offs compared to$719,000 in net loan recoveries in the same period in 2019. The nine month period endedSeptember 30, 2020 was impacted by a$4.1 million charge-off taken inJune 2020 related to a single loan relationship with a movie theater business where the underlying assets were sold through bankruptcy proceedings. The increase in provision for loan losses in the 2020 periods was also impacted by increases to qualitative environmental factors to address increased risk of loss attributable to the COVID-19 pandemic. Each of these items is discussed more fully below. -39-
--------------------------------------------------------------------------------
Index
Net Interest Income: Net interest income totaled$14.7 million for the three months endedSeptember 30, 2020 compared to$15.8 million for the same period in 2019. Net interest income decreased to$45.0 million in the nine months endedSeptember 30, 2020 compared to$47.8 million in the nine months endedSeptember 30, 2019 . Net interest income was positively impacted in the three months endedSeptember 30, 2020 by an increase in average earning assets of$494.7 million compared to the same period in 2019. However, our average yield on earning assets for the three months endedSeptember 30, 2020 decreased 134 basis points compared to the same period in 2019 from 3.96% to 2.62%, more than offsetting the positive impact of the earning assets growth. For the nine months endedSeptember 30, 2020 , our average earning assets increased by$305.2 million compared to the same period in 2019, while our average yield on earning assets decreased 105 basis points compared to the same period in 2019 from 4.12% to 3.07%. Net interest income for the third quarter of 2020 decreased$1.2 million compared to the same period in 2019. Of this decrease,$5.6 million was due to changes in rates earned or paid, partially offset by an increase of$4.4 million from changes in the volume of average interest assets and interest bearing liabilities. The largest changes came from interest income on commercial loans (excluding PPP loans) which fluctuated significantly in the third quarter of 2020 compared to the same period in 2019. The net change was$2.9 million with a decrease in interest income due to rate of$2.0 million and a decrease in interest income of$946,000 due to portfolio contraction. PPP loans contributed$2.1 million in net interest income in the third quarter of 2020. The other large change came in federal funds sold and other short-term investments interest income which decreased by$1.3 million in the third quarter of 2020 compared to the same period in 2019. Of the$1.3 million decrease in interest income on federal funds sold and other short-term investments,$6.2 million was due to decreases in rates earned, partially offset by a$4.9 million increase from increases in average balances. Average interest earning assets totaled$2.42 billion for the three months endedSeptember 30, 2020 compared to$1.92 billion for the same period in 2019. An increase of$196.0 million in average loans between periods and an increase of$279.6 million in average federal funds sold and other short-term investments were the primary drivers of the increases. The net interest margin was 2.43% for the three months endedSeptember 30, 2020 compared to 3.29% for the same period in 2019. Yield on commercial loans excluding PPP loans decreased from 4.67% for the three months endedSeptember 30, 2019 to 3.88% for the same period in 2020. Yield on residential mortgage loans decreased from 3.73% for the three months endedSeptember 30, 2019 to 3.64% for the same period in 2020, while yields on consumer loans decreased from 5.22% for the third quarter of 2019 to 4.14% for the third quarter of 2020. The decreases in yields on commercial loans and consumer loans, in particular, were the result of the predominance of loans in these categories with variable rates of interest tied to prime and LIBOR which decreased significantly from 2019 to 2020. TheFederal Reserve Board decreased the target federal funds rate by 50 basis points in the third quarter of 2019 and by 25 basis points in the fourth quarter of 2019 as the economy showed signs of slowing. In response to the news and government action related to COVID-19, theFederal Reserve Board decreased the target federal funds rate by 150 basis points inMarch 2020 . As the Company is in an asset-sensitive position, reductions in market interest rates have a negative impact on margin as the Company's interest earning assets reprice faster than its interest-bearing liabilities. Much of our asset-sensitivity is due to commercial and consumer loans that have variable interest rates. For both loan types we established floor rates several years ago. These floors provide protection to net interest income when short-term interest rates decline. Our variable rate commercial and consumer loans tied to the prime rate or one-month LIBOR amounted to$506.2 million atSeptember 30, 2020 . Of this total, approximately 75.1%, or$380.4 million have interest rate floors. Without these floors net interest income for the third quarter of 2020 would have been lower than stated by approximately$1.0 million . The cost of funds decreased to 0.29% in the third quarter of 2020 compared to 0.96% in the third quarter of 2019. For the first nine months of 2020, the cost of funds decreased to 0.44% compared to 0.99% for the same period in 2019. The sharp drop in the rates paid on our interest-bearing checking, savings and money market accounts in response to the federal funds rate decreases in the first quarter of 2020 and in the third and fourth quarters of 2019 caused the decrease in our cost of funds. Also contributing to the reduction in the cost of funds is our redemption of$20.0 million in trust preferred securities onDecember 31, 2019 , so there was no related interest expense in the 2020 periods. -40-
--------------------------------------------------------------------------------
Index
The following table shows an analysis of net interest margin for the three month
periods ended
For the three months ended September 30,
2020 2019
Interest Average Interest Average
Average Earned Yield Average Earned Yield
Balance or Paid or Cost Balance or Paid or Cost
Assets
Taxable securities $ 179,887 $ 867 1.92 % $ 171,290 $ 968 2.26 %
Tax-exempt securities (1) 137,351 861 3.23 126,820 919 3.73
Commercial loans (2) 955,695 9,480 3.88 1,039,518 12,408 4.67
Paycheck protection program
loans (3) 346,073 2,067 2.34 - - -
Residential mortgage loans 175,978 1,604 3.64 230,391 2,150 3.73
Consumer loans 67,549 703 4.14 79,372 1,045 5.22
Federal Home Loan Bank stock 11,558 100 3.41 11,558 159 5.37
Federal funds sold and other
short-term investments 541,981 140 0.10 262,397 1,430 2.13
Total interest earning assets
(1) 2,416,072 15,822 2.62 1,921,346 19,079 3.96
Noninterest earning assets:
Cash and due from banks 35,737 35,471
Other 102,389 92,189
Total assets $ 2,554,198 $ 2,049,006
Liabilities
Deposits:
Interest bearing demand $ 587,356 $ 78 0.05 % $ 455,799 $ 342 0.30 %
Savings and money market
accounts 743,612 121 0.07 632,632 1,236 0.78
Time deposits 128,551 422 1.31 152,091 765 1.99
Borrowings:
Other borrowed funds 72,057 364 1.97 60,000 349 2.27
Long-term debt 20,619 163 3.10 41,238 551 5.23
Total interest bearing
liabilities 1,552,195 1,148 0.29 1,341,760 3,243 0.96
Noninterest bearing liabilities:
Noninterest bearing demand
accounts 755,990 488,135
Other noninterest bearing
liabilities 14,311 11,080
Shareholders' equity 231,702 208,031
Total liabilities and
shareholders' equity $ 2,554,198 $ 2,049,006
Net interest income $ 14,674 $ 15,836
Net interest spread (1) 2.33 % 3.00 %
Net interest margin (1) 2.43 % 3.29 %
Ratio of average interest
earning assets to average
interest bearing liabilities 155.66 % 143.20 %
(1) Yields are presented on a tax equivalent basis using an assumed tax rate of
21% at
(2) Includes loan fees of
of approximately
30, 2020 and 2019, respectively. Excludes paycheck protection program loans.
(3) Includes loan fees of
2020.
-41---------------------------------------------------------------------------------
Index
The following table shows an analysis of net interest margin for the nine month
periods ended
For the nine months ended September 30,
2020 2019
Interest Average Interest Average
Average Earned Yield Average Earned Yield
Balance or Paid or Cost Balance or Paid or Cost
Assets
Taxable securities $ 184,809 $ 2,882 2.08 % $ 177,969 $ 2,952 2.21 %
Tax-exempt securities
(1) 132,471 2,607 3.38 120,505 2,623 3.73
Commercial loans (2) 1,035,247 31,882 4.06 1,055,873 38,428 4.80
Paycheck protection
program loans (3) 203,875 3,682 2.38 - - -
Residential mortgage
loans 190,782 5,275 3.69 234,823 6,541 3.71
Consumer loans 71,732 2,354 4.38 81,222 3,211 5.29
Federal Home Loan
Bank stock 11,558 339 3.86 11,558 475 5.42
Federal funds sold
and other short-term
investments 346,900 802 0.30 190,245 3,278 2.27
Total interest
earning assets (1) 2,177,374 49,823 3.07 1,872,195 57,508 4.12
Noninterest earning
assets:
Cash and due from
banks 30,572 31,649
Other 96,605 88,587
Total assets $ 2,304,551 $ 1,992,431
Liabilities
Deposits:
Interest bearing
demand $ 510,181 $ 356 0.09 % $ 442,789 $ 1,175 0.36 %
Savings and money
market accounts 698,097 1,050 0.20 619,861 3,678 0.79
Time deposits 141,762 1,712 1.62 146,142 2,113 1.94
Borrowings:
Other borrowed funds 68,610 1,069 2.06 59,954 1,020 2.24
Long-term debt 20,619 612 3.90 41,238 1,710 5.47
Total interest
bearing liabilities 1,439,269 4,799 0.44 1,309,984 9,696 0.99
Noninterest bearing
liabilities:
Noninterest bearing
demand accounts 625,759 472,345
Other noninterest
bearing liabilities 13,327 9,255
Shareholders' equity 226,196 200,847
Total liabilities and
shareholders' equity $ 2,304,551 $ 1,992,431
Net interest income $ 45,024 $ 47,812
Net interest spread
(1) 2.63 % 3.13 %
Net interest margin
(1) 2.77 % 3.43 %
Ratio of average
interest earning
assets to average
interest bearing
liabilities 151.28 % 142.92 %
(1) Yields are presented on a tax equivalent basis using an assumed tax rate of
21% at
(2) Includes loan fees of
of approximately $2.8 million and $431,000 for the nine months ended
September 30, 2020 and 2019, respectively. Excludes paycheck protection
program loans.
(3) Includes loan fees of
2020.
-42---------------------------------------------------------------------------------
Index
The following table presents the dollar amount of changes in net interest income due to changes in volume and rate (dollars in thousands):
For the three months ended September 30, For the nine months ended September 30,
2020 vs 2019 2020 vs 2019
Increase (Decrease) Due to Increase (Decrease) Due to
Volume Rate Total Volume Rate Total
Interest income
Taxable securities $ 264 $ (365 ) $ (101 ) $ 157 $ (227 ) $ (70 )
Tax-exempt securities 463 (521 ) (58 ) 430 (446 ) (16 )
Commercial loans,
excluding PPP loans (946 ) (1,982 ) (2,928 ) (738 ) (5,808 ) (6,546 )
Paycheck protection
program loans 2,067 - 2,067 3,682 - 3,682
Residential mortgage
loans (497 ) (49 ) (546 ) (1,218 ) (48 ) (1,266 )
Consumer loans (142 ) (200 ) (342 ) (346 ) (511 ) (857 )
Federal Home Loan
Bank stock - (59 ) (59 ) - (136 ) (136 )
Federal funds sold
and other short-term
investments 4,948 (6,238 ) (1,290 ) 2,438 (4,914 ) (2,476 )
Total interest income 6,157 (9,414 ) (3,257 ) 4,405 (12,090 ) (7,685 )
Interest expense
Interest bearing
demand $ 516 $ (780 ) $ (264 ) $ 255 $ (1,074 ) $ (819 )
Savings and money
market accounts 1,277 (2,392 ) (1,115 ) 679 (3,307 ) (2,628 )
Time deposits (106 ) (237 ) (343 ) (62 ) (339 ) (401 )
Other borrowed funds 226 (211 ) 15 174 (125 ) 49
Long-term debt (214 ) (174 ) (388 ) (698 ) (400 ) (1,098 )
Total interest
expense 1,699 (3,794 ) (2,095 ) 348 (5,245 ) (4,897 )
Net interest income
Provision for Loan Losses: The provision for loan losses for the three months endedSeptember 30, 2020 was$500,000 compared to$0 for the same period in 2019. The provision for loan losses for the first nine months of 2020 was$2.2 million compared to a negative$450,000 for the same period in 2019. The provisions for loan losses for the 2020 periods were impacted by additional qualitative adjustments made to provide for estimated losses associated with the COVID-19 pandemic as well as the large charge-off taken inJune 2020 , some of which was specifically reserved for previously. A$4.1 million charge-off was taken inJune 2020 related to a single loan relationship with a movie theater business for which the underlying assets were sold through bankruptcy proceedings. No other loans of this industry type remain in our portfolio. This was partially offset by continued strong asset quality metrics and loan portfolio contraction. The balances of loans graded 5 and 6, which receive higher allocations, decreased by$5.0 million fromDecember 31, 2019 toSeptember 30, 2020 . Specific reserves on impaired loans decreased by$608,000 from$1.6 million atDecember 31, 2019 to$1.0 million atSeptember 30, 2020 . When excluding PPP loans, which are 100% guaranteed by the SBA, total loans decreased by$22.8 million in the three months endedSeptember 30, 2020 . Net loan recoveries were$203,000 in the three months endedSeptember 30, 2020 compared to net loan recoveries of$259,000 in the same period in 2019. Gross loan recoveries were$227,000 for the three months endedSeptember 30, 2020 and$307,000 for the same period in 2019. In the three months endedSeptember 30, 2020 , we had$24,000 in charge-offs, compared to$48,000 in the same period in 2019. For the nine months endedSeptember 30, 2020 , we experienced gross loan recoveries of$1.4 million compared to$965,000 for the same period in 2019. Gross charge-offs for the nine months endedSeptember 30, 2020 were$4.2 million compared to$246,000 for the same period in 2019. The amounts of loan loss provision in both the most recent quarter and comparable prior year period were the result of establishing our allowance for loan losses at levels believed necessary based upon our methodology for determining the adequacy of the allowance. More information about our allowance for loan losses and our methodology for establishing its level may be found under the heading "Allowance for Loan Losses" below. -43-
--------------------------------------------------------------------------------
Index
Noninterest Income: Noninterest income for the three and nine month periods endedSeptember 30, 2020 was$6.1 million and$16.9 million compared to$5.2 million and$14.6 million for the same periods in 2019, respectively. The components of noninterest income are shown in the table below (in thousands): Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended September 30, September 30, September 30, September 30, 2020 2019 2020 2019 Service charges and fees on deposit accounts $ 987 $ 1,139 $ 2,957 $ 3,267 Net gains on mortgage loans 1,546 824 4,045 1,650 Trust fees 921 920 2,801 2,813 ATM and debit card fees 1,542 1,469 4,199 4,276 Bank owned life insurance ("BOLI") income 215 252 688 737 Investment services fees 328 286 980 934 Other income 553 323 1,234 962 Total noninterest income $ 6,092 $ 5,213$ 16,904 $ 14,639 Net gains on mortgage loans were up$722,000 in the three months endedSeptember 30, 2020 and were up$2.4 million in the nine months endedSeptember 30, 2020 compared to the same periods in 2019 as a result of an increase in the volume of loans originated for sale in the 2020 periods due to a lower interest rate environment, spurring more refinancing of fixed rate loans which we sell into the secondary market. Mortgage loans originated for sale in the three months endedSeptember 30, 2020 were$40.8 million , compared to$24.9 million in the same period in 2019. For the first nine months of 2020, mortgages originated for sale were$120.2 million , compared to$53.7 million for the same period in 2019. Investment services fees were up$43,000 in the three months endedSeptember 30, 2020 and were up$46,000 in the nine months endedSeptember 30, 2020 compared to the three and nine months endedSeptember 30, 2019 , respectively. ATM and debit card fees were up$73,000 in the three months endedSeptember 30, 2020 and down$77,000 in the nine months endedSeptember 30, 2020 as compared to the three and nine months endedSeptember 30, 2019 , respectively. We saw reduced volume of usage by our customers during the COVID-19 shutdown of the economy in the second quarter of 2020 and a return to normal volumes in the third quarter of 2020. Service charges on deposit accounts decreased in the three and nine months endedSeptember 30, 2020 as compared to the same periods in 2019 due to lower overdraft fees as our customers have generally retained higher deposit balances in the low interest rate environment and due to uncertainty related to the COVID-19 pandemic, thereby resulting in fewer overdrafts. That said, these fees have increased in the third quarter of 2020 compared to the second quarter of 2020 as businesses reopened and economic activity began to recover. Other income was up in the three and nine months endedSeptember 30, 2020 due to fees collected on customer back-to-back interest rate swaps. These fees were up$253,000 and$402,000 in the three and nine month periods endedSeptember 30, 2020 , respectively. Noninterest Expense: Noninterest expense increased by$524,000 to$11.5 million for the three month period endedSeptember 30, 2020 as compared to the same period in 2019. Noninterest expense increased by$177,000 to$33.8 million for the nine months endedSeptember 30, 2020 compared to$33.6 million for the same period in 2019. The components of noninterest expense are shown in the table below (in thousands): Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended September 30, September 30, September 30, September 30, 2020 2019 2020 2019 Salaries and benefits $ 6,480 $ 6,272$ 18,937 $ 18,895 Occupancy of premises 1,026 966 2,984 3,055 Furniture and equipment 967 887 2,704 2,597 Legal and professional 260 211 798 652 Marketing and promotion 239 228 716 689 Data processing 761 735 2,309 2,226 FDIC assessment 131 - 207 239 Interchange and other card expense 367 347 1,041 1,057 Bond and D&O insurance 104 103 313 309 Net (gains) losses on repossessed and foreclosed properties - - 32 (69 ) Administration and disposition of problem assets 25 46 71 183 Outside services 491 403 1,322 1,348 Other noninterest expense 682 811 2,325 2,401 Total noninterest expense$ 11,533 $ 11,009 $ 33,759 $ 33,582 -44-
--------------------------------------------------------------------------------
Index
Most categories of noninterest expense were relatively unchanged compared to the three months endedSeptember 30, 2019 due to our ongoing efforts to manage expenses and scale our operations. Our largest component of noninterest expense, salaries and benefits, increased by$208,000 in the three months endedSeptember 30, 2020 from same period in 2019. This increase was due primarily to an increase in salaries and compensation and an increase in variable-based compensation due to higher mortgage origination volume. Salaries and benefits increased by$42,000 for the nine months endedSeptember 30, 2020 compared to the nine months endedSeptember 30, 2019 due to the same combination of factors. Benefitting the 2020 periods was a decrease in our medical insurance plan as we experienced lower claims, and higher cost deferrals from commercial loan production associated with the origination of PPP loans. The 401k match and the bonus accruals that were curtailed in the second quarter of 2020 in reaction to the uncertainty surrounding the COVID-19 pandemic were reinstated during the third quarter of 2020. The table below identifies the primary components of salaries and benefits (in thousands): Three Months Three Months Nine Months Nine Months Ended Ended Ended Ended September 30, September 30, September 30, September 30, 2020 2019 2020 2019 Salaries and other compensation 5,678 5,520 16,919 16,333 Salary deferral from commercial loans (229 ) (219 ) (899 ) (601 ) Bonus accrual 296 284 619 853 Mortgage production - variable comp 316 228 834 434 401k matching contributions 194 183 464 555 Medical insurance costs 225 276 1,000 1,321 Total salaries and benefits $ 6,480 $ 6,272$ 18,937 $ 18,895 Occupancy expenses were up$60,000 in the three months endedSeptember 30, 2020 and were down$71,000 in the nine months endedSeptember 30, 2020 compared to the same periods in 2019 due to maintenance costs incurred associated with branch facilities. Furniture and equipment expenses were up$80,000 in the three months endedSeptember 30, 2020 and were up$107,000 in the nine months endedSeptember 30, 2020 compared to the same periods in 2019 due to costs associated with equipment and service contracts. OurFDIC assessment costs increased by$131,000 in the three months endedSeptember 30, 2020 compared to the same period in 2019 due to our full utilization of assessment credits. InJanuary 2019 , theFDIC notified us that the Bank would receive an assessment credit of approximately$400,000 to offset future assessments as theFDIC Deposit Insurance Fund had exceeded its target ratio of 1.35%. Assessment credits totaling$266,000 were applied in the third and fourth quarters of 2019,$136,000 was applied in the first quarter of 2020 and the remaining$36,000 was applied in the second quarter of 2020. Expenses for future periods will increase as the Bank has utilized all of its assessment credits. Costs associated with administration and disposition of problem assets have decreased significantly over the past several years. These expenses include legal costs and repossessed and foreclosed property administration expense. Repossessed and foreclosed property administration expense includes survey and appraisal, property maintenance and management and other disposition and carrying costs. Net (gains) losses on repossessed and foreclosed properties include both net gains and losses on the sale of properties and unrealized losses from value declines for outstanding properties.
These costs are itemized in the following table (in thousands):
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2020 2019 2020 2019
Legal and professional - nonperforming
assets $ 14 $ 19 $ 38 $ 69
Repossessed and foreclosed property
administration 11 27 33 68
Net (gains) losses on repossessed and
foreclosed properties - - 32 (69 )
Total $ 25 $ 46 $ 103 $ 68
As the level of problem loans and assets has declined, the costs associated with
these nonperforming assets have decreased significantly over the past several
years. Other real estate owned decreased from $3.1 million at September 30,
2019 to $2.6 million at September 30, 2020 .
For the first nine months of 2020, net (gains) losses on repossessed and
foreclosed properties swung unfavorably by $101,000 compared to the same period
in 2019. The net increase in expense was due to an improvement in net gains
realized in the 2019 period. There were no valuation writedowns in the three
month periods ended September 30, 2020 and 2019. In the nine month period ended
September 30, 2020 , valuation writedowns totaled $32,000 compared to valuation
writedowns of $10,000 for the same period in 2019. There were no realized gains
or losses on repossessed assets and foreclosed properties in the three months
ended September 30, 2020 and 2019. For the nine months ended September 30,
2020 , net realized gains totaled $0 , compared to net realized gains of $79,000
for the same period in 2019.
-45---------------------------------------------------------------------------------
Index
Outside services were up$88,000 in the three month period endedSeptember 30, 2020 and were down$26,000 in the nine month period endedSeptember 30, 2020 compared to the same periods in 2019 due to ongoing efforts to manage and scale these costs. Federal Income Tax Expense: We recorded$1.6 million and$4.8 million in federal income tax expense for the three and nine month periods endedSeptember 30, 2020 compared to$1.9 million and$5.5 million for the same periods in 2019. Our effective tax rates for the three and nine month periods endedSeptember 30, 2020 were 18.47% and 18.48%, respectively, compared to 18.75% and 18.80% for the same periods in 2019. FINANCIAL CONDITION Total assets were$2.51 billion atSeptember 30, 2020 , an increase of$439.9 million fromDecember 31, 2019 . This change reflected increases of$260.6 million in cash and cash equivalents,$4.7 million in securities available for sale,$8.7 million in securities held to maturity,$339.2 million in PPP loans, and$5.7 million in other assets, partially offset by decreases of$182.5 million in our loan portfolio excluding PPP loans. Total deposits increased by$417.3 million atSeptember 30, 2020 compared toDecember 31, 2019 . Cash and Cash Equivalents: Our cash and cash equivalents, which include federal funds sold and short-term investments, were$533.0 million atSeptember 30, 2020 compared to$272.5 million atDecember 31, 2019 . The increase in these balances related to an increase in our total deposits due to customers holding higher balances, particularly liquid deposits, in the low interest rate environment and due to uncertainty related to the COVID-19 pandemic. Securities: Debt securities available for sale were$229.9 million atSeptember 30, 2020 compared to$225.2 million atDecember 31, 2019 . The balance atSeptember 30, 2020 primarily consisted ofU.S. agency securities, agency mortgage backed securities and various municipal investments. Our held to maturity portfolio was$91.4 million atSeptember 30, 2020 compared to$82.7 million atDecember 31, 2019 . Our held to maturity portfolio is comprised of state, municipal and privately placed commercial bonds. Portfolio Loans and Asset Quality: Total portfolio loans increased by$156.7 million in the first nine months of 2020 and were$1.54 billion atSeptember 30, 2020 compared to$1.39 billion atDecember 31, 2019 . During the first nine months of 2020, our commercial portfolio increased by$212.7 million . The SBA created the Paycheck Protection Program to provide an efficient means to provide funding for small businesses to maintain payroll and operations during the COVID-19 pandemic. We are an active participant in this program and originated a total of 1,738 loans totaling$346.7 million in principal in first nine months of 2020. Borrowers who use the funds from their PPP loans to maintain payroll and for certain fixed expenses such as rent, occupancy, etc. are eligible to have 100% of their loans forgiven by the SBA. We expect a substantial majority of our PPP borrowers will apply for and receive approval for loan forgiveness by early 2021. This expectation is subject to change due to borrower behavior, changing SBA requirements and processes relating to loan forgiveness and other relevant factors. In earlyOctober 2020 , the SBA issued a streamlined forgiveness application for PPP loans under$50,000 . This should accelerate the forgiveness timeline for small loans. ThroughOctober 20, 2020 , we have received forgiveness proceeds from the SBA totaling$3.1 million for PPP forgiveness applications submitted to date amounting to$90.5 million . Excluding the PPP originations, our commercial loans decreased by$125.4 million in the first nine months of 2020. Our consumer portfolio decreased by$10.9 million and our residential mortgage portfolio decreased by$46.2 million in the first nine months of 2020. Mortgage loans originated for portfolio are typically adjustable rate loans as well as fixed rate loans that conform to secondary market requirements and have a term of fifteen years or less. Mortgage loans originated for portfolio in the first nine months of 2020 increased$127,000 compared to the same period in 2019, from$29.2 million in the first nine months of 2019 to$29.3 million in the same period in 2020. The volume of residential mortgage loans originated for sale in the first nine months of 2020 increased$66.5 million compared to the same period in 2019. Residential mortgage loans originated for sale were$120.2 million in the first nine months of 2020 compared to$53.7 million in the first nine months of 2019. -46-
--------------------------------------------------------------------------------
Index
The following table shows our loan origination activity for loans to be held in
portfolio during the first nine months of 2020 and 2019, broken out by loan type
and also shows average originated loan size (dollars in thousands):
Nine months ended September 30, 2020 Nine months ended September 30, 2019
Percent of Percent of
Portfolio Total Average Portfolio Total Average
Originations Originations Loan Size Originations Originations Loan Size
Commercial real estate:
Residential developed $ 3,035 0.5 % 217 $ 6,042 2.1 % 302
Unsecured to residential
developers 170 - 170 - - -
Vacant and unimproved 23,943 3.7 2,394 2,179 0.7 436
Commercial development - - - - - -
Residential improved 45,463 7.0 425 39,059 13.6 315
Commercial improved 45,493 7.0 1,379 54,463 18.9 1,184
Manufacturing and
industrial 12,098 1.9 432 14,384 5.0 899
Total commercial real
estate 130,202 20.1 675 116,127 40.3 550
Commercial and
industrial (1) 458,588 70.8 246 110,289 38.3 702
Total commercial 588,790 90.9 287 226,416 78.6 615
Consumer
Residential mortgage 29,327 4.5 333 29,174 10.1 260
Unsecured 21 - 11 - - -
Home equity 28,727 4.4 112 30,383 10.6 107
Other secured 1,003 0.2 15 2,090 0.7 23
Total consumer 59,078 9.1 142 61,647 21.4 127
Total loans $ 647,868 100.0 % 262 $ 288,063 100.0 % 338
(1) Nine months ended
originations
The following table shows a breakout of our commercial loan activity during the first nine months of 2020 and 2019 (dollars in thousands):
Nine Months Nine Months
Ended Ended
September 30, September 30,
2020 2019
Commercial loans originated (1) $ 588,790 $ 226,416
Repayments of commercial loans (288,049 ) (237,205 )
Change in undistributed - available credit (86,930 ) 1,286
Net increase (decrease) in total commercial loans $
213,811
(1) Nine months ended
originations
Overall, the commercial loan portfolio increased $213.8 million in the first
nine months of 2020. Our commercial and industrial portfolio increased by
$253.3 million while our commercial real estate loans decreased by $39.5
million . As discussed above, included in the commercial production for the
first nine months of 2020 is $346.7 million in PPP loans. Our overall
production of commercial loans increased by $362.4 million , predominantly due to
the PPP loans, from $226.4 million in the first nine months of 2019 to $588.8
million in the same period of 2020. Beyond the effect of the PPP loan
production, our commercial and industrial portfolio is subject to seasonal
fluctuations includes floor plan loan lines to vehicle dealers, which were
impacted by COVID-19. The decline in borrowings in this sector was primarily
the result of our dealers selling through their inventory but not being able to
receive new inventory due to supply shortages from the COVID-19 shutdown of the
economy.
Commercial and commercial real estate loans remained our largest loan segment
and accounted for approximately 85.0% and 79.2% of the total loan portfolio at
September 30, 2020 and December 31, 2019 , respectively. Residential mortgage and
consumer loans comprised approximately 15.0% and 20.8% of total loans at
September 30, 2020 and December 31, 2019 , respectively.
-47---------------------------------------------------------------------------------
Index
A further breakdown of the composition of the loan portfolio is shown in the table below (in thousands):
September 30, 2020 December 31, 2019
Percent of Percent of
Balance Total Loans Balance Total Loans
Commercial real estate: (1)
Residential developed $ 10,072 0.6 % $ 14,705 1.1 %
Unsecured to residential developers - - - -
Vacant and unimproved 45,534 3.0 41,796 3.0
Commercial development 605 - 665 0.1
Residential improved 117,202 7.6 130,861 9.4
Commercial improved 273,355 17.7 292,799 21.1
Manufacturing and industrial 112,155 7.3 117,632 8.5
Total commercial real estate 558,923 36.2 598,458 43.2
Commercial and industrial (2) 752,918 48.8 499,572 36.0
Total commercial 1,311,841 85.0 1,098,030 79.2
Consumer
Residential mortgage 164,818 10.7 211,049 15.3
Unsecured 189 - 274 -
Home equity 61,276 4.0 70,936 5.1
Other secured 4,211 0.3 5,338 0.4
Total consumer 230,494 15.0 287,597 20.8
Total loans $ 1,542,335 100.0 % $ 1,385,627 100.0 %
(1) Includes both owner occupied and non-owner occupied commercial real estate.
(2)
Commercial real estate loans accounted for 36.2% and 43.2% of the total loan portfolio atSeptember 30, 2020 andDecember 31, 2019 , respectively, and consisted primarily of loans to business owners and developers of owner and non-owner occupied commercial properties and loans to developers of single and multi-family residential properties. In the table above, we show our commercial real estate portfolio by loans secured by residential and commercial real estate, and by stage of development. Improved loans are generally secured by properties that are under construction or completed and placed in use. Development loans are secured by properties that are in the process of development or fully developed. Vacant and unimproved loans are secured by raw land for which development has not yet begun and agricultural land. Our consumer residential mortgage loan portfolio, which also includes residential construction loans made to individual homeowners, comprised 10.7% of portfolio loans atSeptember 30, 2020 and 15.3% atDecember 31, 2019 . We expect to continue to retain in our loan portfolio certain types of residential mortgage loans (primarily high quality, low loan-to-value loans) in an effort to continue to diversify our credit risk and deploy our excess liquidity. The volume of residential mortgage loans originated for sale during the first nine months of 2020 increased significantly from the first nine months of 2019 as a result of interest rate conditions. The decrease in market interest rates in early 2020 has caused an increase in refinancing of fixed rate mortgages which we sell into the secondary market. Our portfolio of other consumer loans includes loans secured by personal property and home equity fixed term and line of credit loans. This portfolio decreased by$10.9 million to$65.7 million atSeptember 30, 2020 from$76.5 million atDecember 31, 2019 , due primarily to a decrease in home equity loans. These other consumer loans comprised 4.3% of our portfolio loans atSeptember 30, 2020 and 5.5% atDecember 31, 2019 . Our loan portfolio is reviewed regularly by our senior management, our loan officers, and an internal loan review team that is independent of our loan originators and credit administration. An administrative loan committee consisting of senior management and seasoned lending and collections personnel meets quarterly to manage our internal watch list and proactively manage high risk loans. When reasonable doubt exists concerning collectability of interest or principal of one of our loans, the loan is placed in nonaccrual status. Any interest previously accrued but not collected is reversed and charged against current earnings. Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. AtSeptember 30, 2020 , nonperforming assets totaled$2.8 million compared to$3.0 million atDecember 31, 2019 . There were no additions to other real estate owned in the first nine months of 2020 or in the first nine months of 2019. AtSeptember 30, 2020 , there were no loans in redemption, so we expect there to be few additions to other real estate owned in the fourth quarter of 2020. Proceeds from sales of foreclosed properties were$92,000 in the first nine months of 2020, resulting in net realized gain on sales of$0 . Proceeds from sales of foreclosed properties were$340,000 in the first nine months of 2019 resulting in net realized gain on sales of$79,000 . -48-
--------------------------------------------------------------------------------
Index
Nonperforming loans include loans on nonaccrual status and loans delinquent more than 90 days but still accruing. Nonperforming loans atSeptember 30, 2020 consisted of$97,000 of commercial real estate loans and$98,000 of consumer and residential mortgage loans. As ofSeptember 30, 2020 , nonperforming loans totaled$195,000 , or 0.01% of total portfolio loans, compared to$203,000 , or 0.01% of total portfolio loans, atDecember 31, 2019 . Foreclosed and repossessed assets include assets acquired in settlement of loans. Foreclosed assets totaled$2.6 million atSeptember 30, 2020 and$2.7 million atDecember 31, 2019 . The entire balance atSeptember 30, 2020 was comprised of six commercial real estate properties. All properties acquired through or in lieu of foreclosure are initially transferred at their fair value less estimated costs to sell and then evaluated monthly for impairment after transfer using a lower of cost or market approach. Updated property valuations are obtained at least annually on all foreclosed assets. AtSeptember 30, 2020 , our foreclosed asset portfolio had a weighted average age held in portfolio of 8.6 years. Below is a breakout of our foreclosed asset portfolio atSeptember 30, 2020 andDecember 31, 2019 by property type and the percentages the property has been written down since taken into our possession and the combined writedown percentage, including losses taken when the property was loan collateral (dollars in thousands): September 30, 2020 December 31, 2019 Combined Combined Writedown Writedown Foreclosed (Loan and Foreclosed (Loan and
Foreclosed Asset Carrying Asset Foreclosed Carrying Asset Foreclosed Property Type
Value Writedown Asset) Value Writedown Asset)
Vacant Land 66 72.0 % 78.2 % 79 66.6 % 74.1 %
Residential
Development 215 51.2 77.7 326 38.7 69.1
Commercial Improved 2,343 - - 2,343 - -
$ 2,624 13.1 27.3 $ 2,748 11.7 25.8
The following table shows the composition and amount of our nonperforming assets
(dollars in thousands):
September 30, December 31,
2020 2019
Nonaccrual loans $ 195 $ 203
Loans 90 days or more delinquent and still accruing - -
Total nonperforming loans (NPLs) 195 203
Foreclosed assets 2,624 2,748
Repossessed assets - -
Total nonperforming assets (NPAs) $ 2,819 $ 2,951
NPLs to total loans 0.01 % 0.01 %
NPAs to total assets 0.11 % 0.14 %
The following table shows the composition and amount of our troubled debt
restructurings (TDRs) at
September 30, 2020
Commercial Consumer Total Commercial Consumer Total
Performing TDRs $ 4,881 $ 4,356 $ 9,237 $ 8,469 $ 5,140 $ 13,609
Nonperforming TDRs (1) 97 - 97 98 - 98
Total TDRs $ 4,978 $ 4,356 $ 9,334 $ 8,567 $ 5,140 $ 13,707 (1) Included in nonperforming asset table above
We had a total of$9.3 million and$13.7 million of loans whose terms have been modified in TDRs as ofSeptember 30, 2020 andDecember 31, 2019 , respectively. These loans may have involved the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow. These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit. For each restructuring, a comprehensive credit underwriting analysis of the borrower's financial condition and prospects of repayment under the revised terms is performed to assess whether the structure can be successful and whether cash flows will be sufficient to support the restructured debt. An analysis is also performed to determine whether the restructured loan should be on accrual status. Generally, if the loan is on accrual at the time of restructure, it will remain on accrual after the restructuring. In some cases, a nonaccrual loan may be placed on accrual at restructuring if the loan's actual payment history demonstrates it would have cash flowed under the restructured terms. After six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accruing status. In situations where there is a subsequent modification or renewal and the loan is brought to market terms, including a contractual interest rate not less than a market interest rate for new debt with similar credit risk characteristics, the TDR and impaired designations may be removed. Total TDRs decreased by$4.4 million fromDecember 31, 2019 toSeptember 30, 2020 due to payoffs and paydowns on existing TDRs exceeding new additions. There were 82 loans identified as TDRs atSeptember 30, 2020 compared to 91 loans atDecember 31, 2019 . -49-
--------------------------------------------------------------------------------
Index
As with other impaired loans, an allowance for loan loss is estimated for each TDR based on the most likely source of repayment for each loan. For impaired commercial real estate loans that are collateral dependent, the allowance is computed based on the fair value of the underlying collateral, less estimated costs to sell. For impaired commercial loans where repayment is expected from cash flows from business operations, the allowance is computed based on a discounted cash flow computation. Certain groups of TDRs, such as residential mortgages, have common characteristics and for them the allowance is computed based on a discounted cash flow computation on the change in weighted rate for the pool. The allowance allocations for commercial TDRs where we have reduced the contractual interest rate are computed by measuring cash flows using the new payment terms discounted at the original contractual rate. OnMarch 22, 2020 , the federal banking agencies issued an "Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus". This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19. The guidance goes on to explain that in consultation with the FASB staff that the federal banking agencies conclude that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not Troubled Debt Restructurings ("TDRs"). The Coronavirus Aid, Relief and Economic Security ("CARES") Act was passed byCongress onMarch 27, 2020 . Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were current as ofDecember 31, 2019 are not TDRs. ThroughSeptember 30, 2020 , the Bank had applied this guidance and modified 726 individual loans with aggregate principal balances totaling$337.2 million . The majority of these modifications involved three-month extensions. BySeptember 30, 2020 , most of these modification had expired, other than those receiving a second short-term modification as allowed under the guidance. AtSeptember 30, 2020 , there were 26 such loans under COVID-19 modifications, totaling$79.9 million . This is down from a quarter end peak of$297.3 million atJune 30, 2020 . The table below shows the number and balances of loans with such modifications as of the past three quarter end dates (dollars in thousands): Outstanding Balance Number of COVID-19 of COVID-19 Modifications Modifications March 31, 2020 176 $ 87,917 June 30, 2020 599 297,269 September 30, 2020 26 79,894 Allowance for loan losses: The allowance for loan losses atSeptember 30, 2020 was$16.6 million , a decrease of$642,000 fromDecember 31, 2019 . The allowance for loan losses represented 1.07% of total portfolio loans atSeptember 30, 2020 and 1.24% atDecember 31, 2019 . The ratio atSeptember 30, 2020 is impacted by$339.2 million of PPP loans which were generated during the second and third quarters of 2020. The ratio excluding these loans was 1.38% atSeptember 30, 2020 . The allowance for loan losses to nonperforming loan coverage ratio increased from 8473% atDecember 31, 2019 to 8491% atSeptember 30, 2020 .
The table below shows the changes in certain credit metrics over the past five quarters (dollars in millions):
Quarter Ended Quarter Ended Quarter Ended Quarter Ended Quarter Ended
September 30, June 30, March 31, December 31, September 30,
2020 2020 2020 2019 2019
Commercial loans $ 1,311.9 $ 1,310.7 $ 1,120.0 $ 1,098.0 $ 1,072.5
Nonperforming loans 0.2 3.0 7.2 0.2 0.2
Other real estate owned and
repo assets 2.6 2.6 2.6 2.7 3.1
Total nonperforming assets 2.8 5.6 9.9 3.0 3.3
Net charge-offs (recoveries) (0.2 ) 4.0 (1.0 ) (0.0 ) (0.3 )
Total delinquencies 0.5 3.3 0.5 0.4 0.2
A $4.1 million charge-off was taken in June 2020 related to a single loan
relationship with a movie theater business for which the underlying assets were
sold through bankruptcy proceedings. This was an isolated charge-off, the
amount of which was amplified by the COVID-19 shutdown of the economy. No other
loans of this industry type remain in our portfolio. At September 30, 2020 , we
had net loan recoveries in twenty-one of the past twenty-three quarters. Our
total delinquencies were $524,000 at September 30, 2020 and $405,000 at December
31, 2019 . Our delinquency percentage at September 30, 2020 was 0.03%.
These factors all impact our necessary level of allowance for loan losses and
our provision for loan losses. The allowance for loan losses decreased $642,000
in the first nine months of 2020. We recorded a provision for loan losses of
$2.2 million for the nine months ended September 30, 2020 compared to a negative
$450,000 for the same period of 2019. Net loan charge-offs were $2.8 million
for the nine months ended September 30, 2020 , compared to net loan recoveries of
$719,000 for the same period in 2019. The ratio of net charge-offs (recoveries)
to average loans was 0.25% on an annualized basis for the first nine months of
2020 and -0.07% for the first nine months of 2019.
-50---------------------------------------------------------------------------------
Index
Despite the large charge-off taken in the second quarter of 2020, we are encouraged by the reduced level of gross charge-offs over recent quarters. We do, however, recognize that future charge-offs and resulting provisions for loan losses are expected to be impacted by the timing and extent of changes in the overall economy and the real estate markets, in particular due to the impact of COVID-19. Our allowance for loan losses is maintained at a level believed appropriate based upon our assessment of the probable estimated losses inherent in the loan portfolio. Our methodology for measuring the appropriate level of allowance and related provision for loan losses relies on several key elements, which include specific allowances for loans considered impaired, general allowance for commercial loans not considered impaired based upon applying our loan rating system, and general allocations based on historical trends for homogeneous loan groups with similar risk characteristics. Overall, impaired loans declined by$4.5 million to$9.3 million atSeptember 30, 2020 compared to$13.9 million atDecember 31, 2019 . The specific allowance for impaired loans decreased$608,000 to$1.0 million atSeptember 30, 2020 , compared to$1.6 million atDecember 31, 2019 . The specific allowance for impaired loans represented 10.9% of total impaired loans atSeptember 30, 2020 and 11.7% atDecember 31, 2019 . The general allowance allocated to commercial loans that were not considered to be impaired was based upon the internal risk grade of such loans. We use a loan rating method based upon an eight point system. Loans are stratified between real estate secured and non-real estate secured. The real estate secured portfolio is further stratified by the type of real estate. Each stratified portfolio is assigned a loss allocation factor. A higher numerical grade assigned to a loan category generally results in a greater allocation percentage. Changes in risk grade of loans affect the amount of the allowance allocation. The determination of our loss factors is based upon our actual loss history by loan grade and adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the analysis date. We use a rolling 18 month actual net charge-off history as the base for our computation. Over the past few years, the 18 month period computations have reflected sizeable decreases in net charge-off experience. We addressed this volatility in the qualitative factor considerations applied in our allowance for loan losses computation. We also considered the extended period of strong asset quality in assessing the overall qualitative component. AtSeptember 30, 2020 , we also considered the effect that the COVID-19 pandemic has had and is having on our loan borrowers and our local economy. An analysis of each credit in our commercial loan portfolio was performed during the quarter endedSeptember 30, 2020 to evaluate the impact of the shutdown on each business and identify the potential loss exposure. While this analysis revealed limited stress in our portfolio and significant stimulus and mitigation efforts are expected to soften the shutdown impact, we believe a downgrade to our economic qualitative factor was appropriate and, after adding 7 basis points to this qualitative factor atMarch 31, 2020 , we added another 6 basis points atJune 30, 2020 and maintained this level atSeptember 30, 2020 . We also added 4 basis points to our valuation qualitative factor atJune 30, 2020 due to the potential for devalued collateral in the current environment and maintained at this level atSeptember 30, 2020 . We also added 2 basis points to the external factors qualitative atSeptember 30, 2020 . As discussed earlier, under the CARES Act, we provided payment relief, primarily in the form of interest-only periods, to a number of our borrowers. Most of these modifications had expired bySeptember 30, 2020 , but 26 loans totaling$79.9 million remain under modified terms as ofSeptember 30, 2020 , primarily those which received a second modification. Recognizing that these loans may have higher risk of loss than other portfolio loans, we have isolated them in our allowance computation atSeptember 30, 2020 and applied an additional 35 basis point allocation on these loans. Certain industry sectors will be more negatively impacted than others by the economic effects of COVID-19 and governmental action. For example, businesses that thrive on large masses of people assembling in close proximity, such as hospitality, restaurants and sporting events will likely incur longer lasting negative effects than other industries. We believe our commercial portfolio is adequately diversified, with our largest commercial concentrations in Real Estate, Rental and Leasing (22.6%), followed by Manufacturing (13.7%) and Retail Trade (10.4%). -51-
--------------------------------------------------------------------------------
Index
The table below breaks down our commercial loan portfolio by industry type atSeptember 30, 2020 and identifies the percentage of loans in each type that have a pass rating within our grading system (4 or better) and criticized rating (5 or worse) (dollars in thousands): September 30, 2020 Percent Percent Percent of Grade 4 or Grade 5 or Excluding PPP PPP Loans Total Total Loans Better Worse Industry: Agricultural Products$ 58,078 $ 17,757 $ 75,835 5.78 % 90.00 % 10.00 % Mining and Oil Extraction 1,956 104 2,060 0.16 % 100.00 % 0.00 % Utilities - 43 43 0.00 % 100.00 % 0.00 % Construction 74,089 52,473 126,562 9.65 % 99.07 % 0.93 % Manufacturing 119,386 60,098 179,484 13.68 % 96.99 % 3.01 % Wholesale Trade 58,974 16,573 75,547 5.76 % 99.89 % 0.11 % Retail Trade 113,037 22,792 135,829 10.35 % 99.92 % 0.08 % Transportation and Warehousing 44,666 21,047 65,713 5.01 % 99.27 % 0.73 % Information 795 4,612 5,407 0.41 % 100.00 % 0.00 % Finance and Insurance 43,419 6,633 50,052 3.82 % 100.00 % 0.00 % Real Estate and Rental and Leasing 292,066 4,382 296,448 22.60 % 99.50 % 0.50 % Professional, Scientific and Technical Services 5,157 24,634 29,791 2.27 % 99.13 % 0.87 % Management of Companies and Enterprises 1,990 350 2,340 0.18 % 100.00 % 0.00 % Administrative and Support Services 21,495 28,902 50,397 3.84 % 99.77 % 0.23 % Education Services 3,060 10,089 13,149 1.00 % 99.25 % 0.75 % Health Care and Social Assistance 55,091 32,549 87,640 6.68 % 99.99 % 0.01 % Arts, Entertainment and Recreation 7,590 4,510 12,100 0.92 % 97.11 % 2.89 % Accommodations and Food Services 42,036 13,215 55,251 4.21 % 83.30 % 16.70 % Other Services 29,744 18,342 48,086 3.67 % 99.26 % 0.74 % Public Administration - 107 107 0.01 % 100.00 % 0.00 % Private Households - - - 0.00 % 0.00 % 0.00 % Total commercial loans$ 972,629 $ 339,212 $ 1,311,841 100.00 % 97.96 % 2.04 % Accommodations and Food Services in the table above includes our loans to restaurants and hotels. We have reviewed each relationship in this industry group and have determined based upon their nature of operations and our loan structure that we believe our loss exposure is limited. Groups of homogeneous loans, such as residential real estate and open- and closed-end consumer loans, receive allowance allocations based on loan type. A rolling 12 month (four quarter) historical loss experience period was applied to residential mortgage and consumer loan portfolios. As with commercial loans that are not considered impaired, the determination of the allowance allocation percentage is based principally on our historical loss experience. These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent loss experience for these similar pools of loans. The homogeneous loan allowance was$2.6 million atSeptember 30, 2020 and$2.6 million atDecember 31, 2019 . The allowance allocations are not intended to imply limitations on usage of the allowance for loan losses. The entire allowance for loan losses is available for any loan losses without regard to loan type.
Premises and Equipment: Premises and equipment totaled
Other Assets: Other assets totaled$15.5 million atSeptember 30, 2020 , up$5.7 million from$9.8 million atDecember 31, 2019 . This increase is largely attributable to additional customer back-to-back interest rate swaps and changes in their market values. The market value of these swaps was$5.1 million atSeptember 30, 2020 and$1.8 million atDecember 31, 2019 . Deposits and Other Borrowings: Total deposits increased$417.3 million to$2.17 billion atSeptember 30, 2020 , as compared to$1.75 billion atDecember 31, 2019 . Non-interest checking account balances increased$256.0 million during the first nine months of 2020. Interest bearing demand account balances increased$80.7 million and savings and money market account balances increased$198.0 million in the first nine months of 2020. Certificates of deposits decreased by$36.7 million in the first nine months of 2020. Our overall deposit balances are elevated as a result of customers holding higher level of liquid deposits in this low interest rate environment and due to uncertainty related to the COVID-19 pandemic. Business deposits are also elevated partially due to PPP loan proceeds but also due to cash conservation efforts deployed by many of our customers given COVID-19 pandemic uncertainty. We typically see seasonal deposit growth in the third quarter each year from municipal customers from property tax collections. We believe our success in maintaining the balances of personal and business checking and savings accounts was primarily attributable to our focus on quality customer service, the desire of customers to deal with a local bank, the convenience of our branch network and the breadth and depth of our sophisticated product line. -52-
--------------------------------------------------------------------------------
Index
Noninterest bearing demand accounts comprised 34.0% of total deposits atSeptember 30, 2020 and 27.5% atDecember 31, 2019 . These balances typically increase at year end for many of our commercial customers, then decline in the first quarter. Because of the generally low rates paid on interest bearing account alternatives, many of our business customers chose to keep their balances in these more liquid noninterest bearing demand account types. Interest bearing demand, including money market and savings accounts, comprised 60.7% of total deposits atSeptember 30, 2020 and 63.8% atDecember 31, 2019 . Time accounts as a percentage of total deposits were 5.3% atSeptember 30, 2020 and 8.7%December 31, 2019 . Borrowed funds totaled$90.6 million atSeptember 30, 2020 , including$70.0 million ofFederal Home Loan Bank ("FHLB") advances and$20.6 million in long-term debt associated with trust preferred securities. Borrowed funds totaled$80.6 million atDecember 31, 2019 , including$60.0 million of FHLB advances and$20.6 million in long-term debt associated with trust preferred securities. The$10.0 million increase in borrowed funds in the nine months endedSeptember 30, 2020 was due to the addition of a$10.0 million FHLB advance inFebruary 2020 . CAPITAL RESOURCES Total shareholders' equity of$233.9 million atSeptember 30, 2020 increased$16.4 million from$217.5 million atDecember 31, 2019 . The increase was primarily a result of net income of$21.2 million earned in the first nine months of 2020 and an increase of$3.1 million in accumulated other comprehensive income, partially offset by a payment of$8.2 million in cash dividends to shareholders. The Bank was categorized as "well capitalized" atSeptember 30, 2020 . Capital guidelines forU.S. banks are commonly known as Basel III guidelines. The rules include a common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, effectively resulting in a minimum CET1 ratio of 7.0%. The Basel III minimum ratio of Tier 1 capital to risk-weighted assets is 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5%), and the minimum total capital to risk-weighted assets ratio is 10.5% (with the capital conservation buffer), and Basel III requires a minimum leverage ratio of 4.0%. The capital ratios for the Company and the Bank under Basel III have continued to exceed the well capitalized minimum capital requirements.
The following table shows our regulatory capital ratios (on a consolidated basis) for the past several quarters:
Sept 30, June 30, March 31, Dec 31, Sept 30,
Macatawa Bank Corporation 2020 2020 2020 2019 2019
Total capital to risk weighted
assets 17.7 % 17.3 % 15.8 % 15.8 % 16.8 %
Common Equity Tier 1 to risk
weighted assets 15.3 14.9 13.4 13.5 13.2
Tier 1 capital to risk weighted
assets 16.6 16.3 14.7 14.7 15.8
Tier 1 capital to average
assets 9.8 10.5 11.9 11.5 12.2
LIQUIDITY
Liquidity of Macatawa Bank : The liquidity of a financial institution reflects
its ability to manage a variety of sources and uses of funds. Our Consolidated
Statements of Cash Flows categorize these sources and uses into operating,
investing and financing activities. We primarily focus on developing access to a
variety of borrowing sources to supplement our deposit gathering activities and
provide funds for our investment and loan portfolios. Our sources of liquidity
include our borrowing capacity with the FRB's discount window, the Federal Home
Loan Bank , federal funds purchased lines of credit and other secured borrowing
sources with our correspondent banks, loan payments by our borrowers, maturity
and sales of our securities available for sale, growth of our deposits, federal
funds sold and other short-term investments, and the various capital resources
discussed above.
Liquidity management involves the ability to meet the cash flow requirements of
our customers. Our customers may be either borrowers with credit needs or
depositors wanting to withdraw funds. Our liquidity management involves periodic
monitoring of our assets considered to be liquid and illiquid, and our funding
sources considered to be core and non-core and short-term (less than 12 months)
and long-term. We have established parameters that monitor, among other items,
our level of liquid assets to short-term liabilities, our level of non-core
funding reliance and our level of available borrowing capacity. We maintain a
diversified wholesale funding structure and actively manage our maturing
wholesale sources to reduce the risk to liquidity shortages. We have also
developed a contingency funding plan to stress test our liquidity requirements
arising from certain events that may trigger liquidity shortages, such as rapid
loan growth in excess of normal growth levels or the loss of deposits and other
funding sources under extreme circumstances.
We have actively pursued initiatives to maintain a strong liquidity position.
The Bank has reduced its reliance on non-core funding sources, including
brokered deposits, and focused on achieving a non-core funding dependency ratio
below its peer group average. We have had no brokered deposits on our balance
sheet since December 2011 . We continue to maintain significant on-balance sheet
liquidity. At September 30, 2020 , the Bank held $504.7 million of federal funds
sold and other short-term investments. In addition, the Bank had available
borrowing capacity from correspondent banks of approximately $315.8 million as
of September 30, 2020 .
-53---------------------------------------------------------------------------------
Index
In the normal course of business, we enter into certain contractual obligations, including obligations which are considered in our overall liquidity management. The table below summarizes our significant contractual obligations atSeptember 30, 2020 (dollars in thousands): Less than More than 1 year 1-3 years 3-5 years 5 years Long term debt $ - $ - $ -$ 20,619 Time deposit maturities 93,946 19,114 2,349 57 Other borrowed funds 10,000 10,000 40,000 10,000 Operating lease obligations 383 479 271 26 Total$ 104,329 $ 29,593 $ 42,620 $ 30,702 In addition to normal loan funding, we also maintain liquidity to meet customer financing needs through unused lines of credit, unfunded loan commitments and standby letters of credit. The level and fluctuation of these commitments is also considered in our overall liquidity management. AtSeptember 30, 2020 , we had a total of$594.1 million in unused lines of credit,$83.1 million in unfunded loan commitments and$12.5 million in standby letters of credit. Liquidity of Holding Company: The primary sources of liquidity for the Company are dividends from the Bank, existing cash resources and the capital markets if the need to raise additional capital arises. Banking regulations and the laws of theState of Michigan in which our Bank is chartered limit the amount of dividends the Bank may declare and pay to the Company in any calendar year. Under the state law limitations, the Bank is restricted from paying dividends to the Company in excess of retained earnings. In 2019, the Bank paid dividends to the Company totaling$32.5 million . In the same period, the Company paid$20.0 million to redeem trust preferred securities and paid$9.5 million in dividends to its shareholders. OnFebruary 25, 2020 , the Bank paid a dividend totaling$2.8 million to the Company in anticipation of the common share cash dividend of$0.08 per share paid onFebruary 27, 2020 to shareholders of record onFebruary 11, 2020 . The cash distributed for this cash dividend payment totaled$2.7 million . OnMay 26, 2020 , the Bank paid a dividend totaling$2.7 million to the Company in anticipation of the common share cash dividend of$0.08 per share paid onMay 28, 2020 to shareholders of record onMay 12, 2020 . The cash distributed for this cash dividend payment totaled$2.7 million . OnAugust 26, 2020 , the Bank paid a dividend totaling$3.2 million to the Company in anticipation of the common share cash dividend of$0.08 per share paid onAugust 27, 2020 to shareholders of record onAugust 11, 2020 . The cash distributed for this cash dividend payment totaled$2.7 million . The Company retained the remaining balance in each period for general corporate purposes. AtSeptember 30, 2020 , the Bank had a retained earnings balance of$80.0 million . The Company has the right to defer interest payments for 20 consecutive quarters on its trust preferred securities if necessary for liquidity purposes. During the deferral period, the Company may not declare or pay any dividends on its common stock or make any payment on any outstanding debt obligations that rank equally with or junior to the trust preferred securities.
The Company's cash balance at
CRITICAL ACCOUNTING POLICIES AND ESTIMATES:
To prepare financial statements in conformity with accounting principles generally accepted inthe United States of America , management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and future results could differ. The allowance for loan losses, other real estate owned valuation, loss contingencies, revenue recognition and income taxes are deemed critical due to the required level of management judgment and the use of estimates, making them particularly subject to change. Our methodology for determining the allowance for loan losses and the related provision for loan losses is described above in the "Allowance for Loan Losses" discussion. This area of accounting requires significant judgment due to the number of factors which can influence the collectability of a loan. Unanticipated changes in these factors could significantly change the level of the allowance for loan losses and the related provision for loan losses. Although, based upon our internal analysis, and in our judgment, we believe that we have provided an adequate allowance for loan losses, there can be no assurance that our analysis has properly identified all of the probable losses in our loan portfolio. As a result, we could record future provisions for loan losses that may be significantly different than the levels that we recorded in the first nine months of 2020. Assets acquired through or instead of foreclosure, primarily other real estate owned, are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. New real estate appraisals are generally obtained at the time of foreclosure and are used to establish fair value. If fair value declines, a valuation allowance is recorded through expense. Estimating the initial and ongoing fair value of these properties involves a number of factors and judgments including holding time, costs to complete, holding costs, discount rate, absorption and other factors. Loss contingencies are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. This, too, is an accounting area that involves significant judgment. Although, based upon our judgment, internal analysis, and consultations with legal counsel we believe that we have properly accounted for loss contingencies, future changes in the status of such contingencies could result in a significant change in the level of contingent liabilities and a related impact to operating earnings. -54-
--------------------------------------------------------------------------------
Index
Noninterest revenue is recognized in accordance with contractual requirements and as we fulfill our obligations under contractual terms. Most of our noninterest revenue comes from services that are transaction based and such revenue is recognized as the related service is provided.
Our accounting for income taxes involves the valuation of deferred tax assets and liabilities primarily associated with differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes. AtSeptember 30, 2020 , we had gross deferred tax assets of$5.8 million and gross deferred tax liabilities of$3.2 million resulting in a net deferred tax asset of$2.5 million . Accounting standards require that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard. AtDecember 31, 2018 , a valuation allowance of$92,000 was established against a capital loss carryforward created by the liquidation of the assets of a partnership interest the Bank acquired through a loan settlement thereby reducing net deferred tax assets. This valuation allowance was maintained atSeptember 30, 2020 , resulting in a net deferred tax asset balance of$2.4 million . With the positive results in 2019 and the first nine months of 2020, we concluded atSeptember 30, 2020 that no other valuation allowance on our net deferred tax asset was required. Changes in tax laws, changes in tax rates, changes in ownership and our future level of earnings can impact the ultimate realization of our net deferred tax asset.
© Edgar Online, source
