(dollars in thousands, except share and per share data)
Forward Looking Statements
Certain statements contained in this report and other publicly available
documents incorporated herein by reference constitute "forward looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Act of 1934, as amended (the
"Exchange Act"), and as defined in the Private Securities Litigation Reform Act
of 1995. Such statements are often, but not always, identified by the use of
such words as "believes," "anticipates," "expects," "intends," "plan," "goal,"
"seek," "project," "estimate," "strategy," "future," "likely," "may," "should,"
"will," and other similar expressions. Such statements involve various important
assumptions, risks, uncertainties, and other factors, many of which are beyond
our control, particularly with regard to developments related to the Coronavirus
("COVID-19") pandemic, and which could cause actual results to differ materially
from those expressed in such forward looking statements. These factors include,
but are not limited to: the effects of COVID-19 on our business, operations,
customers and capital position; higher default rates on loans made to our
customers related to COVID-19 and its impact on our customers' operations and
financial condition; the impact of COVID-19 on local, national and global
economic conditions; unexpected changes in interest rates or disruptions in the
mortgage market related to COVID-19; the effects of various governmental
responses to COVID-19; changes in political, economic or other factors, such as
inflation rates, recessionary or expansive trends, taxes, the effects of
implementation of legislation and the continuing economic uncertainty in various
parts of the world; competitive pressures; fluctuations in interest rates; the
level of defaults and prepayment on loans made by the Company; unanticipated
litigation, claims, or assessments; fluctuations in the cost of obtaining funds
to make loans; and regulatory changes. Additional detailed information
concerning such factors is available in the Company's filings with the
Securities and Exchange Commission, under the Exchange Act, including the
disclosure under the heading "Item 1A. Risk Factors" of Part I of the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2020. Readers
are cautioned not to place undue reliance on such forward looking statements,
which speak only as of the date hereof. The Company undertakes no obligation
and disclaims any intention to republish revised or updated forward looking
statements, whether as a result of new information, unanticipated future events
or otherwise.
Financial Overview
BUSINESS OVERVIEW: The Company is primarily engaged in commercial and retail
banking, offering a blend of commercial and consumer banking services within
southeastern Ohio as well as western West Virginia. The banking services
offered by the Bank include the acceptance of deposits in checking, savings,
time and money market accounts; the making and servicing of personal,
commercial, floor plan and student loans; the making of construction and real
estate loans; and credit card services. The Bank also offers individual
retirement accounts, safe deposit boxes, wire transfers and other standard
banking products and services. Furthermore, the Bank offers Tax Refund Advance
Loans ("TALs") to Loan Central tax customers. A TAL represents a short-term loan
offered by the Bank to tax preparation customers of Loan Central. TAL
originations began in 2020 in response to a state law enacted in 2019 that
placed various restrictions on Loan Central's short-term and small loan
originations. As a result, the Company changed its business model beginning in
2020 from assessing TAL fees to assessing tax preparation fees.
IMPACT of COVID-19: COVID-19 has continued to cause significant disruption in
the United States and international economies and financial markets. The primary
markets served by the Company in southeastern Ohio and western West Virginia
have been significantly impacted by COVID-19, which has changed the way we live
and work. The actions taken by the Governors of the States of Ohio and West
Virginia beginning in March of 2020 were imposed to mitigate the spread and
lessen the public health impact of COVID-19. During this time, the Bank's
primary channels of serving our customers have primarily consisted of
drive-thru, mobile, and online banking services and appointment-only lobby
services. We have leveraged our digital banking platform with our customers, and
we have implemented company-wide remote working arrangements. In March 2021, the
Company re-opened the lobbies of all the Bank's financial service centers,
stressing the importance of safety to its customers and employees. As per state
mandates in Ohio and West Virginia, masks will be required and social distancing
measures will be maintained.
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On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act
("CARES Act") was signed into law. The CARES Act provides assistance to small
businesses through the establishment of the Paycheck Protection Program ("PPP").
The PPP provides small businesses with funds to use for payroll and certain
other expenses. The funds are provided in the form of loans that will be fully
forgiven if certain criteria are met. In 2021, Congress amended the PPP by
extending the authority of the SBA to guarantee loans and the ability of PPP
lenders to disburse PPP loans until May 31, 2021. The Company continues to
support its clients who have experienced financial hardship due to COVID-19
through participation in the PPP, assistance with expedited deposits of CARES
Act stimulus payments, and loan modifications, as needed.
FINANCIAL RESULTS OVERVIEW: Net income totaled $3,531 during the first quarter
of 2021, an increase of $2,529 over the same period of 2020. Earnings per share
for the first quarter of 2021 finished at $.74 per share, compared to $.21 per
share during the first quarter of 2020. Quarterly earnings improved largely due
to lower provision expense and lower noninterest expense being partially offset
by a decrease in noninterest income, while net interest income remained
relatively stable. The impact of higher net earnings during the first quarter
of 2021 also had a direct impact to the Company's annualized net income to
average asset ratio, or return on assets, which increased to 1.20% at March 31,
2021, compared to 0.40% at March 31, 2020. The Company's net income to average
equity ratio, or return on equity, also increased to 10.47% at March 31, 2021,
compared to 3.14% at March 31, 2020.
During the three months ended March 31, 2021, net interest income increased $44,
or 0.4%, over the same period in 2020. This increase reflected the benefit of a
$169,976, or 18.2%, increase in average earning assets, which fully offset a 61
basis point decrease in the fully tax-equivalent ("FTE") net interest margin.
Average earning assets were mostly impacted by growth in loans and higher
balances maintained in the Company's interest-bearing Federal Reserve clearing
account. Growth in loans benefited from the Company's participation in the PPP
to assist various businesses in our market during the pandemic. Higher Federal
Reserve balances were the result of various stimulus payments received by
customers. The margin was negatively impacted by the actions of the Federal
Reserve to reduce interest rates by 150 basis points in March 2020 due to
concerns about the impact of COVID-19 on the economy. This has led to a
sustained low-rate interest environment over the past year. The change in asset
mix during 2020 and 2021 into more PPP loans and elevated deposits at the
Federal Reserve has had a dilutive effect on the net interest margin, with PPP
loans carrying a 1.0% interest rate and the rate on balances maintained at the
Federal Reserve currently at 10 basis points.
During the three months ended March 31, 2021, the Company experienced negative
provision for loan loss, which contributed to a $3,898 decrease in provision
expense when compared to the same period in 2020. The decrease from the prior
year was largely impacted by the economic effects of the COVID-19 pandemic,
which resulted in a higher general allocation of the allowance for loan losses
during the first quarter of 2020. Based on declining economic conditions and
increasing unemployment levels, management increased general reserves by $2,287
during the first quarter of 2020 to reflect higher anticipated losses due to the
expected financial impact of COVID-19 on its customers. Further impacting lower
provision expense was a $1,168 decrease in net loan charge-offs, primarily from
the commercial real estate and consumer loan portfolios.
During the three months ended March 31, 2021, noninterest income decreased
$1,103, or 24.8%, from the same period in 2020. The large decline came primarily
from the one-time payment of $2,000 received in a litigation settlement with a
third-party during the first quarter of 2020, which did not reoccur in 2021. As
part of the settlement agreement, the Bank is scheduled to process a certain
amount of tax items starting in 2021 and ending in 2025. As a result of this
agreed processing, the Bank recognized $540 in electronic refund
check/electronic refund deposit ("ERC/ERD") income during the first quarter of
2021. This, along with higher interchange income, mortgage banking income, tax
preparation fees, and lower losses on other real estate owned, helped to
partially offset the decrease in noninterest income related to 2020's litigation
settlement.
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During the three months ended March 31, 2021, noninterest expense decreased
$332, or 3.5%, from the same period in 2020. The decrease was primarily related
to the expense savings associated with a lower number of employees, which
contributed to a $185, or 3.4%, decrease in salaries and employee benefits
expense from the prior year. The Company also experienced lower professional
fees, decreasing $168, or 28.1%, from the prior year. This was in large part due
to lower legal fees associated with collecting troubled loans. Furthermore,
other noninterest expense was down $138, or 9.4%, in large part due to lower
incentives paid on customer deposit accounts. Partially offsetting the expense
decreases were higher FDIC insurance, software, and occupancy and equipment
costs during 2021.
The Company's provision for income taxes increased $642 during the three months
ended March 31, 2021, largely due to the changes in taxable income affected by
the factors mentioned above.
At March 31, 2021, total assets were $1,225,184, an increase of $38,252 from
total assets of $1,186,932 at year-end 2020. Higher assets were primarily
impacted by increases in cash and cash equivalents and investment securities,
which were collectively up $53,306, or 20.4%, from year-end 2020. This was
related to the investment of heightened deposit balances impacted by the various
stimulus payments received by customers. The growth in assets from year-end
2020 was partially offset by a $17,614, or 2.1%, decrease in loans. The loan
portfolio experienced decreases in the residential real estate segment (-4.9%),
commercial real estate segment (-0.9%) and consumer loan segment (-1.9%).
At March 31, 2021, total liabilities were $1,087,444, up $36,836 from year-end
2020. Contributing most to this increase were higher deposit balances, which
increased $38,889 from year-end 2020. The increase was impacted mostly by
customers receiving stimulus funds and their desire to preserve cash during this
uncertain economic environment.
At March 31, 2021, total shareholders' equity was $137,740, up $1,416 since
December 31, 2020. Regulatory capital ratios of the Company remained higher
than the "well capitalized" minimums.
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Comparison of Financial Condition
at March 31, 2021 and December 31, 2020
The following discussion focuses, in more detail, on the consolidated financial
condition of the Company at March 31, 2021 compared to December 31, 2020. This
discussion should be read in conjunction with the interim consolidated financial
statements and the footnotes included in this Form 10Q.
Cash and Cash Equivalents
At March 31, 2021, cash and cash equivalents were $176,420, an increase of
$38,117, or 27.6%, from December 31, 2020. The increase in cash and cash
equivalents came mostly from higher interest-bearing deposits on hand with
correspondent banks. Over 89% of cash and cash equivalents consist of the
Company's interest-bearing Federal Reserve Bank clearing account, which
increased $37,111, or 30.6%, from year-end 2020. The Company utilizes its
interest-bearing Federal Reserve Bank clearing account to manage excess funds,
as well as to assist in funding earning asset growth. The primary factor for the
significant influx in clearing account balances was the investment of heightened
deposit balances received during 2021 as a result of the pandemic environment.
Total deposits increased 27.6% from year-end 2020 in relation to customers
receiving stimulus funds from various government programs and their desire to
preserve cash during this uncertain economic environment. Furthermore, several
congressional acts led to the extension of the PPP loan program during the first
quarter of 2021. Under the reopened PPP, commercial business customers received
loan proceeds, which helped to generate higher levels of investable deposits
during the first quarter of 2021. The interest rate paid on both the required
and excess reserve balances of the Federal Reserve Bank account is based on the
targeted federal funds rate established by the Federal Open Market Committee.
During the first quarter of 2020, the rate associated with the Company's Federal
Reserve Bank clearing account decreased 150 basis points due to concerns about
the impact of COVID-19 on the economy, resulting in a target federal funds rate
range of 0% to 0.25%. Although interest-bearing deposits in the Federal Reserve
Bank are the Company's lowest-yielding interest-earning asset, the investment
rate is higher than the rate the Company would have received from its
investments in federal funds sold. Furthermore, Federal Reserve balances are
100% secured.
As liquidity levels continuously vary based on consumer activities, amounts of
cash and cash equivalents can vary widely at any given point in time. The
Company's focus during periods of heightened liquidity will be to invest excess
funds into longer-term, higher-yielding assets, primarily loans, when the
opportunities arise.
Certificates of deposit
At March 31, 2021, the Company had $2,255 in certificates of deposit owned by
the Captive, down from $2,500 at year-end 2020. The deposits on hand at March
31, 2021 consist of ten certificates with remaining maturity terms ranging from
less than 3 months up to 26 months.
Securities
The balance of total securities increased $15,189, or 12.4%, compared to
year-end 2020. The Company's investment securities portfolio is made up mostly
of U.S. Government agency ("Agency") mortgage-backed securities, which increased
$4,237, or 4.5%, from year-end 2020 and represented 71.6% of total investments
at March 31, 2021. During the first three months of 2021, the Company invested
$15,248 in new Agency mortgage-backed securities, while receiving principal
repayments of $9,752. The monthly repayment of principal has been the primary
advantage of Agency mortgage-backed securities as compared to other types of
investment securities, which deliver proceeds upon maturity or call date. The
Company also redeployed a portion of its heightened excess funds to purchase
$5,174 in U.S. Government securities, as well as $5,399 in Agency securities,
net of maturities, during the first quarter of 2021.
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Loans
The loan portfolio represents the Company's largest asset category and is its
most significant source of interest income. Gross loan balances lowered to
$831,050 at March 31, 2021, representing a decrease of $17,614, or 2.1%, as
compared to $848,664 at December 31, 2020. The decrease in loans came primarily
from the residential real estate portfolio, with other decreases coming from the
total consumer and commercial loan portfolios from year-end 2020.
The majority of the Company's decrease in loans came from the residential real
estate loan segment, which decreased $14,891, or 4.9%, from year-end 2020.
Although down, the residential real estate loan segment still comprises the
largest portion of the Company's overall loan portfolio at 35.0% and consists
primarily of one- to four-family residential mortgages and carries many of the
same customer and industry risks as the commercial loan portfolio. The decrease
in residential real estate loans came largely from the Bank's warehouse lending
volume. Warehouse lending consists of a line of credit provided by the Bank to
another mortgage lender that makes loans for the purchase of one- to four-family
residential real estate properties. The mortgage lender eventually sells the
loans and repays the Bank. As mortgage refinancings reached their peak during
the second half of 2020, the volume of warehouse lending balances have decreased
during the first quarter of 2021, finishing at $3,720 at March 31, 2021, as
compared to $19,365 at December 31, 2020. Furthermore, the low rate environment
has contributed to a shift into more long-term fixed-rate mortgages (up $1,064)
and less short-term adjustable-rate mortgages (down $3,519) at March 31, 2021.
The Company's commercial loan portfolio, consisting of commercial real estate
and commercial and industrial loans, decreased $279, or 0.1%, from year-end
2020. Contributing most to the decrease were lower loan balances within the
commercial real estate portfolio, decreasing $2,303, or 0.9%, from year-end
2020. The commercial real estate segment comprised the largest portion of the
Company's total commercial loan portfolio at March 31, 2021 at 61.1%. Decreases
were largely from the principal repayments and payoffs of nonowner-occupied loan
balances from year-end 2020.
Decreases in commercial real estate loans were partially offset by a $2,024, or
1.3%, increase in the commercial and industrial portfolio from year-end 2020.
Commercial and industrial loans consist of loans to corporate borrowers
primarily in small to mid-sized industrial and commercial companies that include
service, retail and wholesale merchants. Collateral securing these loans
includes equipment, inventory, and stock. The commercial and industrial segment
also includes PPP loan balances that had a significant impact on average earning
asset growth in 2021. Although a second round of PPP loans were initiated by the
Bank during the first quarter of 2021, the Bank experienced no net loan growth
in its PPP loan portfolio from year-end 2020. This was because the payoffs of
PPP loans from the initial round of originations in 2020 completely offset the
new PPP loan originations in 2021. PPP loans are forgiven by the SBA as long as
the small business borrower meets certain criteria on the use of loan proceeds.
At March 31, 2021, the Company's PPP loans totaled $25,829 as compared to
$27,933 at year-end 2020.
While management believes lending opportunities exist in the Company's markets,
future commercial lending activities will depend upon economic and other related
conditions, such as general demand for loans in the Company's primary markets,
interest rates offered by the Company, the effects of competitive pressure and
normal underwriting considerations. Management will continue to place emphasis
on its commercial lending, which generally yields a higher return on investment
as compared to other types of loans.
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The Company's loan portfolio at March 31, 2021 was also impacted by less
consumer loan balances from year-end 2020, decreasing $2,444, or 1.9%. This
change was primarily impacted by a decline in automobile loan balances.
Automobile loans represent the Company's largest consumer loan segment at 41.3%
of total consumer loans. Automobile loans decreased primarily as a result of
COVID-19 and the stay-at-home orders that resulted in limited automobile sales
within the Company's market areas during 2020. The pandemic environment
continued to have a negative impact on consumer loan demand in 2021. Further
limiting the volume of automobile loan originations were heightened incentives
being offered from the captive auto finance companies in response to the
pandemic. The remaining consumer loan portfolio decreased $678, or 0.9%, from
year-end 2020, mostly from decreases in unsecured loans, partially offset by
higher home equity lines of credit. The Company will continue to attempt to
increase its auto lending segment while maintaining strict loan underwriting
processes to limit future loss exposure. However, the Company will place more
emphasis on loan portfolios (i.e. commercial and, to a smaller extent,
residential real estate) with higher returns than auto loans. Indirect
automobile loans bear additional costs from dealers that partially offset
interest revenue and lower the rate of return.
Allowance for Loan Losses
The Company established a $6,887 allowance for loan losses at March 31, 2021,
which represents a decrease from the $7,160 allowance at year-end 2020. As part
of the Company's quarterly analysis of the allowance for loan losses, management
will review various factors that directly impact the general allocation needs of
the allowance, which include: historical loan losses, loan delinquency levels,
local economic conditions and unemployment rates, criticized/classified asset
coverage levels and loan loss recoveries. During the first quarter of 2021, the
Company experienced a $363 decrease in its general allocations of the allowance
for loan losses. A stable historical loan loss factor combined with lower
criticized and classified assets and higher annualized loan recoveries were the
key factors to the first quarter drop in general allocations. The historical
loan loss factor remain unchanged at 0.24% from year-end 2020 to March 31, 2021,
while the criticized and classified risk factors decreased as a result of
various commercial loan upgrades from improvements in the financial performance
of certain borrowers' ability to repay their loans. This contributed to lower
classified assets from year-end 2020, particularly within the commercial and
industrial loan segment. Additionally, the Company's delinquency levels
decreased from year-end 2020, with nonperforming loans to total loans of 0.74%
at March 31, 2021 compared to 0.82% at December 31, 2020, and lower
nonperforming assets to total assets of 0.50% at March 31, 2021 compared to
0.59% at year-end 2020. General allocations during the first quarter of 2021
increased in relation to higher unemployment rates within the Company's market
areas, only partially offsetting the decreasing allocation factors already
discussed.
During the first quarter of 2020, the Company added a new risk factor to the
evaluation of the allowance for loan losses pertaining to the COVID-19 pandemic.
The risk factor was necessary to account for the changes in economic conditions
resulting from increases in unemployment that would produce higher anticipated
losses as a result of COVID-19. The general reserve allocation related to
COVID-19 totaled $2,233 at March 31, 2021 as compared to $2,315 at December 31,
2020. While the Company has yet to experience any significant charge-offs
related to COVID-19, the continued uncertainty regarding the severity and
duration of the pandemic and related economic effects will continue to impact
the Company's estimate of its allowance for loan losses and resulting provision
expense going forward.
Decreases in general allocations were partially offset by a $90 increase in
specific allocations from year-end 2020. Specific allocations of the allowance
for loan losses identify loan impairment by measuring fair value of the
underlying collateral and the present value of estimated future cash flows. The
change in specific reserves was primarily related to the loan impairments of one
borrower relationship during the first quarter of 2021.
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The Company's allowance for loan losses to total loans ratio finished at 0.83%
at March 31, 2021 and 0.84% at year-end 2020. Management believes that the
allowance for loan losses at March 31, 2021 was adequate and reflected probable
incurred losses in the loan portfolio. There can be no assurance, however, that
adjustments to the allowance for loan losses will not be required in the
future. Changes in the circumstances of particular borrowers, as well as
adverse developments in the economy, particularly with respect to COVID-19, are
factors that could change, and management will make adjustments to the allowance
for loan losses as needed. Asset quality will continue to remain a key focus of
the Company, as management continues to stress not just loan growth, but quality
in loan underwriting.
Deposits
Deposits continue to be the most significant source of funds used by the Company
to meet obligations for depositor withdrawals, to fund the borrowing needs of
loan customers, and to fund ongoing operations. Total deposits at March 31,
2021 increased $38,889, or 3.9%, from year-end 2020. This change in deposits
came primarily from interest-bearing deposit balances, which were up by $27,072,
or 5.7%, from year-end 2020, while noninterest-bearing deposits increased
$13,199, or 4.2%, from year-end 2020. The Company attributes much of this
increase to retention of proceeds from government stimulus programs, such as the
PPP and consumer economic impact payments received, and a more cautious
consumer.
The increase in interest-bearing deposits came mostly from higher
interest-bearing NOW account balances from year-end 2020, which increased
$19,552, or 10.6%. This increase was largely driven by higher municipal NOW
product balances, particularly within the Gallia County, Ohio and Mason County,
West Virginia market areas. Growth in interest-bearing deposits also came from
savings deposits, which increased $11,280, or 9.4%, from year-end 2020,
primarily from higher statement savings account balances impacted by the
government stimulus proceeds previously mentioned. Interest-bearing deposit
growth was partially offset by lower money market balances from year-end 2020,
which decreased $3,760, or 2.3%. The deposit rate on the Company's Prime
Investment money market account was reduced during the first quarter of 2021 in
response to decreasing market rates in 2020. This contributed to a consumer
shift from money market deposits into savings and noninterest-bearing deposit
accounts.
Partially offsetting the increases in interest-bearing deposits were time
deposit balances, which decreased $1,382, or 0.7%, from year-end 2020. The
decrease came from lower brokered and internet CD issuances as a result of the
heightened liquidity position from year-end 2020. The Company's retail time
deposits were relatively stable from year-end 2020.
The increase in noninterest-bearing deposits came mostly from the Company's
business and incentive-based checking account balances from year-end 2020.
While facing increased competition for deposits in its market areas, the Company
will continue to emphasize growth and retention in its core deposit
relationships during the remainder of 2021, reflecting the Company's efforts to
reduce its reliance on higher cost funding and improve net interest income.
Other Borrowed Funds
Other borrowed funds were $26,691 at March 31, 2021, a decrease of $1,172, or
4.2%, from year-end 2020. The decrease was related primarily to the principal
repayments applied to various FHLB advances during the first quarter of 2021.
While deposits continue to be the primary source of funding for growth in
earning assets, management will continue to utilize FHLB advances and promissory
notes to help manage interest rate sensitivity and liquidity.
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Shareholders' Equity
Total shareholders' equity at March 31, 2021 increased $1,416, or 1.0%, to
finish at $137,740, as compared to $136,324 at December 31, 2020. This was from
quarterly net income being partially offset by cash dividends paid and a
decrease in net unrealized gain on available for sale securities.
Comparison of Results of Operations
For the Three Months Ended
March 31, 2021 and 2020
The following discussion focuses, in more detail, on the consolidated results of
operations of the Company for the three months ended March 31, 2021 compared to
the same period in 2020. This discussion should be read in conjunction with the
interim consolidated financial statements and the footnotes included in this
Form 10Q.
Net Interest Income
The most significant portion of the Company's revenue, net interest income,
results from properly managing the spread between interest income on earning
assets and interest expense incurred on interest-bearing liabilities. During the
three months ended March 31, 2021, net interest income remained relatively
stable at $10,048 compared to $10,004 at March 31, 2020. The moderate change was
mostly attributable to higher average earning assets providing favorable
increases to interest revenue being offset by a net interest margin compression
in relation to decreases in market rates that contributed to lower earning asset
yields.
Total interest and fee income recognized on the Company's earning assets
decreased $659, or 5.6%, during the first quarter of 2021 compared to the same
period in 2020. The decrease was impacted by interest and fees on loans, which
decreased $308, or 2.8%. This result was directly related to the decline in loan
yields, which decreased from 5.78% to 5.18% when comparing the first quarters of
2020 to 2021. Loan yields were impacted by interest rate reductions from the
Federal Reserve Bank in March 2020. This trend of decreasing market rates led to
lower yields on the Company's loan portfolio and lower loan interest revenue.
Partially offsetting the effects from lower loan yields was average growth in
loans. Average loans for the quarter ended March 31, 2021 compared to the
quarter ended March 31, 2020 increased $72,151, or 9.4%, which came mostly from
the origination of PPP loans during 2020 and 2021. While PPP loans contributed
to higher earning asset balances, they also had a dilutive effect to loan yields
as a result of the 1% interest rate associated with each loan. These factors
contributed to a decrease of $670 in loan interest income during the three
months ended March 31, 2021 compared to the same period in 2020.
Loan revenue was positively impacted by loan fees, which increased $362 during
the first quarter of 2021 compared to the same period in 2020. The increase came
largely from $367 in loan fees earned on the origination of
government-guaranteed PPP loans as a result of normal amortization and loan
forgiveness.
During the three months ended March 31, 2021, interest income from
interest-bearing deposits with banks decreased $134, or 82.7% when compared to
the same period in 2020. This change in interest revenue came primarily from the
Company's interest-bearing Federal Reserve Bank clearing account. The quarterly
decrease in interest income was primarily due to the interest rate tied to this
interest-bearing clearing account, which was 0.10% at March 31, 2021 compared to
0.25% at March 31, 2020. The increase in liquidity from the surge in deposit
liabilities allowed the Company to maintain higher average balances within the
account, which increased $83,223 during the first quarter of 2021compared to the
same period in 2020.
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Total interest on securities decreased $206, or 30.7%, during the first quarter
of 2021 compared to the same period in 2020. The Company has taken opportunities
to reinvest a portion of excess deposits into new U.S. Government, Agency and
Agency mortgage-backed securities, contributing to a $14,038 increase in average
securities during the first quarter of 2021 over the first quarter of 2020.
However, the increase in average securities was completely offset by a decline
in securities yield of 87 basis points from 2.33% to 1.46%.
Total interest expense incurred on the Company's interest-bearing liabilities
decreased $703, or 39.5%, during the first quarter of 2020 compared to the same
period in 2020. Interest expense decreased despite an increase in average
interest-bearing deposits of $76,252 during the first quarter of 2021 compared
to the same period in 2020. The converse relationship between increasing average
interest-bearing liabilities to lower interest expense is related to the
repricing efforts in a lower rate environment which drove down average costs
during 2020. This included the rate reduction to the Company's Prime Investment
deposit account, which contributed to a $213 decrease in money market interest
expense during the first quarter of 2021 compared to the same period in 2020.
Deposit expense was further impacted by lower CD rates, which have contributed
to a $394 decrease in time deposit interest expense during the first quarter of
2021 compared to the same period in 2020. As CD rates have repriced downward,
the Company has benefited from lower interest expense on newly issued CDs at
lower rates. As a result of the rate repricings on money market accounts and
time deposits, the Company's total weighted average costs on interest-bearing
deposits has decreased by 48 basis points from 1.00% at March 31, 2020 to 0.52%
at March 31, 2021.
The Company's net interest margin is defined as fully tax-equivalent net
interest income as a percentage of average earning assets. During 2021, the
Company's first quarter net interest margin finished at 3.73%, compared to
2020's first quarter net interest margin of 4.34%. The decrease in margin was
largely impacted by the decreasing market rates that impacted lower earning
asset yields primarily during 2020. Interest rates were reduced at the end of
the first quarter of 2020 because of the growing concern of the COVID-19
pandemic. The Company's primary focus is to invest its funds into higher
yielding assets, particularly loans, as opportunities arise. However, if loan
balances do not continue to expand and remain a larger component of overall
earning assets, the Company will face pressure within its net interest income
and margin improvement.
Provision for Loan Losses
For the three months ended March 31, 2021, the Company's provision expense
decreased $3,898 from the same period in 2020. The quarterly improvement came
primarily from the addition of a new risk reserve allocation in 2020 that was
less impactful in 2021. As previously discussed, the Company's general reserves
during the first quarter of 2020 were significantly impacted by a $1,942
allocation of the allowance for loan losses as a result of the expected
financial impact of COVID-19 on its customers. The allocation resulted in a
corresponding entry to provision expense in March 2020. Further reducing
provision expense was a decrease of $1,168 in net charge-offs during the three
months ended March 31, 2021 compared to the same period in 2020. This was
primarily from lower charge-offs recorded within the commercial real estate and
consumer loan portfolios. Further contributing to lower provision expense were
the impacts of lower general reserve allocations. During the first quarter of
2021, the Company decreased its general allocation from $7,160 at December 31,
2020 to $6,797 at March 31, 2021. Conversely, this is compared to a $468
general allocation increase during the same period in 2020, excluding the
COVID-19 risk factor. Lower general reserves have been affected by various
improvements within the economic risk factor calculation that included: lower
criticized and classified assets, lower delinquency levels, and higher
annualized level of loan recoveries. Lower provision expense was also impacted
by a decrease in specific allocations that totaled $90 at March 31, 2021
compared to $854 in specific allocations at March 31, 2020.
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Future provisions to the allowance for loan losses will continue to be based on
management's quarterly in-depth evaluation that is discussed in further detail
under the caption "Critical Accounting Policies - Allowance for Loan Losses"
within this Management's Discussion and Analysis.
Noninterest Income
Noninterest income for the three months ended March 31, 2021 decreased $1,103,
or 24.8%, when compared to the three months ended March 31, 2020. The key
contributor to the decrease in noninterest revenue was the one-time payment
received in a litigation settlement with a third-party in 2020. During the first
quarter of 2020, the Bank entered into a settlement agreement related to the
previously disclosed litigation the Bank had filed against a third-party tax
software product provider for breach of contract. Under the settlement
agreement, the third-party paid a $2,000 settlement payment to the Bank in March
2020, which was recorded as noninterest income. As part of the settlement
agreement, the Bank is scheduled to process a certain amount of tax items
starting in 2021 and ending in 2025. As a result of this processing agreement,
the Bank recognized $540 in ERC/ERD income during the first quarter of 2021,
which helped to partially offset the effects of the settlement proceeds received
in 2020.
Increases in noninterest revenue also came from interchange income, which
increased $107, or 11.4%, during the first quarter of 2021. This was largely
impacted by the economic stimulus proceeds received by customers due to the
COVID-19 pandemic that increased consumer spending.
Lower losses on the sales of foreclosed assets also improved noninterest income
during the first quarter of 2021. The Company experienced $101 in losses on the
sale of foreclosed assets during the first quarter of 2020 compared to a $1 gain
during the first quarter of 2021. This was primarily from an adjustment to the
fair value of one foreclosed commercial property during the first quarter of
2020.
Increases to noninterest revenue also came from mortgage banking income.
Mortgage banking income is highly influenced by mortgage interest rates and
housing market conditions. With mortgage rates at record lows during 2020
impacted by the COVID-19 pandemic, the consumer demand to refinance long-term,
fixed-rate real estate mortgages significantly increased. While the heavy volume
of refinancing has slowed since 2020, the amount of loans sold during the first
quarter of 2021 still exceeded the volume of loan sales experienced during the
first quarter of 2020. This led to an increase of $89 in mortgage banking income
during the first quarter of 2021 over the same period in 2020.
Tax preparation fee income also increased during the first quarter of 2021. As
previously discussed, the Company changed its business model in 2020 for
assessing fees related to tax refund advance loans. By charging for the tax
preparation services, the Company recorded $694 in tax preparation fee income
for the first three months of 2021 compared to $615 during the same period in
2020.
The remaining noninterest income categories decreased $20, or 2.2%, during the
first quarter of 2021 compared to the same period in 2020, largely from lower
service charges on deposit accounts as a result of less overdraft fees impacted
by economic stimulus proceeds received by customers.
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Noninterest Expense
Noninterest expense during the first quarter of 2021 decreased $332, or 3.5%
compared to the same period in 2020. Contributing most to the decline in
noninterest expense was salaries and employee benefits, which decreased $185, or
3.4%, during the three months ended March 31, 2021 compared to the same period
in 2020. The expense savings can be related to a lower employee base, with the
Bank's average full-time equivalent employee base at 234 employees for March 31,
2021 compared to 244 employees at March 31, 2020. The impact of a lower employee
base has more than offset the expense increases associated with annual merit
increases in 2021.
Further impacting lower overhead costs were professional fees, which decreased
$168, or 28.1%, during the first quarter of 2021 compared to the same period in
2020. These decreases were largely from lower litigation costs related to a
fewer number of bankruptcy-related loan cases in 2021 impacted by the COVID-19
pandemic environment.
Other noninterest expense also decreased $138, or 9.4%, during the first quarter
of 2021 compared to the same period in 2020. This was primarily impacted by
lower customer incentive expenses paid on deposit accounts and use of credit
cards.
Decreases in noninterest expense were partially offset by an increase in FDIC
assessment costs. The Bank's FDIC assessment at March 31, 2021 was $79 compared
to no assessment cost at March 31, 2020. During 2020, the Bank had continued to
utilize a portion of its remaining FDIC credits that had been issued in
September 2019. Excluding the credit, the Bank's first quarter 2020 assessment
would have been $68.
Further impacting overhead costs were higher occupancy, furniture, equipment and
software expenses, which were collectively up $137, or 12.7%, during the first
quarter of 2020 over the same period in 2020. Building and equipment costs were
driven by increases in depreciable assets associated with the new OVB On the
Square facility. Higher software costs were associated with the platform used
to facilitate the second round of PPP loans during the first quarter of 2021.
The remaining noninterest expense categories decreased $57, or 6.2%, during the
first quarter of 2021 compared to the same period in 2020. These decreases were
impacted mostly from expense savings related to lower data processing and
foreclosure costs.
Efficiency
The Company's efficiency ratio is defined as noninterest expense as a percentage
of fully tax-equivalent net interest income plus noninterest income. The effects
from provision expense are excluded from the efficiency ratio. Management
continues to place emphasis on managing its balance sheet mix and interest rate
sensitivity as well as developing more innovative ways to generate noninterest
revenue. Comparing the first quarters of 2021 and 2020, the Company's asset
yields were negatively impacted by market rate reductions related to COVID-19,
which resulted in a greater decrease in yield on earning assets than the average
cost on interest-bearing liabilities. Loan fee increases in 2021 impacted by PPP
loans were able to bring net interest income back more in line with 2020.
However, the Company's noninterest expense savings of 3.5% was not enough to
offset a 24.8% decrease in noninterest income. As a result, the Company's
efficiency number increased (regressed) to 68.0% during the quarterly period
ended March 31, 2021 compared to 65.4% during the same period in 2020.
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Provision for income taxes
The Company's income tax provision increased $642 during the three months ended
March 31, 2021 compared to the same period in 2020. The change in tax expense
corresponded directly to the change in associated taxable income during 2021 and
2020.
Capital Resources
Federal regulators have classified and defined capital into the following
components: (1) tier 1 capital, which includes tangible shareholders' equity for
common stock, qualifying preferred stock and certain qualifying hybrid
instruments, and (2) tier 2 capital, which includes a portion of the allowance
for loan losses, certain qualifying long-term debt, preferred stock and hybrid
instruments which do not qualify as tier 1 capital.
In September 2019, consistent with Section 201 of the Economic Growth,
Regulatory Relief, and Consumer Protection Act, the federal banking agencies
issued a final rule providing simplified capital requirements for certain
community banking organizations (banks and holding companies). Under the rule, a
qualifying community banking organization ("QCBO") is eligible to opt into the
Community Bank Leverage Ratio ("CBLR") framework in lieu of the Basel III
capital requirements if it has less than $10 billion in total consolidated
assets, limited amounts of certain trading assets and liabilities, limited
amounts of off-balance sheet exposure and a leverage ratio greater than 9.0%.
The new rule took effect January 1, 2020, and QCBOs were allowed to opt into the
new CBLR framework in their call report beginning the first quarter of 2020.
A QCBO opting into the CBLR framework must maintain a CBLR of 9.0%, subject to a
two quarter grace period to come back into compliance, provided that the QCBO
maintains a leverage ratio of more than 8.0% during the grace period. A QCBO
failing to satisfy these requirements must comply with the existing Basel III
capital requirements as implemented by the banking regulators in July 2013.
The numerator of the CBLR is Tier 1 capital, as calculated under present rules.
The denominator of the CBLR is the QCBO's average assets, calculated in
accordance with the QCBO's Call Report instructions and less assets deducted
from Tier 1 capital.
The Bank has opted into the CBLR, and will therefore not be required to comply
with the Basel III capital requirements. As of March 31, 2021, the Bank's CBLR
was 10.65%, and the Company's CBLR was 11.64%.
Pursuant to the CARES Act, the federal banking regulators in April 2020 issued
interim final rules to set the CBLR at 8% beginning in the second quarter of
2020 through the end of 2020. Beginning in 2021, the CBLR increased to 8.5% for
the calendar year. Community banks will have until January 1, 2022 before the
CBLR requirement will return to 9%.
Cash dividends paid by the Company were $1,005 during the first three months of
2021. The year-to-date dividends paid totaled $0.21 per share.
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Liquidity
Liquidity relates to the Company's ability to meet the cash demands and credit
needs of its customers and is provided by the ability to readily convert assets
to cash and raise funds in the marketplace. Total cash and cash equivalents,
held to maturity securities maturing within one year and available for sale
securities, totaling $305,236, represented 24.9% of total assets at March 31,
2021. The COVID-19 pandemic had a significant impact on higher levels of excess
funds in 2021, which included customer deposits of stimulus monies from various
government relief programs. In addition, the FHLB offers advances to the Bank,
which further enhances the Bank's ability to meet liquidity demands. At March
31, 2021, the Bank could borrow an additional $92,178 from the FHLB.
Furthermore, the Bank has established a borrowing line with the Federal Reserve.
At March 31, 2021, this line had total availability of $57,389. Lastly, the Bank
also has the ability to purchase federal funds from a correspondent bank.
Off-Balance Sheet Arrangements
As discussed in Note 5 - Financial Instruments with Off-Balance Sheet Risk, the
Company engages in certain off-balance sheet credit-related activities,
including commitments to extend credit and standby letters of credit, which
could require the Company to make cash payments in the event that specified
future events occur. 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. Standby letters of credit are
conditional commitments to guarantee the performance of a customer to a third
party. While these commitments are necessary to meet the financing needs of the
Company's customers, many of these commitments are expected to expire without
being drawn upon. Therefore, the total amount of commitments does not
necessarily represent future cash requirements.
Critical Accounting Policies
The most significant accounting policies followed by the Company are presented
in Note A to the financial statements in the Company's 2020 Annual Report to
Shareholders. These policies, along with the disclosures presented in the other
financial statement notes, provide information on how significant assets and
liabilities are valued in the financial statements and how those values are
determined. Management views critical accounting policies to be those which are
highly dependent on subjective or complex judgments, estimates and assumptions,
and where changes in those estimates and assumptions could have a significant
impact on the financial statements. Management currently views the adequacy of
the allowance for loan losses to be a critical accounting policy.
Allowance for loan losses
The allowance for loan losses is a valuation allowance for probable incurred
credit losses. Loan losses are charged against the allowance when management
believes the uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance. Management estimates the
allowance balance required using past loan loss experience, the nature and
volume of the portfolio, information about specific borrower situations and
estimated collateral values, economic conditions, and other factors. Allocations
of the allowance may be made for specific loans, but the entire allowance is
available for any loan that, in management's judgment, should be charged off.
The allowance consists of specific and general components. The specific
component relates to loans that are individually classified as impaired. A loan
is 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. Impaired loans generally consist of
loans with balances of $200 or more on nonaccrual status or nonperforming in
nature. Loans for which the terms have been modified, and for which the borrower
is experiencing financial difficulties, are considered TDRs and classified as
impaired.
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Factors considered by management in determining impairment include payment
status, collateral value, and the probability of collecting scheduled principal
and interest payments when due. Loans that experience insignificant payment
delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length and reasons for the
delay, the borrower's prior payment record, and the amount of shortfall in
relation to the principal and interest owed.
Commercial and commercial real estate loans are individually evaluated for
impairment. If a loan is impaired, a portion of the allowance is allocated so
that the loan is reported, net, at the present value of estimated future cash
flows using the loan's existing rate or at the fair value of collateral if
repayment is expected solely from the collateral. Smaller balance homogeneous
loans, such as consumer and most residential real estate, are collectively
evaluated for impairment, and accordingly, they are not separately identified
for impairment disclosure. TDRs are measured at the present value of estimated
future cash flows using the loan's effective rate at inception. If a TDR is
considered to be a collateral dependent loan, the loan is reported, net, at the
fair value of the collateral. For TDRs that subsequently default, the Company
determines the amount of reserve in accordance with the accounting policy for
the allowance for loan losses.
The general component covers non-impaired loans and impaired loans that are not
individually reviewed for impairment and is based on historical loss experience
adjusted for current factors. The historical loss experience is determined by
portfolio segment and is based on the actual loss history experienced by the
Company over the most recent 3 years for the consumer and real estate portfolio
segment and 5 years for the commercial portfolio segment. The total loan
portfolio's actual loss experience is supplemented with other economic factors
based on the risks present for each portfolio segment. These economic factors
include consideration of the following: levels of and trends in delinquencies
and impaired loans; levels of and trends in charge-offs and recoveries; trends
in volume and terms of loans; effects of any changes in risk selection and
underwriting standards; other changes in lending policies, procedures, and
practices; experience, ability, and depth of lending management and other
relevant staff; national and local economic trends and conditions; industry
conditions; and effects of changes in credit concentrations. The following
portfolio segments have been identified: Commercial Real Estate, Commercial and
Industrial, Residential Real Estate, and Consumer.
Commercial and industrial loans consist of borrowings for commercial purposes by
individuals, corporations, partnerships, sole proprietorships, and other
business enterprises. Commercial and industrial loans are generally secured by
business assets such as equipment, accounts receivable, inventory, or any other
asset excluding real estate and generally made to finance capital expenditures
or operations. The Company's risk exposure is related to deterioration in the
value of collateral securing the loan should foreclosure become necessary.
Generally, business assets used or produced in operations do not maintain their
value upon foreclosure, which may require the Company to write down the value
significantly to sell.
Commercial real estate consists of nonfarm, nonresidential loans secured by
owner-occupied and nonowner-occupied commercial real estate as well as
commercial construction loans. An owner-occupied loan relates to a borrower
purchased building or space for which the repayment of principal is dependent
upon cash flows from the ongoing business operations conducted by the party, or
an affiliate of the party, who owns the property. Owner-occupied loans that are
dependent on cash flows from operations can be adversely affected by current
market conditions for their product or service. A nonowner-occupied loan is a
property loan for which the repayment of principal is dependent upon rental
income associated with the property or the subsequent sale of the property.
Nonowner-occupied loans that are dependent upon rental income are primarily
impacted by local economic conditions which dictate occupancy rates and the
amount of rent charged. Commercial construction loans consist of borrowings to
purchase and develop raw land into one- to four-family residential properties.
Construction loans are extended to individuals as well as corporations for the
construction of an individual or multiple properties and are secured by raw land
and the subsequent improvements. Repayment of the loans to real estate
developers is dependent upon the sale of properties to third parties in a timely
fashion upon completion. Should there be delays in construction or a downturn in
the market for those properties, there may be significant erosion in value which
may be absorbed by the Company.
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Residential real estate loans consist of loans to individuals for the purchase
of one- to four-family primary residences with repayment primarily through wage
or other income sources of the individual borrower. The Company's loss exposure
to these loans is dependent on local market conditions for residential
properties as loan amounts are determined, in part, by the fair value of the
property at origination.
Consumer loans are comprised of loans to individuals secured by automobiles,
open-end home equity loans and other loans to individuals for household, family,
and other personal expenditures, both secured and unsecured. These loans
typically have maturities of 6 years or less with repayment dependent on
individual wages and income. The risk of loss on consumer loans is elevated as
the collateral securing these loans, if any, rapidly depreciate in value or may
be worthless and/or difficult to locate if repossession is necessary. During the
last several years, one of the most significant portions of the Company's net
loan charge-offs have been from consumer loans. Nevertheless, the Company has
allocated the highest percentage of its allowance for loan losses as a
percentage of loans to the other identified loan portfolio segments due to the
larger dollar balances and inherent risk associated with such portfolios.
Concentration of Credit Risk
The Company maintains a diversified credit portfolio, with residential real
estate loans currently comprising the most significant portion. Credit risk is
primarily subject to loans made to businesses and individuals in southeastern
Ohio and western West Virginia. Management believes this risk to be general in
nature, as there are no material concentrations of loans to any industry or
consumer group. To the extent possible, the Company diversifies its loan
portfolio to limit credit risk by avoiding industry concentrations.
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