EAGLE FINANCIAL SERVICES INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
The purpose of this discussion is to focus on the important factors affecting the Company's financial condition, results of operations, liquidity and capital resources. This discussion should be read in conjunction with the Company's Consolidated Financial Statements and the Notes to the Consolidated Financial Statements presented in Part I, Item 1, Financial Statements, of this Form 10-Q and Item 8, Financial Statements and Supplementary Data, of the 2021 Form 10-K.
Eagle Financial Services, Inc.is a bank holding company which owns 100% of the stock of Bank of Clarke County(the "Bank" and, collectively with Eagle Financial Services, Inc., the "Company", "we", "us" or "our"). Accordingly, the results of operations for the Company are dependent upon the operations of the Bank. The Bank conducts a commercial banking business which consists of attracting deposits from the general public and investing those funds in commercial, consumer and real estate loans and municipal and U.S.government agency securities. The Bank's deposits are insured by the Federal Deposit Insurance Corporationto the maximum extent permitted by law. At March 31, 2022, the Company had total assets of $1.37 billion, net loans of $1.01 billion, total deposits of $1.23 billion, and shareholders' equity of $102.1 million. The Company's net income was $3.25 millionfor the three months ended March 31, 2022.
COVID-19 and related response
The COVID-19 crisis has changed our communities, both in the way we live and the way we do business. While circumstances continue to change at a rapid pace, the Company is steadfastly working to meet and exceed the needs of its customers, employees and the communities in which it does business. The Company, while considered an essential business, has implemented procedures to protect its employees, customers and the community and still serve their banking needs. Branch lobbies are open, but with enhanced safety features for employees and customers. Our customers also continue to conduct their business via automated teller machines, online banking and our call center. In efforts to assist local businesses during this pandemic, the Company approved 1,372 Small Business Association Paycheck Protection Program ("SBA PPP") loans, totaling
$132.1 millionduring the first and second rounds of the SBA PPP. The outstanding balance of SBA PPP loans as of March 31, 2022was $8.3 million. The Company has also worked with local small businesses, consumers and other commercial customers through its loan deferral program whereby customers experiencing hardships due to COVID-19 may be granted a deferral in loan payments for up to six months. During the year ended December 31, 2020, the Company approved 255 deferrals of interest and/or principal payments with respect to loan balances totaling $130.5 millionat December 31, 2020for its customers experiencing hardships related to COVID-19. During the first quarter of 2021, the Company approved two additional deferrals of interest and/or principal with respect to loan balances totaling $41 thousand. No additional deferrals have been made since the first quarter of 2021. As of March 31, 2022, all of the loans for which the Company had approved deferrals had begun making payments on their loans after the deferral period had passed.
The Company strives to be an outstanding financial institution in its market by building solid sustainable relationships with: (1) its customers, by providing highly personalized customer service, a network of conveniently placed branches and ATMs, a competitive variety of products/services and courteous, professional employees, (2) its employees, by providing generous benefits, a positive work environment, advancement opportunities and incentives to exceed expectations, (3) its communities, by participating in local concerns, providing monetary support, supporting employee volunteerism and providing employment opportunities, and (4) its shareholders, by providing sound profits and returns, sustainable growth, regular dividends and committing to its local, independent status. 29 --------------------------------------------------------------------------------
The Bank is a locally owned and managed financial institution. This allows the Bank to be flexible and responsive in the products and services it offers. The Bank grows primarily by lending funds to local residents and businesses at a competitive price that reflects the inherent risk of lending. The Bank attempts to fund these loans through deposits gathered from local residents and businesses. The Bank prices its deposits by comparing alternative sources of funds and selecting the lowest cost available. When deposits are not adequate to fund asset growth, the Bank relies on borrowings, both short and long term. The Bank's primary source of borrowed funds is the
Federal Home Loan Bank of Atlantawhich offers numerous terms and rate structures to the Bank. As interest rates change, the Bank attempts to maintain its net interest margin. This is accomplished by changing the price, terms, and mix of its financial assets and liabilities. The Bank also earns fees on services provided through its trust department, sales of investments through Eagle Investment Services, secondary market mortgage activities, and deposit operations. The Bank also incurs noninterest expenses such as compensating employees, maintaining and acquiring fixed assets, and purchasing goods and services necessary to support its daily operations. The Bank has a marketing department which seeks to develop new business. This is accomplished through an ongoing calling program whereby account officers visit with existing and potential customers to discuss the products and services offered. The Bank also utilizes traditional advertising such as television commercials, radio ads, newspaper ads, and billboards.
Administration and supervision over the lending process is provided by the Bank's
Credit Administration Department. The principal risk associated with the Bank's loan portfolio is the creditworthiness of its borrowers. In an effort to manage this risk, the Bank's policy gives loan amount approval limits to individual loan officers based on their position and level of experience. Credit risk is increased or decreased, depending on the type of loan and prevailing economic conditions. In consideration of the different types of loans in the portfolio, the risk associated with real estate mortgage loans, commercial loans and consumer loans varies based on employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay debt. The Company has written policies and procedures to help manage credit risk. The Company utilizes a loan review process that includes formulation of portfolio management strategy, guidelines for underwriting standards and risk assessment, procedures for ongoing identification and management of credit deterioration, and regular portfolio reviews to establish loss exposure and to ascertain compliance with the Company's policies. The Bank uses a tiered approach to approve credit requests consisting of individual lending authorities, joint approval of Category I officers, and a director loan committee. Lending limits for individuals are set by the Board of Directors and are determined by loan purpose, collateral type, and internal risk rating of the borrower. The highest individual authority (Category I) is assigned to the Bank's President / Chief Executive Officer, Chief Revenue Officer and Chief Credit Officer(approval authority only). Two officers in Category I may combine their authority to approve loan requests to borrowers with credit exposure up to $10.0 millionon a secured basis and $6.0 millionunsecured; and the three Category I Officers can combine to approve loan requests to borrowers with credit exposure up to $15.0 millionon a secured basis and $9.0 millionunsecured. Officers in Category II, III, IV, V, VI and VII have lesser authorities and with approval of a Category I officer may extend loans to borrowers with exposure of $5.0 millionon a secured basis and $3.0 millionunsecured. Officers in Categories A through F can also utilize the co-approval of the Regional and Small Business Credit Officers to extend loans with exposures up to $2.5 millionand $1.5 millionrespectively on a secured basis, and up to $1 millionand $750 thousandrespectively on an unsecured basis. Loans exceeding $15.0 millionand up to the Bank's legal lending limit can be approved by the Director Loan Committee consisting of four directors (three directors constituting a quorum). The Director's Loan Committee also reviews and approves changes to the Bank's Loan Policy as presented by management. 30 --------------------------------------------------------------------------------
The following sections discuss the major categories of loans within the total loan portfolio:
Residential real estate loans for one to four families
Residential lending activity may be generated by the Bank's loan officer solicitations, referrals by real estate professionals, and existing or new bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment and credit history of the applicant. The valuation of residential collateral is provided by independent fee appraisers who have been approved by the Bank's Directors Loan Committee. In connection with residential real estate loans, the Bank requires title insurance, hazard insurance and, if applicable, flood insurance. In addition to traditional residential mortgage loans secured by a first or junior lien on the property, the Bank offers home equity lines of credit.
Commercial real estate loans
Commercial real estate loans are secured by various types of commercial real estate in the Bank's market area, including multi-family residential buildings, commercial buildings and offices, small shopping centers and churches. Commercial real estate loan originations are obtained through broker referrals, direct solicitation of developers and continued business from customers. In its underwriting of commercial real estate, the Bank's loan to original appraised value ratio is generally 80% or less. Commercial real estate lending entails significant additional risk as compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or the economy, in general. The Bank's commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower's creditworthiness, prior credit history and reputation, and the Bank typically requires personal guarantees or endorsements of the borrowers' principal owners.
Loans for construction and land development
The Bank makes local construction loans, primarily residential, and land acquisition and development loans. The construction loans are secured by residential houses under construction and the underlying land for which the loan was obtained. The average life of most construction loans is less than one year and the Bank offers both fixed and variable rate interest structures. The interest rate structure offered to customers depends on the total amount of these loans outstanding and the impact of the interest rate structure on the Bank's overall interest rate risk. There are two characteristics of construction lending which impact its overall risk as compared to residential mortgage lending. First, there is more concentration risk due to the extension of a large loan balance through several lines of credit to a single developer or contractor. Second, there is more collateral risk due to the fact that loan funds are provided to the borrower based upon the estimated value of the collateral after completion. This could cause an inaccurate estimate of the amount needed to complete construction or an excessive loan-to-value ratio. To mitigate the risks associated with construction lending, the Bank generally limits loan amounts to 80% of the estimated appraised value of the finished construction project. The Bank also obtains a first lien on the property as security for its construction loans and typically requires personal guarantees from the borrower's principal owners. Finally, the Bank performs inspections of the construction projects to ensure that the percentage of construction completed correlates with the amount of draws on the construction line of credit. 31 --------------------------------------------------------------------------------
Commercial and industrial loans
Commercial business loans generally have more risk than residential mortgage loans, but have higher yields. To manage these risks, the Bank generally obtains appropriate collateral and personal guarantees from the borrower's principal owners and monitors the financial condition of its business borrowers. Residential mortgage loans generally are made on the basis of the borrower's ability to make repayment from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In contrast, commercial business loans typically are made on the basis of the borrower's ability to make repayment from cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much precision as residential real estate. Refer to the Marine Lending section below for discussion of additional commercial and industrial lending.
The Bank offers various secured and unsecured consumer loans, which include personal installment loans, personal lines of credit, automobile loans, and credit card loans. The Bank originates its consumer loans within its geographic market area and these loans are generally made to customers with whom the Bank has an existing relationship. Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral on a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. Consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant's monthly income may be determined by verification of gross monthly income from primary employment, and from any verifiable secondary income. Although creditworthiness of the applicant is the primary consideration, the underwriting process also includes an analysis of the value of the security in relation to the proposed loan amount.
Refer to the Marine Loans section below for a discussion of additional consumer loans.
Marine LendingThe Bank's marine lending unit includes originated retail loans, which are classified as commercial and industrial loans or consumer loans, depending on the borrower, and dealer floorplan loans, which are classified as commercial and industrial loans. The Company's relationships are limited to well established dealers of global premium brand manufacturers. The Company's top three manufacturer customers have been in business between 30 and 100 years. The Company primarily has secured agreements with premium manufacturers to support dealer floor plan loans which may reduce the Company's credit exposure to the dealer, despite its underwriting of each respective dealer. The Company has developed incentive retail pricing programs with the dealers to drive retail dealer flow. Retail loans are generally limited to premium manufacturers with established relationships with the Company which have a vested interest in the secondary market pricing of their respective brand due to the limited inventory available for resale. Consequently, while not contractually committed, manufacturers will often support secondary resale values which can have the effect of reducing losses from non-performing retail marine loans. Retail borrowers generally have very high credit scores, substantial down payments, substantial net worth, personal liquidity, and excess cash flow. 32 --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES The financial statements of the Company are prepared in accordance with accounting principles generally accepted in
the United States of America("GAAP"). The financial information contained within these statements is, to a significant extent, based on measurements of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of the transactions would be the same, the timing of events that would impact the transactions could change.
Allowance for loan losses
The allowance for loan losses is an estimate of the probable losses inherent in the Company's loan portfolio. As required by GAAP, the allowance for loan losses is accrued when the occurrence of losses is probable and they can be estimated. Impairment losses are accrued based on the differences between the loan balance and the value of its collateral, the present value of future cash flows, or the price established in the secondary market. The Company's allowance for loan losses has three basic components: the general allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when actual events occur. The general allowance uses historical experience and other qualitative factors to estimate future losses and, as a result, the estimated amount of losses can differ significantly from the actual amount of losses which would be incurred in the future. However, the potential for significant differences is mitigated by continuously updating the loss history of the Company. The specific allowance is based upon the evaluation of specific impaired loans on which a loss may be realized. Factors such as past due history, ability to pay, and collateral value are used to identify those loans on which a loss may be realized. Each of these loans is then evaluated to determine how much loss is estimated to be realized on its disposition. The sum of the losses on the individual loans becomes the Company's specific allowance. This process is inherently subjective and actual losses may be greater than or less than the estimated specific allowance. The unallocated allowance is due to imprecision in the model and for losses that are not directly allocable to a specific loan type within the portfolio. As the loans, which are affected by these events, are identified or losses are experienced on the loans which are affected by these events, they will be reflected within the specific or general allowances. Note 1 to the Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Data, of the 2021 Form 10-K, provides additional information related to the allowance for loan losses. 33 --------------------------------------------------------------------------------
The Company makes forward looking statements in this report that are subject to risks and uncertainties. These forward looking statements include statements regarding our expectations, intentions or objectives concerning our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or other similar words or terms are intended to identify forward looking statements. These forward looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:
• the effects of the COVID-19 pandemic, including on the Company’s credit
quality and business operations, as well as its impact on the general economy
and financial market conditions;
• the ability to successfully manage growth or implement growth strategies if
the Bank is unable to identify attractive markets, locations or opportunities to expand in the future or if the Bank is unable to successfully integrate new branches, business lines or other growth opportunities into its existing operations;
• competition with other banks and financial institutions, and companies
outside of the banking industry, including those companies that have substantially greater access to capital and other resources; • the successful management of interest rate risk;
• the risks inherent in the granting of loans such as the risk of repayment and the fluctuation
• changes in general economic and business conditions in the Bank’s market
• dependence on the Bank’s management team, including the ability to attract and
retain key personnel; • changes in interest rates and interest rate policies; • maintaining capital levels adequate to support growth;
• maintain cost control and asset quality as new branches are opened or
acquired; • demand, development and acceptance of new products and services; • problems with technology utilized by the Bank; • changing trends in customer profiles and behavior;
• changes in banking, tax and other laws and regulations and interpretations
or advice thereunder; and
• other factors described in Section 1A., “Risk Factors”, in the Company’s 2021 Report
Due to these uncertainties, actual future results may differ materially from the results indicated by these forward-looking statements. In addition, past operating results are not necessarily indicative of future results.
RESULTS OF OPERATIONS
Net IncomeNet income for the three months ended March 31, 2022was $3.25 million, an increase of 13.56% or $388 thousandwhen compared to the same period in 2021. Earnings per share, basic and diluted were $0.94and $0.84for the three months ended March 31, 2022and 2021, respectively. Return on average assets ("ROA") measures how efficiently the Company uses its assets to produce net income. Some issues reflected within this efficiency include the Company's asset mix, funding sources, pricing, fee generation, and cost control. The ROA of the Company, on an annualized basis, for the three months ended March 31, 2022and 2021 was 0.99% and 1.02%, respectively. Return on average equity ("ROE") measures the utilization of shareholders' equity in generating net income. This measurement is affected by the same factors as ROA with consideration to how much of the Company's assets are funded by shareholders. The ROE of the Company, on an annualized basis, for the three months ended March 31, 2022and 2021 was 12.15% and 11.04%, respectively.
Net interest income
Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. Net interest income was
$11.1 millionand $9.5 millionfor the three months ended March 31, 2022and 2021, respectively, which represents an increase of $1.6 millionor 16.9%. Net interest income increased primarily due to the increase in the average balance of the loan portfolio and the decrease in interest expense on deposits. Average interest earning assets increased $180.9 millionwhen comparing the three months ended March 31, 2021to the three months ended March 31, 2022while the average yield on earning assets decreased by eight basis points over that same period. This decrease in yield can be mostly attributed to the current interest rate environment. Total interest income was $11.5 millionand $10.0 millionfor the three months ended March 31, 2022and 2021, respectively, which represents an increase of $1.5 millionor 15.0%. The increase in interest income was driven by an increase in the average balance of the loan portfolio. Total interest expense was $370 thousandand $487 thousandfor the three months ended March 31, 2022and 2021, respectively, which represents a decrease of $117 thousandor 24.0%. The majority of deposit growth has been in non-maturity deposit accounts which have traditionally paid a lower interest rate than maturity deposit accounts. The growth in non-interest bearing and lower interest rate deposit accounts and the reduction in higher interest rate accounts as well as repricing of those accounts, has resulted in a lower rate paid on interest bearing liabilities. The net interest margin was 3.61% and 3.62% for the three months ended March 31, 2022and 2021, respectively. Tax-equivalent net interest income is calculated by adding the tax benefit on certain securities and loans, whose interest is tax-exempt, to total interest income then subtracting total interest expense. The tax rate used to calculate the tax benefit was 21% for 2022 and 2021.
Given the anticipation of higher interest rates, net interest income and net interest margin may see some improvement as interest-earning assets generally revalue at a faster pace than passives.
35 -------------------------------------------------------------------------------- The following table shows interest income on earning assets and related average yields as well as interest expense on interest-bearing liabilities and related average rates paid for the three months ended
March 31, 2022and 2021 (dollars in thousands): March 31, 2022 March 31, 2021 Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Assets: Balance Expense Rate (3) Balance Expense Rate (3) Securities: Taxable $ 185,157 $ 7891.73 % $ 144,177 $ 4781.35 % Tax-Exempt (1) 12,846 105 3.32 % 17,897 149 3.38 % Total Securities $ 198,003 $ 8941.83 % $ 162,074 $ 6271.57 % Loans: Taxable $ 1,008,211 $ 10,5994.26 % $ 840,368 $ 9,3264.50 % Non-accrual 2,586 - - % 4,581 - - % Tax-Exempt (1) 2,751 26 3.80 % 9,560 104 4.43 % Total Loans $ 1,013,548 $ 10,6254.25 % $ 854,509 $ 9,4304.48 % Federal funds sold 6,384 2 0.13 % 210 - 0.08 % Interest-bearing deposits in other banks 38,274 15 0.16 % 60,474 12 0.08 % Total earning assets (2) $ 1,253,623 $ 11,5363.73 % $ 1,072,686 $ 10,0693.81 % Allowance for loan losses (8,973 ) (7,253 ) Total non-earning assets 88,766 73,143 Total assets $ 1,333,416 $ 1,138,576Liabilities and Shareholders' Equity: Interest-bearing deposits: NOW accounts $ 165,220 $ 850.21 % $ 130,849 $ 740.23 % Money market accounts 257,721 144 0.23 % 209,851 155 0.30 % Savings accounts 175,333 26 0.06 % 144,460 21 0.06 % Time deposits: $250,000and more 65,053 60 0.37 % 68,478 153 0.90 % Less than $250,00058,093 55 0.38 % 59,518 84 0.57 % Total interest-bearing deposits $ 721,420 $ 3700.21 % $ 613,156 $ 4870.32 % Subordinated debt 326 - - % - - - % Total interest-bearing liabilities $ 721,746 $ 3700.21 % $ 613,156 $ 4870.32 % Noninterest-bearing liabilities: Demand deposits 472,876 408,015 Other Liabilities 29,688 12,309 Total liabilities $ 1,224,310 $ 1,033,480Shareholders' equity 109,106 105,096 Total liabilities and shareholders' equity $ 1,333,416 $ 1,138,576Net interest income $ 11,166 $ 9,582Net interest spread 3.52 % 3.49 % Interest expense as a percent of average earning assets 0.12 % 0.18 % Net interest margin 3.61 % 3.62 %
(1) Income and returns are reported on a tax equivalent basis using a
rate of 21%.
(2) Unaccrued loans are not included in this total as they are not
considered productive assets.
(3) Annualized. 36
The following table reconciles net interest income equivalent to taxes, which is a non-GAAP measure, to net interest income.
Three Months Ended March 31, 2022 2021 (in thousands) GAAP Financial Measurements: Interest Income - Loans $ 10,620 $ 9,408 Interest Income - Securities and Other Interest-Earnings Assets 889 608 Interest Expense - Deposits 370 487 Total Net Interest Income $ 11,139 $ 9,529 Non-GAAP Financial Measurements: Add: Tax Benefit on Tax-Exempt Interest Income - Loans (1) $ 5 $
Add: Tax Benefit on Tax-Exempt Interest Income - Securities (1) 22
Total Tax Benefit on Tax-Exempt Interest Income $ 27 $
Tax-Equivalent Net Interest Income $ 11,166 $
(1) The tax benefit was calculated using the federal statutory tax rate of 21%.
The tax-equivalent yield on earning assets decreased from 3.81% to 3.73% for the three months ended
March 31, 2021and 2022, respectively. For those same time periods, the tax-equivalent yield on securities increased 26 basis points. The tax equivalent yield on loans decreased 23 basis points from 4.48% for the three months ended March 31, 2021to 4.25% for the same time period in 2022. The decrease in the tax-equivalent yield on earning assets for the three months ended March 31, 2022resulted mostly from the decrease in the tax-equivalent yield on loans. The decrease in the yield on loans as compared to the corresponding period in 2021 was primarily due to the composition of the current loan portfolio. Additionally, in the current rising interest rate environment, as securities are maturing and being called or sold, they are being replaced with securities at higher rates. The average rate on interest bearing liabilities decreased 11 basis points from 0.32% for the three months ended March 31, 2021to 0.21% for the same time period in 2022. The majority of deposit growth has been in non-maturity deposit accounts which have traditionally paid a lower interest rate than maturity deposit accounts. The growth in lower interest rate deposit accounts and the reduction in higher interest rate accounts as well as the repricing of those accounts, has resulted in a lower rate paid on interest bearing liabilities.
Allowance for loan losses
The provision for loan losses is based upon management's estimate of the amount required to maintain an adequate allowance for loan losses as discussed within the Critical Accounting Policies section above. The allowance represents an amount that, in management's judgment, will be adequate to absorb probable losses inherent in the loan portfolio. Management's judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower's ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. The amount of provision for loan losses is affected by several factors including the growth rate of loans, net charge-offs (recoveries), and the estimated amount of inherent losses within the loan portfolio. The provision for loan losses for the three months ended
March 31, 2022and 2021 was $540 thousandand $599 thousand, respectively. The provision for the three months ended March 31, 2022and 2021 resulted mostly from loan growth during the quarters. 37 --------------------------------------------------------------------------------
Total noninterest income for the three months ended
March 31, 2022and 2021 was $3.2 millionand $2.4 million, respectively. Management reviews the activities which generate noninterest income on an ongoing basis. The following table provides the components of noninterest income for the three months ended March 31, 2022and 2021, which are included within the respective Consolidated Statements of Income headings. Variances that the Company believes require explanation are discussed below the table. Three Months Ended March 31, (dollars in thousands) 2022 2021 $ Change % Change Wealth management fees $ 921 $ 607 $ 31452 % Service charges on deposit accounts 374 253 121 48 % Other service charges and fees 909 1,007 (98 ) (10 )% Gain on sale of securities - 76 (76 )
Gain on sale of loans held for sale 478 - 478
Bank owned life insurance income 179 105 74 70 % Other operating income 382 379 3 1 % Total noninterest income
$ 3,243 $ 2,427 $ 81634 % NM - Not Meaningful Wealth management fee income increased from 2021 to 2022. Wealth management fee income is comprised of income from fiduciary activities as well as commissions from the sale of non-deposit investment products. The amount of income from fiduciary activities is determined by the number of active accounts and total assets under management. With the addition of several new employees during 2021, total assets under management have seen an increase during the three months ended March 31, 2022as well as over the second half of 2021. Services charges on deposit accounts increased during the three months ended March 31, 2022when compared to the same periods in 2021. This increase is mainly due to increases in overdraft charges. Overdraft charges can fluctuate based on changes in customer activity. The amount of other services charges and fees is comprised primarily of loan servicing fee income, fees received from the Bank's credit card program and fees generated from the Bank's ATM/debit card programs. Other service charges and fees decreased during the three months ended March 31, 2022when compared to the same period in 2021. This decrease can be attributed to an decrease in fees received from the Bank's credit card program since the Bank's credit card portfolio has now been brought in-house. During the second quarter of 2021, the Bank began to sell mortgage and marine loans. During the first quarter of 2022, the Company sold $4.3 millionin mortgage loans on the secondary market and $32.5 millionof marine loans from the commercial and consumer loan portfolios. These loan sales resulted in gains of $478 thousandduring the three months ended March 31, 2022. Bank owned life insurance ("BOLI") income was $179 thousandand $105 thousandfor the three months ended March 31, 2022and 2021, respectively. The Company made an investment of $10.0 millionduring the second quarter of 2021. 38 --------------------------------------------------------------------------------
Total noninterest expenses increased
$2.0 millionor 25% for the three months ended March 31, 2022compared to the same period in 2021. The following table presents the components of noninterest expense for the three months ended March 31, 2022and 2021, which are included within the respective Consolidated Statements of Income headings. Variances that the Company believes require explanation are discussed below the table. Three Months Ended March 31, (dollars in thousands) 2022 2021 $ Change % Change Salaries and employee benefits $ 5,952 $ 4,716 $ 1,23626 % Occupancy expenses 518 456 62 14 % Equipment expenses 257 224 33 15 % Advertising and marketing expenses 111 79 32 41 % Stationary and supplies 35 38 (3 ) (8 )% ATM network fees 286 250 36 14 % Other real estate owned expense - (1 ) 1
Loss on other real estate owned - 10 (10 ) NM FDIC assessment 177 107 70 65 % Computer software expense 254 189 65 34 % Bank franchise tax 198 189 9 5 % Professional fees 464 460 4 1 % Data processing fees 480 402 78 19 % Other operating expenses 1,191 797 394 49 % Total noninterest expenses
$ 9,923 $ 7,916 $ 2,00725 % NM - Not Meaningful The Company's growth has had an impact on noninterest expenses. Total assets have grown by $71.3 millionor 5.47% from December 31, 2021to March 31, 2022. This growth has required investments to be made in the Company's infrastructure, causing increases in salaries and employee benefits, occupancy expenses, equipment expenses and computer software expense. In addition, increases in asset size and capital levels have impacted both the FDICassessment and bank franchise tax amounts. Salaries and employee benefits increased during the three months ended March 31, 2022over 2021. Annual pay increases, newly hired employees, increasing insurance costs and enhanced employee incentive plans have attributed to these increases. The number of full-time equivalent employees (FTEs) has increased from 195 at March 31, 2021to 221 at March 31, 2022.
Advertising and marketing spending increased in 2022, primarily due to increased web development and increased digital marketing campaigns.
ATM network fees increased during the three months ended
March 31, 2022over 2021 due to increased ATM usage. During 2021 and 2022, increases in customer activity have been observed.
Data processing fees increased in 2022 due to fees associated with the new general ledger system implemented in 2021.
Other operating expenses increased during the three months ended
March 31, 2022over 2021. This increase is due to increased loan related expenses due to a higher volume, employee travel expense for training, marketing and sales meetings, and charitable contributions in the three months ended March 31, 2022over 2021. 39 -------------------------------------------------------------------------------- The efficiency ratio of the Company was 68.54% and 66.25% for the three months ended March 31, 2022and 2021, respectively. The efficiency ratio is not a measurement under accounting principles generally accepted in the United States. It is calculated by dividing noninterest expense by the sum of tax equivalent net interest income and noninterest income excluding gains and losses on the investment portfolio and other gains/losses from OREO, repossessed vehicles, disposals of bank premises and equipment, etc. The tax rate utilized is 21%. The Company calculates and reviews this ratio as a means of evaluating operational efficiency. The calculation of the efficiency ratio for the three months ended March 31, 2022and 2021 are as follows: Three Months Ended March 31, 2022 2021 (in thousands) Summary of Operating Results: Noninterest expenses $ 9,923 $ 7,916Less: Loss on other real estate owned - 10 Adjusted noninterest expenses $ 9,923 $ 7,906Net interest income 11,139 9,529 Noninterest income 3,243 2,427 Less: Gain on sales of securities -
Adjusted noninterest income
$ 3,243 $ 2,351Tax equivalent adjustment (1) 96
Total net interest income and non-interest income, adjusted
68.54 % 66.25 %
(1) Includes tax equivalent adjustments on loans and securities according to the federal rate
statutory tax rate of 21%.
Income tax expense was
$669 thousandand $579 thousandduring the three months ended March 31, 2022and 2021. The effective tax rate was 17.07% and 16.83% for the three months ended March 31, 2022and 2021, respectively. The effective tax rate is below the statutory rate of 21% due to tax-exempt income on investment securities and loans. The effective tax rate is also impacted by BOLI as well as income tax credits on qualified affordable housing project investments as discussed in Note 12 to the Consolidated Financial Statements as well as qualified rehabilitation credits. 40 --------------------------------------------------------------------------------
Total securities available for sale were
$193.3 millionat March 31, 2022, compared to $192.3 millionat December 31, 2021. This represents an increase of $1.0 millionor 0.54%. The Company purchased $25.8 millionof securities during the three months ended March 31, 2022. The Company had total maturities, calls, and principal repayments of $11.1 millionduring the three months ended March 31, 2022. Note 4 to the Consolidated Financial Statements provides additional details about the Company's securities portfolio at March 31, 2022and December 31, 2021. The Company had a net unrealized loss on available for sale securities of $13.7 millionat March 31, 2022as compared to a net unrealized loss of $218 thousandat December 31, 2021. Unrealized gains or losses on available for sale securities are reported within shareholders' equity, net of the related deferred tax effect, as accumulated other comprehensive income (loss). The primary cause of the unrealized losses at March 31, 2022and December 31,2021was changes in market interest rates and other market conditions and not credit concerns of the issuers. Since the losses can be primarily attributed to changes in market interest rates and conditions and not expected cash flows or an issuer's financial condition and management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, the unrealized losses were deemed to be temporary. Loan Portfolio The Company's primary use of funds is supporting lending activities from which it derives the greatest amount of interest income. Gross loans were $1.02 billionand $985.7 millionat March 31, 2022and December 31, 2021, respectively. This represents an increase of $35.7 millionor 3.63% during the three months ended March 31, 2022. The ratio of gross loans to deposits decreased slightly during the three months ended March 31, 2022from 83.73% at December 31, 2021to 82.96% at March 31, 2022. Loan growth excluding changes in SBA PPP loans during the three months ended March 31, 2022was $43.2 millionor 4.46%. SBA PPP loans were originated during 2020 and 2021 and as of March 31, 2022 $8.4 millionremained outstanding, down $7.5 millionor 47.22% from December 31, 2021due to forgiveness of the PPP loan balances. The loan portfolio consists primarily of loans for owner-occupied single-family dwellings and loans secured by commercial real estate. Note 5 to the Consolidated Financial Statements provides the composition of the loan portfolio at March 31, 2022and December 31, 2021. Residential real estate loans were $287.3 millionor 28.13% and $292.8 millionor 29.71% of total loans at March 31, 2022and December 31, 2021, respectively. Commercial real estate loans were $405.7 millionor 39.72% and $377.1 millionor 38.25% of total loans at March 31, 2022and December 31, 2021, respectively, representing an increase of $28.66 millionor 7.60% during the three months ended March 31, 2022. Construction, land development, and farmland loans were $88.0 millionor 8.61% and $84.9 millionor 8.61% of total loans at March 31, 2022and December 31, 2021, respectively. Consumer installment loans were $75.3 millionor 7.37% and $67.3 millionor 6.83% of total loans at March 31, 2022and December 31, 2021, respectively, representing an increase of $8.0 millionor 11.93% during the three months ended March 31, 2022. Commercial and industrial loans were $144.8 millionor 14.17% and $143.4 millionor 14.55% of total loans at March 31, 2022and December 31, 2021, respectively. During the three months ended March 31, 2022, loan growth was mainly concentrated in growth of our marine lending portfolio which falls into both the consumer installment loan and commercial and industrial loan portfolios. In addition to this strong marine lending growth, commercial real estate loans experienced an increase during the three months ended March 31, 2022due largely to the expansion of the Bank's current market area. 41 --------------------------------------------------------------------------------
Allowance for loan losses
The purpose of, and the methods for, measuring the allowance for loan losses are discussed in the Critical Accounting Policies section above. Note 5 to the Consolidated Financial Statements shows the activity within the allowance for loan losses during the three months ended
March 31, 2022and 2021 and the year ended December 31, 2021. Charged-off loans were $47 thousandand $5 thousandfor the three months ended March 31, 2022and 2021, respectively. Recoveries were $35 thousandand $66 thousandfor the three months ended March 31, 2022and 2021, respectively. This resulted in net charge-offs of $12 thousandand net recoveries of $61 thousandfor the three months ended March 31, 2022and 2021, respectively. The ratio of net charge-offs (recoveries) to average loans was 0.00% and (0.01%) for the three months ended March 31, 2022and 2021, respectively. The allowance for loan losses as a percentage of loans was 0.91% at March 31, 2022and 0.89% at December 31, 2021. Excluding outstanding PPP loans, the allowance for loan losses as a percentage of total loans was 0.92% and 0.91% as of March 31, 2022and December 31, 2021, respectively. The percentage of the allowance for loan losses to total loans was relatively unchanged as compared to the prior year end. The slight net increase in the percentage was primarily due to a $76 thousandincrease in specific reserves and relatively minor updates to qualitative ranges based on historical loss experience, while some qualitative considerations resulted in offsetting changes during the quarter (e.g., increasing inflation and declining unemployment). Refer to the Nonperforming Assets and Other Assets section for discussion on nonperforming loans. All nonaccrual and other impaired loans were evaluated for impairment and any specific allocations were provided for as necessary. Based on management's evaluation and update of the Company's historical loss experience adjusted for qualitative factors assessed, the general reserve as a percentage of non-impaired loans increased from 0.90% at December 31, 2021to 0.91% at March 31, 2022. Management believes that the allowance for loan losses is currently adequate to absorb probable losses inherent in the loan portfolio. Management will continue to evaluate the adequacy of the allowance for loan losses as more economic data becomes available and as changes within the Company's portfolio are known. The long-term effects of the pandemic may require the Company to fund increases in the allowance for loan losses in future periods.
Non-performing assets and other assets
Non-performing assets include non-accrual loans, repossessed assets, OREOs (foreclosed properties), and loans that are 90 days or more past due and still outstanding, as shown in the table below.
March 31, 2022 December 31, 2021 Nonaccrual loans $ 2,606 $ 2,723 Loans past due 90 days and accruing interest - 43 Other real estate owned and repossessed assets - - Total nonperforming assets $ 2,606 $ 2,766 Allowance for loan losses $ 9,315 $ 8,787 Gross loans
$ 1,021,459$ 985,720 Allowance for loan losses to nonperforming assets 357 % 318 % Allowance for loan losses to total loans 0.91 % 0.89 % Allowance for loan losses to nonaccrual loans 357 % 323 % Nonaccrual loans to total loans 0.26 % 0.28 % Non-performing assets to period end loans and other real estate owned 0.26 % 0.28 % 42
-------------------------------------------------------------------------------- Nonperforming assets decreased by
$117 thousandduring the three months ended March 31, 2022. Nonaccrual loans were $2.6 millionand $2.7 millionat March 31, 2022and December 31, 2021. There were no OREO loans at March 31, 2022and December 31, 2021. The percentage of nonperforming assets to loans and OREO was 0.26% at March 31, 2022and 0.28% at December 31, 2021, respectively. There were no loans past due 90 days or more and still accruing interest at March 31, 2022and $43 thousandin loans past due 90 days or more and still accruing at December 31, 2021.
Total loans in arrears, as disclosed in Note 5 to the consolidated financial statements, decreased to
During the three months ended
March 31, 2022, the Bank placed five loans totaling $358 thousandon nonaccrual status. Management evaluates the financial condition of borrowers and the value of any collateral on nonaccrual loans. The results of these evaluations are used to estimate the amount of losses which may be realized on the disposition of these nonaccrual loans and are reflected in the allowance for loan losses. Loans are placed on nonaccrual status when collection of principal and interest is doubtful, generally when a loan becomes 90 days past due. There are three negative implications for earnings when a loan is placed on non-accrual status. First, all interest accrued but unpaid at the date that the loan is placed on non-accrual status is either deducted from interest income or written off as a loss. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Finally, there may be actual losses to principal that require additional provisions for loan losses to be charged against earnings. For real estate loans, upon foreclosure, the balance of the loan is transferred to OREO and carried at the fair value of the property based on current appraisals and other current market trends, less estimated selling costs. If a write down of the OREO property is necessary at the time of foreclosure, the amount is charged-off to the allowance for loan losses. A review of the recorded property value is performed in conjunction with normal loan reviews, and if market conditions indicate that the recorded value exceeds the fair value, additional write downs of the property value are charged directly to operations. In addition, the Company may, under certain circumstances, restructure loans in troubled debt restructurings as a concession to a borrower when the borrower is experiencing financial distress. Formal, standardized loan restructuring programs are not utilized by the Company. Each loan considered for restructuring is evaluated based on customer circumstances and may include modifications to one or more loan provisions. Such restructured loans are included in impaired loans. However, restructured loans are not necessarily considered nonperforming assets. At March 31, 2022, the Company had $2.6 millionin restructured loans with specific allowances totaling $39 thousand. At December 31, 2021, the Company had $2.7 millionin restructured loans with specific allowances totaling $39 thousand. At March 31, 2022and December 31, 2021, total restructured loans performing under the restructured terms and accruing interest were $2.5 million. Two loans, totaling $145 thousand, were in nonaccrual status at March 31, 2022. Two loans, totaling $149 thousand, were in nonaccrual status at December 31, 2021. Deposits Total deposits were $1.23 billionand $1.18 billionat March 31, 2022and December 31, 2021, respectively. This represents an increase of $54.1 millionor 4.59% during the three months ended March 31, 2022. Note 7 to the Consolidated Financial Statements provides the composition of total deposits at March 31, 2022and December 31, 2021. The growth in deposits was organic growth as we expand and grow into newer market areas. Noninterest-bearing demand deposits, which are comprised of checking accounts, increased $19.1 millionor 4.05% from $470.4 millionat December 31, 2021to $489.4 millionat March 31, 2022. Savings and interest-bearing demand deposits, which include NOW accounts, money market accounts and regular savings accounts increased $35.9 millionor 6.16% from $583.3 millionat December 31, 2021to $619.2 millionat March 31, 2022. Time deposits decreased $911 thousandor .074% from $123.6 millionat December 31, 2021to $122.7 millionat March 31, 2022. 43 --------------------------------------------------------------------------------
The Bank continues to be a well capitalized financial institution. Total shareholders' equity at
March 31, 2022was $102.1 million, reflecting a percentage of total assets of 7.43%, as compared to $110.3 millionand 8.46% at December 31, 2021. The reason for the decrease in shareholders' equity during the first quarter of 2022 was due to the unrealized loss recognized on the securities available for sale portfolio. During the three months ended March 31, 2022and 2021, the Company declared dividends of $0.28and $0.27per share, respectively. The Company has a Dividend Investment Plan that allows shareholders to reinvest dividends in Company stock. At March 31, 2022, the Bank met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions. The Bank monitors these ratios on a quarterly basis and has several strategies, including without limitation the issuance of common stock, to ensure that these ratios remain above regulatory minimums. On September 17, 2019, the Federal Deposit Insurance Corporationfinalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio or "CBLR" framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than $10 billionin total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. Under the final rule, an eligible banking organization may opt out and revert to the risk-weighting framework without restriction. As a qualifying community banking organization, the Bank elected to measure its capital adequacy under the CBLR framework as of March 31, 2022and it's leverage ratio was 9.84%. At December 31, 2021, the Bank utilized the risk-based capital rules to assess its capital adequacy and it's leverage, tier 1, common equity tier 1, and total capital ratios were 8.84%, 10.44%, 10.44%, and 11.30%, respectively. Through April 30, 2022, the Bank's capital ratios continued to exceed the regulatory minimums for well-capitalized institutions. We are closely monitoring our capital position and are taking appropriate steps to ensure our level of capital remains strong. Our capital, while significant, may fluctuate in future periods and limit our ability to pay dividends. On March 31, 2022, the Company entered into Subordinated Note Purchase Agreements with certain purchasers pursuant to which the Company issued and sold $30.0 millionin aggregate principal amount of its 4.50% Fixed-to-Floating Rate Subordinated Notes due April 1, 2032(the "Notes"). See Note 14 to the Consolidated Financial Statements included in this Form 10-Q, for discussion of subordinated debt. LIQUIDITY Liquidity management involves meeting the present and future financial obligations of the Company with the sale or maturity of assets or with the occurrence of additional liabilities. Liquidity needs are met with cash on hand, deposits in banks, federal funds sold, securities classified as available for sale and loans maturing within one year. At March 31, 2022, liquid assets totaled $395.0 millionas compared to $365.1 millionat December 31, 2021. These amounts represent 31.05% and 30.61% of total liabilities at March 31, 2022and December 31, 2021, respectively. The Company minimizes liquidity demand by utilizing core deposits to fund asset growth. Securities provide a constant source of liquidity through paydowns and maturities. Also, the Company maintains short-term borrowing arrangements, namely federal funds lines of credit, with larger financial institutions as an additional source of liquidity. The Bank's membership with the Federal Home Loan Bank of Atlantaprovides a source of borrowings with numerous rate and term structures. The Company's senior management monitors the liquidity position regularly and attempts to maintain a position which utilizes available funds most efficiently. 44 --------------------------------------------------------------------------------
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
There were no material changes in off-balance sheet arrangements and contractual obligations, as disclosed in the 2021 Form 10-K.
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