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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
FOR THE QUARTERLY PERIOD ENDED
Commission file number:
(Exact name of Registrant as specified in its charter)
(State of Incorporation) | (IRS Employer Identification No) |
(Address of principal executive offices) (Zip Code)
(
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
| Trading Symbol(s) |
| Name of each exchange on which registered |
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer |
| ☐ |
|
| ☒ | |
Non-accelerated Filer: |
| ☐ |
| Smaller Reporting Company: |
| |
Emerging Growth Company: |
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section7(a)(2)(B) of the Securities Act. ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
As of May 1, 2022, the registrant had
FORM 10-Q
Table of Contents
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Item 2. Management’s Discussion Analysis of Financial Condition Results of Operations | 35 | ||||
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36 | |||||
Overview of the Results of Operations and Financial Condition | 36 | ||||
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57 | |||||
Item 3. Qualitative Quantitative Disclosures about Market Risk | 59 | ||||
59 | |||||
60 | |||||
60 | |||||
60 | |||||
Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds | 60 | ||||
61 | |||||
61 | |||||
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62 | |||||
63 | |||||
PART I - FINANCIAL INFORMATION
Item 1 – Financial Statements
SIERRA BANCORP
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
| March 31, 2022 |
| December 31, 2021 | |||
ASSETS | (unaudited) | (audited) | ||||
Cash and due from banks | $ | | $ | | ||
Interest bearing deposits in banks | | | ||||
Total cash cash equivalents | | | ||||
Investment securities available-for-sale, at fair value (net of | | | ||||
Loans and leases: | ||||||
Gross loans and leases | | | ||||
Deferred loan and lease fees, net | ( | ( | ||||
Allowance for credit losses on loans and leases | ( | ( | ||||
Net loans and leases | | | ||||
Foreclosed assets | | | ||||
Premises and equipment, net | | | ||||
Goodwill | | | ||||
Other intangible assets, net | | | ||||
Bank-owned life insurance | | | ||||
Other assets | | | ||||
Total assets | $ | | $ | | ||
| ||||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||
Deposits: | ||||||
Noninterest bearing | $ | | $ | | ||
Interest bearing | | | ||||
Total deposits | | | ||||
Repurchase agreements | | | ||||
Long-term debt | | | ||||
Subordinated debentures | | | ||||
Allowance for credit losses on unfunded loan commitments | | | ||||
Other liabilities | | | ||||
Total liabilities | | | ||||
| ||||||
Commitments and contingent liabilities (Note 7) | ||||||
| ||||||
Shareholders' equity | ||||||
Common stock, | | | ||||
Additional paid-in capital | | | ||||
Retained earnings | |
| | |||
Accumulated other comprehensive (loss) income, net | ( | | ||||
Total shareholders' equity | | | ||||
Total liabilities and shareholders' equity | $ | | $ | | ||
The accompanying notes are an integral part of these consolidated financial statements
1
SIERRA BANCORP
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2022 AND 2021
(dollars in thousands, except per share data, unaudited)
Three months ended March 31, | ||||||
| 2022 |
| 2021 | |||
Interest and dividend income | ||||||
Loans and leases, including fees | $ | | $ | | ||
Taxable securities | | | ||||
Tax-exempt securities | | | ||||
Federal funds sold and other | | | ||||
Total interest income | | | ||||
Interest expense | ||||||
Deposits | | | ||||
Short-term borrowings | | | ||||
Subordinated debentures | | | ||||
Total interest expense | | | ||||
Net interest income | | | ||||
Provision for credit losses on loans and leases | | | ||||
Benefit for credit losses on unfunded loan commitments | ( | — | ||||
Net interest income after provision for credit losses | | | ||||
Noninterest income | ||||||
Service charges on deposits | | | ||||
Other income | | | ||||
Total noninterest income | | | ||||
Noninterest expense | ||||||
Salaries and employee benefits | | | ||||
Occupancy | | | ||||
Other | | | ||||
Total noninterest expense | | | ||||
Income before taxes | | | ||||
Provision for income taxes | | | ||||
Net income | $ | | $ | | ||
| ||||||
PER SHARE DATA | ||||||
Book value | $ | | $ | | ||
Cash dividends | $ | | $ | | ||
Earnings per share basic | $ | | $ | | ||
Earnings per share diluted | $ | | $ | | ||
Average shares outstanding, basic | | | ||||
Average shares outstanding, diluted | | | ||||
| ||||||
Total shareholders' equity (in thousands) | $ | | $ | | ||
Shares outstanding | | | ||||
Dividends paid (in thousands) | $ | | $ | | ||
The accompanying notes are an integral part of these consolidated financial statements.
2
SIERRA BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS ENDED MARCH 31, 2022 AND 2021
(dollars in thousands, unaudited)
Three months ended March 31, | ||||||
| 2022 |
| 2021 | |||
Net income | $ | | $ | | ||
Other comprehensive loss, before tax: | ||||||
Unrealized gains on securities: | ||||||
Unrealized holding loss arising during period | ( | ( | ||||
Less: reclassification adjustment for gains included in net income (1) | ( | — | ||||
Other comprehensive loss, before tax | ( | ( | ||||
Income tax benefit related to items of other comprehensive loss, net of tax | | | ||||
Other comprehensive loss | ( | ( | ||||
Comprehensive (loss) income | $ | ( | $ | | ||
| (1) | Amounts are included in net gains on investment securities available-for-sale on the Consolidated Statements of Income in noninterest income. Income tax expense associated with the reclassification adjustment for the three months ended March 31, 2022 and 2021 was $ |
The accompanying notes are an integral part of these consolidated financial statements.
3
SIERRA BANCORP
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, 2022 AND 2021
(dollars in thousands, except per share data, unaudited)
Accumulated | |||||||||||||||||
Additional | Other | ||||||||||||||||
Common Stock | Paid In | Retained | Comprehensive | Shareholders' | |||||||||||||
| Shares |
| Amount |
| Capital |
| Earnings |
| Income (Loss) |
| Equity | ||||||
Balance, December 31 2020 | | $ | | $ | | $ | | $ | | $ | | ||||||
Net income | — | — | — | | — | | |||||||||||
Other comprehensive loss, net of tax | — | — | — | — | ( | ( | |||||||||||
Stock options exercised, net of shares surrendered for cashless exercises | | | ( | — | — | | |||||||||||
Stock compensation costs | | — | | — | — | | |||||||||||
Cash dividends - $ | — | — | — | ( | — | ( | |||||||||||
Balance, March 31, 2021 | | $ | | $ | | $ | | $ | | $ | | ||||||
Balance, December 31, 2021 | | $ | | $ | | $ | | $ | | $ | | ||||||
Cumulative effect of change in accounting principle (Note 3) | — | — | — | ( | — | ( | |||||||||||
Net income | — | — | — | | — | | |||||||||||
Other comprehensive loss, net of tax | — | — | — | — | ( | ( | |||||||||||
Restricted stock surrendered due to employee tax liability | ( | ( | — | ( | — | ( | |||||||||||
Restricted stock forfeited / cancelled | ( | — | — | — | — | — | |||||||||||
Stock based compensation - stock options | — | — | | — | — | | |||||||||||
Stock based compensation - restricted stock | — | — | | — | — | | |||||||||||
Stock repurchase | ( | ( | — | ( | — | ( | |||||||||||
Cash dividends - $ | — | — | — | ( | — | ( | |||||||||||
Balance, March 31, 2022 | | $ | | $ | | $ | | $ | ( | $ | | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
SIERRA BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2022 AND 2021
(dollars in thousands, unaudited)
Three months ended March 31, | ||||||
| 2022 |
| 2021 | |||
Cash flows from operating activities: | ||||||
Net income | $ | | $ | | ||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||
| ||||||
Gain on sales of securities | ( | — | ||||
Loss on disposal of fixed assets | | | ||||
Gain on sale on foreclosed assets | ( | ( | ||||
Writedowns on foreclosed assets | — | | ||||
Stock based compensation expense | | | ||||
Provision for credit losses on loans and leases | | | ||||
Depreciation and amortization | | | ||||
Net amortization on securities premiums and discounts | | | ||||
Amortization (accretion) of premiums (discounts) for loans acquired | | ( | ||||
Decrease (increase) in cash surrender value of life insurance policies | | ( | ||||
Amortization of core deposit intangible | | | ||||
(Increase) decrease in interest receivable and other assets | ( | | ||||
Decrease in other liabilities | ( | ( | ||||
Deferred income tax benefit (provision) | | ( | ||||
Decrease (increase) in value of restricted bank equity securities | | ( | ||||
Net amortization of partnership investment | | | ||||
Net cash provided by operating activities | | | ||||
| ||||||
Cash flows from investing activities: | ||||||
Maturities and calls of securities available for sale | | | ||||
Proceeds from sales of securities available for sale | | — | ||||
Purchases of securities available for sale | ( | ( | ||||
Principal pay downs on securities available for sale | | | ||||
Loan originations and payments, net | | | ||||
Purchases of premises and equipment | ( | ( | ||||
Proceeds from sales of foreclosed assets | | | ||||
Purchase of bank-owned life insurance | ( | ( | ||||
Liquidation of bank-owned life insurance | | — | ||||
Amortization of debt issuance costs | | — | ||||
Net cash (used in) provided by investing activities | ( | | ||||
| ||||||
Cash flows from financing activities: | ||||||
Increase in deposits | | | ||||
Decrease in borrowed funds | — | ( | ||||
Increase in repurchase agreements | | | ||||
Cash dividends paid | ( | ( | ||||
Repurchases of common stock | ( | — | ||||
Stock options exercised | — | | ||||
Net cash provided by financing activities | | | ||||
| ||||||
(Decrease) increase in cash and cash equivalents | ( | | ||||
| ||||||
Cash and cash equivalents | ||||||
Beginning of period | | | ||||
End of period | $ | | $ | | ||
Supplemental disclosure of cash flow information: | ||||||
Interest paid | $ | | $ | | ||
Supplemental noncash disclosures: | ||||||
Real estate acquired through foreclosure | $ | — | $ | | ||
The accompanying notes are an integral part of these consolidated financial statements.
5
SIERRA BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2022
(Unaudited)
Note 1 – The Business of Sierra Bancorp
Sierra Bancorp (the “Company”) is a California corporation headquartered in Porterville, California, and is a registered bank holding company under federal banking laws. The Company was formed to serve as the holding company for Bank of the Sierra (the “Bank”), and has been the Bank’s sole shareholder since August 2001. The Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish. As of March 31, 2022, the Company’s only other subsidiaries were Sierra Statutory Trust II, Sierra Capital Trust III, and Coast Bancorp Statutory Trust II, which were formed solely to facilitate the issuance of capital trust pass-through securities (“TRUPS”). Pursuant to the Financial Accounting Standards Board (“FASB”) standard on the consolidation of variable interest entities, these trusts are not reflected on a consolidated basis in the Company’s financial statements. References herein to the “Company” include Sierra Bancorp and its consolidated subsidiary, the Bank, unless the context indicates otherwise.
Bank of the Sierra, a California state-chartered bank headquartered in Porterville, California, offers a wide range of retail and commercial banking services via branch offices located throughout California’s South San Joaquin Valley, the Central Coast, Ventura County, the Sacramento area, and neighboring communities. The Bank was incorporated in September 1977, and opened for business in January 1978 as a
Note 2 – Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. The information furnished in these interim statements reflects all adjustments that are, in the opinion of Management, necessary for a fair statement of the results for such periods. Such adjustments can generally be considered as normal and recurring unless otherwise disclosed in this Form 10-Q. In preparing the accompanying financial statements, Management has taken subsequent events into consideration and recognized them where appropriate. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year. Certain amounts reported for 2020 have been reclassified to be consistent with the reporting for 2021. The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, as filed with the Securities and Exchange Commission (the “SEC”).
Note 3 – Current Accounting Developments
In September 2016 the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which eliminates the probable initial recognition threshold for credit losses in current U.S. GAAP, and instead requires an organization to record a current estimate of all expected credit losses over the contractual term for financial assets carried at amortized cost (generally loans and held-to-maturity investment securities) in addition to certain off balance-sheet credit exposure. Under the current expected credit losses (“CECL”)
6
methodology expected credit losses for financial assets are estimated over the contractual life of the financial asset, adjusted for expected prepayments, considering historical experience, current conditions, and reasonable and supportable forecasts. Additionally, under CECL the accounting for credit losses on available-for-sale debt securities is addressed through an allowance for credit losses which is a change from legacy GAAP which previously required the direct write-down of securities through the other-than-temporary impairment approach. The Company
The following table illustrates the impact of the
Transition Impact on Allowance for Credit Losses | |||||||||||||||
(dollars in thousands, unaudited) | |||||||||||||||
January 1, 2022 | |||||||||||||||
Reserves Under Incurred Loss |
| Reserves Under CECL |
| Transition Impact Gross |
| Impact of Deferred Taxes |
| Impact to Retained Earnings | |||||||
Real estate: | |||||||||||||||
1-4 family residential construction | $ | | $ | | $ | ( | $ | | $ | ( | |||||
Other construction/land | | | | ( | | ||||||||||
1-4 family - closed-end | | | | ( | | ||||||||||
Equity lines | | | ( | | ( | ||||||||||
Multi-family residential | | | | ( | | ||||||||||
Commercial real estate - owner occupied | | | | ( | | ||||||||||
Commercial real estate - non-owner occupied | | | | ( | | ||||||||||
Farmland | | | ( | | ( | ||||||||||
Total real estate | | | | ( | | ||||||||||
Agricultural | | | ( | | ( | ||||||||||
Commercial and industrial | | | | ( | | ||||||||||
Mortgage warehouse lines | | | ( | | ( | ||||||||||
Consumer loans | | | ( | | ( | ||||||||||
Total allowance for credit losses - loans | $ | | $ | | $ | | $ | ( | $ | | |||||
Allowance for credit losses - unfunded loan commitments | $ | | $ | | $ | | $ | ( | $ | | |||||
The Company currently categorizes all of its loans and leases as held-for-investment and following CECL implementation, reports loans and leases on the amortized cost basis. The Company’s amortized cost basis is comprised of the principal balance outstanding, net of remaining purchase discount or premium and any deferred fees or costs. Notably, the Company elected the practical expedient available under CECL to exclude accrued interest receivable from the amortized cost basis of all categorizations of loans and investment securities, and resultingly did not estimate reserves on accrued interest receivable balances, as any past due interest income is reversed on a timely basis. Accrued interest receivable continues to be included in other assets on the Company’s balance sheet and as of March 31, 2022, measured at $
7
For available-for-sale debt securities in an unrealized loss position for which management has an intent to sell the security, or considers it more likely-than-not that the security in question will be sold prior to a recovery of its amortized cost basis, the security will be written down to fair value through a direct charge to income. For the remainder of available sale debt securities in an unrealized loss position, which don’t meet the previously outlined criteria, management evaluates whether the decline in fair value is a reflection of credit deterioration or other factors. In performing this evaluation, management considers the extent which fair value has fallen below amortized cost, changes in rating by rating agencies, and other information indicating a deterioration in repayment capacity of either the underlying issuer or the borrowers providing repayment capacity in a securitization. If management’s evaluation indicates that a credit loss exists then a present value of the expected cash flows is calculated and compared to the amortized cost basis of the security in question and to the degree that the amortized cost basis exceeds the present value an allowance for credit loss (“ACL”) is established, with the caveat that the maximum amount of the reserve on any individual security is the difference between the fair value and amortized cost balance of the security in question. Any impairment that has not been recorded through an ACL is recognized in other comprehensive income.
Similar to practice under legacy GAAP, the Company generally continues to place loans and leases on nonaccrual status when management has determined that the full repayment of principal and collection of contractually agreed upon interest is unlikely or when the loan in question has become delinquent more than 90 days. The Company may decide that it is appropriate to continue to accrue interest on certain loans and leases more than 90 days delinquent if they are well-secured by collateral and collection is in process. When a loan is placed on nonaccrual status, any accrued but uncollected interest for the loan and lease is reversed out of interest income in the period in which the loan’s status changed. For loans and leases with an interest reserve, i.e., where loan and lease proceeds are advanced to the borrower to make interest payments, all interest recognized from the inception of the loan and lease is reversed when the loan and lease is placed on non-accrual. Once a loan and lease is on non-accrual status subsequent payments received from the customer are applied to principal, and no further interest income is recognized until the principal has been paid in full or until circumstances have changed such that payments are again consistently received as contractually required. Generally, loans and leases are not restored to accrual status until the obligation is brought current and has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
Similar to practice under legacy GAAP, the ACL on the loan portfolio is a valuation allowance deducted from the recorded balance in loans and leases. However, under CECL the ACL represents principal which is not expected to be collected over the contractual life of the loans and leases, adjusted for expected prepayment, whereas under legacy GAAP the allowance represented only losses already incurred as of the balance sheet date. The ACL is increased by a provision for credit losses charged to expense, and by principal recovered on charged-off balances. It is reduced by principal charge-offs. The amount of the allowance is based on management’s evaluation of the collectability of the loan and lease portfolio, using information from internal and external sources, relating to past events, current conditions and reasonable and supportable forecasts. Adjustments are also made for changes in risk profile, credit concentrations, historical trends, and other economic conditions.
The ACL for loans and leases is separated between a collective reserve evaluation, for loans where similar risk characteristics exist and an individual reserve evaluation for loans without similar risk characteristics. The collective evaluation of loans is performed at the portfolio segment level, using call code as the primary segmentation key but also considering similarity in quantitative reserve methodology. The Company’s ACL is categorized according to the following portfolio segments: 1-4 Family Real Estate, Commercial Real Estate, Farmland Agricultural Production, Commercial Industrial, Mortgage Warehouse, and Consumer. Management utilizes a discounted cash flow methodology to estimate the quantitative portion of collectively evaluated reserves for the 1-4 Family Real Estate, Commercial Real Estate, Commercial Industrial and Mortgage Warehouse portfolio segments. Management utilizes a Remaining Life Quantitative Reserve Methodology for the Farmland Agricultural Production, and Consumer portfolio segments. Within the portfolio segments utilizing the DCF quantitative reserve methodology, management has made the election to adjust the effective interest rate to consider the impact of expected prepayments.
Loans and leases where similar risk characteristics exist are evaluated for the ACL in the collective reserve evaluation. The Company’s policy is that loans designated as nonaccrual no longer share risk characteristics similar to other loans and leases evaluated collectively and as such, all nonaccrual loans and leases are individually evaluated for reserves. As
8
of March 31, 2022 the Bank’s nonaccrual loans and leases comprised the entire population of loans and leases individually evaluated. The Company’s policy is that nonaccrual loans also represent the subset of loans and leases where borrowers are experiencing financial difficulty where an evaluation of the source of repayment is required to determine if the nonaccrual loan and lease should be categorized as collateral dependent. It is the Company’s policy that the only loans and leases where the credit quality has deteriorated to the point where foreclosure is probable are the Company’s nonaccrual loans and leases.
The implementation of CECL also impacted the Company’s ACL on unfunded loan commitments, as this ACL now represents expected credit losses over the contractual life of commitments not identified as unconditionally cancellable by the Company. The Reserve for Unfunded Commitments is estimated using the same reserve or coverage rates calculated on collectively evaluated loans following the application of a funding rate to the amount of the unfunded commitment. The funding rate represents management’s estimate of the amount of the current unfunded commitment that will be funded over the remaining contractual life of the commitment and is based on historical data. Under CECL the ACL on unfunded loan commitments remains in Other Liabilities while any related provision expense has been moved to provision for credit loss expense from its prior presentation in noninterest expense. Prior period expense has been reclassified for comparative purposes.
Note 4 – Share Based Compensation
On March 16, 2017 the Company’s Board of Directors approved and adopted the 2017 Stock Incentive Plan (the “2017 Plan”), which became effective May 24, 2017, the date approved by the Company’s shareholders. The 2017 Plan replaced the Company’s 2007 Stock Incentive Plan (the “2007 Plan”), which expired by its own terms on March 15, 2017. Options to purchase
Pursuant to FASB’s standards on stock compensation, the value of each stock option and restricted stock award is reflected in our income statement as employee compensation or directors’ expense by amortizing its grant date fair value over the vesting period of the option or award. The Company utilizes a Black-Scholes model to determine grant date fair values for options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. Forfeitures are reflected in compensation costs as they occur for both types of awards. A pre-tax charge of $
Restricted Stock Grants
The Company’s Restricted Stock Awards are awards of time-vested, non-transferrable shares of common stock and are available to be granted to the Company’s employees and directors. The vesting period of Restricted Stock Awards is determined at the time the awards are issued, and different awards may have different vesting terms; provided, however, that no installment of any Restricted Stock Award shall become vested less than one year from the grant date. Restricted Stock Awards are valued utilizing the fair value of the Company’s stock at the grant date. There were
9
The Company’s time-vested award activity for the three months ended March 31, 2022 and 2021 is summarized below (unaudited):
Three months ended March 31, | ||||||||||
2022 | 2021 | |||||||||
Shares | Weighted Average Grant-Date Fair Value | Shares | Weighted Average Grant-Date Fair Value | |||||||
Unvested shares, January 1, | | $ | | | $ | | ||||
Granted | — | — | | | ||||||
Vested | ( | | — | — | ||||||
Forfeited | ( | | — | — | ||||||
Unvested shares March 31, | | $ | | | $ | | ||||
Stock Option Grants
The Company has issued equity instruments in the form of Incentive Stock Options and Nonqualified Stock Options to certain officers and directors and may continue to do so under the 2017 Plan. The exercise price of each stock option is determined at the time of the grant and may be no less than
The Company’s stock option activity during the three months ended March 31, 2022 and 2021 are summarized below (dollars in thousands, except per share data, unaudited):
Three months ended March 31, | ||||||||||||||||||||
2022 | 2021 | |||||||||||||||||||
| Shares |
| Weighted Average | Weighted Average Remaining Contractual Term (in years) |
| Aggregate |
| Shares |
| Weighted Average | Weighted Average Remaining Contractual Term (in years) |
| Aggregate | |||||||
Outstanding at January 1, | | $ | | $ | | | $ | | $ | | ||||||||||
Granted | — | $ | — | $ | — | — | $ | — | $ | — | ||||||||||
Exercised | — | $ | — | $ | | ( | $ | | $ | | ||||||||||
Canceled | ( | $ | | $ | — | ( | $ | | $ | — | ||||||||||
Outstanding at March 31, | | $ | | $ | | | $ | | $ | | ||||||||||
Exercisable at March 31, | | $ | | $ | | | $ | | $ | | ||||||||||
| (1) | The aggregate intrinsic value of stock option in the table above represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31, 2022. This amount changes based on changes in the market value of the Company's stock. |
Note 5 – Earnings per Share
The computation of earnings per share, as presented in the Consolidated Statements of Income, is based on the weighted average number of shares outstanding during each period, excluding unvested restricted stock awards. There were
Diluted earnings per share calculations include the effect of the potential issuance of common shares, which for the Company is limited to shares that would be issued on the exercise of “in-the-money” stock options, and unvested restricted stock awards. For the first quarter of 2022, calculations under the treasury stock method resulted in the equivalent of
10
Note 6 – Comprehensive Income (Loss)
As presented in the Consolidated Statements of Comprehensive Income (Loss), comprehensive income (loss) includes net income and other comprehensive income (loss). The Company’s only source of other comprehensive income (loss) is unrealized gains and losses on available-for-sale investment securities. Investment gains or losses that were realized and reflected in net income of the current period, which had previously been included in other comprehensive income (loss) as unrealized holding gains or losses in the period in which they arose, are considered to be reclassification adjustments that are excluded from other comprehensive income (loss) in the current period.
Note 7 – Commitments and Contingent Liabilities
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business. Those financial instruments currently consist of unused commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet. The Company’s exposure to credit loss in the event of nonperformance by counterparties for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and issuing letters of credit as it does for originating loans included on the balance sheet.
| March 31, 2022 |
| December 31, 2021 | |||
Commitments to extend credit | $ | | $ | | ||
Standby letters of credit | $ | | $ | | ||
Commitments to extend credit consist primarily of the unused or unfunded portions of the following: home equity lines of credit; commercial real estate construction loans, where disbursements are made over the course of construction; commercial revolving lines of credit; mortgage warehouse lines of credit; unsecured personal lines of credit; and formalized (disclosed) deposit account overdraft lines. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many commitments are expected to expire without being drawn upon, the unused portions of committed amounts do not necessarily represent future cash requirements. Standby letters of credit are issued by the Company to guarantee the performance of a customer to a third party, and the credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers.
At March 31, 2022, the Company was also utilizing a letter of credit in the amount of $
The Company is subject to loss contingencies, including claims and legal actions arising in the ordinary course of business, which are recorded as liabilities when the likelihood of loss is probable, and an amount or range of loss can be reasonably estimated. Management does not believe there are such matters that will have a material effect on the financial statements.
As noted under footnote 3 the adoption of CECL on January 1, 2022 impacted the Company’s ACL on unfunded loan commitments. Additional information is included in footnote 3.
Note 8 – Fair Value Disclosures and Reporting and Fair Value Measurements
FASB’s standards on financial instruments, and on fair value measurements and disclosures, require public business entities to disclose in their financial statement footnotes the estimated fair values of financial instruments. In addition to disclosure requirements, FASB’s standard on investments requires that our debt securities that are classified as available for sale and any equity securities which have readily determinable fair values be measured and reported at fair value in our statement of financial position. Certain individually identified loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value. FASB’s standard on financial
11
instruments permits companies to report certain other financial assets and liabilities at fair value, but the Company has not elected the fair value option for any of those financial instruments.
Fair value measurement and disclosure standards also establish a framework for measuring fair values. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date. Further, the standards establish a fair value hierarchy that encourages an entity to maximize the use of observable inputs and limit the use of unobservable inputs when measuring fair values. The standards describe three levels of inputs that may be used to measure fair values:
| ● | Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. |
| ● | Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data. |
| ● | Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the factors that market participants would likely consider in pricing an asset or liability. |
Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments. Fair value disclosures for deposits include demand deposits, which are, by definition, equal to the amount payable on demand at the reporting date. Fair value calculations for loans and leases reflect exit pricing, and incorporate our assumptions with regard to the impact of prepayments on future cash flows and credit quality adjustments based on risk characteristics of various financial instruments, among other things. Since the estimates are subjective and involve uncertainties and matters of significant judgment they cannot be determined with precision, and changes in assumptions could significantly alter the fair values presented.
Estimated fair values for the Company’s financial instruments are as follows, as of the dates noted:
Fair Value of Financial Instruments
(dollars in thousands, unaudited)
March 31, 2022 | |||||||||||||||
Fair Value Measurements | |||||||||||||||
| Carrying |
| Quoted Prices in |
| Significant |
| Significant |
| Total | ||||||
Financial assets: | |||||||||||||||
Cash and cash equivalents | $ | | $ | | $ | | $ | | $ | | |||||
Investment securities available for sale | | | | | | ||||||||||
Loans and leases, net held for investment | | | | | | ||||||||||
Collateral dependent loans | | | | | | ||||||||||
| |||||||||||||||
Financial liabilities: | |||||||||||||||
Deposits | | | | | | ||||||||||
Repurchase agreements | | | | | | ||||||||||
Long-term debt | | | | | | ||||||||||
Subordinated debentures | | | | | | ||||||||||
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December 31, 2021 | |||||||||||||||
Fair Value Measurements | |||||||||||||||
| Carrying |
| Quoted Prices in |
| Significant |
| Significant |
| Total | ||||||
Financial assets: | |||||||||||||||
Cash and cash equivalents | $ | | $ | | $ | | $ | | $ | | |||||
Investment securities available for sale | | | | | | ||||||||||
Loans and leases, net held for investment | | | | | | ||||||||||
Collateral dependent loans | | | | | | ||||||||||
| |||||||||||||||
Financial liabilities: | |||||||||||||||
Deposits | | | | | | ||||||||||
Repurchase agreements | | | | | | ||||||||||
Short term borrowings | | | | | | ||||||||||
Subordinated debentures | | | | | | ||||||||||
For financial asset categories that were carried on our balance sheet at fair value as of March 31, 2022 and December 31, 2021, the Company used the following methods and significant assumptions:
| ● | Investment securities: Fair values are determined by obtaining quoted prices on nationally recognized securities exchanges or by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities by relying on their relationship to other benchmark quoted securities. |
| ● | Collateral-dependent loans: Collateral-dependent loans are carried at fair value when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement and the loan has been written down to the fair value of its underlying collateral, net of expected disposition costs where applicable. |
| ● | Foreclosed assets: Repossessed real estate (known as other real estate owned, or “OREO”) and other foreclosed assets are carried at the lower of cost or fair value. Fair value is the appraised value less expected disposition costs for OREO; fair values for any other foreclosed assets are represented by estimated sales proceeds as determined using reasonably available sources. Foreclosed assets for which appraisals can be feasibly obtained are periodically measured for impairment using updated appraisals. Fair values for other foreclosed assets are adjusted as necessary, subsequent to a periodic reevaluation of expected cash flows and the timing of resolution. If impairment is determined to exist, the book value of a foreclosed asset is immediately written down to its estimated impaired value through the income statement, thus the carrying amount is equal to the fair value and there is no valuation allowance. |
13
Assets reported at fair value on a recurring basis are summarized below:
Fair Value Measurements – Recurring
(dollars in thousands, unaudited)
Fair Value Measurements at March 31, 2022, using | |||||||||||||||
| Quoted Prices in |
| Significant |
| Significant |
| Total |
| Realized | ||||||
Securities: | |||||||||||||||
U.S. government agencies | $ | | $ | | $ | | $ | | $ | | |||||
Mortgage-backed securities | | | | | | ||||||||||
State and political subdivisions | | | | | | ||||||||||
Corporate bonds | | | | | | ||||||||||
Collateralized loan obligations | | | | | | ||||||||||
Total available-for-sale securities | $ | | $ | | $ | | $ | | $ | | |||||
Fair Value Measurements at December 31, 2021, using | |||||||||||||||
| Quoted Prices in |
| Significant |
| Significant |
| Total |
| Realized | ||||||
Securities: | |||||||||||||||
U.S. government agencies | $ | | $ | | $ | | $ | | $ | | |||||
Mortgage-backed securities | | | | | | ||||||||||
State and political subdivisions | | | | | | ||||||||||
Corporate bonds | | | | | | ||||||||||
Collateralized loan obligations | | | | | | ||||||||||
Total available-for-sale securities | $ | | $ | | $ | | $ | | $ | | |||||
Fair Value Measurements - Level 3 Recurring | ||||||||||||
(dollars in thousands, unaudited) | ||||||||||||
| Collateralized Loan Obligations |
| Corporate Bonds | |||||||||
2022 | 2021 | 2022 | 2021 | |||||||||
Balance of recurring Level 3 assets at January 1, | $ | | $ | — | $ | | $ | — | ||||
Purchases | — | — | | — | ||||||||
Transfers out of Level 3 | ( | — | — | — | ||||||||
Balance of recurring Level 3 assets at March 31, | $ | — | $ | — | $ | | $ | — | ||||
All of the Company’s collateralized loan obligations with a fair value of $
14
Assets reported at fair value on a nonrecurring basis are summarized below:
Fair Value Measurements – Nonrecurring
(dollars in thousands, unaudited)
Fair Value Measurements at March 31, 2022, using | ||||||||||||
| Quoted Prices in |
| Significant |
| Significant |
| Total | |||||
Collateral dependent loans | ||||||||||||
Real estate: | ||||||||||||
1-4 family residential construction | $ | | $ | | $ | | $ | | ||||
Other construction/land | | | | | ||||||||
1-4 family - closed-end | | | | | ||||||||
Equity lines | | | | | ||||||||
Multi-family residential | | | | | ||||||||
Commercial real estate - owner occupied | | | | | ||||||||
Commercial real estate - non-owner occupied | | | | | ||||||||
Farmland | | | | | ||||||||
Total real estate | | | | | ||||||||
Agricultural | | | | | ||||||||
Commercial and industrial | | | | | ||||||||
Consumer loans | | | | | ||||||||
Total collateral dependent loans | $ | | $ | | $ | | $ | | ||||
Foreclosed assets | $ | | $ | | $ | | $ | | ||||
Total assets measured on a nonrecurring basis | $ | | $ | | $ | | $ | | ||||
Fair Value Measurements at December 31, 2021, using | ||||||||||||
| Quoted Prices in |
| Significant |
| Significant |
| Total | |||||
Collateral dependent loans | ||||||||||||
Real estate: | ||||||||||||
1-4 family residential construction | $ | | $ | | $ | | $ | | ||||
Other construction/land | | | | | ||||||||
1-4 family - closed-end | | | | | ||||||||
Equity lines | | | | | ||||||||
Multi-family residential | | | | | ||||||||
Commercial real estate - owner occupied | | | | | ||||||||
Commercial real estate - non-owner occupied | | | | | ||||||||
Farmland | | | | | ||||||||
Total real estate | | | | | ||||||||
Agricultural | | | | | ||||||||
Commercial and industrial | | | | | ||||||||
Consumer loans | | | | | ||||||||
Total collateral dependent loans | $ | | $ | | $ | | $ | | ||||
Foreclosed assets | $ | | $ | | $ | | $ | | ||||
Total assets measured on a nonrecurring basis | $ | | $ | | $ | | $ | | ||||
The table above includes collateral-dependent loan balances for which a specific reserve has been established or on which a write-down has been taken. Information on the Company’s total collateral dependent loan balances and specific loss reserves associated with those balances is included in Note 10 below.
15
The unobservable inputs are based on Management’s best estimates of appropriate discounts in arriving at fair market value. Adjusting any of those inputs could result in a significantly lower or higher fair value measurement. For example, an increase or decrease in actual loss rates would create a directionally opposite change in the fair value of unsecured individually identified loans.
Note 9 – Investments
Investment Securities
Although the Company currently has the intent and the ability to hold the securities in its investment portfolio to maturity, the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. Pursuant to FASB’s guidance on accounting for debt securities, available for sale securities are carried on the Company’s financial statements at their estimated fair market values, with monthly tax-effected “mark-to-market” adjustments made vis-à-vis accumulated other comprehensive income in shareholders’ equity.
The amortized cost and estimated fair value of available-for-sale investment securities are as follows:
Amortized Cost And Estimated Fair Value
(dollars in thousands, unaudited)
March 31, 2022 | |||||||||||||||
| Amortized |
| Gross |
| Gross | Allowance for Credit Losses - AFS Securities |
| Estimated Fair | |||||||
U.S. government agencies | $ | | $ | — | $ | ( | $ | — | $ | | |||||
Mortgage-backed securities | | | ( | — | | ||||||||||
State and political subdivisions | | | ( | — | | ||||||||||
Corporate bonds | | — | ( | — | | ||||||||||
Collateralized loan obligations | | — | ( | — | | ||||||||||
Total securities | $ | | $ | | $ | ( | $ | — | $ | | |||||
December 31, 2021 | ||||||||||||
| Amortized |
| Gross |
| Gross |
| Estimated Fair | |||||
U.S. government agencies | $ | | $ | | $ | — | $ | | ||||
Mortgage-backed securities | | | ( | | ||||||||
State and political subdivisions | | | ( | | ||||||||
Corporate bonds | | | ( | | ||||||||
Collateralized loan obligations | | | ( | | ||||||||
Total securities | $ | | $ | | $ | ( | $ | | ||||
The Company did not record an ACL on the AFS portfolio at March 31, 2022 or upon implementation on January 1, 2022. As of both dates the Company considers the unrealized loss across the classes of major security-type to be related to fluctuations in market conditions, primarily interest rates, and not reflective of a deterioration in credit value in any case. The Company maintains that it has intent and ability to hold these securities until the amortized cost basis of each security is recovered and likewise concluded as of both January 1, 2022 and March 31, 2022 that it was not more likely than not that any of the securities in an unrealized loss position would be required to be sold. The following bullets outline additional support for management’s conclusion that
16
| ● | US Government Agencies are supported by the full faith and credit-worthiness of the U.S. Federal Government and the management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either January 1, 2022 or March 31, 2022. |
| ● | Mortgage-backed securities issued by government sponsored entities (“GSEs”) carry an implicit guarantee by the U.S. Federal Government, as the GSEs can draw funds from the U.S. Federal Government up to a limit, with an implied ability to draw funds beyond the limit. Management did not consider a default, much less a loss on these securities to be a reasonable possibility as of either January 1, 2022 or March 31, 2022. |
| ● | Management routinely monitors third party credit grades of the municipal issuers in the Company’s state and political subdivisions portfolio and as of both January 1, 2022 and March 31, 2022 noted that all municipal securities in an unrealized loss position were either investment grade rated or guaranteed. On a quarterly basis management receives financial information from a third-party service related to underlying issuer’s financial stability. In addition, management performs annual reviews of the underlying municipal issuers financial statements in order to evaluate stability and repayment capacity and has noted no concerns with any of the bonds in the Company’s State and Local portfolio. As of both January 1, 2022 and March 31, 2022 management concluded that no reserve was warranted on any of the Company’s municipal securities and the unrealized loss position of each of the securities reflected fluctuations in market conditions, primarily interest rates, since the time of purchase. |
| ● | The Company has invested in corporate debt issuances of other financial institutions. Various financial metrics of each of the issuing financial institutions are reviewed by management quarterly, these metrics include credit quality, reserve adequacy, capital, profitability and capital. Following review of the financial metrics available for each of the underlying institutions as of January 1, 2022 and March 31, 2022 management concluded that the unrealized loss position of these securities related exclusively to the fluctuation in market conditions, primarily interest rates, from the date of purchase, and were not reflective of any credit concerns with the issuing financial institution. |
| ● | The Company has invested in AA and AAA tranches of various collateralized debt obligations, which are securitizations of commercial loans. Management monitors the credit rating of these investments on a quarterly basis in addition to various performance metrics available through a third-party informational service. Following review of financial metrics as of both January 1, 2022 and March 31, 2022 management concluded that the unrealized loss position of these securities related exclusively to the fluctuation in market conditions, primarily interest rate spreads, from the date of purchase, and were not reflective of any credit concerns with the tranches comprising the Company’s investments. |
17
At March 31, 2022 and December 31, 2021, the Company had
Investment Portfolio - Unrealized Losses
(dollars in thousands, unaudited)
March 31, 2022 | ||||||||||||
Less than twelve months | Twelve months or more | |||||||||||
| Gross |
| Fair Value |
| Gross |
| Fair Value | |||||
U.S. government agencies | $ | ( | $ | | $ | — | $ | — | ||||
Mortgage-backed securities | ( | | ( | | ||||||||
State and political subdivisions | ( | | — | — | ||||||||
Corporate bonds | ( | | — | — | ||||||||
Collateralized loan obligations | ( | | — | — | ||||||||
Total | $ | ( | $ | | $ | ( | $ | | ||||
December 31, 2021 | ||||||||||||
Less than twelve months | Twelve months or more | |||||||||||
| Gross |
| Fair Value |
| Gross |
| Fair Value | |||||
U.S. government agencies | $ | — | $ | — | $ | — | $ | — | ||||
Mortgage-backed securities | ( | | ( | | ||||||||
State and political subdivisions | ( | | — | — | ||||||||
Corporate bonds | ( | | — | — | ||||||||
Collateralized loan obligations | ( | | — | — | ||||||||
Total | $ | ( | $ | | $ | ( | $ | | ||||
The table below summarizes the Company’s gross realized gains and losses as well as gross proceeds from the sales of securities, for the periods indicated:
Investment Portfolio - Realized Gains/(Losses)
(dollars in thousands, unaudited)
Three months ended March 31, | ||||||
| 2022 |
| 2021 | |||
Proceeds from sales, calls and maturities of securities available for sale | $ | | $ | | ||
Gross gains on sales, calls and maturities of securities available for sale | | | ||||
Gross losses on sales, calls and maturities of securities available for sale | — | | ||||
Net gains on sale of securities available for sale | $ | | $ | | ||
18
The amortized cost and estimated fair value of investment securities available-for-sale at March 31, 2022 and December 31, 2021 are shown below, grouped by the remaining time to contractual maturity dates. The expected life of investment securities may not be consistent with contractual maturity dates, since the issuers of the securities might have the right to call or prepay obligations with or without penalties.
Estimated Fair Value of Contractual Maturities
(dollars in thousands, unaudited)
March 31, 2022 | ||||||
| Amortized Cost |
| Fair Value | |||
Maturing within one year | $ | | $ | | ||
Maturing after one year through five years | | | ||||
Maturing after five years through ten years | | | ||||
Maturing after ten years | | | ||||
Securities not due at a single maturity date: | ||||||
Mortgage-backed securities | | | ||||
Collateralized loan obligations | | | ||||
| $ | | $ | | ||
December 31, 2021 | ||||||
| Amortized Cost |
| Fair Value | |||
Maturing within one year | $ | | $ | | ||
Maturing after one year through five years | | | ||||
Maturing after five years through ten years | | | ||||
Maturing after ten years | | | ||||
Securities not due at a single maturity date: | ||||||
Mortgage-backed securities | | | ||||
Collateralized loan obligations | | | ||||
| $ | | $ | | ||
At March 31, 2022, the Company’s investment portfolio included
The Company’s investments in bonds issued by corporations, states, municipalities and political subdivisions are evaluated in accordance with Financial Institution Letter 48-2012, issued by the FDIC, “Revised Standards of Creditworthiness for Investment Securities,” and other regulatory guidance. Credit ratings are considered in our analysis only as a guide to the historical default rate associated with similarly rated bonds. There have been no significant differences in our internal analyses compared with the ratings assigned by the third-party credit rating agencies.
19
The following table summarizes the amortized cost and fair values of general obligation and revenue bonds in the Company’s investment securities portfolio at the indicated dates, identifying the state in which the issuing municipality or agency operates for our largest geographic concentrations:
Revenue and General Obligation Bonds by Location
(dollars in thousands, unaudited)
March 31, 2022 | December 31, 2021 | |||||||||||
Amortized | Fair Market | Amortized | Fair Market | |||||||||
General obligation bonds |
| Cost |
| Value |
| Cost |
| Value | ||||
State of issuance | ||||||||||||
Texas | $ | | $ | | $ | | $ | | ||||
California | | | | | ||||||||
Washington | | | | | ||||||||
Other (26 26 states, respectively) | | | | | ||||||||
Total general obligation bonds | | | | | ||||||||
| ||||||||||||
Revenue bonds | ||||||||||||
State of issuance | ||||||||||||
Texas | | | | | ||||||||
Washington | | | | | ||||||||
California | | | | | ||||||||
Other (15 15 states, respectively) | | | | | ||||||||
Total revenue bonds | | | | | ||||||||
Total obligations of states and political subdivisions | $ | | $ | | $ | | $ | | ||||
The revenue bonds in the Company’s investment securities portfolios were issued by government municipalities and agencies to fund public services such as utilities (water, sewer, and power), educational facilities, and general public and economic improvements. The primary sources of revenue for these bonds are delineated in the table below, which shows the amortized cost and fair market values for the largest revenue concentrations as of the indicated dates.
Revenue Bonds by Type
(dollars in thousands, unaudited)
March 31, 2022 | December 31, 2021 | |||||||||||
Amortized | Fair Market | Amortized | Fair Market | |||||||||
Revenue bonds |
| Cost |
| Value |
| Cost |
| Value | ||||
Revenue source: | ||||||||||||
Water | $ | | $ | | $ | | $ | | ||||
Sewer | | | | | ||||||||
Lease | | | | | ||||||||
Tax revenue | | | — | — | ||||||||
Special Tax | | | | | ||||||||
Other (9 and 9 sources, respectively) | | | | | ||||||||
Total revenue bonds | $ | | $ | | $ | | $ | | ||||
Low-Income Housing Tax Credit (“LIHTC”) Fund Investments
The Company has the ability to invest in limited partnerships which own housing projects that qualify for federal and/or California state tax credits, by mandating a specified percentage of low-income tenants for each project. The primary investment return comes from tax credits that flow through to investors. Because rent levels are lower than standard market rents and the projects are generally highly leveraged, each project also typically generates tax-deductible operating losses that are allocated to the limited partners for tax purposes.
20
The Company currently has investments in two different LIHTC fund limited partnerships made in 2014 and 2015, both of which were California-focused funds that help the Company meet its obligations under the Community Reinvestment Act. We utilize the cost method of accounting for our LIHTC fund investments, under which we initially record on our balance sheet an asset that represents the total cash expected to be invested over the life of the partnership. Any commitments or contingent commitments for future investment are reflected as a liability. The income statement reflects tax credits and any other tax benefits from these investments “below the line” within our income tax provision, while the initial book value of the investment is amortized on a straight-line basis as an offset to noninterest income, over the time period in which the tax credits and tax benefits are expected to be received.
As of March 31, 2022, our total LIHTC investment book balance was $
Note 10 – Loans and Leases and Allowance for Credit Losses
We adopted the new current expected credit loss accounting guidance, CECL, and all related amendments as of January 1, 2022. Certain prior period credit quality disclosures related to impaired loans and individually and collectively evaluated loans were superseded with the current guidance and have not been included below as of March 31, 2022. Under CECL, disclosures are required on the amortized cost basis, whereas legacy GAAP required presentation on the recorded investment basis, with the primary difference being net deferred fees and costs. Unless specifically noted otherwise, March 31, 2022 disclosures are prepared on the amortized cost basis and December 31, 2021 disclosures present information according to the recorded investment basis.
The following table presents loans by class as of March 31, 2022 and December 31, 2021. Accrued interest receivable on loans of $
21
Loan And Lease Distribution | ||||||
(dollars in thousands, unaudited) | ||||||
| March 31, 2022 |
| December 31, 2021 | |||
Real estate: | ||||||
1-4 family residential construction | $ | | $ | | ||
Other construction/land | | | ||||
1-4 family - closed-end | | | ||||
Equity lines | | | ||||
Multi-family residential | | | ||||
Commercial real estate - owner occupied | | | ||||
Commercial real estate - non-owner occupied | | | ||||
Farmland | | | ||||
Total real estate | | | ||||
Agricultural | | | ||||
Commercial and industrial | | | ||||
Mortgage warehouse lines | | | ||||
Consumer loans | | | ||||
Subtotal | | | ||||
Less net deferred loan fees and costs | ( | ( | ||||
Loans and leases, amortized cost basis | | | ||||
Allowance for credit losses | ( | ( | ||||
Net loans and leases | $ | | $ | | ||
The following table presents the amortized cost basis of nonaccrual loans, according to loan class, with and without individually evaluated reserves as of March 31, 2022:
Nonaccrual Loans and Leases | ||||||||||||
(dollars in thousands, unaudited) | ||||||||||||
March 31, 2022 | ||||||||||||
Nonaccrual Loans | ||||||||||||
| With no allowance for credit loss |
| With an allowance for credit loss | Total | Loans Past Due 90+ Accruing | |||||||
Real estate: | ||||||||||||
1-4 family residential construction | $ | — | $ | — | $ | — | $ | — | ||||
Other construction/land | — | — | — | — | ||||||||
1-4 family - closed-end | | — | | — | ||||||||
Equity lines | | — | | — | ||||||||
Multi-family residential | — | — | — | — | ||||||||
Commercial real estate - owner occupied | | — | | — | ||||||||
Commercial real estate - non-owner occupied | — | — | — | — | ||||||||
Farmland | | — | | — | ||||||||
Total real estate | | — | | — | ||||||||
Agricultural | | | | — | ||||||||
Commercial and industrial | | | | | ||||||||
Mortgage warehouse lines | — | — | — | — | ||||||||
Consumer loans | | — | | — | ||||||||
Total | $ | | $ | | $ | | $ | | ||||
22
The following table presents the impaired loans as of December 31, 2021, according to loan class, with and without an individually evaluated reserve according to the recorded investment basis. Impaired loans as of December 31, 2021 included both nonaccrual loans and performing TDRs. A separate breakout of nonaccrual loans by class as of December 31, 2021 is included in the past due loans table as of December 31, 2021, later in this footnote.
December 31, 2021 | |||||||||||||||
Unpaid Principal | Recorded | Average Recorded | Interest Income | ||||||||||||
| Balance(1) |
| Investment(2) |
| Related Allowance |
| Investment |
| Recognized(3) | ||||||
With an Allowance Recorded | |||||||||||||||
Real estate: | |||||||||||||||
Other construction/land | $ | | $ | | $ | | $ | | $ | | |||||
1-4 family - closed-end | | | | | | ||||||||||
Equity lines | | | | | | ||||||||||
Commercial real estate - owner occupied | | | | | | ||||||||||
Commercial real estate - non-owner occupied | | | | | | ||||||||||
Total real estate | | | | | | ||||||||||
Agricultural | | | | | — | ||||||||||
Commercial and industrial | | | | | | ||||||||||
Consumer loans | | | | | | ||||||||||
| | | | | | ||||||||||
With no Related Allowance Recorded | |||||||||||||||
Real estate: | |||||||||||||||
1-4 family - closed-end | | | — | | — | ||||||||||
Equity lines | | | — | | | ||||||||||
Commercial real estate - owner occupied | | | — | | — | ||||||||||
Total real estate | | | — | | | ||||||||||
Agricultural | | | — | | — | ||||||||||
Commercial and industrial | | | — | | — | ||||||||||
| | | — | | | ||||||||||
Total | $ | | $ | | $ | | $ | | $ | | |||||
| (1) | Contractual principal balance due from customer. |
| (2) | Principal balance on Company’s books, less any direct charge offs. |
| (3) | Interest income is recognized on performing balances on a regular accrual basis. |
The Company recognized $
23
The following table presents the amortized cost basis of collateral-dependent loans by class as of March 31, 2022:
Collateral Dependent Loans | ||||||
(dollars in thousands, unaudited) | ||||||
March 31, 2022 | ||||||
| Amortized Cost | Individual Reserves | ||||
Real estate: | ||||||
1-4 family residential construction | $ | — | $ | — | ||
Other construction/land | — | — | ||||
1-4 family - closed-end | | — | ||||
Equity lines | | — | ||||
Multi-family residential | — | — | ||||
Commercial real estate - owner occupied | | — | ||||
Commercial real estate - non-owner occupied | — | — | ||||
Farmland | | — | ||||
Total real estate | | — | ||||
Agricultural | | — | ||||
Commercial and industrial | | — | ||||
Mortgage warehouse lines | — | — | ||||
Consumer loans | — | — | ||||
Total loans and leases | $ | | $ | — | ||
Absent the significant deterioration of the collateral value of Farmland securing several loans to a single borrower, which were downgraded to non-accrual and collateral dependent during the first quarter of 2022 there were no significant changes in the population of collateral dependent loans, or in the valuations of the related collateral. All of the Company’s collateral dependent loans had appraised collateral values which exceed the amortized cost basis of the related loan as of March 31, 2022, which the company has applied discounts against. The weighted-average loan to value of the Company’s collateral-dependent loans as of March 31, 2022, was
24
The following table presents the aging of the amortized cost basis in past-due loans, according to class, as of March 31, 2022:
Past Due Loans and Leases | ||||||||||||||||||
(dollars in thousands, unaudited) | ||||||||||||||||||
March 31, 2022 | ||||||||||||||||||
| 30-59 Days Past Due |
| 60-89 Days Past Due | Loans Past Due 90+ Days | Total Past Due | Loans not Past Due | Total Loans | |||||||||||
Real estate: | ||||||||||||||||||
1-4 family residential construction | $ | — | $ | — | $ | — | $ | — | $ | | $ | | ||||||
Other construction/land | — | — | — | — | | | ||||||||||||
1-4 family - closed-end | | — | — | | | | ||||||||||||
Equity lines | — | — | — | — | | | ||||||||||||
Multi-family residential | — | — | — | — | | | ||||||||||||
Commercial real estate - owner occupied | | — | — | | | | ||||||||||||
Commercial real estate - non-owner occupied | | — | — | | | | ||||||||||||
Farmland | | — | — | | | | ||||||||||||
Total real estate | | — | — | | | | ||||||||||||
Agricultural | — | — | | | | | ||||||||||||
Commercial and industrial | | | | | | | ||||||||||||
Mortgage warehouse lines | — | — | — | — | | | ||||||||||||
Consumer loans | | | — | | | | ||||||||||||
Total loans and leases | $ | | $ | | $ | | $ | | $ | | $ | | ||||||
The following table presents the aging of the recorded investment in past-due and nonaccrual loans, according to class, as of December 31, 2021:
December 31, 2021 | 30-59 Days | 60-89 Days | 90 Days Or | Total Financing | Non-Accrual | ||||||||||||||||
| Past Due |
| Past Due |
| Due(2) |
| Total Past Due |
| Current |
| Receivables |
| Loans(1) | ||||||||
Real Estate: | |||||||||||||||||||||
1-4 family residential construction | $ | — | $ | — | $ | — | $ | — | $ | | $ | | $ | — | |||||||
Other construction/land | — | — | — | — | | | — | ||||||||||||||
1-4 family - closed-end | | | — | | | | | ||||||||||||||
Equity lines | | — | — | | | | | ||||||||||||||
Multi-family residential | — | — | — | — | | | — | ||||||||||||||
Commercial real estate owner occupied | | — | | | | | | ||||||||||||||
Commercial real estate non-owner occupied | — | — | — | — | | | — | ||||||||||||||
Farmland | — | — | — | — | | | — | ||||||||||||||
Total real estate loans | | | | | | | | ||||||||||||||
| |||||||||||||||||||||
Agricultural | — | — | | | | | | ||||||||||||||
Commercial and industrial | | — | | | | | | ||||||||||||||
Mortgage warehouse lines | — | — | — | — | | | — | ||||||||||||||
Consumer loans | | | — | | | | | ||||||||||||||
Total gross loans and leases | $ | | $ | | $ | | $ | | $ | | $ | | $ | | |||||||
| (1) | Included in Total Financing Receivables |
| (2) | As of December 31, 2021 there were |
Troubled Debt Restructurings
A loan that is modified for a borrower who is experiencing financial difficulty is classified as a troubled debt restructuring (TDR) if the modification constitutes a concession. At March 31, 2022, the Company had a total of $
25
at the time of loan modification. Regardless of the period of time that has elapsed, if the borrower’s ability to meet the revised payment schedule is uncertain, then the loan will be kept on non-accrual status.
The Company may agree to different types of concessions when modifying a loan or lease. The tables below summarize TDRs which were modified during the noted periods, by type of concession:
Troubled Debt Restructurings, by Type of Loan Modification
(dollars in thousands, unaudited)
Three months ended March 31, 2022 | ||||||||||||||||||
| Rate Modification |
| Term |
| Interest Only Modification |
| Rate Term Modification |
| Term Interest Modification | Total | ||||||||
Real estate: | ||||||||||||||||||
Other construction/land | $ | | $ | | $ | | $ | | $ | — | $ | — | ||||||
1-4 family - closed-end | | | | | — | — | ||||||||||||
Equity lines | | | | | — | — | ||||||||||||
Multi-family residential | | | | | — | — | ||||||||||||
Commercial real estate - owner occupied | | | | | — | — | ||||||||||||
Farmland | | | | | — | — | ||||||||||||
Total real estate loans | | | | | — | — | ||||||||||||
Agricultural | | | | | — | — | ||||||||||||
Commercial and industrial | | | | | — | — | ||||||||||||
Consumer loans | | | | | — | — | ||||||||||||
Total | $ | | $ | | $ | | $ | | $ | — | $ | — | ||||||
Three months ended March 31, 2021 | ||||||||||||||||||
| Rate Modification |
| Term |
| Interest Only |
| Rate Term Modification |
| Term Interest Modification | Total | ||||||||
Real estate: | ||||||||||||||||||
Other construction/land | $ | | $ | | $ | | $ | | $ | — | $ | | ||||||
1-4 family - closed-end | | | | | — | | ||||||||||||
Equity lines | | | | | — | | ||||||||||||
Multi-family residential | | | | | — | | ||||||||||||
Commercial real estate - owner occupied | | | | | — | | ||||||||||||
Farmland | | | | | — | | ||||||||||||
Total real estate loans | | | | | — | | ||||||||||||
Agricultural | | | | | — | | ||||||||||||
Commercial and industrial | | | | | — | | ||||||||||||
Consumer loans | | | | | — | | ||||||||||||
Total | $ | | $ | | $ | | $ | | $ | — | $ | | ||||||
26
Troubled Debt Restructurings
(dollars in thousands, unaudited)
Three months ended March 31, 2022 | ||||||||||||||
Pre- | Post- | |||||||||||||
| Number of |
| Outstanding |
| Outstanding |
| Reserve |
| Reserve | |||||
Real estate: | ||||||||||||||
Other construction/land | $ | | $ | | $ | | $ | | ||||||
1-4 family - closed-end | | | | | ||||||||||
Equity lines | | | | | ||||||||||
Multi-family residential | | | | | ||||||||||
Commercial real estate - owner occupied | | | | | ||||||||||
Farmland | | | | | ||||||||||
Total real estate loans | | | | | ||||||||||
Agricultural | | | | | ||||||||||
Commercial and industrial | | | | | ||||||||||
Consumer loans | | | | | ||||||||||
Total | $ | | $ | | $ | | $ | | ||||||
| (1) | This represents the change in the ACL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology. |
Three months ended March 31, 2021 | ||||||||||||||
Pre- | Post- | |||||||||||||
| Number of |
| Outstanding |
| Outstanding |
| Reserve |
| Reserve | |||||
Real estate: | ||||||||||||||
Other construction/land | $ | | $ | | $ | | $ | | ||||||
1-4 family - closed-end | | | | | ||||||||||
Equity lines | | | | | ||||||||||
Multi-family residential | | | | | ||||||||||
Commercial real estate - owner occupied | | | | | ||||||||||
Farmland | | | | | ||||||||||
Total real estate loans | | | | | ||||||||||
Agricultural | | | | | ||||||||||
Commercial and industrial | | | ( | | ||||||||||
Consumer loans | | | | | ||||||||||
Total | $ | | $ | | $ | | $ | | ||||||
| (1) | This represents the change in the ACL reserve for these credits measured as the difference between the specific post-modification impairment reserve and the pre-modification reserve calculated under our general allowance for loan loss methodology. |
27
The Company had
The Company monitors the credit quality of loans on a continuous basis using the regulatory and accounting classifications of pass, special mention and substandard to characterize and qualify the associated credit risk. Loans classified as “loss” are immediately charged-off. The Company uses the following definitions of risk classifications:
Pass – Loans listed as pass include larger non-homogeneous loans not meeting the risk rating definitions below and smaller, homogeneous loans not assessed on an individual basis.
Special Mention – Loans classified as special mention have the potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard – Loans classified as substandard are those loans with clear and well-defined weaknesses such as a highly leveraged position, unfavorable financial operating results and/or trends, or uncertain repayment sources or poor financial condition, which may jeopardize ultimate recoverability of the debt.
The following tables present the amortized cost of loans and leases by credit quality classification in addition to loan and lease vintage as of March 31, 2022:
28
Loan and Lease Credit Quality by Vintage | ||||||||||||||||||||||||
(dollars in thousands, unaudited) | ||||||||||||||||||||||||
Term Loans and Loans Amortized Cost Basis by Origination Year | ||||||||||||||||||||||||
2022 | 2021 | 2020 | 2019 | 2018 | Prior | Revolving Loans Amortized Cost | Total Loans | |||||||||||||||||
1-4 family construction | ||||||||||||||||||||||||
Pass | $ | $ | — | $ | — | $ | — | $ | — | $ | — | $ | | $ | | |||||||||
Special Mention | — | — | — | — | — | — | — | — | ||||||||||||||||
Substandard | — | — | — | — | — | — | — | — | ||||||||||||||||
Subtotal | — | — | — | — | — | — | | | ||||||||||||||||
Other construction/land | ||||||||||||||||||||||||
Pass | — | | | | | | | | ||||||||||||||||
Special Mention | — | — | — | — | — | — | — | — | ||||||||||||||||
Substandard | — | — | | — | — | — | — | | ||||||||||||||||
Subtotal | — | | | | | | | | ||||||||||||||||
1-4 family - closed-end | ||||||||||||||||||||||||
Pass | | | | | | | — | | ||||||||||||||||
Special Mention | — | — | — | — | | | — | | ||||||||||||||||
Substandard | — | | — | — | | | — | | ||||||||||||||||
Subtotal | | | | | | | — | | ||||||||||||||||
Equity lines | ||||||||||||||||||||||||
Pass | — | | | | | — | | | ||||||||||||||||
Special Mention | — | — | — | — | — | — | | | ||||||||||||||||
Substandard | — | | — | — | — | — | | | ||||||||||||||||
Subtotal | — | | | | | — | | | ||||||||||||||||
Multi-family residential | ||||||||||||||||||||||||
Pass | | | | | | | | | ||||||||||||||||
Special Mention | — | — | — | — | — | | — | | ||||||||||||||||
Substandard | — | — | — | — | — | — | — | — | ||||||||||||||||
Subtotal | | | | | | | | | ||||||||||||||||
Commercial real estate - OO | ||||||||||||||||||||||||
Pass | | | | | | | | | ||||||||||||||||
Special Mention | — | — | — | | — | | — | | ||||||||||||||||
Substandard | | — | — | — | | | | | ||||||||||||||||
Subtotal | | | | | | | | | ||||||||||||||||
Commercial real estate - NOO | ||||||||||||||||||||||||
Pass | | | | | | | | | ||||||||||||||||
Special Mention | — | — | | — | | | | | ||||||||||||||||
Substandard | — | — | — | — | | | | | ||||||||||||||||
Subtotal | | | | | | | | | ||||||||||||||||
Farmland | ||||||||||||||||||||||||
Pass | — | | | | | | | | ||||||||||||||||
Special Mention | — | — | — | — | | | | | ||||||||||||||||
Substandard | — | — | — | — | | | — | | ||||||||||||||||
Subtotal | — | | | | | | | | ||||||||||||||||
Agricultural | ||||||||||||||||||||||||
Pass | | | | | | | | | ||||||||||||||||
Special Mention | — | — | — | — | — | — | | | ||||||||||||||||
Substandard | — | | — | — | — | | | | ||||||||||||||||
Subtotal | | | | | | | | | ||||||||||||||||
Commercial and industrial | ||||||||||||||||||||||||
Pass | | | | | | | | | ||||||||||||||||
Special Mention | — | | | | — | | | | ||||||||||||||||
Substandard | — | — | | | | | | | ||||||||||||||||
Subtotal | | | | | | | | | ||||||||||||||||
Mortgage warehouse lines | ||||||||||||||||||||||||
Pass | — | — | — | — | — | — | | | ||||||||||||||||
Subtotal | — | — | — | — | — | — | | | ||||||||||||||||
Consumer loans | ||||||||||||||||||||||||
Pass | | | | | | | | | ||||||||||||||||
Special Mention | — | | | — | | | | | ||||||||||||||||
Substandard | — | — | | — | — | | — | | ||||||||||||||||
Subtotal | | | | | | | | | ||||||||||||||||
Total | $ | | $ | | $ | | $ | | $ | | $ | | $ | | $ | | ||||||||
29
The following table presents the Company’s loan portfolio on the recorded investment basis, according to loan class and credit grade as of December 31, 2021:
| Pass |
| Special |
| Substandard |
| Impaired |
| Total | ||||||
Real estate: | |||||||||||||||
1-4 family residential construction | $ | | $ | | $ | — | $ | — | $ | | |||||
Other construction/land | | — | — | | | ||||||||||
1-4 family - closed-end | | | | | | ||||||||||
Equity lines | | | | | | ||||||||||
Multi-family residential | | | — | — | | ||||||||||
Commercial real estate owner occupied | | | | | | ||||||||||
Commercial real estate non-owner occupied | | | | | | ||||||||||
Farmland | | | | — | | ||||||||||
Total real estate | | | | | | ||||||||||
Agricultural | | — | | | | ||||||||||
Commercial and industrial | | | | | | ||||||||||
Mortgage warehouse lines | | — | — | — | | ||||||||||
Consumer loans | | | | | | ||||||||||
Total gross loans and leases | $ | | $ | | $ | | $ | | $ | | |||||
CECL replaces the legacy accounting for loans designated as purchased credit impaired (“PCI”) with loans designated as purchased credit deteriorated (“PCD”). PCD loans are loans acquired or purchased, which as of acquisition, had evidence of more than insignificant credit deterioration since origination. Due to the immaterial balance in the Company’s PCI loans as of December 31, 2021 management elected not to transition these loans into the PCD designation. As of March 31, 2022 the Company had no loans categorized as PCD.
As noted in footnote 3, on January 1, 2022 the Company implemented CECL and increased our ACL, previously the allowance for loan and lease losses, with a $
The DCF quantitative reserve methodology incorporates the consideration of probability of default (“PD”) and loss given default (“LGD”) estimates to estimate periodic losses. The PD estimates are derived through the application of reasonable and supportable economic forecasts to call code specific regression models, derived from the consideration of historical bank-specific and peer loss-rate data. The loss rate data has been regressed against benchmark economic indicators, for which reasonable and supportable forecasts exist, in the development of the call-code specific regression models. Regression models are refreshed on an annual basis, in order to pull in more recent loss rate data. Reasonable and supportable forecasts of the selected economic metric are then input into the regression model to calculate an expected default rate. The expected default rates are then applied to expected monthly loan balances estimated through the consideration of contractual repayment terms and expected prepayments. The Company utilizes a four-quarter forecast period, after which the expected default rates revert to the historical average for each call code, over a four-quarter reversion period, on a straight-line basis. The prepayment assumptions applied to expected cash flows over the contractual life of the loans, are based on Bank specific prepayment history, specific to each call code, and subject to update on an annual basis. LGD utilized in the DCF is derived from the application of the Frye-Jacobs theory which
30
relates LGD to PD based on historical peer data, as calculated by a third-party. Economic forecasts are considered over a four-quarter forecast period, with reversion to mean occurring on a straight-line basis over four quarters. The call code regression models utilized upon implementation of CECL on January 1, 2022, and as of March 31, 2022, were identical, and relied upon reasonable and supportable forecasts of the National Unemployment Rate. Management selected the National Unemployment Rate as the driver of quantitative portion of collectively reserves on loan classes reliant upon the DCF methodology, primarily as a result of high correlation coefficients identified in regression modeling, the availability of forecasts including the quarterly FOMC forecast, and given the widespread familiarity of stakeholders with this economic metric.
The quantitative reserves for Farmland, Agricultural Production and Consumer loans are calculated using a Remaining Life methodology where average historical bank specific and peer loss rates are applied to expected loan balances over an estimated remaining life of loans in calculation of the quantitative portion of collectively evaluated loans in these classes. The estimated remaining life is calculated using historical bank-specific loan attrition data. For the Farmland, Agricultural Production and Consumer classes of loans, reasonable and supportable forecasts of the National Unemployment rate, real GDP and the housing price index are considered through estimation of qualitative reserves.
Management recognizes that there are additional factors impacting risk of loss in the loan portfolio beyond what is captured in the quantitative portion of reserves on collectively evaluated loans. As current and expected conditions, may vary compared with conditions over the historical lookback period, which is utilized in the calculation of quantitative reserves, management considers whether additional or reduced reserve levels on collectively evaluated loans may be warranted given the consideration of a variety of qualitative factors. Several of the following qualitative factors (“Q-factors”) considered by management reflect the legacy regulatory guidance on Q-factors, whereas several others represent factors unique to the Company or unique to the current time period.
| ● | Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices |
| ● | Changes in international, regional and local economic and business conditions, and developments that affect the collectability of the portfolio, as reflected in forecasts of the Housing Price Index, Real GDP and the National Unemployment Rate (Farmland Agricultural Production and Consumer segments only) |
| ● | Changes in the nature and volume of the loan portfolio |
| ● | Changes in the experience, ability, and depth of lending management and other relevant staff |
| ● | Changes in the volume and severity of past due, non-accruals loans, and adversely classified loans, as reflected in changes of the relative level of loans classified as substandard and special mention |
| ● | Changes in the quality of the Bank’s loan review processes |
| ● | Changes in the value of underlying collateral for loans not identified as collateral dependent |
| ● | Changes in loan categorization concentrations |
| ● | Other external factors, which include, the influence of peer data on estimated quantitative reserves, residual COVID-19 related risk, impact of government stimulus, reliance on the National Unemployment rate as opposed to the California unemployment rate in the calculation of quantitative reserves, the expected impact of fluctuations in interest rate levels on the life of the Company’s loans |
The qualitative portion of the Company’s reserves on collectively evaluated loans are calculated using a combination of numeric frameworks and management judgement, to determine risk categorizations in each of the Q-factors presented above. The amount of qualitative reserves is also contingent upon the historical peer, life-of-loan-equivalent, loss rate ranges and the relative weighting of Q-factors according to management’s judgement.
Although collectively evaluated reserves are generally calculated separately at the call code or loan class level, management has grouped loan classes with similar risk characteristics into the following portfolio segments: 1-4 Family Real Estate, Commercial Real Estate, Farmland Agricultural Production, Commercial Industrial, Mortgage Warehouse and Consumer loans. Loans secured by 1-4 family residences have a different profile from loans secured by Commercial Real Estate. Generally, the borrowers for 1-4 Family loans are consumers whereas borrowers for Commercial Real Estate are often businesses. The COVID-19 pandemic illustrated how these different categories of real estate loans were subject to different risks, which was exacerbated by the widespread work-from-home model adopted by many companies during and since the pandemic. Farmland and Agricultural Production loans are included in a single
31
segment as these loans are often times to the same borrowers, facing the same risks relating to commodity prices, water supply and drought conditions in addition to other environmental concerns. Commercial Industrial loans are separated into a unique segment given the uniqueness of these loans, which are often revolving and secured by other business assets as opposed to real estate. Mortgage warehouse loans are also unique in the Company’s portfolio and warrant separate presentation as an individual portfolio segment, given the specific nature of these constantly revolving lines to mortgage originators and also attributable to a very limited loss history, even after consideration of peer data. Finally, the Company splits out Consumer loans as a separate segment as a result of the small balance, homogeneous terms that characterize these loans.
Management individually evaluates loans that do not share risk characteristics with other loans when estimating reserves. As of March 31, 2022, the only loans that Management considered to have different risk characteristics from other loans sharing the same Federal Call Report code were loans designated nonaccrual.
The following table presents the activity in the allowance for credit losses by portfolio segment for the quarter ended March 31, 2022:
Allowance for Credit Losses and Recorded Investment in Financing Receivables | |||||||||||||||||||||
(dollars in thousands, unaudited) | |||||||||||||||||||||
| 1-4 Family Real Estate | Commercial Real Estate |
| Farmland Agricultural Production |
| Commercial Industrial | Mortgage Warehouse |
| Consumer |
| Total | ||||||||||
Allowance for credit losses: | |||||||||||||||||||||
Balance, December 31, 2021 | $ | | $ | | $ | | $ | | $ | | $ | | $ | | |||||||
Impact of adopting ASC 326 | | | ( | | ( | ( | | ||||||||||||||
Charge-offs | — | — | ( | ( | — | ( | ( | ||||||||||||||
Recoveries | | | — | | — | | | ||||||||||||||
Provision for credit losses | | ( | | ( | ( | | | ||||||||||||||
Ending allowance balance: | $ | | $ | | $ | | $ | | $ | | $ | | $ | | |||||||
The $
32
The following table presents the activity in the allowance for loan losses by portfolio segment for the quarter ended March 31, 2021:
Three months ended March 31, 2021 | ||||||||||||||||||
| Real Estate |
| Agricultural |
| Commercial and |
| Consumer |
| Unallocated |
| Total | |||||||
Allowance for credit losses: | ||||||||||||||||||
Beginning balance | $ | |
| $ | |
| $ | |
| $ | |
| $ | | $ | | ||
Charge-offs | ( | — | ( | ( | — | ( | ||||||||||||
Recoveries | | — | | | — | | ||||||||||||
Provision | | | ( | ( | ( | | ||||||||||||
Ending balance | $ | | $ | | $ | | $ | | $ | | $ | | ||||||
Reserves: | ||||||||||||||||||
Specific | $ | | $ | | $ | | $ | | $ | — | $ | | ||||||
General | | | | | | | ||||||||||||
Ending balance | $ | | $ | | $ | | $ | | $ | | $ | | ||||||
Loans evaluated for impairment: | ||||||||||||||||||
Individually | $ | | $ | | $ | | $ | | $ | — | $ | | ||||||
Collectively | | | | | — | | ||||||||||||
Ending balance | $ | | $ | | $ | | $ | | $ | — | $ | | ||||||
Note 11 – Long-Term Debt
Long-Term Debt
(dollars in thousands, unaudited)
March 31, 2022 | December 31, 2021 | |||||||||||
Unamortized | Unamortized | |||||||||||
Debt Issuance | Debt Issuance | |||||||||||
| Principal |
| Costs |
| Principal |
| Costs | |||||
Fixed - floating rate subordinated debentures, due 2031 (1) |
| $ | |
| $ | ( |
| $ | |
| $ | ( |
Total long-term debt | $ | | $ | ( | $ | | $ | ( | ||||
| (1) |
Note 12 – Revenue Recognition
The Company utilizes the guidance found in ASU 2014-09, Revenue from Contracts with Customers (ASC 606), when accounting for certain noninterest income. The core principle of this guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Sufficient information should be provided to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The Company’s revenue streams that are within the scope of and accounted for under Topic 606 include service charges on deposit accounts, debit card interchange fees, and fees levied for other services the Company provides its customers. The guidance does not apply to revenue associated with financial instruments such as loans and investments, and other noninterest income such as loan servicing fees and earnings on bank-owned life insurance, which are accounted for on an accrual basis under other provisions of GAAP.
33
All of the Company’s revenue from contracts within the scope of ASC 606 is recognized as noninterest income, except for gains on the sale of OREO which is classified as noninterest expense. The following table presents the Company’s sources of noninterest income for the three-month periods ended March 31, 2022 and 2021. Items outside the scope of ASC 606 are noted as such (dollars in thousands, unaudited).
For the three months ended March 31, | ||||||
| 2022 |
| 2021 | |||
Noninterest income | ||||||
Service charges on deposits | ||||||
Returned item and overdraft fees |
| $ | |
| $ | |
Other service charges on deposits | | | ||||
Debit card interchange income | | | ||||
Loss on limited partnerships(1) | ( | ( | ||||
Dividends on equity investments(1) | | | ||||
Unrealized gains recognized on equity investments(1) | ( | | ||||
Net gains on sale of securities(1) | | — | ||||
Other(1) | | | ||||
Total noninterest income | $ | | $ | | ||
Noninterest expense | ||||||
Salaries and employee benefits (1) | $ | | $ | | ||
Occupancy expense (1) | | | ||||
(Gain) loss on sale of OREO | ( | ( | ||||
Other (1) | | | ||||
Total noninterest expense | $ | | $ | | ||
Percentage of noninterest revenue not within scope of ASC 606. | ||||||
| (1) | Not within scope of ASC 606. Revenue streams are not related to contract with customers and are accounted for on an accrual basis under other provisions of GAAP. |
With regard to noninterest income associated with customer contracts, the Company has determined that transaction prices are fixed, and performance obligations are satisfied as services are rendered, thus there is little or no judgment involved in the timing of revenue recognition under contracts that are within the scope of ASC 606.
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PART I - FINANCIAL INFORMATION
ITEM 2
MANAGEMENT’S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Form 10-Q includes forward-looking statements that involve inherent risks and uncertainties. These forward-looking statements are within the meaning of Section 27A of the Securities Act of 1933 (“1933 Act”), as amended and Section 21E of the Securities Exchange Act of 1934 (“1934 Act”), as amended. Those sections of the 1933 Act and 1934 Act provide a “safe harbor” for forward-looking statements in order to encourage companies to provide prospective information about their financial performance as long as important factors that could cause actual results to differ significantly from projected results are identified with meaningful cautionary statements. Words such as “expects”, “anticipates”, “believes”, “projects”, “intends”, and “estimates” or variations of such words and similar expressions, as well as future or conditional verbs preceded by “will”, “would”, “should”, “could” or “may” are intended to identify forward-looking statements. These forward-looking statements are based on certain underlying assumptions and are not guarantees of future performance, as they could be impacted by several potential risks and developments that cannot be predicted with any degree of certainty.
These statements are based on management’s current expectations regarding economic, legislative, regulatory and other environmental issues that may affect our earnings in future periods. Therefore, actual outcomes and results may differ materially from what is expressed, forecast in, or implied by such forward-looking statements.
A variety of factors could have a material adverse impact on the Company’s financial condition or results of operations, and should be considered when evaluating the Company’s potential future financial performance. They include, but are not limited to:
| ● | the risk of unfavorable economic conditions in the Company’s market areas; |
| ● | risks associated with the current national emergency with respect to COVID-19 and its variants, including the impact that national, state, and local responses, including limitations on business and personal activity as well as any stimulus or relief efforts have on customers’ continued ability to repay loans.; |
| ● | risks associated with fluctuations in interest rates; |
| ● | risks associated with inflation; |
| ● | liquidity risks, including the ability to effectively manage the additional liquidity from the significant increase in deposits during the COVID-19 pandemic including managing the potential loss of a portion of such deposits; |
| ● | increases in nonperforming assets and credit losses that could occur, particularly in times of weak economic conditions or rising interest rates; |
| ● | reductions in the market value of available-for-sale securities that could result if interest rates increase substantially or an issuer has real or perceived financial difficulties; |
| ● | the Company’s ability to diversify and grow its loan portfolio; |
| ● | the Company’s ability to attract and retain skilled employees; |
| ● | the Company’s ability to successfully deploy new technology; |
| ● | the Company’s ability to receive regulatory approval for acquisitions or branch expansion while having a less than satisfactory rating under the Community Reinvestment Act; |
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| ● | the outcome of any existing or future legal action for which the Company or Bank is a defendant; |
| ● | the success of acquisitions or branch expansions, closures or consolidations; and |
| ● | risks associated with the multitude of current and prospective laws and regulations to which the Company is and will be subject. |
Risk factors that could cause actual results to differ materially from results that might be implied by forward-looking statements include the risk factors detailed in the Company’s Form 10-K for the fiscal year ended December 31, 2021 and in Item 1A, herein. We do not update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events.
CRITICAL ACCOUNTING POLICIES
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States. The financial information and disclosures contained within those statements are significantly impacted by Management’s estimates and judgments, which are based on historical experience and incorporate various assumptions that are believed to be reasonable under current circumstances. Actual results may differ from those estimates under divergent conditions.
Critical accounting policies are those that involve the most complex and subjective decisions and assessments, and have the greatest potential impact on the Company’s stated results of operations. In Management’s opinion, the Company’s critical accounting policies deal with the following areas:
| ● | the establishment of the allowance for credit losses, as explained in detail in Note 10 to the consolidated financial statements and in the “Provision for Credit Losses” and “Allowance for Credit Losses” sections of this discussion and analysis; |
| ● | the valuation of individually evaluated loans and foreclosed assets, as discussed in Notes 8 and 10 to the consolidated financial statements; |
| ● | income taxes and related deferred tax assets and liabilities, especially with regard to the ability of the Company to recover deferred tax assets as discussed in the “Provision for Income Taxes” and “Other Assets” sections of this discussion and analysis; and |
| ● | goodwill and other intangible assets, which are evaluated annually for impairment and for which we have determined that no impairment exists, as discussed in the “Other Assets” section of this discussion and analysis. |
Critical accounting areas are evaluated on an ongoing basis to ensure that the Company’s financial statements incorporate our most recent expectations regarding those areas.
OVERVIEW OF THE RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
RESULTS OF OPERATIONS SUMMARY
First Quarter 2022 compared to First Quarter 2021
First quarter 2022 net income was $7.4 million, or $0.49 per diluted share, compared to $11.1 million, or $0.72 per diluted share in the first quarter of 2021. The Company’s annualized return on average equity was 8.64% and annualized return on average assets was 0.88% for the quarter ended March 31, 2022, compared to 12.94% and 1.40%, respectively, for the same quarter in 2021. The primary drivers behind the variance in first quarter net income are as follows:
| ● | Net interest income decreased by $3.8 million mostly due to a 67 bps decline in the yield on earning assets and a shift in mix due to higher levels of average cash invested overnight with the Federal Reserve Bank and lower average loan balances. In addition, there was a $0.4 million unfavorable increase in interest expense due to the issuance of subordinated debt during the third quarter of 2021. |
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| ● | A $0.6 million provision for credit losses on loans and leases as compared to a provision for loan and lease losses of $0.3 million in the same quarter in 2021. This unfavorable impact was attributed to higher charge-offs partially offset by a reduction in the pooled allowance under the new current expected credit losses (“CECL”) methodology implemented on January 1, 2022. |
| ● | Noninterest income decreased $0.8 million or 11% primarily due to a $1.2 million decrease in the change in the annual valuation change of restricted equity investments, as well as BOLI fluctuations associated with deferred compensation plans for $1.2 million. These negative variances were partially offset by a $1.0 million gain on the sale of investment securities in an effort to rebalance the portfolio by selling longer duration and higher price volatility securities as a hedge against rising interest rates, due to likely persistent inflationary pressures in the near-intermediate term environment. Service charges on customer deposit accounts declined by $0.1 million, or 4%, to $3.0 million in the first quarter of 2022 as compared to the fourth quarter of 2021. This same income was $0.3 million higher in the first quarter of 2022 as compared to the first quarter of 2021 due to higher transaction based fees, including analysis fee income. |
| ● | Total noninterest expense had a favorable decline of $0.2 million, or 1%, in the first quarter of 2022 as compared to the first quarter of 2021. Lower occupancy and legal expenses, partially offset by higher salaries and benefits were the primary drivers. |
FINANCIAL CONDITION SUMMARY
March 31, 2022 relative to December 31, 2021
The Company’s assets totaled $3.4 billion at March 31, 2022 unchanged from December 31, 2021. The following provides a summary of key balance sheet changes during the first three months of 2022:
| ● | Investment securities increased 5% to $1.0 billion from $973.3 million at December 31, 2021, primarily due to purchases of collateralized loan obligations. |
| ● | Gross loan balances remained relatively flat during the first quarter of 2022 with an overall 0.3% change. The net change did have some offsetting components with the larger fluctuations being a $44.0 million decline in mortgage warehouse line utilization, a $25.8 million decrease in non-owner occupied commercial real estate, and a $16.8 million of decrease in PPP loans. These declines were mostly offset by a $109.4 million increase in 1-4 family mortgage loans due to purchases of high-quality jumbo mortgage loans. |
| ● | Deposits totaled $2.9 billion at March 31,2022, representing a year-to-date increase of $83.4 million, or 3%. The growth in deposits came primarily from core transaction and savings accounts. |
| ● | Total shareholders’ equity of $325.7 million at March 31, 2022 reflects a decrease of $36.8 million, or 10%, relative to year-end 2021 due to net income of $7.4 million, offset by a $3.5 million dividend paid to shareholders, $4.9 million in share repurchases, a $28.9 million unfavorable swing in other comprehensive income/loss due principally to changes in investment securities' fair value, and a $7.3 million cumulative effect adjustment for the implementation of ASC 326. The remaining difference is related to stock options exercised and restricted stock compensation recognized during the quarter. |
IMPACT OF CORONAVIRUS DISEASE 2019 (COVID-19) PANDEMIC ON THE COMPANY’S OPERATIONS
Overview
On January 31, 2020, the United States Department of Health and Human Services declared a public health emergency with respect to the Coronavirus Disease 2019 (COVID-19). Subsequent to this date, federal, state, and local governmental agencies, regulatory agencies, and the Federal Reserve Board took many actions impacting the Company.
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These actions included, among other things, the Federal Open Market Committee (FOMC) reducing the federal funds rate; California issuing a state-wide shelter-in-place order and various other orders at the state and local levels restricting business operations, closing schools, and thereafter prescribing requirements for reopening; and various pieces of federal legislation were passed to attempt to address the impact of COVID-19 on the economy.
Impact of COVID-19 on the Company’s Operations
| ● | Starting in April 2020, the Company took actions to mitigate the impact on credit losses including permitting short-term payment deferrals to current customers, as well as providing bridge loans and SBA Paycheck Protection Program (PPP) loans. The Company had no loans remaining on deferral, which were modified under the CARES Act, as amended. |
| ● | The uncertainty of national and local economic conditions had an impact on our provision for credit losses in early 2022 and on our provision for loan and lease losses in 2021. The Company implemented the Current Expected Credit Loss (CECL) accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) on January 1, 2022, after having elected under Section 4014 of the CARES Act and the Consolidated Appropriations Act, 2021 to defer earlier implementation. |
| ● | The Company expects that net interest income may continue to be adversely impacted given pressure on the net interest margin as a result of the current interest rate environment. Although the FOMC raised the fed funds rate by 25 bps on March 16, 2022, the overall rate environment is still at historical lows. The FOMC has indicated potential future increases to the overnight fed funds rate but uncertainty as to when and at what rate this may occur still remains. These lower rates have impacted our net interest margin. Our net interest margin for the three months ended March 31, 2022, was 3.21%, compared to a net interest margin of 3.93% for the same period in 2021. Additional liquidity from significant deposit growth in 2021 and the first three months of 2022, coupled with lower loan balances has negatively impacted our net interest margin. This additional liquidity was mostly deployed in overnight funding resulting in $194.8 million in average overnight cash during the first quarter of 2022. This overnight funding earned an average rate of 19 basis points, for the first quarter ending March 31, 2022. In addition, the Company had $1.0 billion in investment securities at average tax effective yield 210 basis points lower than that of current loan yields. |
| ● | The COVID-19 pandemic has not adversely affected our capital or financial resources as of March 31, 2022. During the first three months of 2022, total shareholders’ equity decreased by $36.8 million, or 10%, to $325.7 million. The Company earned $7.4 million in net income in the first three months of 2022, but had a $28.9 million decrease in accumulated other comprehensive income as a result of decreases in the value of our investment portfolio due to an uptick in interest rates. If interest rates continue to rise, this component of equity would be expected to further decline. The Company also paid dividends of $3.5 million and repurchased shares of stock for $4.9 million during the first quarter of 2022. On April 22, 2022, the Company declared a twenty-three cent per share dividend to be paid on May 12, 2022. Although presently not expected, if the Company were to incur significant credit losses as a result of COVID-19’s impact on our customers’ ability to repay loans, capital could be adversely impacted. With respect to liquidity, the Company maintains strong primary and secondary liquidity sources as further described under “Liquidity and Market Risk Management” below. |
| ● | The Company continues to serve its customers. Several of our branch locations were closed during the height of the pandemic, but have since re-opened. Five branch locations were permanently closed in June 2021. This decision to close these branches was made as a result of a change in customer behaviors brought about by the COVID-19 pandemic along with an efficiency review. All of the five closed locations were located outside of Tulare County, the Bank’s primary market area. Many of our customers have found an added convenience and ease of transacting business through online and mobile banking services which precipitated our decision to close locations where in-person transaction volumes no longer warranted a traditional brick-and-mortar branch. Overall deposits at these five closed branches increased during the period of time from announcement to closure and consolidation into a nearby branch. |
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| ● | As a financial institution providing essential services, the Company expects continued demand for loans and deposits. In addition, mortgage warehouse utilization that resulted from the low rate environment is expected to remain at a lower levels. Further, it is expected that SBA PPP loans will continue to be forgiven, with the remainder expected to be forgiven in 2022. |
EARNINGS PERFORMANCE
The Company earns income from two primary sources. The first is net interest income, which is interest income generated by earning assets less interest expense on deposits and other borrowed money. The second is noninterest income, which primarily consists of customer service charges and fees but also comes from non-customer sources such as BOLI and investment gains. The majority of the Company’s noninterest expense is comprised of operating costs that facilitate offering a full range of banking services to our customers.
.
NET INTEREST INCOME AND NET INTEREST MARGIN
Net interest income decreased $3.8 million to $24.8 million, for the first quarter of 2022 over the first quarter of 2021.
For the first quarter of 2022 as compared to the same quarter in 2021, average loan balances decreased $415.3 million, or 18%, primarily due to $181.6 million, or a 75% decrease in the utilization of mortgage warehouse lines, a $126.0 million, or 7% decrease in real estate secured loans, and a $94.5 million, or 49% decrease in commercial loans, mostly from the forgiveness of SBA PPP loans. Ag production loans were also down $12.2 million or 26%. The average yield on the overall loan portfolio decreased 21 basis points, while there was a 8 bps unfavorable increase in the cost of interest-bearing liabilities for the first quarter of 2022 as compared to the same quarter in 2021.
The level of net interest income we recognize in any given period depends on a combination of factors including the average volume and yield for interest earning assets, the average volume and cost of interest-bearing liabilities, and the mix of products which comprise the Company’s earning assets, deposits, and other interest-bearing liabilities.
The following tables show average balances for significant balance sheet categories and the amount of interest income or interest expense associated with each category for the noted periods. The tables also display calculated yields on each major component of the Company’s investment and loan portfolios, average rates paid on each key segment of the Company’s interest-bearing liabilities, and our net interest margin for the noted periods.
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Average Balances and Rates
(dollars in thousands, unaudited)
For the three months ended | For the three months ended | |||||||||||||||
March 31, 2022 | March 31, 2021 | |||||||||||||||
Assets |
| Average |
| Income/ |
| Average |
| Average |
| Income/ |
| Average | ||||
Investments: | ||||||||||||||||
Interest-earning due from banks | $ | 194,846 | $ | 93 | 0.19% | $ | 76,504 | $ | 19 | 0.10% | ||||||
Taxable | 744,599 | 3,490 | 1.90% |
| 317,254 | 1,578 | 2.02% | |||||||||
Non-taxable | 294,409 | 1,726 | 3.01% | 226,838 | 1,449 | 3.28% | ||||||||||
Total investments | 1,233,854 | 5,309 | 1.90% | 620,596 | 3,046 | 2.24% | ||||||||||
Loans and leases:(3) |
| |||||||||||||||
Real estate | 1,753,394 | 18,326 | 4.24% | 1,879,359 | 21,391 | 4.62% | ||||||||||
Agricultural | 33,986 | 302 | 3.60% | 46,153 | 419 | 3.68% | ||||||||||
Commercial | 97,127 | 1,398 | 5.84% | 191,656 | 2,451 | 5.19% | ||||||||||
Consumer | 4,448 | 206 | 18.78% | 5,422 | 196 | 14.66% | ||||||||||
Mortgage warehouse lines | 61,255 | 510 | 3.38% | 242,865 | 1,928 | 3.22% | ||||||||||
Other | 1,485 | 30 | 8.19% | 1,588 | 27 | 6.90% | ||||||||||
Total loans and leases | 1,951,695 | 20,772 | 4.32% | 2,367,043 | 26,412 | 4.53% | ||||||||||
Total interest earning assets (4) |
| 3,185,549 | 26,081 | 3.38% | 2,987,639 | 29,458 | 4.05% | |||||||||
Other earning assets | 15,679 | 13,275 | ||||||||||||||
Non-earning assets | 210,724 | 201,114 | ||||||||||||||
Total assets | $ | 3,411,952 | $ | 3,202,028 | ||||||||||||
Liabilities and shareholders' equity | ||||||||||||||||
Interest bearing deposits: | ||||||||||||||||
Demand deposits | $ | 202,962 | $ | 106 | 0.21% | $ | 130,763 | $ | 73 | 0.23% | ||||||
NOW | 546,280 | 82 | 0.06% | 569,171 | 101 | 0.07% | ||||||||||
Savings accounts | 467,700 | 67 | 0.06% | 391,091 | 53 | 0.05% | ||||||||||
Money market | 151,339 | 23 | 0.06% | 136,422 | 30 | 0.09% | ||||||||||
Time Deposits | 293,684 | 234 | 0.32% | 412,416 | 289 | 0.28% | ||||||||||
Brokered deposits | 60,000 | 48 | 0.32% | 100,000 | 62 | 0.25% | ||||||||||
Total interest bearing deposits | 1,721,965 | 560 | 0.13% | 1,739,863 | 608 | 0.14% | ||||||||||
Borrowed funds: | ||||||||||||||||
Federal funds purchased | 170 | — | — | 5,822 | 1 | 0.07% | ||||||||||
Repurchase agreements | 105,067 | 82 | 0.32% | 46,097 | 45 | 0.40% | ||||||||||
Short term borrowings | 1 | — | — | 11,530 | 2 | 0.07% | ||||||||||
Long-term debt | 49,143 | 428 | 3.53% | — | — | — | ||||||||||
Subordinated debentures | 35,320 | 255 | 2.93% | 35,141 | 247 | 2.85% | ||||||||||
Total borrowed funds | 189,701 | 765 | 1.64% | 98,590 | 295 | 1.21% | ||||||||||
Total interest bearing liabilities | 1,911,666 | 1,325 | 0.28% | 1,838,453 | 903 | 0.20% | ||||||||||
Demand deposits - noninterest bearing | 1,093,709 | 977,137 | ||||||||||||||
Other liabilities | 59,026 | 39,199 | ||||||||||||||
Shareholders' equity | 347,551 | 347,239 | ||||||||||||||
Total liabilities and shareholders' equity | $ | 3,411,952 | $ | 3,202,028 | ||||||||||||
Interest income/interest earning assets | 3.38% | 4.05% | ||||||||||||||
Interest expense/interest earning assets | 0.17% | 0.12% | ||||||||||||||
Net interest income and margin(5) | $ | 24,756 | 3.21% | $ | 28,555 | 3.93% | ||||||||||
| (1) | Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs. |
| (2) | Yields and net interest margin have been computed on a tax equivalent basis utilizing a 21% effective tax rate. |
| (3) | Loans are gross of the allowance for possible loan losses. Loan fees have been included in the calculation of interest income. Net loan fees and loan acquisition FMV amortization were $0.4 million and $1.4 million for the quarters ended March 31, 2022 and 2021, respectively. |
| (4) | Non-accrual loans have been included in total loans for purposes of computing total earning assets. |
| (5) | Net interest margin represents net interest income as a percentage of average interest earning assets. |
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The Volume and Rate Variances table below sets forth the dollar difference for the comparative periods in interest earned or paid for each major category of interest earning assets and interest-bearing liabilities, and the amount of such change attributable to fluctuations in average balances (volume) or differences in average interest rates. Volume variances are equal to the increase or decrease in average balances multiplied by prior period rates, and rate variances are equal to the change in rates multiplied by prior period average balances. Variances attributable to both rate and volume changes, calculated by multiplying the change in rates by the change in average balances, have been allocated to the rate variance.
Volume Rate Variances
(dollars in thousands, unaudited)
Three months ended March 31, | ||||||||||||
2022 over 2021 | ||||||||||||
Increase (decrease) due to | ||||||||||||
Assets: |
| Volume |
| Rate | Mix |
| Net | |||||
Investments: | ||||||||||||
Federal funds sold/due from time |
| $ | 29 |
| $ | 18 | $ | 27 |
| $ | 74 | |
Taxable | 2,125 | (91) | (123) | 1,912 | ||||||||
Non-taxable | 106 | (119) | 290 | 277 | ||||||||
Total investments (1) | 2,260 | (192) | 194 | 2,263 | ||||||||
Loans and leases: | ||||||||||||
Real estate | (1,434) | (1,748) | 117 | (3,065) | ||||||||
Agricultural | (110) | (9) | 2 | (117) | ||||||||
Commercial | (1,209) | 308 | (152) | (1,053) | ||||||||
Consumer | (35) | 55 | (10) | 10 | ||||||||
Mortgage warehouse | (1,442) | 94 | (70) | (1,418) | ||||||||
Other | (2) | 5 | — | 3 | ||||||||
Total loans and leases (1) | (4,232) | (1,295) | (113) | (5,640) | ||||||||
Total interest earning assets (1) | $ | (1,972) | $ | (1,487) | $ | 81 | $ | (3,377) | ||||
Liabilities | ||||||||||||
Interest bearing deposits: | ||||||||||||
Demand deposits | $ | 41 | (5) | (3) | $ | 33 | ||||||
NOW | (4) | (16) | 1 | (19) | ||||||||
Savings accounts | 10 | 3 | 1 | 14 | ||||||||
Money market | 3 | (9) | (1) | (7) | ||||||||
Time Deposits | (84) | 40 | (11) | (55) | ||||||||
Brokered deposits | (25) | 18 | (7) | (14) | ||||||||
Total interest bearing deposits (1) | (59) | 31 | (20) | (48) | ||||||||
Borrowed funds: | ||||||||||||
Federal funds purchased | (1) | (1) | 1 | (1) | ||||||||
Repurchase agreements | 58 | (9) | (12) | 37 | ||||||||
Short term borrowings | (2) | (2) | 2 | (2) | ||||||||
Long-term debt | — | — | 428 | 428 | ||||||||
Subordinated debt | 1 | 7 | — | 8 | ||||||||
Total borrowed funds (1) | 56 | (5) | 419 | 470 | ||||||||
Total interest bearing liabilities (1) | (3) | 26 | 399 | 422 | ||||||||
Net interest income (1) | $ | (1,969) | $ | (1,513) | $ | (318) | $ | (3,799) | ||||
| (1) | Subtotals are a sum of the categories above and are not recalculated on the portfolio totals. |
The volume variance calculated for the first three months of 2022 relative to the first three months of 2021 was an unfavorable $2.0 million due to lower average balances of interest earning assets, resulting from a decrease in all categories of loans, partially offset by an increase in investment balances. There was an unfavorable rate variance of $1.5 million for the comparative quarters since the weighted average yield on interest earning assets decreased by 67 basis points and the weighted average cost of interest-bearing liabilities increased by 8 basis points. There was also an
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unfavorable mix variance of $0.3 million primarily from the issuance of subordinated debentures issued at 3.25% in September of 2021. The rate variance was negatively impacted by the following factors: high average balances of cash and due from banks earning on average 19 bps, new loans and investments having lower yields overall, including low-yielding purchased 1-4 SFD mortgage loans. Increased costs on interest bearing liabilities also had a negative impact on the variance primarily from the issuance of subordinated debt mentioned above. The Company’s net interest margin for the first quarter of 2022 was 3.21%, as compared to 3.93% for the first quarter of 2021.
At March 31, 2022, approximately 7% of our total portfolio, or $142.6 million, consists of variable rate loans. Of these variable rate loans, approximately $22.0 million have floors. At March 31, 2022, our outstanding fixed rate loans represented 28% of our loan portfolio. The remaining 65% of our loan portfolio at March 31, 2022 consists of adjustable-rate loans; 78% of these loans (approximately $1.0 billion) will not begin adjusting for at least another 3 years, but up to 10 years. These loans are typically adjustable every five years after the initial adjustment. Approximately $47.8 million of these adjustable-rate loans have the ability to reprice next quarter.
Cash balances for the quarterly comparisons have increased and have a negative impact on our net interest margin since cash balances earn considerably lower yields than other earning assets. Average cash and due from banks was $194.8 million, an increase of $118.3 million for the first quarter of 2021.
Overall average investment securities increased by $494.9 million for the first quarter of March 31, 2022 as compared to March 31, 2021. For the quarter ending March 31, 2022 over the same period for 2021, average non-taxable securities increased $67.6 million and taxable securities increased $427.3 million. The overall investment portfolio had a tax-equivalent yield of 2.22% at March 31, 2022, with an average life of 6.21 years.
Interest expense was $1.3 million in the first quarter of 2022, an increase of $0.4 million, or 47%, compared to the first quarter of 2021. The increase in interest expense for the quarter is primarily attributable to the issuance of subordinated debentures in September of 2021 at 3.25%. The average cost of interest-bearing deposits decreased by 1 basis point to 13 basis points for the first quarter of 2022 compared to the first quarter of 2021, while the average cost of borrowed funds increased 43 basis points for the first quarter of 2022 as compared to the same period in 2021. Non-interest bearing demand deposits increased $116.6 million or 12% for the first quarter of 2022 as compared to the first quarter of 2021.
PROVISION FOR CREDIT LOSSES ON LOANS AND LEASES
The Company implemented the Current Expected Credit Loss (CECL) accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) on January 1, 2022. Upon implementation the Company recorded a $10.4 million increase in the allowance for credit losses, which included a $0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes.
Credit risk is inherent in the business of making loans. The Company sets aside an allowance for credit losses on loans and leases, a contra-asset account, through periodic charges to earnings which are reflected in the income statement as the provision for credit losses on loans and leases. The Company recorded an expense related to a credit loss provision for loans and leases of $0.6 million in the first quarter of 2022 relative to a provision for loan and lease losses of $0.3 million in the first quarter of 2021. The higher provision for credit losses in the first quarter of 2022 over the same quarter in 2021, was primarily due to the impact of a $1.8 million in net charge-offs in the first quarter of 2022, partially offset by a decrease in the allowance for credit losses for loans evaluated on a pool basis. The increase in net charge-offs in the first quarter of 2022 was primarily related to a single loan relationship that defaulted in late March 2022 upon the discovery of new information. No additional allowance was booked for this loan individually evaluated for expected losses. The first quarter of 2022 decrease in the allowance for credit losses evaluated on a pooled basis was primarily due to a decline in the qualitative factors resulting from improvements in regional economic factors.
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Specifically identifiable and quantifiable credit losses are immediately charged off against the allowance, with subsequent recoveries reflected as an increase to the allowance. The Company recorded net charge-offs of $1.8 million in the first quarter of 2022 as compared to net recoveries of $0.3 million for the comparative period of 2021.
The allowance for credit losses on loans and leases is at a level that, in Management’s judgment, is adequate to absorb probable credit losses on loans related to individually identified loans as well as probable incurred credit losses in the remaining loan portfolio.
The Company’s policies for monitoring the adequacy of the allowance, determining loan balances that should be charged off, and other detailed information with regard to changes in the allowance are discussed in Note 10 to the consolidated financial statements, and below, under “Allowance for Credit Losses.” The process utilized to establish an appropriate credit allowance for losses on loans and leases can result in a high degree of variability in the Company’s credit loss provision, and consequently in our net earnings.
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NONINTEREST INCOME AND NONINTEREST EXPENSE
The following table provides details on the Company’s noninterest income and noninterest expense for the three and nine month periods ended March 31, 2022 and 2021:
Noninterest Income/Expense
(dollars in thousands, unaudited)
For the three months ended March 31, | ||||||
Noninterest income: | 2022 | 2021 | ||||
Service charges on deposit accounts |
| $ | 3,040 |
| $ | 2,767 |
Other service charges and fees | 2,787 | 2,560 | ||||
Net gains on sale of securities available-for-sale | 1,032 | — | ||||
Bank-owned life insurance | (645) | 583 | ||||
Other | (151) | 920 | ||||
Total noninterest income | $ | 6,063 | $ | 6,830 | ||
As a % of average interest earning assets (1) | 0.77% | 0.93% | ||||
Noninterest expense: | ||||||
Salaries and employee benefits | $ | 11,805 | $ | 11,151 | ||
Occupancy costs | ||||||
Furniture equipment | 454 | 452 | ||||
Premises | 1,840 | 2,034 | ||||
Advertising and marketing costs | 406 | 321 | ||||
Data processing costs | 1,485 | 1,426 | ||||
Deposit services costs | 2,245 | 2,068 | ||||
Loan services costs | ||||||
Loan processing | 111 | 169 | ||||
Foreclosed assets | (5) | 107 | ||||
Other operating costs | ||||||
Telephone data communications | 444 | 380 | ||||
Postage mail | 56 | 84 | ||||
Other | 419 | 462 | ||||
Professional services costs | ||||||
Legal accounting | 546 | 442 | ||||
Other professional service | 143 | 897 | ||||
Stationery supply costs | 85 | 78 | ||||
Sundry tellers | 139 | 200 | ||||
Total noninterest expense | $ | 20,173 | $ | 20,271 | ||
As a % of average interest earning assets (1) | 2.57% | 2.75% | ||||
Efficiency ratio (2)(3) | 67.08% | 56.43% | ||||
| (1) | Annualized |
| (2) | Tax equivalent |
| (3) | The efficiency ratio is a non-GAAP measure and is a calculation of noninterest expense as a percentage of the sum of net interest income and noninterest income excluding net gains (losses) from securities and bank owned life insurance income. |
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Noninterest Income:
Total noninterest income reflected a decrease of $0.8 million, or 11%, for the quarter ended March 31, 2022 as compared to the same quarter in 2021 due mostly to lower BOLI income and a decrease in the fair market value adjustment for an equity investment, partially offset by a gain on the sale of investment securities.
Service charges on deposit accounts increased by $0.3 million or 10%, for the quarterly comparison. The variance was primarily due to increases in overdraft fees and analysis fees on treasury management customers.
Other service charges and fees increased $0.2 million or 9% for the first quarter of 2022 as compared to the same period in 2021 mainly due to an increase in debit card interchange fees from higher usage.
Gains of the sales of securities were $1.0 million for the first quarter of 2022. There were no sales in the comparable quarter of 2021. The sale in the first quarter of 2022 was a strategic effort to rebalance the portfolio by selling longer duration and higher price volatility securities as a hedge against rising interest rates, due to likely persistent inflationary pressures in the near-intermediate term environment.
BOLI income decreased by $1.2 million for the first quarter of 2022 as compared to the first quarter of 2021. The variance is due mostly to fluctuations in underlying values of assets in the specific account BOLI policies that are designed to have similar assets to those in the deferred compensation plans. Thus, the lower quarterly values in BOLI policies are offset by lower deferred compensation expense reflected primarily in director fees expense. At March 31, 2022, there was $43.5 million in BOLI policies and $10.1 million in separate account BOLI policies associated with the deferred compensation plans.
In the “other” category of noninterest income the Company reflected a $1.1 million decrease in the first quarter of 2022 as compared to the first quarter of 2021. The quarterly comparison includes a $1.2 million change in the valuation adjustment of the Company’s equity investment in Pacific Coast Bankers’ Bank. The valuation of restricted stock held by the Company is required under FASB ASU 2016-01. This stock is related to an equity investment in Pacific Coast Bankers’ Bank and is adjusted when financial information and an updated valuation report becomes available, generally in the late first quarter of each year.
Noninterest Expense:
Total noninterest expense had a favorable decline of $0.1 million in the first quarter of 2022 as compared to the first quarter of 2021.
The tax-equivalent efficiency ratio was 67.08% in the first quarter of 2022 as compared to 56.43% in the same quarter of 2021. The efficiency ratio represents total noninterest expense divided by the sum of fully tax-equivalent net interest and noninterest income; the provision for credit losses on loans and leases and investment gains/losses are excluded from the equation. The ratio spiked higher in the first three months of 2022 despite lower noninterest expense because the denominator of the equation, net interest income and noninterest income was lower during the same period, mainly due to lower interest earning assets.
Salaries and benefits were $0.7 million higher in the first quarter of 2022 as compared to the first quarter of 2021. The increase in the year-over-year quarterly comparison is due to several factors, including merit increases for employees due to annual performance evaluations during the period, higher payroll taxes in the first quarter, and the strategic hiring of lending and management staff. Overall full-time equivalent employees were 484 at March 31, 2022 as compared to 508 at March 31, 2021.
Occupancy expense was $0.2 million lower for the first quarter of 2022 as compared to the same quarter last year. We closed five branch facilities in the second quarter of 2021 which impacted the decrease for the year over year quarterly comparison.
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Further, other noninterest expense categories were $0.7 million lower for the first quarter 2022 as compared to the first quarter in 2021. The principal decreases were in loan services costs mostly from the write up of the provision for credit losses on unfunded commitments for $0.1 million, a favorable variance in foreclosed asset costs for $0.1 million as all but one OREO property was sold in 2021, thus our carrying costs have decreased and a $0.8 million decrease in professional services costs. The positive variance in professional services costs came mostly from a decrease in directors deferred compensation expense which is linked to the fluctuations in BOLI income.
PROVISION FOR INCOME TAXES
The Company sets aside a provision for income taxes on a monthly basis. The amount of that provision is determined by first applying the Company’s statutory income tax rates to estimated taxable income, which is pre-tax book income adjusted for permanent differences, and then subtracting available tax credits. Permanent differences include but are not limited to tax-exempt interest income, BOLI income, and certain book expenses that are not allowed as tax deductions. Our tax credits consist primarily of those generated by investments in low-income housing tax credit funds. The Company's provision for income taxes was 27.0% of pre-tax income in the first quarter of 2022 relative to 25.5% in the first quarter of 2021. The increase in effective tax rate in the first quarter of 2022 is due to tax credits and tax-exempt income representing a smaller percentage of total taxable income.
BALANCE SHEET ANALYSIS
EARNING ASSETS
The Company’s interest earning assets are comprised of loans and investments, including overnight investments and surplus balances held in interest earning accounts in our Federal Reserve Bank account. The composition, growth characteristics, and credit quality of both of those components are significant determinants of the Company’s financial condition. Investments are analyzed in the section immediately below, while the loan and lease portfolio and other factors affecting earning assets are discussed in the sections following investments.
INVESTMENTS
The Company’s investments may at any given time consist of debt securities and marketable equity securities (together, the “investment portfolio”), investments in the time deposits of other banks, surplus interest earning balances in our Federal Reserve Bank account, and overnight fed funds sold. The Company’s investments can serve several purposes, including the following: 1) they can provide liquidity for potential funding needs; 2) they provide a source of pledged assets for securing public deposits, bankruptcy deposits and certain borrowed funds which require collateral; 3) they constitute a large base of assets with structural characteristics that can be changed more readily than loan or deposit portfolios, as might be required for interest rate risk management purposes; 4) they are another interest earning option for the placement of surplus funds when loan demand is light; and 5) they can provide partially tax exempt income.
The investment portfolio is reflected on the balance sheet as investment securities and totaled $1.03 billion, or 30% of total assets at March 31, 2022, and $973.3 million, or 29% of total assets at December 31, 2021. In addition, within the Cash and Due from Banks account on the balance sheet was $186.4 million of surplus interest earning balances in our Federal Reserve Bank account at March 31, 2022, as compared to $193.2 million at December 31, 2021. Surplus balances in our Federal Reserve Bank account and fed funds sold to correspondent banks typically represent the temporary investment of excess liquidity.
The Company carries investments at their fair market values. We currently have the intent and ability to hold our investment securities to maturity, but the securities are all marketable and are classified as “available for sale” to allow maximum flexibility with regard to interest rate risk and liquidity management. The expected average duration was 3.0 years at March 31, 2022, as compared to an average effective duration of 3.2 years at year-end 2021.
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The following table sets forth the amortized cost and fair market value of Company’s investment portfolio by investment type as of the dates noted:
Investment Portfolio
(dollars in thousands, unaudited)
March 31, 2022 | December 31, 2021 | |||||||||||
Amortized | Fair Market | Amortized | Fair Market | |||||||||
| Cost |
| Value |
| Cost |
| Value | |||||
Available for Sale | ||||||||||||
U.S. government agencies |
| $ | 9,695 |
| $ | 9,437 |
| $ | 1,546 | $ | 1,574 | |
Mortgage-backed securities | 304,904 | 293,418 | 303,912 | 306,727 | ||||||||
State and political subdivisions | 294,077 | 286,380 | 290,729 | 304,268 | ||||||||
Corporate bonds | 44,755 | 43,359 | 28,436 | 28,529 | ||||||||
Collateralized loan obligations | 396,741 | 392,438 | 332,836 | 332,216 | ||||||||
Total securities | $ | 1,050,172 | $ | 1,025,032 | $ | 957,459 | $ | 973,314 | ||||
The net unrealized loss on our investment portfolio, or the amount by which amortized cost exceeded aggregate fair market values, was $25.1 million at March 31, 2022, a $41.0 million swing relative to the net unrealized gain of $15.9 million at December 31, 2021. The change was caused by increased long-term market interest rates on fixed-rate bond values. Since the declines in market values were primarily attributable to changes in interest rates and volatility in the financial markets and not a result of an expected credit loss, no allowance for credit losses was recorded as of March 31, 2022.
Municipal bond balances comprise 28% of our total securities portfolio (fair value) at March 31, 2022, and 31% at December 31, 2021. Municipal bonds purchased have strong underlying ratings, and we review all municipal bonds in our portfolio every quarter for potential impairment.
The corporate bonds purchased in the first three months 2022 and throughout 2021 are exclusively subordinated debentures of bank holding companies. These bonds were subject to a credit review by the credit administration department prior to their purchase and are subject to quarterly potential impairment reviews.
The purchases of collateralized loan obligations (“CLOs”) are exclusively AAA and AA rated tranches. Each purchase is subject to a credit, concentration, and structure review by the credit administration department prior to their purchase and are subject to quarterly potential impairment reviews. The AAA and AA-rated CLO purchases were primarily a balance sheet diversification strategy to utilize available liquidity without adding duration. In addition to providing asset class diversification given the high level of real estate backed earning assets on the balance sheet, these floating rate CLOs are more asset sensitive which complements the longer-term fixed-rate earning assets.
Investment securities that were pledged as collateral for borrowings and/or potential borrowings from the Federal Home Loan Bank and the Federal Reserve Bank, customer repurchase agreements, and other purposes as required or permitted by law totaled $160.7 million at March 31, 2022 and $167.2 million at December 31, 2021, leaving $864.3 million in unpledged debt securities at March 31, 2022 and $806.1 million at December 31, 2021. Securities that were pledged in excess of actual pledging needs and were thus available for liquidity purposes, if needed, totaled $40.4 million at March 31, 2022 and $47.0 million at December 31, 2021.
LOAN AND LEASE PORTFOLIO
A distribution of the Company’s loans showing the balance and percentage of loans by type is presented for the noted periods in the table below. The balances in the table are before deferred or unamortized loan origination, extension, or commitment fees, and deferred origination costs. While not reflected in the loan totals and not currently comprising a
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material segment of our lending activities, the Company also occasionally originates and sells, or participates out portions of, loans to non-affiliated investors.
Loan and Lease Distribution
(dollars in thousands, unaudited)
| March 31, 2022 |
| December 31, 2021 | |||||||
Amount | Percent | Amount | Percent | |||||||
Real estate: | ||||||||||
1-4 family residential construction | $ | 8,800 | 0.45% | $ | 21,369 | 1.08% | ||||
Other construction/land | 24,532 | 1.25% | 25,299 | 1.28% | ||||||
1-4 family - closed-end | 399,852 | 20.40% | 289,457 | 14.65% | ||||||
Equity lines | 23,690 | 1.21% | 26,588 | 1.35% | ||||||
Multi-family residential | 59,632 | 3.04% | 53,458 | 2.71% | ||||||
Commercial real estate - owner occupied | 331,800 | 16.93% | 334,446 | 16.93% | ||||||
Commercial real estate - non-owner occupied | 854,504 | 43.61% | 882,888 | 44.69% | ||||||
Farmland | 98,925 | 5.05% | 106,706 | 5.40% | ||||||
Total real estate | 1,801,735 | 91.94% | 1,740,211 | 88.09% | ||||||
Agricultural | 31,761 | 1.62% | 33,990 | 1.72% | ||||||
Commercial and industrial | 87,132 | 4.45% | 109,791 | 5.56% | ||||||
Mortgage warehouse lines | 57,178 | 2.92% | 101,184 | 5.12% | ||||||
Consumer loans | 4,325 | 0.22% | 4,550 | 0.23% | ||||||
Total loans and leases | 1,982,131 | 101.15% | 1,989,726 | 100.72% | ||||||
Allowance for credit losses on loans | (22,530) | (1.15)% | (14,256) | (0.72)% | ||||||
Total loans and leases, net | $ | 1,959,601 | 100.00% | $ | 1,975,470 | 100.00% | ||||
Gross loans and leases at $2.0 billion, remained relatively flat during the first quarter of 2022 with an overall 0.3% change. The net change did have some offsetting components with the larger fluctuations being a $44.0 million decline on mortgage warehouse line utilization. There was also a $25.8 million decrease in non-owner occupied commercial real estate, and a $16.8 million of decrease in Small Business Administration’s Paycheck Protection Program (“PPP”) loans. These declines were mostly offset by a $109.4 million increase in 1-4 family mortgage loans due to purchases of high-quality jumbo mortgage loans designed as a bridge to organic loan growth as the Bank’s core pipeline continues to improve with the recent hiring of loan teams which will further diversify the loan portfolio by specializing in various categories of agricultural real estate and agricultural production loans.
The Company’s regulatory commercial real estate concentration ratio decreased to 234% at March 31, 2022 as compared to 248% at December 31, 2021.
Regarding line utilization, unused commitments, excluding mortgage warehouse and consumer overdraft lines, were $224.4 million at March 31, 2022, compared to $242.3 million at December 31, 2021. Total utilization excluding mortgage warehouse and consumer overdraft lines was 61% at March 31, 2022, compared to 61% at December 31, 2021. Mortgage warehouse utilization was 16% at March 31, 2022, as compared to 28% at December 31, 2021. Utilization of mortgage warehouse lines in the future could be impacted by fluctuations in interest rates, seasonality, and other factors affecting home purchasing or refinancing demand including economic uncertainty.
As expected, PPP loans continue to decline as borrowers receive forgiveness on these loans. There were 160 loans for $15.0 million outstanding at March 31, 2022, compared to 438 loans for $31.8 million at December 31, 2021.
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NONPERFORMING ASSETS
Nonperforming assets are comprised of loans for which the Company is no longer accruing interest, in addition to foreclosed assets which is primarily OREO, but can include other foreclosed assets.
If the Company grants a concession to a borrower in financial difficulty, the loan falls into the category of a TDR, unless the modification was granted under section 4013 of the CARES Act or the April 7, 2020 Interagency Statement. TDRs may be classified as either nonperforming or performing loans depending on their underlying characteristics and circumstances. The following table presents comparative data for the Company’s nonperforming assets and performing TDRs as of the dates noted:
Nonperforming assets and performing troubled debt restructurings
(dollars in thousands, unaudited)
| March 31, 2022 |
| December 31, 2021 |
| March 31, 2021 | ||||
NON-ACCRUAL LOANS: | |||||||||
Real estate: | |||||||||
1-4 family - closed-end | 1,713 | 1,023 | 1,530 | ||||||
Equity lines | 845 | 892 | 2,176 | ||||||
Commercial real estate - owner occupied | 399 | 1,234 | 1,574 | ||||||
Commercial real estate - non-owner occupied | — | — | 563 | ||||||
Farmland | 18,449 | — | 434 | ||||||
TOTAL REAL ESTATE | 21,406 | 3,149 | 6,277 | ||||||
Agriculture | 8,110 | 378 | 466 | ||||||
Commercial and industrial | 912 | 973 | 1,835 | ||||||
Consumer loans | 18 | 22 | 21 | ||||||
TOTAL NONPERFORMING LOANS | 30,446 | 4,522 | 8,599 | ||||||
Foreclosed assets | 93 | 93 | 945 | ||||||
Total nonperforming assets | $ | 30,539 | $ | 4,615 | $ | 9,544 | |||
Performing TDRs (1) | $ | 4,568 | $ | 4,910 | $ | 10,596 | |||
Nonperforming loans as a % of total gross loans and leases | 1.54% | 0.23% | 0.38% | ||||||
Nonperforming assets as a % of total gross loans and leases and foreclosed assets | 1.54% | 0.23% | 0.42% | ||||||
| (1) | Performing TDRs are not included in nonperforming loans above, nor are they included in the numerators used to calculate the ratios disclosed in this table. |
Total nonperforming assets increased by $25.9 million, to $30.6 million during the first three months of 2022, primarily as a result of one relationship in the dairy industry consisting of four separate loans. These loans were written down by $1.96 million in the first quarter of 2022 and no further allowance for credit losses was deemed necessary on these loans. The Company's ratio of nonperforming loans to gross loans increased to 1.54% at March 31, 2022 from 0.23% at December 31, 2021; due primarily to the loan relationship downgrade previously mentioned. All of the Company's nonperforming assets are periodically reviewed and are either well-reserved based on current loss expectations or are carried at the fair value of the underlying collateral, net of expected disposition costs.
As shown in the table, we also had $4.6 million in loans classified as performing TDRs on which we were still accruing interest as of March 31, 2022, a decrease of $0.3 million, or 7%, relative to December 31, 2021.
Foreclosed assets had a carrying value of $0.1 million at March 31, 2022 and December 31, 2021 comprised of one property classified as OREO. All foreclosed assets are periodically evaluated and written down to their fair value less expected disposition costs, if lower than the then-current carrying value.
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An action plan is in place for each of our non-accruing loans and foreclosed assets and they are all being actively managed. Collection efforts are continuously pursued for all nonperforming loans, but we cannot provide assurance that they will be resolved in a timely manner or that nonperforming balances will not increase.
The Company had $3.0 million in loans past due 30-59 days at March 31, 2022. This is an increase of $0.8 million over the balance at December 31, 2021. All of these past due loans are under management supervision and every effort is being taken to assist the borrowers and manage credit risk in this regard.
As described above, the Company provided loan modifications to certain customers and took advantage of either Section 4013 of the CARES Act or the April 7, 2020 Interagency Statement, which provides that such modifications do not result in treatment of such loan as a TDR. Since April 2020, the Company modified approximately $426 million of its loans under this guidance. For the Company, these modifications typically provided a deferral of both principal and interest for 180 days. Interest continues to accrue during the deferral period. At the end of the deferral period, for term loans, payments will be applied to accrued interest first and after the accrued interest is paid in full, the loan will be re-amortized with the maturity extended. For lines of credit, the borrower must repay the accrued interest at the end of the deferral period or take out a second credit facility to repay the accrued interest. As of March 31, 2022, there were no loans remaining on deferral with the Company.
ALLOWANCE FOR CREDIT LOSSES – LOANS AND LEASES RECEIVABLE
The allowance for credit losses on loans and leases, a contra-asset, is established through periodic provisions for credit losses on loans and leases. It is maintained at a level that is considered adequate to measure expected losses on individually identified loans, as well as expected losses inherent in the remaining loan portfolio. Specifically identifiable and quantifiable losses are immediately charged off against the allowance; recoveries are generally recorded only when sufficient cash payments are received subsequent to the charge off.
After deferring implementation of the CECL accounting method under Financial Accounting Standards Board (FASB) Accounting Standards Update 2016-03 and related amendments, Financial Instruments – Credit Losses (Topic 326) under section 4014 of the CARES Act, the Company implemented CECL on January 1, 2022. Upon implementation the Company recorded a $10.4 million increase in the allowance for credit losses, which included a $0.9 million reserve for unfunded commitments as an adjustment to equity, net of deferred taxes.
The Company's allowance for credit losses on loans and leases was $22.5 million at March 31, 2022, as compared to $14.3 million at December 31, 2021, and $18.3 million at March 31, 2021. The $8.3 million increase in the allowance for credit losses on loan and leases during the first quarter of 2022 is due to a $9.5 million one-time adjustment from the implementation of CECL on January 1, 2022, a $0.6 million provision for credit losses on loan and leases, and net loan charge-offs of $1.8 million.
The allowance was 1.14% of total loans at March 31, 2022, 0.72% of total loans at December 31, 2021, and 0.80% of total loans at March 31, 2021. Management's detailed analysis indicates that the Company's allowance for credit losses on loan and leases should be sufficient to cover credit losses for the life of the loan and leases outstanding as of March 31, 2022, but no assurance can be given that the Company will not experience substantial future losses relative to the size of the loan and lease loss allowance.
A separate allowance of $1.0 million for potential credit losses inherent in unused commitments is included in other liabilities at March 31, 2022, as compared to $0.2 million at December 31, 2021. As mentioned previously a $0.9 million one-time adjustment was recorded to the reserve for unfunded commitments on January 1, 2022 upon the implementation of CECL.
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The following table summarizes activity in the credit allowance for losses on loans and leases for the noted periods:
Allowance for Credit Losses on Loans and Leases
(dollars in thousands, unaudited)
For the three | For the three | For the year ended | |||||||
| March 31, |
| March 31, |
| December 31, | ||||
Balances: | 2022 | 2021 | 2021 | ||||||
Average gross loans and leases outstanding during period (1) | $ | 1,951,695 | $ | 2,367,043 | $ | 2,169,582 | |||
Gross loans and leases outstanding at end of period | $ | 1,983,331 | $ | 2,288,468 | $ | 1,989,726 | |||
Allowance for credit losses on loans and leases: | |||||||||
Balance at beginning of period | $ | 14,256 | $ | 17,738 | $ | 17,738 | |||
Adoption of ASC 326 | 9,454 | — | — | ||||||
Provision charged to expense | 600 | 250 | (3,650) | ||||||
Charge-offs | |||||||||
Real estate | |||||||||
1-4 family residential construction | — | — | — | ||||||
Other construction/land | — | — | — | ||||||
1-4 family - closed-end | — | — | — | ||||||
Equity lines | — | — | 12 | ||||||
Multi-family residential | — | — | — | ||||||
Commercial real estate- owner occupied | — | 233 | 233 | ||||||
Commercial real estate- non-owner occupied | — | — | — | ||||||
Farmland | 1,958 | — | — | ||||||
Total real estate | 1,958 | 233 | 245 | ||||||
Agricultural | — | — | 50 | ||||||
Commercial and industrial | 74 | 52 | 159 | ||||||
Consumer loans | 299 | 163 | 946 | ||||||
Total | $ | 2,331 | $ | 448 | $ | 1,400 | |||
Recoveries | |||||||||
Real estate | |||||||||
1-4 family residential construction | — | — | — | ||||||
Other construction/land | 260 | 218 | 328 | ||||||
1-4 family - closed-end | 87 | 3 | (67) | ||||||
Equity lines | — | — | 25 | ||||||
Multi-family residential | — | — | — | ||||||
Commercial real estate- owner occupied | — | 233 | 233 | ||||||
Commercial real estate- non-owner occupied | — | — | 82 | ||||||
Farmland | — | — | — | ||||||
Total real estate | 347 | 454 | 601 | ||||||
Agricultural | — | — | — | ||||||
Commercial and industrial | 20 | 110 | 223 | ||||||
Consumer loans | 184 | 215 | 744 | ||||||
Total | $ | 551 | $ | 779 | $ | 1,568 | |||
Net loan charge offs (recoveries) | $ | 1,780 | $ | (331) | $ | (168) | |||
Balance at end of period | $ | 22,530 | $ | 18,319 | $ | 14,256 | |||
RATIOS | |||||||||
Net charge-offs (recoveries) to average loans and leases (annualized) | 0.37% | (0.06)% | (0.01)% | ||||||
Allowance for credit losses on loans and leases to gross loans and leases at end of period | 1.14% | 0.80% | 0.72% | ||||||
Allowance for credit losses on loans and leases to nonperforming loans | 74.00% | 213.04% | 315.26% | ||||||
Net loan charge-offs (recoveries) to allowance for credit losses on loans and leases at end of period | 7.90% | (1.81)% | (1.18)% | ||||||
Net loan charge-offs (recoveries) to provision for credit losses on loans and leases | 296.67% | (132.40)% | 4.60% | ||||||
| (1) | Average balances are obtained from the best available daily or monthly data and are net of deferred fees and related direct costs. |
The Company’s credit allowance for losses on loans and leases at March 31, 2022 represents Management’s best estimate of expected losses in the loan portfolio as of that date, but no assurance can be given that the Company will not experience substantial losses relative to the size of the allowance. Furthermore, fluctuations in credit quality, changes in economic conditions, updated accounting or regulatory requirements, and/or other factors could induce us to augment or reduce the allowance.
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OFF-BALANCE SHEET ARRANGEMENTS
The Company maintains commitments to extend credit in the normal course of business, as long as there are no violations of conditions established in the outstanding contractual arrangements. It is unlikely that all unused commitments will ultimately be drawn down. Unused commitments to extend credit, which included standby letters of credit, totaled $582 million at March 31, 2022 and $561 million at December 31, 2021, representing approximately 29% of gross loans outstanding at March 31, 2022 and 28% at December 31, 2021. The decrease in unused commitments is due in large part to the decrease in loan balances with unfunded commitments. The Company also had undrawn letters of credit issued to customers totaling $3.6 million at March 31, 2022 and December 31, 2021. The effect on the Company’s revenues, expenses, cash flows and liquidity from the unused portion of commitments to provide credit cannot be reasonably predicted because there is no guarantee that the lines of credit will ever be used. However, the “Liquidity” section in this Form 10-Q outlines resources available to draw upon should we be required to fund a significant portion of unused commitments.
In addition to unused commitments to provide credit, the Company is utilizing a $125 million letter of credit issued by the Federal Home Loan Bank on the Company’s behalf as security for certain local agency deposits which totaled $78.3 million at March 31, 2022. That letter of credit is backed by loans that are pledged to the FHLB by the Company. For more information on the Company’s off-balance sheet arrangements, see Note 7 to the consolidated financial statements located elsewhere herein.
OTHER ASSETS
Interest earning cash balances were discussed above in the “Investments” section, but the Company also maintains a certain level of cash on hand in the normal course of business as well as non-earning deposits at other financial institutions. Our balance of cash and due from banks depends on the timing of collection of outstanding cash items (checks), the amount of cash held at our branches, and our reserve requirement among other things, and it is subject to significant fluctuations in the normal course of business. While cash flows are normally predictable within limits, those limits are fairly broad and the Company manages its short-term cash position through the utilization of overnight loans to, and borrowings from, correspondent banks, including the Federal Reserve Bank and the Federal Home Loan Bank. Should a large “short” overnight position persist for any length of time, the Company typically raises money through focused retail deposit gathering efforts or by adding brokered time deposits. If a “long” position is prevalent, we could let brokered deposits or other wholesale borrowings roll off as they mature, or we might invest excess liquidity into investments or loans, subject to the bank’s risk tolerances. The Company’s balance of non-earning cash and due from banks was $66.0 million at March 31, 2022 relative to $63.1 million at December 31, 2021.
Foreclosed assets are discussed above in the section titled “Nonperforming Assets.”
Net premises and equipment decreased by $0.3 million during the first three months of 2022, to $23.2 million. This decline was primarily a result of normal depreciation during the quarter net of new purchases.
Goodwill was $27.4 million at March 31, 2022, unchanged during the first three months of 2022. Goodwill is tested for impairment annually, unless events and circumstances exist which indicate that an impairment test should be performed. A Goodwill impairment test was last performed during the fourth quarter 2021 and determined that no impairment existed. There have been no triggering events in the first three months of 2022 that would require the Company to perform a Goodwill impairment test, however the Company will continue to monitor its Goodwill for potential impairment.
Bank-owned life insurance, with a balance of $53.6 million at March 31, 2022, is discussed in detail above in the “Noninterest Income and Noninterest Expense” section.
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DEPOSITS AND INTEREST BEARING LIABILITIES
DEPOSITS
Deposits represent another key balance sheet category impacting the Company’s net interest income and profitability metrics. Deposits provide liquidity to fund growth in earning assets, and the Company’s net interest margin is improved to the extent that growth in deposits is concentrated in less volatile and typically less costly non-maturity accounts such as demand deposit accounts, NOW accounts, savings accounts, and money market demand accounts. Information concerning average balances and rates paid by deposit type is included in the Average Balances and Rates tables appearing above, in the section titled “Net Interest Income and Net Interest Margin.” A distribution of the Company’s deposits by type, showing the period-end balance and percentage of total deposits, is presented as of the dates indicated in the following table.
Deposit Distribution
(dollars in thousands, unaudited)
| March 31, 2022 |
| December 31, 2021 | |||
Noninterest bearing demand deposits | $ | 1,104,691 | $ | 1,084,544 | ||
Interest bearing demand deposits | 228,885 | 129,783 | ||||
NOW | 547,572 | 614,770 | ||||
Savings | 480,178 | 450,785 | ||||
Money market | 149,918 | 147,793 | ||||
Time | 293,699 | 293,897 | ||||
Brokered deposits | 60,000 | 60,000 | ||||
Total deposits | $ | 2,864,943 | $ | 2,781,572 | ||
Percentage of Total Deposits | ||||||
Noninterest bearing demand deposits | 38.57% | 38.99% | ||||
Interest bearing demand deposits | 7.99% | 4.67% | ||||
NOW | 19.11% | 22.10% | ||||
Savings | 16.76% | 16.21% | ||||
Money market | 5.23% | 5.31% | ||||
Time | 10.25% | 10.57% | ||||
Brokered deposits | 2.09% | 2.16% | ||||
Total | 100.00% | 100.00% | ||||
Deposit balances reflect net growth of $83.4 million, or 3%, during the first three months of 2022. Time deposits were $293.7 million at March 31, 2022 as compared to $293.9 million at December 31, 2021. Brokered deposits were unchanged at $60.0 million at March 31, 2022 from December 31, 2021. Non-maturity deposit growth of $83.6 million for the first three months of 2022 was primarily the result of increases in balances of existing customers as the total number of customers was relatively unchanged.
Management is of the opinion that a relatively high level of core customer deposits is one of the Company’s key strengths, and we continue to strive for core deposit retention and growth. In particular, the Company’s ratio of noninterest-bearing deposits to total deposits was 38.6% at March 31, 2022 as compared to 39.0% at December 31, 2021.
OTHER INTEREST-BEARING LIABILITIES
The Company’s non-deposit borrowings may, at any given time, include fed funds purchased from correspondent banks, borrowings from the Federal Home Loan Bank, advances from the Federal Reserve Bank, securities sold under agreements to repurchase, and/or junior subordinated debentures. The Company uses short-term FHLB advances and fed funds purchased on uncommitted lines to support liquidity needs created by seasonal deposit flows, to temporarily
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satisfy funding needs from increased loan demand, and for other short-term purposes. The FHLB line is committed, but the amount of available credit depends on the level of pledged collateral.
Total non-deposit interest-bearing liabilities increased by $0.9 million, during the first three months of 2022 primarily due to an increase in customer repurchase agreements. Repurchase agreements totaled $107.8 million at March 31,2022 relative to a balance of $106.9 million at year-end 2021. Repurchase agreements represent “sweep accounts”, where certain customers have elected to have their commercial deposit balances above a specified threshold transferred at the close of each business day into non-deposit investments accounts. The balance in the investment account is used to have the customer purchase securities or a perfected interest in specifically identified pledged securities from the bank, which are then repurchased by the bank from the customer the next business day.
The Company had Long term debt totaling $49.2 million and $49.1 million at March 31, 2022 and December 31, 2021, respectively, in the form of 3.25% fixed – floating subordinated debt with a ten-year maturity and junior subordinated debentures totaling $35.3 million at both March 31, 2022 and December 31, 2021, in the form of long-term borrowings from trust subsidiaries formed specifically to issue trust preferred securities.
OTHER NONINTEREST BEARING LIABILITIES
Other liabilities are principally comprised of operating lease right-of-use liabilities, accrued interest payable, other accrued but unpaid expenses, and certain clearing amounts. The Company’s balance of other liabilities was $36.0 million at March 31, 2022 as compared to $35.6 million at December 31, 2021.
LIQUIDITY AND MARKET RISK MANAGEMENT
LIQUIDITY
Liquidity management refers to the Company’s ability to maintain cash flows that are adequate to fund operations and meet other obligations and commitments in a timely and cost-effective manner. Detailed cash flow projections are reviewed by Management on a monthly basis, with various stress scenarios applied to assess our ability to meet liquidity needs under unusual or adverse conditions. Liquidity ratios are also calculated and reviewed on a regular basis. While those ratios are merely indicators and are not measures of actual liquidity, they are closely monitored, and we are committed to maintaining adequate liquidity resources to draw upon should unexpected needs arise.
The Company, on occasion, experiences cash needs as the result of loan growth, deposit outflows, asset purchases or liability repayments. To meet these short-term needs, we can borrow overnight funds from other financial institutions, draw advances via Federal Home Loan Bank lines of credit, or solicit brokered deposits if customer deposits are not immediately obtainable from local sources.
At March 31, 2022 and December 31, 2021, the Company had the following sources of primary and secondary liquidity (dollars in thousands):
Primary and secondary liquidity sources | March 31, 2022 | December 31, 2021 | ||||
Cash and cash equivalents | $ | 253,534 | $ | 257,528 | ||
Unpledged investment securities | 861,857 | 806,132 | ||||
Excess pledged securities | 40,403 | 47,024 | ||||
FHLB borrowing availability | 748,101 | 787,519 | ||||
Unsecured lines of credit | 305,000 | 305,000 | ||||
Funds available through fed discount window | 44,587 | 50,608 | ||||
Totals | $ | 2,253,482 | $ | 2,253,811 |
In addition to the above sources, the Company could obtain brokered deposits, obtain deposits via deposit listing services, or offer higher rate time deposits within our market.
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Cash and cash equivalents during the first three months of 2022, declined $4.0 million due to increases in investment securities. Utilization of remaining excess liquidity is expected to come from a combination of new loans, including loan purchases, and new investment purchases. In addition, it is possible that a portion of the deposits built-up during the COVID-19 pandemic could be withdrawn by customers. When looking to reduce these low-yielding cash balances with earning assets, management considers interest rate risk, including duration and extension risk; credit risk; and the liquidity risk of such alternative assets.
The Company performs regular stress tests on its liquidity and at this time, believes that we have sufficient primary and secondary liquidity sources for operations.
The Company has a higher level of actual balance sheet liquidity than might otherwise be the case, since we utilize a letter of credit from the FHLB rather than investment securities for certain pledging requirements. That letter of credit, which is backed by loans pledged to the FHLB by the Company, totaled $125 million at March 31, 2022 and December 31, 2021. Other sources of liquidity include the brokered deposit market, deposit listing services, and the ability to offer local time-deposit campaigns. Management is of the opinion that available investments and other potentially liquid assets, along with standby funding sources it has arranged, are more than sufficient to meet the Company’s current and anticipated short-term liquidity needs and that its liquidity has not been adversely impacted by COVID-19.
The Company’s primary liquidity ratio and net loans to deposits were 40.43% and 69.19%, respectively, at March 31, 2022, as compared to internal policy guidelines of “greater than 15%” and “less than 95%.” Ratios and sub-limits for the various components comprising wholesale funding, which were all well within policy guidelines at March 31, 2022, are also periodically reviewed by Management and the Board. The Company has been able to maintain a robust liquidity position in recent periods, but no assurance can be provided that our liquidity position will continue at current strong levels.
The holding company’s primary uses of funds include operating expenses incurred in the normal course of business, interest on trust preferred securities and subordinated debt, shareholder dividends, and share repurchases. Its primary source of funds is dividends from the Bank since the holding company does not conduct regular banking operations. As of March 31, 2022, the holding company maintained a cash balance of $11.6 million. Management anticipates that the holding company has sufficient liquidity to meet its funding requirements for the foreseeable future. Both the holding company and the Bank are subject to legal and regulatory limitations on dividend payments, as outlined in Item 5(c) Dividends in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 which was filed with the SEC.
INTEREST RATE RISK MANAGEMENT
Market risk arises from changes in interest rates, exchange rates, commodity prices and equity prices. The Company does not engage in the trading of financial instruments, nor does it have exposure to currency exchange rates. Our market risk exposure is primarily that of interest rate risk, and we have established policies and procedures to monitor and limit our earnings and balance sheet exposure to changes in interest rates. The principal objective of interest rate risk management is to manage the financial components of the Company’s balance sheet in a manner that will optimize the risk/reward equation for earnings and capital under a variety of interest rate scenarios.
To identify areas of potential exposure to interest rate changes, we utilize commercially available modeling software to perform monthly earnings simulations and calculate the Company’s market value of portfolio equity under varying interest rate scenarios. The model imports relevant information for the Company’s financial instruments and incorporates Management’s assumptions on pricing, duration, and optionality for anticipated new volumes. Various rate scenarios consisting of key rate and yield curve projections are then applied in order to calculate the expected effect of a given interest rate change on interest income, interest expense, and the value of the Company’s financial instruments. The rate projections can be shocked (an immediate and parallel change in all base rates, up or down), ramped (an incremental increase or decrease in rates over a specified time period), economic (based on current trends and econometric models) or stable (unchanged from current actual levels).
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In addition to a stable rate scenario, which presumes that there are no changes in interest rates, we typically use at least eight other interest rate scenarios in conducting our rolling 12-month net interest income simulations: upward shocks of 100, 200, 300, and 400 basis points, and downward shocks of 100, 200, and 300 basis points. Those scenarios may be supplemented, reduced in number, or otherwise adjusted as determined by Management to provide the most meaningful simulations considering economic conditions and expectations at the time. Given the current near zero interest rate environment it is unlikely that rates could decline much further beyond the downward shock of 100 basis points, therefore the downward shock scenarios of 200, 300, and 400 basis points are temporarily being suspended after concurrence by the Company’s Board of Directors. Pursuant to policy guidelines, we generally attempt to limit the projected decline in net interest income relative to the stable rate scenario to no more than 5% for a 100 basis point (bp) interest rate shock, 10% for a 200 bp shock, 15% for a 300 bp shock, and 20% for a 400 bp shock.
The Company had the following estimated net interest income sensitivity profiles over one-year, without factoring in any potential negative impact on spreads resulting from competitive pressures or credit quality deterioration:
March 31, 2022 | March 31, 2021 | |||||||||||
Immediate change in Interest Rates (basis points) | % Change in Net Interest Income | $ Change in Net Interest Income | % Change in Net Interest Income | $ Change in Net Interest Income | ||||||||
+400 | 13.3% | $ | 14,321 | 7.2% | $ | 7,726 | ||||||
+300 | 10.9% | $ | 11,684 | 5.7% | $ | 6,137 | ||||||
+200 | 8.1% | $ | 8,712 | 4.4% | $ | 4,741 | ||||||
+100 | 4.3% | $ | 4,624 | 2.8% | $ | 2,991 | ||||||
Base | ||||||||||||
-100 | (9.2)% | $ | (9,892) | (7.6)% | $ | (8,181) | ||||||
For the periods ending March 31, 2022 and March 31, 2021, management believes that the Company was asset sensitive, with net income increasing in a rising rate environment in all scenarios but declining considerably in the down shocks. The change in the magnitude of the Company’s asset sensitivity based on its interest rate risk model at March 31, 2022 as compared to March 31, 2021, is due primarily to the change in the structure of the balance sheet with the addition of $392.4 million in variable rate collateralized loan obligations and cash on hand of $253.5 million. In the up 400 basis point shock scenario, expected net interest income over the next twelve months increases $14.3 million, or 13%, to $122.05 million at March 31, 2022 compared to a 7.2% increase or $7.7 million for the same period in 2021.
Over the next twelve months, $253.5 million in surplus cash is projected to decline due to expected core loan growth as our pipelines begin to increase with the addition of several loan teams and the opening of the Templeton LPO mentioned earlier. Further, a portion of the significant increase in deposits during the COVID-19 pandemic could be withdrawn by customers. These expected changes in earnings assets, including overnight cash, are not modeled in the immediate rate shock model described above. Although the cost of interest-bearing liabilities will also increase in a rate shock, the deposit betas utilized in the interest rate model mitigate the magnitude of a deposit rate increase.
If there was an immediate downward adjustment, it is anticipated that interest income would decline. The reason for the drop in net interest income is because many deposit products are at or below their modeled floors of 0.15% or 0.20 % and cannot be re-priced lower, while non-floored interest earning assets such as loans and securities can theoretically still be re-priced lower in a falling rate environment. Due to the historically low current rate environment, we view any material interest rate reductions as unlikely in the near term.
In addition to the net interest income simulations shown above, we run stress scenarios for the unconsolidated Bank where we model the possibility of no balance sheet growth, the potential runoff of “surge” core deposits which flowed into the Bank in the most recent economic cycle, and unfavorable movement in deposit rates relative to yields on earning assets (i.e., higher deposit betas). When a static balance sheet and a stable interest rate environment are assumed, projected annual net interest income is $8.1 million lower than in our standard simulation.
The modeled economic value (or “fair value”) of financial instruments on the Company’s balance sheet will also vary under the interest rate scenarios previously discussed. The difference between the projected fair value of the Company’s financial assets and the fair value of its financial liabilities is referred to as the economic value of equity (“EVE”), and changes in EVE under different interest rate scenarios are effectively a gauge of the Company’s longer-term exposure to
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interest rate fluctuations. Fair values for financial instruments are estimated by discounting projected cash flows (principal and interest) at anticipated replacement interest rates for each account type, while the fair value of non-financial accounts is assumed to equal their book value for all rate scenarios. An economic value simulation is a static measure utilizing balance sheet accounts at a given point in time, and the measurement can change substantially over time, as is evident in the tables below for the periods ending March 31, 2022 and 2021, respectively, as the Company’s balance sheet evolves and interest rate and yield curve assumptions are updated.
The change in economic value under different interest rate scenarios depends on the characteristics of each class of financial instrument, including stated interest rates or spreads relative to current or projected market-level interest rates or spreads, the likelihood of principal prepayments, whether contractual interest rates are fixed or floating, and the average remaining time to maturity. As a general rule, fixed-rate financial assets become more valuable in declining rate scenarios and less valuable in rising rate scenarios, while fixed-rate financial liabilities gain in value as interest rates rise and lose value as interest rates decline. The longer the duration of the financial instrument, the greater the impact a rate change will have on its value. In our economic value simulations, estimated prepayments are factored in for financial instruments with stated maturity dates, and decay rates for non-maturity deposits are projected based on historical patterns and Management’s best estimates.
Our EVE decreased in the past twelve months due to asset composition changes. The tables below show estimated changes in the Company’s EVE as modeled under different interest rate scenarios relative to a base case of current interest rates:
March 31, 2022 | March 31, 2021 | |||||||||||
Immediate change in Interest Rates (basis points) | % Change in Fair Value of Equity | $ Change in Fair Value of Equity | % Change in Fair Value of Equity | $ Change in Fair Value of Equity | ||||||||
+400 | 25.8% | $ | 171,796 | 31.5% | $ | 174,274 | ||||||
+300 | 22.8% | $ | 151,682 | 28.0% | $ | 155,182 | ||||||
+200 | 18.4% | $ | 122,257 | 22.8% | $ | 126,402 | ||||||
+100 | 11.0% | $ | 72,882 | 13.7% | $ | 76,032 | ||||||
Base | ||||||||||||
-100 | (20.2)% | $ | (134,598) | (20.1)% | $ | (111,586) | ||||||
The table shows that our EVE is modeled to deteriorate in moderate declining rate scenarios but should benefit from a parallel shift upward in the yield curve. The rate of increase in EVE accelerates the higher interest rates rise. This increase in sensitivity is caused by the increase in gross deposits, namely, an increase in noninterest bearing deposits which become more valuable as interest rates rise. We also run stress scenarios for the unconsolidated Bank’s EVE to simulate the possibility of adverse movement in loan prepayment rates, unfavorable changes in deposit rates, and higher deposit decay rates. Model results are highly sensitive to changes in assumed decay rates for non-maturity deposits, in particular, with material unfavorable variances occurring relative to the standard simulations shown above as decay rates are increased. Furthermore, while not as extreme as the variances produced by increasing non-maturity deposit decay rates, EVE also displays a relatively high level of sensitivity to unfavorable changes in deposit rate betas in rising interest rate scenarios.
CAPITAL RESOURCES
The Company had total shareholders’ equity of $325.7 million at March 31, 2022, comprised of $111.7 million in common stock, $4.3 million in additional paid-in capital, $227.4 million in retained earnings, and accumulated other comprehensive loss of $17.7 million. At the end of 2021, total shareholders’ equity was $362.5 million. The decrease in equity during the first quarter of 2022 is due to net income of $7.4 million, offset by a $3.5 million dividend paid to shareholders, $4.9 million in share repurchases, a $28.9 million unfavorable swing in other comprehensive income/loss due principally to changes in investment securities' fair value and a $7.3 million decrease in retained earnings due to the cumulative effect of a change in accounting principal from the implementation of CECL, topic 326. The remaining difference is related to stock options exercised and restricted stock compensation recognized during the quarter. The Company approved a new share repurchase program (the 2021 Share Repurchase Plan) on October 21, 2021 and authorized one million shares to be repurchased under this plan. The previous 2003 Share Repurchase Plan was cancelled and the 268,301 shares remaining in that plan were incorporated into the 2021 Share Repurchase Plan. There
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were 182,562 shares repurchased in the first quarter of 2022, with 630,000 shares remaining to be repurchased under the 2021 Share Repurchase Plan.
The Company uses a variety of measures to evaluate its capital adequacy, including the leverage ratio which is calculated separately for the Company and the Bank. Management reviews these capital measurements on a quarterly basis and takes appropriate action to help ensure that they meet or surpass established internal and external guidelines. As permitted by the regulators for financial institutions that are not deemed to be “advanced approaches” institutions, the Company has elected to opt out of the Basel III requirement to include accumulated other comprehensive income in risk-based capital. The following table sets forth the Bank’s regulatory capital ratios as of the dates indicated.
Regulatory Capital Ratios
Minimum | Minimum | ||||||||
Requirement | Required | ||||||||
March 31, |
| December 31, |
| to be | Community Bank | ||||
| 2022 |
| 2021 |
| Well Capitalized (1) | Leverage Ratio (2) | |||
Bank of the Sierra | |||||||||
Tier 1 Capital to Adjusted Average Assets (Leverage Ratio) (3) | 11.65 | % | 11.31 | % | 5.00 | % | 9.00 | % | |
Sierra Bancorp | |||||||||
Tier 1 Capital to Adjusted Average Assets (Leverage Ratio) (3) | 10.48 | % | 10.43 | % | 5.00 | % | N/A |
| (1) | The Company was subject to these minimum requirements under the regulatory framework for Prompt Corrective Action at December 31, 2019. |
| (2) | If the subsidiary bank’s Leverage Ratio exceeds the minimum ratio under the Community Bank Leverage Ratio Framework, it is deemed to be “well capitalized” under all other regulatory capital requirements. The Company may revert back to the regulatory framework for Prompt Corrective Action if the subsidiary bank’s Leverage Ratio falls below the minimum under the Community Bank Leverage Ratio Framework. |
| (3) | The Company has elected to phase in the impact of implementing CECL on regulatory capital over a three-year period. |
The federal banking agencies published a final rule on November 13, 2019, that provided a simplified measure of capital adequacy for qualifying community banking organizations. A qualifying community banking organization that opts into the community bank leverage ratio framework and maintains a leverage ratio greater than 9 percent will be considered to have met the minimum capital requirements, the capital ratio requirements for the well capitalized category under the Prompt Corrective Action framework, and any other capital or leverage requirements to which the qualifying banking organization is subject. A qualifying community banking organization with a leverage ratio of greater than 9 percent may opt into the community bank leverage ratio framework if has average consolidated total assets of less than $10 billion, has off-balance-sheet exposures of 25% or less of total consolidated assets, and has total trading assets and trading liabilities of 5 percent or less of total consolidated assets. Further, the bank must not be an advance approaches banking organization.
The final rule became effective January 1, 2020 and banks that meet the qualifying criteria can elect to use the community bank leverage framework starting with the quarter ended March 31, 2020. The CARES Act reduced the required community bank leverage ratio to 8% until the earlier of December 31, 2020, or the national emergency is declared over. Beginning in 2021 the CBLR was increased to 8.5% for the calendar year with the CBLR increasing to 9% on January 1, 2022. The federal bank regulatory agencies adopted an interim final rule to implement this change from the CARES Act. At September 30, 2021, the Company and the Bank met the criteria outlined in the final rule and the interim final rule and elected to measure capital adequacy under the CBLR framework.
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PART I – FINANCIAL INFORMATION
ITEM 3
QUALITATIVE QUANTITATIVE DISCLOSURES
ABOUT MARKET RISK
The information concerning quantitative and qualitative disclosures about market risk is included in Part I, Item 2 above. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Market Risk Management.”
PART I – FINANCIAL INFORMATION
Item 4
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s Chief Executive Officer and its Chief Financial Officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report (the “Evaluation Date”) have concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities, particularly during the period in which this quarterly report was being prepared.
Disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our Management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure, and that such information is recorded, processed, summarized, and reported within the time periods specified by the SEC.
Changes in Internal Controls
There were no significant changes in the Company’s internal controls over financial reporting that occurred in the first three months of 2022 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
The Company and the Bank are defendants, from time to time, in legal proceedings in various points of the legal process arising from transactions conducted in the ordinary course of business. In the opinion of Management, in consultation with legal counsel, it is not probable that current legal actions will results in an unfavorable outcome that has a material adverse effect on the Company’s consolidated financial condition, results of operations. Comprehensive income, or cash flows. In the event that such legal action results in an unfavorable outcome, the resulting liability could have a material adverse effect on the Company’s consolidated financial position, results of operations, comprehensive income, or cash flows.
ITEM 1A: RISK FACTORS
There were no material changes from the risk factors disclosed in the Company’s Form 10-K for the fiscal year ended December 31, 2021.
ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) Stock Repurchases
In October 2021 the Board approved the 2021 Share Repurchase Plan by authorizing 1,000,000 shares of common stock for repurchase. In conjunction with this action, the Board terminated the current Share Repurchase Plan which authorized 500,000 shares of common stock for repurchase. There are 630,000 shares remaining for repurchase under the current Share Repurchase Plan.
The following table provides information concerning the Company’s stock repurchase transactions during the third quarter of 2021:
Stock Repurchases | |||||||||
Period | Total Number of Shares Purchased (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of a Publicly Announced Plan | Maximum Number (or Approximate Dollar Value) of Shares That May Yet Be Purchased Under the Plan at the End of the Period | |||||
January 1, 2022 - January 31, 2022 | 15,543 | $ | 26.85 | 15,543 | 797,019 | ||||
February 1, 2021 - February 31, 2022 | 118,677 | $ | 26.69 | 118,677 | 678,342 | ||||
March 1, 2021 - March 31, 2022 | 48,342 | $ | 26.51 | 48,342 | 630,000 | ||||
Total | 182,562 | 182,562 |
| (1) | These shares do not include the net settlement by employees related to vested, restricted stock awards and do not impact the 630,000 shares available for repurchase under the current repurchase plan. Net settlements of 1,196 shares during the first quarter of 2022 represent instances where employees elect to satisfy their income tax liability related to the vesting of restricted stock through the surrender of a proportionate number of the vested shares to the Company |
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ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable
ITEM 4: MINE SAFETY DISCLOSURES
Not applicable
ITEM 5: OTHER INFORMATION
Not applicable
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ITEM 6: EXHIBITS
Exhibit # |
| Description |
|---|---|---|
3.1 | ||
3.2 | ||
4.1 | ||
4.2 | 3.25% Fixed to Floating Subordinated Debt issued September 24, 2021 (4) | |
10.3 | Director Retirement and Split dollar Agreements Effective October 1, 2002, for Albert Berra, Morris Tharp, and Gordon Woods (5)* | |
10.4 | ||
10.5 | ||
10.6 | ||
10.7 | ||
10.8 | Amended and Restated Declaration of Trust of Sierra Capital Trust III, dated as of June 15, 2006 (7) | |
10.9 | ||
10.10 | ||
10.11 | ||
10.14 | First Amendment to the Salary Continuation Agreement for Kevin J. McPhaill (10)* | |
10.15 | ||
10.16 | ||
10.17 | ||
10.18 | ||
10.19 | Employment agreements dated as of December 27, 2018 for Kevin McPhaill, CEO and Michael Olague, Chief Banking Officer (13)* | |
10.21 | ||
10.22 | ||
10.23 | Employment agreement dated as of December 14, 2020 for Hugh Boyle, Chief Credit Officer (16)* | |
10.24 | Form Indemnification Agreement dated as of January 28, 2021 for Directors and Executive Officers (17)* | |
31.1 | Certification of Chief Executive Officer (Section 302 Certification) | |
31.2 | Certification of Chief Financial Officer (Section 302 Certification) | |
32 | Certification of Periodic Financial Report (Section 906 Certification) | |
101.INS | Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |
101.SCH | Inline XBRL Taxonomy Extension Schema Document | |
101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document | |
101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document | |
101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document | |
101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document | |
104 | Cover Page Interactive Data File - The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. |
| (1) | Filed as Exhibit 3.1 to the Form 10-Q filed with the SEC on August 7, 2009 and incorporated herein by reference. |
| (2) | Filed as an Exhibit to the Form 8-K filed with the SEC on February 21, 2007 and incorporated herein by reference. |
| (3) | Filed as an Exhibit to the Form 10-K filed with the SEC on March 12, 2020 and incorporated herein by reference. |
| (4) | Filed as an Exhibit to the Form 8-K filed with the SEC on September 24, 2021 and incorporated herein by reference. |
| (5) | Filed as Exhibits 10.18 through 10.20, and 10.22 to the Form 10-K filed with the SEC on March 15, 2006 and incorporated herein by reference. |
| (6) | Filed as Exhibits 10.9 and 10.10 to the Form 10-Q filed with the SEC on May 14, 2004 and incorporated herein by reference. |
| (7) | Filed as Exhibits 10.26 and 10.27 to the Form 10-Q filed with the SEC on August 9, 2006 and incorporated herein by reference. |
| (8) | Filed as Exhibit 10.20 to the Form 10-K filed with the SEC on March 15, 2007 and incorporated herein by reference. |
| (9) | Filed as Exhibits 10.1 through 10.2 to the Form 8-K filed with the SEC on January 8, 2007 and incorporated herein by reference. |
| (10) | Filed as Exhibit 10.24 to the Form 10-Q filed with the SEC on May 7, 2015 and incorporated herein by reference. |
| (11) | Filed as Exhibits 10.1 through 10.3 to the Form 8-K filed with the SEC on July 11, 2016 and incorporated herein by reference. |
| (12) | Filed as Exhibit 10.1 to the Form 8-K filed with the SEC on March 17, 2017 and incorporated herein by reference. |
| (13) | Filed as Exhibits 99.1 and 99.4 to the Form 8-K filed with the SEC on December 28, 2018 and incorporated by reference. |
| (14) | Filed as Exhibit 99.1 to the Form 8-K filed with the SEC on November 11, 2019 and incorporated by reference. |
| (15) | Filed as Exhibit 99.1 to the Form 8-K filed with the SEC on January 21, 2020 and incorporated by reference. |
| (16) | Filed as Exhibit 10.1 to the Form 8-K filed with the SEC on December 09, 2020 and incorporated herein by reference. |
| (17) | Filed as Exhibit 10.1 to the Form 8-K filed with the SEC on January 29, 2021 and incorporated herein by reference. |
*Indicates management contract or compensatory plan or arrangement.
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SIGNATURES
Pursuant to the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:
May 5, 2022 |
| /s/ Kevin J. McPhaill |
Date | SIERRA BANCORP | |
Kevin J. McPhaill | ||
President Chief Executive Officer | ||
(Principal Executive Officer) | ||
May 5, 2022 | /s/ Christopher G. Treece | |
Date | SIERRA BANCORP | |
Christopher G. Treece | ||
Chief Financial Officer | ||
May 5, 2022 | /s/ Cindy L. Dabney | |
Date | SIERRA BANCORP | |
Cindy L. Dabney | ||
Principal Accounting Officer |
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