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The purpose of this discussion is to focus on the important factors affecting the Company's financial condition, results of operations, liquidity and capital resources. This discussion should be read in conjunction with the Company's Consolidated Financial Statements and the Notes to the Consolidated Financial Statements presented in Part I, Item 1, Financial Statements, of this Form 10-Q and Item 8, Financial Statements and Supplementary Data, of the 2020 Form 10-K.
GENERAL
Eagle Financial Services, Inc. is a bank holding company which owns 100% of the stock ofBank of Clarke County (the "Bank" and collectively withEagle Financial Services, Inc. , the "Company"). Accordingly, the results of operations for the Company are dependent upon the operations of the Bank. The Bank conducts a commercial banking business which consists of attracting deposits from the general public and investing those funds in commercial, consumer and real estate loans and municipal andU.S. government agency securities. The Bank's deposits are insured by theFederal Deposit Insurance Corporation to the maximum extent permitted by law. AtMarch 31, 2021 , the Company had total assets of$1.18 billion , net loans of$867.2 million , total deposits of$1.07 billion , and shareholders' equity of$105.1 million . The Company's net income was$2.9 million for the three months endedMarch 31, 2021 .
COVID-19 and Related Response
The COVID-19 crisis has changed our communities, both in the way we live and the
way we do business. While circumstances continue to change at a rapid pace, the
Company is steadfastly working to meet and exceed the needs of its customers,
employees and the communities in which it does business. The Company, while
considered an essential business, has implemented procedures to protect its
employees, customers and the community and still serve their banking needs.
Branch lobbies are open, but with enhanced safety features for employees and
customers. Our customers also continue to conduct their business via automated
teller machines, online banking and our call center. Approximately 50% of our
employees are currently working from home with the remaining essential workers
showing up every day at our branches and operations centers. In efforts to
assist local businesses during this pandemic, the Company has approved 1,268
Small Business Association Paycheck Protection Program ("SBA PPP") loans,
totaling $126.5 million . The Company is also working with local small
businesses, consumers and other commercial customers through its loan deferral
program whereby customers experiencing hardships due to COVID-19 may be granted
a deferral in loan payments for up to six months. Since the first quarter of
2020, the Company approved 256 deferrals with current loan balances totaling
$127.5 million for its customers experiencing hardships related to COVID-19. As
of March 31, 2021 , 253 loans with loan balances totaling approximately $127.4
million had begun making payments on their loans after the deferral date had
passed.
MANAGEMENT'S STRATEGY
The Company strives to be an outstanding financial institution in its market by
building solid sustainable relationships with: (1) its customers, by providing
highly personalized customer service, a network of conveniently placed branches
and ATMs, a competitive variety of products/services and courteous, professional
employees, (2) its employees, by providing generous benefits, a positive work
environment, advancement opportunities and incentives to exceed expectations,
(3) its communities, by participating in local concerns, providing monetary
support, supporting employee volunteerism and providing employment
opportunities, and (4) its shareholders, by providing sound profits and returns,
sustainable growth, regular dividends and committing to its local, independent
status.
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OPERATING STRATEGY The Bank is a locally owned and managed financial institution. This allows the Bank to be flexible and responsive in the products and services it offers. The Bank grows primarily by lending funds to local residents and businesses at a competitive price that reflects the inherent risk of lending. The Bank attempts to fund these loans through deposits gathered from local residents and businesses. The Bank prices its deposits by comparing alternative sources of funds and selecting the lowest cost available. When deposits are not adequate to fund asset growth, the Bank relies on borrowings, both short and long term. The Bank's primary source of borrowed funds is theFederal Home Loan Bank of Atlanta which offers numerous terms and rate structures to the Bank. As interest rates change, the Bank attempts to maintain its net interest margin. This is accomplished by changing the price, terms, and mix of its financial assets and liabilities. The Bank also earns fees on services provided through its trust department, sales of investments through Eagle Investment Services, secondary market mortgage activities, and deposit operations. The Bank also incurs noninterest expenses such as compensating employees, maintaining and acquiring fixed assets, and purchasing goods and services necessary to support its daily operations. The Bank has a marketing department which seeks to develop new business. This is accomplished through an ongoing calling program whereby account officers visit with existing and potential customers to discuss the products and services offered. The Bank also utilizes traditional advertising such as television commercials, radio ads, newspaper ads, and billboards.
LENDING POLICIES
Administration and supervision over the lending process is provided by the Bank'sCredit Administration Department . The principal risk associated with the Bank's loan portfolio is the creditworthiness of its borrowers. In an effort to manage this risk, the Bank's policy gives loan amount approval limits to individual loan officers based on their position and level of experience. Credit risk is increased or decreased, depending on the type of loan and prevailing economic conditions. In consideration of the different types of loans in the portfolio, the risk associated with real estate mortgage loans, commercial loans and consumer loans varies based on employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay debt. The Company has written policies and procedures to help manage credit risk. The Company utilizes a loan review process that includes formulation of portfolio management strategy, guidelines for underwriting standards and risk assessment, procedures for ongoing identification and management of credit deterioration, and regular portfolio reviews to establish loss exposure and to ascertain compliance with the Company's policies. The Bank uses a tiered approach to approve credit requests consisting of individual lending authorities, joint approval of Category I officers, and a director loan committee. Lending limits for individuals are set by the Board of Directors and are determined by loan purpose, collateral type, and internal risk rating of the borrower. The highest individual authority (Category I) is assigned to the Bank's President / Chief Executive Officer, Chief Revenue Officer andChief Credit Officer (approval authority only). Two officers in Category I may combine their authority to approve loan requests to borrowers with credit exposure up to$10.0 million on a secured basis and$6.0 million unsecured; and the three Category I Officers can combine to approve loan requests to borrowers with credit exposure up to$15.0 million on a secured basis and$9.0 million unsecured. Officers in Category II, III, IV, V, VI and VII have lesser authorities and with approval of a Category I officer may extend loans to borrowers with exposure of$5.0 million on a secured basis and$3.0 million unsecured. Loans exceeding$15.0 million and up to the Bank's legal lending limit can be approved by the Director Loan Committee consisting of four directors (three directors constituting a quorum). The Director's Loan Committee also reviews and approves changes to the Bank's Loan Policy as presented by management. 29
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The following sections discuss the major loan categories within the total loan
portfolio:
One-to-Four-Family Residential Real Estate Lending
Residential lending activity may be generated by the Bank's loan officer solicitations, referrals by real estate professionals, and existing or new bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment and credit history of the applicant. The valuation of residential collateral is provided by independent fee appraisers who have been approved by the Bank's Directors Loan Committee. In connection with residential real estate loans, the Bank requires title insurance, hazard insurance and, if applicable, flood insurance. In addition to traditional residential mortgage loans secured by a first or junior lien on the property, the Bank offers home equity lines of credit.
Commercial Real Estate Lending
Commercial real estate loans are secured by various types of commercial real estate in the Bank's market area, including multi-family residential buildings, commercial buildings and offices, small shopping centers and churches. Commercial real estate loan originations are obtained through broker referrals, direct solicitation of developers and continued business from customers. In its underwriting of commercial real estate, the Bank's loan to original appraised value ratio is generally 80% or less. Commercial real estate lending entails significant additional risk as compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or the economy, in general. The Bank's commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower's creditworthiness, prior credit history and reputation, and the Bank typically requires personal guarantees or endorsements of the borrowers' principal owners.
Construction and Land Development Lending
The Bank makes local construction loans, primarily residential, and land
acquisition and development loans. The construction loans are secured by
residential houses under construction and the underlying land for which the loan
was obtained. The average life of most construction loans is less than one year
and the Bank offers both fixed and variable rate interest structures. The
interest rate structure offered to customers depends on the total amount of
these loans outstanding and the impact of the interest rate structure on the
Bank's overall interest rate risk. There are two characteristics of construction
lending which impact its overall risk as compared to residential mortgage
lending. First, there is more concentration risk due to the extension of a large
loan balance through several lines of credit to a single developer or
contractor. Second, there is more collateral risk due to the fact that loan
funds are provided to the borrower based upon the estimated value of the
collateral after completion. This could cause an inaccurate estimate of the
amount needed to complete construction or an excessive loan-to-value ratio. To
mitigate the risks associated with construction lending, the Bank generally
limits loan amounts to 80% of the estimated appraised value of the finished
construction project. The Bank also obtains a first lien on the property as
security for its construction loans and typically requires personal guarantees
from the borrower's principal owners. Finally, the Bank performs inspections of
the construction projects to ensure that the percentage of construction
completed correlates with the amount of draws on the construction line of
credit.
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Commercial and Industrial Lending
Commercial business loans generally have more risk than residential mortgage
loans, but have higher yields. To manage these risks, the Bank generally obtains
appropriate collateral and personal guarantees from the borrower's principal
owners and monitors the financial condition of its business borrowers.
Residential mortgage loans generally are made on the basis of the borrower's
ability to make repayment from employment and other income and are secured by
real estate whose value tends to be readily ascertainable. In contrast,
commercial business loans typically are made on the basis of the borrower's
ability to make repayment from cash flow from its business and are secured by
business assets, such as commercial real estate, accounts receivable, equipment
and inventory. As a result, the availability of funds for the repayment of
commercial business loans is substantially dependent on the success of the
business itself. Furthermore, the collateral for commercial business loans may
depreciate over time and generally cannot be appraised with as much precision as
residential real estate.
Consumer Lending
The Bank offers various secured and unsecured consumer loans, which include
personal installment loans, personal lines of credit, automobile loans, and
credit card loans. The Bank originates its consumer loans within its geographic
market area and these loans are generally made to customers with whom the Bank
has an existing relationship. Consumer loans generally entail greater risk than
residential mortgage loans, particularly in the case of consumer loans which are
unsecured or secured by rapidly depreciable assets such as automobiles. In such
cases, any repossessed collateral on a defaulted consumer loan may not provide
an adequate source of repayment of the outstanding loan balance as a result of
the greater likelihood of damage, loss or depreciation. Consumer loan
collections are dependent on the borrower's continuing financial stability, and
thus are more likely to be adversely affected by job loss, divorce, illness or
personal bankruptcy. Furthermore, the application of various federal and state
laws, including federal and state bankruptcy and insolvency laws, may limit the
amount which can be recovered on such loans.
The underwriting standards employed by the Bank for consumer loans include a
determination of the applicant's payment history on other debts and an
assessment of ability to meet existing obligations and payments on the proposed
loan. The stability of the applicant's monthly income may be determined by
verification of gross monthly income from primary employment, and from any
verifiable secondary income. Although creditworthiness of the applicant is the
primary consideration, the underwriting process also includes an analysis of the
value of the security in relation to the proposed loan amount.
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CRITICAL ACCOUNTING POLICIES The financial statements of the Company are prepared in accordance with accounting principles generally accepted inthe United States of America ("GAAP"). The financial information contained within these statements is, to a significant extent, based on measurements of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of the transactions would be the same, the timing of events that would impact the transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the probable losses inherent in
the Company's loan portfolio. As required by GAAP, the allowance for loan losses
is accrued when their occurrence is probable and they can be
estimated. Impairment losses are accrued based on the differences between the
loan balance and the value of its collateral, the present value of future cash
flows, or the price established in the secondary market. The Company's allowance
for loan losses has three basic components: the general allowance, the specific
allowance and the unallocated allowance. Each of these components is determined
based upon estimates that can and do change when actual events occur. The
general allowance uses historical experience and other qualitative factors to
estimate future losses and, as a result, the estimated amount of losses can
differ significantly from the actual amount of losses which would be incurred in
the future. However, the potential for significant differences is mitigated by
continuously updating the loss history of the Company. The specific allowance is
based upon the evaluation of specific impaired loans on which a loss may be
realized. Factors such as past due history, ability to pay, and collateral value
are used to identify those loans on which a loss may be realized. Each of these
loans is then evaluated to determine how much loss is estimated to be realized
on its disposition. The sum of the losses on the individual loans becomes the
Company's specific allowance. This process is inherently subjective and actual
losses may be greater than or less than the estimated specific allowance. The
unallocated allowance is due to imprecision in the model and for losses that are
not directly allocable to a specific loan type within the portfolio. As the
loans, which are affected by these events, are identified or losses are
experienced on the loans which are affected by these events, they will be
reflected within the specific or general allowances. Note 1 to the Consolidated
Financial Statements presented in Item 8, Financial Statements and Supplementary
Data, of the 2020 Form 10-K, provides additional information related to the
allowance for loan losses.
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FORWARD LOOKING STATEMENTS The Company makes forward looking statements in this report that are subject to risks and uncertainties. These forward looking statements include statements regarding our expectations, intentions or objectives concerning our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or other similar words or terms are intended to identify forward looking statements. These forward looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:
• the effects of the COVID-19 pandemic, including on the Company’s credit
quality and business operations, as well as its impact on general economic
and financial market conditions;
• the ability to successfully manage growth or implement growth strategies if
the Bank is unable to identify attractive markets, locations or
opportunities to expand in the future or if the Bank is unable to
successfully integrate new branches, business lines or other growth
opportunities into its existing operations;
• competition with other banks and financial institutions, and companies
outside of the banking industry, including those companies that have
substantially greater access to capital and other resources;
• the successful management of interest rate risk;
• risks inherent in making loans such as repayment risks and fluctuating
collateral values;
• changes in general economic and business conditions in the Bank’s market
area;
• reliance on the Bank’s management team, including the ability to attract and
retain key personnel; • changes in interest rates and interest rate policies; • maintaining capital levels adequate to support growth;
• maintaining cost controls and asset qualities as new branches are opened or
acquired; • demand, development and acceptance of new products and services; • problems with technology utilized by the Bank; • changing trends in customer profiles and behavior;
• changes in banking, tax and other laws and regulations and interpretations
or guidance thereunder; and
• other factors described in Item 1A., “Risk Factors,” in the Company’s 2020
Form10-K.
Because of these uncertainties, actual future results may be materially
different from the results indicated by these forward looking statements. In
addition, past results of operations do not necessarily indicate future results.
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RESULTS OF OPERATIONSNet Income
Net income for the three months ended
increase of 17.2% or
2020. Earnings per share, basic and diluted were
months ended
Return on average assets ("ROA") measures how efficiently the Company uses its
assets to produce net income. Some issues reflected within this efficiency
include the Company's asset mix, funding sources, pricing, fee generation, and
cost control. The ROA of the Company, on an annualized basis, for the three
months ended March 31, 2021 and 2020 was 1.02% and 1.10%, respectively.
Return on average equity ("ROE") measures the utilization of shareholders'
equity in generating net income. This measurement is affected by the same
factors as ROA with consideration to how much of the Company's assets are funded
by shareholders. The ROE of the Company, on an annualized basis, for the three
months ended March 31, 2021 and 2020 was 11.04% and 10.02%, respectively.
Net Interest Income
Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. Net interest income was$9.5 million and$8.0 million for the three months endedMarch 31, 2021 and 2020, respectively, which represents an increase of$1.5 million or 19.0%. Despite the decline in the interest rate environment, net interest income increased due to the increase in the average balance of the loan portfolio. Average interest earning assets increased$231.5 million when comparing the three months endedMarch 31, 2020 to the three months endedMarch 31, 2021 while the average yield on earning assets decreased by 58 basis points over that same period. This decrease in yield can be mostly attributed to the production of SBA PPP loans. BetweenMarch 31, 2020 andMarch 31, 2021 , the Company originated$126.5 million in these loans at an interest rate of 1.00%. This decrease in yield is partially offset by fee income on these loans. Fees are recognized through the net interest margin as loans are forgiven or repaid. Total interest income was$10.0 million and$9.1 million for the three months endedMarch 31, 2021 and 2020, respectively, which represents an increase of$909 thousand or 10.0%. The increase in interest income was driven by an increase in the average balance of the loan portfolio partially offset by the overall decrease in the interest rate environment during the reported time periods. As stated in the paragraph above, SBA PPP loans originated at a lower yield than the existing portfolio have contributed to this decrease in yield. Total interest expense was$487 thousand and$1.1 million for the three months endedMarch 31, 2021 and 2020, respectively, which represents a decrease of$615 thousand or 55.8%. The decrease in interest expense resulted from the reduction in interest rates paid on deposit accounts. The net interest margin was 3.62% and 3.86% for the three months endedMarch 31, 2021 and 2020, respectively. Tax-equivalent net interest income is calculated by adding the tax benefit on certain securities and loans, whose interest is tax-exempt, to total interest income then subtracting total interest expense. The tax rate used to calculate the tax benefit was 21% for 2021 and 2020.
Given the expectation of continued low interest rates and a flat yield curve,
net interest income and net interest margin could experience continued pressure.
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-------------------------------------------------------------------------------- The following table shows interest income on earning assets and related average yields as well as interest expense on interest-bearing liabilities and related average rates paid for the three months endedMarch 31, 2021 and 2020 (dollars in thousands): March 31, 2021 March 31, 2020 Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Assets: Balance Expense Rate (3) Balance Expense Rate (3) Securities: Taxable$ 144,177 $ 478 1.35 %$ 137,858 $ 914 2.67 % Tax-Exempt (1) 17,897 149 3.38 % 23,904 211 3.55 %Total Securities $ 162,074 $ 627 1.57 %$ 161,762 $ 1,125 2.80 % Loans: Taxable$ 840,368 $ 9,326 4.50 %$ 645,380 $ 7,850 4.89 % Non-accrual 4,581 - - % 2,049 - - % Tax-Exempt (1) 9,560 104 4.43 % 10,246 113 4.40 % Total Loans$ 854,509 $ 9,430 4.48 %$ 657,675 $ 7,963 4.87 % Federal funds sold 210 - 0.08 % 240 1 1.25 % Interest-bearing deposits in other banks 60,474 12 0.08 % 23,520 86 1.47 % Total earning assets (2)$ 1,072,686 $ 10,069 3.81 %$ 841,148 $ 9,175 4.39 % Allowance for loan losses (7,253 ) (5,422 ) Total non-earning assets 73,143 52,804 Total assets$ 1,138,576 $ 888,530 Liabilities and Shareholders' Equity: Interest-bearing deposits: NOW accounts$ 130,849 $ 74 0.23 %$ 100,540 $ 124 0.50 % Money market accounts 209,851 155 0.30 % 164,478 342 0.84 % Savings accounts 144,460 21 0.06 % 109,116 44 0.16 % Time deposits:$250,000 and more 68,478 153 0.90 % 77,181 371 1.93 % Less than$250,000 59,518 84 0.57 % 62,217 221 1.43 % Total interest-bearing deposits$ 613,156 $ 487 0.32 %$ 513,532 $ 1,102 0.86 % Federal funds purchased - - - % 1 - 0.80 % Total interest-bearing liabilities$ 613,156 $ 487 0.32 %$ 513,533 $ 1,102 0.86 % Noninterest-bearing liabilities: Demand deposits 408,015 267,560 Other Liabilities 12,309 9,485 Total liabilities$ 1,033,480 $ 790,578 Shareholders' equity 105,096 97,952 Total liabilities and shareholders' equity$ 1,138,576 $ 888,530 Net interest income$ 9,582 $ 8,073 Net interest spread 3.49 % 3.53 % Interest expense as a percent of average earning assets 0.18 % 0.53 % Net interest margin 3.62 % 3.86 %
(1) Income and yields are reported on a tax-equivalent basis using a federal tax
rate of 21%.
(2) Non-accrual loans are not included in this total since they are not
considered earning assets.
(3) Annualized.
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The following table reconciles tax-equivalent net interest income, which is not
a measurement under GAAP, to net interest income.
Three Months Ended
March 31,
2021 2020
(in thousands)
GAAP Financial Measurements:
Interest Income - Loans $ 9,408 $ 7,939
Interest Income - Securities and Other
Interest-Earnings Assets 608 1,168
Interest Expense - Deposits 487 1,102
Total Net Interest Income $ 9,529 $ 8,005
Non-GAAP Financial Measurements:
Add: Tax Benefit on Tax-Exempt Interest Income -
Loans (1) $ 22 $
24
Add: Tax Benefit on Tax-Exempt Interest Income - Securities (1) 31
44
Total Tax Benefit on Tax-Exempt Interest Income $ 53 $
68
Tax-Equivalent Net Interest Income $ 9,582 $ 8,073
(1) Tax benefit was calculated using the federal statutory tax rate of 21%.
The tax-equivalent yield on earning assets decreased from 4.39% to 3.81% for the three months endedMarch 31, 2020 and 2021, respectively. For those same time periods, the tax-equivalent yield on securities decreased 123 basis points. The tax equivalent yield on loans decreased 39 basis points from 4.87% for the three months endedMarch 31, 2020 to 4.48% for the same time period in 2021. The decrease in the tax-equivalent yield on earning assets for the three months endedMarch 31, 2021 resulted mostly from the decrease in the tax-equivalent yield on loans. The decrease in the yield on loans as compared to the corresponding period in the prior year was primarily due to SBA PPP loans originating at a lower yield than the existing portfolio as well as rate decreases during early 2020. Additionally, as securities are maturing and being called or sold, they are being replaced with securities at lower rates. The average rate on interest bearing liabilities decreased 54 basis points from 0.86% for the three months endedMarch 31, 2020 to 0.32% for the same time period in 2021.Federal Reserve Bank interest rate decreases during early 2020 drove a reduction in interest rates paid on deposit accounts, which resulted in a lower rate paid on interest bearing liabilities.
Provision for Loan Losses
The provision for loan losses is based upon management's estimate of the amount required to maintain an adequate allowance for loan losses as discussed within the Critical Accounting Policies section above. The allowance represents an amount that, in management's judgment, will be adequate to absorb probable losses inherent in the loan portfolio. Management's judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower's ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. The amount of provision for loan losses is affected by several factors including the growth rate of loans, net charge-offs (recoveries), and the estimated amount of inherent losses within the loan portfolio. The provision for (recovery of) loan losses for the three months endedMarch 31, 2021 and 2020 was$599 thousand and$(97) thousand , respectively. The provision for the three months endedMarch 31, 2021 resulted mostly from loan growth during the quarter. The negative provision during the quarter endedMarch 31, 2020 was mainly due to a large recovery received from a commercial loan that was charged off during 2019. 36
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Noninterest Income Total noninterest income for the three months endedMarch 31, 2021 was$2.4 million and$1.7 million , respectively. Management reviews the activities which generate noninterest income on an ongoing basis. The following table provides the components of noninterest income for the three months endedMarch 31, 2021 and 2020, which are included within the respective Consolidated Statements of Income headings. Variances that the Company believes require explanation are discussed below the table. Three Months Ended March 31, (dollars in thousands) 2021 2020 $ Change % Change Income from fiduciary activities$ 341 $ 297 $ 44 15 % Service charges on deposit accounts 217 284 (67 ) (24 )% Other service charges and fees 1,309 1,104 205 19 % Gain on sale of securities 76 - 76 NM Other operating income 484 5 479 9580 % Total noninterest income$ 2,427 $ 1,690 $ 737 44 % NM - Not Meaningful Income from fiduciary activities increased during the three months endedMarch 31, 2021 when compared to the same period in 2020. The majority of the increase is due to a one-time fee related to the settlement of a real estate transaction. The amount of income from fiduciary activities is primarily determined by the number of active accounts and total assets under management; accordingly, income also fluctuated due to changes in the market value of the assets under management. These fluctuations do not necessarily indicate future results. Services charges on deposit accounts decreased during the three months endedMarch 31, 2021 when compared to the same period in 2020. This decrease is mainly due to decreases in overdraft charges. Reduced overdraft charges can be attributed mostly to changes in customer activity during the COVID-19 pandemic. The amount of other services charges and fees is comprised primarily of commissions from the sale of non-deposit investment products, fees received from the Bank's credit card program, fees generated from the Bank's ATM/debit card programs, and fees generated from procuring applications for secondary market loans. Other service charges and fees increased during the three months endedMarch 31, 2021 when compared to the same periods in 2020. Fees generated from procuring applications for secondary market loans increased$102 thousand for 2021. This increase can be attributed to increased activity in the secondary market. In addition, this increase can be attributed to an increase in ATM fees. This fee income fluctuates due to ATM usage. Other operating income increased during the three months endedMarch 31, 2021 when compared to the same period in 2020. This increase can be mainly be attributed to cash distributions received from various investments of the Company. In addition, there was an increase in income from Bank Owned Life Insurance ("BOLI") investments. During 2020 the Company invested$12 million into BOLI. BOLI income for the three months endedMarch 31, 2021 was$105 thousand . There was no BOLI income recognized during quarter endedMarch 31, 2020 . 37
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Noninterest Expenses
Total noninterest expenses increased$1.0 million or 15.1% for the three months endedMarch 31, 2021 compared to the same period in 2020. The following table presents the components of noninterest expense for the three months endedMarch 31, 2021 and 2020, which are included within the respective Consolidated Statements of Income headings. Variances that the Company believes require explanation are discussed below the table. Three Months Ended March 31, (dollars in thousands) 2021 2020 $ Change % Change Salaries and employee benefits$ 4,716 $ 4,088 $ 628 15 % Occupancy expenses 456 395 61 15 % Equipment expenses 224 232 (8 ) (3 )% Advertising and marketing expenses 108 205 (97 ) (47 )% Stationary and supplies 38 32 6 19 % ATM network fees 250 242 8 3 % Other real estate owned expense (1 ) 2 (3 ) NM Loss (gain) on other real estate owned 10 (132 ) 142 NM FDIC assessment 107 - 107 #DIV/0 ! Computer software expense 189 120 69 58 % Bank franchise tax 189 174 15 9 % Professional fees 460 354 106 30 % Data processing fees 402 481 (79 ) (16 )% Other operating expenses 768 682 86 13 % Total noninterest expenses$ 7,916 $ 6,875 $ 1,041 15 % NM - Not Meaningful The COVID-19 pandemic has had and continues to have an impact on noninterest expenses. Decreases in expenses compared to the prior year were noted in advertising and marketing expenses. The decrease was due to adjustments in the timing of marketing promotions. Increases in computer software expenses in comparison to the prior year were largely due to software purchases to allow for remote work during the COVID-19 pandemic. Salaries and employee benefits increased during the three months endedMarch 31, 2021 over 2020. Annual pay increases, newly hired employees, increasing insurance costs and enhanced employee incentive plans have attributed to these increases. Occupancy expenses increased year over year due mostly to$27 thousand of snow removal costs incurred during the three months endedMarch 31, 2021 that were not incurred during the same period in 2020.FDIC assessment increased during the three months endedMarch 31, 2021 over 2020. The Company received notification of a Small Bank Credit Assessment for approximately$178 thousand during the second quarter of 2019. This credit was received because theDeposit Insurance Fund reserve ratio exceeded the established level as ofJune 30, 2019 . Credits were applied to the successive invoices in 2019 and 2020. There was no credit balance to apply to the assessment starting with the quarter endedSeptember 30, 2020 .
Professional fees increased during the three months ended
2020 due mainly to the increase in recruiting fees paid during those two
periods. In addition, increased legal fees were incurred during the first
quarter of 2021 related to increased lending activity.
Data processing fees decreased during the three months ended
2020 mainly due to fluctuations in activity levels of the customer base.
Other operating expenses increased during the three months endedMarch 31, 2021 over 2020. This increase is due primarily to increased loan related expenses due to a higher volume in the three months endedMarch 31, 2021 over 2020. 38 -------------------------------------------------------------------------------- The efficiency ratio of the Company was 66.25% and 71.77% for the three months endedMarch 31, 2021 and 2020, respectively. The efficiency ratio is not a measurement under accounting principles generally accepted inthe United States . It is calculated by dividing noninterest expense by the sum of tax equivalent net interest income and noninterest income excluding gains and losses on the investment portfolio and other gains/losses from OREO, repossessed vehicles, disposals of bank premises and equipment, etc. The tax rate utilized is 21%. The Company calculates and reviews this ratio as a means of evaluating operational efficiency. The calculation of the efficiency ratio for the three months endedMarch 31, 2021 and 2020 are as follows: Three Months Ended March 31, 2021 2020 (in thousands) Summary of Operating Results: Noninterest expenses$ 7,916 $ 6,875 Less: Loss (gain) on other real estate owned 10 (132 ) Adjusted noninterest expenses$ 7,906 $ 7,007 Net interest income 9,529 8,005 Noninterest income 2,427 1,690 Less: Gain (loss) on sales of securities 76
–
Adjusted noninterest income$ 2,351 $ 1,690 Tax equivalent adjustment (1) 53
68
Total net interest income and noninterest income, adjusted
$ 9,763 Efficiency ratio 66.25 % 71.77 %
(1) Includes tax-equivalent adjustments on loans and securities using the federal
statutory tax rate of 21%. Income Taxes Income tax expense was$579 thousand and$476 thousand during the three months endedMarch 31, 2021 and 2020, respectively. The effective tax rate was 16.83% and 16.30% for the three months endedMarch 31, 2021 and 2020, respectively. The effective tax rate is below the statutory rate of 21% due to tax-exempt income on investment securities and loans. The effective tax rate is also impacted by BOLI as well as income tax credits on qualified affordable housing project investments as discussed in Note 12 to the Consolidated Financial Statements as well as qualified rehabilitation credits.
FINANCIAL CONDITION
Securities
Total securities available for sale were$173.8 million atMarch 31, 2021 , compared to$165.0 million atDecember 31, 2020 . This represents an increase of$8.8 million or 5.31%. The Company purchased$32.4 million securities during the three months endedMarch 31, 2021 . The Company had total maturities, calls, and principal repayments of$17.5 million . There were$3.0 million sales during the three months endedMarch 31, 2021 . The Company did not have any securities from a single issuer, other thanU.S. government agencies, whose amount exceeded 10% of shareholders' equity atMarch 31, 2021 . Note 4 to the Consolidated Financial Statements provides additional details about the Company's securities portfolio atMarch 31, 2021 andDecember 31, 2020 . The Company had a net unrealized gain on available for sale securities of$1.4 million atMarch 31, 2021 as compared to a net unrealized gain of$4.2 million atDecember 31, 2020 . Unrealized gains or losses on available for sale securities are reported within shareholders' equity, net of the related deferred tax effect, as accumulated other comprehensive income. 39
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Loan Portfolio The Company's primary use of funds is supporting lending activities from which it derives the greatest amount of interest income. Gross loans were$875.0 million and$836.3 million atMarch 31, 2021 andDecember 31, 2020 , respectively. This represents an increase of$38.7 million or 4.62% during the three months endedMarch 31, 2021 . The ratio of gross loans to deposits increased very slightly during the three months endedMarch 31, 2021 from 81.85% atDecember 31, 2020 to 81.93% atMarch 31, 2021 . Loan growth excluding SBA PPP loans during the three months endedMarch 31, 2021 was$33.7 million or 4.46%. SBA PPP loans originated during 2020 and 2021 and outstanding as ofMarch 31, 2021 were$86.3 million . The loan portfolio consists primarily of loans for owner-occupied single family dwellings and loans secured by commercial real estate. Note 5 to the Consolidated Financial Statements provides the composition of the loan portfolio atMarch 31, 2021 andDecember 31, 2020 . Residential real estate loans were$269.4 million or 30.79% and$269.7 million or 32.25% of total loans atMarch 31, 2021 andDecember 31, 2020 , respectively. Commercial real estate loans were$340.7 million or 38.94% and$334.7 million or 40.02% of total loans atMarch 31, 2021 andDecember 31, 2020 , respectively. Construction, land development, and farmland loans were$61.2 million or 7.00% and$58.4 million or 6.98% of total loans atMarch 31, 2021 andDecember 31, 2020 , respectively. Consumer installment loans were$30.5 million or 3.48% and$21.3 million or 2.55% of total loans atMarch 31, 2021 andDecember 31, 2020 , respectively, representing an increase of$9.2 million or 42.98% during the three months endedMarch 31, 2021 . Commercial and industrial loans were$162.2 million or 18.54% and$140.8 million or 16.83% of total loans atMarch 31, 2021 andDecember 31, 2020 , respectively, representing an increase of$21.4 million or 15.25% during the three months endedMarch 31, 2021 . During the three months endedMarch 31, 2021 , loan growth was mainly concentrated in growth of our marine lending portfolio.
Allowance for Loan Losses
The purpose of, and the methods for, measuring the allowance for loan losses are discussed in the Critical Accounting Policies section above. Note 5 to the Consolidated Financial Statements shows the activity within the allowance for loan losses during the three months endedMarch 31, 2021 and 2020 and the year endedDecember 31, 2020 . Charged-off loans were$5 thousand and$67 thousand for the three months endedMarch 31, 2021 and 2020, respectively. Recoveries were$66 thousand and$578 thousand for the three months endedMarch 31, 2021 and 2020, respectively. This resulted in net recoveries of$61 thousand and$511 thousand for the three months endedMarch 31, 2021 and 2020, respectively. The Company collected a$459 thousand recovery during the first quarter of 2020 related to an$850 thousand commercial and industrial loan charge-off in 2019. The allowance for loan losses as a percentage of loans was 0.89% atMarch 31, 2021 and 0.85% atDecember 31, 2020 . Excluding outstanding PPP loans, the allowance for loan losses as a percentage of total loans was 0.98% and 0.94% as ofMarch 31, 2021 andDecember 31, 2020 , respectively. During the three months endedMarch 31, 2021 , loan growth was concentrated in mostly commercial and industrial loans as well as consumer loans. These two loan pools have a higher general allocation than certain other loan pools due to the inherent risk of the portfolio. This was the main cause of the increase in the allowance for loan losses as a percentage of loans. The allowance for loan losses was 179.82% of nonperforming loans atMarch 31, 2021 and 146.85% of nonperforming loans atDecember 31, 2020 . Refer to the Nonperforming Assets and Other Assets section on the following page for further discussion on nonperforming loans. 40 -------------------------------------------------------------------------------- All nonaccrual and other impaired loans were evaluated for impairment and any specific allocations were provided for as necessary. Based on management's evaluation and update of the Company's historical loss experience adjusted for qualitative factors assessed, the general reserve as a percentage of non-impaired loans increased from 0.85% atDecember 31, 2020 to 0.88% atMarch 31, 2021 . Management believes that the allowance for loan losses is currently adequate to absorb probable losses inherent in the loan portfolio. Management will continue to evaluate the adequacy of the allowance for loan losses as more economic data becomes available and as changes within the Company's portfolio are known. The effects of the pandemic may require the Company to fund increases in the allowance for loan losses in future periods.
Nonperforming Assets and Other Assets
Nonperforming assets consist of nonaccrual loans, repossessed assets, OREO (foreclosed properties), and loans past due 90 days or more and still accruing. Nonperforming assets decreased by$441 thousand during the three months endedMarch 31, 2021 . Nonaccrual loans were$4.3 million and$4.8 million atMarch 31, 2021 andDecember 31, 2020 . OREO was$515 thousand and$607 thousand atMarch 31, 2021 andDecember 31, 2020 , respectively. The Company held two properties in OREO with an average balance of$258 thousand atMarch 31, 2021 . The Company held three properties in OREO with an average balance of$202 thousand atDecember 31, 2020 . The percentage of nonperforming assets to loans and OREO was 0.55% atMarch 31, 2021 and 0.64% atDecember 31, 2020 , respectively. There were no loans past due 90 days or more and still accruing interest atMarch 31, 2021 andDecember 31, 2020 .
Total past due loans, as disclosed in note 5 to the Consolidated Financial
Statements, decreased to
million
During the three months endedMarch 31, 2021 , the Bank placed two loans with an outstanding balance of$190 thousand on nonaccrual status. During the same period, four loans with an outstanding balance of$435 thousand were paid off. Management evaluates the financial condition of borrowers and the value of any collateral on nonaccrual loans. The results of these evaluations are used to estimate the amount of losses which may be realized on the disposition of these nonaccrual loans and are reflected in the allowance for loan losses. Loans are placed on nonaccrual status when collection of principal and interest is doubtful, generally when a loan becomes 90 days past due. There are three negative implications for earnings when a loan is placed on non-accrual status. First, all interest accrued but unpaid at the date that the loan is placed on non-accrual status is either deducted from interest income or written off as a loss. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Finally, there may be actual losses to principal that require additional provisions for loan losses to be charged against earnings. For real estate loans, upon foreclosure, the balance of the loan is transferred to OREO and carried at the fair value of the property based on current appraisals and other current market trends, less estimated selling costs. If a write down of the OREO property is necessary at the time of foreclosure, the amount is charged-off to the allowance for loan losses. A review of the recorded property value is performed in conjunction with normal loan reviews, and if market conditions indicate that the recorded value exceeds the fair value, additional write downs of the property value are charged directly to operations. 41
-------------------------------------------------------------------------------- In addition, the Company may, under certain circumstances, restructure loans in troubled debt restructurings as a concession to a borrower when the borrower is experiencing financial distress. Formal, standardized loan restructuring programs are not utilized by the Company. Each loan considered for restructuring is evaluated based on customer circumstances and may include modifications to one or more loan provisions. Such restructured loans are included in impaired loans. However, restructured loans are not necessarily considered nonperforming assets. AtMarch 31, 2021 , the Company had$3.4 million in restructured loans with specific allowances totaling$83 thousand . AtDecember 31, 2020 , the Company had$3.3 million in restructured loans with specific allowances totaling$72 thousand . AtMarch 31, 2021 andDecember 31, 2020 , total restructured loans performing under the restructured terms and accruing interest were$2.6 million . Three loans, totaling$825 thousand , were in nonaccrual status atMarch 31, 2021 . Three loans, totaling$796 thousand , were in nonaccrual status atDecember 31, 2020 . As noted in Note 6 to the consolidated financial statements the Bank modified a significant number of loans during 2020 to allow for short-term payment deferrals. These loans were not considered TDRs based on the provisions of the CARES Act and interagency guidance issued.
Deposits
Total deposits were$1.07 billion and$1.01 billion atMarch 31, 2021 andDecember 31, 2020 , respectively. This represents an increase of$54.9 million or 5.42% during the three months endedMarch 31, 2021 . Note 7 to the Consolidated Financial Statements provides the composition of total deposits atMarch 31, 2021 andDecember 31, 2020 . The growth in deposits mainly reflected PPP loan proceeds being deposited into customers' accounts at the time the loans were originated and remaining on deposit as ofMarch 31, 2021 . Deposit growth, net of 2021 SBA PPP loan proceeds, was$24.4 million or 2.41%. Noninterest-bearing demand deposits, which are comprised of checking accounts, increased$27.7 million or 6.80% from$407.6 million atDecember 31, 2020 to$435.3 million atMarch 31, 2021 . Savings and interest-bearing demand deposits, which include NOW accounts, money market accounts and regular savings accounts increased$27.9 million or 5.85% from$476.9 million atDecember 31, 2020 to$504.8 million atMarch 31, 2021 . Savings and interest-bearing demand deposits included$37.0 million and$34.6 million in reciprocal ICS deposits atMarch 31, 2021 andDecember 31, 2020 , respectively. Time deposits decreased$740 thousand or 0.58% from$128.7 million atDecember 31, 2020 to$127.9 million atMarch 31, 2021 . CAPITAL RESOURCES The Bank continues to be a well capitalized financial institution. Total shareholders' equity atMarch 31, 2021 was$105.1 million , reflecting a percentage of total assets of 8.87%, as compared to$105.1 million and 9.08% atDecember 31, 2020 . During the three months endedMarch 31, 2021 and 2020, the Company declared dividends of$0.27 and$0.26 per share, respectively. The Company has a Dividend Investment Plan that allows shareholders to reinvest dividends in Company stock. AtMarch 31, 2021 , the Bank met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions. The Bank monitors these ratios on a quarterly basis and has several strategies, including without limitation the issuance of common stock, to ensure that these ratios remain above regulatory minimums. Federal regulatory risk-based capital guidelines require percentages to be applied to various assets, including off-balance sheet assets, based on their perceived risk in order to calculate risk-weighted assets. Tier 1 capital consists of total shareholders' equity less net unrealized gains and losses on available for sale securities and changes in the benefit obligations and plan assets for the post retirement benefit plan. Total capital is comprised of Tier 1 capital plus the allowable portion of the allowance for loan losses. 42 -------------------------------------------------------------------------------- For capital adequacy purposes financial institutions must maintain a Tier 1 common equity risk-based capital ratio of 4.50%, a Tier 1 risk-based capital ratio of at least 6.00%, a Total risk-based capital ratio of at least 8.00% and a minimum Tier 1 leverage ratio of 4.00%. The rules require the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer", (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer, (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer, and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets. The Bank's institution specific capital conservation buffer atMarch 31, 2021 andDecember 31, 2020 was 4.75% and 5.29%, respectively. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with any ratio (excluding the leverage ratio) above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall. The Bank's Tier 1 common risk-based capital ratio was 11.82% atMarch 31, 2021 as compared to 12.39% atDecember 31, 2020 . The Bank's Tier 1 risk-based capital ratio was 11.82% atMarch 31, 2021 as compared to 12.39% atDecember 31, 2020 . The Bank's total risk-based capital ratio was 12.75% atMarch 31, 2021 as compared to 13.29% atDecember 31, 2020 . The Bank's Tier 1 capital to average total assets ratio was 8.77% atMarch 31, 2021 as compared to 9.06% atDecember 31, 2020 . ThroughApril 30, 2021 , the Bank's capital ratios continued to exceed the regulatory minimums for well-capitalized institutions. We are closely monitoring our capital position and are taking appropriate steps to ensure our level of capital remains strong. Our capital, while significant, may fluctuate in future periods due to the effects of the pandemic and limit our ability to pay dividends. OnSeptember 17, 2019 , theFederal Deposit Insurance Corporation finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio or "CBLR" framework), as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework. In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than$10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. OnApril 6, 2020 , in a joint statement, theFDIC ,Federal Reserve and theOffice of Comptroller of the Currency ("OCC"), issued two interim final rules regarding temporary changes to the CBLR framework to implement provisions of the CARES Act. Under the interim final rules, the community bank leverage ratio will be reduced to 8 percent beginning in the second quarter and for the remainder of calendar year 2020, 8.5 percent for calendar year 2021, and 9 percent thereafter. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital. The CBLR framework was first available for banks to use beginning in theirMarch 31, 2020 , Call Report. The Bank did not opt into the CBLR framework as ofMarch 31, 2021 . 43
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LIQUIDITY Liquidity management involves meeting the present and future financial obligations of the Company with the sale or maturity of assets or with the occurrence of additional liabilities. Liquidity needs are met with cash on hand, deposits in banks, federal funds sold, securities classified as available for sale and loans maturing within one year. AtMarch 31, 2021 , liquid assets totaled$347.6 million as compared to$320.4 million atDecember 31, 2020 . These amounts represent 32.19% and 31.26% of total liabilities atMarch 31, 2021 andDecember 31, 2019 , respectively. The Company minimizes liquidity demand by utilizing core deposits to fund asset growth. Securities provide a constant source of liquidity through paydowns and maturities. Also, the Company maintains short-term borrowing arrangements, namely federal funds lines of credit, with larger financial institutions as an additional source of liquidity. The Bank's membership with theFederal Home Loan Bank of Atlanta provides a source of borrowings with numerous rate and term structures. InApril 2020 , theFederal Reserve initiated the Payment Protection Program Liquidity Facility ("PPPLF"), which is designed to facilitate lending by financial institutions to small businesses under the SBA PPP. Only SBA PPP loans are eligible to serve as collateral for the PPPLF. Although approved to use the PPPLF, as ofMarch 31, 2021 , the Company had not borrowed any funds via the PPPLF. The Company's senior management monitors the liquidity position regularly and attempts to maintain a position which utilizes available funds most efficiently. Our liquidity, while significant, may fluctuate in future periods due to the effects of the pandemic, funding of SBA PPP loans and deferral of loan payments.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
There have been no material changes in off-balance sheet arrangements and
contractual obligations as reported in the 2020 Form 10-K.
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