Southern First Bancshares Inc 10-Q for FY2022 Q3
Southern First Bancshares Inc (SFST)
About this 10-Q
Southern First Bancshares Inc filed this 10-Q on November 1, 2022, covering the quarter ended September 30, 2022 (FY2022 Q3).
Headline figures
Quarter ended September 30, 2022, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $1.23M
- down 56.5% from $2.83M a year earlier
- Net income
- $8.41M
- down 40.0% from net income of $14.02M a year earlier
- Diluted EPS
- $1.04
- down 40.6% from $1.75 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
For the Quarterly Period Ended
OR
For the Transition Period from
to
Commission file number
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. 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 | ||
| The |
Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 and posted 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 and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See 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 Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
September 30, 2022 Form 10-Q
INDEX
i
PART I. CONSOLIDATED FINANCIAL INFORMATION
Item 1. CONSOLIDATED FINANCIAL STATEMENTS
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
| September 30, | December 31, | |||||||
| (dollars in thousands, except share data) | 2022 | 2021 | ||||||
| (Unaudited) | (Audited) | |||||||
| ASSETS | ||||||||
| Cash and cash equivalents: | ||||||||
| Cash and due from banks | $ | |||||||
| Federal funds sold | ||||||||
| Interest-bearing deposits with banks | ||||||||
| Total cash and cash equivalents | ||||||||
| Investment securities: | ||||||||
| Investment securities available for sale | ||||||||
| Other investments | ||||||||
| Total investment securities | ||||||||
| Mortgage loans held for sale | ||||||||
| Loans | ||||||||
| Less allowance for credit losses | ( | ) | ( | ) | ||||
| Loans, net | ||||||||
| Bank owned life insurance | ||||||||
| Property and equipment, net | ||||||||
| Deferred income taxes, net | ||||||||
| Accrued interest receivable | ||||||||
| Other assets | ||||||||
| Total assets | $ | |||||||
| LIABILITIES | ||||||||
| Deposits | $ | |||||||
| FHLB advances and related debt | ||||||||
| Subordinated debentures | ||||||||
| Other liabilities | ||||||||
| Total liabilities | ||||||||
| SHAREHOLDERS’ EQUITY | ||||||||
| Preferred stock, par value $ | ||||||||
| Common stock, par value $ | ||||||||
| Nonvested restricted stock | ( | ) | ( | ) | ||||
| Additional paid-in capital | ||||||||
| Accumulated other comprehensive loss | ( | ) | ( | ) | ||||
| Retained earnings | ||||||||
| Total shareholders’ equity | ||||||||
| Total liabilities and shareholders’ equity | $ | |||||||
See notes to consolidated financial statements that are an integral part of these consolidated statements.
1
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
| For the three months | For the nine months | |||||||||||||||
| ended September 30, | ended September 30, | |||||||||||||||
| (dollars in thousands, except share data) | 2022 | 2021 | 2022 | 2021 | ||||||||||||
| Interest income | ||||||||||||||||
| Loans | $ | |||||||||||||||
| Investment securities | ||||||||||||||||
| Federal funds sold and interest-bearing deposits with banks | ||||||||||||||||
| Total interest income | ||||||||||||||||
| Interest expense | ||||||||||||||||
| Deposits | ||||||||||||||||
| Borrowings | ||||||||||||||||
| Total interest expense | ||||||||||||||||
| Net interest income | ||||||||||||||||
| Provision for (reversal of) credit losses | ( | ) | ( | ) | ||||||||||||
| Net interest income after provision for credit losses | ||||||||||||||||
| Noninterest income | ||||||||||||||||
| Mortgage banking income | ||||||||||||||||
| Service fees on deposit accounts | ||||||||||||||||
| ATM and debit card income | ||||||||||||||||
| Income from bank owned life insurance | ||||||||||||||||
| Net lender and referral fees on PPP loans | - | |||||||||||||||
| Loss on disposal of fixed assets | - | ( | ) | - | ||||||||||||
| Other income | ||||||||||||||||
| Total noninterest income | ||||||||||||||||
| Noninterest expenses | ||||||||||||||||
| Compensation and benefits | ||||||||||||||||
| Occupancy | ||||||||||||||||
| Other real estate owned (income) expenses | ( | ) | ||||||||||||||
| Outside service and data processing costs | ||||||||||||||||
| Insurance | ||||||||||||||||
| Professional fees | ||||||||||||||||
| Marketing | ||||||||||||||||
| Other | ||||||||||||||||
| Total noninterest expenses | ||||||||||||||||
| Income before income tax expense | ||||||||||||||||
| Income tax expense | ||||||||||||||||
| Net income | $ | |||||||||||||||
| Earnings per common share | ||||||||||||||||
| Basic | $ | |||||||||||||||
| Diluted | ||||||||||||||||
| Weighted average common shares outstanding | ||||||||||||||||
| Basic | ||||||||||||||||
| Diluted | ||||||||||||||||
See notes to consolidated financial statements that are an integral part of these consolidated statements.
2
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
| For the three months ended September 30, | For the nine months ended September 30, | |||||||||||||||
| (dollars in thousands) | 2022 | 2021 | 2022 | 2021 | ||||||||||||
| Net income | $ | |||||||||||||||
| Other comprehensive loss: | ||||||||||||||||
| Unrealized gain (loss) on securities available for sale: | ||||||||||||||||
| Unrealized holding gain (loss) arising during the period, pretax | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Tax benefit (expense) | ||||||||||||||||
| Reclassification of realized gain (loss) | - | ( | ) | |||||||||||||
| Tax benefit (expense) | - | |||||||||||||||
| Other comprehensive loss | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Comprehensive income | $ | |||||||||||||||
See notes to consolidated financial statements that are an integral part of these consolidated statements.
3
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited)
| For the three months ended September 30, | ||||||||||||||||||||||||||||||||||||
| Common stock | Preferred stock | Nonvested restricted | Additional paid-in | Accumulated other comprehensive | Retained | |||||||||||||||||||||||||||||||
| (dollars in thousands, except share data) | Shares | Amount | Shares | Amount | stock | capital | income (loss) | earnings | Total | |||||||||||||||||||||||||||
| June 30, 2021 | $ | $ | $ | ( | ) | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Net income | - | - | ||||||||||||||||||||||||||||||||||
| Proceeds from exercise of stock options | - | |||||||||||||||||||||||||||||||||||
| Issuance of restricted stock | - | ( | ) | |||||||||||||||||||||||||||||||||
| Compensation expense related to restricted stock, net of tax | - | - | ||||||||||||||||||||||||||||||||||
| Compensation expense related to stock options, net of tax | - | - | ||||||||||||||||||||||||||||||||||
| Other comprehensive loss | - | - | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| September 30, 2021 | $ | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | |||||||||||||||||||||||||
| June 30, 2022 | ( | ) | ( | ) | ||||||||||||||||||||||||||||||||
| Net income | - | - | ||||||||||||||||||||||||||||||||||
| Proceeds from exercise of stock options | ||||||||||||||||||||||||||||||||||||
| Issuance of restricted stock | - | ( | ) | |||||||||||||||||||||||||||||||||
| Compensation expense related to restricted stock, net of tax | - | - | ||||||||||||||||||||||||||||||||||
| Compensation expense related to stock options, net of tax | - | - | ||||||||||||||||||||||||||||||||||
| Other comprehensive loss | - | - | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| September 30, 2022 | $ | - | $ | - | $ | ( | ) | $ | $ | ( | ) | $ | $ | |||||||||||||||||||||||
For the nine months ended September 30, | ||||||||||||||||||||||||||||||||||||
| Common stock | Preferred stock | Nonvested restricted | Additional paid-in | Accumulated other comprehensive | Retained | |||||||||||||||||||||||||||||||
| (dollars in thousands, except share data) | Shares | Amount | Shares | Amount | stock | capital | income (loss) | earnings | Total | |||||||||||||||||||||||||||
| December 31, 2020 | $ | $ | $ | ( | ) | $ | $ | $ | $ | |||||||||||||||||||||||||||
| Net income | - | - | ||||||||||||||||||||||||||||||||||
| Proceeds from exercise of stock options | ||||||||||||||||||||||||||||||||||||
| Issuance of restricted stock | ( | ) | ||||||||||||||||||||||||||||||||||
| Compensation expense related to restricted stock, net of tax | - | - | ||||||||||||||||||||||||||||||||||
| Compensation expense related to stock options, net of tax | - | - | ||||||||||||||||||||||||||||||||||
| Other comprehensive loss | - | - | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| September 30, 2021 | $ | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | |||||||||||||||||||||||||
| December 31, 2021 | ( | ) | ( | ) | ||||||||||||||||||||||||||||||||
| Adoption of ASU 2016-13 | - | - | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| Net income | - | - | ||||||||||||||||||||||||||||||||||
| Proceeds from exercise of stock options | ||||||||||||||||||||||||||||||||||||
| Issuance of restricted stock | ( | ) | ||||||||||||||||||||||||||||||||||
| Compensation expense related to restricted stock, net of tax | - | - | ||||||||||||||||||||||||||||||||||
| Compensation expense related to stock options, net of tax | - | - | ||||||||||||||||||||||||||||||||||
| Other comprehensive loss | - | - | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| September 30, 2022 | $ | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | |||||||||||||||||||||||||
See notes to consolidated financial statements that are an integral part of these consolidated statements.
4
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
| For the nine months ended September 30, | ||||||||
| (dollars in thousands) | 2022 | 2021 | ||||||
| Operating activities | ||||||||
| Net income | $ | |||||||
| Adjustments to reconcile net income to cash provided by operating activities: | ||||||||
| Provision for (reversal of) credit losses | ( | ) | ||||||
| Depreciation and other amortization | ||||||||
| Accretion and amortization of securities discounts and premium, net | ||||||||
| Loss on sale of real estate owned | ||||||||
| (Gain) Loss on sale of fixed assets | ( | ) | ||||||
| Gain on sale of securities | ( | ) | ||||||
| Net change in operating leases | ||||||||
| Compensation expense related to stock options and restricted stock grants | ||||||||
| Gain on sale of loans held for sale | ( | ) | ( | ) | ||||
| Loans originated and held for sale | ( | ) | ( | ) | ||||
| Proceeds from sale of loans held for sale | ||||||||
| Increase in cash surrender value of bank owned life insurance | ( | ) | ( | ) | ||||
| Increase in deferred tax asset | ( | ) | ( | ) | ||||
| Decrease in other assets | ||||||||
| Increase in other liabilities | ( | ) | ||||||
| Net cash provided by operating activities | ||||||||
| Investing activities | ||||||||
| Increase (decrease) in cash realized from: | ||||||||
| Increase in loans, net | ( | ) | ( | ) | ||||
| Purchase of property and equipment | ( | ) | ( | ) | ||||
| Purchase of investment securities: | ||||||||
| Available for sale | ( | ) | ( | ) | ||||
| Other investments | ( | ) | ( | ) | ||||
| Payments and maturities, calls and repayments of investment securities: | ||||||||
| Available for sale | ||||||||
| Other investments | ||||||||
| Purchase of bank owned life insurance | ( | ) | ||||||
| Proceeds from sale of fixed assets | ||||||||
| Proceeds from sale of other real estate owned | ||||||||
| Net cash used for investing activities | ( | ) | ( | ) | ||||
| Financing activities | ||||||||
| Increase (decrease) in cash realized from: | ||||||||
| Increase in deposits, net | ||||||||
| Increase (decrease) in Federal Home Loan Bank advances and other borrowings, net | ( | ) | ||||||
| Proceeds from the exercise of stock options | ||||||||
| Net cash provided by financing activities | ||||||||
| Net decrease in cash and cash equivalents | ( | ) | ||||||
| Cash and cash equivalents at beginning of the period | ||||||||
| Cash and cash equivalents at end of the period | $ | |||||||
| Supplemental information | ||||||||
| Cash paid for | ||||||||
| Interest | $ | |||||||
| Income taxes | ||||||||
| Schedule of non-cash transactions | ||||||||
| Foreclosure of other real estate | ||||||||
| Unrealized loss on securities, net of income taxes | ( | ) | ( | ) | ||||
| Right-of-use assets obtained in exchange for lease obligations: | ||||||||
| Operating leases | ||||||||
See notes to consolidated financial statements that are an integral part of these consolidated statements.
5
SOUTHERN FIRST BANCSHARES, INC. AND SUBSIDIARY
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – Summary of Significant Accounting Policies
Nature of Business
Southern First Bancshares, Inc. (the “Company”) is a South Carolina corporation that owns all of the capital stock of Southern First Bank (the “Bank”) and all of the stock of Greenville First Statutory Trusts I and II (collectively, the “Trusts”). The Trusts are special purpose non-consolidated entities organized for the sole purpose of issuing trust preferred securities. The Bank’s primary federal regulator is the Federal Deposit Insurance Corporation (the “FDIC”). The Bank is also regulated and examined by the South Carolina Board of Financial Institutions. The Bank is primarily engaged in the business of accepting demand deposits and savings deposits insured by the FDIC, and providing commercial, consumer and mortgage loans to the general public.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three- and nine- month period ended September 30, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 as filed with the U.S. Securities and Exchange Commission (“SEC”) on March 4, 2022. The consolidated financial statements include the accounts of the Company and the Bank. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation,” the financial statements related to the Trusts have not been consolidated.
Business Segments
The Company, through the Bank, provides a broad range of financial services to individuals and companies in South Carolina, North Carolina, and Georgia. These services include demand, time and savings deposits; lending services; ATM processing and mortgage banking services. While the Company’s management periodically reviews limited production information for these revenue streams, that information is not complete as it does not include a full allocation of revenue, costs and capital from key corporate functions. Management will continue to evaluate these lines of business for separate reporting as facts and circumstances change. Accordingly, the Company’s various banking operations are not considered by management to constitute more than one reportable operating segment.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amount of income and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for credit losses, real estate acquired in the settlement of loans, fair value of financial instruments, evaluating other-than-temporary-impairment of investment securities and valuation of deferred tax assets.
Reclassifications
Certain amounts, previously reported, have been reclassified to state all periods on a comparable basis and had no effect on shareholders’ equity or net income.
Subsequent Events
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.
6
Adoption of New Accounting Standard
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326). The ASU introduces a new credit loss methodology, the Current Expected Credit Loss (“CECL”) methodology, which requires earlier recognition of credit losses, while also providing additional transparency about credit risk. Since its original issuance in 2016, the FASB has issued several updates to the original ASU.
The CECL methodology utilizes a lifetime “expected credit loss” measurement objective for the recognition of credit losses for loans, held-to-maturity securities and other receivables at the time the financial asset is originated or acquired. It also applies to off-balance sheet credit exposures, such as unfunded commitments to extend credit. The expected credit losses are adjusted each period for changes in expected lifetime credit losses. The methodology replaces the multiple existing impairment methods in current GAAP, which generally require that a loss be incurred before it is recognized. For available-for-sale securities where fair value is less than cost, credit-related impairment, if any, is recognized through an allowance for credit losses and adjusted each period for changes in credit risk.
On January 1, 2022, the Company adopted the guidance
prospectively with a cumulative adjustment to retained earnings. Results for reporting periods beginning after January 1, 2022 are presented
under CECL while prior period amounts continue to be reported in accordance with the previously applicable incurred loss accounting methodology.
The transition adjustment for the adoption of CECL included an increase in the allowance for credit losses on loans of $
Significant Accounting Policy Changes
Upon adoption of ASC 326, the Company revised the accounting policy for the Allowance for Credit Losses as detailed below.
Allowance for Credit Losses - Securities Available for Sale
For available for sale debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or if it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with the establishment of an allowance under CECL compared to a direct write down of the security under Incurred Loss. For debt securities available for sale that do not meet the aforementioned criteria, the Company evaluates whether any decline in fair value is due to credit loss factors. In making this assessment, management considers any changes to the rating of the security by a rating agency and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.
Changes in the allowance for credit losses under CECL are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the allowance when management believes the uncollectibility of an available-for-sale security is confirmed or when either of the criteria regarding intent or requirement to sell is met. At September 30, 2022, there was no allowance for credit losses related to the available-for-sale portfolio.
Accrued interest receivable on available for sale
debt securities totaled $
7
Allowance for Credit Losses - Loans
Under the current expected credit loss model, the allowance for credit losses on loans is a valuation allowance estimated at each balance sheet date in accordance with GAAP that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans.
Management assesses the adequacy of the allowance on a quarterly basis. This assessment includes procedures to estimate the allowance and test the adequacy and appropriateness of the resulting balance. The level of the allowance is based upon management’s evaluation of historical default and loss experience, current and projected economic conditions, asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay a loan, the estimated value of any underlying collateral, composition of the loan portfolio, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. Management believes the level of the allowance for credit losses is adequate to absorb all expected future losses inherent in the loan portfolio at the balance sheet date. The allowance is increased through provision for credit losses and decreased by charge-offs, net of recoveries of amounts previously charged-off.
The allowance for credit losses is measured on a collective basis for pools of loans with similar risk characteristics. The Company has identified the following pools of financial assets with similar risk characteristics for measuring expected credit losses:
Commercial loans
| ● | Owner occupied real estate - Owner occupied commercial mortgages consist of loans to purchase or re-finance owner occupied nonresidential properties. This includes office buildings, other commercial facilities, and farmland. Commercial mortgages secured by owner occupied properties are primarily dependent on the ability of borrowers to achieve business results consistent with those projected at loan origination. While these loans and leases are collateralized by real property in an effort to mitigate risk, it is possible the liquidation of collateral will not fully satisfy the obligation. |
| ● | Non-owner occupied real estate - Non-owner occupied commercial mortgages consist of loans to purchase or refinance investment nonresidential properties. This includes office buildings and other facilities rented or leased to unrelated parties, as well as farmland and multifamily properties. The primary risk associated with income producing commercial mortgage loans is the ability of the income-producing property that collateralizes the loan to produce adequate cash flow to service the debt. While these loans are collateralized by real property in an effort to mitigate risk, it is possible the liquidation of collateral will not fully satisfy the obligation. |
| ● | Construction - Construction loans consist of loans to finance land for development of commercial or residential real property and construction of multifamily apartments or other commercial properties. These loans are highly dependent on the supply and demand for commercial real estate as well as the demand for newly constructed residential homes and lots acquired for development. Deterioration in demand could result in decreased collateral values, which could make repayments of outstanding loans difficult for customers. |
| ● | Commercial business - Commercial business loans consist of loans or lines of credit to finance accounts receivable, inventory or other general business needs, business credit cards, and lease financing agreements for equipment, vehicles, or other assets. The primary risk associated with commercial and industrial and lease financing loans is the ability of borrowers to achieve business results consistent with those projected at origination. Failure to achieve these projections presents risk the borrower will be unable to service the debt consistent with the contractual terms of the loan. |
Consumer loans
| ● | Real estate - Residential mortgages consist of loans to purchase or refinance the borrower’s primary dwelling, second residence or vacation home and are often secured by 1-4 family residential property. Significant and rapid declines in real estate values can result in borrowers having debt levels in excess of the current market value of the collateral. |
8
| ● | Home equity – Home equity loans consist of home equity lines of credit and other lines of credit secured by first or second liens on the borrower’s primary residence. These loans are secured by both senior and junior liens on the residential real estate and are particularly susceptible to declining collateral values. This risk is elevated for loans secured by junior lines as a substantial decline in value could render the junior lien position effectively unsecured. |
| ● | Construction - Construction loans consist of loans to construct a borrower’s primary or secondary residence or vacant land upon which the owner intends to construct a dwelling at a future date. These loans are typically secured by undeveloped or partially developed land in anticipation of completing construction of a 1-4 family residential property. There is risk these construction and development projects can experience delays and cost overruns exceeding the borrower’s financial ability to complete the project. Such cost overruns can result in foreclosure of partially completed and unmarketable collateral. |
| ● | Other - Consumer loans consist of loans to finance unsecured home improvements, student loans, automobiles and revolving lines of credit that can be secured or unsecured. The value of the underlying collateral within this class is at risk of potential rapid depreciation which could result in unpaid balances in excess of the collateral. |
For all loan pools, the Company uses a lifetime probability of default and loss given default modeling approach to estimate the allowance for credit losses on loans. This method uses historical correlations between default experience and the age of loans to forecast defaults and losses, assuming that a loan in a pool shares similar risk characteristics such as loan product type, risk rating and loan age, and demonstrates similar default characteristics as other loans in that pool, as the loan progresses through its lifecycle. The Company calculates lifetime probability of default and loss given default rates based on historical loss experience, which is used to calculate expected losses based on the pool’s loss rate and the age of loans in the pool. Management believes that the Company’s historical loss experience provides the best basis for its assessment of expected credit losses to determine the allowance for credit losses. The Company uses its own internal data to measure historical credit loss experience within the pools with similar risk characteristics over an economic cycle. The probability of default and loss given default method also includes assumptions of observed migration over the lifetime of the underlying loan data.
Management also considers further adjustments to historical loss information for current conditions and reasonable and supportable forecasts that differ from the conditions that exist for the period over which historical information is evaluated as well as other changes in qualitative factors not inherently considered in the quantitative analyses. The qualitative categories and the measurements used to quantify the risks within each of these categories are subjectively selected by management, but measured by objective measurements period over period. The data for each measurement may be obtained from internal or external sources. The current period measurements are evaluated and assigned a factor commensurate with the current level of risk relative to past measurements over time. The resulting qualitative adjustments are applied to the relevant collectively evaluated loan pools. These adjustments are based upon quarterly trend assessments in certain economic factors as well as associate retention and turnover, portfolio concentrations, and growth characteristics. The qualitative analysis increases or decreases the allowance allocation for each loan pool based on the assessment of factors described above.
Loans that do not share similar risk characteristics with the collectively evaluated pools are evaluated on an individual basis and are excluded from the collectively evaluated loan pools. Individual loan evaluations are generally performed for impaired loans, which includes nonaccrual loans and loans modified in a troubled debt restructuring (“TDR”). Such loans are evaluated for credit losses based on either discounted cash flows or the fair value of collateral. The Company has elected the practical expedient under ASC 326 to estimate expected credit losses based on the fair value of collateral, which considers selling costs in the event sale of the collateral is expected. Loans for which terms have been modified in a TDR are evaluated using these same individual evaluation methods. In the event the discounted cash flow method is used for a TDR, the original interest rate is used to discount expected cash flows.
9
While the Company’s policies and procedures used to estimate the allowance for credit losses, as well as the resultant provision for credit losses charged to income, are considered adequate by management and are reviewed periodically by regulators, model validators and internal audit, they are necessarily approximate and imprecise. There are factors beyond the Company’s control, such as changes in projected economic conditions, real estate markets or particular industry conditions which may materially impact asset quality and the adequacy of the allowance for credit losses and thus the resulting provision for credit losses.
Accrued Interest Receivable
Accrued interest receivable related to loans totaled
$
Unfunded Commitments
Effective with the adoption of CECL, the Company estimates expected credit losses on commitments to extend credit over the contractual period in which the Company is exposed to credit risk on the underlying commitments, unless the obligation is unconditionally cancelable by the Company. The allowance for off-balance sheet credit exposures, which is reflected within other liabilities on the consolidated balance sheet, is adjusted for as an increase or decrease to the provision for credit losses. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to fund.
The Company’s CECL allowances will fluctuate over time due to macroeconomic conditions and forecasts as well as the size and composition of the loan portfolios.
Newly Issued, But Not Yet Effective Accounting Standards
In March 2022, the FASB amended the Receivables–Troubled Debt Restructuring by Creditors subtopic and Financial Instruments–Credit Losses subtopic to the Accounting Standards Codification. The amendments eliminate the accounting guidance for TDRs by creditors while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. In addition, for public business entities, the amendments require disclosure of current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20. The amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption of the amendments is permitted if ASU 2016-13 has been adopted, including adoption in an interim period. The Company does not expect these amendments to have a material effect on its financial statements.
10
NOTE 2 – Investment Securities
The amortized costs and fair value of investment securities are as follows:
| September 30, 2022 | ||||||||||||||||
| Amortized | Gross Unrealized | Fair | ||||||||||||||
| (dollars in thousands) | Cost | Gains | Losses | Value | ||||||||||||
| Available for sale | ||||||||||||||||
| Corporate bonds | $ | |||||||||||||||
| US treasuries | ||||||||||||||||
| US government agencies | ||||||||||||||||
| State and political subdivisions | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| FHLMC | ||||||||||||||||
| FNMA | ||||||||||||||||
| GNMA | ||||||||||||||||
| Total mortgage-backed securities | ||||||||||||||||
| Total investment securities available for sale | $ | |||||||||||||||
| December 31, 2021 | ||||||||||||||||
| Amortized | Gross Unrealized | Fair | ||||||||||||||
| Cost | Gains | Losses | Value | |||||||||||||
| Available for sale | ||||||||||||||||
| Corporate bonds | $ | |||||||||||||||
| US treasuries | ||||||||||||||||
| US government agencies | ||||||||||||||||
| SBA securities | ||||||||||||||||
| State and political subdivisions | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| FHLMC | ||||||||||||||||
| FNMA | ||||||||||||||||
| GNMA | ||||||||||||||||
| Total mortgage-backed securities | ||||||||||||||||
| Total investment securities available for sale | $ | |||||||||||||||
Contractual maturities and yields on the Company’s investment securities at September 30, 2022 and December 31, 2021 are shown in the following table. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
11
| September 30, 2022 | ||||||||||||||||||||||||||||||||||||||||
| Less than one year | One to five years | Five to ten years | Over ten years | Total | ||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | ||||||||||||||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||||||||||||||||||
| Corporate bonds | $ | % | % | |||||||||||||||||||||||||||||||||||||
| US treasuries | % | % | ||||||||||||||||||||||||||||||||||||||
| US government agencies | % | % | % | % | ||||||||||||||||||||||||||||||||||||
| State and political subdivisions | % | % | % | % | ||||||||||||||||||||||||||||||||||||
| Asset-backed securities | % | % | % | |||||||||||||||||||||||||||||||||||||
| Mortgage-backed securities | % | % | % | % | ||||||||||||||||||||||||||||||||||||
| Total investment securities | $ | % | % | % | % | |||||||||||||||||||||||||||||||||||
|
December 31, 2021 | ||||||||||||||||||||||||||||||||||||||||
| Less than one year | One to five years | Five to ten years | Over ten years | Total | ||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | Amount | Yield | ||||||||||||||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||||||||||||||||||
| Corporate bonds | $ | % | % | |||||||||||||||||||||||||||||||||||||
| US treasuries | % | % | ||||||||||||||||||||||||||||||||||||||
| US government agencies | % | % | % | % | ||||||||||||||||||||||||||||||||||||
| SBA securities | % | % | ||||||||||||||||||||||||||||||||||||||
| State and political subdivisions | % | % | % | % | ||||||||||||||||||||||||||||||||||||
| Asset-backed securities | % | % | % | |||||||||||||||||||||||||||||||||||||
| Mortgage-backed securities | % | % | % | % | % | |||||||||||||||||||||||||||||||||||
| Total investment securities | $ | % | % | % | % | % | ||||||||||||||||||||||||||||||||||
12
The tables below summarize gross unrealized losses on investment securities and the fair market value of the related securities at September 30, 2022 and December 31, 2021, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.
| September 30, 2022 | ||||||||||||||||||||||||||||||||||||
| Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | # | Fair value | Unrealized losses | # | Fair value | Unrealized losses | # | Fair value | Unrealized losses | |||||||||||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||||||||||||||
| Corporate bonds | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| US treasuries | ||||||||||||||||||||||||||||||||||||
| US government agencies | ||||||||||||||||||||||||||||||||||||
| State and political subdivisions | ||||||||||||||||||||||||||||||||||||
| Asset-backed | ||||||||||||||||||||||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||||||||||||||||||||||
| FHLMC | ||||||||||||||||||||||||||||||||||||
| FNMA | ||||||||||||||||||||||||||||||||||||
| GNMA | ||||||||||||||||||||||||||||||||||||
| Total investment securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||||||||||||||
| Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||||||||||||||
| (dollars in thousands) | # | Fair value | Unrealized losses | # | Fair value | Unrealized losses | # | Fair value | Unrealized losses | |||||||||||||||||||||||||||
| Available for sale | ||||||||||||||||||||||||||||||||||||
| Corporate bonds | $ | $ | - | $ | - | $ | - | $ | $ | |||||||||||||||||||||||||||
| US treasuries | - | - | - | |||||||||||||||||||||||||||||||||
| US government agencies | ||||||||||||||||||||||||||||||||||||
| State and political subdivisions | ||||||||||||||||||||||||||||||||||||
| Asset-backed | ||||||||||||||||||||||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||||||||||||||||||||||
| FHLMC | ||||||||||||||||||||||||||||||||||||
| FNMA | ||||||||||||||||||||||||||||||||||||
| GNMA | ||||||||||||||||||||||||||||||||||||
| Total investment securities | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
13
At
September 30, 2022 the Company had
Other investments are comprised of the following and are recorded at cost which approximates fair value.
| (dollars in thousands) | September 30, 2022 | December 31, 2021 | ||||||
| Federal Home Loan Bank stock | $ | |||||||
| Other nonmarketable investments | ||||||||
| Investment in Trust Preferred subsidiaries | ||||||||
| Total other investments | $ | |||||||
The Company has evaluated other investments for impairment and determined that the other investments are not impaired as of September 30, 2022 and that ultimate recoverability of the par value of the investments is probable. All of the FHLB stock is used to collateralize advances with the FHLB.
NOTE 3 – Mortgage Loans Held for Sale
Mortgage
loans originated and intended for sale in the secondary market are reported as loans held for sale and carried at fair value under the
fair value option with changes in fair value recognized in current period earnings. At the date of funding of the mortgage loan held
for sale, the funded amount of the loan, the related derivative asset or liability of the associated interest rate lock commitment, less
direct loan costs becomes the initial recorded investment in the loan held for sale. Such amount approximates the fair value of the loan.
At September 30, 2022, mortgage loans held for sale totaled $
NOTE 4 – Loans and Allowance for Credit Losses
The
following table summarizes the composition of our loan portfolio. Total gross loans are recorded net of deferred loan fees and costs,
which totaled $
| September 30, 2022 | December 31, 2021 | |||||||||||||||
| (dollars in thousands) | Amount | % of Total | Amount | % of Total | ||||||||||||
| Commercial | ||||||||||||||||
| Owner occupied RE | $ | % | $ | % | ||||||||||||
| Non-owner occupied RE | % | % | ||||||||||||||
| Construction | % | % | ||||||||||||||
| Business | % | % | ||||||||||||||
| Total commercial loans | % | % | ||||||||||||||
| Consumer | ||||||||||||||||
| Real estate | % | % | ||||||||||||||
| Home equity | % | % | ||||||||||||||
| Construction | % | % | ||||||||||||||
| Other | % | % | ||||||||||||||
| Total consumer loans | % | % | ||||||||||||||
| Total gross loans, net of deferred fees | % | % | ||||||||||||||
| Less—allowance for credit losses | ( | ) | ( | ) | ||||||||||||
| Total loans, net | $ | $ | ||||||||||||||
14
Maturities and Sensitivity of Loans to Changes in Interest Rates
The information in the following tables summarizes the loan maturity distribution by type and related interest rate characteristics based on the contractual maturities of individual loans, including loans which may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon maturity. Actual repayments of loans may differ from the maturities reflected below, because borrowers have the right to prepay obligations with or without prepayment penalties.
| September 30, 2022 | ||||||||||||||||||||
| (dollars in thousands) | One
year or less | After one but within five years | After five but within fifteen years | After fifteen years | Total | |||||||||||||||
| Commercial | ||||||||||||||||||||
| Owner occupied RE | $ | |||||||||||||||||||
| Non-owner occupied RE | ||||||||||||||||||||
| Construction | ||||||||||||||||||||
| Business | ||||||||||||||||||||
| Total commercial loans | ||||||||||||||||||||
| Consumer | ||||||||||||||||||||
| Real estate | $ | |||||||||||||||||||
| Home equity | ||||||||||||||||||||
| Construction | ||||||||||||||||||||
| Other | ||||||||||||||||||||
| Total consumer loans | ||||||||||||||||||||
| Total gross loans, net of deferred fees | $ | |||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||
| (dollars in thousands) | One year or less | After
one but within five years | After
five but within fifteen years | After fifteen years | Total | |||||||||||||||
| Commercial | ||||||||||||||||||||
| Owner occupied RE | $ | |||||||||||||||||||
| Non-owner occupied RE | ||||||||||||||||||||
| Construction | ||||||||||||||||||||
| Business | ||||||||||||||||||||
| Total commercial loans | ||||||||||||||||||||
| Consumer | ||||||||||||||||||||
| Real estate | ||||||||||||||||||||
| Home equity | ||||||||||||||||||||
| Construction | ||||||||||||||||||||
| Other | ||||||||||||||||||||
| Total consumer | ||||||||||||||||||||
| Total gross loan, net of deferred fees | $ | |||||||||||||||||||
15
The following table summarizes the loans due after one year by category.
| September 30, 2022 | December 31, 2021 | |||||||||||||||
| Interest Rate | Interest Rate | |||||||||||||||
| (dollars in thousands) | Fixed | Floating or Adjustable | Fixed | Floating or Adjustable | ||||||||||||
| Commercial | ||||||||||||||||
| Owner occupied RE | $ | |||||||||||||||
| Non-owner occupied RE | ||||||||||||||||
| Construction | ||||||||||||||||
| Business | ||||||||||||||||
| Total commercial loans | ||||||||||||||||
| Consumer | ||||||||||||||||
| Real estate | ||||||||||||||||
| Home equity | ||||||||||||||||
| Construction | ||||||||||||||||
| Other | ||||||||||||||||
| Total consumer loans | ||||||||||||||||
| Total gross loans, net of deferred fees | $ | |||||||||||||||
Credit Quality Indicators
The Company tracks credit quality based on its internal risk ratings. Upon origination, a loan is assigned an initial risk grade, which is generally based on several factors such as the borrower’s credit score, the loan-to-value ratio, the debt-to-income ratio, etc. After loans are initially graded, they are monitored regularly for credit quality based on many factors, such as payment history, the borrower’s financial status, and changes in collateral value. Loans can be downgraded or upgraded depending on management’s evaluation of these factors. Internal risk-grading policies are consistent throughout each loan type.
A description of the general characteristics of the risk grades is as follows:
| ● | Pass—These loans range from minimal to average credit risk however still have acceptable credit risk. Watch loans also fall into this category, representing loans with above average risk due to minor weaknesses and warrant closer scrutiny by management. |
| ● | Special mention—A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position at some future date. |
| ● | Substandard—A substandard loan is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that may jeopardize the liquidation of the debt. A substandard loan is characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. |
| ● | Doubtful—A doubtful loan has all of the weaknesses inherent in one classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of the currently existing facts, conditions and values, highly questionable and improbable. |
16
The following table presents loan balances classified by credit quality indicators by year of origination as of September 30, 2022.
| September 30, 2022 | ||||||||||||||||||||||||||||||||||||
| (dollars in thousands) | 2022 | 2021 | 2020 | 2019 | 2018 | Prior | Revolving | Revolving Converted to Term | Total | |||||||||||||||||||||||||||
| Commercial | ||||||||||||||||||||||||||||||||||||
| Owner occupied RE | ||||||||||||||||||||||||||||||||||||
| Pass | $ | |||||||||||||||||||||||||||||||||||
| Watch | ||||||||||||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Total Owner occupied RE | ||||||||||||||||||||||||||||||||||||
| Non-owner occupied RE | ||||||||||||||||||||||||||||||||||||
| Pass | ||||||||||||||||||||||||||||||||||||
| Watch | ||||||||||||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Total Non-owner occupied RE | ||||||||||||||||||||||||||||||||||||
| Construction | ||||||||||||||||||||||||||||||||||||
| Pass | ||||||||||||||||||||||||||||||||||||
| Watch | ||||||||||||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Total Construction | ||||||||||||||||||||||||||||||||||||
| Business | ||||||||||||||||||||||||||||||||||||
| Pass | ||||||||||||||||||||||||||||||||||||
| Watch | ||||||||||||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Total Business | ||||||||||||||||||||||||||||||||||||
| Total Commercial loans | ||||||||||||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||||||||||
| Real estate | ||||||||||||||||||||||||||||||||||||
| Pass | ||||||||||||||||||||||||||||||||||||
| Watch | ||||||||||||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Total Real estate | ||||||||||||||||||||||||||||||||||||
| Home equity | ||||||||||||||||||||||||||||||||||||
| Pass | ||||||||||||||||||||||||||||||||||||
| Watch | ||||||||||||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Total Home equity | ||||||||||||||||||||||||||||||||||||
| Construction | ||||||||||||||||||||||||||||||||||||
| Pass | ||||||||||||||||||||||||||||||||||||
| Watch | ||||||||||||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Total Construction | ||||||||||||||||||||||||||||||||||||
| Other | ||||||||||||||||||||||||||||||||||||
| Pass | ||||||||||||||||||||||||||||||||||||
| Watch | ||||||||||||||||||||||||||||||||||||
| Special Mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Total Other | ||||||||||||||||||||||||||||||||||||
| Total Consumer loans | ||||||||||||||||||||||||||||||||||||
| Total loans | $ | |||||||||||||||||||||||||||||||||||
17
The following table presents loan balances classified by credit quality indicators and loan categories as of December 31, 2021.
| December 31, 2021 | ||||||||||||||||||||||||||||||||||||
| Commercial | Consumer | |||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Owner occupied RE | Non-owner occupied RE | Construction | Business | Real Estate | Home Equity | Construction | Other | Total | |||||||||||||||||||||||||||
| Pass | $ | |||||||||||||||||||||||||||||||||||
| Special mention | ||||||||||||||||||||||||||||||||||||
| Substandard | ||||||||||||||||||||||||||||||||||||
| Total loans | $ | |||||||||||||||||||||||||||||||||||
The following tables present loan balances by payment status.
| September 30, 2022 | ||||||||||||||||||||||||
| (dollars in thousands) | Accruing 30-59 days past due | Accruing 60-89 days past due | Accruing 90 days or more past due | Nonaccrual loans | Accruing current | Total | ||||||||||||||||||
| Commercial | ||||||||||||||||||||||||
| Owner occupied RE | $ | |||||||||||||||||||||||
| Non-owner occupied RE | ||||||||||||||||||||||||
| Construction | ||||||||||||||||||||||||
| Business | ||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||
| Real estate | ||||||||||||||||||||||||
| Home equity | ||||||||||||||||||||||||
| Construction | ||||||||||||||||||||||||
| Other | ||||||||||||||||||||||||
| Total loans | $ | |||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||
| (dollars in thousands) | Accruing 30-59 days past due | Accruing 60-89 days past due | Accruing 90 days or more past due | Nonaccrual loans | Accruing current | Total | ||||||||||||||||||
| Commercial | ||||||||||||||||||||||||
| Owner occupied RE | $ | |||||||||||||||||||||||
| Non-owner occupied RE | ||||||||||||||||||||||||
| Construction | ||||||||||||||||||||||||
| Business | ||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||
| Real estate | ||||||||||||||||||||||||
| Home equity | ||||||||||||||||||||||||
| Construction | ||||||||||||||||||||||||
| Other | ||||||||||||||||||||||||
| Total loans | $ | |||||||||||||||||||||||
As
of September 30, 2022 and December 31, 2021, loans 30 days or more past due represented
Nonperforming assets
Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when the Company believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the contractual principal or interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received.
18
The following table shows the nonperforming assets and the related percentage of nonperforming assets to total assets and gross loans.
| (dollars in thousands) | September 30, 2022 | December 31, 2021 | ||||||
| Nonaccrual loans | $ | |||||||
| Nonaccruing TDRs | ||||||||
| Total nonaccrual loans, including nonaccruing TDRs | ||||||||
| Other real estate owned | ||||||||
| Total nonperforming assets | $ | |||||||
| Nonperforming assets as a percentage of: | ||||||||
| Total assets | % | % | ||||||
| Gross loans | % | % | ||||||
| Total loans over 90 days past due | $ | |||||||
| Loans over 90 days past due and still accruing | ||||||||
| Accruing troubled debt restructurings | ||||||||
The table below summarizes nonaccrual loans by major categories for the periods presented.
| CECL | Incurred loss | |||||||||||||||
| September 30, 2022 | December 31, 2021 | |||||||||||||||
| Nonaccrual | Nonaccrual | |||||||||||||||
| loans | loans | Total | Total | |||||||||||||
| with no | with an | nonaccrual | nonaccrual | |||||||||||||
| (dollars in thousands) | allowance | allowance | loans | loans | ||||||||||||
| Commercial | ||||||||||||||||
| Owner occupied RE | ||||||||||||||||
| Non-owner occupied RE | $ | |||||||||||||||
| Construction | ||||||||||||||||
| Business | - | |||||||||||||||
| Total commercial | ||||||||||||||||
| Consumer | ||||||||||||||||
| Real estate | - | |||||||||||||||
| Home equity | ||||||||||||||||
| Construction | ||||||||||||||||
| Other | - | |||||||||||||||
| Total consumer | ||||||||||||||||
| Total | $ | |||||||||||||||
19
The table below summarizes key information for loans individually evaluated for impairment loans under the incurred loss methodology. These loans include loans on nonaccrual status and loans modified in a TDR, whether on accrual or nonaccrual status. These loans may have estimated impairment which is included in the allowance for credit losses.
| December 31, 2021 | ||||||||||||||||||||
| Recorded investment | ||||||||||||||||||||
| Impaired loans | Impaired loans | |||||||||||||||||||
| Unpaid | with no related | with related | Related | |||||||||||||||||
| Principal | Impaired | allowance for | allowance for | allowance for | ||||||||||||||||
| (dollars in thousands) | Balance | loans | credit losses | credit losses | credit losses | |||||||||||||||
| Commercial | ||||||||||||||||||||
| Owner occupied RE | $ | |||||||||||||||||||
| Non-owner occupied RE | ||||||||||||||||||||
| Construction | ||||||||||||||||||||
| Business | ||||||||||||||||||||
| Total commercial | ||||||||||||||||||||
| Consumer | ||||||||||||||||||||
| Real estate | ||||||||||||||||||||
| Home equity | ||||||||||||||||||||
| Construction | ||||||||||||||||||||
| Other | ||||||||||||||||||||
| Total consumer | ||||||||||||||||||||
| Total gross loans | $ | |||||||||||||||||||
The following table provides the average recorded investment in individually assessed loans and the amount of interest income recognized on individually assessed loans after impairment by portfolio segment and class.
| Three months ended September 30, 2022 | Three months ended September 30, 2021 | |||||||||||||||
| (dollars in thousands) | Average recorded investment | Recognized interest income | Average recorded investment | Recognized interest income | ||||||||||||
| Commercial | ||||||||||||||||
| Owner occupied RE | $ | |||||||||||||||
| Non-owner occupied RE | ||||||||||||||||
| Construction | ||||||||||||||||
| Business | ||||||||||||||||
| Total commercial | ||||||||||||||||
| Consumer | ||||||||||||||||
| Real estate | ||||||||||||||||
| Home equity | ||||||||||||||||
| Construction | ||||||||||||||||
| Other | ||||||||||||||||
| Total consumer | ||||||||||||||||
| Total gross loans | $ | |||||||||||||||
20
| Nine months ended September 30, 2022 | Nine months ended September 30, 2021 | Year ended December 31, 2021 | ||||||||||||||||||||||
| (dollars in thousands) | Average recorded investment | Recognized interest income | Average recorded investment | Recognized interest income | Average recorded investment | Recognized interest income | ||||||||||||||||||
| Commercial | ||||||||||||||||||||||||
| Owner occupied RE | $ | |||||||||||||||||||||||
| Non-owner occupied RE | ||||||||||||||||||||||||
| Construction | ||||||||||||||||||||||||
| Business | ||||||||||||||||||||||||
| Total commercial | ||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||
| Real estate | ||||||||||||||||||||||||
| Home equity | ||||||||||||||||||||||||
| Construction | ||||||||||||||||||||||||
| Other | ||||||||||||||||||||||||
| Total consumer | ||||||||||||||||||||||||
| Total gross loans | $ | |||||||||||||||||||||||
Allowance for Credit Losses
The following table summarizes the activity related to the allowance for credit losses for the nine months ended September 30, 2022 under the CECL methodology.
| Three months ended September 30, 2022 | ||||||||||||||||||||||||||||||||||||
| Commercial | Consumer | |||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Owner occupied RE | Non- owner occupied RE | Construction | Business | Real Estate | Home Equity | Construction | Other | Total | |||||||||||||||||||||||||||
| Balance, beginning of period | $ | |||||||||||||||||||||||||||||||||||
| Provision for credit losses | ( | ) | ( | ) | ||||||||||||||||||||||||||||||||
| Loan charge-offs | ||||||||||||||||||||||||||||||||||||
| Loan recoveries | ||||||||||||||||||||||||||||||||||||
| Net loan recoveries (charge-offs) | ||||||||||||||||||||||||||||||||||||
| Balance, end of period | $ | |||||||||||||||||||||||||||||||||||
| Net charge-offs to average loans (annualized) | ( | %) | ||||||||||||||||||||||||||||||||||
| Allowance for credit losses to gross loans | % | |||||||||||||||||||||||||||||||||||
| Allowance for credit losses to nonperforming loans | % | |||||||||||||||||||||||||||||||||||
| Nine months ended September 30, 2022 | ||||||||||||||||||||||||||||||||||||
| Commercial | Consumer | |||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Owner occupied RE | Non- owner occupied RE | Construction | Business | Real Estate | Home Equity | Construction | Other | Total | |||||||||||||||||||||||||||
| Balance, beginning of period | $ | |||||||||||||||||||||||||||||||||||
| Adjustment for CECL | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| Provision for credit losses | ( | ) | ||||||||||||||||||||||||||||||||||
| Loan charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||||
| Loan recoveries | - | |||||||||||||||||||||||||||||||||||
| Net loan recoveries (charge-offs) | - | ( | ) | ( | ) | |||||||||||||||||||||||||||||||
| Balance, end of period | $ | |||||||||||||||||||||||||||||||||||
| Net charge-offs (recoveries) to average loans (annualized) | ( | %) | ||||||||||||||||||||||||||||||||||
| Allowance for credit losses to gross loans | % | |||||||||||||||||||||||||||||||||||
| Allowance for credit losses to nonperforming loans | % | |||||||||||||||||||||||||||||||||||
21
Prior to the adoption of ASC 326 on January 1, 2022, the Company calculated the allowance for loan losses under the incurred loss methodology. The following two tables are disclosures related to the allowance for loan losses in prior periods under this methodology.
| Three months ended September 30, 2021 | ||||||||||||||||||||||||||||||||||||
| Commercial | Consumer | |||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Owner occupied RE | Non- owner occupied RE | Construction | Business | Real Estate | Home equity | Construction | Other | Total | |||||||||||||||||||||||||||
| Balance, beginning of period | $ | |||||||||||||||||||||||||||||||||||
| Provision for loan losses | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||
| Loan charge-offs | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||||||
| Loan recoveries | ||||||||||||||||||||||||||||||||||||
| Net loan recoveries (charge-offs) | ( | ) | ( | ) | ||||||||||||||||||||||||||||||||
| Balance, end of period | $ | |||||||||||||||||||||||||||||||||||
| Net charge-offs (recoveries) to average loans (annualized) | ( | %) | ||||||||||||||||||||||||||||||||||
| Allowance for loan losses to gross loans | % | |||||||||||||||||||||||||||||||||||
| Allowance for loan losses to nonperforming loans | % | |||||||||||||||||||||||||||||||||||
| Nine months ended September 30, 2021 | ||||||||||||||||||||||||||||||||||||
| Commercial | Consumer | |||||||||||||||||||||||||||||||||||
| (dollars in thousands) | Owner occupied RE | Non- owner occupied RE | Construction | Business | Real Estate | Home Equity | Construction | Other | Total | |||||||||||||||||||||||||||
| Balance, beginning of period | $ | |||||||||||||||||||||||||||||||||||
| Provision for loan losses | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Loan charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||||
| Loan recoveries | ||||||||||||||||||||||||||||||||||||
| Net loan recoveries (charge-offs) | ( | ) | ||||||||||||||||||||||||||||||||||
| Balance, end of period | $ | |||||||||||||||||||||||||||||||||||
| Net charge-offs to average loans (annualized) | % | |||||||||||||||||||||||||||||||||||
The following table disaggregates the allowance for loan losses and recorded investment in loans by impairment methodology under the incurred loss methodology.
| December 31, 2021 | ||||||||||||||||||||||||
| Allowance for loan losses | Recorded investment in loans | |||||||||||||||||||||||
| (dollars in thousands) | Commercial | Consumer | Total | Commercial | Consumer | Total | ||||||||||||||||||
| Individually evaluated | $ | |||||||||||||||||||||||
| Collectively evaluated | ||||||||||||||||||||||||
| Total | $ | |||||||||||||||||||||||
| September 30, 2021 | ||||||||||||||||||||||||
| Allowance for loan losses | Recorded investment in loans | |||||||||||||||||||||||
| (dollars in thousands) | Commercial | Consumer | Total | Commercial | Consumer | Total | ||||||||||||||||||
| Individually evaluated | $ | |||||||||||||||||||||||
| Collectively evaluated | ||||||||||||||||||||||||
| Total | $ | |||||||||||||||||||||||
Collateral dependent loans are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty. The Company reviews individually evaluated loans for designation as collateral dependent loans, as well as other loans that management of the Company designates as having higher risk. These loans do not share common risk characteristics and are not included within the collectively evaluated loans for determining the allowance for credit losses.
22
The following table presents an analysis of collateral-dependent loans of the Company as of September 30, 2022.
| September 30, 2022 | ||||||||||||||||
| Real | Business | |||||||||||||||
| (dollars in thousands) | estate | assets | Other | Total | ||||||||||||
| Commercial | ||||||||||||||||
| Owner occupied RE | $ | |||||||||||||||
| Non-owner occupied RE | ||||||||||||||||
| Construction | ||||||||||||||||
| Business | ||||||||||||||||
| Total commercial | ||||||||||||||||
| Consumer | ||||||||||||||||
| Real estate | ||||||||||||||||
| Home equity | ||||||||||||||||
| Construction | ||||||||||||||||
| Other | ||||||||||||||||
| Total consumer | ||||||||||||||||
| Total | $ | |||||||||||||||
Under CECL, for collateral dependent loans, the Company has adopted the practical expedient to measure the allowance for credit losses based on the fair value of collateral. The allowance for credit losses is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral, which is adjusted for liquidation costs/discounts, and amortized cost. If the fair value of the collateral exceeds the amortized cost, no allowance is required.
Allowance for Credit Losses - Unfunded Loan Commitments
The allowance for credit losses for unfunded loan
commitments was $
| Three months ended | Nine months ended | |||||||
| (dollars in thousands) | September 30, 2022 | September 30, 2022 | ||||||
| Balance, beginning of period | $ | |||||||
| Adjustment for adoption of CECL | ||||||||
| Provision for loan losses | ||||||||
| Balance, end of period | $ | |||||||
| Unfunded Loan Commitments | ||||||||
| Reserve for Unfunded Commitments to Unfunded Loan Commitments | % | |||||||
NOTE 5 – Troubled Debt Restructurings
At September 30, 2022, the Company had
There were three loans considered new
TDRs during the three and nine months ended September 30, 2022. There was
As of September 30, 2022 and 2021, there were no
loans modified as a TDR for which there was a payment default (
23
NOTE 6 – Derivative Financial Instruments
The Company utilizes derivative financial instruments primarily to hedge its exposure to changes in interest rates. All derivative financial instruments are recognized as either assets or liabilities and measured at fair value. The Company accounts for all of its derivatives as free-standing derivatives and does not designate any of these instruments for hedge accounting. Therefore, the gain or loss resulting from the change in the fair value of the derivative is recognized in the Company’s statement of income during the period of change.
The Company enters into commitments to originate residential mortgage loans held for sale, at specified interest rates and within a specified period of time, with clients who have applied for a loan and meet certain credit and underwriting criteria (interest rate lock commitments). These interest rate lock commitments (“IRLCs”) meet the definition of a derivative financial instrument and are reflected in the balance sheet at fair value with changes in fair value recognized in current period earnings. Unrealized gains and losses on the IRLCs are recorded as derivative assets and derivative liabilities, respectively, and are measured based on the value of the underlying mortgage loan, quoted mortgage-backed securities (“MBS”) prices and an estimate of the probability that the mortgage loan will fund within the terms of the interest rate lock commitment, net of estimated commission expenses.
The Company manages the interest rate and price risk associated with its outstanding IRLCs and mortgage loans held for sale by entering into derivative instruments such as forward sales of MBS. Management expects these derivatives will experience changes in fair value opposite to changes in fair value of the IRLCs and mortgage loans held for sale, thereby reducing earnings volatility. The Company takes into account various factors and strategies in determining the portion of the mortgage pipeline (IRLCs and mortgage loans held for sale) it wants to economically hedge.
The following table summarizes the Company’s outstanding financial derivative instruments at September 30, 2022 and December 31, 2021.
| September 30, 2022 | ||||||||||
| Fair Value | ||||||||||
| (dollars in thousands) | Notional | Balance Sheet Location | Asset/(Liability) | |||||||
| Mortgage loan interest rate lock commitments | $ | $ | ( | ) | ||||||
| MBS forward sales commitments | ||||||||||
| Total derivative financial instruments | $ | $ | ||||||||
| December 31, 2021 | ||||||||||
| Fair Value | ||||||||||
| (dollars in thousands) | Notional | Balance Sheet Location | Asset/(Liability) | |||||||
| Mortgage loan interest rate lock commitments | $ | $ | ||||||||
| MBS forward sales commitments | ( | ) | ||||||||
| Total derivative financial instruments | $ | $ | ||||||||
NOTE 7 – Fair Value Accounting
FASB ASC 820, “Fair Value Measurement and Disclosures,” defines fair value 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. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1 – Quoted market price in active markets
Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include certain debt and equity securities that are traded in an active exchange market.
24
Level 2 – Significant other observable inputs
Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include fixed income securities and mortgage-backed securities that are held in the Company’s available-for-sale portfolio and valued by a third-party pricing service, as well as certain impaired loans.
Level 3 – Significant unobservable inputs
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. These methodologies may result in a significant portion of the fair value being derived from unobservable data.
The methods of determining the fair value of assets and liabilities presented in this note are consistent with our methodologies disclosed in Note 14 of the Company’s 2021 Annual Report on Form 10-K. The Company’s loan portfolio is initially fair valued using a segmented approach, using the eight categories of loans as disclosed in Note 4 – Loans and Allowance for Credit Losses. Loans are considered a Level 3 classification.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis as of September 30, 2022 and December 31, 2021.
| September 30, 2022 | ||||||||||||||||
| (dollars in thousands) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Assets | ||||||||||||||||
| Securities available for sale | ||||||||||||||||
| Corporate bonds | $ | |||||||||||||||
| US treasuries | ||||||||||||||||
| US government agencies | ||||||||||||||||
| State and political subdivisions | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| Mortgage loans held for sale | ||||||||||||||||
| MBS forward sales commitments | ||||||||||||||||
| Total assets measured at fair value on a recurring basis | $ | |||||||||||||||
| Liabilities | ||||||||||||||||
| Mortgage loan interest rate lock commitments | $ | |||||||||||||||
| Total liabilities measured at fair value on a recurring basis | $ | |||||||||||||||
25
| December 31, 2021 | ||||||||||||||||
| (dollars in thousands) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Assets | ||||||||||||||||
| Securities available for sale: | ||||||||||||||||
| Corporate bonds | $ | |||||||||||||||
| US treasuries | ||||||||||||||||
| US government agencies | ||||||||||||||||
| SBA securities | ||||||||||||||||
| State and political subdivisions | ||||||||||||||||
| Asset-backed securities | ||||||||||||||||
| Mortgage-backed securities | ||||||||||||||||
| Mortgage loans held for sale | ||||||||||||||||
| Mortgage loan interest rate lock commitments | ||||||||||||||||
| Total assets measured at fair value on a recurring basis | $ | |||||||||||||||
| Liabilities | ||||||||||||||||
| MBS forward sales commitments | $ | |||||||||||||||
| Total liabilities measured at fair value on a recurring basis | $ | |||||||||||||||
Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis
The tables below present the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis as of September 30, 2022 and December 31, 2021.
| As of September 30, 2022 | ||||||||||||||||
| (dollars in thousands) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Assets | ||||||||||||||||
| Individually assessed loans | $ | |||||||||||||||
| Total assets measured at fair value on a nonrecurring basis | $ | |||||||||||||||
| As of December 31, 2021 | ||||||||||||||||
| (dollars in thousands) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
| Assets | ||||||||||||||||
| Impaired loans | $ | |||||||||||||||
| Total assets measured at fair value on a nonrecurring basis | $ | |||||||||||||||
The Company had no liabilities carried at fair value or measured at fair value on a nonrecurring basis.
Fair Value of Financial Instruments
Financial instruments require disclosure of fair value information, whether or not recognized in the consolidated balance sheets, when it is practical to estimate the fair value. A financial instrument is defined as cash, evidence of an ownership interest in an entity or a contractual obligation which requires the exchange of cash. Certain items are specifically excluded from the disclosure requirements, including the Company’s common stock, premises and equipment and other assets and liabilities.
26
The estimated fair values of the Company’s financial instruments at September 30, 2022 and December 31, 2021 are as follows:
| September 30, 2022 | ||||||||||||||||||||
| (dollars in thousands) | Carrying Amount | Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||||
| Financial Assets: | ||||||||||||||||||||
| Other investments, at cost | $ | |||||||||||||||||||
| Loans1 | ||||||||||||||||||||
| Financial Liabilities: | ||||||||||||||||||||
| Deposits | ||||||||||||||||||||
| Subordinated debentures | ||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||
| (dollars in thousands) | Carrying Amount | Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||||
| Financial Assets: | ||||||||||||||||||||
| Other investments, at cost | $ | |||||||||||||||||||
| Loans1 | ||||||||||||||||||||
| Financial Liabilities: | ||||||||||||||||||||
| Deposits | ||||||||||||||||||||
| Subordinated debentures | ||||||||||||||||||||
| 1 | Carrying amount is net of the allowance for credit losses or loan losses, as applicable, and previously presented individually assessed or impaired loans. |
NOTE 8 – Leases
The Company enters into leases in the normal course
of business. As of September 30, 2022, we leased six of our offices under various operating lease agreements. All of our leases are operating
leases under applicable accounting standards and the lease agreements have maturity dates ranging from August 2028 to February 2032, some
of which include options for multiple five-year extensions. The weighted average remaining life of the lease term for these leases was
The discount rate used in determining the lease
liability for each individual lease was the FHLB fixed advance rate which corresponded with the remaining lease term at implementation
of the accounting standard and as of the lease commencement date for leases subsequently entered into. The weighted average discount rate
for leases was
The total operating lease costs were $
27
Maturities of lease liabilities as of September 30, 2022 were as follows:
| Operating | ||||
| (dollars in thousands) | Leases | |||
| 2022 | $ | |||
| 2023 | ||||
| 2024 | ||||
| 2025 | ||||
| 2026 | ||||
| Thereafter | ||||
| Total undiscounted lease payments | ||||
| Discount effect of cash flows | ||||
| Total lease liability | $ | |||
NOTE 9 – Earnings Per Common Share
The following schedule reconciles the numerators
and denominators of the basic and diluted earnings per share computations for the three- and nine- month periods ended September 30, 2022
and 2021. Dilutive common shares arise from the potentially dilutive effect of the Company’s stock options that were outstanding
at September 30, 2022. The assumed conversion of stock options can create a difference between basic and dilutive net income per common
share. At September 30, 2022 and 2021, there were
| Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
| (dollars in thousands, except share data) | 2022 | 2021 | 2022 | 2021 | ||||||||||||
| Numerator: | ||||||||||||||||
| Net income available to common shareholders | $ | |||||||||||||||
| Denominator: | ||||||||||||||||
| Weighted-average common shares outstanding – basic | ||||||||||||||||
| Common stock equivalents | ||||||||||||||||
| Weighted-average common shares outstanding – diluted | ||||||||||||||||
| Earnings per common share: | ||||||||||||||||
| Basic | $ | |||||||||||||||
| Diluted | $ | |||||||||||||||
28
Item 2. MANAGEMENT’S DISCUSSION AND Analysis of Financial Condition and Results of Operations.
The following discussion reviews our results of operations for the three and nine month periods ended September 30, 2022 as compared to the three and nine month periods ended September 30, 2021 and assesses our financial condition as of September 30, 2022 as compared to December 31, 2021. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements and the related notes and the consolidated financial statements and the related notes for the year ended December 31, 2021 included in our Annual Report on Form 10-K for that period. Results for the three and nine month periods ended September 30, 2022 are not necessarily indicative of the results for the year ending December 31, 2022 or any future period.
Unless the context requires otherwise, references to the “Company,” “we,” “us,” “our,” or similar references mean Southern First Bancshares, Inc. and its consolidated subsidiary. References to the “Bank” refer to Southern First Bank.
Cautionary Warning Regarding forward-looking statements
This report contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements may relate to our financial condition, results of operations, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “seek to,” “strive,” “focus,” “expect,” “anticipate,” “predict,” “project,” “potential,” “believe,” “continue,” “assume,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to:
| ● | Changes in the interest rate environment which could reduce anticipated or actual margins; |
| ● | Restrictions or conditions imposed by our regulators on our operations; |
| ● | Increases in competitive pressure in the banking and financial services industries; |
| ● | Changes in access to funding or increased regulatory requirements with regard to funding, which could impair our liquidity; |
| ● | Changes in deposit flows, which may be negatively affected by a number of factors, including rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to clients on alternative investments and general economic conditions; |
| ● | Credit losses as a result of declining real estate values, increasing interest rates, increasing unemployment, changes in payment behavior or other factors; |
| ● | Credit losses due to loan concentration; |
| ● | Changes in the amount of our loan portfolio collateralized by real estate and weaknesses in the real estate market; |
| ● | Our ability to successfully execute our business strategy; |
| ● | Our ability to attract and retain key personnel; |
| ● | The success and costs of our expansion into the Charlotte, North Carolina, Greensboro, North Carolina and Atlanta, Georgia markets and into potential new markets; |
| ● | Risks with respect to future mergers or acquisitions, including our ability to successfully expand and integrate the businesses and operations that we acquire and realize the anticipated benefits of the mergers or acquisitions; |
| ● | Changes in political conditions or the legislative or regulatory environment, including new governmental initiatives affecting the financial services industry; |
| ● | Changes in economic conditions resulting in, among other things, a deterioration in credit quality; |
| ● | Changes occurring in business conditions and inflation; |
| ● | Increased cybersecurity risk, including potential business disruptions or financial losses; |
| ● | Changes in technology; |
| ● | The adequacy of the level of our allowance for credit losses and the amount of loan loss provisions required in future periods; |
| ● | Examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for credit losses or write-down assets; |
| ● | Changes in monetary and tax policies; |
| ● | The rate of delinquencies and amounts of loans charged-off; |
| ● | The rate of loan growth in recent years and the lack of seasoning of a portion of our loan portfolio; |
29
| ● | Our ability to maintain appropriate levels of capital and to comply with our capital ratio requirements; |
| ● | Adverse changes in asset quality and resulting credit risk-related losses and expenses; |
| ● | Changes in accounting standards, rules and interpretations and the related impact on our financial statements, including the effects from our adoption of the current expected credit losses (“CECL”) model on January 1, 2022; |
| ● | Risks associated with actual or potential litigation or investigations by customers, regulatory agencies or others; |
| ● | Adverse effects of failures by our vendors to provide agreed upon services in the manner and at the cost agreed; |
| ● | The potential effects of events beyond our control that may have a destabilizing effect on financial markets and the economy, such as epidemics and pandemics (including COVID-19), war or terrorist activities, disruptions in our customers’ supply chains, disruptions in transportation, essential utility outages or trade disputes and related tariffs; and |
| ● | Other risks and uncertainties detailed in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2021, in Part II, Item 1A, “Risk Factors” of our Quarterly Reports on Form 10-Q, and in our other filings with the SEC. |
If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking statements proves to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q. We make these forward-looking statements as of the date of this document and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those expressed in, or implied or projected by, the forward-looking statements, except as required by law.
OVERVIEW
Our business model continues to be client-focused, utilizing relationship teams to provide our clients with a specific banker contact and support team responsible for all of their banking needs. The purpose of this structure is to provide a consistent and superior level of professional service, and we believe it provides us with a distinct competitive advantage. We consider exceptional client service to be a critical part of our culture, which we refer to as “ClientFIRST.”
At September 30, 2022, we had total assets of $3.44 billion, a 17.6% increase from total assets of $2.93 billion at December 31, 2021. The largest component of our total assets is loans which were $3.03 billion and $2.49 billion at September 30, 2022 and December 31, 2021, respectively. Our liabilities and shareholders’ equity at September 30, 2022 totaled $3.15 billion and $287.8 million, respectively, compared to liabilities of $2.65 billion and shareholders’ equity of $277.9 million at December 31, 2021. The principal component of our liabilities is deposits which were $3.00 billion and $2.56 billion at September 30, 2022 and December 31, 2021, respectively.
Like most community banks, we derive the majority of our income from interest received on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread. In addition to earning interest on our loans and investments, we earn income through fees and other charges to our clients.
Our net income to common shareholders was $8.4 million and $14.0 million for the three months ended September 30, 2022 and 2021, respectively. Diluted earnings per share (“EPS”) was $1.04 for the third quarter of 2022 as compared to $1.75 for the same period in 2021. The decrease in net income was primarily driven by an increase in the provision for credit losses and a decrease in mortgage banking income, as well as an increase in noninterest expenses.
30
Our net income to common shareholders was $23.6 million and $34.7 million for the nine months ended September 30, 2022 and 2021. Diluted EPS was $2.93 for the nine months ended September 30, 2022 as compared to $4.36 for the same period in 2021. The decrease in net income was primarily driven by an increase in the provision for credit losses and a decrease in mortgage banking income, as well as an increase in noninterest expenses.
results of operations
Net Interest Income and Margin
Our level of net interest income is determined by the level of earning assets and the management of our net interest margin. Our net interest income was $25.5 million for the third quarter of 2022, a 14.8% increase over net interest income of $22.2 million for the third quarter of 2021, driven by an increase in interest income primarily as a result of loan growth during the past 12 months. In addition, our net interest margin, on a tax-equivalent basis (TE), was 3.19% for the third quarter of 2022 compared to 3.38% for the same period in 2021.
We have included a number of tables to assist in our description of various measures of our financial performance. For example, the “Average Balances, Income and Expenses, Yields and Rates” table reflects the average balance of each category of our assets and liabilities as well as the yield we earned or the rate we paid with respect to each category during the three and nine month periods ended September 30, 2022 and 2021. A review of this table shows that our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we direct a substantial percentage of our earning assets into our loan portfolio. Similarly, the “Rate/Volume Analysis” tables demonstrate the effect of changing interest rates and changing volume of assets and liabilities on our financial condition during the periods shown. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included tables to illustrate our interest rate sensitivity with respect to interest-earning accounts and interest-bearing accounts.
The following tables entitled “Average Balances, Income and Expenses, Yield and Rates” set forth information related to our average balance sheets, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. All investments owned have an original maturity of over one year. Nonaccrual loans are included in the following tables. Loan yields have been reduced to reflect the negative impact on our earnings of loans on nonaccrual status. The net of capitalized loan costs and fees are amortized into interest income on loans.
31
Average Balances, Income and Expenses, Yields and Rates
| For the Three Months Ended September 30, | ||||||||||||||||||||||||
| 2022 | 2021 | |||||||||||||||||||||||
| (dollars in thousands) | Average Balance | Income/ Expense | Yield/ Rate(1) | Average Balance | Income/ Expense | Yield/ Rate(1) | ||||||||||||||||||
| Interest-earning assets | ||||||||||||||||||||||||
| Federal funds sold and interest-bearing deposits with banks | $ | 122,071 | $ | 676 | 2.20 | % | $ | 145,899 | $ | 68 | 0.18 | % | ||||||||||||
| Investment securities, taxable | 91,462 | 449 | 1.95 | % | 93,428 | 301 | 1.28 | % | ||||||||||||||||
| Investment securities, nontaxable(2) | 10,160 | 74 | 2.89 | % | 10,974 | 70 | 2.54 | % | ||||||||||||||||
| Loans(3) | 2,941,350 | 29,752 | 4.01 | % | 2,351,467 | 23,063 | 3.89 | % | ||||||||||||||||
| Total interest-earning assets | 3,165,043 | 30,951 | 3.88 | % | 2,601,768 | 23,502 | 3.58 | % | ||||||||||||||||
| Noninterest-earning assets | 159,233 | 132,929 | ||||||||||||||||||||||
| Total assets | $ | 3,324,726 | $ | 2,734,697 | ||||||||||||||||||||
| Interest-bearing liabilities | ||||||||||||||||||||||||
| NOW accounts | $ | 361,500 | 178 | 0.20 | % | $ | 316,775 | 48 | 0.06 | % | ||||||||||||||
| Savings & money market | 1,417,181 | 3,663 | 1.03 | % | 1,209,991 | 651 | 0.21 | % | ||||||||||||||||
| Time deposits | 361,325 | 1,180 | 1.30 | % | 161,300 | 235 | 0.58 | % | ||||||||||||||||
| Total interest-bearing deposits | 2,140,006 | 5,021 | 0.93 | % | 1,688,066 | 934 | 0.22 | % | ||||||||||||||||
| FHLB advances and other borrowings | 1,357 | 10 | 2.92 | % | - | - | 0.00 | % | ||||||||||||||||
| Subordinated debentures | 36,169 | 449 | 4.93 | % | 36,062 | 380 | 4.18 | % | ||||||||||||||||
| Total interest-bearing liabilities | 2,177,532 | 5,480 | 1.00 | % | 1,724,128 | 1,314 | 0.30 | % | ||||||||||||||||
| Noninterest-bearing liabilities | 858,202 | 753,901 | ||||||||||||||||||||||
| Shareholders’ equity | 288,542 | 256,668 | ||||||||||||||||||||||
| Total liabilities and shareholders’ equity | $ | 3,324,276 | $ | 2,734,697 | ||||||||||||||||||||
| Net interest spread | 2.88 | % | 3.28 | % | ||||||||||||||||||||
| Net interest income (tax equivalent) / margin | $ | 25,471 | 3.19 | % | $ | 22,188 | 3.38 | % | ||||||||||||||||
| Less: tax-equivalent adjustment(2) | 17 | (16 | ) | |||||||||||||||||||||
| Net interest income | $ | 25,454 | $ | 22,172 | ||||||||||||||||||||
| (1) | Annualized for the three month period. |
| (2) | The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. |
| (3) | Includes mortgage loans held for sale. |
Our net interest margin (TE) decreased 19 basis points to 3.19% during the third quarter of 2022, compared to the third quarter of 2021, primarily due to higher costs on our interest-bearing liabilities, partially offset by an increase in yield on our interest-earning assets. Our average interest-bearing liabilities grew by $453.4 million during the third quarter of 2022, while the rate on these liabilities increased 70 basis points to 1.00%. In contrast, our average interest-earning assets grew by $563.3 million during the third quarter of 2022, however, the average yield on these assets increased by 30 basis points to 3.88% during the same period.
The increase in average interest-earning assets for the third quarter of 2022 related primarily to an increase of $589.9 million in our average loan balances. The 30-basis point increase in yield on our interest-earning assets was driven by a 12 basis point increase in loan yield as our loan portfolio has repriced at rates higher than historical for the majority of the past 12 months. Following the Federal Reserve’s recent interest rate hikes, our loan yield has begun to increase, resulting in a 19-basis point gain from 3.82% in the second quarter of 2022.
The increase in our average interest-bearing liabilities during the third quarter of 2022 resulted primarily from a $451.9 million increase in our interest-bearing deposits, while the 70-basis point increase in rate on our interest-bearing liabilities resulted primarily from a 71-basis point increase in deposit rates.
Our net interest spread was 2.88% for the third quarter of 2022 compared to 3.28% for the same period in 2021. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 70-basis point increase in the rate on our interest-bearing liabilities was partially offset by a 30 basis point increase in yield on our interest-bearing assets, resulting in a 40 basis point decrease in our net interest spread for the 2022 period. We anticipate continued pressure on our net interest spread and net interest margin in future periods as a significant portion of our loan portfolio is at fixed rates which do not move with the Federal Reserve’s interest rate increases, while our deposit accounts reprice much more quickly.
32
Average Balances, Income and Expenses, Yields and Rates
| For the Nine Months Ended September 30, | ||||||||||||||||||||||||
| 2022 | 2021 | |||||||||||||||||||||||
| (dollars in thousands) | Average Balance | Income/ Expense | Yield/ Rate(1) | Average Balance | Income/ Expense | Yield/ Rate(1) | ||||||||||||||||||
| Interest-earning assets | ||||||||||||||||||||||||
| Federal funds sold and interest-bearing deposits with banks | $ | 97,479 | $ | 915 | 1.25 | % | $ | 118,417 | $ | 167 | 0.19 | % | ||||||||||||
| Investment securities, taxable | 100,947 | 1,278 | 1.69 | % | 87,981 | 759 | 1.15 | % | ||||||||||||||||
| Investment securities, nontaxable(2) | 10,811 | 195 | 2.41 | % | 11,197 | 217 | 2.59 | % | ||||||||||||||||
| Loans(3) | 2,771,546 | 80,294 | 3.87 | % | 2,267,611 | 67,938 | 4.01 | % | ||||||||||||||||
| Total interest-earning assets | 2,980,783 | 82,682 | 3.71 | % | 2,485,206 | 69,081 | 3.72 | % | ||||||||||||||||
| Noninterest-earning assets | 155,511 | 117,679 | ||||||||||||||||||||||
| Total assets | $ | 3,136,294 | $ | 2,602,885 | ||||||||||||||||||||
| Interest-bearing liabilities | ||||||||||||||||||||||||
| NOW accounts | $ | 385,543 | 437 | 0.15 | % | $ | 298,785 | 141 | 0.06 | % | ||||||||||||||
| Savings & money market | 1,309,502 | 5,481 | 0.56 | % | 1,142,409 | 1,817 | 0.21 | % | ||||||||||||||||
| Time deposits | 266,791 | 1,855 | 0.93 | % | 183,239 | 1,051 | 0.77 | % | ||||||||||||||||
| Total interest-bearing deposits | 1,961,836 | 7,773 | 0.53 | % | 1,624,433 | 3,009 | 0.25 | % | ||||||||||||||||
| FHLB advances and other borrowings | 23,665 | 129 | 0.73 | % | 941 | 4 | 0.57 | % | ||||||||||||||||
| Subordinated debentures | 36,143 | 1,233 | 4.56 | % | 36,035 | 1,143 | 4.24 | % | ||||||||||||||||
| Total interest-bearing liabilities | 2,021,644 | 9,135 | 0.60 | % | 1,661,409 | 4,156 | 0.33 | % | ||||||||||||||||
| Noninterest-bearing liabilities | 831,684 | 697,533 | ||||||||||||||||||||||
| Shareholders’ equity | 282,966 | 243,943 | ||||||||||||||||||||||
| Total liabilities and shareholders’ equity | $ | 3,136,294 | $ | 2,602,885 | ||||||||||||||||||||
| Net interest spread | 3.11 | % | 3.39 | % | ||||||||||||||||||||
| Net interest income (tax equivalent) / margin | $ | 73,547 | 3.30 | % | $ | 64,925 | 3.49 | % | ||||||||||||||||
| Less: tax-equivalent adjustment(2) | (45 | ) | (50 | ) | ||||||||||||||||||||
| Net interest income | $ | 73,502 | $ | 64,875 | ||||||||||||||||||||
| (1) | Annualized for the nine month period. |
| (2) | The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. |
| (3) | Includes mortgage loans held for sale. |
During the first nine months of 2022, our net interest margin (TE) decreased by 19 basis points to 3.30%, compared to 3.49% for the first nine months of 2021, driven by the increase in yield on our interest-bearing liabilities. Our average interest-bearing liabilities grew by $360.2 million, while the rate on these liabilities increased 27 basis points to 0.60%. In addition, our average interest-earning assets grew by $495.6 million from the prior year, with the average yield decreasing by one basis point to 3.71%.
The increase in average interest-earning assets for the first nine months of 2022 related primarily to a $503.9 million increase in our average loan balances. The decrease in yield on our interest-earning assets was driven by a 14-basis point decrease in our loan yield as new and renewed loans were repriced at lower rates related to the interest rate reductions by the Federal Reserve which occurred during 2020. Recently, the yield on our loan portfolio has begun to increase as the Federal Reserve has raised interest rates by 300 basis points during the first nine months of 2022.
The increase in average interest-bearing liabilities for the first nine months of 2022 was driven by an increase in interest-bearing deposits of $337.4 million and a $22.7 million increase in FHLB advances and other borrowings, while the increase in cost was driven by a 28-basis point increase on our interest-bearing deposits.
Our net interest spread was 3.11% for the first nine months of 2022 compared to 3.39% for the same period in 2021. The 28-basis point decrease in our net interest spread was driven by the 27-basis point increase in yield on our interest-bearing liabilities.
33
Rate/Volume Analysis
Net interest income can be analyzed in terms of the impact of changing interest rates and changing volume. The following tables set forth the effect which the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for the periods presented.
| Three Months Ended | ||||||||||||||||||||||||||||||||
| September 30, 2022 vs. 2021 | September 30, 2021 vs. 2020 | |||||||||||||||||||||||||||||||
| Increase (Decrease) Due to | Increase (Decrease) Due to | |||||||||||||||||||||||||||||||
| (dollars in thousands) | Volume | Rate | Rate/ Volume | Total | Volume | Rate | Rate/ Volume | Total | ||||||||||||||||||||||||
| Interest income | ||||||||||||||||||||||||||||||||
| Loans | $ | 5,674 | 815 | 200 | 6,689 | $ | 2,898 | (2,556 | ) | (321 | ) | 21 | ||||||||||||||||||||
| Investment securities | (9 | ) | 164 | (4 | ) | 151 | 73 | (23 | ) | (5 | ) | 45 | ||||||||||||||||||||
| Federal funds sold and interest-bearing deposits with banks | (11 | ) | 740 | (121 | ) | 608 | (6 | ) | 13 | (2 | ) | 5 | ||||||||||||||||||||
| Total interest income | 5,654 | 1,719 | 75 | 7,448 | 2,965 | (2,566 | ) | (328 | ) | 71 | ||||||||||||||||||||||
| Interest expense | ||||||||||||||||||||||||||||||||
| Deposits | 217 | 3,142 | 728 | 4,087 | 276 | (1,556 | ) | (179 | ) | (1,459 | ) | |||||||||||||||||||||
| FHLB advances and other borrowings | - | - | 10 | 10 | - | - | - | - | ||||||||||||||||||||||||
| Subordinated debentures | 1 | 68 | - | 69 | 1 | (6 | ) | - | (5 | ) | ||||||||||||||||||||||
| Total interest expense | 218 | 3,210 | 738 | 4,166 | 277 | (1,562 | ) | (179 | ) | (1,464 | ) | |||||||||||||||||||||
| Net interest income | $ | 5,436 | (1,491 | ) | (663 | ) | 3,282 | $ | 2,688 | (1,004 | ) | (149 | ) | 1,535 | ||||||||||||||||||
Net interest income, the largest component of our income, was $25.5 million for the third quarter of 2022 and $22.2 million for the third quarter of 2021, a $3.3 million, or 14.8%, increase year over year. The increase during 2022 was driven by a $7.4 million increase in interest income primarily due to higher volume of loans. In addition, interest expense increased by $4.2 million primarily due to an increase in rates on our interest-bearing deposits.
| Nine Months Ended | ||||||||||||||||||||||||||||||||
| September 30, 2022 vs. 2021 | September 30, 2021 vs. 2020 | |||||||||||||||||||||||||||||||
| Increase (Decrease) Due to | Increase (Decrease) Due to | |||||||||||||||||||||||||||||||
| (dollars in thousands) | Volume | Rate | Rate/ Volume | Total | Volume | Rate | Rate/ Volume | Total | ||||||||||||||||||||||||
| Interest income | ||||||||||||||||||||||||||||||||
| Loans | $ | 16,300 | (3,180 | ) | (764 | ) | 12,356 | $ | 4,994 | (6,565 | ) | (454 | ) | (2,025 | ) | |||||||||||||||||
| Investment securities | 146 | 307 | 49 | 502 | 281 | (354 | ) | (91 | ) | (164 | ) | |||||||||||||||||||||
| Federal funds sold and interest-bearing deposits with banks | (11 | ) | 813 | (54 | ) | 748 | 3 | (53 | ) | (1 | ) | (51 | ) | |||||||||||||||||||
| Total interest income | 16,435 | (2,060 | ) | (769 | ) | 13,606 | 5,278 | (6,972 | ) | (546 | ) | (2,240 | ) | |||||||||||||||||||
| Interest expense | ||||||||||||||||||||||||||||||||
| Deposits | 719 | 3,265 | 780 | 4,764 | 966 | (8,425 | ) | (727 | ) | (8,186 | ) | |||||||||||||||||||||
| FHLB advances and other borrowings | 63 | 3 | 59 | 125 | (324 | ) | (220 | ) | 212 | (332 | ) | |||||||||||||||||||||
| Subordinated debentures | 4 | 86 | - | 90 | 3 | (93 | ) | - | (90 | ) | ||||||||||||||||||||||
| Total interest expense | 786 | 3,354 | 839 | 4,979 | 645 | (8,738 | ) | (515 | ) | (8,608 | ) | |||||||||||||||||||||
| Net interest income | $ | 15,649 | (5,414 | ) | (1,608 | ) | 8,627 | $ | 4,633 | 1,766 | (31 | ) | 6,368 | |||||||||||||||||||
Net interest income for the first nine months of 2022 was $73.5 million compared to $64.9 million for 2021, an $8.6 million, or 13.3%, increase. The increase in net interest income during 2022 was driven by a $13.6 million increase in interest income, related primarily to loan growth.
Provision for Credit Losses
The provision for credit losses, which includes a provision for losses on unfunded commitments, is a charge to earnings to maintain the allowance for credit losses and reserve for unfunded commitments at levels consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. On January 1, 2022, we adopted the Current Expected Credit Loss (CECL) methodology for estimating credit losses, which resulted in an increase of $1.5 million in our allowance for credit losses and an increase of $2.0 million in our reserve for unfunded commitments. The tax-effected impact of these two items amounted to $2.8 million and was recorded as an adjustment to our retained earnings as of January 1, 2022. We review the adequacy of the allowance for credit losses on a quarterly basis. Please see the discussion included in Note 1 – Summary of Significant Accounting Policies and Note 4 – Loans and Allowance for Credit Losses for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this allowance.
34
We recorded a $950,000 provision for credit losses in the third quarter of 2022, compared to a $6.0 million reversal of provision expense in the third quarter of 2021. We recorded a provision expense of $3.8 million and a provision reversal of $8.2 million for the nine months ended September 30, 2022 and September 30, 2021, respectively. The $950,000 provision in 2022, which included a $425,000 provision for unfunded commitments, was driven by $184.8 million in loan growth during the third quarter, combined with a $102.3 million increase in unfunded commitments. The $3.8 million provision expense for the first nine months of 2022 included a $755,000 provision for unfunded commitments. The prior year reversals of provision expense related to a reduction in qualitative adjustment factors driven by the overall improvement in economic conditions as well as improvement in the credit quality of our portfolio following the pandemic.
Noninterest Income
The following table sets forth information related to our noninterest income.
| Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
| (dollars in thousands) | 2022 | 2021 | 2022 | 2021 | ||||||||||||
| Mortgage banking income | $ | 1,230 | 2,829 | 3,907 | 9,445 | |||||||||||
| Service fees on deposit accounts | 194 | 199 | 594 | 557 | ||||||||||||
| ATM and debit card income | 559 | 542 | 1,651 | 1,532 | ||||||||||||
| Income from bank owned life insurance | 315 | 321 | 945 | 919 | ||||||||||||
| Net lender and referral fees on PPP loans | - | - | - | 268 | ||||||||||||
| Loss on disposal of fixed assets | - | - | (394 | ) | - | |||||||||||
| Other income | 382 | 348 | 1,170 | 1,043 | ||||||||||||
| Total noninterest income | $ | 2,680 | 4,239 | 7,873 | 13,764 | |||||||||||
Noninterest income decreased $1.6 million, or 36.8%, for the third quarter of 2022 as compared to the same period in 2021. The decrease in total noninterest income resulted primarily from the following:
| ● | Mortgage banking income decreased by $1.6 million, or 56.5%, driven by low inventory in the housing market, lower refinance volumes, and a decrease in margin on loan sales. We do not expect mortgage origination volume to continue at levels seen in the prior year which will reduce the amount of mortgage banking income recorded in future periods in comparison to prior periods. |
Noninterest income decreased $5.9 million, or 42.8%, during the first nine months of 2022 as compared to 2021. The decrease in total noninterest income resulted primarily from decreases in mortgage banking income and the disposal of fixed assets from our prior headquarters building.
Noninterest expenses
The following table sets forth information related to our noninterest expenses.
| Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
| (dollars in thousands) | 2022 | 2021 | 2022 | 2021 | ||||||||||||
| Compensation and benefits | $ | 9,843 | 9,064 | 29,214 | 26,897 | |||||||||||
| Occupancy | 2,442 | 1,685 | 6,439 | 4,875 | ||||||||||||
| Real estate owned (income) expenses | - | (3 | ) | - | 385 | |||||||||||
| Outside service and data processing costs | 1,529 | 1,368 | 4,591 | 4,072 | ||||||||||||
| Insurance | 507 | 244 | 1,134 | 807 | ||||||||||||
| Professional fees | 555 | 694 | 1,848 | 1,905 | ||||||||||||
| Marketing | 338 | 247 | 934 | 645 | ||||||||||||
| Other | 832 | 740 | 2,360 | 2,109 | ||||||||||||
| Total noninterest expense | $ | 16,046 | 14,039 | 46,520 | 41,695 | |||||||||||
35
Noninterest expense was $16.0 million for the third quarter of 2022, a $2.0 million, or 14.3%, increase from noninterest expense of $14.0 million for the third quarter of 2021. The increase in noninterest expense was driven primarily by the following:
| ● | Compensation and benefits expense increased $779,000, or 8.6%, relating primarily to annual salary increases and compensation and benefits expense related to the hiring of new team members. |
| ● | Occupancy costs increased $757,000, or 44.9%, driven by costs associated with the relocation of our headquarters, as well as increased rent expense and depreciation on our new office in Charlotte, North Carolina, and the expansion of our Summerville office. |
| ● | Insurance costs increased $263,000, or 107.8%, during the third quarter of 2022 driven by higher FDIC insurance premiums. |
| ● | Outside service and data processing costs increased $161,000, or 11.8%, during the third quarter of 2022 related to increased item processing, electronic banking costs, and ATM card related expenses which are primarily driven by transaction volume. |
| ● | Marketing expenses increased $91,000, or 36.8%, due to an increase in community outreach and sponsorships. |
Offsetting these increases was a decrease in professional fees of $139,000, or 20.0%, primarily from a decrease in loan appraisal fees and other consulting fees.
Noninterest expense was $46.5 million for the first nine months of 2022, a $4.8 million, or 11.6%, increase from noninterest expense of $41.7 million for the first nine months of 2021. The increase in noninterest expense was driven primarily by increases in compensation and benefits, occupancy, outside services and data processing costs and marketing expenses as discussed above. Partially offsetting these increases was a decrease in real estate owned expenses during the 2022 period.
Our efficiency ratio was 57.0% for the third quarter of 2022, compared to 53.2% for the third quarter of 2021 and 57.2% for the first nine months of 2022 compared to 53.0% for the first nine months of 2021. The efficiency ratio represents the percentage of one dollar of expense required to be incurred to earn a full dollar of revenue and is computed by dividing noninterest expense by the sum of net interest income and noninterest income. The higher ratio during the third quarter of 2022, compared to the third quarter of 2021, relates primarily to the decrease in mortgage banking income, combined with higher noninterest expenses.
We incurred income tax expense of $2.7 million and $4.4 million for the three months ended September 30, 2022 and 2021, respectively, and $7.4 million and $10.4 million for the nine months ended September 30, 2022 and 2021, respectively. Our effective tax rate was 23.9% and 23.1% for the nine months ended September 30, 2022 and 2021, respectively. The higher tax rate during the first nine months of 2022 relates to the lesser impact of equity compensation transactions during the period.
Balance Sheet Review
Investment Securities
At September 30, 2022, the $97.0 million in our investment securities portfolio represented approximately 2.8% of our total assets. Our available for sale investment portfolio included corporate bonds, US treasuries, US government agency securities, state and political subdivisions, asset-backed securities and mortgage-backed securities with a fair value of $91.5 million and an amortized cost of $109.3 million, resulting in an unrealized loss of $17.7 million. At December 31, 2021, the $124.3 million in our investment securities portfolio represented approximately 4.2% of our total assets, including investment securities with a fair value of $120.3 million and an amortized cost of $121.2 million for an unrealized loss of $937,000.
Loans
Since loans typically provide higher interest yields than other types of interest earning assets, a substantial percentage of our earning assets are invested in our loan portfolio. Average loans, excluding mortgage loans held for sale, for the nine months ended September 30, 2022 and 2021 were $2.76 billion and $2.23 billion, respectively. Before the allowance for credit losses, total loans outstanding at September 30, 2022 and December 31, 2021 were $3.03 billion and $2.49 billion, respectively.
36
The principal component of our loan portfolio is loans secured by real estate mortgages. As of September 30, 2022, our loan portfolio included $2.58 billion, or 85.2%, of real estate loans, compared to $2.13 billion, or 85.5%, at December 31, 2021. Most of our real estate loans are secured by residential or commercial property. We obtain a security interest in real estate, in addition to any other available collateral, in order to increase the likelihood of the ultimate repayment of the loan. Generally, we limit the loan-to-value ratio on loans to coincide with the appropriate regulatory guidelines. We attempt to maintain a relatively diversified loan portfolio to help reduce the risk inherent in concentration in certain types of collateral and business types. Home equity lines of credit totaled $171.9 million as of September 30, 2022, of which approximately 50% were in a first lien position, while the remaining balance was second liens. At December 31, 2021, our home equity lines of credit totaled $154.8 million, of which approximately 49% were in first lien positions, while the remaining balance was in second liens. The average home equity loan had a balance of approximately $83,000 and a loan to value of 72% as of September 30, 2022, compared to an average loan balance of $81,000 and a loan to value of approximately 62% as of December 31, 2021. Further, 0.72% and 1.0% of our total home equity lines of credit were over 30 days past due as of September 30, 2022 and December 31, 2021, respectively.
Following is a summary of our loan composition at September 30, 2022 and December 31, 2021. During the first nine months of 2022, our loan portfolio increased by $540.2 million, or 21.7%, with a 20.9% increase in commercial loans while consumer loans increased by 23.0% during the period. The majority of the increase was in loans secured by real estate. Our consumer real estate portfolio grew by $179.1 million and includes high quality 1-4 family consumer real estate loans. Our average consumer real estate loan currently has a principal balance of $471,000, a term of 22 years, and an average rate of 3.53% as of September 30, 2022, compared to a principal balance of $454,000, a term of 21 years, and an average rate of 3.47% as of December 31, 2021.
| September 30, 2022 | December 31, 2021 | |||||||||||||||
| (dollars in thousands) | Amount | % of Total | Amount | % of Total | ||||||||||||
| Commercial | ||||||||||||||||
| Owner occupied RE | $ | 572,972 | 18.9 | % | $ | 488,965 | 19.6 | % | ||||||||
| Non-owner occupied RE | 799,569 | 26.4 | % | 666,833 | 26.8 | % | ||||||||||
| Construction | 85,850 | 2.8 | % | 64,425 | 2.6 | % | ||||||||||
| Business | 419,312 | 13.8 | % | 333,049 | 13.4 | % | ||||||||||
| Total commercial loans | 1,877,703 | 61.9 | % | 1,553,272 | 62.4 | % | ||||||||||
| Consumer | ||||||||||||||||
| Real estate | 873,471 | 28.8 | % | 694,401 | 27.9 | % | ||||||||||
| Home equity | 171,904 | 5.7 | % | 154,839 | 6.2 | % | ||||||||||
| Construction | 77,798 | 2.6 | % | 59,846 | 2.4 | % | ||||||||||
| Other | 29,151 | 1.0 | % | 27,519 | 1.1 | % | ||||||||||
| Total consumer loans | 1,152,324 | 38.1 | % | 936,605 | 37.6 | % | ||||||||||
| Total gross loans, net of deferred fees | 3,030,027 | 100.0 | % | 2,489,877 | 100.0 | % | ||||||||||
| Less—allowance for credit losses | (36,317 | ) | (30,408 | ) | ||||||||||||
| Total loans, net | $ | 2,993,710 | $ | 2,459,469 | ||||||||||||
Nonperforming assets
Nonperforming assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure and loans on nonaccrual status. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of the contractual principal or interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received. Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms and to show capacity to continue performing into the future before that loan can be placed back on accrual status. As of September 30, 2022 and December 31, 2021, we had no loans 90 days past due and still accruing.
37
Following is a summary of our nonperforming assets, including nonaccruing TDRs.
| (dollars in thousands) | September 30, 2022 | December 31, 2021 | ||||||
| Commercial | $ | 332 | 270 | |||||
| Consumer | 197 | 1,642 | ||||||
| Nonaccruing troubled debt restructurings | 2,086 | 2,952 | ||||||
| Total nonaccrual loans | 2,615 | 4,864 | ||||||
| Other real estate owned | - | - | ||||||
| Total nonperforming assets | $ | 2,615 | 4,864 | |||||
At September 30, 2022, nonperforming assets were $2.6 million, or 0.08% of total assets and 0.09% of gross loans. Comparatively, nonperforming assets were $4.9 million, or 0.17% of total assets and 0.20% of gross loans at December 31, 2021. Nonaccrual loans decreased $2.2 million during the first nine months of 2022 due primarily to $1.5 million of loans paid or charged off and $1.4 million of loans returned to accruing status.
The amount of foregone interest income on nonaccrual loans in the first nine months of 2022 and 2021 was not material. At September 30, 2022 and 2021, the allowance for credit losses represented 1,388.87% and 259.95% of the total amount of nonperforming loans, respectively. A significant portion, or approximately 97%, of nonperforming loans at September 30, 2022, was secured by real estate. We have evaluated the underlying collateral on these loans and believe that the collateral on these loans is sufficient to minimize future losses.
As a general practice, most of our commercial loans and a portion of our consumer loans are originated with relatively short maturities of less than ten years. As a result, when a loan reaches its maturity we frequently renew the loan and thus extend its maturity using similar credit standards as those used when the loan was first originated. Due to these loan practices, we may, at times, renew loans which are classified as nonaccrual after evaluating the loan’s collateral value and financial strength of its guarantors. Nonaccrual loans are renewed at terms generally consistent with the ultimate source of repayment and rarely at reduced rates. In these cases, we will generally seek additional credit enhancements, such as additional collateral or additional guarantees to further protect the loan. When a loan is no longer performing in accordance with its stated terms, we will typically seek performance under the guarantee.
In addition, at September 30, 2022, 85.2% of our loans were collateralized by real estate and 97.0% of our impaired loans were secured by real estate. We utilize third party appraisers to determine the fair value of collateral dependent loans. Our current loan and appraisal policies require us to obtain updated appraisals on an annual basis, either through a new external appraisal or an appraisal evaluation. Impaired loans are individually reviewed on a quarterly basis to determine the level of impairment. As of September 30, 2022, we did not have any impaired real estate loans carried at a value in excess of the appraised value. We typically charge-off a portion or create a specific reserve for impaired loans when we do not expect repayment to occur as agreed upon under the original terms of the loan agreement.
At September 30, 2022, impaired loans totaled $7.2 million, for which $5.5 million of these loans had a reserve of approximately $1.3 million allocated in the allowance. During the first nine months of 2022, the average recorded investment in impaired loans was approximately $7.5 million. Comparatively, impaired loans totaled $8.2 million at December 31, 2021 for which $2.9 million of these loans had a reserve of approximately $836,000 allocated in the allowance. During 2021, the average recorded investment in impaired loans was approximately $12.5 million.
We consider a loan to be a TDR when the debtor experiences financial difficulties and we provide concessions such that we will not collect all principal and interest in accordance with the original terms of the loan agreement. Concessions can relate to the contractual interest rate, maturity date, or payment structure of the note. As part of our workout plan for individual loan relationships, we may restructure loan terms to assist borrowers facing challenges in the current economic environment. As of September 30, 2022, we determined that we had loans totaling $6.8 million that we considered TDRs compared to $6.3 million as of December 31, 2021.
38
Allowance for Credit Losses
On January 1, 2022, we adopted CECL for estimating credit losses, which resulted in an increase of $1.5 million in our allowance for credit losses and an increase of $2.0 million in our reserve for unfunded commitments, which is recorded within other liabilities. The tax-effected impact of those two items amounted to $2.8 million and was recorded as an adjustment to our retained earnings as of January 1, 2022. The allowance for loan loss accounting in effect at December 31, 2021 and all prior periods was based on our estimate of probable incurred loan losses as of the reporting date.
The allowance for credit losses was $36.3 million, representing 1.20% of outstanding loans and providing coverage of 1,388.87%, of nonperforming loans at September 30, 2022 compared to $30.4 million, or 1.22% of outstanding loans and 625.22% of nonperforming loans at December 31, 2021. At September 30, 2021, the allowance for loan losses was $36.1 million, or 1.51% of outstanding loans and 259.95% of nonperforming loans. The adoption of CECL on January 1, 2022 increased the allowance for credit losses by $1.5 million. In addition, we recorded a provision for credit losses of $525,000 during the third quarter of 2022 driven by the growth in our loan portfolio.
Deposits and Other Interest-Bearing Liabilities
Our primary source of funds for loans and investments is our deposits and advances from the FHLB. In the past, we have chosen to obtain a portion of our certificates of deposits from areas outside of our market in order to obtain longer term deposits than are readily available in our local market. Our internal guidelines regarding the use of brokered CDs limit our brokered CDs to 20% of total deposits. In addition, we do not obtain time deposits of $100,000 or more through the Internet. These guidelines allow us to take advantage of the attractive terms that wholesale funding can offer while mitigating the related inherent risk.
Our retail deposits represented $2.83 billion, or 94.2% of total deposits, while our wholesale deposits represented $175.1 million, or 5.8%, of total deposits at September 30, 2022. At December 31, 2021, retail deposits represented $2.56 billion, or 100%, of our total deposits. Our loan-to-deposit ratio was 101% at September 30, 2022 and 97% at December 31, 2021.
The following is a detail of our deposit accounts:
| September 30, | December 31, | |||||||
| (dollars in thousands) | 2022 | 2021 | ||||||
| Non-interest bearing | $ | 791,050 | 768,650 | |||||
| Interest bearing: | ||||||||
| NOW accounts | 357,863 | 401,788 | ||||||
| Money market accounts | 1,452,958 | 1,201,099 | ||||||
| Savings | 42,335 | 39,696 | ||||||
| Time, less than $250,000 | 79,386 | 68,179 | ||||||
| Time and out-of-market deposits, $250,000 and over | 277,860 | 84,414 | ||||||
| Total deposits | $ | 3,001,452 | 2,563,826 | |||||
During the past 12 months, we continued our focus on increasing core deposits, which exclude out-of-market deposits and time deposits of $250,000 or more, in order to provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $2.72 billion and $2.48 billion at September 30, 2022, and December 31, 2021, respectively.
39
The following table shows the average balance amounts and the average rates paid on deposits.
| Nine months ended September 30, | ||||||||||||||||
| 2022 | 2021 | |||||||||||||||
| (dollars in thousands) | Amount | Rate | Amount | Rate | ||||||||||||
| Noninterest-bearing demand deposits | $ | 781,303 | 0.00 | % | $ | 648,930 | 0.00 | % | ||||||||
| Interest-bearing demand deposits | 385,543 | 0.15 | % | 298,785 | 0.06 | % | ||||||||||
| Money market accounts | 1,268,039 | 0.58 | % | 1,110,579 | 0.22 | % | ||||||||||
| Savings accounts | 41,463 | 0.05 | % | 31,830 | 0.05 | % | ||||||||||
| Time deposits less than $100,000 | 24,519 | 0.45 | % | 39,136 | 0.48 | % | ||||||||||
| Time deposits greater than $100,000 | 242,272 | 0.40 | % | 144,103 | 0.87 | % | ||||||||||
| Total deposits | $ | 2,743,139 | 0.33 | % | $ | 2,273,363 | 0.18 | % | ||||||||
During the first nine months of 2022, our average transaction account balances increased by $386.2 million, or 18.5%, from the prior year, while our average time deposit balances increased by $84,000, or 45.6%.
All of our time deposits are certificates of deposits. The maturity distribution of our time deposits $250,000 or more at September 30, 2022 was as follows:
| (dollars in thousands) | September 30, 2022 | |||
| Three months or less | $ | 130,449 | ||
| Over three through six months | 104,180 | |||
| Over six through twelve months | 29,773 | |||
| Over twelve months | 13,458 | |||
| Total | $ | 277,860 | ||
Time deposits that meet or exceed the FDIC insurance limit of $250,000 at September 30, 2022 and December 31, 2021 were $283.4 million and $84.4 million, respectively.
Liquidity and Capital Resources
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.
At September 30, 2022 and December 31, 2021 our cash and cash equivalents totaled $160.6 million and $167.2 million, respectively, or 4.7% and 5.7% of total assets, respectively. Our investment securities at September 30 2022 and December 31, 2021 amounted to $97.0 million and $124.3 million, respectively, or 2.8% and 4.2% of total assets, respectively. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner.
Our ability to maintain and expand our deposit base and borrowing capabilities serves as our primary source of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, loan payoffs, and from additional borrowings. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. We maintain five federal funds purchased lines of credit with correspondent banks totaling $118.5 million for which there were no borrowings against the lines of credit at September 30, 2022.
We are also a member of the FHLB, from which applications for borrowings can be made. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. The unused borrowing capacity currently available from the FHLB at September 30, 2022 was $618.9 million, based primarily on the Bank’s qualifying mortgages available to secure any future borrowings. However, we are able to pledge additional securities to the FHLB in order to increase our available borrowing capacity. In addition, at September 30, 2022 and December 31, 2021 we had $307.5 million and $254.5 million, respectively, of letters of credit outstanding with the FHLB to secure client deposits.
40
We also have a line of credit with another financial institution for $15.0 million, which was unused at September 30, 2022. The line of credit was renewed on December 21, 2021 at an interest rate of One Month CME Term SOFR plus 3.5% and a maturity date of December 20, 2023.
We believe that our existing stable base of core deposits, federal funds purchased lines of credit with correspondent banks, and borrowings from the FHLB will enable us to successfully meet our long-term liquidity needs. However, as short-term liquidity needs arise, we have the ability to sell a portion of our investment securities portfolio to meet those needs.
Total shareholders’ equity was $287.8 million at September 30, 2022 and $277.9 million at December 31, 2021. The $9.9 million increase from December 31, 2021 is primarily related to net income of $23.6 million during the first nine months of 2022 and stock option exercises and equity compensation expenses of $2.3 million, partially offset by a $13.3 million decrease in other comprehensive loss and the tax-effected impact of $2.8 million of expense related to the adoption of CECL recorded as an adjustment to retained earnings.
The following table shows the return on average assets (net income divided by average total assets), return on average equity (net income divided by average equity), equity to assets ratio (average equity divided by average assets), and tangible common equity ratio (total equity less preferred stock divided by total assets) annualized for the nine months ended September 30, 2022 and the year ended December 31, 2021. Since our inception, we have not paid cash dividends.
| September 30, 2022 | December 31, 2021 | |||||||
| Return on average assets | 1.01 | % | 1.75 | % | ||||
| Return on average equity | 11.16 | % | 18.64 | % | ||||
| Return on average common equity | 11.16 | % | 18.64 | % | ||||
| Average equity to average assets ratio | 9.02 | % | 9.39 | % | ||||
| Tangible common equity to assets ratio | 8.37 | % | 9.50 | % | ||||
Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.
Regulatory capital rules, which we refer to Basel III, impose minimum capital requirements for bank holding companies and banks. The Basel III rules apply to all national and state banks and savings associations regardless of size and bank holding companies and savings and loan holding companies other than “small bank holding companies,” generally holding companies with consolidated assets of less than $3 billion (such as the Company). Although we had over $3 billion in assets at September 30, 2022, under Federal Reserve guidance, the Company will maintain its status as a “small bank holding company” until March 2023. In order to avoid restrictions on capital distributions or discretionary bonus payments to executives, a covered banking organization must maintain a “capital conservation buffer” on top of our minimum risk-based capital requirements. This buffer must consist solely of common equity Tier 1, but the buffer applies to all three measurements (common equity Tier 1, Tier 1 capital and total capital). The capital conservation buffer consists of an additional amount of CET1 equal to 2.5% of risk-weighted assets.
41
To be considered “well-capitalized” for purposes of certain rules and prompt corrective action requirements, the Bank must maintain a minimum total risked-based capital ratio of at least 10%, a total Tier 1 capital ratio of at least 8%, a common equity Tier 1 capital ratio of at least 6.5%, and a leverage ratio of at least 5%. As of September 30, 2022, our capital ratios exceed these ratios and we remain “well capitalized.”
The following table summarizes the capital amounts and ratios of the Bank and the regulatory minimum requirements.
| September 30, 2022 | ||||||||||||||||||||||||
| Actual | For capital adequacy purposes minimum plus the capital conservation buffer | To be well capitalized under prompt corrective action provisions minimum | ||||||||||||||||||||||
| (dollars in thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
| Total Capital (to risk weighted assets) | $ | 358,442 | 13.09 | % | $ | 287,578 | 10.50 | % | $ | 273,884 | 10.00 | % | ||||||||||||
| Tier 1 Capital (to risk weighted assets) | 324,181 | 11.84 | % | 232,802 | 8.50 | % | 219,107 | 8.00 | % | |||||||||||||||
| Common Equity Tier 1 Capital (to risk weighted assets) | 324,181 | 11.84 | % | 191,719 | 7.00 | % | 178,025 | 6.50 | % | |||||||||||||||
| Tier 1 Capital (to average assets) | 324,181 | 9.72 | % | 133,432 | 4.00 | % | 166,790 | 5.00 | % | |||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||
| Actual | For capital adequacy purposes minimum plus the capital conservation buffer | To be well capitalized under prompt corrective action provisions minimum | ||||||||||||||||||||||
| (dollars in thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
| Total Capital (to risk weighted assets) | $ | 331,052 | 14.36 | % | $ | 242,048 | 10.50 | % | $ | 230,522 | 10.00 | % | ||||||||||||
| Tier 1 Capital (to risk weighted assets) | 302,217 | 13.11 | % | 195,944 | 8.50 | % | 184,418 | 8.00 | % | |||||||||||||||
| Common Equity Tier 1 Capital (to risk weighted assets) | 302,217 | 13.11 | % | 161,365 | 7.00 | % | 149,839 | 6.50 | % | |||||||||||||||
| Tier 1 Capital (to average assets) | 302,217 | 10.55 | % | 114,537 | 4.00 | % | 143,172 | 5.00 | % | |||||||||||||||
42
The following table summarizes the capital amounts and ratios of the Company and the minimum regulatory requirements.
| September 30, 2022 | ||||||||||||||||||||||||
| Actual | For
capital adequacy purposes minimum plus the capital conservation buffer (1) | To
be well capitalized under prompt corrective action provisions minimum | ||||||||||||||||||||||
| (dollars in thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
| Total Capital (to risk weighted assets) | $ | 372,055 | 13.58 | % | $ | 287,578 | 10.50 | % | N/A | N/A | ||||||||||||||
| Tier 1 Capital (to risk weighted assets) | 314,794 | 11.49 | % | 232,802 | 8.50 | % | N/A | N/A | ||||||||||||||||
| Common Equity Tier 1 Capital (to risk weighted assets) | 301,794 | 11.02 | % | 191,719 | 7.00 | % | N/A | N/A | ||||||||||||||||
| Tier 1 Capital (to average assets) | 314,794 | 9.44 | % | 133,450 | 4.00 | % | N/A | N/A | ||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||
| Actual | For
capital adequacy purposes minimum plus the capital conservation buffer (1) | To be well capitalized under
prompt | ||||||||||||||||||||||
| (dollars in thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||
| Total Capital (to risk weighted assets) | $ | 343,476 | 14.90 | % | $ | 242,048 | 10.50 | % | N/A | N/A | ||||||||||||||
| Tier 1 Capital (to risk weighted assets) | 291,641 | 12.65 | % | 195,944 | 8.50 | % | N/A | N/A | ||||||||||||||||
| Common Equity Tier 1 Capital (to risk weighted assets) | 278,641 | 12.09 | % | 161,365 | 7.00 | % | N/A | N/A | ||||||||||||||||
| Tier 1 Capital (to average assets) | 291,641 | 10.18 | % | 114,555 | 4.00 | % | N/A | N/A | ||||||||||||||||
| (1) | Under the Federal Reserve’s Small Bank Holding Company Policy Statement, the Company is not subject to the minimum capital adequacy and capital conservation buffer capital requirements at the holding company level, unless otherwise advised by the Federal Reserve (such capital requirements are applicable only at the Bank level). Although the minimum regulatory capital requirements are not applicable to the Company, we calculate these ratios for our own planning and monitoring purposes. |
43
The ability of the Company to pay cash dividends is dependent upon receiving cash in the form of dividends from the Bank. The dividends that may be paid by the Bank to the Company are subject to legal limitations and regulatory capital requirements. Since our inception, we have not paid cash dividends.
Effect of Inflation and Changing Prices
The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost basis in accordance with generally accepted accounting principles.
Unlike most industrial companies, our assets and liabilities are primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate fluctuations, including those resulting from inflation.
Off-Balance Sheet Risk
Commitments to extend credit are agreements to lend money to a client as long as the client has not violated any material condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. At September 30, 2022, unfunded commitments to extend credit were $840.9 million, of which $315.1 million were at fixed rates and $525.8 million were at variable rates. At December 31, 2021, unfunded commitments to extend credit were $618.7 million, of which approximately $205.4 million were at fixed rates and $413.3 million were at variable rates. A significant portion of the unfunded commitments related to commercial business loans and consumer home equity lines of credit. We evaluate each client’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. The type of collateral varies but may include accounts receivable, inventory, property, plant and equipment, and commercial and residential real estate. Following the adoption of CECL on January 1, 2022, we recorded a reserve for unfunded commitments of $2.0 million, or 0.31% of total unfunded commitments. As of September 30, 2022, the reserve for unfunded commitments was $2.8 million or 0.33% of total unfunded commitments.
At September 30, 2022 and December 31, 2021, there were commitments under letters of credit for $12.6 million and $10.2 million, respectively. The credit risk and collateral involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Since most of the letters of credit are expected to expire without being drawn upon, they do not necessarily represent future cash requirements.
Except as disclosed in this report, we are not involved in off-balance sheet contractual relationships, unconsolidated related entities that have off-balance sheet arrangements or transactions that could result in liquidity needs or other commitments that significantly impact earnings.
Critical Accounting Estimates
We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements.
Certain accounting policies inherently involve a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported, which could have a material impact on the carrying values of our assets and liabilities and our results of operations. Of the significant accounting policies used in the preparation of our consolidated financial statements, we have identified certain items as critical accounting policies based on the associated estimates, assumptions, judgments and complexity. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2021, for a description our significant accounting policies that use critical accounting estimates.
44
We have historically identified the determination of the allowance for loan losses as a significant accounting policy that uses critical accounting estimates. On January 1, 2022, we adopted the new CECL accounting methodology that requires entities to estimate and recognize an allowance for lifetime expected credit losses for loans and other financial assets measured at amortized cost. In prior periods, our allowance was based on the incurred loss methodology where we recognized an allowance for loan losses based on probable incurred losses. We believe that the accounting estimates relating to the allowance for credit losses is also a “critical accounting policy” as:
| ● | changes in the provision for credit losses can materially affect our financial results; |
| ● | estimates relating to the allowance for credit losses require us to project future borrower performance, including cash flows, delinquencies and charge-offs, along with, when applicable, collateral values, based on a reasonable and supportable forecast period utilizing forward-looking economic scenarios in order to estimate lifetime probability of default and loss given default; |
| ● | the allowance for credit losses is influenced by factors outside of our control such as changes in projected economic conditions, real estate markets or particular industry conditions which may materially impact asset quality and the adequacy of the allowance for credit losses; and |
| ● | considerable judgment is required to determine whether the models used to generate the allowance for credit losses produce an estimate that is sufficient to encompass the current view of lifetime expected credit losses. |
Because our estimates of the allowance for credit losses involve judgment and are influenced by factors outside our control, there is uncertainty inherent in these estimates. Our estimate of lifetime expected credit losses is inherently uncertain because it is highly sensitive to changes in economic conditions and other factors outside of our control. Changes in such estimates could significantly impact our allowance and provision for credit losses. See Note 1 – Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included elsewhere in this report for a discussion of our Allowance for Credit Losses.
Accounting, Reporting, and Regulatory Matters
See Note 1 – Summary of Significant Accounting Policies in the accompanying notes to consolidated financial statements included elsewhere in this report for details of recently issued accounting pronouncements and their expected impact on our consolidated financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk is the risk of loss from adverse changes in market prices and rates, which principally arises from interest rate risk inherent in our lending, investing, deposit gathering, and borrowing activities. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not generally arise in the normal course of our business.
We actively monitor and manage our interest rate risk exposure in order to control the mix and maturities of our assets and liabilities utilizing a process we call asset/liability management. The essential purposes of asset/liability management are to seek to ensure adequate liquidity and to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize potentially adverse impacts on earnings from changes in market interest rates. Our asset/liability management committee (“ALCO”) monitors and considers methods of managing exposure to interest rate risk. We have both an internal ALCO consisting of senior management that meets at various times during each month and a board ALCO that meets monthly. The ALCOs are responsible for maintaining the level of interest rate sensitivity of our interest sensitive assets and liabilities within board-approved limits.
45
As of September 30, 2022, the following table summarizes the forecasted impact on net interest income using a base case scenario given upward and downward movements in interest rates of 100, 200, and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical interest rate cycles and other factors deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the Consolidated Financial Statements. Therefore, management’s assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market conditions.
| Interest rate scenario | Change in net interest income from base | |||
| Up 300 basis points | (9.97 | )% | ||
| Up 200 basis points | (6.47 | )% | ||
| Up 100 basis points | (3.17 | )% | ||
| Base | - | |||
| Down 100 basis points | 7.17 | % | ||
| Down 200 basis points | 11.16 | % | ||
| Down 300 basis points | 7.15 | % | ||
Item 4. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our 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. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including our Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There has been no change in the Company’s internal control over financial reporting during the nine months ended September 30, 2022, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
46
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS.
We are a party to claims and lawsuits arising in the course of normal business activities. Management is not aware of any material pending legal proceedings against the Company which, if determined adversely, would have a material adverse impact on the company’s financial position, results of operations or cash flows.
Item 1A. RISK FACTORS.
Investing in shares of our common stock involves certain risks, including those identified and described in Item 1A. of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, as well as cautionary statements contained in this Quarterly Report on Form 10-Q, including those under the caption “Cautionary Warning Regarding Forward-Looking Statements” set forth in Part I, Item 2 of this Form 10-Q, risks and matters described elsewhere in this Form 10-Q, and in our other filings with the SEC.
There have been no material changes to the risk factors disclosed in Item 1A. of Part I in our Annual Report on Form 10-K for the year ended December 31, 2021.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
| (a) | Not applicable. |
| (b) | Not applicable. |
| (c) | Issuer Purchases of Registered Equity Securities |
The following table reflects share repurchase activity during the third quarter of 2022:
| (d) Maximum | ||||||||||||||||
| (c) Total | Number (or | |||||||||||||||
| Number of | Approximate | |||||||||||||||
| Shares (or | Dollar Value) of | |||||||||||||||
| Units) | Shares (or | |||||||||||||||
| (a) Total | Purchased as | Units) that May | ||||||||||||||
| Number of | Part of Publicly | Yet Be | ||||||||||||||
| Shares (or | (b) Average | Announced | Purchased | |||||||||||||
| Units) | Price Paid per | Plans or | Under the Plans | |||||||||||||
| Period | Purchased | Share (or Unit) | Programs | or Programs | ||||||||||||
| July 1, 2022 – July 31, 2022 | - | - | - | 399,026 | * | |||||||||||
| August 1, 2022 – August 31, 2022 | - | - | - | 399,026 | * | |||||||||||
| September 1, 2022 – September 30, 2022 | - | - | - | 399,026 | * | |||||||||||
| Total | - | - | - | 399,026 | * | |||||||||||
*On June 21, 2022, the Company announced a share repurchase plan allowing us to repurchase up to 399,026 shares of our common stock (the “Repurchase Plan”). As of September 30, 2022, we have not repurchased any of the shares authorized for repurchase under the Repurchase Plan. The Company is not obligated to purchase any such shares under the Repurchase Plan, and the Repurchase Plan may be discontinued, suspended or restarted at any time; however, repurchases under the Repurchase Plan after December 31, 2022 would require additional approval of our Board of Directors and the Federal Reserve.
Item 3. DEFAULTS UPON SENIOR SECURITIES.
None.
Item 4. MINE SAFETY DISCLOSURES.
Not applicable.
Item 5. OTHER INFORMATION.
None.
Item 6. EXHIBITS.
The exhibits required to be filed as part of this Quarterly Report on Form 10-Q are listed in the Index to Exhibits attached hereto and are incorporated herein by reference.
47
INDEX TO EXHIBITS
| Exhibit
Number |
Description | |
| 31.1 | Rule 13a-14(a) Certification of the Principal Executive Officer. | |
| 31.2 | Rule 13a-14(a) Certification of the Principal Financial Officer. | |
| 32 | Section 1350 Certifications. | |
| 101 | The following materials from the Quarterly Report on Form 10-Q of Southern First Bancshares, Inc. for the quarter ended September 30, 2022, formatted in iXBRL (Inline eXtensible Business Reporting Language): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statement of Changes in Shareholders’ Equity, (v) Consolidated Statements of Cash Flows and (vi) Notes to Unaudited Consolidated Financial Statements. | |
| 104 | Cover Page Interactive Data File (embedded within the Inline XBRL document) | |
| ______ | ________________________________________________ |
48
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| SOUTHERN FIRST BANCSHARES, INC. | |
| Registrant | |
| Date: November 1, 2022 | /s/ R. Arthur Seaver, Jr. |
| R. Arthur Seaver, Jr. | |
| Chief
Executive Officer (Principal Executive Officer) | |
| Date: November 1, 2022 | /s/ Michael D. Dowling |
| Michael D. Dowling | |
| Chief
Financial Officer (Principal Financial and Accounting Officer) | |
49
Exhibit 31.1
Rule 13a-14(a) Certification of the Principal Executive Officer.
Exhibit 31.1
Rule 13a-14(a) Certification of the Principal Executive Officer.
I, R. Arthur Seaver, Jr., certify that:
| 1. | I have reviewed this quarterly report on Form 10-Q of Southern First Bancshares, Inc.; | |
| 2. | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; | |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; | |
| 4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; | ||
| b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; | ||
| c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and | ||
| d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and | ||
| 5. | The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| a) | All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and | ||
| b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. | ||
| Date: November 1, 2022 | By: | /s/ R. Arthur Seaver, Jr. |
| R. Arthur Seaver, Jr. | ||
| Chief Executive Officer | ||
Exhibit 31.2
Rule 13a-14(a) Certification of the Principal Financial Officer.
Exhibit 31.2
Rule 13a-14(a) Certification of the Principal Financial Officer.
I, Michael D. Dowling, certify that:
| 1. | I have reviewed this quarterly report on Form 10-Q of Southern First Bancshares, Inc.; | |
| 2. | Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; | |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; | |
| 4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; | ||
| b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; | ||
| c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and | ||
| d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and | ||
| 5. | The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| a) | All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and | ||
| b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. | ||
| Date: November 1, 2022 | By: | /s/ Michael D. Dowling |
| Michael D. Dowling | ||
| Chief Financial Officer | ||
Exhibit 32
Section 1350 Certifications.
Exhibit 32
CERTIFICATION PURSUANT
TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned, the Chief Executive Officer and the Chief Financial Officer of Southern First Bancshares, Inc. (the “Company”), each certify that, to his knowledge on the date of this certification:
| 1. | The quarterly report of the Company for the period ended September 30, 2022 as filed with the Securities and Exchange Commission on this date (the “Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and | |
| 2. | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. | |
| /s/ R. Arthur Seaver, Jr. | |
| R. Arthur Seaver, Jr. | |
| Chief Executive Officer | |
| Date: November 1, 2022 | |
| /s/ Michael D. Dowling | |
| Michael D. Dowling | |
| Chief Financial Officer | |
| Date: November 1, 2022 |