Wilson Bank Holding Co 10-Q for FY2020 Q1
Wilson Bank Holding Co (WBHC)
About this 10-Q
Wilson Bank Holding Co filed this 10-Q on May 8, 2020, covering the quarter ended March 31, 2020 (FY2020 Q1).
Headline figures
Quarter ended March 31, 2020, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Net income
- $9.03M
- up 8.9% from net income of $8.29M a year earlier
- Diluted EPS
- $0.83
- up 7.8% from $0.77 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number
WILSON BANK HOLDING COMPANY
(Exact name of registrant as specified in its charter)
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(I.R.S. Employer Identification No.) |
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(Zip Code) |
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(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
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Smaller reporting company |
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Emerging growth company |
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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
Securities registered pursuant to Section 12(b) of the Exchange Act: None
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Common stock outstanding:
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| Item 1. |
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| The unaudited consolidated financial statements of the Company and its subsidiary are as follows: |
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Consolidated Balance Sheets — March 31, 2020 and December 31, 2019. |
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Consolidated Statements of Earnings — For the three months ended March 31, 2020 and 2019. |
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Consolidated Statements of Cash Flows — For the three months ended March 31, 2020 and 2019. |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
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Disclosures required by Item 3 are incorporated by reference to Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
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| Part II: |
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| Item 1. |
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| Item 1A. |
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| Item 2. |
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Unregistered Sales of Equity Securities and Use of Proceeds. |
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| Item 3. |
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| Item 4. |
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| Item 5. |
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| Item 6. |
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| EX-31.1 SECTION 302 CERTIFICATION OF THE CEO |
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| EX-31.2 SECTION 302 CERTIFICATION OF THE CFO |
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| EX-32.1 SECTION 906 CERTIFICATION OF THE CEO |
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| EX-32.2 SECTION 906 CERTIFICATION OF THE CFO |
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| EX-101.INS |
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| EX-101.SCH |
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| EX-101.CAL |
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| EX-101.DEF |
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| EX-101.PRE |
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| EX-104 |
Item 1. Financial Statements
WILSON BANK HOLDING COMPANY
Consolidated Balance Sheets
March 31, 2020 and December 31, 2019
| (Unaudited) |
(Audited) |
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| March 31, 2020 | December 31, 2019 | |||||||
| (Dollars in Thousands Except Share Amounts) |
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| Assets |
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| Loans |
$ | $ | ||||||
| Less: Allowance for loan losses |
( |
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| Net loans |
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| Available-for-sale, at market (amortized cost $ and $, respectively) |
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| Loans held for sale |
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| Interest bearing deposits |
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| Restricted equity securities |
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| Federal funds sold |
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| Total earning assets |
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| Cash and due from banks |
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| Bank premises and equipment, net |
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| Accrued interest receivable |
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| Deferred income tax asset |
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| Other real estate |
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| Bank owned life insurance |
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| Other assets |
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| Goodwill |
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| Total assets |
$ | $ | ||||||
| Liabilities and Stockholders’ Equity |
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| Deposits |
$ | $ | ||||||
| Federal Home Loan Bank advances |
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| Accrued interest and other liabilities |
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| Total liabilities |
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| Stockholders’ equity: |
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| Common stock, $ par value; authorized shares, issued and outstanding and shares, respectively |
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| Additional paid-in capital |
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| Retained earnings |
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| Net unrealized gains on available-for-sale securities, net of income taxes of $ and $, respectively |
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| Total stockholders’ equity |
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| Total liabilities and stockholders’ equity |
$ | $ | ||||||
See accompanying notes to consolidated financial statements (unaudited)
Consolidated Statements of Earnings
Three Months Ended March 31, 2020 and 2019
(Unaudited)
| Three Months Ended |
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| March 31, |
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| 2020 |
2019 |
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| (Dollars in Thousands Except Per Share Amounts) |
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| Interest income: |
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| Interest and fees on loans |
$ | $ | ||||||
| Interest and dividends on securities: |
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| Taxable securities |
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| Exempt from federal income taxes |
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| Interest on loans held for sale |
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| Interest on federal funds sold |
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| Interest on balances held at depository institutions |
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| Interest and dividends on restricted securities |
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| Total interest income |
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| Interest expense: |
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| Interest on negotiable order of withdrawal accounts |
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| Interest on money market and savings accounts |
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| Interest on time deposits |
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| Interest on Federal Home Loan Bank advances |
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| Total interest expense |
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| Net interest income before provision for loan losses |
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| Provision for loan losses |
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| Net interest income after provision for loan losses |
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| Non-interest income: |
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| Service charges on deposit accounts |
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| Other fees and commissions |
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| Income on BOLI and annuity contracts |
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| Gain on sale of loans |
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| Loss on the sale of fixed assets |
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| Loss on sale of other real estate |
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| Gain (loss) on sale of securities |
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| Total non-interest income |
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| Non-interest expense: |
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| Salaries and employee benefits |
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| Occupancy expenses, net |
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| Advertising & public relations expense |
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| Furniture and equipment expense |
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| Data processing expense |
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| ATM & interchange expense |
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| Directors’ fees |
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| Audit, legal & consulting expenses |
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| Other operating expenses |
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| Total non-interest expense |
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| Earnings before income taxes |
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| Income taxes |
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| Net earnings |
$ | $ | ||||||
| Weighted average number of common shares outstanding-basic |
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| Weighted average number of common shares outstanding-diluted |
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| Basic earnings per common share |
$ | $ | ||||||
| Diluted earnings per common share |
$ | $ | ||||||
| Dividends per common share |
$ | $ | ||||||
See accompanying notes to consolidated financial statements (unaudited)
Consolidated Statements of Comprehensive Earnings
Three Months Ended March 31, 2020 and 2019
(Unaudited)
| Three Months Ended |
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| March 31, |
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| 2020 |
2019 |
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| (In Thousands) |
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| Net earnings |
$ | $ | ||||||
| Other comprehensive earnings , net of tax: |
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| Unrealized gains on available-for-sale securities arising during period, net of taxes of $ and $, respectively |
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| Reclassification adjustment for net losses (gains) on the sale of securities included in net earnings, net of taxes of $ and $, respectively |
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| Other comprehensive earnings |
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| Comprehensive earnings |
$ | $ | ||||||
See accompanying notes to consolidated financial statements (unaudited)
Consolidated Statements of Changes in Stockholders’ Equity
Three Months Ended March 31, 2020 and 2019
(Unaudited)
| Dollars In Thousands |
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| Common Stock | Additional Paid-In Capital | Retained Earnings | Net Unrealized Gain (Loss) On Available-For-Sale Securities | Total |
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| Three months ended: |
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| March 31, 2020 |
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| Balance at beginning of period |
$ | |||||||||||||||||||
| Cash dividends declared, $ per share | — | — | ( |
) | — | ( |
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| Issuance of shares of common stock pursuant to the dividend reinvestment plan | — | — | ||||||||||||||||||
| Issuance of shares of common stock pursuant to exercise of stock options | — | — | ||||||||||||||||||
| Share based compensation expense | — | — | — | |||||||||||||||||
| Net change in fair value of available-for-sale securities during the period, net of taxes of $ | — | — | — | |||||||||||||||||
| Net earnings for the quarter | — | — | — | |||||||||||||||||
| Balance at end of period |
$ | |||||||||||||||||||
| March 31, 2019 |
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| Balance at beginning of period |
$ | ( |
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| Cash dividends declared, $per share | — | — | ( |
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| Issuance of shares of common stock pursuant to dividend reinvestment plan |
— | — | ||||||||||||||||||
| Issuance of shares of common stock pursuant to exercise of stock options |
— | — | ||||||||||||||||||
| Share based compensation expense |
— | — | ||||||||||||||||||
| Net change in fair value of available-for-sale securities during the period, net of taxes of $ |
— | — | — | |||||||||||||||||
| Reclassification adjustment for the adoption of lease standard |
— | — | ( |
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| Net earnings for the quarter |
— | — | — | |||||||||||||||||
| Balance at end of period |
$ | ( |
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See accompanying notes to consolidated financial statements (unaudited)
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2020 and 2019
Increase (Decrease) in Cash and Cash Equivalents
(Unaudited)
| Three Months Ended March 31, |
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| 2020 |
2019 |
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| (In Thousands) |
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| Cash flows from operating activities: |
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| Interest received |
$ | $ | ||||||
| Fees and commissions received |
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| Proceeds from sale of loans held for sale |
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| Origination of loans held for sale |
( |
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| Interest paid |
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| Cash paid to suppliers and employees |
( |
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| Income taxes paid |
( |
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| Net cash provided by operating activities |
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| Cash flows from investing activities: |
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| Proceeds from maturities, calls, and principal payments of available-for-sale securities |
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| Proceeds from the sale of available-for-sale securities |
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| Purchase of available-for-sale securities |
( |
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| Loans made to customers, net of repayments |
( |
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| Purchase of restricted equity securities |
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| Purchase of premises and equipment |
( |
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| Proceeds from sale of other real estate |
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| Proceeds from sale of other assets |
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| Net cash used in investing activities |
( |
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| Cash flows from financing activities: |
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| Net increase in non-interest bearing, savings and NOW deposit accounts |
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| Net increase (decrease) in time deposits |
( |
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| Net increase (decrease) in Federal Home Loan Bank advances |
( |
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| Common stock dividends paid |
( |
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| Proceeds from sale of common stock pursuant to dividend reinvestment plan |
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| Proceeds from exercise of stock options |
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| Net cash provided by financing activities |
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| Net increase in cash and cash equivalents |
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| Cash and cash equivalents at beginning of period |
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| Cash and cash equivalents at end of period |
$ | $ | ||||||
See accompanying notes to consolidated financial statements (unaudited)
WILSON BANK HOLDING COMPANY
Consolidated Statements of Cash Flows, Continued
Three Months Ended March 31, 2020 and 2019
Increase (Decrease) in Cash and Cash Equivalents
(Unaudited)
| Three Months Ended March 31, |
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| 2020 |
2019 |
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| (In Thousands) |
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| Reconciliation of net earnings to net cash provided by operating activities: |
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| Net earnings |
$ | $ | ||||||
| Adjustments to reconcile net earnings to net cash provided by operating activities: |
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| Depreciation, amortization, and accretion |
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| Provision for loan losses |
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| Loss on sale of other real estate |
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| Loss (gain) on sale of securities |
( |
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| Share-based compensation expense |
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| Loss on the sale of bank premises and equipment |
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| Increase in loans held for sale |
( |
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| Increase in deferred tax asset |
( |
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| Increase in other assets, bank owned life insurance and annuity contract earnings, net |
( |
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| Increase in interest receivable |
( |
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| Increase in other liabilities |
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| Increase in taxes payable |
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| Increase (decrease) in interest payable |
( |
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| Total adjustments |
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| Net cash provided by operating activities |
$ | $ | ||||||
| Supplemental schedule of non-cash activities: |
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| Unrealized gain in value of securities available-for-sale, net of taxes of and for the three months ended March 31, 2020 and 2019, respectively |
$ | $ | ||||||
| Non-cash transfers from loans to other real estate |
$ | $ | ||||||
| Non-cash transfers from loans to other assets |
$ | $ | ||||||
See accompanying notes to consolidated financial statements (unaudited)
Notes to Consolidated Financial Statements
(Unaudited)
Note 1. Summary of Significant Accounting Policies
Nature of Business — Wilson Bank Holding Company (the “Company”) is a bank holding company whose primary business is conducted by its wholly-owned subsidiary, Wilson Bank & Trust (the “Bank”). The Bank is a commercial bank headquartered in Lebanon, Tennessee. The Bank provides a full range of banking services in its primary market areas of Wilson, Davidson, Rutherford, Trousdale, Sumner, Dekalb, Putnam, Smith, and Williamson Counties, Tennessee.
Basis of Presentation — The accompanying unaudited, consolidated financial statements have been prepared in accordance with instructions to Form 10-Q and therefore do not include all information and footnotes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with U.S. generally accepted accounting principles. All adjustments consisting of normally recurring accruals that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods covered by the report have been included. The accompanying unaudited consolidated financial statements should be read in conjunction with the Company’s consolidated audited financial statements and related notes appearing in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.
These consolidated financial statements include the accounts of the Company and the Bank. Significant intercompany transactions and accounts are eliminated in consolidation.
Use of Estimates — The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term include the determination of the allowance for loan losses, the valuation of deferred tax assets, determination of any impairment of goodwill or other intangibles, other-than-temporary impairment of securities, the valuation of other real estate, and the fair value of financial instruments. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2019. There have been no significant changes to the Company’s significant accounting policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.
Loans — Loans are reported at their outstanding principal balances less unearned income, the allowance for loan losses and any deferred fees or costs on originated loans. Interest income on loans is accrued based on the principal balance outstanding. Loan origination fees, net of certain loan origination costs, are deferred and recognized as an adjustment to the related loan yield using a method which approximates the interest method.
Loans are charged off when management believes that the full collectability of the loan is unlikely. As such, a loan may be partially charged-off after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan is unlikely.
Loans are placed on nonaccrual status when there is a significant deterioration in the financial condition of the borrower, which often is determined when the principal or interest on the loan is more than 90 days past due, unless the loan is both well-secured and in the process of collection. Generally, all interest accrued but not collected for loans that are placed on nonaccrual status, is reversed against current income. Interest income is subsequently recognized only to the extent cash payments are received while the loan is classified as nonaccrual, but interest income recognition is reviewed on a case-by-case basis. A nonaccrual loan is returned to accruing status once the loan has been brought current and collection is reasonably assured or the loan has been “well-secured” through other techniques. Past due status is determined based on the contractual due date per the underlying loan agreement.
All loans that are placed on nonaccrual are further analyzed to determine if they should be classified as impaired loans. At December 31, 2019 and March 31, 2020, there were
Allowance for Loan Losses — The allowance for loan losses is maintained at a level that management believes to be adequate to absorb probable losses in the loan portfolio. Loan losses are charged against the allowance when they are known. Subsequent recoveries are credited to the allowance. Management’s determination of the adequacy of the allowance is based on an evaluation of the portfolio, current economic conditions, volume, growth, composition of the loan portfolio, homogeneous pools of loans, risk ratings of specific loans, historical loan loss factors, loss experience of various loan segments, identified impaired loans and other factors related to the portfolio. This evaluation is performed quarterly and is inherently subjective, as it requires material estimates that are susceptible to significant change including the amounts and timing of future cash flows expected to be received on any impaired loans.
In assessing the adequacy of the allowance, we also consider the results of our ongoing independent loan review process. We undertake this process both to ascertain whether there are loans in the portfolio whose credit quality has weakened over time and to assist in our overall evaluation of the risk characteristics of the entire loan portfolio. Our loan review process includes the judgment of management, independent loan reviewers, and reviews that may have been conducted by third-party reviewers. We incorporate relevant loan review results in the loan impairment determination. In addition, regulatory agencies, as an integral part of their examination process, will periodically review the Company’s allowance for loan losses, and may require the Company to record adjustments to the allowance based on their judgment about information available to them at the time of their examinations.
Recently Issued Accounting Pronouncements
ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 along with several other subsequent codification updates related to accounting for credit losses, requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.
ASU 2016-13 was originally to become effective for us on January 1, 2020. On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security ("CARES") Act. The law contains several provisions, among them, it gives lenders, including the Company, the option to defer the implementation of ASU 2016-13, which is known as the Current Expected Credit Losses (CECL) standard, until 60 days after the declaration of the end of the public health emergency related to the COVID-19 pandemic or December 31, 2020, whichever comes first. In addition, the Securities and Exchange Commission (SEC) staff has stated that opting to delay the implementation of CECL shall be considered to be in accordance with generally accepted accounting principles. As a result, the Company has elected to delay implementation of CECL.
We currently believe the adoption of ASU 2016-13 would have resulted in approximately a
Prior to the CARES Act being signed and the Company’s decision to delay the implementation of CECL, the Company was completing its CECL implementation plan with a cross-functional working group, under the direction of the Chief Credit Officer along with our Chief Financial Officer. The working group also included individuals from various functional areas including credit, risk management, accounting and information technology, among others. The Company’s implementation plan included assessment and documentation of processes, internal controls and data sources; model development, documentation and validation; and system configuration, among other things. The Company contracted with a third-party vendor to assist it in the implementation of CECL. As we are currently finalizing the execution of our implementation controls and processes, the ultimate impact of the adoption of ASU 2016-13 could differ from our current expectation. Furthermore, ASU 2016-13 will necessitate that we establish an allowance for expected credit losses for available-for-sale securities and other financial assets and it also applies to off-balance sheet credit exposure like loan commitments and other investments; however, we do not expect these allowances to be significant. The adoption of ASU 2016-13 is not expected to have a significant impact on our regulatory capital ratios.
ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates Step 2 from the goodwill impairment test which required entities to compute the implied fair value of goodwill. Under ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 became effective for us on January 1, 2020, and did not have a significant impact on our financial statements.
ASU 2018-13, "Fair Value Measurement (Topic 820) - Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement." ASU 2018-13 modifies the disclosure requirements on fair value measurements in Topic 820. The amendments in this update remove disclosures that no longer are considered cost beneficial, modify/clarify the specific requirements of certain disclosures, and add disclosure requirements identified as relevant. ASU 2018-13 became effective for us on January 1, 2020 and did not have a significant impact on our financial statements.
Note 2. Loans and Allowance for Loan Losses
For financial reporting purposes, the Company classifies its loan portfolio based on the underlying collateral utilized to secure each loan. This classification is consistent with that utilized in the Quarterly Report of Condition and Income filed by the Bank with the Federal Deposit Insurance Corporation (“FDIC”).
The following schedule details the loans of the Company at March 31, 2020 and December 31, 2019:
| (In Thousands) |
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| March 31, 2020 | December 31, 2019 | |||||||
| Mortgage loans on real estate: |
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| Residential 1-4 family |
$ | $ | ||||||
| Multifamily |
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| Commercial |
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| Construction and land development |
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| Farmland |
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| Second mortgages |
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| Equity lines of credit |
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| Total mortgage loans on real estate |
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| Commercial loans |
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| Agricultural loans |
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| Consumer installment loans |
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| Personal |
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| Credit cards |
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| Total consumer installment loans |
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| Other loans |
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| Total loans before net deferred loan fees |
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| Net deferred loan fees |
( |
) | ( |
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| Total loans |
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| Less: Allowance for loan losses |
( |
) | ( |
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| Net loans |
$ | $ | ||||||
Risk characteristics relevant to each portfolio segment are as follows:
Construction and land development: Loans for non-owner-occupied real estate construction or land development are generally repaid through cash flow related to the operation, sale or refinance of the property. The Company also finances construction loans for owner-occupied properties. A portion of the Company’s construction and land portfolio segment is comprised of loans secured by residential product types (residential land and single-family construction). With respect to construction loans to developers and builders that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction and land development loans are underwritten utilizing independent appraisal reviews, sensitivity analysis of absorption and lease rates, market sales activity, and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayments substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.
1-4 family residential real estate: Residential real estate loans represent loans to consumers or investors to finance a residence. These loans are typically financed on
1-4 family HELOC: This loan segment includes open-end home equity loans that are secured by a first or second mortgage on the borrower’s residence. This allows customers to borrow against the equity in their home utilizing a revolving line of credit. These loans are underwritten and approved based on a number of credit quality criteria including limits on maximum LTV ratios, minimum credit scores, and maximum debt to income ratios. Real estate market values as of the time the loan is made directly affect the amount of credit extended and, in addition, changes in these residential property values impact the depth of potential losses in this portfolio segment. Because of the revolving nature of these loans, as well as the fact that many represent second mortgages, this portfolio segment can contain more risk than the amortizing 1-4 family residential real estate loans.
Multi-family and commercial real estate: Multi-family and commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate.
Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. The Company also utilizes third-party experts to provide insight and guidance about economic conditions and trends affecting the market areas it serves. In addition, management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. Non-owner occupied commercial real estate loans are loans secured by multifamily and commercial properties where the primary source of repayment is derived from rental income associated with the property (that is, loans for which 50 percent or more of the source of repayment comes from third party, nonaffiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. These loans are made to finance income-producing properties such as apartment buildings, office and industrial buildings, and retail properties. Owner-occupied commercial real estate loans are loans where the primary source of repayment is the cash flow from the ongoing operations and business activities conducted by the party, or affiliate of the party, who owns the property.
Commercial and Industrial: The commercial and industrial loan portfolio segment includes commercial and industrial loans to commercial customers for use in normal business operations to finance working capital needs, equipment purchases or other expansion projects. Collection risk in this portfolio is driven by the creditworthiness of underlying borrowers, particularly cash flow from customers’ business operations. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower, if any. The cash flows of borrowers, however, may not be as expected and any collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and usually incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
Consumer: The consumer loan portfolio segment includes non-real estate secured direct loans to consumers for household, family, and other personal expenditures. Consumer loans may be secured or unsecured and are usually structured with short or medium term maturities. These loans are underwritten and approved based on a number of consumer credit quality criteria including limits on maximum LTV ratios on secured consumer loans, minimum credit scores, and maximum debt to income ratios. Many traditional forms of consumer installment credit have standard monthly payments and fixed repayment schedules of to years. These loans are made with either fixed or variable interest rates that are based on specific indices. Installment loans fill a variety of needs, such as financing the purchase of an automobile, a boat, a recreational vehicle or other large personal items, or for consolidating debt. These loans may be unsecured or secured by an assignment of title, as in an automobile loan, or by money in a bank account. In addition to consumer installment loans, this portfolio segment also includes secured and unsecured personal lines of credit as well as overdraft protection lines. Loans in this portfolio segment are sensitive to unemployment and other key consumer economic measures.
The adequacy of the allowance for loan losses is assessed at the end of each calendar quarter. The level of the allowance is based upon evaluation of the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, current and anticipated economic conditions, historical loss experience, industry and peer bank loan quality indicators and other pertinent factors, including regulatory recommendations.
Transactions in the allowance for loan losses for the three months ended March 31, 2020 and 2019 and year ended December 31, 2019 are summarized as follows:
| (In Thousands) |
||||||||||||||||||||||||||||||||||||||||
| Residential 1-4 Family | Multifamily |
Commercial Real Estate | Construction |
Farmland |
Second Mortgages | Equity Lines of Credit | Commercial |
Agricultural, Installment and Other | Total |
|||||||||||||||||||||||||||||||
| March 31, 2020 |
||||||||||||||||||||||||||||||||||||||||
| Allowance for loan losses: |
||||||||||||||||||||||||||||||||||||||||
| Beginning balance |
$ | |||||||||||||||||||||||||||||||||||||||
| Provision |
( |
) | ( |
) | ( |
) | ( |
) | ||||||||||||||||||||||||||||||||
| Charge-offs |
( |
) | ( |
) | ||||||||||||||||||||||||||||||||||||
| Recoveries |
||||||||||||||||||||||||||||||||||||||||
| Ending balance |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance individually evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance collectively evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Loans: |
||||||||||||||||||||||||||||||||||||||||
| Ending balance |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance individually evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance collectively evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Residential 1-4 Family | Multifamily |
Commercial Real Estate | Construction |
Farmland |
Second Mortgages | Equity Lines of Credit | Commercial |
Agricultural, Installment and Other | Total |
|||||||||||||||||||||||||||||||
| December 31, 2019 |
||||||||||||||||||||||||||||||||||||||||
| Allowance for loan losses: |
||||||||||||||||||||||||||||||||||||||||
| Beginning balance |
$ | |||||||||||||||||||||||||||||||||||||||
| Provision |
( |
) | ( |
) | ( |
) | ||||||||||||||||||||||||||||||||||
| Charge-offs |
( |
) | ( |
) | ( |
) | ( |
) | ( |
) | ||||||||||||||||||||||||||||||
| Recoveries |
||||||||||||||||||||||||||||||||||||||||
| Ending balance |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance individually evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance collectively evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Loans: |
||||||||||||||||||||||||||||||||||||||||
| Ending balance |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance individually evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance collectively evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Residential 1-4 Family | Multifamily |
Commercial Real Estate | Construction |
Farmland |
Second Mortgages | Equity Lines of Credit | Commercial |
Agricultural, Installment and Other | Total |
|||||||||||||||||||||||||||||||
| March 31, 2019 |
||||||||||||||||||||||||||||||||||||||||
| Allowance for loan losses: |
||||||||||||||||||||||||||||||||||||||||
| Beginning balance |
$ | |||||||||||||||||||||||||||||||||||||||
| Provision |
( |
) | ( |
) | ( |
) | ||||||||||||||||||||||||||||||||||
| Charge-offs |
( |
) | ( |
) | ||||||||||||||||||||||||||||||||||||
| Recoveries |
||||||||||||||||||||||||||||||||||||||||
| Ending balance |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance individually evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance collectively evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Loans: |
||||||||||||||||||||||||||||||||||||||||
| Ending balance |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance individually evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
| Ending balance collectively evaluated for impairment |
$ | |||||||||||||||||||||||||||||||||||||||
Impaired Loans
At March 31, 2020, the Company had certain impaired loans of $
| In Thousands |
||||||||||||||||||||
| Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||
| March 31, 2020 |
||||||||||||||||||||
| With no related allowance recorded: |
||||||||||||||||||||
| Residential 1-4 family |
$ | — | ||||||||||||||||||
| Multifamily |
— | |||||||||||||||||||
| Commercial real estate |
— | |||||||||||||||||||
| Construction |
— | |||||||||||||||||||
| Farmland |
— | |||||||||||||||||||
| Second mortgages |
— | |||||||||||||||||||
| Equity lines of credit |
— | |||||||||||||||||||
| Commercial |
— | |||||||||||||||||||
| Agricultural, installment and other |
— | |||||||||||||||||||
| $ | $ | — | $ | $ | ||||||||||||||||
| With related allowance recorded: |
||||||||||||||||||||
| Residential 1-4 family |
$ | |||||||||||||||||||
| Multifamily |
||||||||||||||||||||
| Commercial real estate |
||||||||||||||||||||
| Construction |
||||||||||||||||||||
| Farmland |
||||||||||||||||||||
| Second mortgages |
||||||||||||||||||||
| Equity lines of credit |
||||||||||||||||||||
| Commercial |
||||||||||||||||||||
| Agricultural, installment and other |
||||||||||||||||||||
| $ | $ | $ | $ | $ | ||||||||||||||||
| Total |
||||||||||||||||||||
| Residential 1-4 family |
$ | |||||||||||||||||||
| Multifamily |
||||||||||||||||||||
| Commercial real estate |
||||||||||||||||||||
| Construction |
||||||||||||||||||||
| Farmland |
||||||||||||||||||||
| Second mortgages |
||||||||||||||||||||
| Equity lines of credit |
||||||||||||||||||||
| Commercial |
||||||||||||||||||||
| Agricultural, installment and other |
||||||||||||||||||||
| $ | $ | $ | $ | $ | ||||||||||||||||
| In Thousands |
||||||||||||||||||||
| Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||
| December 31, 2019 |
||||||||||||||||||||
| With no related allowance recorded: |
||||||||||||||||||||
| Residential 1-4 family |
$ | — | ||||||||||||||||||
| Multifamily |
— | |||||||||||||||||||
| Commercial real estate |
— | |||||||||||||||||||
| Construction |
— | |||||||||||||||||||
| Farmland |
— | |||||||||||||||||||
| Second mortgages |
— | |||||||||||||||||||
| Equity lines of credit |
— | |||||||||||||||||||
| Commercial |
— | |||||||||||||||||||
| Agricultural, installment and other |
— | |||||||||||||||||||
| $ | — | |||||||||||||||||||
| With related allowance recorded: |
||||||||||||||||||||
| Residential 1-4 family |
$ | |||||||||||||||||||
| Multifamily |
||||||||||||||||||||
| Commercial real estate |
||||||||||||||||||||
| Construction |
||||||||||||||||||||
| Farmland |
||||||||||||||||||||
| Second mortgages |
||||||||||||||||||||
| Equity lines of credit |
||||||||||||||||||||
| Commercial |
||||||||||||||||||||
| Agricultural, installment and other |
||||||||||||||||||||
| $ | ||||||||||||||||||||
| Total: |
||||||||||||||||||||
| Residential 1-4 family |
$ | |||||||||||||||||||
| Multifamily |
||||||||||||||||||||
| Commercial real estate |
||||||||||||||||||||
| Construction |
||||||||||||||||||||
| Farmland |
||||||||||||||||||||
| Second mortgages |
||||||||||||||||||||
| Equity lines of credit |
||||||||||||||||||||
| Commercial |
||||||||||||||||||||
| Agricultural, installment and other |
||||||||||||||||||||
| $ | ||||||||||||||||||||
Impaired loans also include loans that the Bank may elect to formally restructure due to the weakening credit status of a borrower such that the restructuring may facilitate a repayment plan that minimizes the potential losses that the Bank may otherwise incur. These loans are classified as impaired loans and, if on non-accruing status as of the date of restructuring, the loans are included in the nonperforming loan balances. Not included in nonperforming loans are loans that have been restructured that were performing as of the restructure date.
Troubled Debt Restructuring
The Bank’s loan portfolio includes certain loans that have been modified in a troubled debt restructuring ("TDR"), where economic or other concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Bank’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months.
The following table summarizes the carrying balances of TDRs at March 31, 2020 and December 31, 2019.
| March 31, 2020 |
December 31, 2019 |
|||||||
| (In thousands) |
||||||||
| Performing TDRs |
$ | $ | ||||||
| Nonperforming TDRs |
||||||||
| Total TDRS |
$ | $ | ||||||
The following table outlines the amount of each troubled debt restructuring categorized by loan classification for the three months ended March 31, 2020 and the three months ended March 31, 2019 (in thousands, except for number of contracts):
| March 31, 2020 |
March 31, 2019 |
|||||||||||||||||||||||
| Number of Contracts | Pre Modification Outstanding Recorded Investment | Post Modification Outstanding Recorded Investment, Net of Related Allowance | Number of Contracts | Pre Modification Outstanding Recorded Investment | Post Modification Outstanding Recorded Investment, Net of Related Allowance | |||||||||||||||||||
| Residential 1-4 family |
$ | $ | $ | $ | ||||||||||||||||||||
| Multifamily |
||||||||||||||||||||||||
| Commercial real estate |
||||||||||||||||||||||||
| Construction |
||||||||||||||||||||||||
| Farmland |
||||||||||||||||||||||||
| Second mortgages |
||||||||||||||||||||||||
| Equity lines of credit |
||||||||||||||||||||||||
| Commercial |
||||||||||||||||||||||||
| Agricultural, installment and other |
||||||||||||||||||||||||
| Total |
$ | $ | $ | $ | ||||||||||||||||||||
As of March 31, 2020 the Company had loan relationship totaling $
In response to the COVID-19 pandemic and its economic impact to the Bank’s customers, the Bank proactively began providing relief to its customers in the middle of March 2020 through a 90 day interest only payment option or a full 90 day payment deferral option. Following the passage of the CARES Act the Bank expanded this program to provide a six-month interest only payment option in an effort to provide flexibility to its customers as they navigate these uncertain times. Pursuant to interagency regulatory guidance and the CARES Act, the Bank may elect to not classify loans for which these deferrals are granted between March 1, 2020 and the earlier of (i) December 31, 2020 or (ii) 60 days after the end of the COVID-19 national emergency as troubled debt restructurings.
As of April 30, 2020, the Bank had granted deferrals of principal or both principal and interest on approximately
As of March 31, 2020, the Company’s recorded investment in consumer mortgage loans in the process of foreclosure amounted to approximately $
Potential problem loans, which include nonperforming loans, amounted to approximately $
The following summary presents the Bank's loan balances by primary loan classification and the amount classified within each risk rating category. Pass rated loans include all credits other than those included in special mention, substandard and doubtful which are defined as follows:
| • |
Special mention loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. |
|
| • |
Substandard loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that jeopardize liquidation of the debt. Substandard loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. |
|
| • |
Doubtful loans have all the characteristics of substandard loans with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The Bank considers all doubtful loans to be impaired and places such loans on nonaccrual status. |
The following table is a summary of the Bank’s loan portfolio by risk rating at March 31, 2020 and December 31, 2019:
| (In Thousands) |
||||||||||||||||||||||||||||||||||||||||
| Residential 1-4 Family | Multifamily |
Commercial Real Estate | Construction |
Farmland |
Second Mortgages | Equity Lines of Credit | Commercial |
Agricultural, installment and other | Total |
|||||||||||||||||||||||||||||||
| March 31, 2020 |
||||||||||||||||||||||||||||||||||||||||
| Credit Risk Profile by Internally Assigned Rating |
||||||||||||||||||||||||||||||||||||||||
| Pass |
$ | |||||||||||||||||||||||||||||||||||||||
| Special Mention |
||||||||||||||||||||||||||||||||||||||||
| Substandard |
||||||||||||||||||||||||||||||||||||||||
| Doubtful |
||||||||||||||||||||||||||||||||||||||||
| Total |
$ | |||||||||||||||||||||||||||||||||||||||
| December 31, 2019 |
||||||||||||||||||||||||||||||||||||||||
| Credit Risk Profile by Internally Assigned Rating |
||||||||||||||||||||||||||||||||||||||||
| Pass |
$ | |||||||||||||||||||||||||||||||||||||||
| Special Mention |
||||||||||||||||||||||||||||||||||||||||
| Substandard |
||||||||||||||||||||||||||||||||||||||||
| Doubtful |
||||||||||||||||||||||||||||||||||||||||
| Total |
$ | |||||||||||||||||||||||||||||||||||||||
Note 3. Debt and Equity Securities
Debt and equity securities have been classified in the consolidated balance sheet according to management’s intent. Debt and equity securities at March 31, 2020 and December 31, 2019 are summarized as follows:
| March 31, 2020 |
||||||||||||||||
| Securities Available-For-Sale |
||||||||||||||||
| In Thousands |
||||||||||||||||
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Market Value | |||||||||||||
| U.S. Government-sponsored enterprises (GSEs) |
$ | $ | $ | $ | ||||||||||||
| Mortgage-backed securities |
||||||||||||||||
| Asset-backed securities |
||||||||||||||||
| Obligations of states and political subdivisions |
||||||||||||||||
| $ | $ | $ | $ | |||||||||||||
| December 31, 2019 |
||||||||||||||||
| Securities Available-For-Sale |
||||||||||||||||
| In Thousands |
||||||||||||||||
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Market Value | |||||||||||||
| U.S. Government-sponsored enterprises (GSEs) |
$ | $ | $ | $ | ||||||||||||
| Mortgage-backed securities |
||||||||||||||||
| Asset-backed securities |
||||||||||||||||
| Obligations of states and political subdivisions |
||||||||||||||||
| $ | $ | $ | $ | |||||||||||||
There were
Included in mortgage-backed securities are collateralized mortgage obligations totaling $
The amortized cost and estimated market value of debt securities at March 31, 2020, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| Available-For-Sale |
||||||||
| In Thousands |
||||||||
| Amortized Cost | Estimated Market Value | |||||||
| Due in one year or less |
$ | $ | ||||||
| Due after one year through five years |
||||||||
| Due after five years through ten years |
||||||||
| Due after ten years |
||||||||
| $ | $ | |||||||
The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 31, 2020 and December 31, 2019.
| In Thousands, Except Number of Securities |
||||||||||||||||||||||||||||||||
| Less than 12 Months |
12 Months or More |
Total |
||||||||||||||||||||||||||||||
| March 31, 2020 |
Fair Value | Unrealized Losses | Number of Securities Included | Fair Value | Unrealized Losses | Number of Securities Included | Fair Value | Unrealized Losses | ||||||||||||||||||||||||
| Available-for-Sale Securities: |
||||||||||||||||||||||||||||||||
| GSEs |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||
| Mortgage-backed securities |
||||||||||||||||||||||||||||||||
| Asset-backed securities |
||||||||||||||||||||||||||||||||
| Obligations of states and political subdivisions |
||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
| In Thousands, Except Number of Securities |
||||||||||||||||||||||||||||||||
| Less than 12 Months |
12 Months or More |
Total |
||||||||||||||||||||||||||||||
| December 31, 2019 |
Fair Value | Unrealized Losses | Number of Securities Included | Fair Value | Unrealized Losses | Number of Securities Included | Fair Value | Unrealized Losses | ||||||||||||||||||||||||
| Available-for-Sale Securities: |
||||||||||||||||||||||||||||||||
| GSEs |
$ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||
| Mortgage-backed securities |
||||||||||||||||||||||||||||||||
| Asset-backed securities |
||||||||||||||||||||||||||||||||
| Obligations of states and political subdivisions |
||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||
Unrealized losses on securities have not been recognized into income because the Company does not consider these securities to be other-than-temporarily impaired at March 31, 2020, as the issuers’ securities are of high credit quality, management does not intend to sell the securities and it is not more likely than not that management will be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions. The issuers continue to make timely principal and interest payment on the securities. The fair value is expected to recover as the securities approach maturity.
The carrying values of the Company’s investment securities could decline in the future if the financial condition of issuers deteriorates and management determines it is probable that the Company will not recover the entire amortized cost bases of the securities. As a result, there is a risk that other-than-temporary impairment charges may occur in the future given the current economic environment.
Note 4. Earnings Per Share
The computation of basic earnings per share is based on the weighted average number of common shares outstanding during the period, adjusted for stock splits. The computation of diluted earnings per share for the Company begins with the basic earnings per share and includes the effect of common shares contingently issuable from stock options.
The following is a summary of components comprising basic and diluted earnings per share (“EPS”) for the three months ended March 31, 2020 and 2019:
| Three Months Ended March 31, |
||||||||
| 2020 |
2019 |
|||||||
| (Dollars in Thousands Except Share and Per Share Amounts) |
||||||||
| Basic EPS Computation: |
||||||||
| Numerator – Earnings available to common stockholders |
$ | $ | ||||||
| Denominator – Weighted average number of common shares outstanding |
||||||||
| Basic earnings per common share |
$ | |||||||
| Diluted EPS Computation: |
||||||||
| Numerator – Earnings available to common stockholders |
$ | $ | ||||||
| Denominator – Weighted average number of common shares outstanding |
||||||||
| Dilutive effect of stock options |
||||||||
| Weighted average diluted common shares outstanding |
||||||||
| Diluted earnings per common share |
$ | |||||||
Note 5. Income Taxes
Accounting Standards Codification (“ASC”) 740, Income Taxes, defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. This section also provides guidance on the derecognition, measurement and classification of income tax uncertainties, along with any related interest and penalties, and includes guidance concerning accounting for income tax uncertainties in interim periods. As of March 31, 2020, the Company had
As of and for the three months ended March 31, 2020, the Company has accrued or recognized interest or penalties related to uncertain tax positions. The Company’s policy is to recognize interest and/or penalties related to income tax matters in income tax expense.
The Company and the Bank file consolidated U.S. Federal and State of Tennessee income tax returns. The Company is currently open to audit under the statute of limitations by the State of Tennessee for the years ended December 31, through 2019 and the IRS for the years ended December 31, 2017 through
Note 6. Commitments and Contingent Liabilities
In the normal course of business, the Bank has entered into off-balance sheet financial instruments which include commitments to extend credit (i.e., including unfunded lines of credit) and standby letters of credit. Commitments to extend credit are usually the result of lines of credit granted to existing borrowers under agreements that the total outstanding indebtedness will not exceed a specific amount during the term of the indebtedness. Typical borrowers are commercial concerns that use lines of credit to supplement their treasury management functions, thus their total outstanding indebtedness may fluctuate during any time period based on the seasonality of their business and the resultant timing of their cash flows. Other typical lines of credit are related to home equity loans granted to consumers. Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee.
Standby letters of credit are generally issued on behalf of an applicant (the Bank's customer) to a specifically named beneficiary and are the result of a particular business arrangement that exists between the applicant and the beneficiary. Standby letters of credit have fixed expiration dates and are usually for terms of years or less unless terminated sooner due to criteria specified in the standby letter of credit. A typical arrangement involves the applicant routinely being indebted to the beneficiary for such items as inventory purchases, insurance, utilities, lease guarantees or other third party commercial transactions. The standby letter of credit would permit the beneficiary to obtain payment from the Bank under certain prescribed circumstances. Subsequently, the Bank would then seek reimbursement from the applicant pursuant to the terms of the standby letter of credit.
The Bank follows the same credit policies and underwriting practices when making these commitments as it does for on-balance sheet instruments. Each customer’s creditworthiness is evaluated on a case-by-case basis, and the amount of collateral obtained, if any, is based on management’s credit evaluation of the customer. Collateral held varies but may include cash and cash equivalents, real estate and improvements, marketable securities, accounts receivable, inventory, equipment, and personal property.
The contractual amounts of these commitments are not reflected in the consolidated financial statements and would only be reflected if drawn upon. Since many of the commitments are expected to expire without being drawn upon, the contractual amounts do not necessarily represent future cash requirements. However, should the commitments be drawn upon and should our customers default on their resulting obligation to us, the Company’s maximum exposure to credit loss, without consideration of collateral, is represented by the contractual amount of those instruments.
A summary of the Company’s total contractual amount for all off-balance sheet commitments at March 31, 2020 is as follows:
| Commitments to extend credit | $ | |||
| Standby letters of credit |
$ |
The Bank originates residential mortgage loans, sells them to third-party purchasers, and does not retain the servicing rights. These loans are originated internally and are primarily to borrowers in the Company’s geographic market footprint. These sales are typically to investors that follow guidelines of conventional government sponsored entities ("GSE") and the Department of Housing and Urban Development/U.S. Department of Veterans Affairs ("HUD/VA"). Generally, loans held for sale are underwritten by the Company, including HUD/VA loans. In the fourth quarter of 2018, the Bank began to participate in a mandatory delivery program that requires the Bank to deliver a particular volume of mortgage loans by agreed upon dates. A majority of the Bank’s secondary mortgage volume is delivered to the secondary market via mandatory delivery with the remainder done on a best efforts basis. The Bank does not realize any exposure delivery penalties as the mortgage department only bids loans post-closing to ensure that
Each purchaser has specific guidelines and criteria for sellers of loans, and the risk of credit loss with regard to the principal amount of the loans sold is generally transferred to the purchasers upon sale. While the loans are sold without recourse, the purchase agreements require the Bank to make certain representations and warranties regarding the existence and sufficiency of file documentation and the absence of fraud by borrowers or other third parties such as appraisers in connection with obtaining the loan. If it is determined that the loans sold were in breach of these representations or warranties or the loan had an early payoff or payment default, the Bank has obligations to either repurchase the loan for the unpaid principal balance and related investor fees or make the purchaser whole for the economic benefits of the loan.
To date, repurchase activity pursuant to the terms of these representations and warranties has been insignificant and has resulted in insignificant losses to the Company.
Based on information currently available, management believes that the Bank does not have significant exposure to contingent losses that may arise relating to the representations and warranties that it has made in connection with its mortgage loan sales.
Various legal claims also arise from time to time in the normal course of business. In the opinion of management, the resolution of these claims outstanding at March 31, 2020 will not have a material impact on the Company’s consolidated financial statements.
Note 7. Fair Value Measurements
FASB ASC 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value in U.S. GAAP and expands disclosures about fair value measurements. The definition of fair value focuses on the exit price, i.e., the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, not the entry price (i.e., the price that would be paid to acquire the asset or received to assume the liability at the measurement date). The statement emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, the fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.
Valuation Hierarchy
FASB ASC 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:
| • |
Level 1 — inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. |
|
| • |
Level 2 — inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. |
|
| • |
Level 3 — inputs to the valuation methodology are unobservable and significant to the fair value measurement. |
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Following is a description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such assets and liabilities pursuant to the valuation hierarchy.
Assets
Securities available-for-sale — Where quoted prices are available for identical securities in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid government securities and certain other financial products. If quoted market prices are not available, then fair values are estimated by using pricing models that use observable inputs or quoted prices of securities with similar characteristics and are classified within Level 2 of the valuation hierarchy. In certain cases where there is limited activity or less transparency around inputs to the valuation and more complex pricing models or discounted cash flows are used, securities are classified within Level 3 of the valuation hierarchy.
Impaired loans — A loan is considered to be impaired when it is probable the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected payments using the loan’s original effective rate as the discount rate, the loan’s observable market price, or the fair value of the collateral less selling costs if the loan is collateral dependent. If the recorded investment in the impaired loan exceeds the measure of fair value, a valuation allowance may be established as a component of the allowance for loan losses or the expense is recognized as a charge-off. Impaired loans are classified within Level 3 of the valuation hierarchy due to the unobservable inputs used in determining their fair value such as collateral values and the borrower’s underlying financial condition.
Other real estate owned — Other real estate owned (“OREO”) represents real estate foreclosed upon by the Company through loan defaults by customers or acquired in lieu of foreclosure. Substantially all of these amounts relate to construction and land development, other loans secured by land, and commercial real estate loans for which the Company believes it has adequate collateral. Upon foreclosure, the property is recorded at the lower of cost or fair value, based on appraised value, less selling costs estimated as of the date acquired with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation downward adjustments are determined on a specific property basis and are included as a component of noninterest expense along with holding costs. Any gains or losses realized at the time of disposal are also reflected in noninterest expense, as applicable. OREO is included in Level 3 of the valuation hierarchy due to the lack of observable market inputs into the determination of fair value. Appraisal values are property-specific and sensitive to the changes in the overall economic environment.
Bank Owned Life Insurance — The cash surrender value of bank owned life insurance policies is carried at fair value. The Company uses financial information received from insurance carriers indicating the performance of the insurance policies and cash surrender values in determining the carrying value of life insurance. The Company reflects these assets within Level 3 of the valuation hierarchy due to the unobservable inputs included in the valuation of these items. The Company does not consider the fair values of these policies to be materially sensitive to changes in these unobservable inputs.
Mortgage loans held-for-sale — Mortgage loans held-for-sale are carried at fair value, and are classified within Level 2 of the valuation hierarchy. The fair value of mortgage loans held-for-sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan.
Mortgage banking derivatives —The fair values of mortgage banking derivatives are based on valuation models using observable market data as of the measurement date (Level 2).
The following tables present the financial instruments carried at fair value as of March 31, 2020 and December 31, 2019, by caption on the consolidated balance sheet and by FASB ASC 820 valuation hierarchy (as described above):
| Assets and Liabilities Measured at Fair Value on a Recurring Basis |
||||||||||||||||
| (In Thousands) |
||||||||||||||||
| Total Carrying Value in the Consolidated Balance Sheet | Quoted Market Prices in an Active Market (Level 1) | Models with Significant Observable Market Parameters (Level 2) | Models with Significant Unobservable Market Parameters (Level 3) | |||||||||||||
| March 31, 2020 |
||||||||||||||||
| Investment securities available-for-sale: |
||||||||||||||||
| U.S. Government sponsored enterprises |
$ | |||||||||||||||
| Mortgage-backed securities |
||||||||||||||||
| Asset-backed securities |
||||||||||||||||
| State and municipal securities |
||||||||||||||||
| Total investment securities available-for-sale |
||||||||||||||||
| Mortgage loans held for sale |
||||||||||||||||
| Mortgage banking derivatives |
||||||||||||||||
| Bank owned life insurance |
||||||||||||||||
| Total assets |
$ | |||||||||||||||
| Mortgage banking derivatives |
$ | |||||||||||||||
| Total liabilities |
$ | |||||||||||||||
| December 31, 2019 |
||||||||||||||||
| Investment securities available-for-sale: |
||||||||||||||||
| U.S. Government sponsored enterprises |
$ | |||||||||||||||
| Mortgage-backed securities |
||||||||||||||||
| Asset-backed securities |
||||||||||||||||
| State and municipal securities |
||||||||||||||||
| Total investment securities available-for-sale |
||||||||||||||||
| Mortgage loans held for sale |
||||||||||||||||
| Mortgage banking derivatives |
||||||||||||||||
| Bank owned life insurance |
||||||||||||||||
| Total assets |
$ | |||||||||||||||
| Mortgage banking derivatives |
$ | |||||||||||||||
| Total liabilities |
$ | |||||||||||||||
| Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis |
||||||||||||||||
| (In Thousands) |
||||||||||||||||
| Total Carrying Value in the Consolidated Balance Sheet | Quoted Market Prices in an Active Market (Level 1) | Models with Significant Observable Market Parameters (Level 2) | Models with Significant Unobservable Market Parameters (Level 3) | |||||||||||||
| March 31, 2020 |
||||||||||||||||
| Other real estate owned |
$ | |||||||||||||||
| Impaired loans, net (¹) |
||||||||||||||||
| Total |
$ | |||||||||||||||
| December 31, 2019 |
||||||||||||||||
| Other real estate owned |
$ | |||||||||||||||
| Impaired loans, net (¹) |
||||||||||||||||
| Total |
$ | |||||||||||||||
| (1) |
Amount is net of a valuation allowance of $ |
The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which we have utilized Level 3 inputs to determine fair value at March 31, 2020 and December 31, 2019:
| Valuation Techniques (2) |
Significant Unobservable Inputs |
Weighted Average |
|||||
| Impaired loans |
Appraisal |
Estimated costs to sell |
|||||
| Other real estate owned |
Appraisal |
Estimated costs to sell |
| (2) |
The fair value is generally determined through independent appraisals of the underlying collateral, which may include Level 3 inputs that are not identifiable, or by using the discounted cash flow method if the loan is not collateral dependent. |
In the case of its investment securities portfolio, the Company monitors the valuation technique utilized by various pricing agencies to ascertain when transfers between levels have been affected. The nature of the remaining assets and liabilities is such that transfers in and out of any level are expected to be rare. For the three months ended March 31, 2020, there were no transfers between Levels 1, 2 or 3.
The table below includes a rollforward of the balance sheet amounts for the three months ended March 31, 2020 and 2019 (including the change in fair value) for financial instruments classified by the Company within Level 3 of the valuation hierarchy for assets and liabilities measured at fair value on a recurring basis. When a determination is made to classify a financial instrument within Level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement. However, since Level 3 financial instruments typically include, in addition to the unobservable or Level 3 components, observable components (that is, components that are actively quoted and can be validated to external sources), the gains and losses in the table below include changes in fair value due in part to observable factors that are part of the valuation methodology (in thousands):
| For the Three Months Ended March 31, |
||||||||||||||||
| 2020 |
2019 |
|||||||||||||||
| Other Assets | Other Liabilities | Other Assets | Other Liabilities | |||||||||||||
| Fair value, January 1 |
$ | $ | ||||||||||||||
| Total realized gains included in income |
||||||||||||||||
| Change in unrealized gains/losses included in other comprehensive income for assets and liabilities still held at March 31 |
||||||||||||||||
| Purchases, issuances and settlements, net |
||||||||||||||||
| Transfers out of Level 3 |
||||||||||||||||
| Fair value, March 31 |
$ | $ | ||||||||||||||
| Total realized gains included in income related to financial assets and liabilities still on the consolidated balance sheet at March 31 |
$ | $ | ||||||||||||||
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments that are not measured at fair value. In cases where quoted market prices or observable components are not available, fair values are based on estimates using discounted cash flow models. Those models are significantly affected by the assumptions used, including the discount rates, estimates of future cash flows and borrower creditworthiness. The fair value estimates presented herein are based on pertinent information available to management as of March 31, 2020 and December 31, 2019. Such amounts have not been revalued for purposes of these consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
Cash and cash equivalents — The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.
Held-to-maturity securities — Estimated fair values for investment securities are based on quoted market prices where available. If quoted market prices are not available, then fair values are estimated by using pricing models that use observable inputs or quoted prices of securities with similar characteristics.
Loans — The fair value of our loan portfolio includes a credit risk factor in the determination of the fair value of our loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. Our loan portfolio is initially fair valued using a segmented approach. We divide our loan portfolio into the following categories: variable rate loans, impaired loans and all other loans. The results are then adjusted to account for credit risk.
For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. Fair values for impaired loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral. For other loans, fair values are estimated using discounted cash flow models, using current market interest rates offered for loans with similar terms to borrowers of similar credit quality. The values derived from the discounted cash flow approach for each of the above portfolios are then further discounted to incorporate credit risk to determine the exit price.
Deposits and Federal Home Loan Bank borrowings — Fair values for deposits and Federal Home Loan Bank borrowings are estimated using discounted cash flow models, using current market interest rates offered on deposits with similar remaining maturities.
Restricted equity securities — It is not practical to determine the fair value of Federal Home Loan Bank or Federal Reserve Bank stock due to restrictions placed on its transferability.
Accrued interest receivable/payable — The carrying amounts of accrued interest approximate fair value resulting in a Level 1, Level 2 or Level 3 classification based on the asset/liability with which they are associated.
Off-Balance Sheet Instruments — The fair values of the Company’s off-balance-sheet financial instruments are based on fees charged to enter into similar agreements. However, commitments to extend credit do not represent a significant value to the Company until such commitments are funded.
The following table presents the carrying amounts, estimated fair value and placement in the fair valuation hierarchy of the Company’s financial instruments at March 31, 2020 and December 31, 2019. This table excludes financial instruments for which the carrying amount approximates fair value. For short-term financial assets such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization.
| Carrying/ Notional | Estimated |
Quote Market Prices in an Active Market | Models with Significant Observable Market Parameters | Models with Significant Unobservable Market Parameters | ||||||||||||||||
| (in Thousands) |
Amount |
Fair Value (¹) |
(Level 1) |
(Level 2) |
(Level 3) |
|||||||||||||||
| March 31, 2020 |
||||||||||||||||||||
| Financial assets: |
||||||||||||||||||||
| Cash and cash equivalents |
$ | |||||||||||||||||||
| Loans, net |
||||||||||||||||||||
| Restricted equity securities |
NA | NA | NA | NA | ||||||||||||||||
| Accrued interest receivable |
||||||||||||||||||||
| Financial liabilities: |
||||||||||||||||||||
| Deposits |
||||||||||||||||||||
| Federal Home Loan Bank borrowings |
||||||||||||||||||||
| Accrued interest payable |
||||||||||||||||||||
| December 31, 2019 |
||||||||||||||||||||
| Financial assets: |
||||||||||||||||||||
| Cash and cash equivalents |
$ | |||||||||||||||||||
| Loans, net |
||||||||||||||||||||
| Restricted equity securities |
NA | NA | NA | NA | ||||||||||||||||
| Accrued interest receivable |
||||||||||||||||||||
| Financial liabilities: |
||||||||||||||||||||
| Deposits |
||||||||||||||||||||
| Federal Home Loan Bank borrowings | ||||||||||||||||||||
| Accrued interest payable |
||||||||||||||||||||
| (1) | Estimated fair values are consistent with an exit-price concept. The assumptions used to estimate the fair values are intended to approximate those that a market-participant would realize in a hypothetical orderly transaction. |
Note 8. Equity Incentive Plans
In April 2009, the Company’s shareholders approved the Wilson Bank Holding Company 2009 Stock Option Plan (the “2009 Stock Option Plan”). The 2009 Stock Option Plan was effective as of April 14, 2009. Under the 2009 Stock Option Plan, awards could be in the form of options to acquire common stock of the Company. Subject to adjustment as provided by the terms of the 2009 Stock Option Plan, the maximum number of shares of common stock with respect to which awards could be granted under the 2009 Stock Option Plan was
During the second quarter of 2016, the Company’s shareholders approved the Wilson Bank Holding Company 2016 Equity Incentive Plan, which authorizes awards of up to
As of March 31, 2020, the Company had outstanding
The following table summarizes information about stock options and cash-settled SARs for the three months ended March 31, 2020 and 2019:
| March 31, 2020 |
March 31, 2019 |
|||||||||||||||
| Shares |
Weighted Average Exercise Price | Shares |
Weighted Average Exercise Price | |||||||||||||
| Options and SARs outstanding at beginning of period |
$ | $ | ||||||||||||||
| Granted |
||||||||||||||||
| Exercised |
||||||||||||||||
| Forfeited or expired |
||||||||||||||||
| Outstanding at end of period |
$ | $ | ||||||||||||||
| Options and SARs exercisable at March 31 |
$ | $ | ||||||||||||||
As of March 31, 2020, there was $
Note 9. Mortgage Banking Derivatives
Commitments to fund certain mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of mortgage loans to third party investors under the Bank's mandatory delivery program are considered derivatives. It is the Company's practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from its commitments to fund the loans. At March 31, 2020 and December 31, 2019, the Company had approximately $
The net gains (losses) relating to free-standing derivative instruments used for risk management is summarized below (in thousands):
| In Thousands |
||||||||
| March 31, 2020 |
March 31, 2019 |
|||||||
| Forward contracts related to mortgage loans held for sale and interest rate contracts |
$ | ( |
) | ( |
) | |||
| Interest rate contracts for customers |
||||||||
The following table reflects the amount and fair value of mortgage banking derivatives included in the consolidated balance sheet as of March 31, 2020 and December 31, 2019 (in thousands):
| In Thousands |
||||||||||||||||
| March 31, 2020 |
December 31, 2019 |
|||||||||||||||
| Notional Amount |
Fair Value |
Notional Amount |
Fair Value |
|||||||||||||
| Included in other assets (liabilities): |
||||||||||||||||
| Interest rate contracts for customers |
$ | |||||||||||||||
| Forward contracts related to mortgage loans held-for-sale |
( |
) | ( |
) | ||||||||||||
Note 10. Pandemic Impact (COVID-19)
In March 2020, the World Health Organization declared the outbreak of a novel coronavirus (COVID-19) as a pandemic, which continues to spread throughout the United States. On April 2, 2020 the Governor of Tennessee declared a health emergency and issued an order to close all nonessential businesses until further notice. As a financial institution, Wilson Bank was deemed to be an essential business and accordingly, our operations were sustained. Nonetheless, out of concerns for our employees and customers and pursuant to government orders, branch operations were limited to drive through access and in-person appointments only. To the extent possible, a portion of our staff was moved to remote working locations and teleconferencing practices were established. To date, the operations of our company and the services offered to our customers have not been adversely affected in a material manner. The extent to which COVID-19 impacts our future operations will depend on further developments, which are highly uncertain and cannot be predicted with confidence, including the duration and severity of the outbreak and the actions that may be required to contain the COVID-19 or treat its impact. The coronavirus outbreak and government responses are creating disruption in global supply chains and adversely impacting many industries. The outbreak could have a continued material adverse impact on economic and market conditions and trigger a period of global economic slowdown. While the Company believes this matter could negatively impact its results of operations, cash flows and financial position, the related impact cannot be reasonably estimated at this time. Nevertheless, the outbreak presents uncertainty and risk with respect to the Company, its performance and its financial results. Management's evaluation of the events and conditions as well as management's plans to mitigate these matters are described in the Management's Discussion and Analysis section elsewhere in this report.
As a result of the pandemic, many states and municipalities are facing a strain on resources and a reduction in tax collections. As a result, state and municipalities have asked for potential assistance from the Federal government to cover the cost of resource depletion and tax shortfalls. The ability of states and municipalities to fund shortfalls could have an affect on their ability to sustain debt maintenance, which would consequently impact the value of our municipal bond portfolio.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this discussion is to provide insight into the financial condition and results of operations of the Company and its bank subsidiary. This discussion should be read in conjunction with the Company's consolidated financial statements appearing elsewhere in this report. Reference should also be made to the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 for a more complete discussion of factors that impact the Company's liquidity, capital and results of operations.
Forward-Looking Statements
This Form 10-Q contains certain forward-looking statements within the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act") regarding, among other things, the anticipated financial and operating results of the Company. Investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly release any modifications or revisions to these forward-looking statements to reflect events or circumstances occurring after the date hereof or to reflect the occurrence of unanticipated events.
The Company cautions investors that future financial and operating results may differ materially from those projected in forward-looking statements made by, or on behalf of, the Company. The words “expect,” “intend,” “should,” “may,” “could,” “believe,” “suspect,” “anticipate,” “seek,” “plan,” “estimate” and similar expressions are intended to identify such forward-looking statements, but other statements not based on historical fact may also be considered forward-looking. Such forward-looking statements involve known and unknown risks and uncertainties, including, but not limited to those described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, and also include, without limitation, (i) deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for these losses, (ii) the effects of the emergence of widespread health emergencies or pandemics, including the magnitude and duration of the COVID-19 pandemic and its impact on general economic and financial market conditions and on the Company's and its customers' business, results of operations, asset quality and financial condition; (iii) the effect on our allowance for loan losses and provisioning expense as a result of our decision to defer the implementation of CECL (iv) deterioration in the real estate market conditions in the Company’s market areas, (v) the impact of increased competition with other financial institutions, including pricing pressures on loans and deposits, and the resulting impact on the Company's results, including as a result of compression to net yield on earning assets, (vi) the deterioration of the economy in the Company’s market areas, (vii) fluctuations or differences in interest rates on earning assets and interest bearing liabilities from those that the Company is modeling or anticipating, including as a result of the Bank's inability to lower deposit rates with the speed and at the levels desired in connection with the declining short-term rate environment currently contemplated, or that affect the yield curve, (viii) the ability to grow and retain low-cost core deposits, (ix) significant downturns in the business of one or more large customers, (x) the inability of the Company to comply with regulatory capital requirements, including those resulting from changes to capital calculation methodologies, required capital maintenance levels, or regulatory requests or directives, (xi) changes in state or Federal regulations, policies, or legislation applicable to banks and other financial service providers, including regulatory or legislative developments arising out of current unsettled conditions in the economy, including implementation of the Dodd Frank Wall Street Reform and Consumer Protection Act, (xii) changes in capital levels and loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments, (xiii) inadequate allowance for loan losses, (xiv) the effectiveness of the Company’s activities in improving, resolving or liquidating lower quality assets, (xv) results of regulatory examinations, (xvi) the vulnerability of the Company's network and online banking portals, and the systems of parties with whom the Company contracts, to unauthorized access, computer viruses, phishing schemes, spam attacks, human error, natural disasters, power loss, and other security breaches, (xvii) the possibility of additional increases to compliance costs or other operational expenses as a result of increased regulatory oversight, (xviii) loss of key personnel, and (xix) adverse results (including costs, fines, reputational harm and/or other negative effects) from current or future litigation, examinations or other legal and/or regulatory actions, including as a result of the Company's participation in and execution of government progress related to the COVID-19 pandemic. These risks and uncertainties may cause the actual results or performance of the Company to be materially different from any future results or performance expressed or implied by such forward-looking statements. The Company’s future operating results depend on a number of factors which were derived utilizing numerous assumptions that could cause actual results to differ materially from those projected in forward-looking statements.
Impact of COVID-19
In March 2020, the outbreak of the novel Coronavirus Disease 2019 (“COVID-19”) was recognized as a pandemic by the World Health Organization. The spread of COVID-19 has created a global public health crisis that has resulted in uncertainty, volatility and deterioration in financial markets and in governmental, commercial and consumer activity including in the United States, where we conduct substantially all of our activity.
To combat the spread of COVID-19, federal, state and local governments, including the Governor of the State of Tennessee and mayors and county executives of the communities in which we operate, have taken a variety of actions that have materially and adversely affected the businesses and lives of our customers. These actions have included orders or directives closing non-essential businesses and restricting movement of individuals through the issuance of shelter-in-place or safer-at-home orders and other guidance encouraging individuals to observe strict social distancing measures. At times, the actions being taken by these governmental authorities are not always coordinated or consistent across the state of Tennessee and the impact of those actions across our markets may be uneven. These actions, together with the independent actions of individuals and businesses aimed at slowing the spread of the virus, have resulted in extensive economic disruption and rapid declines in consumer and commercial activity.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security ("CARES") Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes the Paycheck Protection Program ("PPP"), a nearly $659 billion program designed to aid small- and medium-sized businesses through federally guaranteed loans distributed through banks. These loans are intended to guarantee eight weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills.
In response to the COVID-19 pandemic and its economic impact to our customers, we proactively began providing relief to our customers in the middle of March 2020 through a 90 day interest only payment option or a full 90 day payment deferral option. Following the passage of the CARES Act we expanded this program to provide a six-month interest only payment option in an effort to provide flexibility to our customers as they navigate these uncertain times. Pursuant to interagency regulatory guidance and the CARES Act, we may elect to not classify loans for which these deferrals are granted between March 1, 2020 and the earlier of (i) December 31, 2020 or (ii) 60 days after the end of the COVID-19 national emergency as troubled debt restructurings.
As of April 30, 2020, the Bank had granted deferrals of principal or both principal and interest on approximately 855 loans, totaling $572.4 million in aggregate principal amount. Under the applicable guidance, none of these loans were considered troubled debt restructurings as of April 30, 2020.
In connection with our response to COVID-19 we have taken deliberate actions to ensure that we have the balance sheet strength to serve our clients and communities, including increases in liquidity and reserves supported by a strong capital position. Our business and consumer customers are experiencing varying degrees of financial distress, which is expected to increase in coming months.
In order to protect the health of our customers and employees, and to comply with applicable government directives, we have modified our business practices, including restricting employee travel, directing employees to work from home insofar as is possible and implementing our business continuity plans and protocols to the extent necessary. We also held a virtual annual shareholders’ meeting for the first time in our history.
Critical Accounting Estimates
The accounting principles we follow and our methods of applying these principles conform with U.S. generally accepted accounting principles and with general practices within the banking industry. In connection with the application of those principles, we have made judgments and estimates which, in the case of the determination of our allowance for loan losses have been critical to the determination of our financial position and results of operations. There have been no significant changes to our critical accounting policies as discussed in our Annual Report on Form 10-K for the year ended December 31, 2019.
Allowance for Loan Losses (“allowance”). Our management assesses the adequacy of the allowance prior to the end of each calendar quarter. 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 the loan portfolio, past loan loss experience, current asset quality trends, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payment), the estimated value of any underlying collateral, composition of the loan portfolio, current and anticipated economic conditions, historical loss experience, industry and peer bank loan quality indications and other pertinent factors, including regulatory recommendations. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Loan losses are charged off when management believes that the full collectability of the loan is unlikely. A loan may be partially charged off after a “confirming event” has occurred which serves to validate that full repayment pursuant to the terms of the loan is unlikely. Allocation of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, is deemed to be uncollectible.
A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. Collection of all amounts due according to the contractual terms means that both the interest and principal payments of a loan will be collected as scheduled in the loan agreement.
An impairment allowance is recognized if the fair value of the loan is less than the recorded investment in the loan (recorded investment in the loan is the principal balance plus any accrued interest, net of deferred loan fees or costs and unamortized premium or discount). The impairment is recognized through the allowance. Loans that are impaired are recorded at the present value of expected future cash flows discounted at the loan’s effective interest rate, or if the loan is collateral dependent, impairment measurement is based on the fair value of the collateral, less estimated disposal costs. If the measure of the impaired loan is less than the recorded investment in the loan, the Company recognizes an impairment by creating a valuation allowance with a corresponding charge to the provision for loan losses or by adjusting an existing valuation allowance for the impaired loan with a corresponding charge or credit to the provision for loan losses. Management believes it follows appropriate accounting and regulatory guidance in determining impairment and accrual status of impaired loans.
The level of allowance maintained is believed by management to be adequate to absorb probable losses inherent in the loan portfolio at the balance sheet date. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.
In assessing the adequacy of the allowance, we also consider the results of our ongoing loan review process. We undertake this process both to ascertain whether there are loans in the portfolio whose credit quality has weakened over time and to assist in our overall evaluation of the risk characteristics of the entire loan portfolio. Our loan review process includes the judgment of management, the input from our independent loan reviewers, and reviews that may have been conducted by bank regulatory agencies as part of their usual examination process. We incorporate loan review results in the determination of whether or not it is probable that we will be able to collect all amounts due according to the contractual terms of a loan.
As part of management’s quarterly assessment of the allowance, management divides the loan portfolio into twelve segments based on bank call reporting requirements. The allowance allocation begins with a process of estimating the probable losses in each of the twelve loan segments. The estimates for these loans are based on our historical loss data for that category over the last twenty quarters. Each segment is then analyzed such that an allocation of the allowance is estimated for each loan segment.
The estimated loan loss allocation for all twelve loan portfolio segments is then adjusted for several “environmental” factors. The allocation for environmental factors is particularly subjective and does not lend itself to exact mathematical calculation. This amount represents estimated probable inherent credit losses which exist, but have not yet been identified, as of the balance sheet date, and are based upon quarterly trend assessments in delinquent and nonaccrual loans, unanticipated charge-offs, credit concentration changes, prevailing economic conditions, changes in lending personnel experience, changes in lending policies, increase in interest rates, or procedures and other influencing factors. These environmental factors are considered for each of the twelve loan segments and the allowance allocation, as determined by the processes noted above for each component, is increased or decreased through provision expense based on the incremental assessment of these various environmental factors.
We then test the resulting allowance by comparing the balance in the allowance to industry and peer information. Our management then evaluates the result of the procedures performed, including the result of our testing, and concludes on the appropriateness of the balance of the allowance in its entirety. The board of directors reviews and approves the assessment prior to the filing of quarterly and annual financial information.
ASU 2016-13 was originally to become effective for us on January 1, 2020. Pursuant to the CARES Act, lenders, like us, were given the option to defer the implementation of ASU 2016-13, which is known as the Current Expected Credit Losses (CECL) standard, until 60 days after the declaration of the end of the public health emergency related to the COVID-19 pandemic or December 31, 2020, whichever comes first. In addition, the Securities and Exchange Commission (SEC) staff has stated that opting to delay the implementation of CECL shall be considered to be in accordance with generally accepted accounting principles. As a result, we elected to delay implementation of CECL. See Note 1. Recently Issued Accounting Pronouncements in the Notes to our Consolidated Financial Statements elsewhere in this Form 10-Q for further information regarding our delayed implementation of CECL.
Impairment of Goodwill. Goodwill is evaluated for impairment annually and more frequently if events and circumstances indicate that the asset might be impaired. ASC 350, Intangibles — Goodwill and Other, provides an entity the option to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity does a qualitative assessment and determines it is necessary, or if a qualitative assessment is not performed, it is required to perform a goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment loss to be recognized for that reporting unit (if any). The results of our quantitative assessment as of December 31, 2019, our annual assessment date, indicated that the fair value of our reporting unit was more than its carrying value.
Should our common stock experience a sustained price decline or other impairment indicators become known, additional impairment testing of goodwill may be required. Should it be determined in a future period that the goodwill has become impaired, then a charge to earnings will be recorded in the period such determination is made.
Other-than-temporary Impairment. A decline in the fair value of any available-for-sale or held-to-maturity security below cost that is deemed to be other-than-temporary results in a reduction in the carrying amount of the security. To determine whether impairment is other-than-temporary, management considers whether the entity expects to recover the entire amortized cost basis of the security by reviewing the present value of the future cash flows associated with the security. The shortfall of the present value of the cash flows expected to be collected in relation to the amortized cost basis is referred to as a credit loss and is deemed to be other-than temporary impairment. If a credit loss is identified, the credit loss is recognized as a charge to earnings and a new cost basis for the security is established. If management concludes that no credit loss exists and it is not more-likely-than-not that the Company will be required to sell the security before maturity, then the security is not other-than-temporarily impaired and the shortfall is recorded as a component of equity.
Results of Operations
Net earnings increased 8.94% to $9,031,000 for the three months ended March 31, 2020, from $8,290,000 in the first three months of 2019. The increase in net earnings during the three months ended March 31, 2020 as compared to the prior year comparable period was primarily due to an increase in net interest income, reflecting an increase in average interest earning asset balances between the relevant periods, as well as an increase in non-interest income, partially offset by a decrease in net yield on interest earning assets and an increase in non-interest expense. The increase in non-interest expense resulted from the Company's continued growth.
The executive management and Board of Directors of the Company evaluate key performance indicators (KPIs) on a continuing basis. These KPIs serve as benchmarks of Company performance and are used in making strategic decisions. Return on average assets (ROA) is the most common benchmark for bank profitability and is calculated by taking our annualized net earnings and dividing by the average assets. ROA measures a company’s return on investment in a format that is easily comparable to other financial institutions. It is particularly important to the Company as is it serves as the basis for certain executive and employee bonuses. The ROA for the periods ended March 31, 2020 and 2019 was 1.29% and 1.31%, respectively.
Net Interest Income
The average balances, interest, and average rates of our assets and liabilities for the three month periods ended March 31, 2020 and March 31, 2019 are presented in the following table (dollars in thousands):
| Three Months Ended |
Three Months Ended |
|||||||||||||||||||||||
| March 31, 2020 |
March 31, 2019 |
|||||||||||||||||||||||
| Average Balance | Interest Rate | Income/ Expense | Average Balance | Interest Rate | Income/ Expense | |||||||||||||||||||
| Loans, net of unearned interest (2) (3) |
$ | 2,133,599 | 5.24 | % | $ | 27,276 | $ | 2,037,980 | 5.19 | % | $ | 25,774 | ||||||||||||
| Investment securities—taxable |
364,723 | 2.25 | 2,040 | 260,621 | 2.50 | 1,607 | ||||||||||||||||||
| Investment securities—tax exempt |
49,339 | 1.97 | 242 | 33,311 | 2.03 | 167 | ||||||||||||||||||
| Taxable equivalent adjustment (1) |
— | 0.52 | 64 | — | 0.54 | 44 | ||||||||||||||||||
| Total tax-exempt investment securities |
49,339 | 2.49 | 306 | 33,311 | 2.57 | 211 | ||||||||||||||||||
| Total investment securities |
414,062 | 2.28 | 2,346 | 293,932 | 2.51 | 1,818 | ||||||||||||||||||
| Loans held for sale |
12,787 | 3.40 | 108 | 7,028 | 4.50 | 78 | ||||||||||||||||||
| Federal funds sold |
19,430 | 1.16 | 56 | 1,682 | 1.93 | 8 | ||||||||||||||||||
| Accounts with depository institutions |
105,050 | 1.21 | 316 | 109,329 | 2.23 | 600 | ||||||||||||||||||
| Restricted equity securities |
4,680 | 4.21 | 49 | 3,025 | 6.70 | 50 | ||||||||||||||||||
| Total earning assets |
2,689,608 | 4.59 | 30,151 | 2,452,976 | 4.74 | 28,328 | ||||||||||||||||||
| Cash and due from banks |
14,732 | 10,589 | ||||||||||||||||||||||
| Allowance for loan losses |
(28,957 | ) | (27,308 | ) | ||||||||||||||||||||
| Bank premises and equipment |
60,041 | 58,162 | ||||||||||||||||||||||
| Other assets |
70,716 | 72,822 | ||||||||||||||||||||||
| Total assets |
$ | 2,806,140 | $ | 2,567,241 | ||||||||||||||||||||
| Three Months Ended |
Three Months Ended |
|||||||||||||||||||||||
| March 31, 2020 |
March 31, 2019 |
|||||||||||||||||||||||
| Average Balance | Interest Rate | Income/ Expense | Average Balance | Interest Rate | Income/ Expense | |||||||||||||||||||
| Deposits: |
||||||||||||||||||||||||
| Negotiable order of withdrawal accounts |
$ | 561,960 | 0.32 | % | $ | 443 | $ | 504,978 | 0.46 | % | $ | 572 | ||||||||||||
| Money market demand accounts |
809,702 | 0.59 | 1,182 | 740,225 | 0.84 | 1,530 | ||||||||||||||||||
| Time Deposits |
626,592 | 1.95 | 3,041 | 625,895 | 1.87 | 2,886 | ||||||||||||||||||
| Other savings |
146,145 | 0.49 | 177 | 135,487 | 0.63 | 210 | ||||||||||||||||||
| Total interest-bearing deposits |
2,144,399 | 0.91 | 4,843 | 2,006,585 | 1.05 | 5,198 | ||||||||||||||||||
| Federal Home Loan Bank advances |
22,637 | 2.68 | 151 | 1,833 | 2.88 | 13 | ||||||||||||||||||
| Total interest-bearing liabilities |
2,167,036 | 0.93 | 4,994 | 2,008,418 | 1.05 | 5,211 | ||||||||||||||||||
| Non-interest bearing deposits |
280,435 | 247,318 | ||||||||||||||||||||||
| Other liabilities |
15,295 | 9,909 | ||||||||||||||||||||||
| Stockholders’ equity |
343,374 | 301,596 | ||||||||||||||||||||||
| Total liabilities and stockholders’ equity |
$ | 2,806,140 | $ | 2,567,241 | ||||||||||||||||||||
| Net interest income, on a tax equivalent basis |
$ | 25,157 | $ | 23,117 | ||||||||||||||||||||
| Net yield on earning assets (4) |
3.84 | % | 3.88 | % | ||||||||||||||||||||
| Net interest spread (5) |
3.66 | % | 3.69 | % | ||||||||||||||||||||
Notes:
(1) The tax equivalent adjustment has been computed using a 21% Federal tax rate.
(2) Yields on loans and total earning assets include the impact of State income tax credits related to incentive loans at below market rates and tax exempt loans to municipalities.
(3) Loan fees of $2.0 million and $1.9 million are included in interest income in 2020 and 2019, respectively.
(4) Annualized net interest income on a tax equivalent basis divided by average interest-earning assets.
(5) Average interest rate on interest-earning assets less average interest rate on interest-bearing liabilities.
Net yield on earning assets for the three months ended March 31, 2020 and 2019 was 3.84% and 3.88%, respectively. The decrease in net yield on earning assets was due to a decrease in the yield earned on our earning assets, specifically investment yields and the rate earned on fed funds and accounts with depository institutions, that outpaced the decrease in rates paid on our interest-bearing liabilities. The yield on loans increased during the three months ended March 31, 2020 when compared to the comparable period in 2019. The Federal Reserve influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, decreased 150 basis points late in the first quarter of 2020 and 75 basis points during the third quarter of 2019 as a result of reductions in the federal funds rate by the Federal Reserve. Although prime rates decreased during the first quarter of 2020 and late 2019, and we continued to face competitive pressures in our markets, we were able to increase our yield on loans due to strategic loan pricing on certain loan segments, and an increase in loans qualified to receive state income tax credit. The decrease in yield on securities was also due to the declining rate environment discussed above, in which higher yielding securities were called and were replaced with securities yielding lower market rates. The net interest spread was 3.66% and 3.69% for the three months ended March 31, 2020 and March 31, 2019, respectively. The rate we pay on our deposits and other funding sources decreased in the three months ended March 31, 2020 when compared to the comparable periods in 2019, as we decreased the rates on several of our deposit products in response to decreases in short-term rates throughout 2019 and the first quarter of 2020. We also incurred additional funding costs related to the utilization of Federal Home Loan Bank borrowings to increase our balance sheet liquidity. These borrowings are at a higher rate than our core deposits. As a result of the significant reduction in short-term rates late in the first quarter of 2020 and the tremendous uncertainty resulting from COVID-19, our net yield on earning assets will likely continue to decline during the remainder of 2020 as will our net interest spread as the impact of the declining rate environment will more quickly impact our earning assets than our interest-bearing liabilities, and competitive pressures in our markets may limit our ability to reduce the rates we pay on our interest bearing liabilities. Efforts to maintain elevated levels of on-balance sheet liquidity will also likely negatively impact our net yield on earning assets.
Net interest income represents the amount by which interest earned on various earning assets exceeds interest paid on deposits and other interest-bearing liabilities and is the most significant component of the Company’s earnings. Reflecting loan growth and an increase in the yields earned on loans, the Company’s total interest income, excluding tax equivalent adjustments relating to tax exempt securities and loans, increased $1,803,000, or 6.37%, during the three months ended March 31, 2020 as compared to the same period in 2019. The ratio of average earning assets to total average assets was 95.8% for the three months ended March 31, 2020 and 95.5% for the three months ended March 31, 2019.
Interest expense decreased $217,000, or 4.16%, for the three months ended March 31, 2020 as compared to the same period in 2019. The decrease for the three months ended March 31, 2020 as compared to the prior year's comparable period was primarily due to a decrease in the rates of average interest bearing deposits, reflecting the declining rate environment that we experienced throughout 2019 and the first quarter of 2020, partially offset by an increase in interest expense related to the FHLB borrowings.
Provision for Loan Losses
The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, is adequate to provide coverage for estimated losses on outstanding loans and to provide for uncertainties in the economy. The provision for loan losses for the three months ended March 31, 2020 was $1,469,000, an increase of $436,000 from the provision of $1,033,000 incurred in the first three months of 2019. The increase in provision expense for the three months ended March 31, 2020 from the comparable period in 2019 is primarily attributable to increasing our allowance for loans losses in response to the expected economic downturn related to COVID-19. The provision for loan losses is based on past loan experience and other factors which, in management’s judgment, deserve current recognition in estimating loan losses. Such factors include changes in the amount and composition of the loan portfolio, review of specific problem loans, past due and nonperforming loans, change in lending staff, the recommendations of the Company’s regulators, and current economic conditions that may affect the borrowers’ ability to repay.
The Bank’s charge-off policy for impaired loans is similar to its charge-off policy for all loans in that loans are charged-off in the month when a determination is made that the loan is uncollectible. The volume of net loans recovered for the first three months of 2020 totaled approximately $86,000 compared to approximately $73,000 in net recoveries during the first three months of 2019. Though tremendous uncertainty remains regarding the length and severity of COVID-19's impact, we believe net charge-offs could increase over the remainder of 2020.
The allowance for loan losses (net of charge-offs and recoveries) was $30,281,000 at March 31, 2020, an increase of $1,555,000, or 5.41%, from $28,726,000 at December 31, 2019, and of $2,001,000, or 7.08%, from $28,280,000 at March 31, 2019. The allowance for loan losses was 1.40% of total loans outstanding at March 31, 2020, compared to 1.38% at December 31, 2019 and 1.38% at March 31, 2019. As a percentage of nonperforming loans at March 31, 2020, December 31, 2019, and March 31, 2019, the allowance for loan losses represented 760%, 359% and 701%, respectively. The internally classified loans as a percentage of the allowance for loan losses were31.8% and 44.1%, respectively, at March 31, 2020 and 2019.
The level of the allowance and the amount of the provision involve evaluation of uncertainties and matters of judgment. The Company maintains an allowance for loan losses which management believes is adequate to absorb losses inherent in the loan portfolio. A formal review is prepared quarterly by the Chief Financial Officer and provided to the Board of Directors to assess the risk in the portfolio and to determine the adequacy of the allowance for loan losses. The review includes analysis of historical performance, the level of non-performing and adversely rated loans, specific analysis of certain problem loans, loan activity since the previous assessment, reports prepared by the Company's independent Loan Review Department, consideration of current economic conditions and other pertinent information. The level of the allowance to net loans outstanding will vary depending on the overall results of this quarterly assessment. See the discussion above under “Critical Accounting Estimates” for more information. While the severity of the impact of the COVID-19 pandemic for individuals, small businesses and corporations is still unknown, leading economic indicators suggest that an economic downturn is likely. In an effort to recognize an appropriate allowance for loan losses, management incorporated qualitative factors into our quarterly assessment during the three months ended March 31, 2020, including current and anticipated economic conditions and value of collateral considerations, to increase the Company's reserve for the potential impact of the COVID-19 pandemic. Of the $1,469,000 total provision for loan loss that was recorded in the first quarter of 2020, $933,000 was attributable to management's estimates of the impact of the COVID-19 pandemic on our loan portfolio. Management believes the allowance for loan losses at March 31, 2020 to be adequate, but if economic conditions deteriorate beyond management’s current expectations and additional charge-offs are incurred, the allowance for loan losses may require an increase through additional provision for loan losses expense which would negatively impact earnings. Moreover, though we have deferred the implementation of CECL at this time pursuant to relief offered by the CARES Act, when we become obligated to adopt CECL we are likely to have to increase our allowance for loan losses meaningfully.
Non-Interest Income
The components of the Company’s non-interest income include service charges on deposit accounts, other fees and commissions, income on BOLI and annuity earnings, gain on sale of loans, gain (loss) on sale of other real estate, gain (loss) on sale of fixed assets, gain (loss) on sale of securities, and gain (loss) on sale of other assets. Total non-interest income for the three months ended March 31, 2020 increased $175,000, or 2.80%, to $6,435,000 from $6,260,000 for the same period in 2019. The Company’s non-interest income in the three-month period ended March 31, 2020 increased from the comparable period in 2019 mainly due to an increase in other fees and commissions and a gain on the sale of securities, partially offset by a decrease in the gain on sale of loans. Other fees and commissions increased $401,000, or 12.91%, to $3,508,000 during the three months ended March 31, 2020 compared to the same period in 2019 primarily due to an increase in debit card interchange fee income and an increase in brokerage income. Debit card interchange fee income increased due to an increase in the number and volume of debit card holders and transactions. Brokerage income increased due to new client acquisition and the opening of new investment accounts along with an increase in fees collected. Gain on sale of securities increased $467,000, or 151.13%, to $158,000 from a loss on sale of $309,000 for the three months ended March 31, 2020 compared to the same period in 2019, due to management's decision in 2019 to sell securities for a loss and reinvest the proceeds in higher yielding assets in 2019. Gain on sale of loans decreased $735,000, or, 44.65%, to $911,000 during the three months ended March 31, 2020 compared to the same period in 2019. This is a result of a new capital markets execution process implemented in January 2019 which reflected higher than normal gains at process launch. In addition, the Bank experienced lower refinance activity in the first quarter of 2020 when compared to the same period in 2019. The extreme economic worries associated with business closures, unemployment and the equity market sell-off related to the COVID-19 pandemic has contributed to unprecedented volatility with mortgage rates and caused us to pause issuing our rate locks via mandatory delivery methodology. We inserted issuing rates on our loans utilizing best efforts pricing methods. We anticipate that we will resume mandatory delivery when the volatility with the interest rate markets abates.
The stimulus packages associated with the CARES Act have required mortgage servicers to allow borrowers who are impacted by COVID-19 to have up to 12 months forbearance on their mortgage loans. This has all but eliminated the demand side of mortgage sales on the secondary market as investors have a diminished appetite to buy loans that have a high expectation of customers who will stop making their payments shortly after purchase. As a result, our revenue execution has deteriorated. We are in an environment of credit tightening from purchasers of mortgage loans and some product offerings have been eliminated. We have been able to sustain higher than normal closed loan production which should negate somewhat the lower revenue return, but if the disruption from the COVID-19 pandemic continues, our ability to maintain this elevated volume could be adversely impacted. While the Company believes this matter could negatively impact its results of operations, cash flows and financial position, the related impact cannot be reasonably estimated at this time. Nevertheless, the outbreak presents uncertainty and risk with respect to the Company, its performance and its financial results.
Non-Interest Expense
Non-interest expense consists primarily of employee costs, occupancy expenses, furniture and equipment expenses, advertising and public relations expenses, data processing expenses, ATM and interchange expenses, director’s fees, audit, legal and consulting fees, and other operating expenses. Total non-interest expense increased $1,284,000, or 7.37%, during the first three months of 2020 compared to the same period in 2019. The increase in non-interest expense for the three months ended March 31, 2020 when compared to the comparable period in 2019 is primarily attributable to an increase in salaries and employee benefits, data processing expenses, ATM and interchange fees, and advertising and public relations expenses. Salaries and employee benefits increased $722,000, or 6.94%, to $11,132,000 during the three months ended March 31, 2020 compared to the same period in 2019 primarily due to an increase in the number of employees necessary to support the Company’s growth in operations. Data processing expenses increased $191,000, or 19.53%, to $1,169,000 during the three months ended March 31, 2020 compared to the same period in 2019 primarily due to an increase in computer maintenance and computer licenses. These expenses included upgrades of our current systems as well as additional investments in computer software, an increase in I.T. consulting expense and an increase in computer home banking expense resulting from the evolution of our new mobile application. The mobile banking expense is now incurred on a per user basis as opposed to an overall flat fee. ATM and interchange fees increased $89,000, or 11.35%, to $873,000 during the three months ended March 31, 2020 compared to the same period in 2019 primarily due to increasing interchange fees associated with a higher volume of debit card transactions, and an increase in debit card expenses. Advertising and public relations expenses increased $126,000, or 26.42% to $603,000 during the three months ended March 31, 2020 compared to the same period in 2019 primarily due to an increase in print, digital media, design and development, and media plans as the Bank continues to market awareness of the Bank's brand. The Company anticipates that salaries and employee benefits expense and occupancy expense will continue to increase as the Company's operations and facilities continue to grow though the growth rate may slow as a result of COVID-19's likely impact on our hiring plans.
As a financial institution, Wilson Bank was deemed to be an essential business and accordingly, our operations were sustained. To the extent possible, a portion of our staff was moved to remote working locations and teleconferencing practices were established. Wilson Bank is dedicated to retaining our employees and providing a stable income to them throughout this global pandemic; therefore, the Company does not anticipate salary and employee benefit expenses to decrease.
The efficiency ratio is a common and comparable KPI used in the banking industry. The Company uses this metric to monitor how effective management is at using our internal resources. It is calculated by taking our non-interest expense divided by our net interest income plus non-interest income. Our efficiency ratio for the periods ended March 31, 2020 and 2019 were 59.32% and 59.38%, respectively.
Income Taxes
The Company’s income tax expense was $2,326,000 for the three months ended March 31, 2020, a decrease of $266,000 over the comparable period in 2019. The percentage of income tax expense to net income before taxes was 20.48% and 23.82% for the three months ended March 31, 2020 and March 31, 2019, respectively. The decrease in the percentage of income tax expense to earnings before taxes is primarily due to additional state tax credits that lowered our effective tax rate. Our effective tax rate represents our blended federal and state rate of 26.135% affected by the impact of anticipated favorable permanent differences between our book and taxable income such as bank-owned life insurance, income earned on tax-exempt securities and certain federal and state tax credits.
Financial Condition
Balance Sheet Summary
The Company’s total assets increased $82,834,000, or 2.96%, to $2,877,043,000 at March 31, 2020 from $2,794,209,000 at December 31, 2019. Loans, net of allowance for loan losses, totaled $2,131,731,000 at March 31, 2020, a 3.62% increase compared to $2,057,175,000 at December 31, 2019. In the first half of 2019 management made a strategic decision to begin focusing loan growth in the commercial and industrial and residential 1-4 family segments of our loan portfolio, which have historically grown at slower rates than the other segments of the portfolio. As a result, loan growth slowed in 2019. In the first quarter of 2020, the strategic focus for loans also included construction and commercial real estate lending which tends to grow at a more rapid pace, thus causing the increase in loans discussed above. We operate in a market area that was experiencing economic growth prior to the onset of COVID-19, which caused our commercial real estate and residential 1-4 family portfolio to increase as of March 31, 2020, when compared to December 31, 2019. Commercial real estate loans increased 6.07% and 15.69%, respectively, from December 31, 2019 and March 31, 2019 to March 31, 2020, and comprised 38.79% of the Company’s loan portfolio at March 31, 2020, compared to 37.91% at December 31, 2019 and 35.34% at March 31, 2019. Residential 1-4 family loans increased 1.67% and 13.41%, respectively, from December 31, 2019 and March 31, 2019 to March 31, 2020, and comprised 23.96% of the Company’s loan portfolio at March 31, 2020, compared to 24.43% at December 31, 2019 and 22.27% at March 31, 2019. The increase in commercial real estate loans is a result of an increase in demand for such loans in the overall economy and the Company’s markets prior to the onset of COVID-19. Construction and land development loans decreased 8.56% and 21.47%, respectively from December 31, 2019 and March 31, 2019 to March 31, 2020, and comprised 17.92% of the Company's loan portfolio at March 31, 2020, compared to 20.31% at December 31, 2019 and 24.06% at March 31, 2019. The decrease in construction and land development loans from December 31, 2019 to March 31, 2020 was primarily due to the completion of a large project which transitioned to permanent financing.
Because construction loans remain a meaningful portion of our portfolio, the Bank has implemented an additional layer of monitoring as it seeks to avoid advancing funds that exceed the present value of the collateral securing the loan. The responsibility for monitoring percentage of completion and distribution of funds tied to these completion percentages is now monitored and administered by a Credit Administration Department independent of the lending function. The Bank continues to seek to diversify its real estate portfolio as it seeks to lessen concentrations in any one type of loan.
The COVID-19 pandemic has had a notable impact on general economic conditions, including but not limited to the temporary closure of many businesses, "shelter in place" and other governmental orders and directives, and reduced consumer spending due to both job losses and other effects attributable to COVID-19. Many unknowns remain surrounding this situation. Although the Company has not experienced a decrease in demand from its customers for loan-related products, if the pandemic continues for an extended period of time and the economy continues to be negatively impacted, the Company could experience a decrease in demand for loans and the financial condition of the Company could be negatively impacted. The extent to which the COVID-19 outbreak will impact loan demand and thus affect financial results is uncertain.
On March 27, 2020, the President of the United States signed into law the CARES Act, which contains significant monetary relief for American workers and small businesses. One of the provisions of the CARES Act was to establish the PPP that allows certain companies and individuals to obtain a loan, a portion of which may be forgivable, through the Small Business Administration's (SBA) program to help fund operations and cover payroll expenses. Originally, Congress allocated $349 billion to the PPP, which amount has been fully utilized. On April 24, 2020, Congress approved an additional $310 billion for the PPP. Although the PPP is sponsored by the SBA, the CARES Act establishes that the loan itself will be made through lending institutions who are authorized to make SBA loans. We have taken the necessary steps to qualify as an approved lender under the PPP and have begun providing relief to small businesses and individuals in our community through the funding of these loans. Through the date of this report, the Company has funded $63.5 million of these loans to our small business customers.
Securities decreased $13,921,000, or 3.31%, to $407,224,000 at March 31, 2020 from $421,145,000 at December 31, 2019 due to an increased amount of securities being called as a result of the declining rate environment. The current rate environment also caused the fair market value on the securities portfolio to increase from December 31, 2019 to March 31, 2020. The average yield, excluding tax equivalent adjustment, of the securities portfolio at March 31, 2020 was 2.44% with a weighted average life of 8.42 years, as compared to an average yield of 2.42% and a weighted average life of 7.08 years at December 31, 2019. The weighted average lives on mortgage-backed securities reflect the repayment rate used for book value calculations.
Debt securities that management has the positive intent and ability to hold to maturity are classified as “held-to-maturity” and recorded at amortized cost. Trading securities are recorded at fair value with changes in fair value included in earnings. Securities not classified as held-to-maturity or trading, including equity securities with readily determinable fair values, are classified as “available-for-sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. There were no debt and equity securities classified as held-to-maturity or trading securities at March 31, 2020 or December 31, 2019.
Premises and equipment decreased $533,000 or 0.88% from December 31, 2019 to March 31, 2020. The primary reason for the decrease was due to current year depreciation of $998,000.
The increase in deposits combined with the decrease in securities outpaced loan growth causing federal funds sold and interest bearing deposits to increase to $160,435,000 at March 31, 2020 from $146,827,000 at December 31, 2019.
Total liabilities increased by 2.88% to $2,528,046,000 at March 31, 2020 compared to $2,457,225,000 at December 31, 2019. The increase in total liabilities since December 31, 2019 was composed of a $67,932,000, or 2.81%, increase in total deposits, and a $5,694,000, or 35.57%, increase in accrued interest and other liabilities, partially offset by a $2,805,000, or 11.88%, decrease, in Federal Home Loan Bank advances. We experienced an increase in deposits in the second half of the quarter ended March 31, 2020 as customers sought more stable places for excess liquidity. At March 31, 2020, our borrowing capacity with the Federal Home Loan Bank of Cincinnati totaled $298,284,000. The Bank pledges substantially all of its 1-4 family residential real estate loans to secure its borrowings from the Federal Home Loan Bank of Cincinnati. The increase in total deposits since December 31, 2019 was primarily attributable to management's strategic decision to grow market share through targeted marketing strategies in our newer markets that resulted in the opening of new accounts. The decrease in Federal Home Loan Bank advances was due to scheduled principal payments that reduced the outstanding balance. The increase in accrued interest and other liabilities since December 31, 2019 was primarily attributable to an increase in employee bonus payable, lease payable, other taxes payable and escrow tax payable.
Non Performing Assets
The following tables present the Company’s non-accrual loans and past due loans as of March 31, 2020 and December 31, 2019.
Loans on Nonaccrual Status
| In Thousands |
||||||||
| March 31, | December 31, | |||||||
| 2020 | 2019 | |||||||
| Residential 1-4 family |
$ | — | $ | 949 | ||||
| Multifamily |
— | — | ||||||
| Commercial real estate |
311 | 1,661 | ||||||
| Construction |
— | — | ||||||
| Farmland |
— | — | ||||||
| Second mortgages |
— | — | ||||||
| Equity lines of credit |
— | — | ||||||
| Commercial |
— | — | ||||||
| Agricultural, installment and other |
— | — | ||||||
| Total |
$ | 311 | $ | 2,610 | ||||
Past Due Loans
| (In thousands) |
||||||||||||||||||||||||||||
| 30-59 Days Past Due | 60-89 Days Past Due | Non Accrual and Greater Than 90 Days | Total Non Accrual and Past Due | Current |
Total Loans | Recorded Investment Greater Than 90 Days Past Due and Accruing | ||||||||||||||||||||||
| March 31, 2020 |
||||||||||||||||||||||||||||
| Residential 1-4 family |
$ | 2,830 | 506 | 2,512 | 5,848 | 513,927 | 519,775 | $ | 2,512 | |||||||||||||||||||
| Multifamily |
— | — | — | — | 151,929 | 151,929 | — | |||||||||||||||||||||
| Commercial real estate |
3,995 | 51 | 311 | 4,357 | 837,164 | 841,521 | — | |||||||||||||||||||||
| Construction |
1,987 | 195 | 46 | 2,228 | 386,541 | 388,769 | 46 | |||||||||||||||||||||
| Farmland |
84 | — | 5 | 89 | 18,521 | 18,610 | 5 | |||||||||||||||||||||
| Second mortgages |
63 | — | 100 | 163 | 11,091 | 11,254 | 100 | |||||||||||||||||||||
| Equity lines of credit |
50 | — | 448 | 498 | 74,410 | 74,908 | 448 | |||||||||||||||||||||
| Commercial |
263 | 2 | — | 265 | 95,282 | 95,547 | — | |||||||||||||||||||||
| Agricultural, installment and other |
583 | 248 | 64 | 895 | 66,479 | 67,374 | 64 | |||||||||||||||||||||
| Total |
$ | 9,855 | 1,002 | 3,486 | 14,343 | 2,155,344 | 2,169,687 | $ | 3,175 | |||||||||||||||||||
| December 31, 2019 |
||||||||||||||||||||||||||||
| Residential 1-4 family |
$ | 4,760 | 799 | 2,336 | 7,895 | 503,355 | 511,250 | $ | 1,387 | |||||||||||||||||||
| Multifamily |
— | — | — | — | 97,104 | 97,104 | — | |||||||||||||||||||||
| Commercial real estate |
500 | — | 1,661 | 2,161 | 791,218 | 793,379 | — | |||||||||||||||||||||
| Construction |
1,535 | 147 | 594 | 2,276 | 422,909 | 425,185 | 594 | |||||||||||||||||||||
| Farmland |
57 | — | 8 | 65 | 19,203 | 19,268 | 8 | |||||||||||||||||||||
| Second mortgages |
— | — | 100 | 100 | 10,660 | 10,760 | 100 | |||||||||||||||||||||
| Equity lines of credit |
143 | — | 372 | 515 | 71,864 | 72,379 | 372 | |||||||||||||||||||||
| Commercial |
71 | 30 | — | 101 | 98,164 | 98,265 | — | |||||||||||||||||||||
| Agricultural, installment and other |
517 | 116 | 46 | 679 | 64,773 | 65,452 | 46 | |||||||||||||||||||||
| Total |
$ | 7,583 | 1,092 | 5,117 | 13,792 | 2,079,250 | 2,093,042 | $ | 2,507 | |||||||||||||||||||
Generally, at the time a loan is placed on nonaccrual status, all interest accrued on the loan in the current fiscal year is reversed from income, and all interest accrued and uncollected from the prior year is charged off against the allowance for loan losses. Thereafter, interest on nonaccrual loans is recognized as interest income only to the extent that cash is received and future collection of principal is not in doubt. A nonaccrual loan may be restored to accruing status when principal and interest are no longer past due and unpaid and future collection of principal and interest on a timely basis is not in doubt. Management has assessed the loans that are 90 days past due and determined that all are well-collateralized and in the process of collection, thus accrual of interest is appropriate.
Non-performing loans, which included non-accrual loans and loans 90 days past due, at March 31, 2020 totaled $3,486,000, a decrease from $5,117,000 at December 31, 2019. The decrease in non-performing loans during the three months ended March 31, 2020 of $1,631,000 is due primarily to the payoff of two large loan relationships and the pay-down of one large loan relationship. Management believes that it is probable that it will incur losses on its non-performing loans but believes that these losses should not exceed the amount in the allowance for loan losses already allocated to these loans, unless there is unanticipated deterioration of local real estate values or further, or greater than anticipated, economic disruption resulting from COVID-19. Although deterioration of the real estate market is not currently apparent, the coronavirus outbreak could have a continued material adverse impact on economic and market conditions and could potentially cause a negative impact on the value of real estate being held as collateral. The rapid development and fluidity of this situation precludes any prediction as to the ultimate material adverse impact to the value of real estate; however, the pandemic presents uncertainty and risk with respect to the Company, its performance, and its financial results.
The net non-performing asset ratio (NPA) is used as a measure of the overall quality of the Company's assets. Our NPA ratio is calculated by taking the total of our loans greater than 90 days past due and accruing interest, non-accrual loans and other real estate owned divided by our total assets outstanding. Our NPA ratio for the periods ended March 31, 2020 and December 31, 2019 were 0.15% and 0.21%, respectively.
Other loans may be classified as impaired when the current net worth and financial capacity of the borrower or of the collateral pledged, if any, is viewed as inadequate and it is probable that the Company will be unable to collect the scheduled payments of principal and interest due under the contractual terms of the loan agreement. Such loans generally have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt, and if such deficiencies are not corrected, there is a probability that the Company will sustain some loss. In such cases, interest income continues to accrue as long as the loan does not meet the Company’s criteria for nonaccrual status. Impaired loans are measured at the present value of expected future cash flows discounted at the loan’s effective interest rate, at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. If the measure of the impaired loan is less than the recorded investment in the loan, the Company shall recognize impairment by creating a valuation allowance with a corresponding charge to the provision for loan losses or by adjusting an existing valuation allowance for the impaired loan with a corresponding charge or credit to the provision for loan losses.
At March 31, 2020the Company had impaired loans of $2,433,000 down from $5,052,000 at December 31, 2019. The decrease in impaired loans during the three months ended March 31, 2020 as compared to December 31, 2019 is due to the removal of one impaired loan relationship, the pay-down of one large loan relationship, and the payoff of two large loan relationships. Overall, prior to the onset of the COVID-19 pandemic the Company’s market areas had seen continued strengthening in the residential real estate market in recent years while the commercial real estate market had remained steady. The allowance for loan losses related to collateral dependent impaired loans was measured based upon the estimated fair value of related collateral. Although deterioration of the real estate market is not currently apparent, the coronavirus outbreak could have a continued material adverse impact on economic and market conditions and could potentially cause a negative impact on the value of real estate being held as collateral. The rapid development and fluidity of this situation precludes any prediction as to the ultimate material adverse impact to the value of real estate; however, the outbreak presents uncertainty and risk with respect to the Company, its performance, and its financial results.
The Company’s loan portfolio includes certain loans that have been modified in a troubled debt restructuring (TDR), where economic or other concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. The concessions typically result from the Company’s loss mitigation activities and could include reduction in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months. Total TDRs decreased $1,675,000 to $2,872,000 from December 31, 2019 to March 31, 2020 due to the pay-down of one large loan relationship and the payoff of two large loan relationships that were classified as TDRs at December 31,2019. The CARES Act provides financial institutions the option to temporarily suspend certain requirements under GAAP related to TDRs for a limited period of time to account for the effects of COVID-19. If the pandemic continues for an extended period of time and the economy continues to be negatively impacted, the Company could experience an increase in TDRs and the financial condition of the Company could be negatively impacted. The extent to which the COVID-19 outbreak will impact our financial results and asset quality is uncertain. For more information regarding the deferrals we have offered to our customers see “Impact of COVID-19” above.
Loans are charged-off in the month when the determination is made that the loan is uncollectible. Net recoveries for the three months ended March 31, 2020 were $86,000 as compared to $73,000 in net recoveries for the same period in 2019. Overall, the Bank has experienced minimal charge-offs during 2020; however if the COVID-19 pandemic continues for an extended period of time and the economy continues to be negatively impacted, the Company could experience an increase in charge-offs and the financial condition of the Company could be negatively impacted. The extent to which the COVID-19 outbreak will impact financial results is uncertain.
At March 31, 2020, our internally classified loans had decreased $1,027,000, or 9.64%, to $9,624,000 from $10,651,000 at December 31, 2019 primarily due to the pay-down of one internally classified loan relationship and payoffs of several internally classified loan relationships. Classified loan balances have remained relatively consistent due to favorable economic conditions prior to the onset of the COVID-19 pandemic. Loans are listed as classified when information obtained about possible credit problems of the borrower has prompted management to question the ability of the borrower to comply with the repayment terms of the loan agreement. As with other asset quality measures, prolonged economic disruption as a result of the ongoing COVID-19 pandemic will likely result in increased levels of classified loans.
The largest categories of internally graded loans at March 31, 2020 were residential real estate mortgage loans and commercial real estate. Included within the residential real estate category are residential real estate construction and development loans, including loans to home builders and developers of land, as well as 1-4 family mortgage loans. Residential real estate loans, including construction and land development loans that are internally classified totaled $8,806,000 and $8,663,000 at March 31, 2020 and December 31, 2019, respectively. Commercial real estate loans that are internally classified totaled $607,000and $1,769,000 at March 31, 2020 and December 31, 2019, respectively. These loans have been graded accordingly due to bankruptcies, inadequate cash flows and/or delinquencies. The $143,000 increase in internally graded residential real estate loans since December 31, 2019 was due to the downgrade of one loan due to insufficient payment history. The $1,162,000 decrease in internally graded commercial real estate loans since December 31, 2019 was due to the payoff of one large loan relationship and pay-down of one large loan relationship. As of March 31, 2020, the Bank has experienced a stabilization in internally graded loans as the cash flows from home builders, land developers, and commercial real estate borrowers have stabilized. The COVID-19 pandemic has had a notable impact on general economic conditions and there are many unknowns surrounding this situation. If the pandemic continues for an extended period of time and the economy continues to be negatively impacted, the Company could experience an increase in internally graded loans and the financial condition of the Company could be negatively impacted.
Many of the Bank's customers have been negatively impacted by the COVID-19 pandemic either through supply chain shortages, government mandated closures, job loss, furloughs, salary decreases, reduced consumer spending and a reduced workforce, among many other factors. In an effort to provide relief to those customers, the Bank proactively began providing relief to our customers in mid March 2020 through a 90 day interest only payment option or a full 90 day payment deferral option. The first week of April 2020, the Bank expanded its efforts to provide a six-month interest only payment option in an effort to provide flexibility to our customers as they navigate these uncertain economic times. The Bank is monitoring the bank's loan portfolio on a weekly basis to identify the segments that are utilizing the COVID relief efforts and the overall percentage of the loan portfolio that has taken advantage of the relief. These reports are being reviewed by executive management and appropriately communicated to the Board of Directors.
Liquidity and Asset Management
The Company’s management seeks to maximize net interest income by managing the Company’s assets and liabilities within appropriate constraints on capital, liquidity and interest rate risk. Liquidity is the ability to maintain sufficient cash levels necessary to fund operations, meet the requirements of depositors and borrowers, and fund attractive investment opportunities. Higher levels of liquidity, like those we built up in response to the COVID-19 pandemic, bear corresponding costs, measured in terms of lower yields on short-term, more liquid earning assets and higher interest expense involved in extending liability maturities.
Liquid assets include cash, due from banks, interest bearing deposits and unpledged investment securities that will mature within one year. At March 31, 2020, the Company’s liquid assets totaled $303.6 million. Additionally, as of March 31, 2020, the Company had available approximately $90.4 million in unused federal funds lines of credit with regional banks and, subject to certain restrictions and collateral requirements, approximately $298.3 million of borrowing capacity with the Federal Home Loan Bank of Cincinnati to meet short term funding needs. The Company maintains a formal asset and liability management process to quantify, monitor and control interest rate risk and to assist management in maintaining stability in net yield on earning assets under varying interest rate environments. The Company accomplishes this process through the development and implementation of lending, funding and pricing strategies designed to maximize net interest income under varying interest rate environments subject to specific liquidity and interest rate risk guidelines.
Analysis of rate sensitivity and rate gap analysis are the primary tools used to assess the direction and magnitude of changes in net interest income resulting from changes in interest rates. Included in the analysis are cash flows and maturities of financial instruments held for purposes other than trading, changes in market conditions, loan volumes and pricing and deposit volume and mix. These assumptions are inherently uncertain, and, as a result, net interest income cannot be precisely estimated nor can the impact of higher or lower interest rates on net interest income be precisely predicted. Actual results will differ due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management’s strategies, among other factors.
The Company’s primary source of liquidity is a stable core deposit base. In addition, short-term borrowings, loan payments and investment security maturities provide a secondary source. At March 31, 2020, the Company had a liability sensitive position (a negative gap). Liability sensitivity means that more of the Company’s liabilities are capable of re-pricing over certain time frames than its assets, and in a rising rate environment liability sensitivity could cause net yield on earning assets to experience compression which would negatively impact net interest income. The interest rates associated with these liabilities may not actually change over this period but are capable of changing. Liability sensitivity generally should lead to an expansion in net yield on earning assets in a declining rate environment, as we are currently experiencing, but for that to occur the Bank will need to reprice its deposits more quickly than it reprices rates it earns on loans. As discussed elsewhere herein, the Bank was not able to widen its net yield on earning assets in the period ended March 31, 2020, and does not anticipate that it will be able to do so for the remainder of 2020 because of competitive pressures in its markets and the impacts of the COVID-19 pandemic.
The Company also uses simulation modeling to evaluate both the level of interest rate sensitivity as well as potential balance sheet strategies. The Company's Asset Liability Committee meets quarterly to analyze the interest rate shock simulation. The interest rate shock simulation model is based on a number of assumptions. These assumptions include, but are not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows and balance sheet management strategies. We model instantaneous change in interest rates using a growth in the balance sheet as well as a flat balance sheet to understand the impact to earnings and capital. The Company also uses Economic Value of Equity (“EVE”) sensitivity analysis to understand the impact of changes in interest rates on long-term cash flows, income and capital. EVE is calculated by discounting the cash flows for all balance sheet instruments under different interest rate scenarios. The EVE is a longer term view of interest rate risk because it measures the present value of the future cash flows. Presented below is the estimated impact on the Bank’s net interest income and EVE as of March 31, 2020, assuming an immediate shift in interest rates:
| % Change from Base Case for Immediate Parallel Changes in Rates | ||||||||||||||||||||
| -200 BP(1) |
-100 BP(1) |
+100 BP |
+200 BP |
+300 BP |
||||||||||||||||
| Net interest income |
(5.24 | )% | (2.23 | )% | (1.78 | )% | 1.69 | % | 3.17 | % | ||||||||||
| EVE |
(12.01 | )% | (7.56 | )% | 0.03 | % | 0.72 | % | 1.86 | % | ||||||||||
| (1) |
Currently, some short term interest rates are below the standard down rate scenarios (100, 200, 300 bps). The asset liability model does not calculate negative interest rates and will floor any index at 0. |
While an instantaneous and severe shift in interest rates was used in this analysis to provide an estimate of exposure under these scenarios, we believe that a gradual shift in interest rates would have a more modest impact. Further, the earnings simulation model does not take into account factors such as future balance sheet growth, changes in product mix, changes in yield curve relationships, and changing product spreads that could mitigate any potential adverse impact of changes in interest rates. Moreover, since EVE measures the discounted present value of cash flows over the estimated lives of instruments, the change in EVE does not directly correlate to the degree that earnings would be impacted over a shorter time horizon (i.e., the current year). Further, EVE does not take into account factors such as future balance sheet growth, changes in product mix, changes in yield curve relationships, and changing product spreads that could mitigate any potential adverse impact of changes in interest rates.
Interest rate risk (sensitivity) management focuses on the earnings risk associated with changing interest rates. Management seeks to maintain profitability in both immediate and long-term earnings through funds management/interest rate risk management. The Company’s rate sensitivity position has an important impact on earnings. Senior management of the Company analyzes the rate sensitivity position quarterly. Management focuses on the spread between the Company’s cost of funds and interest yields generated primarily through loans and investments.
The Company’s securities portfolio consists of earning assets that provide interest income. Securities classified as available-for-sale include securities intended to be used as part of the Company’s asset/liability strategy and/or securities that may be sold in response to changes in interest rate, prepayment risk, the need or desire to increase capital and similar economic factors. At March 31, 2020, securities totaling approximately $15,405,000 mature or will be subject to rate adjustments within the next twelve months.
A secondary source of liquidity is the Company’s loan portfolio. At March 31, 2020, loans totaling approximately $705,078,000 either will become due or will be subject to rate adjustments within twelve months from that date.
As for liabilities, at March 31, 2020, certificates of deposit of $250,000 or greater totaling approximately $55,478,000 will become due or reprice during the next twelve months. Historically, there has been no significant reduction in immediately withdrawable accounts such as negotiable order of withdrawal accounts, money market demand accounts, demand deposit accounts and regular savings accounts. Management anticipates that there will be no significant withdrawals from these accounts in the future.
At March 31, 2020, the scheduled maturities of these advances and interest rates were as follows (scheduled maturities will differ from scheduled repayments):
| (in thousands) |
||||
| Scheduled Maturities |
Amount |
Weighted Average Rates |
||
| 2020 |
$ — |
—% |
||
| 2021 |
2,000 |
2.67 |
||
| 2022 |
2,000 |
2.68 |
||
| 2023 |
2,250 |
2.68 |
||
| 2024 |
14,558 |
2.67 |
||
| Thereafter |
— |
— |
||
| $ 20,808 |
2.67% |
|||
Management believes that with present maturities, the anticipated growth in deposit base, and the efforts of management in its asset/liability management program, liquidity will not pose a problem in the near term future. The COVID-19 pandemic has presented overall uncertainty in the financial markets and the Bank has seen an increase in deposits as some customers have shifted funds from market based products to more stable FDIC insured options. In addition, the CARES Act includes an economic stimulus package for individuals who meet the federal income qualifications in the form of a direct payment. Management anticipates that these payments will increase the Bank's deposit accounts, thus increasing liquidity. At the present time, management does not believe that the COVID-19 pandemic will result in the Company’s liquidity changing in a materially adverse way.
Off Balance Sheet Arrangements
At March 31, 2020, we had unfunded loan commitments outstanding of $684,851,000 and outstanding standby letters of credit of $72,727,000. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Bank has the ability to liquidate federal funds sold or securities available-for-sale or on a short-term basis to borrow and purchase federal funds from other financial institutions. Additionally, the Bank could sell participations in these or other loans to correspondent banks. As mentioned above, the Bank has been able to fund its ongoing liquidity needs through its stable core deposit base, loan payments, investment security maturities and short-term borrowings.
Capital Position and Dividends
At March 31, 2020, total stockholders’ equity was $348,997,000, or 12.13% of total assets, which compares with $336,984,000, or 12.06% of total assets, at December 31, 2019. The dollar increase in stockholders’ equity during the three months ended March 31, 2020 results from the Company’s net income of $9,031,000, proceeds from the issuance of common stock related to exercise of stock options of $239,000, the net effect of a $5,555,000 unrealized gain on investment securities net of applicable income tax expense of $1,452,000, cash dividends declared of $6,476,000 of which $5,008,000 was reinvested under the Company’s dividend reinvestment plan, and $108,000 related to stock option compensation.
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. Management believes that, as of December 31, 2019, the Company and Bank meet all capital adequacy requirements to which they are subject.
Under the Basel III rules, in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers, a banking organization must hold a capital conservation buffer composed of Common Equity Tier 1 Capital above its minimum risk-based capital requirements. The buffer is measured relative to risk weighted assets. Phase-in of the capital conservation buffer requirements began on January 1, 2016 and the requirements were fully phased in on January 1, 2019. The capital conservation buffer threshold for 2019 and the first quarter of 2020 was 2.5%. A banking organization with a buffer greater than 2.5% will not be subject to limits on capital distributions or discretionary bonus payments; however, a banking organization with a buffer of less than 2.5% will be subject to increasingly stringent limitations as the buffer approaches zero. The rule also prohibits a banking organization from making distributions or discretionary bonus payments during any quarter if its eligible retained income is negative in that quarter and its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. The eligible retained income of a banking organization is defined as its net income for the four calendar quarters preceding the current calendar quarter, based on the organization’s quarterly regulatory reports, net of any distributions and associated tax effects not already reflected in net income. Now that the new rule is fully phased in, the minimum capital requirements plus the capital conservation buffer will exceed the prompt corrective action (“PCA”) well-capitalized thresholds. PCA regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At December 31, 2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.
The Company’s and Wilson Bank’s actual capital amounts and ratios as of December 31, 2019 are presented in the following table:
| Actual |
Regulatory Minimum Capital Requirement with Basel III Capital Conservation Buffer |
||||||||
| Amount |
Ratio |
Amount |
Ratio |
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| (dollars in thousands) |
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| December 31, 2019 |
|||||||||
| Total capital to risk weighted assets: |
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| Consolidated |
$360,645 |
15.0% |
$253,215 |
10.5% |
|||||
| Wilson Bank |
359,576 |
14.9 |
252,675 |
10.5 |
|||||
| Tier 1 capital to risk weighted assets: |
|||||||||
| Consolidated |
331,485 |
13.7 |
204,984 |
8.5 |
|||||
| Wilson Bank |
330,416 |
13.7 |
204,547 |
8.5 |
|||||
| Common equity Tier 1 capital to risk weighted assets: |
|||||||||
| Consolidated |
331,485 |
13.7 |
168,810 |
7.0 |
|||||
| Wilson Bank |
330,416 |
13.7 |
168,451 |
7.0 |
|||||
| Tier 1 capital to average assets: |
|||||||||
| Consolidated |
331,485 |
12.4 |
106,565 |
4.0 |
|||||
| Wilson Bank |
330,416 |
11.9 |
110,764 |
4.0 |
|||||
In 2018, the U.S. Congress passed, and the President signed into law, the Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 (the “Growth Act”). The Growth Act, among other things, requires the federal banking agencies to issue regulations allowing community bank organizations with total assets of less than $10.0 billion in assets and limited amounts of certain assets and off-balance sheet exposures to access a simpler capital regime focused on a bank’s Tier 1 leverage capital levels rather than risk-based capital levels that are the focus of the capital rules issued under the Dodd-Frank Act implementing Basel III.
In October 2019, the federal banking agencies approved final rules under the Growth Act that exempt a qualifying community bank and its holding company that have Community Bank Leverage Ratios, calculated as Tier 1 capital over average total consolidated assets (the “Community Bank Leverage Ratio”), of greater than 9 percent from the risk-based capital requirements of the capital rules issued under the Dodd-Frank Act. A qualifying community banking organization and its holding company that have chosen the proposed framework are not required to calculate the existing risk-based and leverage capital requirements. Such a bank would also be considered to have met the capital ratio requirements to be well capitalized for the agencies' prompt corrective action rules provided it has a Community Bank Leverage Ratio greater than 9 percent. Tier 1 capital for purposes of calculating the Community Bank Leverage Ratio is defined as total equity less accumulated other comprehensive income, less goodwill, less all other intangible assets, less deferred tax assets that arise from net operating loss and tax carryforwards, net of any related valuation allowances.
Pursuant to the CARES Act, the required Community Bank Leverage Ratio was lowered to 8% until the earlier of December 31, 2020 and 60 days following the end of the national emergency declared with respect to COVID-19.
The Company opted to take advantage of this rule effective January 1, 2020. As a result, the capital conservation buffer applicable under the Basel III capital guidelines is not applicable to the Company or the Bank.
As a result of opting to utilize the Community Bank Leverage Ratio calculation, total off-balance sheet exposures must be 25% or less of total consolidated assets. For purposes of this test, off-balance sheet exposures include, among other items, unused portions of commitments, securities lent or borrowed, credit enhancements and financial standby letters of credit.
The Company and the Bank may subsequently opt out of utilizing the Community Bank Leverage Ratio and again calculate their capital ratios under those ratios that the Company and the Bank utilized prior to January 1, 2020.
Failure to meet statutorily mandated capital guidelines or more restrictive ratios separately established for a financial institution could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting or renewing brokered deposits, limitations on the rates of interest that the institution may pay on its deposits, and other restrictions on its business.
The Company’s and Wilson Bank’s Community Bank Leverage Ratio as of March 31, 2020 are presented in the following table:
| Actual |
Regulatory Minimum Capital Requirement Community Bank Leverage Ratio |
||||||||
| Amount |
Ratio |
Amount |
Ratio |
||||||
| (dollars in thousands) |
|||||||||
| March 31, 2020 |
|||||||||
| Community Bank Leverage Ratio: |
|||||||||
| Consolidated |
$339,395 |
12.1% |
$252,303 |
9.0% |
|||||
| Wilson Bank |
339,643 |
12.1 |
252,121 |
9.0 |
|||||
Impact of Inflation
Although interest rates are significantly affected by inflation, the inflation rate is immaterial when reviewing the Company’s results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company’s primary component of market risk is interest rate volatility. Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on a large portion of the Company’s assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which possess a short term to maturity. Based upon the nature of the Company’s operations, the Company is not subject to foreign currency exchange or commodity price risk.
Interest rate risk (sensitivity) management focuses on the earnings risk associated with changing interest rates. Management seeks to maintain profitability in both short-term and long-term earnings through funds management/interest rate risk management. The Company’s rate sensitivity position has an important impact on earnings. Senior management of the Company meets monthly to analyze the rate sensitivity position. These meetings focus on the spread between the cost of funds and interest yields generated primarily through loans and investments.
The COVID-19 pandemic and the government response to such pandemic has materially changed the reported market risks during the three months ended March 31, 2020. Since March 3, 2020, the Federal Reserve has lowered the Fed Funds benchmark rate by a full 1.5 percentage points to a target range of 0 percent to 0.25 percent. The Fed also announced it would purchase more Treasury securities to encourage lending to try to offset the impact of the coronavirus outbreak. This was an emergency response as the coronavirus escalated sharply in the United States, with stay-at-home orders and directives in nearly all states, mandatory business closures and mandatory work-from-home policies. Because economic indicators suggested that a recession was impending, the Federal Reserve stepped in with a broad array of monetary policy actions including direct lending to banks and corporations, expanding the scope of repurchase agreements, lowering the reserve requirements for banks at the federal reserve and supporting small and mid size businesses. As discussed in the Management's Discussion and Analysis section above, the Bank has experienced some compression to its net yield on earning assets due to the rate cuts enacted by the Federal Reserve. The extent to which the COVID-19 pandemic and the response by federal, state and local governments will ultimately impact the financial performance of the Bank is uncertain and management continues to actively monitor and adopt to the rapid market changes.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures, as defined in Rule 13a-15(e) promulgated under the Exchange Act, that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and its Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. The Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of these disclosure controls and procedures, its Chief Executive Officer and its Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective.
Overall, there were no changes in the Company’s internal control over financial reporting during the Company’s fiscal quarter ended March 31, 2020 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Not applicable
There were no material changes to the Company’s risk factors as previously disclosed in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019 except as set forth below.
The COVID-19 pandemic is adversely affecting our business and the businesses and lives of a significant percentage of our customers as well as certain of our third-party vendors and service providers, and the adverse impacts on our business, financial position, capital, liquidity, results of operations and prospects could be significant.
The spread of COVID-19 has created a global public health crisis that has resulted in uncertainty, volatility and deterioration in financial markets and in governmental, commercial and consumer activity including in the United States, where we conduct substantially all of our activity.
To combat the spread of COVID-19, federal, state and local governments, including the Governor of the state of Tennessee and mayors or county executives of many of the communities in which we operate, have taken a variety of actions that have materially and adversely affected the businesses and lives of our customers. These actions have included orders or directives closing non-essential businesses and restricting movement of individuals through the issuance of shelter-in-place or safer-at-home orders and other guidance encouraging individuals to observe strict social distancing measures. At times, the actions being taken by governmental authorities are not always coordinated or consistent across the state of Tennessee and the impact of those actions across our markets may be uneven. These actions, together with the independent actions of individuals and businesses aimed at slowing the spread of the virus, have resulted in extensive economic disruption and rapid declines in consumer and commercial activity. Many businesses are experiencing significant declines in revenue and there has been a rapid rise in unemployment rates throughout our markets with corresponding negative effects on consumer spending and behavior. Global supply chains have also been negatively impacted as have equity and debt markets. Whether the efforts to stop the spread of COVID-19 will be successful is unknown at this time, and continued spread of the disease or a recurrence later in 2020 or into 2021 will further negatively impact the businesses of our customers and our results of operations.
In March 2020, the Federal Reserve reduced the target federal funds rate by 150 basis points and for a portion of March 2020 the 10-year treasury bond rate fell to below 1.00% for the first time in history. These actions, and other actions being taken by governmental and regulatory agencies affecting monetary policy in response to the unprecedented challenges resulting from the spread of COVID-19, have negatively impacted our net yield on earnings assets and our results and are likely to continue to negatively impact our net yield on earning assets and our results throughout 2020. The fair values of certain of our investments are also likely to decline as a result of COVID-19.
As a result of COVID-19 many of our borrowers, including owners of commercial real estate properties, are experiencing varying degrees of financial distress, which is expected to continue, and may likely increase, over the coming months. As a result, these borrowers will likely have difficulty paying, on a timely basis, interest and principal payments on their loans and the value of collateral securing these obligations is likely to be adversely impacted as well. Though we have offered these borrowers, and others, the ability to defer interest and principal payments for 90 days with the right to extend the deferral of interest for an additional 90 days, that deferral period may not be sufficient to allow the impacts of COVID-19 to have sufficiently subsided, and these borrowers may still be experiencing distress at the expiration of those deferral periods.
The ability of states and municipalities to fund shortfalls could have an affect on their ability to sustain debt maintenance, which would consequently impact the value of our municipal bond portfolio.
As we sought to protect the health and safety of our employees and customers during the first quarter of 2020, we took numerous actions to modify our business operations, including restricting employee travel, directing a significant percentage of our employees that were able to do so to work from home, closing the lobbies of many of our branches and implementing our business continuity plans and protocols. We may take further actions in the future either of our own volition or as a result of government orders or directives. Though we believe we have been able to adequately service our clients under these restrictions, we cannot provide any assurances that our ability to do so wouldn’t be negatively impacted if additional restrictions are necessary in the future, including if key employees of ours or a significant number of our associates become ill as a result of contracting the virus. We rely on the services of various key vendors and business partners to service our clients and if those companies’ businesses or workforces are impacted in ways similar to those that may impact our business, our ability to service our customers could be impacted.
Under the CARES Act, Congress created the PPP and authorized the Treasury to implement rules regarding the program. Banks facilitated funding under the program on behalf of the SBA for borrowers that were eligible participants. Since the roll out of the PPP, Treasury has issued rules and other interpretive guidance seeking to address uncertainty surrounding the program and its eligibility and other criteria. This constantly changing guidance caused challenges for us and other lenders under the program in finalizing and submitting applications and, in some cases, borrowers’ requests were not met before the initial funding under the program was exhausted. Though Congress has approved additional funding under the program it is possible that not all borrowers that desire loans under the program will have their requests met. As a result, we, and other lenders under the PPP, may face criticism from customers or others that sought to apply for the program and were unable to receive funding. This criticism could cause reputational damage to us and there is a possibility that customers or others may threaten and pursue legal action against banks and other lenders like us under the program. Moreover, as a result of updated guidance regarding the PPP and its eligibility standards, some borrowers that received loans through our processing efforts, have repaid their loans in full and others may choose to do the same. If that happens, we may not receive the fees that we were entitled to as a result of originating these loans.
The economic uncertainty caused by COVID-19’s spread and the efforts of government and non-governmental authorities to slow its spread, are likely to cause certain of our borrowers to experience distress and as a result increases to our provision expense for loan losses. We have also taken efforts to increase our on-balance sheet liquidity and those efforts may cause our net yield on earning assets and our results of operations to be adversely impacted.
COVID-19 has not yet been contained, and given the ongoing and fluid nature of the country’s response to the pandemic, it is difficult for us to accurately estimate the length and severity of the economic disruption being caused by COVID-19. As a result, the extent to which our results of operations, provision expense, capital levels, liquidity ratios and published credit ratings will be impacted is difficult to predict.
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) None
(b) Not applicable.
(c) None
Item 3. DEFAULTS UPON SENIOR SECURITIES
(a) None
(b) Not applicable.
Item 4. MINE SAFETY DISCLOSURES
Not applicable
None
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| 101.INS |
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Inline XBRL Instance Document (the Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document) |
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| 101.SCH |
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Inline XBRL Taxonomy Extension Schema Document. |
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| 101.CAL |
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Inline XBRL Taxonomy Extension Calculation Linkbase Document. |
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| 101.DEF |
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Inline XBRL Taxonomy Extension Definition Linkbase Document. |
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| 101.LAB |
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Inline XBRL Taxonomy Extension Label Linkbase Document. |
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| 101.PRE |
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Inline XBRL Taxonomy Extension Presentation Linkbase Document. |
| 104 | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) |
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.
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WILSON BANK HOLDING COMPANY |
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(Registrant) |
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| DATE: May 8, 2020 |
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/s/ John C. McDearman III |
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John C. McDearman III |
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President and Chief Executive Officer |
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| DATE: May 8, 2020 |
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/s/ Lisa Pominski |
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Lisa Pominski |
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Executive Vice President & Chief Financial Officer |