Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This section discusses the consolidated financial condition and results of operations of Emclaire Financial Corp and its wholly owned subsidiaries for the three and nine months ended September 30, 2019, compared to the same periods in 2018 and should be read in conjunction with the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC and with the accompanying consolidated financial statements and notes presented in this Form 10-Q.
This Form 10-Q, including the financial statements and related notes, contains forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These forward looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections and statements of our beliefs concerning future events, business plans, objectives, expected operating results and the assumptions upon which those statements are based. Forward looking statements include without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and are typically identified with words such as “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” or words or phrases of similar meaning. We caution that the forward looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control. Actual results, performances or achievements could differ materially from those contemplated, expressed or implied by the forward looking statements. Therefore, we caution you not to place undue reliance on our forward looking information and statements. Except as required by applicable law or regulation, we will not update the forward looking statements to reflect actual results or changes in factors affecting the forward looking statements.
CHANGES IN FINANCIAL CONDITION
Total assets increased $42.6 million, or 4.7%, to $941.4 million at September 30, 2019 from $898.9 million at December 31, 2018. The change in assets was driven primarily by an increase in cash and cash equivalents, securities and interest earning time deposits of $38.3 million, $20.2 million and $3.5 million, respectively, partially offset by a decrease in net loans of $20.3 million. Total liabilities increased $36.6 million, or 4.5%, to $855.5 million at September 30, 2019 from $818.9 million at December 31, 2018 primarily due to an increase in customer deposits of $46.5 million, partially offset by a decrease in borrowed funds of $11.6 million.
Stockholders’ equity increased $5.9 million, or 7.4%, to $85.9 million at September 30, 2019 from $80.0 million at December 31, 2018 primarily due to a $3.8 million increase in retained earnings as a result of $6.3 million of net income, partially offset by $2.4 million of dividends paid. Additionally, the accumulated other comprehensive loss declined by $1.9 million as a result of improvement in the Corporation unrealized gains on securities. The Corporation remains well capitalized and is positioned for continued growth with total stockholders’ equity at 9.1% of total assets. Book value per common share was $30.28 at September 30, 2019, compared to $28.09 at December 31, 2018.
At September 30, 2019, the Bank was considered “well-capitalized” with a Tier 1 leverage ratio, Common Equity Tier 1 ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio of 8.13%, 12.66%, 12.66% and 13.78%, respectively. The Bank was also considered “well-capitalized” at December 31, 2018 with a Tier 1 leverage ratio, Common Equity Tier 1 ratio, Tier 1 risk-based capital ratio and total risk-based capital ratio of 7.95%, 11.82%, 11.82% and 12.93%, respectively.
RESULTS OF OPERATIONS
Comparison of Results for the Three Months Ended September 30, 2019 and 2018
General. Net income available to common stockholders increased $1.0 million, or 86.7%, to $2.2 million for the three months ended September 30, 2019 from $1.2 million for the same period in 2018. This increase was the result of increases in net interest income and noninterest income of $875,000 and $147,000, respectively, and a decrease of $445,000 in the provision for loan losses, partially offset by increases in the provision for income taxes and noninterest expense of $257,000 and $203,000, respectively.
Net interest income. Tax equivalent net interest income increased $872,000, or 14.1%, to $7.1 million for the three months ended September 30, 2019 from $6.2 million for the three months ended September 30, 2018. This increase was attributed to an increase in tax equivalent interest income of $1.7 million, partially offset by an increase in interest expense of $846,000.
Interest income. Tax equivalent interest income increased $1.7 million, or 22.9%, to $9.2 million for the three months ended September 30, 2019 from $7.5 million for the same period in 2018. This increase was attributed to increases in interest earned on loans, interest-earning deposits with banks and securities and dividends on federal bank stocks of $1.5 million, $139,000, $52,000 and $39,000, respectively.
Tax equivalent interest earned on loans receivable increased $1.5 million, or 22.2%, to $8.2 million for the three months ended September 30, 2019 compared to $6.7 million for the same period in 2018. This increase resulted from a $100.9 million, or 17.0%, increase in average loans, accounting for a $1.2 million increase in interest income. The increase in loans receivable was related to the acquisition of Community First Bancorp, Inc. in October 2018. Adding to this favorable volume variance, the average yield on loans increased 20 basis points to 4.68% for the three months ended September 30, 2019, versus 4.48% for the same period in 2018. This favorable yield variance accounted for a $307,000 increase in interest income. Accretion of purchase accounting adjustments on acquired loans accounted for approximately 5 basis points of the yield increase.
Interest earned on deposits with banks increased $139,000 to $251,000 for the three months ended September 30, 2019 compared to $112,000 for the same period in 2018. This increase resulted from a $25.2 million, or 98.2%, increase in average cash balances, accounting for a $123,000 increase in interest income. Adding to this favorable volume variance, the average yield on cash and cash equivalent balances increased 23 basis points to 1.96% for the three months ended September 30, 2019, versus 1.73% for the same period in 2018, accounting for a $16,000 increase in interest income.
Tax equivalent interest earned on securities increased $52,000, or 8.4%, to $674,000 for the three months ended September 30, 2019 compared to $622,000 for the same period in 2018. The average balance of securities increased $4.3 million, or 4.3%, accounting for a $27,000 increase in interest income. Additionally, the average yield on securities increased by 10 basis points to 2.58% for the three months ended September 30, 2019 versus 2.48% for the same period in 2018. This favorable yield variance accounted for a $25,000 increase in interest income.
Dividends on federal bank stocks increased $39,000, or 60.0%, to $104,000 for the three months ended September 30, 2019 from $65,000 for the same period in 2018. This increase was primarily due to a $1.4 million, or 30.5%, increase in the average balance of federal bank stocks, accounting for a $22,000 increase in interest income. Additionally, an increase of 131 basis points in the average yield on federal bank stocks to 7.10% for the three months ended September 30, 2019, versus 5.79% for the same period in 2018, accounted for an $17,000 increase in interest income.
Interest expense. Interest expense increased $846,000, or 63.8%, to $2.2 million for the three months ended September 30, 2019 from $1.3 million for the same period in 2018. This increase in interest expense can be attributed to increases in interest incurred on deposits and borrowed funds of $755,000 and $91,000, respectively.
Interest expense incurred on deposits increased $755,000, or 63.8%, to $1.9 million for the three months ended September 30, 2019 compared to $1.2 million for the same period in 2018. The average cost of interest-bearing deposits increased 35 basis points to 1.21% for the three months ended September 30, 2019, versus 0.86% for the same period in 2018, accounting for a $550,000 increase in interest expense. Additionally, the average balance of interest-bearing deposits increased $85.4 million, or 15.6%, to $633.9 million for the three months ended September 30, 2019, compared to $548.5 million for the same period in 2018 causing a $205,000 increase in interest expense. This increase was primarily due to the acquisition of Community First in October 2018.
Interest expense incurred on borrowed funds increased $91,000, or 64.1%, to $233,000 for the three months ended September 30, 2019, compared to $142,000 for the same period in the prior year. The average balance of borrowed funds increased $14.0 million, or 70.7%, to $33.8 million for the three months ended September 30, 2019, compared to $19.8 million for the same period in 2018 causing an $90,000 increase in interest expense. The increase in the outstanding balance of borrowed funds primarily resulted from three additional $5.0 million FHLB long-term notes taken in December 2018. The average cost of long-term borrowed funds increased 12 basis points to 2.54% for the three months ended September 30, 2019 compared to 2.42% for the same period in 2018 causing a $5,000 increase in interest expense. Partially offsetting the cost of long-term borrowings, the average cost of short-term borrowed funds decreased 60 basis points to 5.71% for the three months ended September 30, 2019 compared to 6.31% for the same period in 2018 causing a $4,000 decrease in interest expense.
Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.
(Dollar amounts in thousands)
|
|
Three Months Ended September 30,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
Average Balance
|
|
|
Interest
|
|
|
Yield/ Rate
|
|
|
Average Balance
|
|
|
Interest
|
|
|
Yield/ Rate
|
|
Interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans, taxable
|
|
$
|
673,970
|
|
|
$
|
7,994
|
|
|
|
4.71
|
%
|
|
$
|
574,904
|
|
|
$
|
6,536
|
|
|
|
4.51
|
%
|
Loans, tax exempt
|
|
|
21,163
|
|
|
|
210
|
|
|
|
3.93
|
%
|
|
|
19,294
|
|
|
|
180
|
|
|
|
3.70
|
%
|
Total loans receivable
|
|
|
695,133
|
|
|
|
8,204
|
|
|
|
4.68
|
%
|
|
|
594,198
|
|
|
|
6,716
|
|
|
|
4.48
|
%
|
Securities, taxable
|
|
|
90,247
|
|
|
|
583
|
|
|
|
2.56
|
%
|
|
|
75,759
|
|
|
|
464
|
|
|
|
2.43
|
%
|
Securities, tax exempt
|
|
|
13,511
|
|
|
|
91
|
|
|
|
2.68
|
%
|
|
|
23,733
|
|
|
|
158
|
|
|
|
2.65
|
%
|
Total securities
|
|
|
103,758
|
|
|
|
674
|
|
|
|
2.58
|
%
|
|
|
99,492
|
|
|
|
622
|
|
|
|
2.48
|
%
|
Interest-earning deposits with banks
|
|
|
50,881
|
|
|
|
251
|
|
|
|
1.96
|
%
|
|
|
25,670
|
|
|
|
112
|
|
|
|
1.73
|
%
|
Federal bank stocks
|
|
|
5,813
|
|
|
|
104
|
|
|
|
7.10
|
%
|
|
|
4,453
|
|
|
|
65
|
|
|
|
5.79
|
%
|
Total interest-earning cash equivalents
|
|
|
56,694
|
|
|
|
355
|
|
|
|
2.48
|
%
|
|
|
30,123
|
|
|
|
177
|
|
|
|
2.33
|
%
|
Total interest-earning assets
|
|
|
855,585
|
|
|
|
9,233
|
|
|
|
4.28
|
%
|
|
|
723,813
|
|
|
|
7,515
|
|
|
|
4.12
|
%
|
Cash and due from banks
|
|
|
3,515
|
|
|
|
|
|
|
|
|
|
|
|
2,940
|
|
|
|
|
|
|
|
|
|
Other noninterest-earning assets
|
|
|
62,389
|
|
|
|
|
|
|
|
|
|
|
|
46,375
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
921,489
|
|
|
|
|
|
|
|
|
|
|
$
|
773,128
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing demand deposits
|
|
$
|
405,051
|
|
|
$
|
712
|
|
|
|
0.70
|
%
|
|
$
|
379,544
|
|
|
$
|
502
|
|
|
|
0.52
|
%
|
Time deposits
|
|
|
228,869
|
|
|
|
1,226
|
|
|
|
2.12
|
%
|
|
|
168,933
|
|
|
|
681
|
|
|
|
1.60
|
%
|
Total interest-bearing deposits
|
|
|
633,920
|
|
|
|
1,938
|
|
|
|
1.21
|
%
|
|
|
548,477
|
|
|
|
1,183
|
|
|
|
0.86
|
%
|
Borrowed funds, short-term
|
|
|
2,050
|
|
|
|
29
|
|
|
|
5.71
|
%
|
|
|
2,050
|
|
|
|
33
|
|
|
|
6.31
|
%
|
Borrowed funds, long-term
|
|
|
31,750
|
|
|
|
204
|
|
|
|
2.54
|
%
|
|
|
17,753
|
|
|
|
109
|
|
|
|
2.42
|
%
|
Total borrowed funds
|
|
|
33,800
|
|
|
|
233
|
|
|
|
2.74
|
%
|
|
|
19,803
|
|
|
|
142
|
|
|
|
2.84
|
%
|
Total interest-bearing liabilities
|
|
|
667,720
|
|
|
|
2,171
|
|
|
|
1.29
|
%
|
|
|
568,280
|
|
|
|
1,325
|
|
|
|
0.93
|
%
|
Noninterest-bearing demand deposits
|
|
|
154,837
|
|
|
|
—
|
|
|
|
—
|
|
|
|
134,183
|
|
|
|
—
|
|
|
|
—
|
|
Funding and cost of funds
|
|
|
822,557
|
|
|
|
2,171
|
|
|
|
1.05
|
%
|
|
|
702,463
|
|
|
|
1,325
|
|
|
|
0.75
|
%
|
Other noninterest-bearing liabilities
|
|
|
13,826
|
|
|
|
|
|
|
|
|
|
|
|
10,733
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
836,383
|
|
|
|
|
|
|
|
|
|
|
|
713,196
|
|
|
|
|
|
|
|
|
|
Stockholders' Equity
|
|
|
85,106
|
|
|
|
|
|
|
|
|
|
|
|
59,932
|
|
|
|
|
|
|
|
|
|
Total Liabilities and Stockholders' Equity
|
|
$
|
921,489
|
|
|
|
|
|
|
|
|
|
|
$
|
773,128
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
7,062
|
|
|
|
|
|
|
|
|
|
|
$
|
6,190
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate spread (difference between weighted average rate on interest-earning assets and interest-bearing liabilities)
|
|
|
|
|
|
|
|
|
|
|
2.99
|
%
|
|
|
|
|
|
|
|
|
|
|
3.19
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest margin (net interest income as a percentage of average interest-earning assets)
|
|
|
|
|
|
|
|
|
|
|
3.27
|
%
|
|
|
|
|
|
|
|
|
|
|
3.39
|
%
|
Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation’s interest income and interest expense are attributable to changes in volume (changes in volume multiplied by prior year rate), rate (change in rate multiplied by prior year volume) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis.
(Dollar amounts in thousands)
|
|
Three Months Ended September 30,
|
|
|
|
2019 versus 2018
|
|
|
|
Increase (Decrease) due to
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Total
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
|
$
|
1,181
|
|
|
$
|
307
|
|
|
$
|
1,488
|
|
Securities
|
|
|
27
|
|
|
|
25
|
|
|
|
52
|
|
Interest-earning deposits with banks
|
|
|
123
|
|
|
|
16
|
|
|
|
139
|
|
Federal bank stocks
|
|
|
22
|
|
|
|
17
|
|
|
|
39
|
|
Total interest-earning assets
|
|
|
1,353
|
|
|
|
365
|
|
|
|
1,718
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits
|
|
|
205
|
|
|
|
550
|
|
|
|
755
|
|
Borrowed funds, short-term
|
|
|
—
|
|
|
|
(4
|
)
|
|
|
(4
|
)
|
Borrowed funds, long-term
|
|
|
90
|
|
|
|
5
|
|
|
|
95
|
|
Total interest-bearing liabilities
|
|
|
295
|
|
|
|
551
|
|
|
|
846
|
|
Net interest income
|
|
$
|
1,058
|
|
|
$
|
(186
|
)
|
|
$
|
872
|
|
Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all probable incurred losses estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio.
Information pertaining to the allowance for loan losses and nonperforming assets for the three months ended September 30, 2019 and 2018 is as follows:
(Dollar amounts in thousands)
|
|
As of or for the three months ended
|
|
|
September 30,
|
|
|
2019
|
|
2018
|
Balance at the beginning of the period
|
|
$
|
6,580
|
|
|
$
|
6,118
|
|
Provision for (recovery of) loan losses
|
|
|
(145
|
)
|
|
|
300
|
|
Charge-offs
|
|
|
(69
|
)
|
|
|
(76
|
)
|
Recoveries
|
|
|
143
|
|
|
|
18
|
|
Balance at the end of the period
|
|
$
|
6,509
|
|
|
$
|
6,360
|
|
|
|
|
|
|
|
|
|
|
Nonperforming loans
|
|
$
|
4,977
|
|
|
$
|
5,488
|
|
Nonperforming assets
|
|
|
5,458
|
|
|
|
6,088
|
|
Nonperforming loans to total loans
|
|
|
0.72
|
%
|
|
|
0.92
|
%
|
Nonperforming assets to total assets
|
|
|
0.58
|
%
|
|
|
0.79
|
%
|
Allowance for loan losses to total loans
|
|
|
0.94
|
%
|
|
|
1.06
|
%
|
Allowance for loan losses to nonperforming loans
|
|
|
130.78
|
%
|
|
|
115.89
|
%
|
Nonperforming loans decreased $1.0 million, or 17.0% to $5.0 million at September 30, 2019 from $6.0 million at June 30, 2019. This was primarily due to changes in the non-accrual status of five loans. Three loans totaling $525,000 were removed from non-accrual status after the application of payments to past due balances brought the loans current. Additionally, one $423,000 residential real estate loan previously on non-accrual was paid in full and one $91,000 non-accrual residential real estate loan was transferred to OREO.
As of September 30, 2019, the Corporation’s classified and criticized assets amounted to $20.8 million, or 2.2% of total assets, with $17.2 million classified as substandard and $3.6 million identified as special mention. This compares to classified and criticized assets of $25.5 million, or 2.8% of total assets, with $19.8 million classified as substandard and $5.7 million identified as special mention at June 30, 2019. This $4.7 million decrease was primarily related to a $2.5 million payoff of a commercial relationship previously identified as substandard and the upgrade of a $2.1 million commercial relationship from special mention to pass during the third quarter of 2019.
The provision for loan losses decreased $445,000 to a recovery of $145,000 for the three months ended September 30, 2019 from a provision of $300,000 for the same period in 2018. This recovery was primarily due to the aforementioned improvement in the criticized and classified loan balances during the three months ended September 30, 2019.
Noninterest income. Noninterest income increased $147,000, or 13.8%, to $1.2 million for the three months ended September 30, 2019, compared to $1.1 million for the same period in 2018 due to increases in gains of the sale of securities, gains on the sale of loans and other income of $44,000, $42,000 and $67,000 respectively. The increase in other income was primarily driven by increases in ATM fees.
Noninterest expense. Noninterest expense increased $203,000, or 3.4%, to $5.8 million for the three months ended September 30, 2019 from $5.6 million for the same period in 2018. The increase primarily related to increases in compensation and benefits expense and other noninterest expense of $668,000 and $229,000, respectively, partially offset by a reduction in acquistion costs and FDIC insurance expense of $677,000 and $103,000, respectively. The increases primarily related to costs associated with the new banking offices acquired in the Community First acquisition and normal salary and benefit and operating expense increases. The decrease in FDIC insurance expense was a result of utilizing Small Bank assessment credits of $112,000 during the period.
Provision for income taxes. The provision for income taxes increased $257,000 to $444,000 for the three months ended September 30, 2019 compared to $187,000 for the same period in the prior year as a result of the increase in net income before provision for income taxes.
General. Net income available to common stockholders increased $2.4 million, or 60.1%, to $6.3 million for the nine months ended September 30, 2019 from $3.9 million for the same period in 2018. This increase was the result of increases in net interest income and noninterest income of $3.1 million and $388,000, respectively, and a decrease of $675,000 in the provision for loan losses, partially offset by increases in noninterest expense, provision for income taxes and preferred stock dividends of $1.1 million, $637,000 and $91,000, respectively.
Net interest income. Tax equivalent net interest income increased $3.1 million, or 17.1%, to $21.5 million for the nine months ended September 30, 2019 from $18.3 million for the nine months ended September 30, 2018. This increase was attributed to an increase in tax equivalent interest income of $5.2 million, partially offset by an increase in interest expense of $2.1 million.
Interest income. Tax equivalent interest income increased $5.2 million, or 23.7%, to $27.3 million for the nine months ended September 30, 2019 from $22.0 million for the same period in 2018. This increase was attributed to increases in interest earned on loans, interest on deposits with banks, and securities and dividends on federal bank stocks of $4.8 million, $169,000, $145,000 and $95,000, respectively.
Tax equivalent interest earned on loans receivable increased $4.8 million, or 24.4%, to $24.6 million for the nine months ended September 30, 2019 compared to $19.8 million for the same period in 2018. This increase resulted from a $111.6 million, or 18.9%, increase in average loans, accounting for an increase of $3.9 million in interest income. The increase in loans receivable was related to the acquisition of Community First Bancorp, Inc. in October 2018. Adding to this favorable volume variance, the average yield on loans increased 21 basis points to 4.69% for the nine months ended September 30, 2019, versus 4.48% for the same period in 2018. This favorable yield variance accounted for a $941,000 increase in interest income. Accretion of purchase accounting adjustments on acquired loans accounted for approximately 5 basis points of the yield increase.
Interest earned on deposits with banks increased $169,000, or 74.1%, to $397,000 for the nine months ended September 30, 2019 compared to $228,000 for the nine months ended September 30, 2018. This increase resulted from an $8.5 million increase in the average balance of interest-earning deposits accounting for an increase of $108,000 in interest income. Additionally, a 34 basis point increase in the average yield on these accounts to 1.81% for the nine months ended September 30, 2019, versus 1.47% for the same period in 2018, accounting for a $61,000 increase in interest income.
Tax equivalent interest earned on securities increased $145,000, or 8.0%, to $2.0 million for the nine months ended September 30, 2019 compared to $1.8 million for the nine months ended September 30, 2018. This increase resulted from a 18 basis point increase in the average yield on securities to 2.62% for the nine months ended September 30, 2019 versus 2.44% for the same period in 2018. This favorable yield variance accounted for a $129,000 increase in interest income. Additionally, the average balance of securities increased $841,000 accounting for a $16,000 increase in interest income.
Dividends on federal bank stocks increased $95,000, or 43.0%, to $316,000 for the nine months ended September 30, 2019 from $221,000 for the same period in 2018. This increase was primarily due to a $1.4 million, or 31.3%, increase in the average balance of federal bank stocks, accounting for a $74,000 increase in interest income. Furthermore, an increase of 56 basis points in the average yield on federal bank stocks to 7.20% for the nine months ended September 30, 2019, versus 6.64% for the same period in 2018, accounted for a $21,000 increase in interest income.
Interest expense. Interest expense increased $2.1 million, or 56.4%, to $5.8 million for the nine months ended September 30, 2019 from $3.7 million for the same period in 2018. This increase in interest expense can be attributed to a $1.8 million increase in interest incurred on deposits and an increase of $329,000 in interest incurred on borrowed funds.
Interest expense incurred on deposits increased $1.8 million, or 54.0%, to $5.0 million for the nine months ended September 30, 2019 compared to $3.3 million for the same period in 2018. The average cost of interest-bearing deposits increased 28 basis points to 1.09% for the nine months ended September 30, 2019, versus 0.81% for the same period in 2018, accounting for a $1.3 million increase in interest expense. Additionally, the average balance of interest-bearing deposits increased $75.1 million, or 13.8%, to $618.8 million for the nine months ended September 30, 2019, compared to $543.7 million for the same period in 2018 causing a $498,000 increase in interest expense. This increase was primarily due to the acquisition of Community First in October 2018.
Interest expense incurred on borrowed funds increased $329,000, or 74.8%, to $769,000 for the nine months ended September 30, 2019, compared to $440,000 for the same period in the prior year. The average balance of borrowed funds increased $16.1 million, or 74.8%, to $37.5 million for the nine months ended September 30, 2019, compared to $21.5 million for the same period in 2018 causing a $335,000 increase in interest expense. The increase in the outstanding balance of borrowed funds primarily resulted from three additional $5.0 million FHLB long-term notes taken in December 2018. Additionally, the average cost of long-term borrowed funds increased 11 basis points to 2.56% for the nine months ended September 30, 2019 compared to 2.45% for the same period in 2018 causing a $16,000 increase in interest expense. Partially offsetting these increases, the average cost of short-term borrowed funds decreased 86 basis points to 3.78% for the nine months ended September 30, 2019 compared to 4.64% for the same period in 2018 causing a $22,000 decrease in interest expense.
Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resulting average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resulting average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average loan balances include nonaccrual loans and exclude the allowance for loan losses and interest income includes accretion of net deferred loan fees. Interest and yields on tax-exempt loans and securities (tax-exempt for federal income tax purposes) are shown on a fully tax equivalent basis. The information is based on average daily balances during the periods presented.
(Dollar amounts in thousands)
|
|
Nine Months Ended September 30,
|
|
|
|
2019
|
|
|
2018
|
|
|
|
Average
|
|
|
|
|
|
|
Yield/
|
|
|
Average
|
|
|
|
|
|
|
Yield/
|
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
|
Balance
|
|
|
Interest
|
|
|
Rate
|
|
Interest-earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans, taxable
|
|
$
|
681,235
|
|
|
$
|
24,002
|
|
|
|
4.71
|
%
|
|
$
|
569,745
|
|
|
$
|
19,223
|
|
|
|
4.51
|
%
|
Loans, tax exempt
|
|
|
20,770
|
|
|
|
609
|
|
|
|
3.92
|
%
|
|
|
20,661
|
|
|
|
568
|
|
|
|
3.68
|
%
|
Total loans receivable
|
|
|
702,005
|
|
|
|
24,611
|
|
|
|
4.69
|
%
|
|
|
590,406
|
|
|
|
19,791
|
|
|
|
4.48
|
%
|
Securities, taxable
|
|
|
82,335
|
|
|
|
1,606
|
|
|
|
2.61
|
%
|
|
|
73,705
|
|
|
|
1,312
|
|
|
|
2.38
|
%
|
Securities, tax exempt
|
|
|
17,450
|
|
|
|
348
|
|
|
|
2.67
|
%
|
|
|
25,239
|
|
|
|
497
|
|
|
|
2.63
|
%
|
Total securities
|
|
|
99,785
|
|
|
|
1,954
|
|
|
|
2.62
|
%
|
|
|
98,944
|
|
|
|
1,809
|
|
|
|
2.44
|
%
|
Interest-earning deposits with banks
|
|
|
29,294
|
|
|
|
397
|
|
|
|
1.81
|
%
|
|
|
20,763
|
|
|
|
228
|
|
|
|
1.47
|
%
|
Federal bank stocks
|
|
|
5,860
|
|
|
|
316
|
|
|
|
7.20
|
%
|
|
|
4,461
|
|
|
|
221
|
|
|
|
6.64
|
%
|
Total interest-earning cash equivalents
|
|
|
35,154
|
|
|
|
713
|
|
|
|
2.71
|
%
|
|
|
25,224
|
|
|
|
449
|
|
|
|
2.38
|
%
|
Total interest-earning assets
|
|
|
836,944
|
|
|
|
27,278
|
|
|
|
4.36
|
%
|
|
|
714,574
|
|
|
|
22,049
|
|
|
|
4.13
|
%
|
Cash and due from banks
|
|
|
3,336
|
|
|
|
|
|
|
|
|
|
|
|
2,812
|
|
|
|
|
|
|
|
|
|
Other noninterest-earning assets
|
|
|
62,702
|
|
|
|
|
|
|
|
|
|
|
|
46,172
|
|
|
|
|
|
|
|
|
|
Total Assets
|
|
$
|
902,982
|
|
|
|
|
|
|
|
|
|
|
$
|
763,558
|
|
|
|
|
|
|
|
|
|
Interest-bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing demand deposits
|
|
$
|
395,464
|
|
|
$
|
1,827
|
|
|
|
0.62
|
%
|
|
$
|
373,534
|
|
|
$
|
1,375
|
|
|
|
0.49
|
%
|
Time deposits
|
|
|
223,349
|
|
|
|
3,218
|
|
|
|
1.93
|
%
|
|
|
170,151
|
|
|
|
1,902
|
|
|
|
1.49
|
%
|
Total interest-bearing deposits
|
|
|
618,813
|
|
|
|
5,045
|
|
|
|
1.09
|
%
|
|
|
543,685
|
|
|
|
3,277
|
|
|
|
0.81
|
%
|
Borrowed funds, short-term
|
|
|
5,536
|
|
|
|
156
|
|
|
|
3.78
|
%
|
|
|
2,817
|
|
|
|
98
|
|
|
|
4.64
|
%
|
Borrowed funds, long-term
|
|
|
31,998
|
|
|
|
613
|
|
|
|
2.56
|
%
|
|
|
18,661
|
|
|
|
342
|
|
|
|
2.45
|
%
|
Total borrowed funds
|
|
|
37,534
|
|
|
|
769
|
|
|
|
2.74
|
%
|
|
|
21,478
|
|
|
|
440
|
|
|
|
2.74
|
%
|
Total interest-bearing liabilities
|
|
|
656,347
|
|
|
|
5,814
|
|
|
|
1.18
|
%
|
|
|
565,163
|
|
|
|
3,717
|
|
|
|
0.88
|
%
|
Noninterest-bearing demand deposits
|
|
|
150,096
|
|
|
|
—
|
|
|
|
—
|
|
|
|
128,590
|
|
|
|
—
|
|
|
|
—
|
|
Funding and cost of funds
|
|
|
806,443
|
|
|
|
5,814
|
|
|
|
0.96
|
%
|
|
|
693,753
|
|
|
|
3,717
|
|
|
|
0.72
|
%
|
Other noninterest-bearing liabilities
|
|
|
13,667
|
|
|
|
|
|
|
|
|
|
|
|
10,494
|
|
|
|
|
|
|
|
|
|
Total Liabilities
|
|
|
820,110
|
|
|
|
|
|
|
|
|
|
|
|
704,247
|
|
|
|
|
|
|
|
|
|
Stockholders' Equity
|
|
|
82,872
|
|
|
|
|
|
|
|
|
|
|
|
59,311
|
|
|
|
|
|
|
|
|
|
Total Liabilities and Stockholders' Equity
|
|
$
|
902,982
|
|
|
|
|
|
|
|
|
|
|
$
|
763,558
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
21,464
|
|
|
|
|
|
|
|
|
|
|
$
|
18,332
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate spread (difference between weighted average rate on interest-earning assets and interest-bearing liabilities)
|
|
|
|
|
|
|
|
|
|
|
3.17
|
%
|
|
|
|
|
|
|
|
|
|
|
3.25
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net interest margin (net interest income as a percentage of average interest-earning assets)
|
|
|
|
|
|
|
|
|
|
|
3.43
|
%
|
|
|
|
|
|
|
|
|
|
|
3.43
|
%
|
Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Corporation’s interest income and interest expense are attributable to changes in volume (changes in volume multiplied by prior year rate), rate (change in rate multiplied by prior year volume) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances. Changes in interest income on loans and securities reflect the changes in interest income on a fully tax equivalent basis.
(Dollar amounts in thousands)
|
|
Nine Months Ended September 30,
|
|
|
|
2019 versus 2018
|
|
|
|
Increase (Decrease) due to
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Total
|
|
Interest income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
|
$
|
3,879
|
|
|
$
|
941
|
|
|
$
|
4,820
|
|
Securities
|
|
|
16
|
|
|
|
129
|
|
|
|
145
|
|
Interest-earning deposits with banks
|
|
|
108
|
|
|
|
61
|
|
|
|
169
|
|
Federal bank stocks
|
|
|
74
|
|
|
|
21
|
|
|
|
95
|
|
Total interest-earning assets
|
|
|
4,077
|
|
|
|
1,152
|
|
|
|
5,229
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits
|
|
|
498
|
|
|
|
1,270
|
|
|
|
1,768
|
|
Borrowed funds, short-term
|
|
|
80
|
|
|
|
(22
|
)
|
|
|
58
|
|
Borrowed funds, long-term
|
|
|
255
|
|
|
|
16
|
|
|
|
271
|
|
Total interest-bearing liabilities
|
|
|
833
|
|
|
|
1,264
|
|
|
|
2,097
|
|
Net interest income
|
|
$
|
3,244
|
|
|
$
|
(112
|
)
|
|
$
|
3,132
|
|
Provision for loan losses. The Corporation records provisions for loan losses to maintain a level of total allowance for loan losses that management believes, to the best of its knowledge, covers all probable incurred losses estimable at each reporting date. Management considers historical loss experience, the present and prospective financial condition of borrowers, current conditions (particularly as they relate to markets where the Corporation originates loans), the status of nonperforming assets, the estimated underlying value of the collateral and other factors related to the collectability of the loan portfolio.
(Dollar amounts in thousands)
|
|
As of or for the nine months ended
|
|
|
|
September 30,
|
|
|
|
2019
|
|
|
2018
|
|
Balance at the beginning of the period
|
|
$
|
6,508
|
|
|
$
|
6,127
|
|
Provision for loan losses
|
|
|
305
|
|
|
|
980
|
|
Charge-offs
|
|
|
(544
|
)
|
|
|
(807
|
)
|
Recoveries
|
|
|
240
|
|
|
|
60
|
|
Balance at the end of the period
|
|
$
|
6,509
|
|
|
$
|
6,360
|
|
|
|
|
|
|
|
|
|
|
Nonperforming loans
|
|
$
|
4,977
|
|
|
$
|
5,488
|
|
Nonperforming assets
|
|
|
5,458
|
|
|
|
6,088
|
|
Nonperforming loans to total loans
|
|
|
0.72
|
%
|
|
|
0.92
|
%
|
Nonperforming assets to total assets
|
|
|
0.58
|
%
|
|
|
0.79
|
%
|
Allowance for loan losses to total loans
|
|
|
0.94
|
%
|
|
|
1.06
|
%
|
Allowance for loan losses to nonperforming loans
|
|
|
130.78
|
%
|
|
|
115.89
|
%
|
Nonperforming loans increased $1.9 million, or 98.1%, to $5.0 million at September 30, 2019 from $3.0 million at December 31, 2018. This was primarily due to one commercial relationships totaling $2.4 million being placed on non-accrual status partially offset by the payoff of one residential real estate loan totaling $423,000 during the nine months ended September 30, 2019.
As of September 30, 2019, the Corporation’s classified and criticized assets amounted to $20.8 million, or 2.2% of total assets, with $17.2 million classified as substandard and $3.6 million identified as special mention. This compares to classified and criticized assets of $22.9 million, or 2.5% of total assets, with $16.4 million classified as substandard and $6.5 million identified as special mention at December 31, 2018. This decrease was primarily related to the rating upgrades of two commercial relationships totaling $2.4 million, the payoffs of five commercial relationships totaling $1.9 million, the $423,000 payoff of a residential real estate loan and the transfer to OREO of one commercial relationship totaling $232,000, partially offset by the rating downgrades of five commercial relationships totaling $3.4 million.
The provision for loan losses decreased $675,000, or 68.9%, to $305,000 for the nine months ended September 30, 2019 from $980,000 for the same period in 2018 as criticized and classified loans improved by $2.1 million and portfolio net charge-offs were lower compared to the same period in 2018.
Noninterest income. Noninterest income increased $388,000, or 12.9%, to $3.4 million for the nine months ended September 30, 2019, compared to $3.0 million for the same period in 2018. Fees and service charges increased $194,000, primarily associated with the operation of the three new full-service banking offices which were acquired from Community First and general increases in overdraft fee income. Additionally, net gains on the sale of loans and net gains on the sale of securities increased $69,000 and $52,000, respectively.
Noninterest expense. Noninterest expense increased $1.1 million, or 7.2%, to $16.6 million for the nine months ended September 30, 2019 from $15.5 million for the same period in 2018. The increase primarily related to increases in compensation and benefits expense, other noninterest expense and occupancy and equipment expense of $1.4 million, $718,000 and $272,000, respectively. The increases primarily related to costs associated with the aforementioned new banking offices and normal salary and benefit and operating expense increases. These increases in noninterest expense were partially offset by a decreases of $1.0 million in acquisition costs and $124,000 in FDIC insurance expense. The decrease in FDIC insurance expense was a result of utilizing Small Bank assessment credits of $112,000 during the period.
Provision for income taxes. The provision for income taxes increased $637,000, or 86.7%, to $1.4 million for the nine months ended September 30, 2019 compared to $735,000 for the same period in the prior year as a result of the increase in net income before provision for income taxes.
LIQUIDITY
The Corporation’s primary sources of funds generally have been deposits obtained through the offices of the Bank, borrowings from the FHLB, Federal Reserve and other correspondent banks, and amortization and prepayments of outstanding loans and maturing securities. During the nine months ended September 30, 2019, the Corporation used its sources of funds primarily to reduce short-term borrowed funds and increase interest earning time deposits and investment balances. As of September 30, 2019, the Corporation had outstanding loan commitments, including undisbursed loans and amounts available under credit lines, totaling $107.4 million, and standby letters of credit totaling $979,000, net of collateral maintained by the Bank.
At September 30, 2019, time deposits amounted to $227.2 million, or 28.1% of the Corporation’s total consolidated deposits, including approximately $64.2 million of which are scheduled to mature within the next year. Management of the Corporation believes (i) it has adequate resources to fund all of its commitments, (ii) all of its commitments will be funded as required by related maturity dates and (iii) based upon past experience and current pricing policies, it can adjust the rates of time deposits to retain a substantial portion of maturing liabilities if necessary.
Aside from liquidity available from customer deposits or through sales and maturities of securities, the Corporation and the Bank have alternative sources of funds. These sources include a line of credit for the Corporation with a correspondent bank, the Bank's line of credit and term borrowing capacity from the FHLB and the Federal Reserve’s discount window and, to a more limited extent, through the sale of loans. At September 30, 2019, the Corporation had borrowed funds of $33.8 million consisting of $30.0 million of long-term FHLB advances, a $1.7 million long-term advance with a correspondent bank and $2.1 million outstanding on a line of credit with a correspondent bank. At September 30, 2019, the Corporation’s borrowing capacity with the FHLB, net of funds borrowed and irrevocable standby letters of credit issue to secure certain deposit accounts, was $250.1 million.
Management is not aware of any conditions, including any regulatory recommendations or requirements, which would adversely impact its liquidity or its ability to meet funding needs in the ordinary course of business.
RECENT REGULATORY DEVELOPMENTS
The final rules implementing the Basel Committee on Banking Supervision’s (BCBS) capital guidelines for U.S. banks were approved by the FRB and FDIC. Under the final rules, minimum requirements increased for both the quantity and quality of capital. The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0% and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer comprised of common equity Tier 1 capital was also established above the regulatory minimum capital requirements. This capital conservation buffer was phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and has increased each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Eligibility criteria for regulatory capital instruments were also implemented under the final rules. The final rules also revised the definition and calculation of Tier 1 capital, Total Capital and risk-weighted assets. The phase-in period for the final rules became effective on January 1, 2015 with full compliance with all of the final rules’ requirements phased in over a multi-year schedule which was fully phased-in on January 1, 2019.
At September 30, 2019, the Bank exceeded all minimum capital requirements under these capital guidelines.
CRITICAL ACCOUNTING POLICIES
The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates or judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily though the use of internal cash flow modeling techniques.
The most significant accounting policies followed by the Corporation are presented in Note 1 to the consolidated financial statements included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2018. These policies, along with the disclosures presented in the other financial statement notes provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those which are highly dependent on subjective or complex judgments, estimates and assumptions and where changes in those estimates and assumptions could have a significant impact on the financial statements. Management has identified the following as critical accounting policies.
Allowance for loan losses. The Corporation considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on management’s review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions and other pertinent factors, including management’s assumptions as to future delinquencies, recoveries and losses. All of these factors may be susceptible to significant change. Among the many factors affecting the allowance for loan losses, some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management’s estimates, additional provisions for loan losses may be required that would adversely impact the Corporation’s financial condition or earnings in future periods.
Other-than-temporary impairment. Management evaluates debt securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic, market or other concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions and (4) whether the Corporation has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.
Goodwill and intangible assets. Goodwill represents the excess cost over fair value of assets acquired in a business combination. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated useful lives to their estimated residual values. Goodwill is subject to ongoing periodic impairment tests based on the fair value of the reporting unit compared to its carrying amount, including goodwill. Impairment exists when a reporting unit’s carrying amount exceeds its fair value. At November 30, 2018, the required annual impairment test of goodwill was performed and no impairment existed as of the valuation date. If for any future period it is determined that there has been impairment in the carrying value of our goodwill balances, the Corporation will record a charge to earnings, which could have a material adverse effect on net income, but not risk based capital ratios.