BAY BANKS OF VIRGINIA, INC. The following discussion provides information about the major components of the results of operations and financial condition, liquidity, and capital resources ofBay Banks of Virginia, Inc. and its subsidiaries. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Data, in this Form 10-K.
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains statements concerning the Company's expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute "forward-looking statements" as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. Words such as "anticipates," "believes," "intends," "should," "expects," "will," and variations of similar expressions are intended to identify forward-looking statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, changes in interest rates; general economic conditions; the legislative/regulatory climate; monetary and fiscal policies of theU.S. Government , including policies of theU.S. Treasury and theBoard of Governors of theFederal Reserve System ; the quality or composition of the loan or investment portfolios; the adequacy of the Company's allowance for loan losses; demand for loan products; deposit flows; competition; difficulty managing growth; demand for financial services in the Company's market area; operational risks; the Company's ability to maintain effective systems of internal and disclosure controls; accounting principles, policies and guidelines, and the other factors detailed in Item 1A, Risk Factors, in this Form 10-K and in the Company's other documents publicly filed with theSEC . These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements, which speak only as of the date they are made. OVERVIEWBay Banks of Virginia, Inc. (the "Company") is the holding company forVirginia Commonwealth Bank (the "Bank"), forVCB Financial Group, Inc. (the "Financial Group "), and forSteptoes Holdings, LLC ("Steptoes Holdings "). The consolidated financial statements of the Company include the accounts ofBay Banks of Virginia, Inc. , the Bank, theFinancial Group , andSteptoes Holdings . The Bank is a state-chartered bank, headquartered inRichmond, Virginia , and a member of theFederal Reserve System . The Bank has 18 banking offices, including one loan production office, located throughout the greaterRichmond region ofVirginia , the Northern Neck region ofVirginia ,Middlesex County , and theHampton Roads region ofVirginia . The Bank offers a wide range of deposit and loan products to its retail and commercial customers. A substantial amount of the Bank's deposits are interest bearing. The majority of the Bank's loan portfolio is secured by real estate.The Financial Group provides management services for personal and corporate trusts, including estate planning, estate settlement, and trust administration, and investment and wealth management services from itsRichmond andKilmarnock, Virginia offices. Products and services include revocable and irrevocable living trusts, testamentary trusts, custodial accounts, investment planning, brokerage services, investment managed accounts, and managed and self-directed individual retirement accounts. OnApril 1, 2017 , the Company and Virginia BanCorp completed a merger (the "Merger"), pursuant to which the Company acquired approximately$329.1 million in assets, including$266.1 million of loans, and assumed approximately$294.5 million in liabilities as ofApril 1, 2017 . Merger-related costs incurred by the Company were$0 and$363 thousand for the years endedDecember 31, 2019 and 2018, respectively. 29
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CRITICAL ACCOUNTING POLICIES
The Company's financial statements are prepared in accordance GAAP. The financial information contained within the Company's financial statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. Our financial position and results of operations are affected by management's application of accounting policies, including estimates, assumptions, and judgments. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, or settling a liability. For example, historical loss factors are one factor in determining the inherent loss that may be present in the Company's loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of transactions would be the same, the timing of recording those events that would affect those transactions could change. We consider an accounting policy critical if (1) the accounting estimate requires assumptions about matters that are highly uncertain at the time of the accounting estimate, and (2) different estimates could reasonably have been used in the current period or changes in the accounting estimate that are reasonably likely to occur from period to period would have a material effect on our financial statements. For the years endedDecember 31, 2019 and 2018, we consider the following to be critical accounting policies: (1) accounting for the ALL, (2) accounting for loans, including loans acquired in a business combination, (3) accounting for business combinations, (4) accounting for OREO, (5) accounting for income taxes, including deferred income taxes, (6) accounting for goodwill and other intangible assets, and (7) accounting for leases.
Our significant accounting policies, including those accounting policies we deemed critical, are discussed further in Part II, Item 8 - Financial Statements and Supplementary Data, including the Notes thereto.
INDUSTRY CONDITIONS AND OUTLOOK
The national unemployment rate, seasonally adjusted and as published by theBureau of Labor Statistics , forJanuary 2020 was reported at 3.6%, a 0.4% decline from 4.0% inJanuary 2019 . The unemployment rate inVirginia , which includes the Company's target markets, was 2.6% inDecember 2019 , the lowest unemployment rate sinceMarch 2001 , and a decline of 0.2% from 2.8% inDecember 2018 . According to theFifth District of theFederal Reserve Bank ,Virginia's one-year employment industry sector growth for the year endedDecember 31, 2019 included positive expansion in all industry sectors with the exception of information technology, government, and natural resources and mining. TheFederal Open Market Committee (the "FOMC") stated in aJanuary 29, 2020 press release that the "labor market remains strong and that economic activity has been rising at a moderate rate." TheFOMC indicated that job gains "have been solid, on average, in recent months, the [national] unemployment rate has remained low, [and] household spending has been rising at a moderate pace, while growth of business fixed investment and exports remain weak." TheFOMC also stated, "on a 12-month basis, both overall inflation and inflation for items other than food and energy are running below 2 percent." TheFOMC maintained its view that the current 1-1/2% to 1-3/4% target range for the Federal Funds Rate remained appropriate and theFOMC "will continue to monitor the implications of incoming information for the economic outlook, including global developments and muted inflation pressures, as it assesses the appropriate path of the target range for the federal funds rate."
GENERAL
All dollar amounts included in the tables of this discussion are in thousands, except per share data, unless otherwise stated.
The principal source of earnings for the Company is net interest income. Net
interest income is the amount by which interest income exceeds interest expense.
Net interest margin is net interest income expressed as a percentage of average
interest-earning assets. Changes in the volume and/or mix of interest-earning
assets and interest-bearing liabilities, the associated yields and costs, the
level of noninterest-bearing deposits, and the volume of nonperforming assets
have an effect on net interest income, net interest margin, and net income.
30--------------------------------------------------------------------------------
OVERVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following commentary provides information about the major components of our financial condition, results of operations, liquidity, and capital resources for the years endedDecember 31, 2019 and 2018. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements in Part II, Item 8 - Financial Statements and Supplementary Data, including the Notes thereto.
• Net income for the year ended
compared to
increase of
year ended December 31, 2019 compared to $0.30 for the year ended
December 31, 2018 .
• Income before income taxes was
31, 2019 compared to $4.4 million for the year ended December 31, 2018 ,
an increase of $4.3 million . Income before income taxes included $0 and2019 and 2018, respectively.
• Return on average assets increased to 0.64% for the year ended December
31, 2019 from 0.39% for the same period of 2018. Return on average
assets is calculated as net income divided by average assets.
• Return on average equity increased to 5.79% for the year ended December
31, 2019 from 3.36% for the same period of 2018. Return on average
equity is calculated as net income divided by average shareholders'
equity.
• Total assets increased
2019 from
• Loans, net of allowance for loan losses, increased by
2.5%, to
of
$56.5 million of our purchased loan portfolios, including those acquired in the Merger, net annual loan growth was approximately$78.6 million , or 8.8%.
• Total deposits increased by
of
• Asset quality improved during 2019 with the ratio of nonperforming
assets to total assets declining to 0.56% as of December 31, 2019
compared to 0.81% as of December 31, 2018 .
• Capital levels and regulatory capital ratios for the Bank were above
regulatory minimums for well-capitalized banks as of December 31, 2019
with a total capital ratio and tier 1 leverage ratio of 13.07% and
10.42%, respectively.
31
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RESULTS OF OPERATIONS
NET INTEREST INCOME AND NET INTEREST MARGIN
The following table presents average interest-earning assets and
interest-bearing liabilities, tax-equivalent yields on such assets and rates
(costs) paid on such liabilities, net interest margin, and net interest spread,
as of and for the periods stated.
Average Balances, Income and Expense, Yields and Rates
As
of and For the Year Ended
2019 2018 2017
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Cost Balance Expense Cost Balance Expense Cost
INTEREST-EARNING ASSETS:
Taxable securities $ 72,059 $ 2,298 3.19 % $ 64,098 $ 1,961 3.06 % $ 49,022 $ 1,399 2.85 %
Tax-exempt securities (1) 17,033 538 3.16 % 19,109 601 3.15 % 18,466 640 3.47 %
Total securities 89,092 2,836 3.18 % 83,207 2,562 3.08 % 67,488 2,039 3.02 %
Gross loans (2)(3) 919,152 46,998 5.11 % 817,896 40,752 4.98 % 601,469 31,330 5.21 %
Interest-earning deposits and
federal funds sold 29,899 624 2.09 % 30,292 544 1.80 % 29,391 474 1.61 %
Certificates of deposit 3,479 73 2.10 % 3,133 70 2.23 % 3,720 74 1.99 %
Total interest-earning assets 1,041,622
934,528 $ 43,928 4.70 % 702,068 $ 33,917 4.83 %
Noninterest-earning assets 66,048 65,367 61,375
Total average assets $ 1,107,670 $ 999,895 $ 763,443
INTEREST-BEARING LIABILITIES:
Savings deposits $ 57,524 $ 167 0.29 % $ 62,009 $ 184 0.30 % $ 53,193 $ 130 0.24 %
Demand deposits 73,338 121 0.16 % 80,094 157 0.20 % 76,558 142 0.19 %
Time deposits (4) 386,366 8,179 2.12 % 367,629 5,723 1.56 % 247,839 3,408 1.38 %
Money market deposits 241,705 3,608 1.49 % 173,183 1,928 1.11 % 116,419 833 0.71 %
Total deposits 758,933 12,075 1.59 % 682,915 7,992 1.17 % 494,009 4,513 0.91 %
Federal funds purchased - - 0.00 % - - 0.00 % 1,158 11 0.95 %
Securities sold under repurchase
agreements 6,357 14 0.22 % 6,174 13 0.21 % 13,904 15 0.11 %
Subordinated notes and ESOP debt 14,232 911 6.40 %
7,984 513 6.43 % 7,427 482 6.48 %
FHLB advances 76,181 2,085 2.74 %
71,753 1,707 2.38 % 52,500 980 1.87 %
Total interest-bearing liabilities 855,703
768,826 $ 10,225 1.33 % 568,998 $ 6,001 1.05 %
Noninterest-bearing deposits 119,410 107,237 89,037
Other noninterest-bearing
liabilities 10,698 8,364 24,905
Total average liabilities 985,811 884,427 682,940
Average shareholders' equity 121,859 115,468 80,503
Total average liabilities and
shareholders' equity $ 1,107,670 $ 999,895 $ 763,443
Net interest income and net
interest margin (5) $ 35,446 3.40 % $ 33,703 3.61 % $ 27,916 3.98 %
Total cost of funds (6) 1.55 % 1.17 % 0.91 %
Net interest spread (7) 3.09 % 3.37 % 3.78 %
(1) Income and yield on tax-exempt securities assumes a federal income tax rate
of 21% for the 2019 and 2018 periods and 34% for the 2017 period.
(2) Includes deferred loan fees/costs and nonaccrual loans.
32--------------------------------------------------------------------------------
(3) Includes accretion of fair value adjustments (discounts) on acquired loans
of
(4) Includes amortization of fair value adjustments on acquired time deposits of
31, 2019, 2018, and 2017, respectively.
(5) Net interest margin is net interest income divided by average
interest-earning assets.
(6) Net interest spread is the yield on average interest-earning assets less the
cost of average interest-bearing liabilities.
(7) Cost of funds is total interest expense divided by total interest-bearing
liabilities and noninterest-bearing deposits.
The following table presents the volume and rate analysis of changes in net interest income for the periods presented.
2019 vs. 2018 2018 vs. 2017
Increase (Decrease) Increase (Decrease)
Due to Changes in: Due to Changes in:
Volume (1) Rate (1) Total Volume (1) Rate (1) Total INTEREST-EARNING ASSETS: Taxable securities$ 244 $ 93 $ 337 $ 430 $ 132 $ 562 Tax-exempt securities (2) (65 ) 2 (63 ) 22 (61 ) (39 ) Gross loans (3) 5,045 1,201 6,246 11,273 (1,851 ) 9,422 Interest-earning deposits and federal funds sold (7 ) 87 80 15 55 70 Certificates of deposit 8 (5 ) 3 (12 ) 8 (4 ) Total interest-earning assets$ 5,224 $ 1,379 $ 6,603 $ 11,728 $ (1,717 ) $ 10,011 INTEREST-BEARING LIABILITIES: Savings deposits$ (13 ) $ (4 ) $ (17 ) $ 22$ 32 $ 54 Demand deposits (13 ) (23 ) (36 ) 7 8 15 Time deposits (4) 292 2,164 2,456 1,647 668 2,315 Money market deposits 763 917 1,680 406 689 1,095 Federal funds purchased - - - (11 ) - (11 ) Securities sold under repurchase agreements 0 1 1 (8 ) 6 (2 ) Subordinated notes and ESOP debt 401 (3 ) 398 36 (4 ) 32 FHLB advances 105 273 378 359 368 727 Total interest-bearing liabilities$ 1,535 $ 3,325 $ 4,860 $ 2,458 $ 1,767 $ 4,225 Change in net interest income$ 3,689 $ (1,946 ) $ 1,743 $ 9,270 $ (3,484 ) $ 5,786
(1) Change in income/expense due to both volume and rate has been allocated in
proportion to the absolute dollar amounts of the change in each.
(2) Income and yield on tax-exempt securities assumes a federal income tax rate
of 21% for the 2019 and 2018 periods and 34% for the 2017 period.
(3) Includes accretion of fair value adjustments (discounts) on acquired loans
of
(4) Includes amortization of fair value adjustments on acquired time deposits of
31, 2019, 2018, and 2017, respectively.
33
-------------------------------------------------------------------------------- Interest income, on a taxable-equivalent basis, for the year endedDecember 31, 2019 was$50.5 million , an increase of$6.6 million from 2018, primarily driven by higher average interest-earning assets of$1.04 billion in the 2019 period compared to$934.4 million in the 2018 period, an increase of$107.1 million . This increase in average interest-earning assets was primarily attributable to organic loan growth and purchases of available-for-sale securities. The increase in interest income year over year was also positively affected by higher yields on loans in the 2019 period compared to the 2018 period, including higher accretion of discounts on acquired loans (discussed below) of$1.9 million and$1.8 million for the same periods, respectively. Loans acquired in the Merger were discounted to estimated fair value (for credit losses and interest rates) as of the effective date of the Merger. A portion of the acquisition accounting adjustments (discounts) to record the acquired loans at estimated fair value is being recognized (accreted) into interest income over the estimated remaining life of the loans for those loans that were deemed to be, as of the Merger date, purchased performing and over the period of expected cash flows from the loans that were deemed to be purchased credit-impaired ("PCI"). The amount of accretion income recognized within a period is based on many factors, including among other factors, loan prepayments and curtailments; therefore, amounts recognized are subject to volatility. Interest expense for the year endedDecember 31, 2019 was$15.1 million , an increase of$4.9 million from 2018, primarily driven by higher average interest-bearing liabilities of$855.7 million in the 2019 period compared to$768.8 million in the 2018 period, an increase of$86.9 million . This increase in average interest-bearing liabilities was primarily attributable to organic deposit growth (primarily time and money market deposits) and the issuance of$25 million of subordinated notes onOctober 7, 2019 ("2029 Notes"). Also contributing to the increase in interest expense in 2019 compared to 2018 were higher rates paid on higher average balances of interest-bearing deposits (1.59% and 1.17% for 2019 and 2018, respectively) due to heightened competition for deposits in the Company's existing markets, due to the Company's expansion into theHampton Roads market in the third quarter of 2018, and due to the higher interest rate environment in general. In addition, higher rates were paid onFederal Home Loan Bank of Atlanta ("FHLB") advances (2.74% and 2.38% for 2019 and 2018, respectively) due to the increasing interest rate environment. Finally, the year endedDecember 31, 2019 included a benefit to interest expense of$123 thousand compared to a benefit of$187 thousand for the year endedDecember 31, 2018 , attributable to amortization of a fair value adjustment recorded on acquired time deposits (discussed below). A time deposit (certificate of deposit) fair value adjustment was recorded as of the Merger effective date, which represents a premium over the value of the contractual repayments of fixed-maturity deposits using prevailing market interest rates for similar term deposits. The resulting fair value adjustment is being amortized into interest expense on a level-yield basis over the weighted average remaining life of the acquired time deposit portfolio. Due to the changes in interest income and interest expense discussed above, net interest income for the year endedDecember 31, 2019 , on a taxable-equivalent basis, was$35.4 million , an increase of$1.7 million from the year endedDecember 31, 2018 . The decrease in net interest margin to 3.40% for 2019 compared to 3.61% for 2018 was primarily attributable to higher funding costs, partially offset by higher yields on loans, including accretion of discounts on acquired loans. Management believes the Company's net interest margin will continue to experience compression due to declining levels of accretion, and competition and higher interest rates in general driving higher costs for new deposits and the re-pricing of existing interest-bearing deposits. Additionally, management believes higher yields on new loans and adjustments to existing variable-rate loans will partially offset higher deposit costs.
PROVISION FOR LOAN LOSSES
Provision for loan losses was$1.2 million for the year endedDecember 31, 2019 , while provision for loan losses for the year endedDecember 31, 2018 was$1.4 million . Provision for loan losses in 2019 was primarily attributable to net loan growth of approximately$78.6 million , excluding the payoff and amortization of approximately$56.5 million of purchased portfolio loans, including those acquired in the Merger, and net charge-offs from a select portfolio of purchased consumer loans. The majority of loans acquired in the Merger, which declined in 2019, carry no allowance for loan losses as they were recorded at fair value at the effective date of the Merger. Provision for loan losses in 2018 was primarily attributable to net loan growth of approximately$135.5 million . Provision in the 34
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2018 period also included a benefit of
NONINTEREST INCOME
The following table presents a summary of noninterest income and the dollar and percentage change for the periods presented.
For the Year Ended
December 31, 2019 December 31, 2018 $ Change % Change
Trust management $ 830 $ 710 $ 120 16.90 %
Service charges and fees on deposit 977 768 209 27.21 %
accounts
Wealth management 908 842 66 7.84 %
Interchange fees, net 438 339 99 29.20 %
Other service charges and fees 115 116 (1 ) (0.86 %)
Secondary market sales and servicing 941 659 282 42.79 %
Increase in cash surrender value of 481 497 (16 ) (3.22 %)
bank owned life insurance
Net losses on sale of (1 ) - (1 ) (100.00 %)
available-for-sale securities
Net losses on disposition of other (3 ) (7 ) 4 (57.14 %)
assets
Gain (loss) on rabbi trust assets 192 (138 ) 330 (239.13 %) Gain on curtailment of - 352 (352 ) 100.00 % post-retirement benefit plan Other 80 165 (85 ) (51.52 %) Total noninterest income $ 4,958 $ 4,303$ 655 15.22 % Secondary market sales and servicing income increased$282 thousand in the 2019 period compared to the 2018 period as the Company sold a greater volume of mortgages originated in the 2019 period. The$330 thousand change in rabbi trust assets year-over-year is attributable to a net increase in the fair market value of investments held by the rabbi trust for the benefit of participants in the Company's deferred compensation plan. This increase is offset by the same amount recorded as an expense in salaries and employee benefits in noninterest expense. Service charges and fees on deposit accounts increased in 2019 compared to 2018 primarily attributable to lower fee income collected in the first half of 2018 due to the core operating system conversion (as a result of the Merger), which was initiated in the fourth quarter of 2017. Trust and wealth management income increased in 2019 compared to 2018 as theFinancial Group opened a new office inRichmond, Virginia , added advisors, and converted to new operating platforms. Noninterest income for the year endedDecember 31, 2018 included a gain of$352 thousand on the curtailment of the Company's post-retirement benefit plan effectiveMarch 1, 2018 . 35
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NONINTEREST EXPENSE
The following table presents a summary of noninterest expense and the dollar and percentage change for the periods presented.
For the Year Ended
December 31, 2019 December 31, 2018 $ Change % Change
Salaries and employee benefits $ 15,597 $ 16,233 $ (636 ) (3.92 %)
Occupancy 3,319 3,528 (209 ) (5.92 %)
Data processing 2,221 2,436 (215 ) (8.83 %)
Bank franchise tax 864 726 138 19.01 %
Telecommunications 1,087 831 256 30.81 %
FDIC assessments 483 719 (236 ) (32.82 %)
Foreclosed property 145 175 (30 ) (17.14 %)
Consulting 526 1,068 (542 ) (50.75 %)
Advertising and marketing 384 439 (55 ) (12.53 %)
Directors' fees 678 561 117 20.86 %
Audit and accounting 822 1,129 (307 ) (27.19 %)
Legal 199 500 (301 ) (60.20 %)
Merger-related - 363 (363 ) (100.00 %)
Core deposit intangible
amortization 674 798 (124 ) 100.00 %
Net other real estate owned
(gains) losses 460 (107 ) 567 (529.91 %)
Other 2,943 2,720 223 8.20 %
Total noninterest expense $ 30,402 $ 32,119 $ (1,717 ) (5.35 %)
Salaries and employee benefits decreased in the 2019 period primarily due to
expenses associated with the succession of the Company's chief financial officer
and in the completion of the Company's 2017 year-end reporting incurred in the
first half of 2018, which were approximately $1.2 million . Merger-related
expenses were $0 and $363 thousand for the years ended December 31, 2019 and
2018, respectively, and the 2018 period included $483 thousand of expenses
incurred in connection with the Company's early retirement program announced in
the fourth quarter of 2018. FDIC assessments in the 2019 period included the
benefit of a small bank assessment credit of $226 thousand , whereas the 2018
period included $0 benefit.
INCOME TAXES
The table below presents income tax expense and the effective income tax rate
for the periods presented.
For the Year Ended
December 31, 2019 December 31, 2018
Income tax expense $ 1,649 $ 533
Effective tax rate 18.9 % 12.1 %
Income tax expense and the effective tax rate for the years ended December 31,
2019 and 2018 were positively affected by tax-exempt income primarily from the
Company's holdings of municipal investment securities and bank owned life
insurance policies. Income tax expense and the effective tax rate for the year
ended December 31, 2018 was positively affected by higher than estimated income
tax deductions reported in the Company's 2017 federal income tax return at the
higher 2017 statutory income tax rate (34%), the benefit from which was recorded
when the tax return was filed in 2018.
FINANCIAL CONDITION
CASH AND CASH EQUIVALENTS
36
-------------------------------------------------------------------------------- Cash and cash equivalents include cash and due from banks and interest-earning deposits. Cash and cash equivalents are primarily used for daily cash management purposes, and liquidity to fund loans and meet depositions' needs. Cash and cash equivalents were$40.5 million and$26.7 million as ofDecember 31, 2019 andDecember 31, 2018 , respectively. SECURITIES Our available-for-sale securities are reported at fair value and are used primarily for liquidity, pledging as collateral, earnings, and asset-liability management purposes. Prior to purchasing a new security, we perform an extensive due diligence analysis, and we review our available-for-sale securities portfolio periodically for performance and for possible other-than-temporary impairment. As ofDecember 31, 2019 , the Company determined that no other-than-temporary impairment existed in any individual security in the available-for-sale securities portfolio, and unrealized losses were related to interest rate movements and not the credit quality of the issuers. The total portfolio was in an unrealized gain position of$560 thousand as ofDecember 31, 2019 , which is reported net of income tax in shareholders' equity.
As of
The following tables present information about our available-for-sale securities
portfolio as of the dates stated. Weighted average life calculations and
weighted average yields are based on the current level of contractual maturities
and expected payments as of the dates stated. Yields on tax-exempt securities
are calculated on a taxable-equivalent yield basis, applying a tax rate of 21%
for the 2019 and 2018 periods and 34% for the 2017 period.
December 31, 2019
Weighted
Average Life Weighted
Amortized Cost Fair Value in Years Average Yield
U.S. Government agencies and mortgage
backed securities $ 67,491 $ 67,597 6.12 2.18 %
State and municipal obligations 16,238 16,576 5.35 3.16 %
Corporate bonds 15,165 15,281 3.77 5.61 %
Total available-for-sale securities 98,894 99,454 5.08 2.92 %
Restricted securities 5,706 5,706 n/a 6.30 %
Total securities $ 104,600 $ 105,160 3.18 %
December 31, 2018
Weighted
Average Life Weighted
Amortized Cost Fair Value in Years Average Yield
U.S. Government agencies and mortgage
backed securities $ 51,126 $ 49,882 6.09 2.28 %
State and municipal obligations 20,484 20,217 6.25 3.15 %
Corporate bonds 12,194 12,133 5.21 5.62 %
Total available-for-sale securities 83,804 82,232 5.85 2.87 %
Restricted securities 7,600 7,600 n/a 5.75 %
Total securities $ 91,404 $ 89,832 3.08 %
37
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December 31, 2017
Weighted
Average Life Weighted
Amortized Cost Fair Value in Years Average Yield
U.S. Government agencies and mortgage
backed securities $ 49,964 $ 49,283 5.76 1.76 %
State and municipal obligations 21,113 21,153 5.45 3.47 %
Corporate bonds 6,696 6,717 5.16 6.41 %
Total available-for-sale securities 77,773 77,153 5.46 2.79 %
Restricted securities 5,787 5,787 n/a 6.54 %
Total securities $ 83,560 $ 82,940 3.02 %
The following table presents a maturity analysis of our available-for-sale securities portfolio as of the date stated. Weighted average yield calculations are based on the current level of contractual maturities and expected prepayments as of the date stated. Yields on tax-exempt securities are on a taxable-equivalent yield basis.
As of December 31, 2019
One Year or
Less or No One to Five Five to Ten Over Ten
Maturity Years Years Years
U.S. Government agencies and
mortgage backed securities:
Amortized cost $ 6,097 $ 36,737 $ 19,544 $ 5,113
Fair value 6,096 36,884 19,525 5,092
Weighted average yield 1.87 % 1.99 % 2.37 % 3.06 %
State and municipal
obligations:
Amortized cost $ 220 $ 7,063 $ 8,620 $ 335
Fair value 220 7,182 8,831 343
Weighted average yield 3.50 % 2.50 % 2.50 % 5.18 %
Corporate bonds:
Amortized cost $ 4,211 $ 5,786 $ 5,169 $ -
Fair value 4,247 5,855 5,179 -
Weighted average yield 6.03 % 4.98 % 5.54 % 0.00 %
Total available-for-sale
securities:
Amortized cost $ 10,528 $ 49,586 $ 33,333 $ 5,448
Fair value 10,563 49,921 33,535 5,435
Weighted average yield 3.58 % 2.41 % 2.89 % 3.19 %
LOANS
Our loan portfolio is comprised of construction, land and land development,
commercial real estate, residential real estate, commercial and industrial, and
consumer loans. Lending decisions are based upon evaluation of the financial
strength and credit history of the borrower and the quality and value of the
collateral securing the loan, if applicable. Personal guarantees are required on
most loans; however, exceptions are made based on the financial viability of the
borrower or the underlying project that is being financed.
For the year ended December 31, 2019 , loans, net of allowance for loan losses,
increased by $22.4 million , or 2.5%, from December 31, 2018 . Excluding the
payoff and amortization of approximately $56.5 million in 2019 of purchased loan
portfolios, including those acquired in the Merger, net loan growth was $78.6
million , or 8.8%. The largest components of the 2019 increase in net loans were
a $17.1 million increase in commercial and industrial loans, a $16.5 million
increase in construction, land and land development loans, and an $11.7 million
increase in commercial mortgages, partially offset by an $11.8 million decline
in consumer loans and an $11.4 million decline in residential mortgages. The
decline in consumer loans is primarily attributable to the amortization of
consumer loans acquired in the Merger and in the second and third quarters of
2017.
38
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The following table presents the Company's loan portfolio composition in dollar
amounts and as a percentage of total loans as of the dates stated, excluding
deferred loan costs and fees.
As of December 31, As of December 31, As of December 31, As of December 31, As of December 31,
2019 2018 2017 2016 2015
% of % of % of % of % of
Amount Total Amount Total Amount Total Amount Total Amount Total
Mortgage loans on real
estate:
Construction, land and
land development $ 126,010 13.6 % $ 109,472 12.1 % $ 66,965 8.7 % $ 40,841 10.6 % $ 43,159 12.4 %
Residential mortgages 325,806 35.2 % 337,207 37.4 % 315,863 41.2 % 220,432 57.3 % 190,902 55.1 %
Commercial mortgages 278,972 30.2 % 267,315 29.6 % 226,809 29.6 % 77,168 20.0 % 73,042 21.0 %
Commercial and industrial
loans 181,730 19.7 % 164,608 18.2 % 114,093 14.9 % 43,024 11.2 % 35,104 10.1 %
Consumer 11,985 1.3 % 23,740 2.7 % 42,566 5.6 % 3,544 0.9 % 5,015 1.4 %
Total loans $ 924,503 100.0 % $ 902,345 100.0 % $ 766,296 100.0 % $ 385,009 100.0 % $ 347,222 100.0 %
The following table presents a maturity analysis of select loan types based on whether loans are variable rate or fixed rate loans as of the date stated, excluding deferred loan costs and fees.
December 31, 2019
Construction,
Land and Commercial and
Land Development Industrial
Within one year $ 56,762 $ 26,375
Variable rate
One to five years 29,375 56,988
After five years 13,860 5,737
Total variable rate 43,235 62,725
Fixed rate
One to five years 8,368 41,808
After five years 17,645 50,822
Total fixed rate 26,013 92,630
Total maturities $ 126,010 $ 181,730
ALLOWANCE FOR LOAN LOSSES
The following table presents the Company's allowance for loan losses by loan type and percent of loans in each type to total gross loans as of the dates stated.
As of the Year Ended December 31,
2019 2018 2017 2016 2015
Percent Percent Percent Percent Percent
of loans of loans of loans of loans of loans
in each in each in each in each in each
Amount category Amount category Amount category Amount category Amount category
Mortgage loans on real estate
88.5 %
Commercial and industrial 1,571 19.7 % 1,374 18.2 % 878 14.9 % 493 11.2 % 599 10.1 %
Consumer 619 1.3 % 1,561 2.6 % 3,028 5.6 % 52 0.9 % 122 1.4 %
Total $ 7,562 100.0 % $ 7,902 100.0 % $ 7,770 100.0 % $ 3,863 100.0 % $ 4,223 100.0 %
39
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The following table presents the activity in the Company's allowance for loan losses for the periods stated.
Year Ended December 31,
2019 2018 2017 2016 2015
Balance, beginning of year $ 7,902 $ 7,770 $ 3,863 $ 4,223 $ 3,205
Loans charged off:
Mortgage loans on real estate (455 ) (202 ) (577 ) (735 ) (521 )
Commercial and industrial - (116 ) (729 ) (158 ) (9 )
Consumer (1,470 ) (1,374 ) (171 ) (53 ) (128 )
Total loans charged off (1,925 ) (1,692 ) (1,477 ) (946 ) (658 )
Recoveries of loans previously charged off:
Mortgage loans on real estate 140 110 91 254 27
Commercial and industrial 2 1 263 61 -
Consumer 261 362 96 11 52
Total recoveries 403 473 450 326 79
Net charge-offs (1,522 ) (1,219 ) (1,027 ) (620 ) (579 )
Reclassification of allowance related to sold
loans - - - (27 ) -
Provision for loan losses 1,182 1,351 4,934 287 1,597
Balance, end of year $ 7,562 $ 7,902 $ 7,770 $ 3,863 $ 4,223
Average loans outstanding during the year $ 919,152 $ 817,896 $ 601,469 $ 357,791 $ 319,597
Gross loans $ 924,503 $ 902,345 $ 766,296 $ 385,009 $ 347,222
Allowance for loan losses to gross loans 0.82 % 0.88 % 1.01 % 1.00 % 1.22 %
Ratio of net charge-offs during the year to
average loans outstanding during the year 0.17 % 0.15 % 0.17 % 0.17 % 0.18 %
Our ALL was$7.6 million as ofDecember 31, 2019 compared to$7.9 million as ofDecember 31, 2018 . The decrease in the ALL sinceDecember 31, 2018 was primarily attributable to the reduction in balances (and related ALL) attributable to a select portfolio of purchased consumer loans, including those acquired in the Merger, which had a higher ALL percentage to loans relative to that for other loans in the portfolio. Net charge-offs represented 0.17% of average gross loans for the year endedDecember 31, 2019 compared to 0.15% for the year endedDecember 31, 2018 . As ofDecember 31, 2019 , the ratio of the ALL to total loans was 0.82% compared to 0.88% as ofDecember 31, 2018 . As ofDecember 31, 2019 , we considered our ALL to be sufficient to cover potential loss exposure inherent in the Company's loan portfolio.
NONPERFOMING ASSETS
We classify nonaccrual loans, excluding PCI loans and accruing troubled debt restructurings, and OREO, net, as nonperforming assets. As ofDecember 31, 2019 , nonperforming assets as a percentage of total assets was 0.56%, compared to 0.81% at year-end 2018. The ratio of ALL to total nonperforming loans increased to 168.9% at year-end 2019 from 151.8% at year-end 2018. 40
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The following table presents the components of nonperforming assets and related ratios as of the dates stated.
As of December 31,
2019 2018 2017 2016 2015
Loans past due 90 days or more and
still accruing (1) $ - $ - $ 48 $ - $ 11
Nonaccrual loans (1) 4,476 5,206 6,496 5,300 6,433
Total nonperforming loans 4,476 5,206 6,544 5,300 6,444
Other real estate owned, net 1,916 3,597 4,284 2,494 1,870
Total nonperforming assets $ 6,392 $ 8,803 $ 10,828 $ 7,794 $ 8,314
Allowance for loan losses $ 7,562 $ 7,902 $ 7,770 $ 3,863 $ 4,223
Gross loans $ 924,503 $ 902,345 $ 766,296 $ 385,009 $ 347,222
Total assets $ 1,131,923 $ 1,080,617 $ 970,556 $ 486,710 $ 456,296
Allowance for loan losses to
nonperforming loans 168.9 % 151.8 % 118.7 % 72.9 % 65.5 %
Nonperforming assets to total
assets 0.56 % 0.81 % 1.12 % 1.60 % 1.80 % Nonperforming loans to gross loans 0.48 % 0.58 % 0.85 % 1.38 % 1.86 %
(1) Excludes PCI loans and accruing troubled debt restructurings.
During 2019, nonaccrual loan balances decreased by
AtDecember 31, 2019 , OREO, net, consisting of foreclosed properties, was$1.9 million compared to$3.6 million at year-end 2018. OREO, net, atDecember 31, 2019 consisted of 4 residential properties, 13 vacant lots, and 1 commercial property. After properties are transferred to OREO at foreclosure, we periodically perform fair market value assessments and the properties' values are adjusted to the lower of carrying amount or fair value less estimated costs to sell. Amounts recorded to reduce the carrying amount to the estimated fair value are recorded as valuation adjustments. The Company recorded OREO valuation adjustments of$434 thousand in 2019.
DEPOSITS
As ofDecember 31, 2019 , total deposits were$910.4 million compared to$842.2 million at year-end 2018, a$68.2 million , or 8.1% increase. Noninterest-bearing demand deposits increased$23.8 million , while savings and interest-bearing demand deposits (primarily money market accounts) and time deposits increased$23.2 million and$21.2 million , respectively. The ratio of noninterest-bearing demand deposits to total deposits increased to 15.2% as ofDecember 31, 2019 from to 13.6% as ofDecember 31, 2018 .
The following table presents the average balances and rates paid by deposit category as of the dates stated.
For the Year Ended December 31,
2019 2018 2017
Average Average Average
Balance Rate Balance Rate Balance Rate
Noninterest-bearing demand
deposits $ 119,410 0.00 % $ 107,237 0.00 % $ 89,037 0.00 %
Interest-bearing deposits:
Demand deposits 73,338 0.16 % 80,094 0.17 % 76,558 0.19 %
Savings 57,524 0.29 % 62,009 0.30 % 53,193 0.24 %
Money market deposits 241,705 1.49 % 173,183 1.54 % 116,419 0.71 %
Time deposits 386,366 2.12 % 367,629 2.11 % 247,839 1.38 %
Total interest-bearing
deposits 758,933 1.59 % 682,915 1.60 % 494,009 0.91 %
Total average deposits $ 878,343 1.37 % $ 790,152 1.01 % $ 583,046 0.78 %
The following table presents maturities of large denomination time deposits
(equal to or greater than
41
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As of December 31,
2019 2018 2017
3 months or less $ 38,467 $ 13,553 $ 7,505
3-6 months 44,917 18,226 14,047
6-12 months 58,224 61,086 20,051
Over 12 months 93,050 111,795 17,562
Totals $ 234,658 $ 204,660 $ 59,165
BORROWINGS
We use short-term and long-term borrowings from various sources, including FHLB
advances, securities under repurchase agreements, and subordinated notes to
finance our operations. We manage the level of our borrowings to minimize our
borrowing cost, to maintain sufficient liquidity to meet the daily needs of our
customers, and to meet regulatory reserve requirements.
The following table summarizes the period-end balance, highest month balance,
average balance, and weighted average rate paid for short-term borrowings as of
and for the periods presented.
For the Year Ended December 31, 2019 For the Year Ended December 31, 2018
Highest Highest
Month-End Average Weighted Period-End Month-End Average Weighted
Period-End Balance Balance Balance Average Rate Balance Balance Balance Average Rate
FHLB advances $ 45,000 $ 100,000 $ 76,181 2.74 % $ 100,000 $ 100,000 $ 71,753 2.38 %
Securities sold under
repurchase agreements $ 6,525 $ 7,220 $ 6,357 0.22 % $ 6,089 $ 8,176 $ 6,174 0.21 %
On May 28, 2015 , the Company entered into a purchase agreement with 29
accredited investors under which the Company issued an aggregate of $7.0 million
of subordinated notes (the "2025 Notes") to the accredited investors. The 2025
Notes have a maturity date of May 28, 2025 and bear interest, payable on the
first of March and September of each year, at a fixed interest rate of 6.50% per
year. The 2025 Notes are not convertible into common stock or preferred stock
and are not callable by the holders. We have the right to redeem the 2025 Notes,
in whole or in part, without premium or penalty, at any interest payment date on
or after May 28, 2020 , but in all cases in a principal amount with integral
multiples of $1,000 , plus interest accrued and unpaid through the date of
redemption. If an event of default occurs, such as the bankruptcy of the
Company, a holder may declare the principal amount of the 2025 Notes to be due
and immediately payable. The 2025 Notes are unsecured, subordinated obligations
of the Company and rank junior in right of payment to the Company's existing and
future senior indebtedness. The 2025 Notes qualify as Tier 2 capital for
regulatory reporting. The aggregate carrying value of the 2025 Notes, including
capitalized, unamortized debt issuance costs, was $6.9 million at both December
31, 2019 and 2018. For the year ended December 31, 2019 and 2018, the effective
interest rate on the 2025 Notes was 6.83% and 6.85%, respectively.
On October 7, 2019 , the Company completed a private placement of $25.0 million
in fixed-to-floating rate subordinated notes due 2029 (the "2029 Notes"). The
2029 Notes were structured to qualify as Tier 2 capital under bank regulatory
guidelines, and the proceeds from the sale of the 2029 Notes will be utilized
for general corporate purposes, including the potential repayment of the 2025
Notes (which become callable in May 2020 ), and supporting capital levels at the
Bank. The 2029 Notes bear interest at 5.625% per annum, beginning October 7,
2019 through October 14, 2024 , payable semi-annually in arrears. From October
15, 2024 through October 14, 2029 , or up to an early redemption date, the
interest rate shall reset quarterly to an interest rate per annum equal to the
then current three-month Secured Overnight Funding Rate ("SOFR") (as defined in
the 2029 Notes) plus 433.5 basis points, payable quarterly in arrears. If an
event of default occurs, such as the bankruptcy of the Company, a holder may
declare the principal amount of the 2029 Notes to be due and immediately
payable. The 2029 Notes are unsecured, subordinated obligations of the Company
and rank junior in right of payment to the Company's existing and future senior
indebtedness and rank in parity with the 2025 Notes. Beginning on October 15,
2024 through
42
-------------------------------------------------------------------------------- maturity, the 2029 Notes may be redeemed, at the Company's option, on any scheduled interest payment date. The 2029 Notes will mature onOctober 15, 2029 . The aggregate carrying value of the 2029 Notes, including capitalized, unamortized debt issuance costs was$24.1 million atDecember 31, 2019 . For the year endedDecember 31, 2019 , the effective interest rate on the 2029 Notes was 6.22%.
The aggregate carrying value of the subordinated notes, including capitalized,
unamortized debt issuance costs, was
LIQUIDITY Liquidity represents an institution's ability to meet present and future financial obligations (such as commitments to fund loans or meet depositors' requirements) through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-earning deposits with other banks, federal funds sold, and investment securities and loans maturing within one year. The Company's ability to obtain deposits and purchase funds at favorable rates are major factors for liquidity. We believe that the Company maintains overall liquidity that is sufficient to satisfy its depositors' requirements and its customers' credit needs. As ofDecember 31, 2019 , cash and cash equivalents, including federal funds sold, totaled$41.8 million , investment securities maturing in one year or less totaled$6.1 million , and loans maturing in one year or less totaled$99.6 million . This resulted in a liquidity ratio as ofDecember 31, 2019 of 13.0% compared to 21.5% as ofDecember 31, 2018 . The Company determines this ratio by dividing the sum of cash and cash equivalents and investment securities and loans maturing in one year or less by total assets. The Bank has a line of credit with the FHLB of$276.9 million , with$200.9 million available as ofDecember 31, 2019 . The line of credit with the FHLB is secured by$288.8 million of loans pledged as collateral, primarily residential and commercial mortgages. In addition, the Bank has federal funds lines of credit with correspondent banks totaling$41.0 million . Federal funds lines of credit can be cancelled at any time by the correspondent bank. The following table presents the Company's contractual obligations and scheduled payment amounts, excluding interest, due at various intervals over the next five years and beyond as ofDecember 31, 2019 . Payments Due by Period Less than 1 Total year 1-3 years 3-5 years Over 5 years FHLB advances$ 45,000 $ 45,000 $ - $ - $ - Subordinated notes 32,000 - - - 32,000 Time deposit maturities 389,900 222,413 98,849 68,604 34 Securities sold under repurchase agreements 6,525 6,525 - - - ESOP debt 1,636 273 552 561 250 Total$ 475,061 $ 274,211 $ 99,401 $ 69,165 $ 32,284 As ofDecember 31, 2019 , we were not aware of any other known trends, events, or uncertainties that have or are reasonably likely to have a material effect on the Company's liquidity. CAPITAL RESOURCES Capital resources represent funds, earned or obtained, over which a financial institution can exercise greater long-term control in comparison with deposits and borrowed funds. We review on an ongoing basis the adequacy of the Company's capital with reference to amount, composition, quality, and consistency with regulatory requirements and industry standards. We seek to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allows us to effectively leverage the Company's capital to maximize return to the shareholders. The Company's capital, also known as shareholders' equity, is comprised primarily of outstanding common stock and retained earnings. Capital resources are primarily affected by net income and net unrealized gains or losses on available-for-sale securities (net of tax). The available-for-sale securities portfolio is reported at fair value with unrealized gains or losses, net of taxes, recognized as accumulated other comprehensive income (loss) on the Company's consolidated 43
-------------------------------------------------------------------------------- balance sheets. Other factors affecting accumulated other comprehensive income (loss) are changes in the fair value of the Company's pension and post-retirement benefit plans and changes in plan obligations. Shareholders' equity before accumulated other comprehensive income (loss) was$126.1 million as ofDecember 31, 2019 compared to$118.8 million as ofDecember 31, 2018 . The increase of$7.3 million was primarily attributable to net income of$7.1 million for the year endedDecember 31, 2019 . Accumulated other comprehensive income increased by$1.4 million fromDecember 31, 2018 toDecember 31, 2019 , primarily due to unrealized net gains of$1.7 million (net of tax) in the available-for-sale securities portfolio. This was primarily due to a declining interest rate environment, partially offset by unrealized losses of$279 thousand (net of tax) attributable to the Company's pension and postretirement benefit plans. Book value per share of the Company's common stock, including accumulated other comprehensive loss, increased to$9.51 as ofDecember 31, 2019 from$8.90 as ofDecember 31, 2018 . The Company and the Bank are subject to minimum regulatory capital ratios as defined by theFederal Reserve . As ofDecember 31, 2019 , the Company and the Bank's capital ratios continue to be in excess of regulatory minimums and the Bank was "well capitalized" by these guidelines. EffectiveJanuary 1, 2015 , the Bank became subject to new capital rules adopted by federal bank regulators implementing the Basel III regulatory capital reforms adopted by the Basel Committee, and certain changes required by the Dodd-Frank Act. These rules require the Bank to comply with the following minimum capital ratios: (i) a Common Equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets; (iii) a total capital ratio of 8.0% of risk-weighted assets; and (iv) a leverage ratio of 4.0% of average adjusted assets. The following additional capital requirements related to the capital conservation buffer, which have been phased in over a four-year period. As fully phased in effectiveJanuary 1, 2019 , the rules require the Bank to maintain (i) a minimum ratio of Common Equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (which is added to the 4.5% Common Equity Tier 1, effectively resulting in a minimum ratio of Common Equity Tier 1 to risk-weighted assets of at least 7.0%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (which is added to the 8.0% total capital ratio, effectively resulting in a minimum total capital ratio of 10.5%), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets. The capital conservation buffer was phased in beginningJanuary 1, 2016 , at 0.625% of risk-weighted assets, until fully implemented at 2.5% effectiveJanuary 1, 2019 . The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will be subject to constraints on dividends, equity repurchases, and discretionary compensation paid to certain officers, based on the amount of the shortfall. As ofDecember 31, 2019 and 2018, ratios of the Bank were in excess of the fully phased-in requirements. The following table presents capital ratios for the Bank, minimum capital ratios required, and ratios defined as "well capitalized" by the Bank's regulators as of the dates stated. Minimum Capital Minimum Actual Requirement Ratio to be Well As of December 31, 2019 Ratio with Conservation Buffer Capitalized Total risk-based capital 13.07 % 10.50 % 10.00 % Tier 1 capital 12.26 % 8.50 % 8.00 % Common equity tier 1 12.26 % 7.00 % 6.50 % Tier 1 leverage ratio 10.42 % 4.00 % 5.00 % 44
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Minimum Capital Minimum
Actual Requirement Ratio to be Well
As of December 31, 2018 Ratio with Conservation Buffer Capitalized
Total risk-based capital 11.68 % 9.875 % 10.00 %
Tier 1 capital 10.80 % 7.875 % 8.00 %
Common equity tier 1 10.80 % 6.375 % 6.50 %
Tier 1 leverage ratio 9.42 % 4.000 % 5.00 %
OFF-BALANCE SHEET COMMITMENTS
In the normal course of business, we offer various financial products to our
customers to meet their credit and liquidity needs. These instruments may
involve elements of liquidity, credit, and interest rate risk in excess of the
amount recognized in the Company's consolidated balance sheets. The Company's
exposure to credit loss in the event of nonperformance by the other party to the
financial instruments for commitments to extend credit and standby-letters of
credit is represented by the contractual amount of these instruments. Subject to
normal credit standards and risk monitoring procedures, we make contractual
commitments to extend credit. Commitments generally have fixed expiration dates
or other termination clauses and may require payment of a fee. Since many of the
commitments may expire without being completely drawn upon, the total commitment
amounts do not necessarily represent future cash requirements. Conditional
commitments are issued by the Company in the form of performance stand-by
letters of credit, which guarantee the performance of a customer to a third
party. The credit risk of issuing letters of credit is essentially the same as
that involved in extending loans to customers.
The following table presents the Company's off balance sheet commitments as of
the dates stated.
December 31, 2019 December 31, 2018 December 31, 2017
Total loan commitments outstanding $ 164,751 $ 160,479 $ 144,249
Stand-by letters of credit 6,118 2,848 447
INTEREST RATE SENSITIVITY
Market risk is the potential of loss arising from adverse changes in interest
rates and prices. The Company is exposed to market risk as a consequence of the
normal course of conducting our business activities. We consider interest rate
risk to be a significant market risk for us. Fluctuations in interest rates will
impact both the level of interest income and interest expense. The primary goal
of our asset-liability management strategy is to optimize net interest income
while limiting exposure to fluctuations caused by changes in the interest rate
environment. Our ability to manage our interest rate risk depends generally on
our ability to match the maturities and re-pricing characteristics of our assets
and liabilities while taking into account the separate goals of maintaining
asset quality and liquidity and achieving the desired level of net interest
income. Management, guided by the Asset-Liability Committee of our board of
directors, determines the overall magnitude of interest rate sensitivity risk
and then formulates policies governing asset generation and pricing, funding
sources and pricing, and off-balance sheet commitments. These decisions are
based on our expectations regarding future interest rate movements, the state of
the national and regional economy, and other financial and business risk
factors.
The primary method that we use to quantify and manage interest rate risk is
simulation analysis, which is used to model net interest income from assets and
liabilities over a specified time period under various interest rate scenarios
and balance sheet structures. Key assumptions in the simulation analysis relate
to the behavior of interest rates and spreads, the changes in product balances,
and the behavior of loan and deposit customers in different rate environments.
The following table illustrates the expected effect on net interest income for
the 12 months following December 31, 2019 due to an immediate change
("instantaneous rate shock" scenario) and a gradual change ("ramped rate shock"
scenario) in interest rates at various degrees of change. Estimated changes set
forth below are dependent on material assumptions, such as those previously
discussed. It should be noted that rates are unlikely to change instantly in the
45
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severity of an instantaneous rate shock, and we believe the ramped rate shock
simulation more likely demonstrates the effect of changes in interest rates on
us. In the ramped rate shock simulation, interest rates change pro rata over the
simulation period of 24 months. For this reason, results are similar in a +100
and +200 ramped rate scenario.
December 31, 2019
Change in Net Interest Income
Instantaneous Rate Shock Scenario Ramped Rate Shock Scenario
Change in interest
rates:
+200 basis points $ (597 ) (1.70 %) $ (278 ) (0.80 %)
+100 basis points (248 ) (0.70 %) (278 ) (0.80 %)
Base - - - -
-100 basis points (402 ) (1.10 %) (61 ) (0.20 %)
-200 basis points N/A N/A N/A N/A
As of December 31, 2019 , as the table above illustrates, the Company would
experience an insignificant decline in net interest income under all scenarios.
We believe the Company's balance sheet is well matched. In a rising rate
environment, we assume positive asset adjustments are offset by increases to
funding costs. In a falling rate environment, we assume prepayment speeds result
in lower re-investment yields. In both cases, an assumption in our rate
simulations is that deposits re-price at a slower pace than our floating rate
assets.
It should be noted that the simulation analyses are based upon equivalent
changes in interest rates for all categories of assets and liabilities. In
normal operating conditions, interest rates may not change in a uniform manner.
Many factors affect the timing and magnitude of interest rate changes on
financial instruments. In addition, we may deploy strategies that offset some of
the impact of changes in interest rates. Depending upon the timing and shifts in
the interest rate yield curve, certain rate scenarios could be less favorable
due to loan and deposit re-pricing characteristics. Consequently, actual
outcomes would be expected to vary from the projections due to the controlled
conditions of the simulation analysis.
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