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FVCBankcorp, Inc. - Quarter Report: 2020 March (Form 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2020

 

or

 

¨Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                          to                         

 

Commission File Number:  001-38647

 

FVCBankcorp, Inc.

(Exact name of registrant as specified in its charter)

 

Virginia   47-5020283
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)

 

11325 Random Hills Road
Suite 240
   
Fairfax, Virginia   22030
(Address of principal executive offices)   (Zip Code)

 

(703) 436-3800

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class:   Trading Symbol(s)   Name of Each Exchange on Which Registered:
Common Stock, $0.01 par value   FVCB   The Nasdaq Stock Market, LLC

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No ¨

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes x   No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨ Accelerated filer x
Non-accelerated filer ¨ Smaller reporting company x
  Emerging growth company x

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes  ¨   No  x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

13,453,435 shares of common stock, par value $0.01 per share, outstanding as of May 7, 2020

 

 

 

 

 

 

FVCBankcorp, Inc.

 

INDEX TO FORM 10-Q

 

PART I — FINANCIAL INFORMATION 3
   
Item 1. Financial Statements: 3
   
Consolidated Balance Sheets At March 31, 2020 (unaudited) and December 31, 2019 6
   
Consolidated Statements of Income For the Three Months Ended March 31, 2020 and 2019 (unaudited) 7
   
Consolidated Statements of Comprehensive Income For the Three Months Ended March 31, 2020 and 2019 (unaudited) 8
   
Consolidated Statements of Cash Flows For the Three Months Ended March 31, 2020 and 2019 (unaudited) 9
   
Consolidated Statements of Changes in Stockholders’ Equity For the Three Months Ended March 31, 2020 and 2019 (unaudited) 10
   
Notes to Consolidated Financial Statements (unaudited) 11
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 50
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk 75
   
Item 4. Controls and Procedures 77
   
PART II — OTHER INFORMATION 78
   
Item 1. Legal Proceedings 78
   
Item 1A. Risk Factors 78
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 79
   
Item 3. Defaults Upon Senior Securities 79
   
Item 4. Mine Safety Disclosures 79
   
Item 5. Other Information 79
   
Item 6. Exhibits 79
   
SIGNATURES 80

 

2

 

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

FVCBankcorp, Inc. and Subsidiary

 

Consolidated Balance Sheets

March 31, 2020 and December 31, 2019

(In thousands, except share data)

 

           March 31,   December 31, 
           2020   2019* 
Assets             (Unaudited)      
Cash and due from banks            $23,158   $14,916 
Interest-bearing deposits at other financial institutions             62,402    18,226 
Securities held-to-maturity (fair value of $0.3 million for both                    
March 31, 2020 and December 31, 2019)             264    264 
Securities available-for-sale, at fair value             126,714    141,325 
Restricted stock, at cost             6,608    6,017 
Loans held for sale, at fair value             9,640    11,198 
Loans, net of allowance for loan losses of $11.2 million and $10.2 million                    
at March 31, 2020 and December 31, 2019, respectively             1,270,916    1,260,295 
Premises and equipment, net             2,090    2,084 
Accrued interest receivable             4,390    4,094 
Prepaid expenses             752    546 
Deferred tax assets, net             7,218    7,683 
Goodwill and intangibles, net             8,612    8,689 
Bank owned life insurance (BOLI)             37,352    37,069 
Other real estate owned (OREO)             3,866    3,866 
Operating lease right-of-use assets             13,014    13,279 
Other assets             25,615    7,744 
                     
Total assets            $1,602,611   $1,537,295 
                     
Liabilities and Stockholders' Equity                    
                     
Liabilities                    
Deposits:                    
Noninterest-bearing            $287,801   $306,235 
Interest-bearing checking, savings and money market             613,031    557,148 
Time deposits             443,212    422,339 
                     
Total deposits            $1,344,044   $1,285,722 
                     
Federal funds purchased           $ - -    $10,000 
FHLB advances             25,000    15,000 
Subordinated notes, net of issuance costs             24,507    24,487 
Accrued interest payable             1,079    605 
Operating lease liabilities             13,455    13,686 
Accrued expenses and other liabilities             16,838    8,717 
                     
Total liabilities            $1,424,923   $1,358,217 
                     
Commitments and Contingent Liabilities                    
                     
Stockholders' Equity                    
    2020    2019           
Preferred stock, $0.01 par value                    
Shares authorized   1,000,000    1,000,000           
Shares issued and outstanding   --    --    --    -- 
                     
Common stock, $0.01 par value                    
Shares authorized   20,000,000    20,000,000           
Shares issued and outstanding   13,451,678    13,902,067    135    139 
Additional paid-in capital            $118,913   $125,779 
Retained earnings             56,203    52,470 
Accumulated other comprehensive income, net             2,437    690 
Total stockholders' equity            $177,688   $179,078 
                     
Total liabilities and stockholders' equity            $1,602,611   $1,537,295 

 

See Notes to Consolidated Financial Statements.  

* Derived from audited consolidated financial statements. 

 

6

 

 

 

FVCBankcorp, Inc. and Subsidiary

 

Consolidated Statements of Income

For the three months ended March 31, 2020 and 2019

(In thousands, except per share data)

(Unaudited)

 

   March 31, 
   2020   2019 
Interest and Dividend Income          
Interest and fees on loans  $15,885   $14,867 
Interest and dividends on securities held-to-maturity   2    13 
Interest and dividends on securities available-for-sale   874    891 
Dividends on restricted stock   89    68 
Interest on deposits at other financial institutions   81    121 
Total interest and dividend income  $16,931   $15,960 
           
Interest Expense          
Interest on deposits  $4,176   $3,740 
Interest on federal funds purchased   79    61 
Interest on short-term debt   70    -- 
Interest on subordinated notes   395    395 
Total interest expense  $4,720   $4,196 
           
Net Interest Income  $12,211   $11,764 
           
Provision for loan losses   1,066    515 
Net interest income after provision for loan losses  $11,145   $11,249 
           
Noninterest Income          
Service charges on deposit accounts  $239   $181 
Gain on sale of securities available-for-sale   97    -- 
Loss on loans held for sale   (451)   -- 
BOLI income   283    105 
Other income   525    452 
Total noninterest income  $693   $738 
           
Noninterest Expenses          
Salaries and employee benefits  $4,028   $3,938 
Occupancy and equipment expense   855    827 
Data processing and network administration   434    439 
State franchise taxes   466    422 
Audit, legal and consulting fees   225    130 
Merger and acquisition expense   --    67 
Loan related expenses   211    68 
FDIC insurance   165    111 
Marketing, business development and advertising   103    159 
Director fees   140    121 
Postage, courier and telephone   44    54 
Internet banking   120    107 
Core deposit intangible amortization   90    100 
Other operating expenses   328    361 
Total noninterest expenses  $7,209   $6,904 
           
Net income before income tax expense  $4,629   $5,083 
           
Income tax expense   896    1,157 
           
Net income  $3,733   $3,926 
           
Earnings per share, basic  $0.27   $0.29 
           
Earnings per share, diluted  $0.26   $0.27 

 

See Notes to Consolidated Financial Statements.

 

7

 

 

FVCBankcorp, Inc. and Subsidiary

 

Consolidated Statements of Comprehensive Income

For the three months ended March 31, 2020 and 2019

(In thousands)

(Unaudited)

 

   March 31, 
   2020   2019 
Net income  $3,733   $3,926 
Other comprehensive income:          
Unrealized gain on securities available for sale, net of tax expense
of $609 in 2020 and net of tax expense of $367 in 2019.
   2,292    1,380 
Unrealized loss on interest rate swaps, net of tax benefit of $124 in 2020.   (468)   -- 
Reclassification adjustment for gains realized in income, net of tax
expense of $20 for 2020.
   (77)   -- 
Total other comprehensive income  $1,747   $1,380 
Total comprehensive income  $5,480   $5,306 

 

See Notes to Consolidated Financial Statements.

 

8

 

 

FVCBankcorp, Inc. and Subsidiary

 

Consolidated Statements of Cash Flows

For the three months ended March 31, 2020 and 2019

(In thousands)

(Unaudited)

 

   March 31, 
   2020   2019 
Cash Flows From Operating Activities          
Net income  $3,733   $3,926 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation   159    164 
Provision for loan losses   1,066    515 
Net amortization of premium of securities   101    86 
Net amortization of deferred loan costs and purchase premiums   232    129 
Net accretion of acquisition accounting adjustments   157    3 
Gain on sale of available-for-sale securities   (97)   -- 
Loss on loans held for sale   451    -- 
Payments received on loans held for sale, net   1,107    -- 
Amortization of subordinated debt issuance costs   20    20 
Core deposits intangible amortization   90    100 
Equity-based compensation expense   205    165 
BOLI income   (283)   (105)
Changes in assets and liabilities:          
Increase in accrued interest receivable, prepaid expenses
and other assets
   (7,813)   (334)
Increase (decrease) in accrued interest payable, accrued expenses
and other liabilities
   7,713    (76)
Net cash provided by operating activities  $6,841   $4,593 
           
Cash Flows From Investing Activities          
(Increase) decrease  in interest-bearing deposits at other financial institutions  $(44,176)  $3,701 
Purchases of securities available-for-sale   --    (16,535)
Proceeds from maturities and calls of securities available-for-sale   1,000    -- 
Proceeds from redemptions of securities available-for-sale   6,162    4,020 
Net purchase of restricted stock   (591)   (92)
Net increase in loans   (12,082)   (42,604)
Proceeds from sale of OREO   --    358 
Purchases of premises and equipment, net   (165)   (111)
Net cash used in investing activities  $(49,852)  $(51,263)
           
Cash Flows From Financing Activities          
Net increase in noninterest-bearing, interest-bearing checking,
savings, and money market deposits
  $37,449   $17,771 
Net increase in time deposits   20,879    32,596 
Decrease in federal funds purchased   (10,000)   -- 
Net increase in FHLB advances   10,000    -- 
Repurchase of shares of common stock   (7,280)   -- 
Common stock issuance   205    272 
Net cash provided by financing activities  $51,253   $50,639 
           
Net increase in cash and cash equivalents  $8,242   $3,969 
           
Cash and cash equivalents, beginning of year   14,916    9,435 
           
Cash and cash equivalents, end of year  $23,158   $13,404 

 

See Notes to Consolidated Financial Statements.

 

9

 

 

FVCBankcorp, Inc. and Subsidiary

 

Consolidated Statements of Changes in Stockholders' Equity

For the three months ended March 31, 2020 and 2019

(In thousands)

(Unaudited)

 

                   Accumulated     
           Additional       Other     
       Common   Paid-in   Retained   Comprehensive     
   Shares   Stock   Capital   Earnings   Income (Loss)   Total 
Balance at December 31, 2018   13,713   $137   $123,882   $36,728   $(2,411)  $158,336 
Net income   --    --    --    3,926    --    3,926 
Adoption of lease accounting standard   --    --    --    (86)   --    (86)
Other comprehensive income   --    --    --    --    1,380    1,380 
Common stock issuance for options exercised, net   42    1    271    --    --    272 
Stock-based compensation expense   --    --    165    --    --    165 
Balance at March 31, 2019   13,755   $138   $124,318   $40,568   $(1,031)  $163,993 
                               
Balance at December 31, 2019   13,902   $139   $125,779   $52,470   $690   $179,078 
Net income   --    --    --    3,733    --    3,733 
Other comprehensive income   --    --    --    --    1,747    1,747 
Repurchase of common stock   (487)   (5)   (7,275)   --    --    (7,280)
Common stock issuance for options exercised, net   37    1    204    --    --    205 
Stock-based compensation expense   --    --    205    --    --    205 
Balance at March 31, 2020   13,452    135    118,913    56,203    2,437   $177,688 

 

See Notes to Consolidated Financial Statements.

 

10

 

 

 

Notes to Unaudited Consolidated Financial Statements

 

Note 1.           Organization and Summary of Significant Accounting Policies

 

Organization

 

FVCBankcorp, Inc. (the Company), a Virginia corporation, was formed in 2015 and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company is headquartered in Fairfax, Virginia. The Company conducts its business activities through the branch offices of its wholly owned subsidiary bank, FVCbank (the Bank). The Company exists primarily for the purposes of holding the stock of its subsidiary, the Bank.

 

The Bank was organized under the laws of the Commonwealth of Virginia to engage in a general banking business serving the Washington, D.C. metropolitan area. The Bank commenced regular operations on November 27, 2007 and is a member of the Federal Reserve System (the Federal Reserve) and the Federal Deposit Insurance Corporation (FDIC). It is subject to the regulations of the Board of Governors of the Federal Reserve and the State Corporation Commission of Virginia. Consequently, it undergoes periodic examinations by these regulatory authorities.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) for interim financial information and follow general practice within the banking industry. Accordingly, the unaudited consolidated financial statements do not include all the information and footnotes required by U.S. GAAP for complete financial statements; however, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s audited financial statements for the year ended December 31, 2019. Certain prior period amounts have been reclassified to conform to current period presentation.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Company. All material intercompany balances and transactions have been eliminated in consolidation.

 

Significant Accounting Policies

 

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry.

 

Risks and Uncertainties

 

The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company.  The World Health Organization has declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the outbreak has caused significant disruptions to the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates. While there has been no material impact to the Company’s employees to date, COVID-19 could also potentially create widespread business continuity issues for the Company.

 

11

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts are expected to have a material impact on the Company’s operations.

 

The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions.  If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full universe or extent that the impact of COVID-19, and resulting measures to curtail its spread, will have on the Company’s operations, the Company is aware of the following items that are potentially material to the Company and its operations.

 

Financial Condition and Results of Operations

 

The Company’s interest income could be reduced due to COVID-19.  In keeping with guidance from regulators, the Company is actively working with COVID-19 affected borrowers to defer their payments, interest, and fees.  While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed.  In such a scenario, interest income in future periods could be negatively impacted.  At this time, the Company is unable to project the materiality of such an impact, but recognizes the breadth of the economic impact may affect its borrowers’ ability to repay in future periods.

 

The Company’s fee income could be reduced due to COVID-19.  In keeping with guidance from regulators, the Company is actively working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc.  These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis.  At this time, the Company is unable to project the materiality of such an impact, but recognizes the breadth of the economic impact is likely to impact its fee income in future periods.

 

Capital and Liquidity

 

While the Company believes that it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by future credit losses.  The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt when necessary.  If the Company’s capital deteriorates such that its subsidiary bank is unable to pay dividends to it for an extended period of time, the Company may not be able to service its debt.

 

12

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The Company maintains access to multiple sources of liquidity.  Wholesale funding markets have remained open to the Company, but rates for short term funding have recently been volatile.  If funding costs are elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin.  If an extended recession caused large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.

 

Asset Valuation

 

Currently, the Company does not expect COVID-19 to affect its ability to account timely for the assets on its balance sheet; however, this could change in future periods. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances such as widening credit spreads, the Company does not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.

 

COVID-19 could cause a further and sustained decline in the Company’s stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform a goodwill impairment test and result in an impairment charge being recorded for that period. In the event that the Company concludes that all or a portion of its goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital.

 

It is possible that the lingering effects of COVID-19 could cause the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform an intangible asset impairment test and result in an impairment charge being recorded for that period. In the event that the Company concludes that all or a portion of its intangible assets are impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. 

 

Processes, Controls and Business Continuity Plan

 

The Company has invoked its Board approved Pandemic Preparedness Plan that includes a remote working strategy. The Company does not anticipate incurring additional material cost related to its continued deployment of the remote working strategy.  No material operational or internal control challenges or risks have been identified to date.  The Company does not anticipate significant challenges to its ability to maintain its systems and controls in light of the measures the Company has taken to prevent the spread of COVID-19.  The Company does not currently face any material resource constraint through the implementation of its business continuity plans.

 

Lending Operations and Accommodations to Borrowers

 

In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in the CARES Act, the Company is executing a payment deferral program for its commercial lending clients that are adversely affected by the pandemic.  Depending on the demonstrated need of the client, the Company is deferring either the full loan payment or the principal component of the loan payment generally for 90 days.  As of April 16, 2020, the Company has executed 43 of these deferrals on outstanding loan balances of $83.6 million.  The Company had 99 additional deferral requests representing $116.6 million in outstanding balances that were in process.  In accordance with interagency guidance issued in March 2020, these short term deferrals are not considered troubled debt restructurings (TDRs).

 

13

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

With the passage of the Paycheck Protection Program (PPP), administered by the Small Business Administration (SBA), the Company is actively participating in assisting its customers with applications for resources through the program.  PPP loans have a two-year term and earn interest at 1%. The Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.  As of May 4, 2020, the Company has closed or approved with the SBA 660 PPP loans representing $178 million in funding. It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan losses through a charge to earnings.

 

Credit

 

The Company is working with customers directly affected by COVID-19.  The Company is prepared to offer short-term assistance in accordance with regulator guidelines.  As a result of the current economic environment caused by the COVID-19 virus, the Company is engaging in more frequent communications with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. Should economic conditions worsen, the Company could experience further increases in its required allowance for loan losses and record additional provision for loan loss expense. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.

 

Recent Accounting Pronouncements

 

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASUs 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASUs have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC), such as the Company, and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company has identified a third party vendor to assist in the measurement of expected credit losses under this standard. The implementation committee has completed the data collection process, validated the data inputs, and is in the initial phases of evaluating various allowance methodologies for certain loan segments within the Company’s loan portfolio. The Company is currently evaluating the implementation of ASU 2016-13 due to the change in implementation dates for smaller reporting companies.

 

14

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB Accounting Standards Codification (ASC) 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.

 

In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. For public business entities, such as the Company, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-12 will have on its consolidated financial statements.

 

In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. For public business entities, such as the Company, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-01 to have a material impact on its consolidated financial statements.

 

In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. To facilitate an orderly transition from interbank offered rates (IBORs) and other benchmark rates to alternative reference rates (ARRs), the Company has established an enterprise-wide initiative led by senior management. The objective of this initiative is to identify, assess and monitor risks associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, achieve operational readiness and engage impacted clients in connection with the transition to ARRs. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

 

15

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

On March 12, 2020, the SEC finalized amendments to the definitions of its “accelerated filer” and “large accelerated filer” definitions. The amendments increase the threshold criteria for meeting these filer classifications and are effective on April 27, 2020. Any changes in filer status are to be applied beginning with the filer’s first annual report filed with the SEC subsequent to the effective date.  Prior to these changes, the Company was required to comply with section 404(b) of the Sarbanes Oxley Act concerning auditor attestation over internal control over financial reporting as an “accelerated filer” as it had more than $75 million in public float but less than $700 million at the end of the Company’s most recent second quarter.  The rule change expands the definition of “smaller reporting companies” to include entities with public float of less than $700 million and less than $100 million in annual revenues.  The Company expects to meet this expanded category of small reporting company and will no longer be considered an accelerated filer.  If the Company’s annual revenues exceed $100 million, its category will change back to “accelerated filer”.  The classifications of “accelerated filer” and “large accelerated filer” require a public company to obtain an auditor attestation concerning the effectiveness of internal control over financial reporting (ICFR) and include the opinion on ICFR in its annual report on Form 10-K.  Smaller reporting companies also have additional time to file quarterly and annual financial statements.  All public companies are required to obtain and file annual financial statement audits, as well as provide management’s assertion on effectiveness of ICFR, but the external auditor attestation of ICFR is not required for smaller reporting companies.  As the Company has total assets exceeding $1.0 billion, it remains subject to the Federal Deposit Insurance Corporation Act, which requires an auditor attestation concerning ICFR.  As such, other than the additional time provided to file quarterly and annual financial statements, this change does not significantly change the Company’s annual reporting and audit requirements.

 

In March 2020, various regulatory agencies, including the Federal Reserve and the FDIC, (the agencies), issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. Under ASC 310-40, “Receivables – Troubled Debt Restructurings by Creditors,” a restructuring of debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grands a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. Depending on the demonstrated need of the client, the Company is deferring either the full loan payment or the principal component of the loan payment generally for 90 days.  As of April 16, 2020, the Company has executed 43 of these deferrals on outstanding loan balances of $83.6 million.  The Company had 99 additional deferral requests representing $116.6 million in outstanding balances that were in process.  This interagency guidance is expected to have a material impact on the Company’s financial statements; however, this impact cannot be quantified at this time.

 

16

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Note 2.           Securities

  

Amortized cost and fair values of securities held-to-maturity and securities available-for-sale as of March 31, 2020 and December 31, 2019, are as follows:

 

   March 31, 2020 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
(In thousands)  Cost   Gains   (Losses)   Value 
Held-to-maturity                    
Securities of state and local municipalities tax exempt  $264   $6   $                  - -    $270 
Total Held-to-maturity Securities  $264   $6   $                  - -    $270 
                     
Available-for-sale                    
Securities of U.S. government and federal agencies  $3,000   $19   $                  - -    $3,019 
Securities of state and local municipalities tax exempt   3,658    66    --    3,724 
Securities of state and local municipalities taxable   943    --    (17)   926 
Corporate bonds   6,983    26    (86)   6,923 
SBA pass-through securities   149    --    (2)   147 
Mortgage-backed securities   81,244    3,223    --    84,467 
Collateralized mortgage obligations   26,980    560    (32)   27,508 
Total Available-for-sale Securities  $122,957   $3,894   $(137)  $126,714 

 

17

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

   December 31, 2019 
       Gross   Gross     
   Amortized   Unrealized   Unrealized   Fair 
(In thousands)  Cost   Gains   (Losses)   Value 
Held-to-maturity                    
Securities of state and local municipalities tax exempt  $264   $6   $                  - -     270 
Total Held-to-maturity Securities  $264   $                  - -    $                  - -    $270 
                     
Available-for-sale                    
Securities of U.S. government and federal agencies  $4,000   $                  - -    $(4)  $3,996 
Securities of state and local municipalities tax exempt   3,662    76    --    3,738 
Securities of state and local municipalities taxable   969    --    (14)   955 
Corporate bonds   6,984    78    (81)   6,981 
SBA pass-through securities   163    --    (4)   159 
Mortgage-backed securities   96,358    1,077    (246)   97,189 
Collateralized mortgage obligations   28,236    290    (219)   28,307 
Total Available-for-sale Securities  $140,372   $1,521   $(568)  $141,325 

 

The Company had $12.3 million and $11.3 million in securities pledged with the Federal Reserve Bank of Richmond (FRB) to collateralize certain municipal deposits at March 31, 2020 and December 31, 2019, respectively.

 

18

 

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The following table shows fair value and gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2020 and December 31, 2019, respectively. The reference point for determining when securities are in an unrealized loss position is month-end. Therefore, it is possible that a security’s market value exceeded its amortized cost on other days during the past twelve-month period. Available-for-sale and held-to-maturity securities that have been in a continuous unrealized loss position are as follows:

 

   Less Than 12 Months   12 Months or Longer   Total 
(In thousands)  Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
At March 31, 2020  Value   Losses   Value   Losses   Value   Losses 
Securities of state and                        
local municipalities                              
taxable  $   $             $926   $        (17)  $926   $       (17)
Corporate                              
bonds   3,962    (21)   936    (65)   4,898    (86)
SBA pass-through                              
securities   147    (2)   --    --    147    (2)
Collateralized mortgage                              
obligations   3,008    (26)   696    (6)   3,704    (32)
Total  $7,117   $(49)  $2,558   $(88)  $9,675   $(137)

 

   Less Than 12 Months   12 Months or Longer   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
At December 31, 2019  Value   Losses   Value   Losses   Value   Losses 
Securities of U.S.                        
government and                              
federal agencies  $2,997   $            (3)  $999   $         (1)  $3,996   $          (4)
Securities of state and                              
local municipalities                              
taxable           955    (14)   955    (14)
Corporate                              
bonds   2,463    (22)   941    (59)   3,404    (81)
SBA pass-through                              
securities           159    (4)   159    (4)
Mortgage-backed                              
securities   15,529    (73)   20,475    (173)   36,004    (246)
Collateralized mortgage                              
obligations   7,479    (94)   7,975    (125)   15,454    (219)
Total  $28,468   $(192)  $31,504   $(376)  $59,972   $(568)

 

Securities of state and local municipalities: The unrealized losses on the Company’s investment in securities of state and local municipalities were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Three of the seven investments carry an S&P investment grade rating of AA+ or above, one has a rating of AA-, one has an AA rating, while the remaining two do not carry a rating.

 

19

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Corporate bonds: The unrealized losses on the investments in corporate bonds were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. One of these investments carries an S&P investment grade rating of A-, while one has a rating of BB. The remaining five investments do not carry a rating.

 

SBA pass-through securities: The unrealized loss on the Company's single investment in SBA pass-through securities was caused by interest rate increases. Repayment of the principal on those investments is guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, the Company does not consider that investment to be other-than-temporarily impaired at March 31, 2020.

 

Collateralized mortgage obligations (CMOs): The unrealized losses associated with three CMOs were caused by interest rate increases. The contractual cash flows of these investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s investments. Because the decline in market value is attributable to changes in interest rates and not credit quality, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2020.

 

The amortized cost and fair value of securities as of March 31, 2020, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.

 

   March 31, 2020 
   Held-to-maturity   Available-for-sale 
   Amortized   Fair   Amortized   Fair 
(In thousands)  Cost   Value   Cost   Value 
After 1 year through 5 years  $   $   $1,026   $1,055 
After 5 years through 10 years   264    270    26,609    27,093 
After 10 years           95,322    98,566 
Total  $264   $270   $122,957   $126,714 

 

For the three months ended March 31, 2020 and 2019, proceeds from principal repayments of securities were $6.2 million and $4.0 million, respectively. During the three months ended March 31, 2020, proceeds from calls and maturities of securities were $1.0 million. There were gross realized gains of approximately $97,000 during the three months ended March 31, 2020 resulting from the Company’s commitment to sell available-for-sale securities with a book value of approximately $10.2 million. There were no realized losses on the sale of securities for the three months ended March 31, 2020. During the three months ended March 31, 2019, there were no proceeds from sales of securities available-for-sale, no gross realized gains, and no realized losses.

 

20

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Note 3.           Loans and Allowance for Loan Losses

 

A summary of loan balances by type follows:

 

   March 31, 2020   December 31, 2019 
(In thousands)  Originated   Acquired   Total   Originated   Acquired   Total 
Commercial real estate  $797,276   $43,739   $841,015   $771,320   $50,372   $821,692 
Commercial and industrial   99,006    7,536    106,542    107,698    7,405    115,103 
Commercial construction   219,114    2,679    221,793    210,933    5,050    215,983 
Consumer residential   71,742    33,160    104,902    74,488    34,307    108,795 
Consumer nonresidential   10,215    82    10,297    11,205    85    11,290 
   $1,197,353   $87,196   $1,284,549   $1,175,644   $97,219   $1,272,863 
Less:                              
Allowance for loan losses   11,197    29    11,226    10,202    29    10,231 
Unearned income and (unamortized premiums), net   2,407        2,407    2,337        2,337 
Loans, net  $1,183,749   $87,167   $1,270,916   $1,163,105   $97,190   $1,260,295 

 

During 2018, as a result of the Company’s acquisition of Colombo Bank (Colombo), the loan portfolio was segregated between loans initially accounted for under the amortized cost method (referred to as “originated” loans) and loans acquired (referred to as “acquired” loans).

 

The loans segregated to the acquired loan portfolio were initially measured at fair value and subsequently accounted for under either ASC 310-30 or ASC 310-20. The outstanding principal balance and related carrying amount of acquired loans included in the consolidated balance sheets as of March 31, 2020 and December 31, 2019 are as follows:

 

(In thousands)  March 31, 2020 
Purchased credit impaired acquired loans evaluated individually for future credit losses     
Outstanding principal balance  $5,445 
Carrying amount   3,803 
      
Other acquired loans     
Outstanding principal balance   84,422 
Carrying amount   83,393 
      
Total acquired loans     
Outstanding principal balance   89,867 
Carrying amount   87,196 

 

21

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

(In thousands)  December 31, 2019 
Purchased credit impaired acquired loans evaluated individually for future credit losses     
Outstanding principal balance  $5,605 
Carrying amount   4,810 
      
Other acquired loans     
Outstanding principal balance   93,587 
Carrying amount   92,409 
      
Total acquired loans     
Outstanding principal balance   99,192 
Carrying amount   97,219 

 

 

The following table presents changes during the three months ended March 31, 2020 and the year ended December 31, 2019, respectively, in the accretable yield on purchased credit impaired loans for which the Company applies ASC 310-30.

 

(In thousands)    
Balance at January 1, 2020  $371 
Accretion   (29)
Reclassification of nonaccretable difference due to improvement in expected cash flows   10 
Other changes, net   (39)
Balance at March 31, 2020  $313 

 

(In thousands)    
Balance at January 1, 2019  $357 
Accretion   (136)
Reclassification of nonaccretable difference due to improvement in expected cash flows   78 
Other changes, net   72 
Balance at December 31, 2019  $371 

 

22

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

An analysis of the allowance for loan losses for the three months ended March 31, 2020 and 2019, and for the year ended December 31, 2019, follows:

 

Allowance for Loan Losses

For the three months ended March 31, 2020

(In thousands)

 

   Commercial
Real Estate
   Commercial
and
Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
Allowance for credit losses:                              
Beginning Balance, January 1  $      6,399   $     1,275   $     2,067   $        417   $            73   $10,231 
Charge-offs               (3)   (90)  $(93)
Recoveries       19        1    2   $22 
Provision   1,268    (124)   (163)   12    73   $1,066 
Ending Balance  $7,667   $1,170   $1,904   $427   $58   $11,226 

 

Allowance for Loan Losses

For the three months ended March 31, 2019

(In thousands)

 

   Commercial
Real Estate
   Commercial
and Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
Allowance for credit losses:                              
Beginning Balance, January 1  $          5,548   $        1,474   $       1,285   $         518   $      334   $9,159 
Charge-offs                   (162)   (162)
Recoveries                        
Provision   264    6    206    (23)   62    515 
Ending Balance  $5,812   $1,480   $1,491   $495   $234   $9,512 

 

Allowance for Loan Losses

For the year ended December 31, 2019

(In thousands)

 

   Commercial
Real Estate
   Commercial
and Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
Allowance for credit losses:                              
Beginning Balance  $       5,548   $       1,474   $       1,285   $        518   $           334   $9,159 
Charge-offs   (20)               (692)   (712)
Recoveries   4    35        2    23    64 
Provision   867    (234)   782    (103)   408    1,720 
Ending Balance  $6,399   $1,275   $2,067   $417   $73   $10,231 

 

23

 

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The following tables present the recorded investment in loans and impairment method as of March 31, 2020 and 2019, and at December 31, 2019, by portfolio segment:

 

Allowance for Loan Losses

At March 31, 2020

(In thousands)

 

   Commercial
Real Estate
   Commercial
and
Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
Allowance for credit losses:                              
Ending Balance:                              
Individually evaluated for impairment  $           60   $        298   $            -    $         29   $               -    $    387 
Purchased credit impaired   --    --    --    --    --    -- 
Collectively evaluated for impairment   7,607    872    1,904    398    58    10,839 
   $7,667   $1,170   $1,904   $427   $58   $11,226 

 

Loans Receivable

At March 31, 2020

(In thousands)

 

   Commercial
Real Estate
   Commercial
and
Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
Financing receivables:                              
Ending Balance                              
Individually evaluated for impairment  $1,778   $4,502    820   $199   $-    $7,299 
Purchased credit impaired   3,182    372    --    249    --    3,803 
Collectively evaluated for impairment   836,055    101,668    220,973    104,454    10,297    1,273,447 
   $841,015   $106,542   $221,793   $104,902   $10,297   $1,284,549 

 

24

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Allowance for Loan Losses

At March 31, 2019

(In thousands)

 

   Commercial
Real Estate
   Commercial
and Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
                         
Allowance for credit losses:                              
Ending Balance:                              
Individually evaluated for impairment  $22   $343   $-    $-    $-    $365 
Purchased credit impaired   --    --    --    --    --    -- 
Collectively evaluated for impairment   5,790    1,137    1,491    495    234    9,147 
   $5,812   $1,480   $1,491   $495   $234   $9,512 

 

Loans Receivable

At March 31, 2019

(In thousands)

 

   Commercial Real Estate   Commercial and Industrial   Commercial Construction   Consumer Residential   Consumer Nonresidential   Total 
Financing receivables:                              
Ending Balance                              
Individually evaluated for impairment  $5,693   $2,934   $-    $-    $-    $8,627 
Purchased credit impaired   137    466    687    368    --    1,658 
Collectively evaluated for impairment   689,124    134,701    188,019    131,454    26,935    1,170,233 
   $694,954   $138,101   $188,706   $131,822   $26,935   $1,180,518 

 

25

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Allowance for Loan Losses

At December 31, 2019

(In thousands)

 

   Commercial Real Estate   Commercial and Industrial   Commercial Construction   Consumer Residential   Consumer Nonresidential   Total 
Allowance for credit losses:                              
Ending Balance:                              
Individually evaluated for impairment  $-    $        364   $-    $29   $-    $393 
Purchased credit impaired   --    --    --    --    --    -- 
Collectively evaluated for impairment   6,399    911    2,067           388             73    9,838 
   $6,399   $1,275   $2,067   $417   $73   $10,231 

 

Loans Receivable

At December 31, 2019

(In thousands)

 

   Commercial Real Estate   Commercial and Industrial   Commercial Construction   Consumer Residential   Consumer Nonresidential   Total 
Financing receivables:                              
Ending Balance                              
Individually evaluated for impairment  $13,902   $5,208   $820   $320   $-    $20,250 
Purchased credit impaired   4,043    400    --    367    --    4,810 
Collectively evaluated for impairment   803,747    109,495    215,163    108,108    11,290    1,247,803 
   $821,692   $115,103   $215,983   $108,795   $11,290   $1,272,863 

 

26

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Impaired loans by class excluding purchased credit impaired, at March 31, 2020 and December 31, 2019, are summarized as follows:

 

Impaired Loans - Originated Loan Portfolio
(In thousands)  Recorded Investment   Unpaid Principal Balance   Related Allowance   Average Recorded Investment   Interest Income Recognized 
March 31, 2020                         
With an allowance recorded:                         
Commercial real estate  $        250   $250           60   $    250   $        4 
Commercial and industrial   1,774    1,774    298    1,776    31 
Commercial construction   --    --    --    --    -- 
Consumer residential   --    --    --    --    -- 
Consumer nonresidential   --    --    --    --    -- 
   $2,024   $2,024   $358   $2,026   $35 
                          
March 31, 2020                         
With no related allowance:                         
Commercial real estate  $1,366   $1,370   $-    $1,374   $19 
Commercial and industrial   2,728    2,728    --    2,990    46 
Commercial construction   820    820    --    820    13 
Consumer residential   --    --    --    --    -- 
Consumer nonresidential   --    --    --    --    -- 
   $4,914   $4,918   $- -    $5,184   $78 

 

Impaired Loans - Acquired Loan Portfolio
(In thousands)  Recorded Investment   Unpaid Principal Balance   Related Allowance   Average Recorded Investment   Interest Income Recognized 
March 31, 2020                         
With an allowance recorded:                         
Commercial real estate  $              -    $          -    $            -    $               -    $          -  
Commercial and industrial   --    --    --    --    -- 
Commercial construction   --    --    --    --    -- 
Consumer residential   169    163    29    163    3 
Consumer nonresidential   --    --    --    --    -- 
   $169   $163   $29   $163   $3 
                          
March 31, 2020                         
With no related allowance:                         
Commercial real estate  $162   $165   $-    $165   $3 
Commercial and industrial   --    --    --    --    -- 
Commercial construction   --    --    --    --    -- 
Consumer residential   30    31    --    31    1 
Consumer nonresidential   --    --    --    --    -- 
   $192   $196   $-   $196   $4 

 

27

 

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

Impaired Loans - Originated Loan Portfolio
(In thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
December 31, 2019                         
With an allowance recorded:                         
Commercial real estate    $             --      $             --      $             --      $             --      $             --  
Commercial and industrial   2,040    2,040    364    2,081    157 
Commercial construction   --    --    --    --    -- 
Consumer residential   --    --    --    --    -- 
Consumer nonresidential   --    --    --    --    -- 
   $2,040   $2,040   $364   $2,081   $157 
                          
December 31, 2019                         
With no related allowance:                         
Commercial real estate  $13,732   $13,736     $             --    $14,557   $699 
Commercial and industrial   3,168    3,323    --    5,387    340 
Commercial construction   820    820    --    816    56 
Consumer residential   --    --    --    --    -- 
Consumer nonresidential   --    --    --    --    -- 
   $17,720   $17,879     $             --    $20,760   $1,095 

 

Impaired Loans - Acquired Loan Portfolio
(In thousands)  Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   Average
Recorded
Investment
   Interest
Income
Recognized
 
December 31, 2019                         
With an allowance recorded:                         
Commercial real estate    $            --      $           --      $          --      $          --      $           --  
Commercial and industrial   --    --    --    --    -- 
Commercial construction   --    --    --    --    -- 
Consumer residential   169    163    29    163    10 
Consumer nonresidential   --    --    --    --    -- 
   $169   $163    29   $163   $10 
                          
December 31, 2019                         
With no related allowance:                         
Commercial real estate  $170   $165     $           --    $165   $13 
Commercial and industrial   --    --    --    --    -- 
Commercial construction   --    --    --    --    -- 
Consumer residential   151    152    --    155    8 
Consumer nonresidential   --    --    --    --    -- 
   $321   $317     $           --    $320   $21 

 

 

28

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

No additional funds are committed to be advanced in connection with the impaired loans. There were no nonaccrual loans excluded from the impaired loan disclosure.

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis typically includes larger, non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. The Company uses the following definitions for risk ratings:

 

Pass – Loans listed as pass include larger non-homogeneous loans not meeting the risk rating definitions below and smaller, homogeneous loans not assessed on an individual basis.

 

Special Mention – Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution's credit position at some future date.

 

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the enhanced possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful – Loans classified as doubtful include those loans which have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, based on currently known facts, conditions and values, improbable.

 

Loss – Loans classified as loss include those loans which are considered uncollectible and of such little value that their continuance as loans is not warranted. Even though partial recovery may be achieved in the future, it is neither practical nor desirable to defer writing off these loans.

 

Based on the most recent analysis performed, the risk category of loans by class of loans was as follows as of March 31, 2020 and December 31, 2019:

 

29

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

As of March 31, 2020 - Originated Loan Portfolio                
(In thousands)  Commercial
Real Estate
   Commercial
and Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
Grade:                        
Pass  $793,513   $94,249   $218,294   $71,090   $10,215    1,187,361 
Special mention   3,484    368    --    551    --    4,403 
Substandard   279    4,389    820    101    --    5,589 
Doubtful   --    --    --    --    --    -- 
Loss   --    --    --    --    --    -- 
Total  $797,276   $99,006   $219,114   $71,742   $10,215   $1,197,353 

 

As of March 31, 2020 - Acquired Loan Portfolio                        
(In thousands)  Commercial
Real Estate
   Commercial
and Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
Grade:                              
Pass  $41,257   $7,164   $2,679   $32,594   $82    83,776 
Special mention   --    --        --    138                   --    138 
Substandard   2,482    372    --    428    --    3,282 
Doubtful   --    --    --    --    --    -- 
Loss  --   --   --   --   --   -- 
Total  $43,739   $7,536   $2,679   $33,160   $82   $87,196 

 

As of December 31, 2019 - Originated Loan Portfolio                
(In thousands)  Commercial
Real Estate
   Commercial
and Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
Grade:                        
Pass  $751,161   $102,491   $210,113   $73,834   $11,186   $1,148,785 
Special mention   15,967    476    --    553    19    17,015 
Substandard   4,192    4,731    820    101        --    9,844 
Doubtful   --    --    --    --    --    -- 
Loss   --    --    --    --    --    -- 
Total  $771,320   $107,698   $210,933   $74,488   $11,205   $1,175,644 

 

As of December 31, 2019 - Acquired Loan Portfolio                
(In thousands)  Commercial
Real Estate
   Commercial
and Industrial
   Commercial
Construction
   Consumer
Residential
   Consumer
Nonresidential
   Total 
Grade:                        
Pass  $47,027   $7,005   $5,050   $33,622   $85   $92,789 
Special mention   3,089    --    --    139                     --    3,228 
Substandard   256    400    --    546    --    1,202 
Doubtful   --    --    --    --    --    -- 
Loss   --    --    --    --    --    -- 
Total  $50,372   $7,405   $5,050   $34,307   $85   $97,219 

 

30

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes, larger non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. At March 31, 2020, the Company had $4.4 million in loans identified as special mention within the originated loan portfolio, a decrease of $12.6 million from December 31, 2019. Special mention rated loans are loans that have a potential weakness that deserves management’s close attention. These loans do not have a specific reserve and are considered well-secured. At March 31, 2020, the Company had $5.6 million in loans identified as substandard within the originated loan portfolio, a decrease of $4.3 million from December 31, 2019. Substandard rated loans are loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. For each of these substandard loans, a liquidation analysis is completed. As of March 31, 2020, specific reserves on originated and acquired loans totaling $387 thousand, has been allocated within the allowance for loan losses to supplement any shortfall of collateral.

 

Past due and nonaccrual loans presented by loan class were as follows at March 31, 2020 and December 31, 2019:

 

As of March 31, 2020 - Originated Loan Portfolio                            
(In thousands)  30-59 days past
due
   60-89 days past
due
   90 days or more past
due
   Total past due   Current   Total loans   90 days past due and
still accruing
   Nonaccruals 
Commercial real estate  $6,189   $610   $743   $7,542   $789,734   $797,276   $743   $-- 
Commercial and industrial   1,098    --    238    1,336    97,670    99,006    238    3,505 
Commercial construction   2,000    --    --    2,000    217,114    219,114    --    820 
Consumer residential   238    --    171    409    71,333    71,742    171    -- 
Consumer nonresidential   55    --    67    122    10,093    10,215    67    -- 
Total  $9,580   $610   $1,219   $11,409   $1,185,944   $1,197,353   $1,219   $4,325 

 

As of March 31, 2020 - Acquired Loan Portfolio                            
(In thousands)  30-59 days past
due
   60-89 days past
due
   90 days or more past
due
   Total past due   Current   Total loans   90 days past due and
still accruing
   Nonaccruals 
Commercial real estate  $2,447   $--   $--   $2,447   $41,292   $43,739   $--   $2,482 
Commercial and industrial   --    --    --    --    7,536    7,536    --    253 
Commercial construction   --    --    --    --    2,679    2,679    --    -- 
Consumer residential   2,346    --    118    2,464    30,696    33,160    118    500 
Consumer nonresidential   --    10    --    10    72    82    --    -- 
Total  $4,793   $10   $118   $4,921   $82,275   $87,196   $118   $3,235 

 

31

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

As of December 31, 2019 - Originated Loan Portfolio                        
(In thousands)  30-59 days past
due
   60-89 days past
due
   90 days or more past
due
   Total past due   Current   Total loans   90 days past due and
still accruing
   Nonaccruals 
Commercial real estate  $8,550   $--   $753   $9,303   $762,017   $771,320   $753   $3,903 
Commercial and industrial   1,184    --    48    1,232    106,466    107,698    48    3,822 
Commercial construction   2,000    --    --    2,000    208,933    210,933    --    820 
Consumer residential   289    153    101    543    73,945    74,488    101    -- 
Consumer nonresidential   77    56    12    145    11,060    11,205    12    -- 
Total  $12,100   $209   $914   $13,223   $1,162,421   $1,175,644   $914   $8,545 

 

As of December 31, 2019 - Acquired Loan Portfolio                            
(In thousands)  30-59 days past
due
   60-89 days past
due
   90 days or more past
due
   Total past due   Current   Total loans   90 days past due and
still accruing
   Nonaccruals 
Commercial real estate  $--   $--   $--   $--   $50,372   $50,372   $--   $256 
Commercial and industrial   --    --    --    --    7,405    7,405    --    272 
Commercial construction   --    --    --    --    5,050    5,050    --    -- 
Consumer residential   1,138    241    118    1,497    32,810    34,307    118    620 
Consumer nonresidential   --    --    --    --    85    85    --    -- 
Total  $1,138   $241   $118   $1,497   $95,722   $97,219   $118   $1,148 

 

 

 

As of March 31, 2020, there were $169 thousand of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process. There were $177 thousand of consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process as of December 31, 2019.

 

There were overdrafts of $322 thousand and $181 thousand at March 31, 2020 and December 31, 2019, which have been reclassified from deposits to loans. At March 31, 2020 and December 31, 2019, loans with a carrying value of $143.7 million and $154.0 million were pledged to the Federal Home Loan Bank of Atlanta (FHLB).

 

There were no defaults of TDRs during the twelve months since restructuring for the three months ended March 31, 2020 and 2019.

 

There were no TDRs originated in the three months ended March 31,2020.

 

32

 

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

The following table presents loans designated as TDRs during the three months ended March 31, 2019:

 

For the three months ended March 31, 2019        
Troubled Debt Restructurings  Number of Contracts   Pre-Modification Outstanding Recorded Investment   Post-Modification Outstanding Recorded Investment 
Commercial real estate   1   $3,903   $3,903 
Total   1   $3,903   $3,903 

 

As of March 31, 2020, and December 31, 2019, the Company has a recorded investment in TDRs of $0 and $3.9 million, respectively.

 

The concession made in the TDR was related to the reduction in the stated interest rate for the remaining life of the debt.

 

Note 4.           Derivative Financial Instruments

 

The Company enters into interest rate swap agreements (swap agreements) to facilitate the risk management strategies needed in order to accommodate the needs of its banking customers. The Company mitigates the risk of entering into these loan agreements by entering into equal and offsetting swap agreements with highly-rated third party financial institutions. These back-to-back swap agreements are free-standing derivatives and are recorded at fair value in the Company’s consolidated balance sheets (asset positions are included in other assets and liability positions are included in other liabilities) as of March 31, 2020 and December 31, 2019. The Company is party to master netting arrangements with its financial institution counterparty; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Parties to a centrally cleared over-the-counter derivative exchange daily payments that reflect the daily change in value of the derivative. These payments, commonly referred to as variation margin, are recorded as settlements of the derivatives’ mark-to-market exposure rather than collateral against the exposures, which effectively results in any centrally cleared derivative having a Level 2 fair value that approximates zero on a daily basis, and therefore, these swap agreements were not included in the offsetting table in the Fair Value Measurement section. As of March 31, 2020, the Company entered into 21 interest rate swap agreements which are collateralized with $14.9 million in cash. There were 17 interest rate swap agreements outstanding as of December 31, 2019 which were collateralized with $6.1 million in cash.

 

33

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

The notional amount and fair value of the Company’s derivative financial instruments as of March 31, 2020 and December 31, 2019 were as follows:

 

    March 31, 2020
    Notional Amount    Fair Value 
    (In thousands)
Interest Rate Swap Agreements          
Receive Fixed/Pay Variable Swaps  $158,145   $14,637 
Pay Fixed/Receive Variable Swaps   158,145    (14,637)

 

    December 31, 2019 
    Notional Amount    Fair Value 
    (In thousands)
Interest Rate Swap Agreements          
Receive Fixed/Pay Variable Swaps  $94,755   $(6,001)
Pay Fixed/Receive Variable Swaps   94,755    6,001 

 

Interest Rate Risk Management—Cash Flow Hedging Instruments

 

The Company uses FHLB advances and other wholesale funding from time to time as a source of funds for use in the Company's lending and investment activities and other general business purposes. This wholesale funding exposes the Company to increased interest rate risk as a result of the variability in cash flows (future interest payments). The Company believes it is prudent to reduce this interest rate risk. To meet this objective, the Company entered into interest rate swap agreements whereby the Company reduces the interest rate risk associated with the Company’s variable rate advances (or other wholesale funding) from the designation date and going through the maturity date.

 

At March 31, 2020, the information pertaining to outstanding interest rate swap agreements used to hedge variability in cash flows (FHLB advance which is included in other borrowed funds on the consolidated balance sheet) is as follows:

 

(Dollars in thousands)    
Notional amount   $ 60,000
Weighted average pay rate   0.88%
Weighted average receive rate   1.25%
Weighted average maturity in years   2.85 year
Unrealized loss relating to interest rate swaps   $ (672)

 

These agreements provided for the Company to receive payments determined by a specific index (three month LIBOR) in exchange for making payments at a fixed rate. At March 31, 2020, the unrealized loss relating to interest rate swaps designated as hedging instruments of the variability of cash flows associated with FHLB advances are reported in other comprehensive income. These amounts are subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on the advance affects earnings. The Company measures cash flow hedging relationships for effectiveness on a monthly basis, and at March 31, 2020, the hedges were highly effective and the amount of ineffectiveness reflected in earnings was de minimus.

 

34

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

Note 5.           Financial Instruments with Off-Balance Sheet Risk

 

The Company is party to credit-related financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.

 

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments.

 

At March 31, 2020 and December 31, 2019, the following financial instruments were outstanding which contract amounts represent credit risk:

 

(In thousands)  March 31, 2020   December 31, 2019 
Commitments to grant loans  $21,606   $27,260 
Unused commitments to fund loans and lines of credit   219,066    244,367 
Commercial and standby letters of credit   8,504    9,002 

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.

 

Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.

 

Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Substantially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting those commitments, if deemed necessary.

 

The Company maintains its cash accounts with the FRB and correspondent banks. The total amount of cash on deposit in correspondent banks exceeding the federally insured limits was $20.2 million and $10.6 million at March 31, 2020 and December 31, 2019, respectively.

 

35

 

 

 Notes to Unaudited Consolidated Financial Statements
(Continued)

 

Note 6.           Stock-Based Compensation Plan

 

The Company’s Amended and Restated 2008 Option Plan (the Plan), which is stockholder-approved, was adopted to advance the interests of the Company by providing selected key employees of the Company, their affiliates, and directors with the opportunity to acquire shares of common stock. In June 2018, the stockholders approved an amendment to Plan to extend the term and increase the number of shares authorized for issuance under the Plan by 200,000 shares. The Company has granted stock options and restricted stock units under the Plan.

 

The maximum number of shares with respect to which awards may be made is 2,529,296 shares of common stock, subject to adjustment for certain corporate events. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant, generally vest annually over four years of continuous service and have ten year contractual terms. At March 31, 2020, 164,743 shares were available to grant under the Plan.

 

No options were granted during the three months ended March 31, 2020 and 2019, respectively. For the three months ended March 31, 2020, 2,737 shares were withheld from issuance upon exercise of options in order to cover the cost of the exercise by the participant. There were no shares were withheld from issuance upon exercise of options in order to cover the cost of the exercise by the participant during the three months ended March 31, 2019.

 

A summary of option activity under the Plan as of March 31, 2020, and changes during the three months ended is presented below:

 

           Weighted-     
       Weighted-   Average     
   Number   Average   Remaining   Aggregate 
   of   Exercise   Contractual   Intrinsic 
Options  Shares   Price   Term   Value (1) 
Outstanding at January 1, 2020   1,797,516   $8.09    4.10      
Granted   --    --           
Exercised   (39,629)   6.30           
Forfeited or expired   (157)   11.52           
Outstanding at March 31, 2020   1,757,730   $8.13    3.90   $9,125,180 
Exercisable at March 31, 2020   1,676,681   $7.96    3.79   $8,979,291 

 

(1) The aggregate intrinsic value of stock options represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price of the option) that would have been received by the option holders had all option holders exercised their options on March 31, 2020. This amount changes based on changes in the market value of the Company’s stock.

 

The compensation cost that has been charged to income for the Plan was $205 thousand and $165 thousand for the three months ended March 31, 2020 and 2019, respectively. As of March 31, 2020, there was unamortized compensation expense related to nonvested stock options of $16 thousand that will be amortized over a weighted-average period of 1 month. The total income tax benefit related to stock options exercised and recognized in the income statement for share-based compensation arrangements was $76 thousand and $0 for the three months March 31, 2020 and 2019, respectively.

 

36

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

There were no restricted stock units granted during the three months ended March 31, 2020. 1,000 restricted stock units were granted during the three months ended March 31, 2019.

 

A summary of the Company’s restricted stock unit grant activity as of March 31, 2020 is shown below.

 

   Number of Units   Weighted Average Grant Date Fair Value 
Nonvested at January 1, 2020   109,718   $18.70 
Granted   --    -- 
Vested   (250)   17.25 
Forfeited   (740)   18.72 
Balance at March 31, 2020   108,728   $18.70 

 

 

As of March 31, 2020, there was $1.7 million of total unrecognized compensation cost related to nonvested restricted stock units granted under the Plan. The cost is expected to be recognized over a weighted-average period of 34 months.

 

Note 7.           Fair Value Measurements

 

Determination of Fair Value

 

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

 

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

 

37

 

 

Notes to Unaudited Consolidated Financial Statements
(Continued)

 

Fair Value Hierarchy

 

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

 

Level 1 − Valuation is based on quoted prices in active markets for identical assets and liabilities.

 

Level 2 − Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

 

Level 3 − Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.

 

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

 

Securities available-for-sale: Securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).

 

Cash flow hedges: The Company has interest rate swap derivatives that are designated as cash flow hedges and are recorded at fair value using published yield curve rates from a national valuation service. These observable rates and inputs are applied to a third party industry-wide valuation model, and therefore, the valuations fall into a Level 2 category.

 

38

 

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2020 and December 31, 2019:

 

       Fair Value Measurements at 
       March 31, 2020 Using 
       Quoted Prices         
       in Active   Significant     
      Markets for   Other   Significant 
   Balance as of   Identical   Observable   Unobservable 
(In thousands)  March 31,   Assets   Inputs   Inputs 
Description  2020   (Level 1)   (Level 2)   (Level 3) 
Assets                    
Available-for-sale                    
Securities of U.S. government and federal                    
agencies  $3,019   $              –   $3,019     $               - -  
Securities of state and local municipalities                    
tax exempt   3,724        3,724    -- 
Securities of state and local municipalities                    
taxable   926        926    -- 
Corporate bonds   6,923        6,923    -- 
SBA pass-through securities   147        147    -- 
Mortgage-backed securities   84,467        84,467    -- 
Collateralized mortgage obligations   27,508        27,508    -- 
Total Available-for-Sale
Securities
 
 
 
$
 
126,714
 
 
 
 
 
$
 
 
 
 
 
 
$
 
126,714
 
 
 
 
 
 
 
 $               - -
 
 

 

       Fair Value Measurements at December 31, 2019 Using 
       Quoted Prices         
       in Active   Significant     
       Markets for   Other   Significant 
   Balance as of   Identical   Observable   Unobservable 
   December 31,   Assets   Inputs   Inputs 
Description  2019   (Level 1)   (Level 2)   (Level 3) 
Assets                
Available-for-sale                    
Securities of U.S. government and federal agencies     $  3,996        $  –        $  3,996        $  –   
Securities of state and local municipalities tax exempt           3,738               –               3,738               –    
Securities of state and local municipalities taxable           955               –               955               –    
Corporate bonds        6,981           –           6,981           –   
SBA pass-through securities        159           –           159           –   
Mortgage-backed securities        97,189           –           97,189           –   
Collateralized mortgage obligations        28,307           –           28,307           –   
Total Available-for-Sale                    
Securities  $141,325   $   $141,325   $ 

 

39

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower of cost or market accounting or write-downs of individual assets.

 

The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:

 

Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the present value of future cash flows, observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, has the value derived by discounting comparable sales due to lack of similar properties, or is discounted by the Company due to marketability, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business's financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

 

Loans Held for Sale: During the fourth quarter of 2019, the Company reclassified a portion of its consumer unsecured loan portfolio as held for sale. For the three months ended March 31, 2020, the Company recorded a loss on the market value adjustment totaling $451 thousand. The measurement of loss associated with the loans held for sale can be based on the observable market price of the loan portfolio. Any fair value adjustments are recorded in the period incurred as losses on loans held for sale on the Consolidated Statements of Income.

 

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach with data from comparable properties. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available, which results in a Level 3 classification of the inputs for determining fair value. Other real estate owned properties are evaluated regularly for impairment and adjusted accordingly.

 

40

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis at March 31, 2020 and December 31, 2019:

 

       Fair Value Measurements Using 
(In thousands)   Balance as of   Quoted Prices
in Active
Markets for
Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
 
Description   March 31, 2020   (Level 1)   (Level 2)   (Level 3) 
Assets                    
Impaired loans  $2,284   $           –   $ –   $2,284 
Loans held for sale  $9,640   $   $9,640   $ 
Other real estate owned  $3,866   $   $   $3,866 

 

       Fair Value Measurements Using 
       Quoted Prices         
       in Active   Significant     
       Markets for   Other   Significant 
       Identical   Observable   Unobservable 
(In thousands)  Balance as of   Assets   Inputs   Inputs 
Description  December 31, 2019   (Level 1)   (Level 2)   (Level 3) 
Assets                    
Impaired loans  $1,816   $   $   $1,816 
Loans held for sale  $11,198   $   $11,198   $ 
Other real estate owned  $3,866   $   $   $3,866 

 

41

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The following table displays quantitative information about Level 3 Fair Value Measurements for March 31, 2020 and December 31, 2019:

 

Quantitative information about Level 3 Fair Value Measurements for March 31, 2020
(Dollars in thousands)              
Assets  Fair Value   Valuation Technique(s)  Unobservable input  Range (Avg.) 
Impaired loans  $2,284   Discounted value  Marketability/Selling costs   5% - 8% (7.84%) 
Other real estate owned  $3,866   Discounted appraised value  Selling costs   10.51%

 

Quantitative information about Level 3 Fair Value Measurements for December 31, 2019
(Dollars in thousands)              
Assets  Fair Value   Valuation Technique(s)  Unobservable input  Range (Avg.) 
Impaired loans  $1,816   Discounted appraised value  Marketability/Selling costs   5% - 8% (7.84%) 
Other real estate owned  $3,866   Discounted appraised value  Selling costs   10.51%

 

The following presents the carrying amount, fair value and placement in the fair value hierarchy of the Company’s financial instruments as of March 31, 2020 and December 31, 2019. Fair values for March 31, 2020 and December 31, 2019 are estimated under the exit price notion in accordance with ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities.”

 

42

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

   Fair Value Measurements as of March 31, 2020, using 
       Quoted Prices in
Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
 
(In thousands)  Carrying 
Amount
   Level 1   Level 2   Level 3 
Financial assets:                    
Cash and due from banks  $23,158   $23,158   $   $ 
Interest-bearing deposits at other institutions   62,402    62,402         
Securities held-to-maturity   264        270     
Securities available-for-sale   126,714        126,714     
Restricted stock   6,608        6,608     
Loans held for sale   9,640        9,640     
Loans, net   1,270,916            1,259,887 
Bank owned life insurance   37,352        37,352     
Accrued interest receivable   4,390        4,390     
                     
Financial liabilities:                    
Checking, savings and money market accounts  $900,832   $   $900,832   $ 
Time deposits   443,212        445,777     
FHLB advances   25,000        24,994     
Subordinated notes   24,507        25,648     
Accrued interest payable   1,079        1,079     

 

   Fair Value Measurements as of December 31, 2019, using 
       Quoted Prices in Active Markets for Identical Assets   Significant Other Observable Inputs   Significant Unobservable Inputs 
(In thousands)  Carrying 
Amount
   Level 1   Level 2   Level 3 
Financial assets:                    
Cash and due from banks  $14,916   $14,916   $   $ 
Interest-bearing deposits at other institutions   18,226    18,226         
Securities held-to-maturity   264        270     
Securities available-for-sale   141,325        141,325     
Restricted stock   6,017        6,017     
Loans held for sale   11,198        11,198     
Loans, net   1,260,295            1,254,685 
Bank owned life insurance   37,069        37,069     
Accrued interest receivable   4,094        4,094     
                     
Financial liabilities:                    
Checking, savings and money market accounts  $863,383   $   $863,383   $ 
Time deposits   422,339        424,398     
Federal funds purchased   10,000        10,000     
FHLB advances   15,000        15,000     
Subordinated notes   24,487        24,564     
Accrued interest payable   605        605     

 

43

 

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Note 8.           Earnings Per Share

 

Basic earnings per share excludes dilution and is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if contracts to issue common stock were exercised or converted into common stock, or resulted in the issuance of stock which then shared in the earnings of the Company. Holders of the Company’s restricted stock units do not have voting rights during the vesting period and therefore, restricted stock units are not included in the computation of basic earnings per share. Weighted average shares – diluted includes only the potential dilution of stock options as of March 31, 2020 and 2019, respectively.

 

The following shows the weighted average number of shares used in computing earnings per share and the effect of weighted average number of shares of dilutive potential common stock. Dilutive potential common stock has no effect on income available to common stockholders. There were no anti-dilutive shares for each of the periods ended March 31, 2020 and 2019, respectively.

 

   Three Months Ended 
   March 31, 
(In thousands, except per share data)  2020   2019 
Net income  $3,733   $3,926 
           
Weighted average number of shares   13,752    13,724 
           
Effect of dilutive securities, restricted stock units and options   843    1,056 
           
Weighted average diluted shares   14,595    14,780 
           
Basic EPS  $0.27   $0.29 
Diluted EPS  $0.26   $0.27 

 

Note 9.          Accumulated Other Comprehensive Income (Loss)

 

Changes in accumulated other comprehensive income (AOCI) for the three months ended March 31, 2020 and 2019 are shown in the following table. The Company has two components, which are available-for-sale securities and cash flow hedges, for the periods presented.

 

44

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

(In thousands)            
Three Months Ended March 31, 2020  Available-for-Sale Securities   Cash Flow Hedges   Total 
Balance, beginning of period  $753   $(63)  $690 
Net unrealized gains (losses) during the period   2,292    (468)   1,824 
Net reclassification adjustment for gains realized in income   (77)   --    (77)
Other comprehensive income (loss), net of tax   2,215    (468)   1,747 
Balance, end of period  $2,968   $(531)  $2,437 
                
(In thousands)   Three Months March 31,           
Available-for-Sale Securities   2019           
Balance, beginning of period  $(2,411)          
Net unrealized gains (losses) during the period   1,380           
Other comprehensive income (loss), net of tax   1,380           
Balance, end of period  $(1,031)          

 

The following table presents information related to reclassifications from accumulated other comprehensive income:

 

       
   Amount Reclassified from AOCI
into Income
   Affected Line Item
   For the Three Months Ended
March 31,
   in the Consolidated
Statements of
Details about AOCI  2020   2019   Income
Gains on sale of available-for-sale securities  $97   $                           --   Gain on sale of securities available-for-sale
Income tax expense   (20)   --   Income tax expense
Total  $77   $                         --   Net of tax

 

Note 10.         Subordinated Notes

 

On June 20, 2016, the Company issued $25 million of fixed-to-floating rate subordinated notes due June 30, 2026, in a private placement to accredited investors. Interest is payable at 6.00% per annum, from and including June 20, 2016 to, but excluding, June 30, 2021, payable semi-annually in arrears. From and including June 30, 2021 to the maturity date or early redemption date, the interest rate shall reset quarterly to an interest rate per annum equal to the then current three-month LIBOR rate plus 487 basis points, payable quarterly in arrears.

 

The Company may, at its option, beginning with the interest payment date of June 30, 2021 and on any scheduled interest payment date thereafter redeem the subordinated notes, in whole or in part, upon not fewer than 30 nor greater than 60 days’ notice to holders, at a redemption price equal to 100% of the principal amount of the subordinated notes to be redeemed plus accrued and unpaid interest to, but excluding, the date of redemption. Any partial redemption will be made pro rata among all of the holders.

 

45

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Note 11.         Revenue Recognition

 

On January 1, 2018, the Company adopted ASU No. 2014-09 ‘‘Revenue from Contracts with Customers’’ (Topic 606) and all subsequent ASUs that modified Topic 606. Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, gain on sale of securities, BOLI income, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as trust and asset management income, deposit related fees, interchange fees, merchant income, and insurance commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.

 

Service Charges on Deposit Accounts

 

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and personal checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

 

Fees, Exchange and Other Service Charges

 

Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges and are included in other income on our consolidated statements of income. Debit and credit card income is primarily comprised of interchange fees earned whenever the Company’s debit and credit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. This income is reflected in other income on the Company’s consolidated statements of income.

 

Other income

 

Other noninterest income consists of loan swap fees, insurance commissions, and other miscellaneous revenue streams not meeting the criteria above. When the Company enters into an interest rate swap agreement, the Company may receive an additional one-time payment fee which is recognized as income when received. The Company receives monthly recurring commissions based on a percentage of premiums issued and revenue is recognized when received. Any residual miscellaneous fees are recognized as they occur, and therefore, the Company determined this consistent practice satisfies the obligation for performance.

 

46

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The following presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three months ended March 31, 2020 and 2019:

 

   Three Months Ended March 31, 
(In thousands)  2020   2019 
Noninterest Income          
In-scope of Topic 606          
Service Charges on Deposit Accounts  $239   $181 
Fees, Exchange, and Other Service Charges   82    76 
Other income   9    14 
Noninterest Income (in-scope of Topic 606)   330    271 
Noninterest Income (out-of-scope of Topic 606)   363    467 
Total Noninterest Income  $693   $738 

 

Contract Balances

 

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of March 31, 2020 and 2019, the Company did not have any significant contract balances.

 

Contract Acquisition Costs

 

In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. The Company did not capitalize any contract acquisition cost during the three months ended March 31, 2020 or 2019.

 

47

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

Note 12.         Supplemental Cash Flow Information

 

Below is additional information regarding the Company’s cash flows for the three months ended March 31, 2020 and 2019.

 

   For the Three Months Ended March 31, 
(In thousands)  2020   2019 
Supplemental Disclosure of Cash Flow Information:          
Cash paid for:          
Interest on deposits and borrowed funds  $4,240   $3,964 
Income taxes   455    -- 
Noncash investing and financing activities:          
Unrealized gain on securities available-for-sale   2,804    1,747 
Unsettled sales of available-for-sale securities   10,152    -- 
Initial right of use asset - operating leases   --    12,249 
Initial lease liability - operating leases   --    12,656 
Right-of-use assets obtained in the exchange for lease liabilities during the current period   59    -- 

 

Note 13.        Leases

 

Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

 

Lease payments

 

Lease payments for short-term leases are recognized as lease expense on a straight-line basis over the lease term, or for variable lease payments, in the period in which the obligation was incurred. Payments for leases with terms longer than twelve months are included in the determination of the lease liability. Payments may be fixed for the term of the lease or variable. If the lease agreement provides a known escalator, such as a specified percentage increase per year or a stated increase at a specified time, the variable payment is included in the cash flows used to determine the lease liability. If the variable payment is based upon an unknown escalator, such as the consumer price index at a future date, the increase is not included in the cash flows used to determine the lease liability. The Company’s leases provide known escalators that are included in the determination of the lease liability, with the exception of three lease agreements.

 

Options to Extend, Residual Value Guarantees, and Restrictions and Covenants

 

The Company’s leases offer the option to extend the lease term. For each of the leases, the Company is reasonably certain it will exercise the options and has included the additional time and lease payments in the calculation of the lease liability. None of the Company’s leases provide for residual value guarantees and none provide restrictions or covenants that would impact dividends or require incurring additional financial obligations.

 

48

 

 

Notes to Unaudited Consolidated Financial Statements

(Continued)

 

The following tables present information about leases:

 

(Dollars in thousands)  March 31, 2020   December 31, 2019 
Right-of-Use-Asset  $13,455   $13,686 
Lease Liability  $13,014   $13,279 
Weighted Average Remaining Lease Term (Years)   10.91    11.1 
Weighted Average discount rate   3.32%   3.32%

 

   For the Three Months Ended   For the Three Months Ended 
(In thousands)  March 31, 2020   March 31, 2019 
Operating Lease Expense  $435   $470 
           
Cash paid for amounts included in lease liabilities  $409   $438 
Right-of-use assets obtained in exchange for operating lease liabilities   59    -- 

 

The following table presents a maturity schedule of undiscounted cash flows that contribute to the lease liability:

 

     
(In thousands)  March 31, 2020 
Nine months ending December 31, 2020  $1,178 
Twelve months ending December 31, 2021   1,559 
Twelve months ending December 31, 2022   1,599 
Twelve months ending December 31, 2023   1,596 
Twelve months ending December 31, 2024   1,566 
Twelve months ending December 31, 2025   1,441 
Thereafter   7,198 
Total  $16,137 
Less: discount   (2,682)
   $13,455 

 

49

 

 

 

Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following presents management’s discussion and analysis of our consolidated financial condition at March 31, 2020 and December 31, 2019 and the results of our operations for the three months ended March 31, 2020 and 2019. This discussion should be read in conjunction with our unaudited consolidated financial statements and the notes thereto appearing elsewhere in this report and the audited consolidated financial statements and the notes to consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2019. Results of operations for the three month period ended March 31, 2020 are not necessarily indicative of the results of operations for the balance of 2020, or for any other period. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause results to differ materially from management’s expectations.

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Form 10-Q contains forward-looking statements. 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,” “aim,” “intend,” “plan,” or words or phases 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, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements.

 

The following factors, among others, could cause our financial performance to differ materially from that expressed in such forward-looking statements:

 

·the risk of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;

 

·changes in the assumptions underlying the establishment of reserves for possible loan losses;

 

·changes in market conditions, specifically declines in the commercial and residential real estate market, volatility and disruption of the capital and credit markets, and soundness of other financial institutions we do business with;

 

·risks inherent in making loans such as repayment risks and fluctuating collateral values;

 

·declines in the Company’s stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to record a noncash impairment charge to earnings in future periods the strength of the United States economy in general and the strength of the local economies in which we conduct operations;

 

·geopolitical conditions, including acts or threats of terrorism, or actions taken by the United States or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in the United States and abroad;

 

·the occurrence of significant natural disasters, including severe weather conditions, floods, health related issues (including the recent coronavirus outbreak and the associated efforts to limit the spread of the disease), and other catastrophic events;

 

·our management of risks inherent in our real estate loan portfolio, and the risk of a prolonged downturn in the real estate market, which could impair the value of our collateral and our ability to sell collateral upon any foreclosure;

 

·changes in consumer spending and savings habits;

 

·technological and social media changes;

 

·the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System (the Federal Reserve), inflation, interest rate, market and monetary fluctuations;

 

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·changing bank regulatory conditions, policies or programs, whether arising as new legislation or regulatory initiatives, that could lead to restrictions on activities of banks generally, or our subsidiary bank in particular, more restrictive regulatory capital requirements, increased costs, including deposit insurance premiums, regulation or prohibition of certain income producing activities or changes in the secondary market for loans and other products;

 

·the impact of changes in financial services policies, laws and regulations, including laws, regulations and policies concerning taxes, banking, securities and insurance, and the application thereof by regulatory bodies;

 

·the impact of changes in laws, regulations and policies affecting the real estate industry;

 

·the effect of changes in accounting policies and practices, as may be adopted from time to time by bank regulatory agencies, the U.S. Securities and Exchange Commission, the Public Company Accounting Oversight Board, the Financial Accounting Standards Board or other accounting standards setting bodies;

 

·the timely development of competitive new products and services and the acceptance of these products and services by new and existing customers;

 

·the willingness of users to substitute competitors’ products and services for our products and services;

 

·the effect of acquisitions we may make, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions;

 

·changes in the level of our nonperforming assets and charge-offs;

 

·our involvement, from time to time, in legal proceedings and examination and remedial actions by regulators; and

 

·potential exposure to fraud, negligence, computer theft and cyber-crime.

 

The foregoing factors should not be considered exhaustive and should be read together with other cautionary statements that are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, including those discussed in the section entitled “Risk Factors.” If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Form 10-Q. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We will not update the forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking statements. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence or how they will affect us.

 

Overview

 

We are a bank holding company headquartered in Fairfax County, Virginia. Our sole subsidiary, FVCbank, was formed in November 2007 as a community-oriented, locally-owned and managed commercial bank under the laws of the Commonwealth of Virginia. The Bank offers a wide range of traditional bank loan and deposit products and services to both our commercial and retail customers. Our commercial relationship officers focus on attracting small and medium sized businesses, commercial real estate developers and builders, including government contractors, non-profit organizations, and professionals. Our approach to our market features competitive customized financial services offered to customers and prospects in a personal relationship context by seasoned professionals.

 

On October 12, 2018, we completed our acquisition of Colombo Bank (Colombo). Colombo, which was headquartered in Rockville, Maryland, merged into FVCbank effective October 12, 2018 adding five banking locations in Washington, D.C., and Montgomery County and the City of Baltimore in Maryland.

 

Net interest income is our primary source of revenue. We define revenue as net interest income plus noninterest income. As discussed further in “Quantitative and Qualitative Disclosures About Market Risk” below, we manage our balance sheet and interest rate risk exposure to maximize, and concurrently stabilize, net interest income. We do this by monitoring our liquidity position and the spread between the interest rates earned on interest-earning assets and the interest rates paid on interest-bearing liabilities. We attempt to minimize our exposure to interest rate risk, but are unable to eliminate it entirely. In addition to managing interest rate risk, we also analyze our loan portfolio for exposure to credit risk. Loan defaults and foreclosures are inherent risks in the banking industry, and we attempt to limit our exposure to these risks by carefully underwriting and then monitoring our extensions of credit. In addition to net interest income, noninterest income is a complementary source of revenue for us and includes, among other things, service charges on deposits and loans, merchant services fee income, loan swap fees, insurance commission income, income from bank owned life insurance (BOLI), and gains and losses on sales of investment securities available-for-sale.

 

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Critical Accounting Policies

 

General

 

The accounting principles we apply under GAAP are complex and require management to apply significant judgment to various accounting, reporting and disclosure matters. Management must use assumptions, judgments and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates. Changes in such judgments, assumptions and estimates may have a significant impact on the consolidated financial statements. Actual results, in fact, could differ from initial estimates.

 

The accounting policies we view as critical are those relating to judgments, assumptions and estimates regarding the determination of the allowance for loan losses, accounting for purchase credit-impaired loans, fair value measurements, and the valuation of other real estate owned.

 

Allowance for Loan Losses

 

We maintain the allowance for loan losses at a level that represents management’s best estimate of known and inherent losses in our loan portfolio. We are not required to implement the provisions of the current expected credit losses accounting standard until January 1, 2023, and are continuing to account for the allowance for loan losses under the incurred loss model. Both the amount of the provision expense and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers. Unusual and infrequently occurring events, such as weather-related disasters and health related events, such as the recent coronavirus outbreak and associated efforts to restrict the spread of the disease, may impact our assessment of possible credit losses. As a part of our analysis, we use comparative peer group data and qualitative factors such as levels of and trends in delinquencies, nonaccrual loans, charged-off loans, changes in volume and terms of loans, effects of changes in lending policy, experience, ability and depth of management, national and local economic trends and conditions, concentrations of credit, competition, and loan review results to support estimates.

 

The allowance for loan losses is based first on a segmentation of the loan portfolio by general loan type, or portfolio segments. For originated loans, certain portfolio segments are further disaggregated and evaluated collectively for impairment based on loan segments, which are largely based on the type of collateral underlying each loan. For purposes of this analysis, we categorize loans into one of five categories: commercial and industrial, commercial real estate, commercial construction, consumer residential, and consumer nonresidential loans. Typically, financial institutions use their historical loss experience and trends in losses for each loan category which are then adjusted for portfolio trends and economic and environmental factors in determining the allowance for loan losses. Since the Bank’s inception in 2007, we have experienced minimal loss history within our loan portfolio. Because of this, our allowance model uses the average loss rates of similar institutions (our custom peer group) as a baseline which is then adjusted based on our particular qualitative loan portfolio characteristics and environmental factors. The indicated loss factors resulting from this analysis are applied for each of the five categories of loans.

 

Our peer group is defined by selecting commercial banking institutions of similar size within Virginia, Maryland and the District of Columbia. This is known as our custom peer group. The commercial banking institutions comprising the custom peer group can change based on certain factors including but not limited to the characteristics, size, and geographic footprint of the institution. We have identified 24 banks for our custom peer group which are within $1 billion to $3 billion in total assets, the majority of whom are geographically concentrated in the Washington, D.C. metropolitan area in which we operate, as this area has experienced more stable economic conditions than many other areas of the country. These baseline peer group loss rates are then adjusted based on an analysis of our loan portfolio characteristics, trends, economic considerations and other conditions that should be considered in assessing our credit risk. Our peer loss rates are updated on a quarterly basis.

 

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are determined to be impaired and, therefore, individually evaluated for impairment. We individually assign loss factors to all loans that have been identified as having loss attributes, as indicated by deterioration in the financial condition of the borrower or a decline in underlying collateral value if the loan is collateral dependent. We evaluate the impairment of certain loans on a loan by loan basis for those loans that are adversely risk rated. Measurement of impairment is based on the expected future cash flows of an impaired loan, which are discounted at the loan’s effective interest rate, or measured on an observable market value, if one exists, or the fair value of the collateral underlying the loan, discounted to consider estimated costs to sell the collateral for collateral-dependent loans. If the net collateral value is less than the loan balance (including accrued interest and any unamortized premium or discount associated with the loan) we recognize an impairment and establish a specific reserve for the impaired loan.

 

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Credit losses are an inherent part of our business and, although we believe the methodologies for determining the allowance for loan losses and the current level of the allowance are appropriate, it is possible that there may be unidentified losses in the portfolio at any particular time that may become evident at a future date pursuant to additional internal analysis or regulatory comment. Additional provisions for such losses, if necessary, would be recorded, and would negatively impact earnings.

 

Allowance for Loan Losses - Acquired Loans

 

Acquired loans accounted for under ASC 310-30

 

For our acquired loans, to the extent that we experience a deterioration in borrower credit quality resulting in a decrease in our expected cash flows subsequent to the acquisition of the loans, an allowance for loan losses would be established based on our estimate of future credit losses over the remaining life of the loans.

 

Acquired loans accounted for under ASC 310-20

 

Subsequent to the acquisition date, we establish an allowance for loan losses through a provision for loan losses based upon an evaluation process that is similar to our evaluation process used for originated loans. This evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers, among other factors, the estimated fair value of the underlying collateral, economic conditions, historical net loan loss experience, carrying value of the loans, which includes the remaining net purchase discount or premium, and other factors that may warrant recognition in determining our allowance for loan losses.

 

Purchased Credit-Impaired Loans

 

Purchased credit-impaired (PCI) loans, which are the loans acquired in our acquisition of Colombo, are loans acquired at a discount (that is due, in part, to credit quality). These loans are initially recorded at fair value (as determined by the present value of expected future cash flows) with no allowance for loan losses. We account for interest income on all loans acquired at a discount (that is due, in part, to credit quality) based on the acquired loans’ expected cash flows. The acquired loans may be aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. A pool is accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flow. The difference between the cash flows expected at acquisition and the investment in the loans, or the “accretable yield,” is recognized as interest income utilizing the level-yield method over the life of each pool. Increases in expected cash flows subsequent to the acquisition are recognized prospectively through adjustment of the yield on the pool over its remaining life, while decreases in expected cash flows are recognized as impairment through a loss provision and an increase in the allowance for loan losses. Therefore, the allowance for loan losses on these impaired pools reflect only losses incurred after the acquisition (representing the present value of all cash flows that were expected at acquisition but currently are not expected to be received).  At March 31, 2020, we had a specific reserve for impairment of one acquired loan within our allowance for loan losses totaling $29 thousand that had further deteriorated post acquisition.

 

We periodically evaluate the remaining contractual required payments due and estimates of cash flows expected to be collected. These evaluations, performed quarterly, require the continued use of key assumptions and estimates, similar to the initial estimate of fair value. Changes in the contractual required payments due and estimated cash flows expected to be collected may result in changes in the accretable yield and non-accretable difference or reclassifications between accretable yield and the non-accretable difference. On an aggregate basis, if the acquired pools of PCI loans perform better than originally expected, we would expect to receive more future cash flows than originally modeled at the acquisition date. For the pools with better than expected cash flows, the forecasted increase would be recorded as an additional accretable yield that is recognized as a prospective increase to our interest income on loans.

 

Fair Value Measurements

 

We determine the fair values of financial instruments based on the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. Our investment securities available-for-sale are recorded at fair value using reliable and unbiased evaluations by an industry-wide valuation service. This service uses evaluated pricing models that vary based on asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs. Depending on the availability of observable inputs and prices, different valuation models could produce materially different fair value estimates. The values presented may not represent future fair values and may not be realizable.

 

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Other Real Estate Owned (OREO)

 

Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at fair value of the property, less estimated disposal costs, if any. Any excess of cost over the fair value less costs to sell at the time of acquisition is charged to the allowance for loan losses. The fair value is reviewed periodically by management and any writedowns are charged against current earnings. Accounting policy and treatment is consistent with accounting for impaired loans described above.

 

LIBOR and Other Benchmark Rates

 

Following the announcement by the United Kingdom’s Financial Conduct Authority in July 2017 that it will no longer persuade or require banks to submit rates for the London InterBank Offered Rate (LIBOR) after 2021, central banks and regulators around the world have commissioned working groups to find suitable replacements for Interbank Offered Rates (IBOR) and other benchmark rates and to implement financial benchmark reforms more generally. These actions have resulted in uncertainty regarding the use of alternative reference rates (ARRs) and could cause disruptions in a variety of markets, as well as adversely impact our business, operations and financial results.

 

To facilitate an orderly transition from IBORs and other benchmark rates to ARRs, we have established an enterprise-wide initiative led by senior management. The objective of this initiative is to identify, assess and monitor risks associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, achieve operational readiness and engage impacted clients in connection with the transition to ARRs.

 

Financial Overview

 

During the first quarter of 2020, we continued to expand our market area through organic growth, capitalizing on market disruption as a result of recent merger activity.

 

·Total assets increased to $1.60 billion compared to $1.54 billion at December 31, 2019, an increase of $65.3 million, or 4.3%.

 

·Total loans, net of deferred fees, increased $11.6 million, or 0.9%, from December 31, 2019 to March 31, 2020. Nonperforming loans, including loans past due 90 days or more and still accruing, as a percentage of total assets was 0.56% at March 31, 2020, compared to 0.70% at December 31, 2019. Nonperforming assets, which includes nonperforming loans and other real estate owned, as a percentage of total assets was 0.80% and 0.95%, at March 31, 2020 and December 31, 2019, respectively.

 

·Total deposits increased $58.3 million, or 4.5%, from December 31, 2019 to March 31, 2020.

 

·Tangible book value per share at March 31, 2020 was $12.57, an increase from $12.26 at December 31, 2019 and $11.32 at March 31, 2019.

 

·Net income was $3.7 million for the three months ended March 31, 2020 compared to $3.9 million for the same period of 2019.

 

COVID-19 Pandemic Discussion Matters

 

Employee Matters

 

As a result of the COVID-19 pandemic stay at home orders to reduce the spread of the disease, the majority of our workforce has transitioned to remote access operations. Our information technology infrastructure has afforded our Bank employees the ability to work predominantly remotely with little interruption as we continue to service the needs of our clients. While the majority of our employees operate from home, there are some functions that require a physical presence at our banking offices. Employees are maintaining safe distances and we have provided more frequent cleaning of our facilities to maintain a safe environment. Management remains connected to employees through weekly company-wide conference calls and regular notifications and updates through both email and the Company’s intranet as warranted.

 

Branch Hours

 

Branch hours and availability have been modified in consideration of the safety of our employees and clients. While lobbies are closed at all of our locations, four branches with drive-up windows are open during our normal business hours.

 

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The Coronavirus Aid, Relief, and Economic Security Act (the CARES Act )

 

The CARES Act, which was enacted March 27, 2020, included several provisions designed to provide relief to individuals and businesses as well as the banking system. Among the more significant components of this legislation was the creation of the Small Business Adminstration (SBA) Paycheck Protection Program (PPP). Loans made under the PPP are fully guaranteed as to principal and interest by the SBA, whose guarantee is backed by the full faith and credit of the U.S. government. PPP loans afford borrowers forgiveness up to the principal amount of the PPP covered loan if the proceeds are used to retain workers and maintain payroll or make mortgage interest, lease and utility payments. The SBA will reimburse banks that participate in this program for any amount of a PPP covered loan that is forgiven.

 

We are actively participating in originating PPP loans, and began processing applications at the inception of the program. Under the first round of PPP, we originated 389 applications for approximately $132 million. We continue to participate during the second round of PPP, assisting new and existing clients obtain funding under this program through the origination of 271 loans for approximately $46 million as of May 4, 2020.

 

Loan Portfolio Exposures

 

We have evaluated our exposure to credit risks directly related to the COVID-19 pandemic and have identified the following subgroups of industry segments most impacted by the pandemic as of March 31, 2020:

 

   March 31, 2020   
Industry Segments by Subgroup  Number of   Outstanding   Percent of Total   
(Dollars in thousands)  Loans   Loan Balance   Loan Portfolio   
Retail Subgroup   39   $84,801    6.59%  
Hotels   11    54,873    4.26%  
Churches   25    47,092    3.66%  
Other Commercial Real Estate   23    29,418    2.29%  
    98   $216,184    16.80%  

 

We are closely monitoring the effects of the pandemic on our loan and deposit customers and are focused on assessing risks within the loan portfolio and working with customers to minimize losses. During our assessment of the allowance for loan losses, we addressed the credit risks associated with these subgroups of industry segments.

 

We have also implemented loan payment deferral programs to allow customers who were required to close or reduce business operations to defer loan principal and interest payments for generally up to 90 days. As of April 16, 2020, loan payment deferrals on loans totaling $83.6 million have been recorded.

 

We believe that as a result of our focused and deliberate underwriting discipline since our inception, in addition to the active dialogue we have with our borrowers, we have the ability and necessary flexibility to assist our customers through this pandemic.

 

Liquidity and Backup Sources

 

Our primary and secondary sources of liquidity remain strong. Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $212.3 million at March 31, 2020, or 13.3% of total assets, an increase from $174.5 million, or 11.4%, at December 31, 2019. To maintain ready access to the Bank’s secured lines of credit, the Bank has pledged a portion of its commercial real estate and residential real estate loan portfolios to the Federal Home Loan Bank of Atlanta (FHLB) and Federal Reserve Bank of Richmond (FRB). Additional borrowing capacity at the FHLB at March 31, 2020 was approximately $138.4 million. Borrowing capacity with the FRB was approximately $49.8 million at March 31, 2020. In addition, we have investment securities of $126.7 million which are available to pledge at FHLB to provide additional borrowing capacity if needed. We also have unsecured federal funds purchased lines of $234.0 million available to us. We anticipate maintaining liquidity at a level sufficient to protect depositors as we endure through this pandemic.

 

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In addition to the funding sources noted above, the Federal Reserve has established a PPP Liquidity Facility (PPPLF), authorized under Section 13(3) of the Federal Reserve Act, that can be used to pledge PPP loans we originate as collateral during the second quarter of 2020 under the CARES Act. Under Section 1102 of the CARES Act, a PPP loan is assigned a zero risk weighting under the risk based capital rules of the federal banking agencies. In addition, an interim rule issued on April 9, 2020 from the federal banking agencies will allow banks to neutralize the effect of PPP loans financed under the PPPLF on leverage capital ratios. We anticipate using this facility to provide us with additional liquidity. The interest rate on this facility is fixed at 0.35% for the term of the facility.

 

Share Repurchases

 

While our capital position remains well above the levels to be considered well capitalized for regulatory purposes, due to the heightened volatility of the stock market and uncertainty regarding the impact of COVID-19, we have temporarily suspended stock repurchases. For the first quarter of 2020, we repurchased 487,531 shares of our common stock at an average cost of $14.90 per share. We continue to monitor this area and may enter the markets from time to time as determined appropriate.

 

Risks and Uncertainties

The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company.  The World Health Organization has declared COVID-19 to be a global pandemic indicating that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The spread of the outbreak has caused significant disruptions to the U.S. economy and has disrupted banking and other financial activity in the areas in which the Company operates. While there has been no material impact to the Company’s employees to date, COVID-19 could also potentially create widespread business continuity issues for the Company.

 

Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the CARES Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts are expected to have a material impact on the Company’s operations.

 

The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions.  If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full universe or extent that the impact of COVID-19, and resulting measures to curtail its spread, will have on the Company’s operations, the Company is aware of the following items that are potentially material to the Company and its operations.

 

Financial Condition and Results of Operations

 

The Company’s interest income could be reduced due to COVID-19.  In keeping with guidance from regulators, the Company is actively working with COVID-19 affected borrowers to defer their payments, interest, and fees.  While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed.  In such a scenario, interest income in future periods could be negatively impacted.  At this time, the Company is unable to project the materiality of such an impact, but recognizes the breadth of the economic impact may affect its borrowers’ ability to repay in future periods.

 

The Company’s fee income could be reduced due to COVID-19.  In keeping with guidance from regulators, the Company is actively working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc.  These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis.  At this time, the Company is unable to project the materiality of such an impact, but recognizes the breadth of the economic impact is likely to impact its fee income in future periods.

 

Capital and Liquidity

 

While the Company believes that it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by future credit losses.  The Company relies on cash on hand as well as dividends from its subsidiary bank to service its debt when necessary.  If the Company’s capital deteriorates such that its subsidiary bank is unable to pay dividends to it for an extended period of time, the Company may not be able to service its debt.

 

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The Company maintains access to multiple sources of liquidity.  Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile.  If funding costs are elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin.  If an extended recession caused large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.

 

Asset Valuation

 

Currently, the Company does not expect COVID-19 to affect its ability to account timely for the valuation of assets on its balance sheet; however, this could change in future periods. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances such as widening credit spreads, the Company does not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with GAAP.

 

COVID-19 could cause a further and sustained decline in the Company’s stock price or the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform a goodwill impairment test and result in an impairment charge being recorded for that period. In the event that the Company concludes that all or a portion of its goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital.

 

It is possible that the lingering effects of COVID-19 could cause the occurrence of what management would deem to be a triggering event that could, under certain circumstances, cause us to perform an intangible asset impairment test and result in an impairment charge being recorded for that period. In the event that the Company concludes that all or a portion of its intangible assets are impaired, a non-cash charge for the amount of such impairment would be recorded to earnings. Such a charge would have no impact on tangible capital or regulatory capital. 

 

Processes, Controls and Business Continuity Plan

 

The Company has invoked its Board approved Pandemic Preparedness Plan that includes a remote working strategy. The Company does not anticipate incurring additional material cost related to its continued deployment of the remote working strategy.  No material operational or internal control challenges or risks have been identified to date.  The Company does not anticipate significant challenges to its ability to maintain its systems and controls in light of the measures the Company has taken to prevent the spread of COVID-19.  The Company does not currently face any material resource constraint through the implementation of its business continuity plans.

 

Lending Operations and Accommodations to Borrowers

 

In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in the CARES Act, the Company is executing a payment deferral program for its commercial lending clients that are adversely affected by the pandemic.  Depending on the demonstrated need of the client, the Company is deferring either the full loan payment or the principal component of the loan payment generally for 90 days.  As of April 16, 2020, the Company has executed 43 of these deferrals on outstanding loan balances of $83.6 million.  The Company had 99 additional deferral requests representing $116.6 million in outstanding balances that were in process.  In accordance with interagency guidance issued in March 2020, these short term deferrals are not considered troubled debt restructurings (TDRs).

 

With the passage of the PPP, administered by the SBA, the Company is actively participating in assisting its customers with applications for resources through the program.  PPP loans have a two-year term and earn interest at 1%. The Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.  As of May 4, 2020, the Company has closed or approved with the SBA 660 PPP loans representing $178 million in funding. It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan losses through a charge to earnings.

 

Credit

 

The Company is working with customers directly affected by COVID-19.  The Company is prepared to offer short-term assistance in accordance with regulator guidelines.  As a result of the current economic environment caused by the COVID-19 virus, the Company is engaging in more frequent communications with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. Should economic conditions worsen, the Company could experience further increases in its required allowance for loan losses and record additional provision for loan loss expense. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.

 

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Results of Operations—Three Months Ended March 31, 2020 and 2019

 

Overview

 

We recorded net income of $3.7 million, or $0.26 per diluted common share, for the three months ended March 31, 2020, compared to net income of $3.9 million, or $0.27 per diluted common share for the three months ended March 31, 2019. Net interest income increased $447 thousand to $12.2 million for the three months ended March 31, 2020, compared to $11.8 million for the three months ended March 31, 2019, a result of an increase in interest-earning assets through organic growth. Provision for loan losses was $1.1 million for the three months ended March 31, 2020, compared to $515 thousand for the same period of 2019. Noninterest income decreased $45 thousand to $693 thousand for the three months ended March 31, 2020 as compared to $738 thousand for 2019. Noninterest expense was $7.2 million for the three months ended March 31, 2020 compared to $6.9 million for the same three month period of 2019.

 

The annualized return on average assets for the three months ended March 31, 2020 and 2019 was 0.96% and 1.16%, respectively. The annualized return on average equity for the three months ended March 31, 2020 and 2019 was 8.29% and 9.74%, respectively.

 

Net Interest Income/Margin

 

Net interest income is our primary source of revenue, representing the difference between interest and fees earned on interest-earning assets and the interest paid on deposits and other interest-bearing liabilities. The following table presents average balance sheet information, interest income, interest expense and the corresponding average yield earned and rates paid for the three months ended March 31, 2020 and 2019.

 

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Average Balance Sheets and Interest Rates on Interest-Earning Assets and Interest-Bearing Liabilities

For the Three Months Ended March 31, 2020 and 2019

(Dollars in thousands)

                                      

   2020   2019 
       Interest   Average       Interest   Average 
   Average   Income/   Yield/   Average   Income/   Yield/ 
   Balance   Expense   Rate   Balance   Expense   Rate 
Assets                              
Interest-earning assets:                              
Loans (1):                              
Commercial real estate  $832,545   $9,920    4.77%  $679,268   $8,009    4.72%
Commercial and industrial   110,186    1,570    5.70%   134,803    2,234    6.63%
Commercial construction   220,104    2,802    5.09%   158,880    2,275    5.73%
Consumer residential   108,454    1,228    4.53%   133,939    1,760    5.26%
Consumer nonresidential   10,680    129    4.81%   31,058    589    7.58%
Total loans (1)   1,281,969    15,649    4.88%   1,137,948    14,867    5.23%
                               
Investment securities (2)   137,640    882    2.56%   138,947    910    2.62%
Restricted stock   5,994    89    5.94%   5,162    68    5.23%
Loans held for sale, at fair value   10,492    236    8.99%   --    --    0.00%
Deposits at other financial institutions and federal funds sold   22,213    81    1.48%   25,221    121    1.95%
                               
Total interest-earning assets and interest income   1,458,308    16,937    4.65%   1,307,278    15,966    4.89%
                               
Noninterest-earning assets:                              
Cash and due from banks   13,431              5,807           
Premises and equipment, net   1,941              2,294           
Accrued interest and other assets   87,560              48,489           
Allowance for loan losses   (10,282)             (9,054)          
Total assets  $1,550,958             $1,354,814           
                               
Liabilities and Stockholders' Equity                              
Interest - bearing liabilities:                              
Interest - bearing deposits:                              
                               
Interest checking  $273,976   $881    1.29%  $296,010   $938    1.27%
Savings and money markets   227,497    635    1.12%   235,926    863    1.46%
Time deposits   353,809    2,080    2.35%   307,780    1,486    1.93%
Wholesale deposits   121,047    580    1.92%   74,781    453    2.42%
Total interest - bearing deposits   976,329    4,176    1.72%   914,497    3,740    1.66%
                               
Other borrowed funds   63,635    544    3.44%   33,716    456    5.49%
                               
Total interest-bearing liabilities and interest expense   1,039,964    4,720    1.83%   948,213    4,196    1.79%
                               
Noninterest-bearing liabilities:                              
Demand deposits   304,364              234,149           
Other liabilities   26,476              11,170           
Common stockholders' equity   180,154              161,282           
Total liabilities and stockholders' equity  $1,550,958             $1,354,814           
                               
Net interest income and net interest margin       $12,217    3.37%       $11,770    3.65%

 

 

(1)Nonaccrual loans are included in average balances and do not have a material effect on the average yield. Interest income on nonaccruing loans was not material for the periods presented. Net loan fees and late charges included in interest income on loans totaled $465 thousand and $212 thousand for the three months ended March 31, 2020 and 2019, respectively.
   
(2)The average yields for investment securities are reported on a fully taxable equivalent basis at a rate of 21% for 2020 and 23% for 2019.

 

The level of net interest income is affected primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates. See “Quantitative and Qualitative Disclosures About Market Risk” below for further information. The following table shows the effect that these factors had on the interest earned from our interest-earning assets and interest incurred on our interest-bearing liabilities for the three months ended March 31, 2020.

 

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Rate and Volume Analysis

For the Three Months Ended March 31, 2020 and 2019

(Dollars in thousands)

                    

   2020 Compared to 2019   
   Average   Average   Increase 
   Volume   Rate   (Decrease) 
Interest income:               
                
Loans (1):               
Commercial real estate  $1,807   $104   $1,911 
Commercial and industrial   (408)   (256)   (664)
Commercial construction   877    (350)   527 
Consumer residential   (335)   (197)   (532)
Consumer nonresidential   (386)   (74)   (460)
Total loans (1)   1,555    (773)   782 
                
Investment securities (2)   (8)   (20)   (28)
Restricted stock   10    11    21 
Loans held for sale, at fair value   --    236    236 
Deposits at other financial institutions and federal funds sold   (14)   (26)   (40)
                
Total interest income   1,543    (572)   971 
                
Interest expense:               
                
Interest - bearing deposits:               
Interest checking   (70)   13    (57)
Savings and money markets   (34)   (194)   (228)
Time deposits   218    376    594 
Wholesale deposits   278    (151)   127 
 Total interest - bearing deposits   392    44    436 
                
Other borrowed funds   411    (323)   88 
Total interest expense   803    (279)   524 
                
                
Net interest income  $740   $(293)  $447 

 

 

(1)Nonaccrual loans are included in average balances and do not have a material effect on the average yield. Interest income on nonaccruing loans was not material for the periods presented.
   
(2)The average yields for investment securities are reported on a fully taxable equivalent basis at a rate of 21% for 2020 and 23% for 2019.

 

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Net interest income for the three months ended March 31, 2020 was $12.2 million, compared to $11.8 million for the three months ended March 31, 2019, an increase of $447 thousand, or 3.8%. The increase in net interest income was primarily a result of an increase in the volume of interest-earning assets related to organic growth during 2020 compared to 2019. The yield on interest-earning assets decreased 24 basis points to 4.65% for the three months ended March 31, 2020, compared to 4.89% for the same period of 2019. In addition, the cost of interest-bearing liabilities increased 4 basis points to 1.83% for the three months ended March 31, 2020, compared to 1.79% for the same period of 2019, reflecting a slight increase in rates on interest-bearing deposits. During the month of March 2020, in response to market conditions as the economy was impacted by COVID-19, the Federal Open Market Committee of the Federal Reserve reduced its targeted fed funds rate an unprecedented 150 basis points. We responded by quickly reducing deposit rates substantially to offset the repricing of rates within our variable rate loan portfolio. The full impact of both yields on interest-earnings assets and the costs of interest-bearing liabilities will be seen during the second quarter of 2020.

 

Our net interest margin, on a tax equivalent basis, for the three months ended March 31, 2020 and 2019 was 3.37% and 3.65%, respectively. The decrease in our net interest margin was primarily a result of a decrease in the yields earned on our interest-earning assets during 2020 as compared to 2019, a result of the decreasing rate environment which began during June 2019. Net interest income, on a tax equivalent basis, is a financial measure that we believe provides a more accurate picture of the interest margin for comparative purposes. To derive our net interest margin on a tax equivalent basis, net interest income is adjusted to reflect tax-exempt income on an equivalent before tax basis with a corresponding increase in income tax expense. For purposes of this calculation, we use our statutory tax rates for the periods presented. This measure ensures comparability of net interest income arising from taxable and tax-exempt sources.

 

The following table provides a reconciliation of our GAAP net interest income to our tax equivalent net interest income.

 

Supplemental Financial Data and Reconciliations to GAAP Financial Measures

 For the Three Months Ended March 31, 2020 and 2019

 (Dollars in thousands)

 

   2020   2019 
GAAP Financial Measurements:        
Interest income:          
Loans  $15,885   $14,867 
Deposits at other financial institutions and federal funds sold   81    121 
Investment securities available-for-sale   874    891 
Investment securities held-to-maturity   2    13 
Restricted stock   89    68 
Total interest income   16,931    15,960 
Interest expense:          
Interest-bearing deposits   4,176    3,740 
Other borrowed funds   544    456 
Total interest expense   4,720    4,196 
Net interest income  $12,211   $11,764 
Non-GAAP Financial Measurements:          
Add: Tax benefit on tax-exempt interest income - securities   6    6 
Total tax benefit on tax-exempt interest income  $6   $6 
Tax equivalent net interest income  $12,217   $11,770 

  

Average interest-earning assets increased by 11.6% to $1.46 billion for the three months ended March 31, 2020 compared to $1.31 billion for the three months ended March 31, 2019, which resulted in an increase in total interest income on a tax equivalent basis of $971 thousand, to $16.9 million for the three months ended March 31, 2020, compared to $16.0 million for the three months ended March 31, 2019, despite the decreasing rate environment. The increase in our earning assets was primarily driven by an increase in the average volume of loans receivable of $144.0 million, which contributed to an additional $1.6 million in interest income. This increase in interest income, which was reduced by a decrease in yields earned on the loan portfolio, decreased interest income $773 thousand. Average balances of nonperforming loans, which consist of nonaccrual loans, are included in the net interest margin calculation and did not have a material impact on our net interest margin in 2020 and 2019.

 

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Total average interest-bearing deposits increased $61.8 million to $976.3 million for the three months ended March 31, 2020 compared to $914.5 million for the three months ended March 31, 2019. Average noninterest-bearing deposits increased $70.2 million to $304.4 million for the three months ended March 31, 2020 compared to $234.1 million for the same period in 2019. The largest increase in average interest-bearing customer deposit balances was in our time deposits, which increased $46.0 million compared to 2019. Average wholesale deposits increased $46.3 million to $121.0 million for the first quarter of 2020 compared to $74.8 million for the first quarter of 2019. Wholesale deposits increased during the first quarter of 2020 compared to the same period of 2019, as this was a cheaper source of funding for the Bank during 2020. The cost of other borrowed funds, which include federal funds purchased, FHLB advances, and our subordinated notes, decreased 205 basis points to 3.44% for the three months ended March 31, 2020, from 5.49% for the same period in 2019. The decrease in the cost of other borrowed funds was a result of FHLB advances recorded during 2020 with an average cost of 1.61%.

 

Provision Expense and Allowance for Loan Losses

 

Our policy is to maintain the allowance for loan losses at a level that represents our best estimate of inherent losses in the loan portfolio. Both the amount of the provision and the level of the allowance for loan losses are impacted by many factors, including general and industry-specific economic conditions, actual and expected credit losses, historical trends and specific conditions of individual borrowers.

 

We recorded a provision for loan losses of $1.1 million for the three months ended March 31, 2020 compared to a provision for loan losses of $515 thousand for the same period of 2019, which primarily reflects changes in certain qualitative factors as a result of the local economic conditions resulting from the ongoing COVID-19 pandemic, in addition to a slight increase in loan origination volume during the first quarter of 2020. In addition, as previously mentioned, we evaluated our exposure to certain credit risks within industry segements in our loan portfolio that are most impacted by the pandemic. Industry subgroups such as retail, hotels, churches and other commercial real etate loans were isolated with in our allowance model, and qualitative factors were adjusted to increase the reserves for these loans as a result of their risk profiles. Specific reserves decreased $6 thousand for the three months ended March 31, 2020, a result of the liquidation analysis completed for impaired loans for the first quarter of 2020. See “Asset Quality” below for additional information on the credit quality of the loan portfolio. The allowance for loan losses at March 31, 2020 was $11.2 million compared to $10.2 million at December 31, 2019. Our allowance for loan loss ratio as a percent of total loans, net of deferred fees and costs, for March 31, 2020 was 0.88% compared to 0.81% at December 31, 2019.

 

Noninterest Income

 

Noninterest income includes service charges on deposits and loans, loan swap fee income, and income from our BOLI policies, and continues to supplement our operating results. Noninterest income for the three months ended March 31, 2020 and 2019 was $693 thousand and $738 thousand, respectively. Fee income from fees on loans, service charges on deposits, and other fee income was $764 thousand for the three months ended March 31, 2020, an increase of 20.7%, as compared to the same quarter of 2019, a result of an increase in loan swap fee income of $45 thousand and an increase of $58 thousand for services charges on deposit accounts during the first quarter of 2020, all a result of an increase in customer relationships over the past year.

 

Income from BOLI increased 169.5% to $283 thousand for the first quarter of 2020, compared to $105 thousand for the same period of 2019, primarily as a result of purchases of additional policies during 2019 totaling $20.0 million. Noninterest income for the three months ended March 31, 2020 was improved by gains totaling $97 thousand on the sales of $10.2 million in investment securities available-for-sale. These securities were sold as they had larger premiums susceptible to prepayment risk, decreasing future interest income. Noninterest income for the quarter ended March 31, 2020 was also impacted by losses on loans held for sale totaling $451 thousand. For the three months ended March 31, 2019, we recorded no gains or losses on assets of the Company.

 

Noninterest Expense

 

Noninterest expense includes, among other things, salaries and benefits, occupancy and equipment costs, professional fees, data processing, insurance and miscellaneous expenses. Noninterest expense was $7.2 million and $6.9 million for the three months ended March 31, 2020 and 2019, respectively.

 

Salaries and benefits expense increased $90 thousand to $4.0 million for the three months ended March 31, 2020 compared to $3.9 million for the same period in 2019. Occupancy and equipment expense increased $28 thousand for the three months ended March 31, 2020 as compared to the same period of 2019. Loan related expenses increased $143 thousand for the three months ended March 31, 2020 compared to the same period of 2019, primarily as a result of expenses incurred to resolve several problem loans during the first quarter of 2020. All other increases in noninterest expense for the quarter ended March 31, 2020 as compared to the same period of 2019 are primarily related to supporting the larger organization as a result of continued organic growth.

 

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Income Taxes

 

We recorded a provision for income tax expense of $896 thousand for the three months ended March 31, 2020, compared to $1.2 million for the three months ended March 31, 2019. Our effective tax rate for the three months ended March 31, 2020 was 19.4%, compared to 22.8% for the same period of 2019. Our effective tax rate for the three months ended March 31, 2020 was less than the statutory rate because of discrete tax benefits recorded as a result of exercises of nonqualified stock options during 2020.

 

Discussion and Analysis of Financial Condition

 

Overview

 

At March 31, 2020, total assets were $1.60 billion, an increase of 4.3%, or $65.3 million, from $1.54 billion at December 31, 2019. Total loans receivable, net of deferred fees and costs, increased 0.9%, or $11.6 million, to $1.28 billion at March 31, 2020, from $1.27 billion at December 31, 2019. Total investment securities decreased $14.6 million, or 10.3%, to $127.0 million at March 31, 2020, from $141.6 million at December 31, 2019. Total deposits increased 4.5%, or $58.3 million, to $1.34 billion at March 31, 2020, from $1.29 billion at December 31, 2019. From time to time, we may utilize other borrowed funds such as federal funds purchased and FHLB advances as an additional funding source for the Bank. At March 31, 2020, we had FHLB advances totaling $25.0 million compared to $15.0 million at December 31, 2019.

 

Loans Receivable, Net

 

Total loans receivable, net of deferred fees and costs, were $1.28 billion at March 31, 2020, an increase of $11.6 million, or 0.9%, compared to $1.27 billion at December 31, 2019. The increase in the loans receivable portfolio was a result of organic loan growth primarily in our commercial real estate and commercial construction portfolios.

 

Commercial real estate loans, net of fees, totaled $839.1 million at March 31, 2020, compared to $819.8 million at December 31, 2019, an increase of $19.3 million, or 2.4%. Owner-occupied commercial real estate loans were $192.1 million at March 31, 2020 compared to $205.9 million at December 31, 2019. Nonowner-occupied commercial real estate loans were $573.1 million at March 31, 2020 compared to $547.8 million at December 31, 2019. Construction loans totaled $220.8 million at March 31, 2020, or 17.2% of total loans receivable. Of the $220.8 million in construction loans, $49.6 million are collateralized by land and only $539 thousand are lot acquisition and development loans (which have a higher degree of credit risk than the remaining portion of the construction portfolio). Our commercial real estate portfolio, including construction loans, is diversified by asset type and geographic concentration. We plan to manage this portion of our portfolio in a disciplined manner. We have comprehensive policies to monitor, measure, and mitigate our loan concentrations within this portfolio segment, including rigorous credit approval, monitoring and administrative practices.

 

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The following table presents the composition of our loans receivable portfolio at March 31, 2020 and at December 31, 2019.

 

Loans Receivable
At March 31, 2020 and December 31, 2019
(Dollars in thousands)
 
    March 31,     December 31,  
    2020    2019 
Commercial real estate  $841,015   $821,692 
Commercial and industrial   106,542    115,103 
Commercial construction   221,793    215,983 
Consumer residential   104,902    108,795 
Consumer nonresidential   10,297    11,290 
           
Gross loans   1,284,549    1,272,863 
           
Less:          
Allowance for loan losses   11,226    10,231 
Unearned income and (unamortized premiums)   2,407    2,337 
           
Loans receivable, net  $1,270,916   $1,260,295 

 

Asset Quality

 

Nonperforming assets, defined as nonaccrual loans, loans past due 90 days or more and still accruing, and OREO at March 31, 2020 were $12.8 million compared to $14.6 million at December 31, 2019. Nonperforming loans of $3.2 million are from our acquired loan portfolio. Our ratio of nonperforming assets to total assets was 0.80% at March 31, 2020 compared to 0.95% at December 31, 2019. Nonperforming loans, which are primarily commercial real estate loans, decreased $1.8 million during the quarter ended March 31, 2020, as one loan paid off during the quarter. Loans that we have classified as nonperforming are a result of customer specific deterioration mostly financial in nature that are not a result of economic, industry, or environmental causes that we might see as a pattern for possible future losses within our loan portfolio. For each of our criticized assets, we conduct an impairment analysis to determine the level of additional or specific reserves required for any portion of the loan that may result in a loss. As a result of the analysis completed, we have specific reserves totaling $387 thousand and $393 thousand at March 31, 2020 and December 31, 2019, respectively. Because these loans are individually evaluated for impairment, nonperforming loans are excluded from the general reserve allocation.

 

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Loans contractually past-due 90 days or more at March 31, 2020 consist of four loans which have matured and are awaiting final payment and are well-collateralized. There were no TDRs as of March 31, 2020, as the one loan that was a TDR at December 31, 2019 paid off during the first quarter of 2020.

 

We categorize loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, collateral adequacy, credit documentation, and current economic trends, among other factors. We analyze loans individually by classifying the loans as to credit risk. This analysis includes, larger non-homogeneous loans such as commercial real estate and commercial and industrial loans. This analysis is performed on an ongoing basis as new information is obtained. At March 31, 2020, we had $4.4 million in loans identified as special mention within the originated loan portfolio, a decrease of $12.6 million from December 31, 2019. Special mention rated loans are loans that have a potential weakness that deserves management’s close attention; however, the borrower continues to pay in accordance with their contract. The decrease from December 31, 2019 was primarily related to two loans totaling $11.1 million having been paid off in full including interest within this risk category during the first quarter of 2020. At March 31, 2020, we had $5.6 million in loans identified as substandard within the originated loan portfolio, a decrease of $4.3 million from December 31, 2019. The decrease in substandard loans was primarily related to one loan, which was considered a TDR totaling $3.9 million, having been paid off in full including past due interest and late fees, during the first quarter of 2020. Substandard rated loans are loans that are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. For each of these substandard loans, a liquidation analysis is completed. At March 31, 2020, specific reserves on originated and acquired loans totaling $387 thousand has been allocated within the allowance for loan losses to supplement any shortfall of collateral.

 

We recorded annualized net charge-offs to average loans receivable of 0.02% for the three months ended March 31, 2020, compared to annualized net charge-offs to average loans receivable of 0.06% for the three months ended March 31, 2019. The following tables provide additional information on our asset quality for the periods presented.

 

 

Nonperforming Assets
At March 31, 2020 and December 31, 2019
(Dollars in thousands)
 
         
   March 31,   December 31, 
    2020    2019 
Nonperforming assets:          
Nonaccrual loans  $7,560   $9,693 
           
Loans contractually past-due 90 days or more   1,337    1,032 
           
Total nonperforming loans (NPLs)  $8,897   $10,725 
           
Other real estate owned (OREO)   3,866    3,866 
           
Total nonperforming assets (NPAs)  $12,763   $14,591 
Performing troubled debt restructurings (TDRs)    $                          - -      $                          - -  
           
           
NPLs/Total Assets   0.56%   0.70%
NPAs/Total Assets   0.80%   0.95%
NPAs and TDRs/Total Assets   0.80%   0.95%
Allowance for loan losses/NPLs   126.18%   95.39%

 

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Nonperforming Loans by Type
At March 31, 2020 and December 31, 2019
(Dollars in thousands)
 
   March 31,   December 31, 
   2020   2019 
Commercial real estate  $3,225   $4,912 
Commercial and industrial   3,996    4,142 
Commercial construction   820    820 
Consumer residential   789    839 
Consumer nonresidential   67    12 
   $8,897   $10,725 

  

At March 31, 2020 and December 31, 2019, there were no performing loans considered potential problem loans. Potential problem loans are defined as loans that are not included in the 90 days or more past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories. We take a conservative approach with respect to risk rating loans in our portfolio. Based upon the status as a potential problem loan, these loans receive heightened scrutiny and ongoing intensive risk management. Additionally, our loan loss allowance methodology incorporates increased reserve factors for certain loans that are adversely rated but not impaired as compared to the general portfolio.

 

As previously mentioned, we have evaluated our exposure to credit risks directly related to the COVID-19 pandemic and have identified the following subgroups of industry segments most impacted by the pandemic as of March 31, 2020:

 

       March 31, 2020     
Industry Segments by Subgroup  Number of   Outstanding   Percent of Total 
(Dollars in thousands)  Loans   Loan Balance   Loan Portfolio 
Retail Subgroup   39   $84,801    6.59%
Hotels   11    54,873    4.26%
Churches   25    47,092    3.66%
Other Commercial Real Estate   23    29,418    2.29%
    98   $216,184    16.80%

 

We are closely monitoring the effects of the pandemic on our loan and deposit customers and are focused on assessing risks within the loan portfolio and working with customers to minimize losses. During our assessment of the allowance for loan losses, we addressed the credit risks associated with these subgroups of industry segments.

 

We have also implemented loan payment deferral programs to allow customers who were required to close or reduce business operations to defer loan principal and interest payments for generally up to 90 days. As of April 16, 2020, loan payment deferrals on loans totaling $83.6 million have been recorded.

 

We believe that as a result of our focused and deliberate underwriting discipline since our inception, in addition to the active dialogue we have with our borrowers, we have the ability and necessary flexibility to assist our customers through this pandemic.

 

At March 31, 2020, we had one OREO property with a fair value of $3.9 million. We are in the process of selling this property and do not expect a material gain or loss from the current fair value of the property as we recorded a $1.1 million gain on the foreclosure of the property during the year ended December 31, 2017.

 

While our loan growth has continued to be strong, unexpected changes in economic growth could adversely affect our loan portfolio, including causing increases in delinquencies and default rates, which would adversely impact our charge-offs and provision for loan losses. Deterioration in real estate values, employment data and household incomes may also result in higher credit losses for us. Also, in the ordinary course of business, we may also be subject to a concentration of credit risk to a particular industry, counterparty, borrower or issuer. At March 31, 2020, our commercial real estate portfolio (including construction lending) was 82.7% of our total loan portfolio. A deterioration in the financial condition or prospects of a particular industry or a failure or downgrade of, or default by, any particular entity or group of entities could negatively impact our business, perhaps materially, and the systems by which we set limits and monitor the level of our credit exposure to individual entities and industries, may not function as we have anticipated.

 

See “Critical Accounting Policies” above for more information on our allowance for loan losses methodology.

 

The following tables present additional information pertaining to the activity in and allocation of the allowance for loan losses by loan type and the percentage of the loan type to the total loan portfolio. The allocation of the allowance for loan losses to a category of loans is not necessarily indicative of future losses or charge-offs, and does not restrict the use of the allowance to any specific category of loans.

 

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Allowance for Loan Losses

For the Three Months Ended March 31, 2020 and 2019

(Dollars in thousands)

 

   Three Months Ended March 31, 
   2020   2019 
Beginning balance  $10,231   $9,159 
           
Provision for loan losses   1,066    515 
           
Loans charged off:          
Commercial real estate   --    -- 
Commercial and industrial   --    -- 
Commercial construction   --    -- 
Consumer residential   (3)   -- 
Consumer nonresidential   (90)   (162)
Total loans charged off   (93)   (162)
           
Recoveries:          
Commercial real estate   --    -- 
Commercial and industrial   19    -- 
Commercial construction   --    -- 
Consumer residential   1    -- 
Consumer nonresidential   2    -- 
Total recoveries   22    -- 
           
Net (charge offs) recoveries   (71)   (162)
           
Ending balance  $11,226   $9,512 

 

   Three Months Ended March 31, 
Loans, net of deferred fees:  2020   2019 
Balance at period end  $1,282,142   $1,178,941 
Allowance for loan losses to loans receivable, net of fees   0.88%   0.81%
Net charge-offs (recoveries) to average loans receivable, annualized   0.02%   0.06%

 

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Allocation of the Allowance for Loan Losses

At March 31, 2020 and December 31, 2019

(Dollars in thousands)

 

   March 31,   December 31, 
   2020   2019 
   Allocation   % of Total*   Allocation   % of Total* 
Commercial real estate  $7,667    65.47%  $6,399    64.55%
Commercial and industrial   1,170    8.29%   1,275    9.04%
Commercial construction   1,904    17.27%   2,067    16.97%
Consumer residential   427    8.17%   417    8.55%
Consumer nonresidential   58    0.80%   73    0.89%
                     
Total allowance for loan losses  $11,226    100.00%  $10,231    100.00%

 

* Percentage of loan type to the total loan portfolio. 

 

Investment Securities

 

Our investment securities portfolio is used as a source of income and liquidity. The investment portfolio consists of investment securities available-for-sale, investment securities held-to-maturity and certificates of deposit. Investment securities available-for-sale are those securities that we intend to hold for an indefinite period of time, but not necessarily until maturity. These securities are carried at fair value and may be sold as part of an asset/liability strategy, liquidity management or regulatory capital management. Investment securities held-to-maturity for each of March 31, 2020 and December 31, 2019 totaled $264 thousand, and are those securities that we have the intent and ability to hold to maturity and are carried at amortized cost. The fair value of our investment securities available-for-sale was $126.7 million at March 31, 2020, a decrease of $14.6 million or 10.3%, from $141.3 million at December 31, 2019. We sold $10.2 million in available-for-sale investment securities during the three months ended March 31, 2020. These securities were sold as they had larger premiums susceptible to prepayment risk, decreasing future interest income.

 

As of March 31, 2020 and December 31, 2019, the majority of the investment securities portfolio consisted of securities rated AAA by a leading rating agency. Investment securities which carry a AAA rating are judged to be of the best quality and carry the smallest degree of investment risk. All of our mortgage-backed securities are guaranteed by either the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, or the Government National Mortgage Association. Investment securities that were pledged to secure public deposits totaled $12.3 million and $11.3 million at March 31, 2020 and December 31, 2019, respectively.

 

We complete reviews for other-than-temporary impairment at least quarterly. At March 31, 2020 and December 31, 2019, only investment grade securities were in an unrealized loss position. Investment securities with unrealized losses are a result of pricing changes due to recent and negative conditions in the current market environment and not as a result of permanent credit impairment. Contractual cash flows for the agency mortgage-backed securities are guaranteed and/or funded by the U.S. government. Municipal securities have third party protective elements and there are no negative indications that the contractual cash flows will not be received when due. We do not intend to sell nor do we believe we will be required to sell any of our temporarily impaired securities prior to the recovery of the amortized cost.

 

No other-than-temporary impairment has been recognized for the securities in our investment portfolio as of March 31, 2020 and December 31, 2019.

 

We hold restricted investments in equities of the FRB and FHLB. At March 31, 2020, we owned $2.4 million in FHLB stock and $4.0 million in FRB stock. At December 31, 2019, we owned $1.9 million in FHLB stock and $4.0 million in FRB stock.

 

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The following table reflects the composition of our investment portfolio, at amortized cost, at March 31, 2020 and December 31, 2019.

 

Investment Securities

At March 31, 2020 and December 31, 2019

(Dollars in thousands)

 

   March 31,   December 31, 
   2020   2019 
Held-to-maturity  Balance   Percent of Total   Balance   Percent of Total 
Securities of state and local municipalities
tax exempt
  $264    0.22%  $264    0.19%
Total held-to-maturity securities  $264    0.22%  $264    0.19%
                     
Available-for-sale                    
Securities of U.S. government and
federal agencies
  $3,000    2.43%  $4,000    2.84%
Securities of state and local municipalities   4,601    3.73%   4,631    3.29%
Corporate bonds and securities   6,983    5.67%   6,984    4.97%
Mortgage-backed securities   108,373    87.95%   124,757    88.71%
Total available-for-sale securities  $122,957    99.78%  $140,372    99.81%
                     
Total investment securities  $123,221    100.00%  $140,636    100.00%

 

The following tables present the amortized cost of our investment portfolio by their stated maturities, as well as the weighted average yields for each of the maturity ranges at March 31, 2020 and December 31, 2019.

 

 

Investment Securities by Stated Maturity

At March 31, 2020

(Dollars in thousands)

 

   At March 31, 2020 
   Within One Year   One to Five Years   Five to Ten Years   Over Ten Years   Total 
       Weighted       Weighted       Weighted       Weighted       Weighted 
   Amortized   Average   Amortized   Average   Amortized   Average   Amortized   Average   Amortized   Average 
Held-to-maturity  Cost   Yield   Cost   Yield   Cost   Yield   Cost   Yield   Cost   Yield 
Securities of state and local municipalities
tax exempt
  $          - -     --   $           - -     --   $264    2.32%  $            - -     --   $264    2.32%
Total held-to-maturity securities  $           - -     --   $            - -     --   $264    2.32%  $            - -     --   $264    2.32%
                                                   
Available-for-sale                                                  
Securities of U.S. government and
federal agencies
  $           - -     --   $           - -     --   $3,000    2.32%  $            - -     --   $3,000    2.32%
Securities of state and local municipalities   --    --    1,026    2.25%   1,380    2.30%   2,195    2.81%   4,601    2.54%
Corporate bonds   --    --    --    --    6,983    4.82%   --    --    6,983    4.82%
Mortgage-backed securities   --    --    --    --    15,246    2.35%   93,127    2.51%   108,373    2.49%
Total available-for-sale securities  $            - -     --   $1,026    2.25%  $26,609    2.99%  $95,322    2.51%  $122,957    2.61%
                                                   
Total investment securities  $            - -     --   $1,026    2.25%  $26,873    2.99%  $95,322    2.51%  $123,221    2.61%

 

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Deposits and Other Borrowed Funds

 

Total deposits were $1.34 billion at March 31, 2020, an increase of $58.3 million, or 4.5%, from $1.29 billion at December 31, 2019. Noninterest-bearing deposits totaled $287.8 million at March 31, 2020, comprising 21.4% of total deposits and decreased $18.4 million, or 6.0%, compared to December 31, 2019. At March 31, 2020, deposits from municipalities which are secured by a letter of credit issued by the FHLB, represented 7.0% of our total deposits. Deposits of any individual municipality are generally limited to 5% of total assets and in the aggregate, municipalities are limited to 18% of total assets. Some of these customers utilize our treasury management services, and all maintain deposits of varying types and maturities. As such, we believe that these customers are unlikely to abruptly terminate their relationship with us. However, in the event that we were to lose all or a significant portion of the deposits of one or more of these customers, we believe that we have adequate alternative sources of liquidity to enable us to replace these funds, although the cost of such replacement sources of liquidity could be higher.

 

The following table provides information on our deposit composition at March 31, 2020 and December 31, 2019.

 

Deposit Composition

At March 31, 2020 and December 31, 2019

(Dollars in thousands)

 

   March 31,   December 31, 
   2020   2019 
   Balance   Average
Rate
   Balance   Average
Rate
 
Noninterest bearing demand  $287,801    --   $306,235    -- 
Interest bearing - checking, savings and money market   613,031    0.54%   557,148    1.18%
Time deposits $100,000 or more   262,659    2.26%   270,508    2.37%
Other time deposits   180,553    1.79%   151,831    2.19%
   $1,344,044        $1,285,722      

 

The remaining maturity of time deposits at March 31, 2020 and December 31, 2019 are as follows:

 

   March 31,   December 31, 
   2020   2019 
Three months or less  $143,343   $114,991 
Over three months through six months   96,499    94,550 
Over six months through twelve months   104,607    114,281 
Over twelve months   98,763    98,517 
   $443,212   $422,339 

 

Wholesale deposits increased to $124.5 million at March 31, 2020 from $100.0 million at December 31, 2019. In addition, we are a member of the Promontory Interfinancial Network (Promontory) which gives us the ability to offer Certificates of Deposit Account Registry Service (CDARS) and Insured Cash Sweep (ICS) products to our customers who seek to maximize FDIC insurance protection. When a customer places a large deposit with us for Promontory, funds are placed into certificates of deposit or other deposit products with other banks in the CDARS and ICS networks in increments of less than $250 thousand so that principal and interest are eligible for FDIC insurance protection. These deposits are part of our core deposit base. At March 31, 2020 and December 31, 2019, we had $54.0 million and $71.4 million, respectively, in either CDARS reciprocal or ICS reciprocal products. The following table reports those certificates of deposit that exceed $100,000 by maturity as of March 31, 2020 and December 31, 2019.

 

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Certificates of Deposit Over $100,000

At March 31, 2020 and December 31, 2019

(Dollars in thousands)

 

   March 31,   December 31, 
   2020   2019 
Three months or less  $61,405   $45,309 
Over three months through six months   48,680    59,303 
Over six months through twelve months   80,581    93,456 
Over twelve months   71,993    72,440 
   $262,659   $270,508 

  

Other borrowed funds, which include federal funds purchased, FHLB advances, and our subordinated notes, were $49.5 million at March 31, 2020, and consisted of $25.0 million in FHLB advances and $24.5 million of subordinated notes. At December 31, 2019, we had other borrowed funds totaling $49.5 million, which consisted of $10.0 million in fed funds purchased, $15.0 million in FHLB advances and subordinated notes totaling $24.5 million.

 

The following table reflects the short-term borrowings and other borrowed funds outstanding at March 31, 2020 and December 31, 2019.

 

Other Borrowed Funds
At March 31, 2020 and December 31, 2019
(Dollars in thousands)
                 
   March 31,   December 31, 
   2020   2019 
   Amount   Weighted   Amount   Weighted 
   Outstanding   Average Rate   Outstanding   Average Rate 
Other short-term borrowed funds:                    
Federal funds purchased  $                    - -     1.46%  $10,000    1.60%
FHLB advances - short term   25,000    1.61%   15,000    1.73%
Total borrowed funds and weighted average rate  $25,000    1.61%  $25,000    1.68%
                     
Other borrowed funds:                    
Subordinated Debt  $24,507    6.00%  $24,487    6.00%
Total other borrowed funds and weighted average rate  $24,507    6.00%  $24,487    6.00%
                     
Total borrowed funds and weighted average rate  $49,507    3.78%  $49,487    3.83%

  

Capital Resources

 

Capital adequacy is an important measure of financial stability and performance. Our objectives are to maintain a level of capitalization that is sufficient to sustain asset growth and promote depositor and investor confidence.

 

Regulatory agencies measure capital adequacy utilizing a formula that takes into account the individual risk profile of the financial institution. The minimum capital requirements for the Bank are: (i) a common equity Tier 1, or CET1, capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6%; (iii) a total risk based capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. Additionally, a capital conservation buffer requirement of 2.5% of risk-weighted assets is designed to absorb losses during periods of economic stress and is applicable to the Bank’s CET1 capital, Tier 1 capital and total capital ratios. Including the conservation buffer, we currently consider the Bank’s minimum capital ratios to be as follows: 7.00% for CET1; 8.50% for Tier 1 capital; and 10.50% for Total capital. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation.

 

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On January 1, 2020, the federal banking agencies adopted a “Community Bank Leverage Ratio” (CBLR), which is calculated by dividing tangible equity capital by average consolidated total assets. If a “qualified community bank,” generally a depository institution or depository institution holding company with consolidated assets of less than $10 billion, opts into the CBLR framework and has a leverage ratio that exceeds the CBLR threshold, which was initially set at 9%, then such bank will be considered to have met all generally applicable leverage and risk based capital requirements under Basel III, the capital ratio requirements for “well capitalized” status under Section 38 of the Federal Deposit Insurance Act, and any other leverage or capital requirements to which it is subject. A bank or holding company may be excluded from qualifying community bank status based on its risk profile, including consideration of its off-balance sheet exposures; trading assets and liabilities; total notional derivatives exposures and such other facts as the appropriate federal banking agencies determine to be appropriate.

 

In April 2020, as required by the CARES Act, the federal banking agencies issued two interim final rules related to the CBLR framework. One interim final rule provides that, as of the second quarter of 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement.

 

At January 1, 2020, we qualified and adopted this simplified capital structure, however, there can be no assurance that satisfaction of the CBLR will provide adequate capital for our operations and growth, or an adequate cushion against increased levels of nonperforming assets or weakened economic conditions.

 

Shareholders’ equity at March 31, 2020 was $177.7 million, a decrease of $1.4 million, compared to $179.1 million at December 31, 2019. The decrease in shareholders’ equity was primarily attributable to our adoption of a share repurchase program during the first quarter of 2020. The Company may purchase up to 1,112,165 shares of the our issued and outstanding shares of common stock, or approximately 8% of outstanding shares as of December 31, 2019. For the three months ended March 31, 2020, we repurchased and cancelled a total of 487,531 shares of common stock at an average price of $14.90, totaling $7.3 million. Due to the uncertainty related to the potential economic impact of the COVID-19 pandemic, we have temporarily suspended stock repurchases. Offsetting share repurchases during the quarter ended March 31, 2020 was the recognition of net income of $3.7 million. Common stock issued as a result of option exercises increased shareholders’ equity by $205 thousand for the three months ended March 31, 2020. Accumulated other comprehensive income increased $1.7 million during 2020, primarily as a result of an increase in market value of our available-for-sale investment securities portfolio.

 

Total shareholders’ equity to total assets for March 31, 2020 and December 31, 2019 was 11.1% and 11.7%, respectively. Tangible book value per share at March 31, 2020 and December 31, 2019 was $12.57 and $12.26, respectively. The Bank’s CBLR at March 31, 2020 was 12.05%. Total risk-based capital to risk-weighted assets for the Bank was 13.43% at December 31, 2019, which was the former capitalization calculation completed prior to the adoption of CBLR. Accordingly, we were considered “well capitalized” for regulatory purposes at March 31, 2020 and December 31, 2019.

 

As noted above, regulatory capital levels for the Bank meet those established for “well capitalized” institutions. While we are currently considered “well capitalized,” we may from time to time find it necessary to access the capital markets to meet our growth objectives or capitalize on specific business opportunities.

 

As the Company is a bank holding company with less than $3 billion in assets, and which does not (i) conduct significant off balance sheet activities, (ii) engage in significant non-banking activities, and (iii) have a material amount of securities registered under the Securities Exchange Act of 1934 (the Exchange Act), it is not currently subject to risk-based capital requirements adopted by the Federal Reserve, pursuant to the small bank holding company policy statement. The Federal Reserve has not historically deemed a bank holding company ineligible for application of the small bank holding company policy statement solely because its common stock is registered under the Exchange Act. There can be no assurance that the Federal Reserve will continue this practice.

 

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The following tables shows the minimum capital requirement and our capital position at March 31, 2020 and December 31, 2019 for the Bank.

 

Capital Components

At March 31, 2020 and December 31, 2019

(Dollars in thousands)

 

                       To Be Well 
                       Capitalized Under 
           For Capital   Prompt Corrective 
   Actual   Adequacy Purposes   Action Provisions 
   Amount   Ratio   Amount       Ratio   Amount       Ratio 
At March 31, 2020                                        
Leverage capital ratio   185,106    12.05%   139,288     >    9.00%               
                                         
                                         
At December 31, 2019                                        
Total risk-based capital  $192,364    13.43%  $150,369     >    10.500%  $143,208     >    10.00%
Tier I risk-based capital   182,121    12.72%   121,727     >    8.500%   114,567     >    8.00%
Common equity tier I capital   182,121    12.72%   100,246     >    7.000%   93,085     >    6.50%
Leverage capital ratio   182,121    12.15%   98,214     >    6.500%   75,550     >    5.00%
                                         

 

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Liquidity

 

Liquidity in the banking industry is defined as the ability to meet the demand for funds of both depositors and borrowers. We must be able to meet these needs by obtaining funding from depositors or other lenders or by converting non-cash items into cash. The objective of our liquidity management program is to ensure that we always have sufficient resources to meet the demands of our depositors and borrowers. Stable core deposits and a strong capital position provide the base for our liquidity position. We believe we have demonstrated our ability to attract deposits because of our convenient branch locations, personal service, technology and pricing.

 

In addition to deposits, we have access to the different wholesale funding markets. These markets include the brokered certificate of deposit market and the federal funds market. We are a member of the Promontory Interfinancial Network, which allows banking customers to access FDIC insurance protection on deposits through our Bank which exceed FDIC insurance limits. We also have one-way authority with Promontory for both their CDARs and ICS products which provides the Bank the ability to access additional wholesale funding as needed. We also maintain secured lines of credit with the FRB and the FHLB for which we can borrow up to the allowable amount for the collateral pledged. Having diverse funding alternatives reduces our reliance on any one source for funding.

 

Cash flow from amortizing assets or maturing assets also provides funding to meet the needs of depositors and borrowers.

 

We have established a formal liquidity contingency plan which establishes a liquidity management team and provides guidelines for liquidity management. For our liquidity management program, we first determine our current liquidity position and then forecast liquidity based on anticipated changes in the balance sheet. In this forecast, we expect to maintain a liquidity cushion. We also stress test our liquidity position under several different stress scenarios, from moderate to severe. Guidelines for the forecasted liquidity cushion and for liquidity cushions for each stress scenario have been established. We believe that we have sufficient resources to meet our liquidity needs.

 

Liquid assets, which include cash and due from banks, federal funds sold and investment securities available for sale, totaled $212.3 million at March 31, 2020, or 13.3% of total assets, an increase from $174.5 million, or 11.4%, at December 31, 2019. The increase in liquid assets is a result of an increase in deposits that occurred late during the first quarter of 2020 as a result of a “flight to safety” due to the current economic conditions from the COVID-19 pandemic. We held investments that are classified as held-to-maturity in the amount of $264 thousand at March 31, 2020. To maintain ready access to the Bank’s secured lines of credit, the Bank has pledged a portion of its commercial real estate and residential real estate loan portfolios to the FHLB and FRB. Additional borrowing capacity at the FHLB at March 31, 2020 was approximately $138.4 million. Borrowing capacity with the FRB was approximately $49.8 million at March 31, 2020. These facilities are subject to the FHLB and the FRB approving disbursement to us. In addition, we have investment securities of $126.7 million which are available to pledge at FHLB to provide additional borrowing capacity if needed. We also have unsecured federal funds purchased lines of $234.0 million available to us. We anticipate maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth and fully comply with all regulatory requirements.

 

In addition to the funding facilities noted above, the Federal Reserve has established a PPP Liquidity Facility, authorized under Section 13(3) of the Federal Reserve Act, that can be used to pledge PPP loans we originate as collateral during the second quarter of 2020 under the CARES Act. Under Section 1102 of the CARES Act, a PPP loan is assigned a zero risk weighting under the risk based capital rules of the federal banking agencies. In addition, an interim rule issued on April 9, 2020 from the federal banking agencies will allow banks to neutralize the effect of PPP loans financed under the PPPLF on leverage capital ratios. We anticipate using this facility to provide us with additional liquidity. The interest rate on this facility is fixed at 0.35% for the term of the facility.

 

Liquidity is essential to our business. Our liquidity could be impaired by an inability to access the capital markets or by unforeseen outflows of cash, including deposits. This situation may arise due to circumstances that we may be unable to control, such as general market disruption, negative views about the financial services industry generally, or an operational problem that affects a third party or us. Our ability to borrow from other financial institutions on favorable terms or at all could be adversely affected by disruptions in the capital markets or other events. As discussed under the caption “Deposits and Other Borrowed Funds” above, we have a deposit concentration related to municipalities at March 31, 2020. While we believe we have a healthy liquidity position and do not anticipate the loss of deposits of any of the significant deposit customers, any of the factors discussed above could materially impact our liquidity position in the future.

 

Financial Instruments with Off-Balance-Sheet Risk and Credit Risk

 

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.

 

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The Bank’s maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. We evaluate each customer’s credit worthiness on a case-by-case basis and require collateral to support financial instruments when deemed necessary. The amount of collateral obtained upon extension of credit is based on management’s evaluation of the counterparty. Collateral held varies but may include deposits held by us, marketable securities, accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates up to one year or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. These instruments represent obligations to extend credit or guarantee borrowings and are not recorded on the consolidated statements of financial condition. The rates and terms of these instruments are competitive with others in the market in which we do business.

 

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may not be drawn upon to the total extent to which we have committed.

 

Standby letters of credit are conditional commitments we issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. We hold certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.

 

With the exception of these off-balance sheet arrangements, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, results of operations, changes in financial condition, revenue, expenses, capital expenditures, or capital resources, that is material to the business of the Company.

 

At March 31, 2020 and December 31, 2019, unused commitments to fund loans and lines of credit totaled $219.1 million and $244.4 million, respectively. Commercial and standby letters of credit totaled $8.5 million and $9.0 million at March 31, 2020 and December 31, 2019, respectively.

 

Quantitative and Qualitative Disclosures About Market Risk

 

As a financial institution, we are exposed to various business risks, including interest rate risk. Interest rate risk is the risk to earnings and value arising from volatility in market interest rates. Interest rate risk arises from timing differences in the repricings and maturities of interest-earning assets and interest-bearing liabilities, changes in the expected maturities of assets and liabilities arising from embedded options, such as borrowers’ ability to prepay loans and depositors’ ability to redeem certificates of deposit before maturity, changes in the shape of the yield curve where interest rates increase or decrease in a nonparallel fashion, and changes in spread relationships between different yield curves, such as U.S. Treasuries and LIBOR. Our goal is to maximize net interest income without incurring excessive interest rate risk. Management of net interest income and interest rate risk must be consistent with the level of capital and liquidity that we maintain. We manage interest rate risk through an asset and liability committee (ALCO). ALCO is responsible for managing our interest rate risk in conjunction with liquidity and capital management.

 

We employ an independent consulting firm to model our interest rate sensitivity. We use a net interest income simulation model as our primary tool to measure interest rate sensitivity. Many assumptions are developed based on expected activity in the balance sheet. For maturing assets, assumptions are created for the redeployment of these assets. For maturing liabilities, assumptions are developed for the replacement of these funding sources. Assumptions are also developed for assets and liabilities that could reprice during the modeled time period. These assumptions also cover how we expect rates to change on non-maturity deposits such as interest checking, money market checking, savings accounts as well as certificates of deposit. Based on inputs that include the current balance sheet, the current level of interest rates and the developed assumptions, the model then produces an expected level of net interest income assuming that market rates remain unchanged. This is considered the base case. Next, the model determines what net interest income would be based on specific changes in interest rates. The rate simulations are performed for a two year period and include ramped rate changes of down 100 basis points to 400 basis points and up 100 basis points to 400 basis points. In both the up and down scenarios, the model assumes a parallel shift in the yield curve. The results of these simulations are then compared to the base case.

  

Stress testing the balance sheet and net interest income using instantaneous parallel shock movements in the yield curve of 100 to 400 basis points is a regulatory and banking industry practice. However, these stress tests may not represent a realistic forecast of future interest rate movements in the yield curve. In addition, instantaneous parallel interest rate shock modeling is not a predictor of actual future performance of earnings. It is a financial metric used to manage interest rate risk and track the movement of the Bank’s interest rate risk position over a historical time frame for comparison purposes.

 

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At March 31, 2020, our asset/liability position was liability sensitive based on our interest rate sensitivity model in the one-year time frame and asset sensitive in the the two-year time frame. Our net interest income would decrease by 1.2% in an up 100 basis point scenario and would decrease by 2.2% in an up 400 basis point scenario over a one-year time frame. In the two-year time horizon, our net interest income would increase by 2.0% in an up 100 basis point scenario and would increase by 6.6% in an up 400 basis point scenario. At March 31, 2020 and December 31, 2019, all interest rate risk stress tests measures were within our board policy established limits in each of the increased rate scenarios.

 

Additional information on our interest rate sensitivity for a static balance sheet over a one-year time horizon as of March 31, 2020 and December 31, 2019 can be found below.

 

Interest Rate Risk to Earnings (Net Interest Income) 
March 31, 2020   December 31, 2019 
Change in interest
rates (basis points)
   Percentage change in
net interest income
   Change in interest
rates (basis points)
   Percentage change in
net interest income
 
 +400    -2.22%   +400    -0.69%
 +300    -1.82%   +300    -0.20%
 +200    -1.58%   +200    0.11%
 +100    -1.21%   +100    0.11%
 0        0     
 –100    0.53%   –100    0.56%
 –200    –1.13%   –200    –0.80%

 

Economic value of equity (EVE) measures the period end market value of assets less the market value of liabilities and the change in this value as rates change. It models simultaneous parallel shifts in market interest rates, implied by the forward yield curve. The EVE model calculates the market value of capital by taking the present value of all asset cash flows less the present value of all liability cash flows.

 

The interest rate risk to capital at March 31, 2020 and December 31, 2019 is shown below and reflects that our market value of capital is in a liability position in which an increase in short-term interest rates is expected to generate lower market values of capital. At March 31, 2020 and December 31, 2019, all EVE stress tests measures were within our board policy established limits.

 

Interest Rate Risk to Capital 
March 31, 2020   December 31, 2019 
Change in interest
rates (basis points)
   Percentage change in
economic value of equity
   Change in interest
rates (basis points)
   Percentage change in
economic value of equity
 
 +400    -12.50%   +400    –13.72%
 +300    -8.49%   +300    –9.36%
 +200    -4.95%   +200    –5.21%
 +100    -2.29%   +100    –1.99%
 0        0     
 –100    -0.17%   –100    1.68%
 –200    1.33%   –200    1.55%

 

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Item 4.  Controls and Procedures

 

The Company maintains disclosure controls and procedures (as defined in Rule 13a — 15(e) under the Exchange Act).  As of the end of the period covered by this report, an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures was carried out under the supervision and with the participation of the Company’s management, including its chief executive officer and chief financial officer. Based on and as of the date of such evaluation, these officers concluded that the Company’s disclosure controls and procedures were effective.

 

The Company also maintains a system of internal accounting controls that is designed to provide assurance that assets are safeguarded and that transactions are executed in accordance with management’s authorization and are properly recorded. This system is continually reviewed and is augmented by written policies and procedures, the careful selection and training of qualified personnel and an internal audit program to monitor its effectiveness. There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter that materially affected, or are likely to materially affect, our internal control over financial reporting.

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

 

In the ordinary course of our operations, we become party to various legal proceedings.  Currently, we are not party to any material legal proceedings, and no such proceedings except as noted above are, to management’s knowledge, threatened against us.

 

Item 1A. Risk Factors

 

In addition to the other information contained in this Quarterly Report on Form 10-Q, the following risk factors update and supplement, and should be read together with, the risk factors previously disclosed in our Annual Report on Form 10- K for the year ended December 31, 2019. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations. See also “Cautionary Note Regarding Forward-Looking Statements,” included in Part 1, Item 2, of this Quarterly Report on Form 10-Q.

 

The ongoing COVID-19 pandemic and measures intended to prevent its spread may adversely affect our business, financial condition and operations; the extent of such impacts are highly uncertain and difficult to predict.

 

Global health and economic concerns relating to the COVID-19 outbreak and government actions taken to reduce the spread of the virus have had a material adverse impact on the macroeconomic environment, and the outbreak has significantly increased economic uncertainty. The pandemic has resulted in federal, state and local authorities, including those who govern the markets in which we operate, implementing numerous measures to try to contain the virus.  These measures, including shelter in place orders and business limitations and shutdowns, have significantly contributed to rising unemployment and negatively impacted consumer and business spending.

 

The COVID-19 outbreak has adversely impacted and is likely to continue to adversely impact our workforce and operations and the operations of our customers and business partners. In particular, we may experience adverse effects due to a number of operational factors impacting us or our customers or business partners, including but not limited to:

 

·loan losses resulting from financial stress experienced by our borrowers, especially those operating in industries hardest hit by government measures to contain the spread of the virus;
   
·collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;
   
·as a result of the decline in the Federal Reserve’s target federal funds rate, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread, and reducing net income;
   
·operational failures, disruptions or inefficiencies due to changes in our normal business practices necessitated by our internal measures to protect our employees and government-mandated measures intended to slow the spread of the virus;
   
·possible business disruptions experienced by our vendors and business partners in carrying out work that supports our operations;
   
·decreased demand for our products and services due to economic uncertainty, volatile market conditions and temporary business closures;
   
·potential financial liability, loan losses, litigation costs or reputational damage resulting from our origination of PPP loans; and
   
·heightened levels of cyber and payment fraud, as cyber criminals try to take advantage of the disruption and increased online activity brought about by the pandemic.

 

The extent to which the pandemic impacts our business, liquidity, financial condition and operations will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, its duration and severity, the actions to contain it or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In addition, the rapidly changing and unprecedented nature of COVID-19 heightens the inherent uncertainty of forecasting future economic conditions and their impact on our loan portfolio, thereby increasing the risk that the assumptions, judgments and estimates used to determine the allowance for loan losses and other estimates are incorrect. Further, our loan deferral program could delay or make it difficult to identify the extent of asset quality deterioration during the 90-day deferral period. As a result of these and other conditions, the ultimate impact of the pandemic is highly uncertain and subject to change, and we cannot predict the full extent of the impacts on our business, our operations or the global economy as a whole. To the extent any of the foregoing risks or other factors that develop as a result of COVID-19 materialize, it could exacerbate the risk factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2019, or otherwise materially and adversely affect our business, liquidity, financial condition and results of operations.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

(a)  None.

 

(b)  Not applicable.

 

(c)  On February 4, 2020, we publicly announced that the Board of Directors had adopted a program to repurchase up to 1,112,165 shares of our common stock, or approximately 8% of our outstanding shares of common stock at December 31, 2019. The timing and amount of repurchases, if any, will depend on market conditions, share price, trading volume and other factors, and there is no assurance that we will purchase shares during any period. The repurchase program will expire on December 31, 2020, subject to earlier termination of the program by the board of directors. Shares may be purchased in the open market or through privately negotiated transactions.

 

As of March 31, 2020, we had purchased 487,531 shares of our common stock at a total cost of $7.3 million. All of these shares have been cancelled and returned to the status of authorized but unissued.

 

Period  (a)     Total Number of Shares Purchased   (b)     Average
Price Paid
per Share
($)
   (c)     Total
Number of
Shares
Purchased
as Part of
Publicly
Announced
Program
   (d)     Maximum
Number of
Shares that
May Yet Be
Purchased
Under the
Program
 
January 1 – January 31, 2020  -   -   -   - 
February 1 – February 29, 2020   219,661    16.68    219,661    892,504 
March 1 – March 31, 2020   267,870    13.65    267,870    624,634 
Total   487,531    14.90    487,531      

 

While our capital position remains well above the levels to be considered well capitalized for regulatory purposes, due to the heightened volatility of the stock market and uncertainty regarding the impact of COVID-19, we have temporarily suspended stock repurchases.

 

Item 3. Defaults Upon Senior Securities

 

(a)  None.

 

(b)  None.

 

Item 4. Mine Safety Disclosures

 

None.

 

Item 5. Other Information

 

(a)  None.

 

(b)  None.

 

Item 6. Exhibits

 

  3.2By-laws of FVCBankcorp, Inc., as amended through April 7, 2020 (incorporated by reference to Exhibit 3.1 of FVCBankcorp, Inc.’s Form 8-K filed with the SEC on April 9, 2020).
  31.1   Rule 13a-14(a) Certification of Principal Executive Officer
  31.2   Rule 13a-14(a) Certification of Principal Financial Officer
  32.1   Statement of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350
  32.2   Statement of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350
  101  

The following materials from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, formatted in Extensible Business Reporting Language (XBRL), include: (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows, and (vi) related notes.

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  FVCBankcorp, Inc.
  (Registrant)
   
Date: May 11, 2020 /s/ David W. Pijor
  David W. Pijor
  Chairman and Chief Executive Officer
  (Principal Executive Officer)
   
Date: May 11, 2020 /s/ Jennifer L. Deacon
  Jennifer L. Deacon
  Executive Vice President and Chief Financial Officer
  (Principal Financial Officer and Principal Accounting Officer)

 

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