NEW PEOPLES BANKSHARES INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q/A)
Caution Regarding Forward-Looking Statements
We make forward-looking statements in this quarterly report on Form 10-Q that are subject to risks and uncertainties. These forward-looking statements include statements regarding expectations, intentions, projections and beliefs concerning our profitability, liquidity, and allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or other similar words or terms are intended to identify forward looking statements. The forward-looking information is based on various factors and was derived using numerous assumptions. Important factors that may cause actual results to differ from projections include:
º the success or failure of our efforts to implement our business plan;
º any required increase in our regulatory capital ratios;
º meet other regulatory requirements that may arise from the examinations,
changes in the law and other similar factors; º deterioration of asset quality; º changes in the level of our nonperforming assets and charge-offs; º fluctuations of real estate values in our markets; º our ability to attract and retain talent;
º demographic changes in our markets which have a negative impact
economy;
º the uncertain outcome of current or future legislation or regulation or
the policies of state and federal regulators;
º good management of interest rate risk;
º good liquidity management;
º changes in general economic and business conditions in our market area and
º the credit risks inherent in granting loans such as changes in
ability to repay and our management of those risks;
º competition with other banks and financial institutions, and companies
outside the banking sector, including online lenders and those
businesses that have significantly greater access to capital and other
Resources;
º demand, development and acceptance of new products and services that we have
offered or may offer;
º the effects of and changes in trade, monetary and fiscal policies and
laws, including interest rate policies
interest rate, market and currency fluctuations;
º the occurrence of major natural disasters, including severe weather events
conditions, floods, health issues (including ongoing novel
coronavirus (COVID-19) outbreak and associated efforts to limit
spread of the disease), and other catastrophic events; º technology utilized by us; º our ability to successfully manage cybersecurity; º our reliance on third-party vendors and correspondent banks; º changes in generally accepted accounting principles;
º changes in government regulations, tax rates and other similar matters; and,
º other risks, which may be described, from time to time, in our filings with
the
Because of these uncertainties, our actual future results may be materially
different from the results indicated by these forward-looking statements. In
addition, our past results of operations do not necessarily indicate our future
results. We expressly disclaim any obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise, except as required by law.
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Critical Accounting Policies
For discussion of our significant accounting policies, see our Annual Report on
Form 10-K for the year ended December 31, 2021 (the 2021 Form 10-K). Certain
critical accounting policies affect the more significant judgments and estimates
used in the preparation of our financial statements. Our most critical
accounting policies relate to our provision for loan losses and the calculation
of our deferred tax asset.
The allowance represents an amount that, in the Company's judgment, will be
adequate to absorb probable and estimable losses inherent in the loan portfolio.
The judgment in determining the level of the allowance is based on evaluations
of the collectability of loans while taking into consideration such factors as
trends in delinquencies and charge-offs for relevant periods of time, changes in
the nature and volume of the loan portfolio, current economic conditions that
may affect a borrower's ability to repay and the value of collateral, overall
portfolio quality and review of specific potential losses. This evaluation is
inherently subjective because it requires estimates that are susceptible to
significant revision as more information becomes available.
Deferred tax assets or liabilities are computed based upon the difference
between financial statement and income tax bases of assets and liabilities using
the enacted marginal tax rate. In the past, the Company provided a valuation
allowance on its net deferred tax assets where it was deemed more likely than
not such assets would not be realized. At June 30, 2022 and December 31, 2021 ,
the Company had no valuation allowance on its net deferred tax assets.
The Company recognizes the tax benefit from an uncertain tax position only if it
is more likely than not the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the position. The tax
benefits recognized in the financial statements from such positions are then
measured based on the largest benefit that has a greater than 50% likelihood of
being realized upon settlement.
For more information on the deferred tax asset and the valuation allowance, we refer you to the section “Deferred tax asset and income taxes” below.
Overview and Highlights OnJune 15, 2022 , we became aware of a cybersecurity incident that temporarily interrupted the operability of our computer systems. As a result of this incident branch services could not be provided for two and one-half days, however, customers had access to our Interactive Teller Machine (ITM) network and credit and debit card activity was available. Limited branch operations resumed onJune 17, 2022 , and full operations were restored onJune 21, 2022 . OnJune 29, 2022 , we issued a press release outlining the timeline, restoration efforts and communications, services and safeguards being offered to our customers in response to this incident, and filed a Current Report on Form 8-K relating to the incident. During the three months endedJune 30, 2022 , expenses related to the cybersecurity incident were recorded for insurance deductibles along with costs for onsite security provided during the first few days that lobby service was restarted. Certain other direct costs for forensic, legal and recovery services, along with communication management, will be disbursed during the third quarter and are expected to be recovered through insurance coverage. To minimize the inconvenience to our customers, we increased ITM withdrawal, and debit card transaction limits for all customers and temporarily eliminated overdraft fees. These actions resulted in an increase in overdrawn deposit accounts and a reduction of overdraft revenue that impacted the second quarter of 2022, and is expected to have ongoing impact into the third quarter of 2022. For the three months endedJune 30, 2022 , we earned net income of$1.9 million , which equates to$0.08 per share, and is$260 thousand higher than the$1.7 million net income during the same period in 2021. All major components of the income statement improved, with the exception of noninterest income, which was impacted by the cybersecurity incident. Net interest income grew$193 thousand , provision for loan losses decreased$111 thousand , non-interest income decreased$30 thousand , and non-interest expense decreased$66 thousand . Consequently, income tax expense increased$80 thousand due to the increase in income before income taxes.
For the six months endedJune 30, 2022 , net income totaled$3.8 million or$0.16 per share compared to$3.2 million or$0.14 per share for the same six-month period in 2021. All major components of the income statement improved, with the exception of noninterest expense. Net interest income grew$401 thousand , provision for loan losses decreased$197 thousand , non-interest income increased$210 thousand , and non-interest expense increased$24 thousand . Consequently, income tax expense increased$188 thousand due to the increase in net income before income taxes. 26 The balance sheet grew to$847.0 million as ofJune 30, 2022 , from$794.6 million as ofDecember 31, 2021 , due toFederal Home Loan Bank advances taken as a precautionary measure in response to the cybersecurity incident. Total deposits decreased$449 thousand to$707.1 million atJune 30, 2022 from$707.5 million atDecember 31, 2021 . Loans decreased$8.1 million to$585.6 million during the first six months of 2022, due to repayments of several large commercial real estate loans combined with PPP loan repayments of approximately$5.6 million .
During the second quarter of 2022, plans were announced for the closure of branches in
During the second quarter of 2022, we initiated a previously announced stock repurchase program. ThroughJune 30, 2022 , 16,510 shares have been repurchased at an average price of$2.28 per share.
Comparison of three months ended
While the cybersecurity incident impacted branch operations and limited our abilities for loan and financial services production, the results for the three months endedJune 30, 2022 are favorable before considering the effect of the cybersecurity incident.
Highlights of the quarter to date include:
Average return on assets and equity of 0.94% and 13.45% for the second
quarter of 2022, compared to 0.82% and 11.15% in the second quarter of 2021,
respectively;
The net interest income was
improvement of
The provision for loan losses has been
reduction of
Non-interest income was
during the second quarter of 2022 compared to the second quarter of 2021; and
· Non-interest expenses have been
the second quarter of 2022 compared to the second quarter of 2021. The Company's primary source of income is net interest income, which increased by$193 thousand , or 2.9%, to$6.8 million for the second quarter of 2022 compared to$6.7 million for the second quarter of 2021. Interest income increased$112 thousand due to a$26 million increase in the average balance of earning assets, a shift of funds from interest bearing deposit balances at other banks to higher-yielding investment securities, and the 2022 increases in the fed funds rate partially offset by a decline in accelerated fee recognition when PPP loans are forgiven. Additionally, total interest expense decreased$81 thousand driven primarily by a$171 thousand decrease in interest on deposits, a result of growth in noninterest bearing deposits. This decrease in deposit interest expense offset increases for borrowed funds, resulting from FHLB advances taken during the second quarter of 2022, and increases to the interest rates associated with trust preferred securities. Overall there was a 13 basis-point decrease in the cost of funds to 33 bps, while the net interest margin decreased 2 bps to 3.50%. During the second quarter of 2022, theFederal Reserve's Open Market Committee (FOMC) increased the discount rate two times for a total of 125 bps. The Company experienced some benefit of the rate increases during the second quarter, but the full impact will be somewhat lagging as certain loans, investments, and trust preferred securities will not reprice until the individual instruments next interest rate repricing date. Deposit rates were not immediately impacted by the rate increases, and the Company will continue to evaluate rate adjustments for factors, including competitive pressure within the local markets, funding needs to support growth and other needs. 27
The following table shows the rates paid on earning assets and interest-bearing liabilities for the periods indicated:
Net Interest Margin Analysis
Average Balances, Income and Expense, and Yields and Rates
(Dollars in thousands)
Three Months Ended June 30,
2022 2021
Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rates Balance Expense Rates
ASSETS
Loans (1) (2) $ 597,570 $ 6,791 4.56%
Mortgage loans held for sale 124 1 4.17% 187 2 4.40% Federal funds sold 189 1 0.87% 188 - 0.08%
Interest-bearing deposits with other banks 68,298,158 0.93%
89,540 22 0.10%
Taxable investment securities 117,905 509 1.73%
72,540,366 2.02%
Total earning assets 784,086 7,460 3.82%
758,325 7,348 3.89%
Less: Allowance for loans losses (6,887) (7,355)
Non-earning assets 43,371 61,054
Total Assets $ 820,570 $ 812,024
LIABILITIES AND EQUITY
Interest-bearing demand deposits$ 71,805 $ 19 0.10%
Savings and money market deposits 197,346 40 0.08% 178,369 36 0.08% Time deposits 187,891 345 0.74% 221,131 523 0.95% Short-term borrowings 12,692 71 2.21% 4,979 17 1.35% Trust preferred securities 16,496 141 3.38% 16,496 105 2.52%
Total interest-bearing liabilities 486,230,616 0.51%
480,424,697 0.69%
Non-interest-bearing deposits 268,802 - -% 263,023 - - %
Total deposit liabilities and cost of
funds 755,032 616 0.33%
743,447,697 0.46%
Other liabilities 8,213 8,755
Total Liabilities 763,245 752,202
Shareholders' Equity 57,325 59,822
Total liabilities and shareholders
Equity$ 820,570 $ 812,024 Net Interest Income$ 6,844 $ 6,651 Net Interest Margin 3.50% 3.52% Net Interest Spread 3.31% 3.31%
(1) Unexpected loans and loans held for sale have been included in the average loan balances. (2) Tax-exempt income is not material and has been treated as fully taxable.
Net interest income is affected by changes in both average interest rates and average volumes (balances) of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total changes in interest income and interest expense which can be attributed to rates and volume for the three months endedJune 30, 2022 , as compared to the three months endedJune 30, 2021 . 28 Volume and Rate Analysis Increase (decrease) Three Months EndedJune 30, 2022 versus 2021 Change in Interest
(Dollars in thousands) Volume Effect Rate Effect Income/ Expense Interest Income: Loans$ (249 ) $ 82 $ (167 ) Mortgage loans held for sale (1 ) - (1 ) Federal funds sold - 1 1 Interest bearing deposits in other banks (6 ) 142 136 Taxable investment securities 172
(29 ) 143 Total Earning Assets (84 ) 196 112 Interest Expense:
Interest-bearing demand deposits 4 (1 ) 3 Savings and money market deposits 4
- 4 Time deposits (73 ) (105 ) (178 ) Short-term borrowings 41 13 54
Trust preferred securities - 36 36 Total Interest-bearing Liabilities (24 ) (57 ) (81 ) Change in Net Interest Income $ (60 ) $
253 $ 193
Based on our current assessment of the loan portfolio, a lower provision of$75 thousand was made in the second quarter of 2022, after considering the overall loan quality, despite increases to past due and nonaccrual loans during the three months endedJune 30, 2022 . These increases appear to be attributable to delays in providing account notices during the latter portion ofJune 2022 . Although the provision declined from the same period of 2021, the allowance for loan losses as a percentage of loans increased from 1.13% atDecember 31, 2021 to 1.16% as ofJune 30, 2022 . For a discussion of the factors affecting the allowance for loan losses, including provision expense, refer to Note 7, Allowance for Loan Losses, in Item 1 of this Form 10-Q. Noninterest income for the second quarter of 2022 was$2.3 million , a decrease of$30 thousand , or 1.3%, when compared to the same period in 2021. During the period immediately after the cybersecurity incident, we temporarily stopped assessing overdraft and certain other service charges. While service charges for the three months endedJune 30, 2022 , exceeded the same three-month period in 2021 by$56 thousand , we estimate that additional normalized charges of approximately$125 thousand would have been realized during this period. Card processing and interchange revenue decreased$45 thousand for the three months endedJune 30, 2022 , as compared to the same period in 2021, due to a decline in transaction volume. Revenue from financial services activities decreased$33 thousand , or 12.0%, as we were limited in executing client transactions, especially new account activity during the disruption to our computer systems. Total non-interest expense decreased$66 thousand , year-over-year for the three-month period endedJune 30, 2022 . Increases to salaries and benefits expenses of$283 thousand were largely offset by reduced occupancy expenses, data processing and other noninterest expenses which decreased$167 thousand ,$52 thousand and$130 thousand , respectively. The increase to salaries and benefits was due to the impact of overall salary adjustments implemented during the fourth quarter of 2021 and accruals for performance related payments in 2022 that had not yet been implemented in 2021. These changes accounted for$91 thousand and$72 thousand of the overall increase to salaries and benefits. Occupancy expense benefitted from reduced depreciation and property tax expenses, which decreased$113 thousand and$15 thousand , respectively, due to the disposals of real estate and equipment over the past year. The decrease in other nonoperating expenses was due largely to reduced costs associated with loan collections and costs associated with the foreclosure and holding of other real estate owned. In addition, certain costs associated with the recovery from the cyber security incident, including insurance deductibles, were recorded during the second quarter of 2022.
The efficiency ratio, a non-GAAP measure which is defined as non-interest expense divided by the sum of net interest income and non-interest income, improved from 74.5% in the second quarter of 2021 to 72.4% for the second quarter of 2021. We continue to evaluate our operating procedures and our structure in order to improve efficiency and contain costs. A review of deposit operations is planned for the third quarter of 2022
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OnApril 29, 2022 , the Bank notified its principal regulators that it will be closing branch offices inBig Stone Gap andChilhowie, Virginia , onAugust 12, 2022 . Accounts serviced at these offices will be transferred to nearby branches, and employees will be reassigned to other positions or offices, as available. Interactive teller machines at these locations will remain in service for the foreseeable future. This restructuring of the branch network should improve the efficiency of services to the customers of these communities. Income tax expense for the second quarter of 2022 totaled$536 thousand , an increase of$80 thousand , or 17.5% from the$456 thousand recorded during the same period in 2021. The effective tax rate for the three months endedJune 30, 2022 , was 21.8%, compared to 21.5% for the same period in 2021. The year-over-year, quarterly increase approximates the percentage increase of
pre-tax earnings.
Comparison of the six months ended
While the cybersecurity incident impacted branch operations and limited our abilities for loan and financial services production, the results for the six months endedJune 30, 2022 are favorable to the six-month period ended June
30, 2021.
Highlights of the year to date include:
Net interest income improved for
improvement of
Net interest margin was 3.52% for the first half of 2022, down 3bps
compared to 3.55% for the first half of 2021;
The provision for loan losses has been
reduction of
Non-interest income was
compared to the first half of 2021;
· Salary and benefits expenses have been
thousand, i.e. 7.8%, compared to the first half of 2021; and
The total non-interest expense has been
0.18%, compared to the first half of 2021. Overall, during the six months endedJune 30, 2022 , compared to the same period in 2021, net income improved 18.4% to$3.8 million from$3.2 million . Although interest income was virtually unchanged, increasing$50 thousand , reduced interest expense of$351 thousand contributed to an improvement of$401 thousand in net interest income. The following table presents the rates earned on earning assets and paid on interest-bearing liabilities for the periods indicated.
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Net Interest Margin Analysis Average Balances, Income and Expense, and Yields
and Rates
(Dollars in thousands)
Six Months Ended June 30,
2022 2021
Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rates Balance Expense Rates
ASSETS
Loans (1) (2) $ 596,813 $ 13,465 4.55% $ 591,066 $ 13,877 4.74%
Mortgage loans held for sale 69 1 4.33% 355 4 2.40%
Federal funds sold 203 1 0.49% 207 - 0.07%
Interest-bearing deposits with other banks 61,094,179 0.59%
88,543 41 0.09%
Taxable investment securities 114,190 971 1.70%
61,177,645 2.11%
Total earning assets 772,369 14,617 3.82%
741,348 14,567 3.96%
Less: Allowance for loans losses (6,867) (7,329)
Non-earning assets 46,335 60,499
Total Assets $ 811,837 $ 794,518
LIABILITIES AND EQUITY
Interest-bearing demand deposits$ 69,523 $ 35 0.10%
Savings and money market deposits 195,780 78 0.08% 171,353 73 0.09% Time deposits 192,064 720 0.76% 227,002 1,155 1.03% Short-term borrowings 6,381 71 2.21% 4,989 33 1.35% Trust preferred securities 16,496 248 2.98% 16,496 212 2.55%
Total interest-bearing liabilities 480,244 1,152 0.48%
476,082 1,503 0.64%
Non-interest-bearing deposits 263,509 - -% 250,309 - - %
Total deposit liabilities and cost of
funds 743,753 1,152 0.31%
726,391 1,503 0.42%
Other liabilities 7,773 8,898
Total Liabilities 751,526 794,523
Shareholders' Equity 60,188 59,234
Total liabilities and shareholders
Equity$ 811,714 $ 794,523 Net Interest Income$ 13,465 $ 13,064 Net Interest Margin 3.52% 3.55% Net Interest Spread 3.33% 3.32%
(1) Unexpected loans and loans held for sale have been included in the average loan balances. (2) Tax-exempt income is not material and has been treated as fully taxable.
Net interest income is affected by changes in both average interest rates and average volumes (balances) of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total changes in interest income and interest expense which can be attributed to rates and volume for the six months endedJune 30, 2022 , as compared to the six months ended
June 30, 2021 . 31 Volume and Rate Analysis Increase (decrease) Six Months EndedJune 30, 2022 versus 2021 Change in Interest
(Dollars in thousands) Volume Effect Rate Effect Income/ Expense Interest Income: Loans $ (408 ) $ (4 ) $ (412 ) Mortgage loans held for sale (3 ) - (3 ) Federal funds sold - 1 1
Interest bearing deposits in other banks (16 )
154 138 Taxable investment securities 385 (59 ) 326 Total Earning Assets (42 ) 92 50 Interest Expense:
Interest-bearing demand deposits 8 (3 ) 5 Savings and money market deposits 10
(5 ) 5 Time deposits (161 ) (273 ) (435 ) Short-term borrowings 15 22 37 Trust preferred securities - 36 36
Total Interest-bearing Liabilities (128 ) (223 ) (351 ) Change in Net Interest Income $ 86
$ 315 $ 401
During the first six months of 2022 compared to the first half of 2021, net interest income increased$401 thousand primarily due to a reduction in interest expense on deposits of$424 thousand , partially offset by increases to the cost of borrowed funds of$73 thousand . The increase in expense for borrowed funds was due to$95 million of FHLB advances taken during the second quarter, combined with rate increases on trust preferred securities. The reduction in interest expense on deposits was driven mainly by a reduction in the average cost of retail time deposits, which declined 27 basis points, to 0.76% from 1.03%, plus a decrease in average balances of$34.9 million . There was a modest increase in interest income of$50 thousand due to increases to the investment portfolio and increased rates paid on deposits with other banks. These improvements offset reductions in loan interest and fees due principally to the reduction in fees from PPP loan repayments as these fees fell$535 thousand during the comparative six-month periods. As a result, the net interest margin for the first half of 2022 was 3.52%, a reduction of 3 bps compared to 3.55% for the first half of 2021. During the first six months of 2022, theFOMC increased the discount rate three times for a total of 150 bps. This increased interest rate environment has improved returns on certain assets that immediately adjust as these changes are made, such as interest-bearing deposits in other banks, credit cards, home equity lines of credit and certain commercial and commercial real estate loans. It is anticipated that yields on these assets will improve moving forward. Conversely, it is expected that there will be a need to adjust, upward, rates paid on deposit accounts, which will increase our overall cost of funds. Additionally, in response to the cybersecurity incident, in earlyAugust 2022 , we began offering a customer appreciation time deposit product to recognize the patience and loyalty of our customers. This product pays a higher rate than is currently offered on similar non-promotional products and is expected to contribute to an increased cost of funds going forward. Based on our current assessment of the loan portfolio,$175 thousand was provided to the allowance for loan losses during the first six months of 2022 compared to$372 thousand provided during the same period in 2021. For more information on the factors affecting the allowance for loan losses, including provision expense, refer to Note 7, Allowance for loan Losses, in Item 1 of this Form 10-Q. Depending on changes to economic conditions and the impact those changes may have on individual borrowers, it is possible that additional provisions may be needed beyond those necessary to support organic growth of the loan portfolio. Total non-interest income for the first half of 2022 compared to the same period in 2021 grew by$210 thousand to$4.7 million . This improvement was driven by increases in service charges and fees which increased$231 thousand or 13.8%, despite the negative impact during the second quarter resulting from foregoing certain charges during the cybersecurity incident, as previously discussed. Card processing and interchange income showed a slight increase of$7 thousand , as transaction volume has plateaued, as consumers respond to the cessation of stimulus payments and the effects of historic inflation. Financial services revenues of$483 thousand represent a decrease of$18 thousand or 3.6%. As previously discussed, our ability to provide certain services was hampered during the latter portion ofJune 2022 , and it is uncertain whether those lost opportunities can be recovered. 32 For the six months endedJune 30, 2022 , compared to the same period in 2021, total non-interest expense increased$24 thousand , to$13.1 million . The modest increase was due to reductions to occupancy, data processing and other noninterest expenses of$337 thousand ,$71 thousand and$47 thousand , respectively which offset increases to salaries and benefits of$479 thousand . As discussed previously, salaries and benefits increased year-over-year due to the impact of overall salary adjustments implemented during the fourth quarter of 2021 and accruals for performance related payments in 2022 that had not yet been fully initiated in 2021. Also, as discussed, occupancy costs decreased due to the reduction of depreciation and property tax costs from the reduction and disposition of branches and equipment, which decreased year-over-year$208 thousand and$28 thousand , respectively. It is anticipated that the branch closings scheduled forAugust 12, 2022 will serve to further reduce occupancy and related costs. Data processing and telecommunication costs decreased due to negotiated reductions for the cost, or elimination, of certain services, as local phone and data line costs decreased$30 thousand and data processing costs decreased$37 thousand for the comparative year-to-date periods. Other noninterest expenses benefited from reduced costs associated with loan collection efforts which decreased$50 thousand for the first six months of 2022 as compared to the same period in 2021.
The efficiency ratio, a non-GAAP measure, improved to 72.0% for the first half of 2022, from 74.4% for the first half of 2021.
Balance Sheet Balance sheet growth in 2022, specifically activity during the second quarter, was impacted by efforts to address any possible adverse impact from the cybersecurity incident. As a preventative measure against a possible surge in deposit withdrawal activity, we obtained FHLB advances totaling$95 million , transferred additional funds to our account at theFederal Reserve Bank and temporarily increased cash on hand at various branch locations. As we moved from the immediate aftermath of the incident, we repaid$35 million of FHLB advances prior toJune 30, 2022 . Total assets increased$52.4 million , or 6.6%, to$847.0 million atJune 30, 2022 from$794.6 million atDecember 31, 2021 . This growth was primarily driven by the FHLB advances as total deposits decreased$449 thousand , as noninterest-bearing deposits increased$8.7 million while interest-bearing deposits decreased$9.2 million . The year-to-date deposit activity is due to a combination of factors including customer reaction to the cybersecurity incident, time deposit customers seeking higher interest rates and actions taken by customers at the two branch locations scheduled for closure inAugust 2022 . The FHLB advance funds were transferred to interest bearing deposits with other banks which increased$60.0 million year-to-date. Total investments decreased$6.7 million , or 6.3%, to$100.6 million atJune 30, 2022 due primarily to an increase of$12.8 million in net unrealized losses and$8.6 million of repayments and maturities, which more than offset purchases of$14.9 million . Purchases are expected to continue as we replace security repayments, deploy excess liquidity, and use the investment portfolio in the overall management of the interest rate risk and liquidity of the balance sheet. There were$62 thousand of loans held for sale atJune 30, 2022 versus$0 atDecember 31, 2021 . These loans are originated for sale into the secondary market on a best efforts basis. Loans receivable decreased$8.1 million , or 1.4% during the first six months of 2022, due to repayments of commercial real estate and commercial loans. Commercial real estate loans decreased$9.6 million or 4.6%, to$196.6 million atJune 30, 2022 , due largely to several borrowers liquidating properties held as collateral. These repayments were offset by increases in construction and development loans, and loans secured by multi-family real estate which increased$5.4 million or 16.6% and$4.6 million or 13.8%, respectively. Commercial loans decreased$7.6 million or 14.0% to$46.7 million atJune 30, 2022 , due largely to repayments and forgiveness of PPP loans which declined$5.6 million during the first six months of 2022. AtJune 30, 2022 , PPP loans totaled$845 thousand . Total deposits decreased$449 thousand or 0.1% to$707.1 million atJune 30, 2022 from$707.5 million atDecember 31, 2021 . While the year-to-date change is modest, during the second quarter of 2022, deposits decreased$23.9 million from$731.0 million atMarch 31, 2022 . While we have experienced deposit runoff in response to the cybersecurity incident, other factors have also influenced customers' activities, including interest rates available for time deposits and the previously announced closure of two branch offices scheduled forAugust 2022 . Additionally, some of this deposit activity is due to normal churn of deposit accounts and depositors. The year-to-date decrease in deposits is primarily due to time deposit runoff as total time deposits decreased$17.1 million or 8.6%. The decrease in time deposits was offset by increases in non-interest bearing and interest-bearing transaction accounts which increased$8.7 million or 3.5% and$7.9 million or 3.1% during the six months endedJune 30, 2022 . Another factor influencing deposit retention is the dissipation of liquidity experienced by depositors, as stimulus and other economic support funds distributed during the height of the COVID-19 pandemic are spent or otherwise distributed. While it is likely that recent and expected increases to the federal funds rate will, at some point, impact liquidity, we continue to maintain core deposits through attractive consumer and commercial deposit products and strong ties with our customer base and communities. 33 AtJune 30, 2022 , FHLB advances totaling$60 million were outstanding. As previously discussed, these advances were taken inJune 2022 , as a precautionary measure related to the cybersecurity incident. The advances have schedule maturities of$20 million inSeptember 2022 , and$40 million inDecember 2022 . OnAugust 1, 2022 ,$15 million of the$40 million advance was repaid. Trust preferred securities of$16.5 million atJune 30, 2022 were unchanged compared toDecember 31, 2021 . Total equity atJune 30, 2022 was$56.2 million , a decrease of$7.5 million , or 11.7%, compared to$63.6 million atDecember 31, 2021 . As discussed previously and in the Capital Resources section below, the primary driver of the decline was the$10.1 million net increase in the other accumulated comprehensive loss, related to the unrealized loss on available for sale investment securities, along with a cash dividend payment. The increase in other accumulated comprehensive loss is related to the recent increase in interest rates and is not related to any deterioration in the credit quality of any investment securities held. Asset Quality Nonperforming assets include nonaccrual loans, other real estate owned (OREO) and loans past due more than 90 days which are still accruing interest. Our policy is to place loans on nonaccrual status once they reach 90 days past due. The makeup of the nonaccrual loans is primarily those secured by residential mortgages and commercial real estate. OREO is primarily made up of commercial and single-family residential properties. Nonperforming assets decreased$347 thousand , or 8.1%, during the first six months of 2022, driven by a decrease in OREO of$1.0 million , which offset an increase in nonaccrual loans of$693 thousand . The increase in nonaccrual loans is attributed to a single credit for a commercial construction loan. This account has been assessed as part of our determination of the adequacy of the allowance for loan losses, and collection efforts are ongoing. No loans 90 days or more past due are accruing interest. As a result, the ratio of nonperforming assets to total assets decreased to 0.50% atJune 30, 2022 compared to 0.54% atDecember 31, 2021 . For detailed information for nonaccrual loans and other real estate owned as ofJune 30, 2022 , andDecember 31, 2021 , refer to Note 6 Loans and Note 9 Other Real Estate Owned in Item 1 of this Form 10-Q. AtJune 30, 2022 , OREO is primarily made up of farmland and land acquired through foreclosure. During the second quarter of 2022, two former branch sites that had been transferred to OREO in 2021, were sold bringing our OREO balance down to$321 thousand . We continue extensive and aggressive measures to work through problem credits and liquidate foreclosed properties in an effort to reduce nonperforming assets. We remain mindful of the impact on earnings and capital as we work to achieve our goal to reduce nonperforming assets. However, we may recognize some losses and reductions in the allowance for loan loss as we expedite the resolution of these problem assets. Loans rated substandard or below totaled$3.6 million atJune 30, 2022 , an increase of$733 thousand from$2.9 million atDecember 31, 2021 . Total past due loans increased to$10.0 million atJune 30, 2022 from$3.4 million atDecember 31, 2021 . As previously discussed this increase is, in part, due to delays in providing loan account notices during the disruption to our computer systems. Our allowance for loan losses atJune 30, 2022 was$6.8 million or 1.16% of total loans as compared to$6.7 million , or 1.13% of total loans atDecember 31, 2021 . Impaired loans totaled$3.2 million with an estimated related specific allowance of$381 thousand atJune 30, 2022 , as compared to$2.8 million of impaired loans with an estimated related allowance of$166 thousand at the end of 2021. A provision of$175 thousand was recorded for the first six months of 2022 compared to$372 thousand during the first six months of 2021. In the first six months of 2022, net charge-offs totaled$94 thousand , or 0.03% of average loans, annualized, as compared to$867 thousand , or 0.29%, of average loans for the same period in 2021. The allowance for loan losses is maintained at a level that management deems appropriate to absorb any potential future losses and known impairments within the loan portfolio, whether or not the losses are actually ever realized. Through our quarterly assessment, we continue to adjust the allowance for loan loss model to best reflect the risks in the portfolio and the improvements made in our internal policies and procedures; however, future provisions may be deemed necessary. During the first six months of 2022, we adjusted our external qualitative factors to reflect positive employment and home sales statistics, along with adjusting for the impact of historically high inflation. Those changes along with the assessment of the inherent and specific risks associated with the loan portfolio resulted in a provision to the allowance of$175 thousand for the first six months 2022. 34
The following table summarizes the components of the allowance for loan losses and loans related to the
Selected Credit Ratios
June 30, December 31,
(Dollars in thousands) 2022 2021
Allowance for loan losses $ 6,816 $ 6,735
Total loans 585,631 593,744
Allowance for loan losses to total loans 1.16%
1.13%
Nonaccrual loans$ 3,634 $
2,941
Nonaccrual loans to total loans 0.62%
0.50%
Ratio of allowance for loan losses to nonaccrual loans 1.88X 2.29X Charge-offs net of recoveries$ 94 $ 828 Average loans$ 596,813 $ 586,963
Net charge-offs to average loans 0.03%
0.14%
We are in the process of preparing to implement the Current Expected Credit Loss (CECL) model to replace our legacy loan loss model. While we had estimated we would be running concurrent models byJune 30, 2022 , due to the cybersecurity incident, we delayed the start of parallel runs. We have recovered and the new model has been constructed, initial assumptions have been input and historical loan and loss activity has been input and validated. Starting inAugust 2022 , the Company will run the new methodology parallel to the current allowance methodology for several periods before full implementation, beginning with
theJune 30, 2022 data.
Deferred tax asset and income taxes
Due to timing differences between book and tax treatment of several income and expense items, a net deferred tax asset, excluding the deferred tax asset on the unrealized loss on securities available for sale, of$813 thousand and$1.5 million existed atJune 30, 2022 andDecember 31, 2021 , respectively. Our income tax expense was computed at the corporate income tax rate of 21% of taxable income. We have no significant nontaxable income or nondeductible expenses.
Capital Resources Total shareholders' equity atJune 30, 2022 was$56.2 million compared to$63.6 million atDecember 31, 2021 , a decrease of$7.5 million , or 11.7%. As previously discussed, this decline was driven by the$10.1 million net increase in the accumulated other comprehensive loss related to the unrealized loss on investment securities available-for-sale. Excluding the impact of the unrealized loss, equity increased$2.6 million , due to net income of$3.8 million less the cash dividend payment of$1.2 million and$38 thousand used for share repurchases. The Company meets the eligibility criteria to be classified as a small bank holding company in accordance with theFederal Reserve's Small Bank Holding Company Policy Statement issued inFebruary 2015 and is therefore not obligated to report consolidated regulatory capital. The Bank continues to be subject to various capital requirements administered by banking agencies.
The Bank’s capital ratios as well as the minimum regulatory thresholds to be considered well capitalized are presented in note 4 of item 1 of this Form 10-Q.
To
terms.
Book value per common share was$2.35 atJune 30, 2022 , and$2.66 atDecember 31, 2021 . Excluding the impact of the accumulated other comprehensive loss, book value per share was$2.80 atJune 30, 2022 , and$2.69 andDecember 31, 2021 , respectively. Other key performance indicators are as follows: 35 Three months ended June 30, Six months ended June 30, 2022 2021 2022 2021 Return on average assets1 0.94% 0.82% 0.95% 0.82% Return on average equity1 13.45% 11.15% 12.88% 11.06%
Average equity to average assets 6.99% 7.37% 7.41
7.46% 1 - Annualized
Under current economic conditions, we believe it is prudent to continue to retain capital sufficient to support planned asset growth while being able to absorb potential losses that may occur if asset quality deteriorates, and based upon projections, we believe our current capital levels will be sufficient. During the first quarter of 2022, the Company paid its first cash dividend of$0.05 per common share to our shareholders. Earnings will continue to be retained to provide capital to support the planned growth and operations of the Company and to continue to pay any future dividends to shareholders. OnApril 28, 2022 the board of directors of the Company authorized the repurchase of up to 500,000 shares of the Company's outstanding common stock throughMarch 31, 2023 . The actual means and timing of any purchases, number of shares and prices or range of prices will be determined by the Company in its discretion and will depend on a number of factors, including the market price of the Company's common stock, general market and economic conditions, and applicable legal and regulatory requirements. During the second quarter of 2022, 16,510 shares were purchased at an average price of$2.28 per share; and, during the third quarter 2022, throughAugust 10, 2022 an additional 5,720 shares have been purchased. There is no assurance that the Company will purchase any additional shares under this program. Liquidity
As discussed previously, in response to the cybersecurity incident we took efforts to increase on balance sheet liquidity through a series of FHLB advances transferred to our account atFederal Reserve Bank and pledging additional investment securities as collateral against unused funding sources for emergency needs. The deposit runoff since the cybersecurity incident has not been significant. We closely monitor our liquidity and our liquid assets in the form of cash, due from banks, federal funds sold, and unpledged available for sale investments. Collectively, those balances were$184.7 million atJune 30, 2022 , an increase of$25.4 million from$159.3 million atDecember 31, 2021 . A surplus of short-term assets is maintained at levels management deems adequate to meet potential liquidity needs during 2022. AtJune 30, 2022 , all of our investment securities were classified as available-for-sale. These investments provide a source of liquidity in the amount of$70.9 million , which is net of the$29.7 million of securities pledged as collateral. Investment securities available for sale serve as a source of liquidity while yielding a higher return versus other short-term investment options, such as federal funds sold and overnight deposits with theFederal Reserve Bank . Our loan to deposit ratio was 82.8% atJune 30, 2022 and 83.9% atDecember 31, 2021 . We anticipate this ratio to remain at or below 90% for the foreseeable future. While we have experienced some deposit runoff in response to the cybersecurity incident, other factors have also influenced customers' activities, including interest rates available for time deposits and the previously announced closure of two branch offices scheduled forAugust 2022 . Additionally, some of this deposit activity is due to normal churn of deposit accounts and depositors. Available third-party sources of liquidity atJune 30, 2022 include the following: a line of credit with the FHLB, access to brokered certificates of deposit markets and the discount window at theFederal Reserve Bank . We also have the ability to borrow$30.0 million in unsecured federal funds through credit facilities extended by correspondent banks. The Bank's line of credit with the FHLB is$203.3 million , with unused availability atJune 30, 2022 of$136.3 million . FHLB advances totaling$60 million were outstanding atJune 30, 2022 , but the credit line also secures a letter of credit totaling$7.0 million . The available line and the outstanding letters of credit are secured by a blanket lien on our residential real estate loans which amounted to$129.2 million atJune 30, 2022 . The Bank also has access to the brokered deposits market and the Certificate of Deposit Registry Service (CDARS). AtJune 30, 2022 , we held no brokered deposits and$2.8 million in CDARS reciprocal time deposits and$10.6 million in ICS reciprocal interest-bearing demand deposits. 36
Additional cash is available through the
With the on-balance sheet liquidity and other external sources of funding, we believe the Bank has adequate liquidity and capital resources to meet our requirements and needs for the foreseeable future. However, liquidity can be further affected by a number of factors such as counterparty willingness or ability to extend credit, regulatory actions and customer preferences, etc., some of which are beyond our control. The bank holding company has approximately$523 thousand in cash on deposit at the Bank atJune 30, 2022 . The holding company receives periodic dividend payments from the Bank which are used to pay operating expenses, to pay trust preferred interest payments, and to fund dividend payments to shareholders and repurchase shares. The Company makes quarterly interest payments on the trust preferred securities. As discussed in the Capital Resources section, the Company authorized the repurchase of up to 500,000 shares of the Company's outstanding common stock throughMarch 31, 2023 . Payments for any repurchases will be distributed from available funds, or from dividends payments from the Bank, and are not expected to have a material impact on available liquidity.
Off-balance sheet items and contractual obligations
There have been no material changes during the six months endedJune 30, 2022 , to the off-balance sheet items and the contractual obligations disclosed in our 2021 Form 10-K.
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