EAGLE FINANCIAL SERVICES, INC. The purpose of this discussion is to focus on the important factors affecting the financial condition, results of operations, liquidity and capital resources ofEagle Financial Services, Inc. (the "Company"). This discussion should be read in conjunction with the Company's Consolidated Financial Statements and the Notes to the Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.
GENERAL
The Company is a bank holding company which owns 100% of the stock ofBank of Clarke (the "Bank"). Accordingly, the results of operations for the Company are dependent upon the operations of the Bank. The Bank conducts a commercial banking business which consists of attracting deposits from the general public and investing those funds in commercial, consumer and real estate loans and corporate, municipal andU.S. government agency securities. The Bank also conducts a marine lending business as well as a wealth management division. The Bank's deposits are insured by theFederal Deposit Insurance Corporation to the extent permitted by law. AtDecember 31, 2022 , the Company had total assets of$1.62 billion , net loans of$1.31 billion , total deposits of$1.26 billion and shareholders' equity of$101.7 million . The Company's net income was$14.5 million for the year endedDecember 31, 2022 . 23 --------------------------------------------------------------------------------
The following table presents selected financial data, which was derived from the Company's audited financial statements for the periods indicated.
As of or for the Years Ended
December 31,
2022 2021 2020 2019 2018
(dollars in thousands, except per share amounts)
Income Statement Data:
Interest and dividend
income $ 54,686 $ 42,676 $ 38,908 $ 35,454 $ 31,923
Interest expense 5,473 1,677 3,281 4,239 2,515
Net interest income
1,483 1,457 629 777
Net interest income after
provision for loan losses $ 47,383 $ 39,516 $ 34,170 $ 30,586 $ 28,631
Noninterest income 13,345 11,320 8,579 7,759 3,879
Net revenue $ 60,728 $ 50,836 $ 42,749 $ 38,345 $ 35,510
Noninterest expenses 43,057 38,049 29,441 26,776 25,195
Income before income
taxes $ 17,671 $ 12,787 $ 13,308 $ 11,569 $ 10,315
Applicable income taxes 3,150 1,766 2,136 1,810 1,314
Net Income $ 14,521 $ 11,021 $ 11,172 $ 9,759 $ 9,001
Performance Ratios:
Return on average assets 1.02 % 0.90 % 1.11 % 1.18 % 1.16 %
Return on average equity 14.06 % 10.28 % 11.03 % 10.60 % 10.67 %
Shareholders' equity to
assets 6.29 % 8.46 % 9.30 % 10.98 % 10.96 %
Dividend payout ratio 27.58 % 34.38 % 31.80 % 35.21 % 36.15 %
Non-performing loans to
total loans 0.19 % 0.28 % 0.57 % 0.34 % 0.35 %
Non-performing assets to
total assets 0.16 % 0.21 % 0.47 % 0.27 % 0.28 %
Share and Per Share Data: Net income, basic$ 4.17 $ 3.20 $ 3.27 $ 2.84 $ 2.60 Net income, diluted 4.17 3.20 3.27 2.84 2.60 Cash dividends declared 1.15 1.10 1.04 1.00 0.94 Book value 29.15 31.93 30.86 28.08 25.42 Market price 35.95 34.65 29.50 31.05 30.99 Average shares outstanding, basic 3,482,368 3,440,080 3,417,543 3,438,410 3,467,667 Average shares outstanding, diluted 3,482,368 3,440,080 3,417,543
3,438,410 3,467,667
Balance Sheet Data: Total securities$ 158,389 $ 193,370 $ 166,222 $ 166,200 $ 145,468 Total loans 1,323,783 985,720 836,334 644,760 606,827 Total assets 1,616,717 1,303,038 1,130,152 877,320 799,617 Total deposits 1,264,075 1,177,235 1,013,087 771,544 703,104 Shareholders' equity 101,729 110,280 105,074 96,326 87,599 24
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MANAGEMENT'S STRATEGY
The Company strives to be an outstanding financial institution in its market by building solid sustainable relationships with: (1) its customers, by providing highly personalized customer service, a network of conveniently placed branches and ATMs, a competitive variety of products/services and courteous, professional employees, (2) its employees, by providing generous benefits, a positive work environment, advancement opportunities and incentives to exceed expectations, (3) its communities, by participating in local concerns, providing monetary support, supporting employee volunteerism and providing employment opportunities, and (4) its shareholders, by providing sound profits and returns, sustainable growth, regular dividends and committing to our local, independent status. OPERATING STRATEGY The Bank is a locally owned and managed financial institution. This allows the Bank to be flexible and responsive in the products and services it offers. The Bank grows primarily by lending funds to local residents and businesses at a competitive price that reflects the inherent risk of lending. The Bank attempts to fund these loans through deposits gathered from local residents and businesses. The Bank prices its deposits by comparing alternative sources of funds and selecting the lowest cost available. When deposits are not adequate to fund asset growth, the Bank relies on borrowings, both short and long term. The Bank's primary source of borrowed funds is theFederal Home Loan Bank of Atlanta which offers numerous terms and rate structures to the Bank. As interest rates change, the Bank attempts to maintain its net interest margin. This is accomplished by changing the price, terms, and mix of its financial assets and liabilities. The Bank also earns fees on services provided through theBank of Clarke Wealth Management Division , which is the Bank's investment management division that offers both trust services and investment sales, mortgage originations and deposit operations. The Bank also incurs noninterest expenses associated with compensating employees, maintaining and acquiring fixed assets, and purchasing goods and services necessary to support its daily operations. The Bank has a marketing department which seeks to develop new business. This is accomplished through an ongoing calling program whereby account officers contact existing and potential customers to discuss the products and services offered. The Bank conducts advertising through television commercials, radio ads, newspaper ads, printed materials, electronic materials, billboards, emails, and social media posts. LENDING POLICIES Administration and supervision over the lending process is provided by the Bank'sCredit Administration Department . The principal risk associated with the Bank's loan portfolio is the creditworthiness of its borrowers. In an effort to manage this risk, the Bank's policy gives loan amount approval limits to individual loan officers based on their position and level of experience. Credit risk is increased or decreased, depending on the type of loan and prevailing economic conditions. In consideration of the different types of loans in the portfolio, the risk associated with real estate mortgage loans, commercial loans and consumer loans varies based on employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay debt. The Company has written policies and procedures to help manage credit risk. The Company utilizes a loan review process that includes formulation of portfolio management strategy, guidelines for underwriting standards and risk assessment, procedures for ongoing identification and management of credit deterioration, and regular portfolio reviews to establish loss exposure and to ascertain compliance with the Company's policies. The Bank uses a tiered approach to approve credit requests consisting of individual lending authorities, joint approval of Co-Approval officers (Executive, Regional Credit Officer, Small Business Credit Officer), and a director loan committee. Lending limits for individuals are set by the Board of Directors and are determined by loan purpose, collateral type, and internal risk rating of the borrower. The highest individual authority (Executive) is assigned to the Bank's President/ Chief Executive Officer, Chief Banking Officer andChief Credit Officer (approval authority only). Two Executive officers may combine their authority to approve loan requests to borrowers with credit exposure up to$10.0 million on a secured basis and$6.0 million unsecured. Three Executive officers may combine to approve loan requests to borrowers with credit exposure up to$15.0 million on a secured basis and$9.0 million unsecured. Consumer Central Lenders can co-approve consumer, home equity lines of credit and home equity loan requests up to their stated authorities. Officers in Categories A through F have lesser authorities and with approval of an Executive officer may extend loans to borrowers with exposure of$5.0 million on a secured basis and$3.0 million unsecured. Officers in Categories A through F can also utilize the co-approval of the Regional and Small Business Credit Officers to extend loans with exposures up to$2.5 million and$1.5 million respectively on a secured basis, and up to$1 million and$750 thousand respectively on an unsecured basis. Loans exceeding$15.0 million and up to the Bank's legal lending limit can be approved by the Director Loan Committee consisting of four directors (three directors 25 --------------------------------------------------------------------------------
constituting a quorum). The Director's Loan Committee also reviews and approves changes to the Bank's Loan Policy as presented by management. The following sections discuss the major loan categories within the total loan portfolio:
One-to-Four-Family Residential Real Estate Lending
Residential lending activity may be generated by the Bank's loan officer solicitations, referrals by real estate professionals, and existing or new bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment and credit history of the applicant. The valuation of residential collateral is provided by independent fee appraisers who have been approved by the Bank's Directors Loan Committee. In connection with residential real estate loans, the Bank requires title insurance, hazard insurance and, if applicable, flood insurance. In addition to traditional residential mortgage loans secured by a first or junior lien on the property, the Bank offers home equity lines of credit. Commercial Real Estate Lending Commercial real estate loans are secured by various types of commercial real estate in the Bank's market area, including multi-family residential buildings, commercial buildings and offices, small shopping centers and churches. Commercial real estate loan originations are obtained through broker referrals, direct solicitation of developers and continued business from customers. In its underwriting of commercial real estate, the Bank's loan to original appraised value ratio is generally 80% or less. Commercial real estate lending entails significant additional risk as compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the repayment of loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or the economy, in general. The Bank's commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower's creditworthiness, prior credit history and reputation, and the Bank typically requires personal guarantees or endorsements of the borrowers' principal owners.
Construction and Land Development Lending
The Bank makes local construction loans and land acquisition and development
loans. The construction loans are secured by residential houses under
construction and the underlying land for which the loan was obtained. The
average life of most construction loans is less than one year and the Bank
offers both fixed and variable rate interest structures. The interest rate
structure offered to customers depends on the total amount of these loans
outstanding and the impact of the interest rate structure on the Bank's overall
interest rate risk. There are two characteristics of construction lending which
impact its overall risk as compared to residential mortgage lending. First,
there is more concentration risk due to the extension of a large loan balance
through several lines of credit to a single developer or contractor. Second,
there is more collateral risk due to the fact that loan funds are provided to
the borrower based upon the estimated value of the collateral after completion.
This could cause an inaccurate estimate of the amount needed to complete
construction or an excessive loan-to-value ratio. To mitigate the risks
associated with construction lending, the Bank generally limits loan amounts to
80% of the estimated appraised value of the finished property. The Bank also
obtains a first lien on the property as security for its construction loans and
typically requires personal guarantees from the borrower's principal owners.
Finally, the Bank performs inspections of the construction projects to ensure
that the percentage of construction completed correlates with the amount of
draws on the construction line of credit.
26
--------------------------------------------------------------------------------Commercial and Industrial Lending
Commercial business loans generally have more risk than residential mortgage loans but have higher yields. To manage these risks, the Bank generally obtains appropriate collateral and personal guarantees from the borrower's principal owners and monitors the financial condition of its business borrowers. Residential mortgage loans generally are made on the basis of the borrower's ability to make repayment from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In contrast, commercial business loans typically are made on the basis of the borrower's ability to make repayment from cash flow from its business and are secured by business assets, such as, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much precision as residential real estate. Refer to the Marine Lending section below for discussion of additional commercial and industrial lending.
Consumer Lending
The Bank offers various secured and unsecured consumer loans, which include personal installment loans, personal lines of credit, automobile loans, and credit card loans. The Bank generally originates its consumer loans within its geographic market area and these loans are largely made to customers with whom the Bank has an existing relationship. Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral on a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. Consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant's monthly income may be determined by verification of gross monthly income from primary employment, and from any verifiable secondary income. Although creditworthiness of the applicant is the primary consideration, the underwriting process also includes an analysis of the value of the security in relation to the proposed loan amount.
Refer to the Marine Lending section below for discussion of additional consumer lending.
Marine Lending The Bank's marine lending unit, which includes originated retail loans, which are classified as commercial and industrial loans or consumer loans depending on borrower, and dealer floorplan loans, which are classified as commercial and industrial loans. The Company's relationships are limited to well established dealers of global premium brand manufacturers. The Company's top three manufacturer customers have been in business between 30 and 100 years. The Company primarily has secured agreements with premium manufacturers to support dealer floor plan loans which reduces the Company's credit exposure to the dealer, despite its underwriting of each respective dealer. The Company has developed incentive retail pricing programs with the dealers to drive retail dealer flow. In addition to the repurchase agreements associated with floor plan lending, manufacturers will often support secondary resale values which can have the effect of reducing losses from non-performing retail marine loans. Retail borrowers generally have very high credit scores, substantial down payments, substantial net worth, personal liquidity, and excess cash flow. 27 --------------------------------------------------------------------------------
CRITICAL ACCOUNTING POLICIES
The financial statements of the Company are prepared in accordance with accounting principles generally accepted inthe United States of America ("GAAP"). The financial information contained within these statements is, to a significant extent, based on measurements of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of the transactions would be the same, the timing of events that would impact the transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the probable losses inherent in
the Company's loan portfolio. As required by GAAP, the allowance for loan losses
is accrued when the occurrence of losses is probable and losses can be
estimated. Impairment losses are accrued based on the differences between the
loan balance and the value of its collateral, the present value of future cash
flows, or the price established in the secondary market. The Company's allowance
for loan losses has three basic components: the general allowance, the specific
allowance and the unallocated allowance. Each of these components is determined
based upon estimates that can and do change when actual events occur. The
general allowance uses historical experience and other qualitative factors to
estimate future losses and, as a result, the estimated amount of losses can
differ significantly from the actual amount of losses which would be incurred in
the future. However, the potential for significant differences is mitigated by
continuously updating the loss history and qualitative factor analyses of the
Company. The specific allowance is based upon the evaluation of specific
impaired loans on which a loss may be realized. Factors such as past due
history, ability to pay, and collateral value are used to identify those loans
on which a loss may be realized. Each of these loans is then evaluated to
determine how much loss is estimated to be realized on its disposition. The sum
of the losses on the individual loans becomes the Company's specific allowance.
This process is inherently subjective and actual losses may be greater than or
less than the estimated specific allowance. The unallocated allowance accounts
for a measure of imprecision in the estimate. Note 1 to the Consolidated
Financial Statements presented in Item 8, Financial Statements and Supplementary
Data, of the 2022 Form 10-K, provides additional information related to the
allowance for loan losses.
28
--------------------------------------------------------------------------------FORWARD LOOKING STATEMENTS
The Company makes forward looking statements in this report that are subject to risks and uncertainties. These forward looking statements include statements regarding our profitability, liquidity, 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. These forward looking statements are subject to significant uncertainties because they are based upon or are affected by factors including: • difficult market conditions in our industry; • effects of soundness of other financial institutions; • potential impact on us of existing and future legislation and regulations; • the ability to successfully manage growth or implement growth strategies if the Bank is unable to identify attractive markets, locations or opportunities to expand in the future, expand into new markets, or successfully implement new product lines; • competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources; • the successful management of interest rate risk; • risks inherent in making loans such as repayment risks and fluctuating collateral values; • changes in general economic and business conditions in the market area; • reliance on the management team, including the ability to attract and retain key personnel; • changes in interest rates and interest rate policies; • maintaining capital levels adequate to support growth; • maintaining cost controls and asset qualities as new branches are opened or acquired; • demand, development and acceptance of new products and services; • deposit flows; • problems with technology utilized by the Bank; • changing trends in customer profiles and behavior; • geopolitical conditions, including acts or threats of terrorism, international hostilities, or actions taken by theU.S. or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in theU.S. and abroad; • the Company's potential exposure to fraud, negligence, computer theft, and cyber-crime • changes in accounting policies and banking and other laws and regulations; and • other factors described in Item 1A., "Risk Factors," above.
Because of these uncertainties, actual future results may be materially different from the results indicated by these forward looking statements. In addition, past results of operations do not necessarily indicate future results.
29
--------------------------------------------------------------------------------RESULTS OF OPERATIONSNet Income Net income for 2022 was$14.5 million , a increase of$3.5 million or 31.76% from 2021's net income of$11.0 million . Basic and diluted earnings per share were$4.17 and$3.20 for 2022 and 2021, respectively. Return on average assets ("ROA") measures how efficiently the Company uses its assets to produce net income. Some issues reflected within this efficiency include the Company's asset mix, funding sources, pricing, fee generation, and cost control. The ROA of the Company, on an annualized basis, was 1.02% and 0.90% for 2022 and 2021, respectively. Return on average equity ("ROE") measures the utilization of shareholders' equity in generating net income. This measurement is affected by the same factors as ROA with consideration to how much of the Company's assets are funded by the shareholders. The ROE for the Company was 14.06% and 10.28% for 2022 and 2021, respectively. Net Interest Income Net interest income, the difference between total interest income and total interest expense, is the Company's primary source of earnings. Net interest income was$49.2 million for 2022 and$41.0 million for 2021, which represents an increase of$8.2 million or 20.03%. Net interest income is derived from the volume of earning assets and the rates earned on those assets as compared to the cost of funds. Total interest income was$54.7 million for 2022 and$42.7 million for 2021, which represents an increase of$12.0 million or 28.14% for 2022. Total interest expense was$5.5 million for 2022 and$1.7 million for 2021, which represents an increase of$3.8 million or 226.36% in 2022. The increase in total interest income, total interest expense and net interest income during 2022 was driven by the growth in interest-earning assets, interest-bearing liabilities and the rising interest rate environment. Refer to the table titled "Volume and Rate Analysis" for further detail.
The table titled "Average Balances, Income and Expenses, Yields and Rates"
displays the composition of interest earnings assets and interest bearing
liabilities and their respective yields and rates for the years ended
The net interest margin was 3.68% for 2022 and 3.59% for 2021. The net interest margin is calculated by dividing tax-equivalent net interest income by total average earnings assets. Tax-equivalent net interest income is calculated by adding the tax benefit on certain securities and loans, whose interest is tax-exempt, to total interest income then subtracting total interest expense. The tax rate used to calculate the tax benefit was the federal statutory rate of 21%. The table titled "Tax-Equivalent Net Interest Income" reconciles net interest income to tax-equivalent net interest income, which is not a measurement under GAAP, for the years endedDecember 31, 2022 and 2021. Net interest income and net interest margin may experience some decline due to additional deposit pricing pressure as interest rates continue to increase and increased competition for new deposits is experienced. These combined also could result in the Company having to borrow wholesale funding to fund asset growth which is more expensive than deposits. 30
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Average Balances, Income and Expenses, Yields and Rates
(dollars in thousands)
Years Ended
December 31, 2022 December 31, 2021
Interest Interest
Average Income/ Average Average Income/ Average
Balance Expense Rate Balance Expense Rate
Assets:
Securities:
Taxable $ 172,501 $ 3,401 1.97 % $ 162,717 $ 2,317 1.42 %
Tax-Exempt (1) 8,305 280 3.37 % 15,936 530 3.33 %
Total Securities $ 180,806 $ 3,681 2.04 % $ 178,653 $ 2,847 1.59 %
Loans: (2)
Taxable 1,121,429 50,509 4.50 % 889,035 39,643 4.46 %
Non-accrual 2,350 - - % 4,024 - - %
Tax-Exempt (1) 5,671 218 3.85 % 6,734 289 4.29 %
Total Loans $ 1,129,450 $ 50,727 4.49 % $ 899,793 $ 39,932 4.44 %
Federal funds sold 5,311 30 0.57 % 223 - 0.10 %
Interest-bearing deposits in
other banks 27,251 352 1.29 % 68,868 69 0.10 %
Total earning assets $ 1,342,818 $ 54,790 4.08 % $ 1,147,537 $ 42,848 3.73 %
Allowance for loan losses (9,852 ) (7,980 )
Total non-earning assets 93,289 79,122
Total assets $ 1,426,255 $ 1,218,679
Liabilities and Shareholders'
Equity:
Interest-bearing deposits:
NOW accounts $ 173,843 $ 663 0.38 % $ 145,652 $ 312 0.21 %
Money market accounts 270,725 1,155 0.43 % 225,960 583 0.26 %
Savings accounts 179,709 130 0.07 % 156,861 92 0.06 %
Time deposits:
$250,000 and more 62,757 560 0.89 % 67,287 411 0.61 %
Less than $250,000 62,907 433 0.69 % 58,565 279 0.48 %
Total interest-bearing
deposits $ 749,941 $ 2,941 0.39 % $ 654,325 $ 1,677 0.26 %
Federal funds purchased 7,882 170 2.16 % 1 - 0.36 %
Federal Home Loan Bank
advances 39,589 1,295 3.27 % - - - %
Subordinated debt 22,193 1,067 4.81 % - - - %
Total interest-bearing
liabilities $ 819,605 $ 5,473 0.67 % $ 654,326 $ 1,677 0.26 %
Noninterest-bearing
liabilities:
Demand deposits 485,061 443,662
Other Liabilities 18,293 12,521
Total liabilities $ 1,322,959 $ 1,110,509
Shareholders' equity 103,296 108,170
Total liabilities and
shareholders' equity $ 1,426,255 $ 1,218,679
Net interest income $ 49,317 $ 41,171
Net interest spread 3.42 % 3.47 %
Interest expense as a percent
of average earning assets 0.41 % 0.15 %
Net interest margin 3.68 % 3.59 %
(1)
Income and yields are reported on a tax-equivalent basis using the federal tax
rate of 21%.
(2)
Interest and yields on loans include the amortization/accretion of origination
costs/fees as well as any purchase premiums or discounts.
31
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Tax-Equivalent Net Interest Income
(dollars in thousands)
Twelve Months Ended
December 31,
2022 2021
(in thousands)
GAAP Financial Measurements:
Interest Income - Loans $ 50,682 $ 39,871
Interest Income - Securities and Other
Interest-Earnings Assets 4,004 2,805
Interest Expense - Deposits 2,941
1,677
Interest Expense - Other Borrowings 2,532
-
Total Net Interest Income$ 49,213 $
40,999
Non-GAAP Financial Measurements: Add: Tax Benefit on Tax-Exempt Interest Income - Loans (1) $ 45 $
61
Add: Tax Benefit on Tax-Exempt Interest Income - Securities (1) 59
111
Total Tax Benefit on Tax-Exempt Interest Income $ 104 $
172
Tax-Equivalent Net Interest Income$ 49,317 $ 41,171 (1)
Tax benefit was calculated using the federal statutory tax rate of 21%.
The tax-equivalent yield on earning assets increased 35 basis points from 2021 to 2022. The tax-equivalent yield on securities increased 45 basis points from 2021 to 2022. The tax-equivalent yield on loans increased five basis points from 2021 to 2022. The increase in the tax-equivalent yield on earning assets resulted mostly from the increase in the tax-equivalent yield on securities. The increase in the tax-equivalent yield on securities as compared to the corresponding period in the prior year was due to a combination of increase of volume of securities and the rising interest rate environment. The average rate on interest-bearing liabilities increased 41 basis points from 2021 to 2022. The average rate on total interest-bearing deposits increased 13 basis points from 2021 to 2022. TheFederal Reserve interest rate increases during early 2022 heightened interest rates paid on deposit accounts. In general, deposit pricing is done in response to monetary policy actions and yield curve changes. Local competition for funds also affects the cost of time deposits, which are primarily comprised of certificates of deposit. The Company prefers to rely most heavily on non-maturity deposits, which include NOW accounts, money market accounts, and savings accounts. The average balance of non-maturity interest-bearing deposits increased$95.8 million or 18.13% from$528.5 million during 2021 to$624.3 million in 2022. The cost of interest bearing liabilities was also higher during 2022 due to the subordinated notes that the Company issued onMarch 31, 2022 , which are currently paying a 4.5% fixed rate, and FHLB advances totaling$175.0 million atDecember 31, 2022 , with interest rates ranging between 3.79% and 4.57%.
The table titled "Volume and Rate Analysis" provides information about the effect of changes in financial assets and liabilities and changes in rates on net interest income.
Tax-equivalent net interest income increased$8.1 million during 2022. The increase in tax-equivalent net interest income during 2022 is comprised of an increase due to volume of$7.6 million and a increase due to rate of$530 thousand . The increase in tax-equivalent net interest income during 2022 was largely affected by the increased volume of taxable loans, as well as increases in rates earned from interest-earning assets. This increase was partially offset by the increased volume in borrowing and increases in rates paid on interest bearing liabilities. 32 -------------------------------------------------------------------------------- Volume and Rate Analysis (Tax-Equivalent Basis) (dollars in thousands) 2022 vs 2021 Increase (Decrease) Due to Changes in: Volume Rate Total Earning Assets: Securities: Taxable$ 146 $ 938 $ 1,084 Tax-exempt (256 ) 6 (250 ) Loans: Taxable 10,506 360 10,866 Tax-exempt (43 ) (28 ) (71 ) Federal funds sold 25 5 30 Interest-bearing deposits in other banks (15 ) 298 283 Total earning assets$ 10,362 $ 1,580 $ 11,942 Interest-Bearing Liabilities: NOW accounts$ 68 $ 283 $ 351 Money market accounts 133 439 572 Savings accounts 18 20 38 Time deposits:$250,000 and more (26 ) 175 149 Less than$250,000 22 132 154 Total interest-bearing deposits$ 215 $ 1,049 $
1,264
Federal funds purchased$ 169 $ 1 $
170
Federal Home Loan Bank advances 1,295 -
1,295
Subordinated debt 1,067 -
1,067
Total interest-bearing liabilities
$ 7,616 $ 530 $ 8,146 Provision for Loan Losses The provision for loan losses is based upon management's estimate of the amount required to maintain an adequate allowance for loan losses as discussed within the Critical Accounting Policies section above. The provision for loan losses was$1.8 million for 2022 and$1.5 million for 2021. The amount of provision for loan losses during each period reflects the results of the Company's analysis used to determine the adequacy of the allowance for loan losses. The provision for loan losses in 2022 reflects loan growth in the portfolio during the year partially offset by net recoveries of$601 thousand . The provision for loan losses in 2021 reflects loan growth in the portfolio during. The Company is committed to maintaining an allowance that adequately reflects the risk inherent in the loan portfolio. This commitment is more fully discussed in the "Asset Quality" section. 33
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Noninterest Income
Total noninterest income was$13.3 million and$11.3 million during 2022 and 2021, respectively. This represents an increase of$2.0 million or 17.89% for 2022. Management reviews the activities which generate noninterest income on an ongoing basis. The following table provides the components of noninterest income for the twelve months endedDecember 31, 2022 and 2021, which are included within the respective Consolidated Statements of Income headings. The following paragraphs provide information about activities which are included within the respective Consolidated Statements of Income headings. Variances that the Company believes require explanation are discussed below the table. December 31, (dollars in thousands) 2022 2021 $ Change % Change Wealth management fees$ 4,149 $ 3,054 $ 1,095 35.85 % Service charges on deposit accounts 1,618 1,235 383 31.01 % Other service charges and fees 3,943 3,941 2 0.05 % (Loss)on the sale and disposal of bank premises and equipment (11 ) - (11 ) NM (Loss) gain on sale of securities (737 ) 24 (761 ) (3,170.83 )% Gain on sale of loans 1,875 1,658 217 13.09 % Bank owned life insurance income 626 527 99 18.79 % Other operating income 1,882 881 1,001 113.62 % Total noninterest income$ 13,345 $ 11,320 $ 2,025 17.89 % NM - Not Meaningful Wealth management fees increased from 2021 to 2022. Wealth management fee income is comprised of income from fiduciary activities as well as commissions from the sale of non-deposit investment products. The amount of income from wealth management fees is determined by the number of active accounts and total assets under management. With the addition of several new key employees, total assets under management have seen an increase during the year. Services charges on deposit accounts increased when comparing the year endedDecember 31, 2022 to 2021. This increase is mainly due to increases in overdraft charges. Overdraft charges can fluctuate based on changes in customer activity. During 2022, the Company sold$12.2 million in mortgage loans on the secondary market and$155.0 million of loans from the commercial and consumer loan portfolios. During the third quarter of 2022, the Company sold$3.0 million inSmall Business Association ("SBA") loans. During the last three quarters of 2021, the Company sold$18.1 million in mortgage loans on the secondary market and$99.2 million of loans from the commercial and consumer loan portfolios. These loan sales resulted in gains of$1.9 million and$1.7 million during the years endedDecember 31, 2022 and 2021, respectively.
Bank owned life insurance ("BOLI") fee income increased during 2022 when
compared to 2021 as a result of investment of
Other operating income increased during 2022. The fluctuation from 2021 to 2022
is mostly attributed to adjustments to the investment in Banker's Insurance as
well as cash distributions received from investments in Small Business
Investment Companies and derivative fee income.
34
--------------------------------------------------------------------------------Noninterest Expenses
Total noninterest expenses were$43.1 million and$38.0 million during 2022 and 2021, respectively. This represents an increase of$5.0 million or 13.16% during 2022. The following table provides the components of noninterest expense for the twelve months endedDecember 31, 2022 and 2021, which are included within the respective Consolidated Statements of Income headings. The following paragraphs provide information about activities which are included within the respective Consolidated Statements of Income headings. Variances that the Company believes require explanation are discussed below the table. December 31, (dollars in thousands) 2022 2021 $ Change % Change Salaries and employee benefits$ 25,730 $ 21,854 $ 3,876 17.74 % Occupancy expenses 2,068 1,803 265 14.70 % Equipment expenses 1,121 959 162 16.89 % Advertising and marketing expenses 770 408 362 88.73 % Stationery and supplies 199 155 44 28.39 % ATM network fees 1,313 1,135 178 15.68 % Other real estate owned expense 34 41 (7 ) (17.07 )% Loss on other real estate owned - 201 (201 ) NM FDIC assessment 614 606 8 1.32 % Computer software expense 960 996 (36 ) (3.61 )% Bank franchise tax 886 781 105 13.44 % Professional fees 2,019 3,760 (1,741 ) (46.30 )% Data processing fees 1,779 1,541 238 15.44 % Other operating expenses 5,564 3,809 1,755 46.08 % Total noninterest expenses$ 43,057 $ 38,049 $ 5,008 13.16 % NM - Not Meaningful The Company's growth has had an impact on noninterest expenses. Total assets have grown by$313.7 million or 24.1% fromDecember 31, 2021 toDecember 31, 2022 . This growth has required investments to be made in the Company's infrastructure, causing increases in salaries and employee benefits, occupancy expenses, equipment expenses, advertising and marketing expenses, stationary and supplies, and other operating expenses. In addition, increases in asset size and capital levels have impacted both theFDIC assessment and bank franchise tax amounts.
Salaries and employee benefits expense increased during 2022. Annual pay
increases, newly hired employees, increasing insurance costs and enhanced
employee incentive plans have attributed to these increases. The number of
full-time equivalent employees (FTEs) has increased from 221 at
Professional fees decreased during 2022. Significant expansion costs of the Company's wealth management business line and buildout of the marine lending division were incurred and completed in 2021, resulting in lower professional fees in 2022.
Data processing fees increased in 2022 due to the fees associated to the new general ledger system implemented in late 2021, the implementation of a new budgeting system and a new loan end-to-end platform system.
Other operating expenses increased during 2022. This increase is due primarily to increased loan related expenses due to a higher loan volume.
35
--------------------------------------------------------------------------------
The efficiency ratio of the Company was 67.90% and 72.14% for 2022 and 2021,
respectively. The efficiency ratio is calculated by dividing total noninterest
expenses by the sum of tax-equivalent net interest income and total noninterest
income, excluding gains and losses on the investment portfolio and other
gains/losses from OREO, repossessed vehicles, disposals of bank premises and
equipment, etc. The tax rate utilized is 21%. The Company calculates and reviews
this ratio as a means of evaluating operational efficiency. A reconciliation of
tax-equivalent net interest income, which is not a measurement under GAAP, to
net interest income is presented within the Net Interest Income section above.
The calculation of the efficiency ratio for the twelve months ended
December 31,
2022 2021
(in thousands)
Summary of Operating Results:
Noninterest expenses $ 43,057 $ 38,049
Less: Loss on other real estate owned -
201
Adjusted noninterest expenses$ 43,057 $ 37,848 Net interest income$ 49,213 $ 40,999 Noninterest income$ 13,345 $ 11,320 Less: (Loss) gain on sales of securities (737 )
24
Less: (Loss) on the sale and disposal of premises and equipment (11 )
-
Adjusted noninterest income$ 14,093 $
11,296
Tax equivalent adjustment (1) 104
172
Total net interest income and noninterest income, adjusted$ 63,410 $ 52,467 Efficiency ratio 67.90 % 72.14 % (1)
Includes tax-equivalent adjustments on loans and securities using the federal statutory tax rate of 21%.
Income Taxes Income tax expense was$3.2 million and$1.8 million for the years endedDecember 31, 2022 and 2021, respectively. These amounts correspond to an effective tax rate of 17.83% and 13.81% for 2022 and 2021, respectively. The effective tax rate is below the statutory rate of 21%, due primarily to tax credits on qualified affordable housing project investments as discussed in Note 25 to the Consolidated Financial Statements as well as qualified rehabilitation credits. During 2021, one of the Company's rehabilitation tax credit investments was finalized and the total amount of credits to be received was determined and certified. The effective tax rate is also impacted by tax-exempt income on investment securities and loans. Note 9 to the Consolidated Financial Statements provides a reconciliation between income tax expense computed using the federal statutory income tax rate and the Company's actual income tax expense during 2022 and 2021. Business Segments The Company has two reportable operating segments: community banking and marine lending. Revenue from community banking operations consist primarily of net interest income related to investments in loans and securities and outstanding deposits and borrowings, fees earned on deposit accounts and debit card interchange activity. Revenue from marine lending operations consist primarily of net interest income related to commercial and consumer marine loans and gains on sales of loans. Financial information for the parent company and theBank of Clarke Wealth Management Division is included in the "All Other" category. The parent company's operating results are comprised primarily of interest expense associated with subordinated debt. The wealth management division's net recenues are comprised primarily of income from offering wealth management services and insurance products through third-party service providers. Refer to Notes 1 and 27 of the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for additional information. 36 -------------------------------------------------------------------------------- Marine lending was identified as a newly reportable segment in 2022 and as such, the Company has included the prior period financial information for comparative purposes. The following table provides income and asset information as of and for the twelve months endedDecember 31, 2022 and 2021, which are included within the Consolidated Balance Sheets and Consolidated Statements of Income. Variances that the Company believes require explanation are discussed below the table. Twelve Months Ended December 31, 2022 Community Banking Marine Lending All Other Eliminations Consolidated (in thousands) Interest Income $ 47,554 $ 7,132 $ - $ -$ 54,686 Interest Expense 3,826 580 1,067 - 5,473 Net Interest Income 43,728 6,552 (1,067 ) - 49,213 Gain on sales of loans 478 1,397 - - 1,875 Other noninterest income 7,222 99 4,149 - 11,470 Net Revenue 51,428 8,048 3,082 - 62,558 Provision for loan losses 1,059 771 - - 1,830 Noninterest expense 36,401 3,695 2,961 - 43,057 Income (loss) before taxes 13,968 3,582 121 - 17,671 Income tax expense (benefit) 2,343 794 13 - 3,150 Net Income (loss) $ 11,625 $ 2,788$ 108 $ -$ 14,521 Other data: Capital expenditures $ 829 $ 9 $ - $ - $ 838 Depreciation and amortization 1,550 236 124 - 1,910 Twelve Months Ended December 31, 2021 Community Banking Marine Lending All Other Eliminations Consolidated (in thousands) Interest Income $ 40,003 $ 2,630$ 43 $ -$ 42,676 Interest Expense 1,645 32 - - 1,677 Net Interest Income 38,358 2,598 43 - 40,999 Gain on sales of loans 636 1,022 - - 1,658 Other noninterest income 6,597 10 3,055 - 9,662 Net Revenue 45,591 3,630 3,098 - 52,319 Provision for loan losses 2,657 (1,153 ) (21 ) - 1,483 Noninterest expense 33,525 2,056 2,468 - 38,049 Income (loss) before taxes 9,409 2,727 651 - 12,787 Income tax expense (benefit) 1,034 573 159 - 1,766 Net Income (loss) $ 8,375 $ 2,154$ 492 $ -$ 11,021 Other data: Capital expenditures $ 520 $ - $ - $ - $ 520 Depreciation and amortization 1,632 14 22 $ - 1,668 Community Banking Marine Lending All Other Eliminations Consolidated Total assets at December 31, 2022 $ 1,377,461$ 237,595 $ 1,661 $ -$ 1,616,717 Total assets at December 31, 2021 1,190,471 110,726 1,841 - 1,303,038 37
-------------------------------------------------------------------------------- The increase in community banking segment net income for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 was primarily due to higher interest income resulting from higher average balances of interest-earning assets, including loans and securities, and the effects of rising interest rates on asset yields. This increase was partially offset by the increase in noninterest expense. The increase in noninterest expense is largely due to the Bank's growth and an increase in the allocated cost of funding. This growth has required investments to be made in the Bank's infrastructure, causing increases in salaries and employee benefits, occupancy expenses, equipment expenses, advertising and marketing expenses, stationary and supplies, and other operating expenses. In addition, increases in asset size and capital levels have impacted both theFDIC assessment and bank franchise tax amounts. The increase in marine lending segment net income for the year endedDecember 31, 2022 compared to the year endedDecember 31, 2021 was also primarily due to higher interest income resulting from higher average balances of interest-earning assets, including loans, and the effects of rising interest rates on asset yields. This increase was partially offset by higher salaries and employee benefits expense, including adding new talent to the marine lending team. FINANCIAL CONDITION
Assets, Liabilities and Shareholders' Equity
The Company's total assets were$1.62 billion atDecember 31, 2022 , an increase of$313.7 million or 24.07% from$1.30 billion atDecember 31, 2021 . Securities decreased$43.2 million or 22.44% between 2021 and 2022. Loans, net of the allowance for loan losses, increased by$335.6 million or 34.36% from 2021 to 2022. Total liabilities were$1.51 billion atDecember 31, 2022 , compared to$1.19 billion atDecember 31, 2021 . Total shareholders' equity at year end 2022 and 2021 was$101.7 million and$110.3 million , respectively.
Securities
Total securities, excluding restricted stock, were$149.2 million and$192.3 million for the years endedDecember 31, 2022 andDecember 31, 2021 , respectively. The Company purchased$26.8 million in securities during 2022. This amount includes$23.1 million or 86.04% in mortgage-backed securities,$1.5 million or 5.57% inU.S. government corporations and agencies and$2.3 million or 8.39% in subordinated debt. The Company had$27.6 million in maturities, calls, and principal repayments on securities during 2022. This amount includes$3.6 million or 12.90% in obligations ofU.S. government corporations and agencies,$19.0 million or 68.86% in mortgage-backed securities,$2.0 million or 7.24% inU.S. Treasuries, and$3.0 million or 11.00% in obligations of states and political subdivisions. Note 2 to the Consolidated Financial Statements provides additional details about the Company's securities portfolio as ofDecember 31, 2022 and 2021. The ability to dispose of available for sale securities prior to maturity provides management more options to react to future rate changes and provides more liquidity, when needed, to meet short-term obligations. The Company had net unrealized losses on available for sale securities of$25.9 million and$218 thousand atDecember 31, 2022 and 2021, respectively. Unrealized gains or losses on available for sale securities are reported within shareholders' equity, net of the related deferred tax effect, as accumulated other comprehensive income (loss). The table titled "Maturity Distribution and Yields of Securities" shows the maturity period and average yield for the different types of securities in the portfolio atDecember 31, 2022 . The weighted average yield is calculated based on the relative amortized costs of the securities. Although mortgage-backed securities have definitive maturities, they provide monthly principal curtailments which can be reinvested at a prevailing rate and for a different term. 38 --------------------------------------------------------------------------------
Maturity Distribution and Yields of Securities
December 31, 2022
Due after 5
Due in one year Due after 1 through 10 Due after 10
or less through 5 years years years Total
Securities available for
sale:
Obligations of U.S.
government corporations and
agencies - % 2.56 % 2.66 % - % 2.62 %
Mortgage-backed securities - % - % 1.06 % 1.75 % 1.71 %
Obligations of states and
political subdivisions,
taxable 2.92 % 3.11 % 3.07 % - % 3.07 %
Subordinated debt - % - % 4.28 % - % 4.28 %
Total taxable 2.92 % 2.82 % 2.46 % 1.75 % 1.88 %
Obligations of states and
political subdivisions,
tax-exempt (1) 4.13 % - % 3.19 % - % 3.26 %
Total 2.98 % 2.82 % 2.47 % 1.75 % 1.89 %
(1)Yields on tax-exempt securities have been computed on a tax-equivalent basis using a federal tax rate of 21%.
Loan Portfolio
The Company's primary use of funds is supporting lending activities from which it derives the greatest amount of interest income. Gross loans net of net deferred costs and premiums were$1.32 billion and$985.7 million atDecember 31, 2022 and 2021, respectively. This represents an increase of$338.1 million or 34.30% for 2022. The ratio of net loans to deposits increased during the year from 82.99% to 104.72% atDecember 31, 2021 andDecember 31, 2022 , respectively. Loans secured by real estate were$938.9 million or 70.92% and$754.8 million or 76.57% of total loans atDecember 31, 2022 and 2021, respectively. This represents an increase of$184.1 million or 24.39% for 2022. Consumer installment loans were$117.1 million or 8.85% and$67.3 million or 6.83% of total loans atDecember 31, 2022 and 2021, respectively. This represents an increase of$49.8 million or 74.06% for 2022. Commercial and industrial loans were$247.7 million or 18.71% and$143.4 million or 14.55% of total loans atDecember 31, 2022 and 2021. This represents an increase of$104.3 million or 72.73% for 2022. All other loans were$12.7 million and$16.8 million atDecember 31, 2022 and 2021. This represents an decrease of$4.1 million or 24.27%. During the year endedDecember 31, 2022 , loan growth was mainly concentrated in commercial real estate loans and commercial and industrial loans, net of PPP forgiveness. Loan growth was also strong in consumer installment loans. Loan growth in commercial and industrial loans and consumer installment loans was mainly due to the marine loan lending. Loan growth was also driven by the expansion into new market areas. The table titled "Maturity Schedule of Selected Loans" shows the different loan categories and the period during which they mature. For loans maturing in more than one year, the table also shows a breakdown between fixed rate loans and floating rate loans. The table indicates that$464.5 million or 35.29% of the loan portfolio matures within five years. The floating rate loans maturing after five years are primarily comprised of loans secured by 1-4 family residential properties. 39 -------------------------------------------------------------------------------- Maturity Schedule of Selected Loans (dollars in thousands) December 31, 2022 After 1 Year After 5 Within Within Years Within After 15 1 Year 5 Years 15 years Years Total Loans secured by real estate: Construction and land development$ 16,166 $ 19,417 $ 31,594 $ 6,490 $ 73,667 Secured by farmland 2,410 7,465 5,683 426$ 15,984 Secured by 1-4 family residential properties 17,563 72,787 95,839 115,569 301,758 Multifamily 2,272 25,147 12,387 - 39,806 Commercial 19,636 191,478 289,294 7,227 507,635 Commercial and industrial loans 24,683 47,677 62,434 112,865 247,659 Consumer installment loans 418 14,411 14,460 87,821 117,110 All other loans 2,163 783 7,692 2,083 12,721$ 85,311 $ 379,165 $ 519,383 $ 332,481 $ 1,316,340 For maturities over one year: Floating rate loans$ 60,626 $ 109,477 $ 135,020 $ 305,123 Fixed rate loans 318,539 409,906 197,461 925,906$ 379,165 $ 519,383 $ 332,481 $ 1,231,029 40
--------------------------------------------------------------------------------
Asset Quality
The Company has policies and procedures designed to control credit risk and to maintain the quality of its loan portfolio. These include underwriting standards for new originations and ongoing monitoring and reporting of asset quality and adequacy of the allowance for loan losses. There were$2.6 million in total non-performing assets, which consist of nonaccrual loans, loans 90 days or more past due and still accruing, other real estate owned, and repossessed assets atDecember 31, 2022 . This is a decrease of$178 thousand when compared to theDecember 31, 2021 balance of$2.8 million . This decrease resulted mostly from a decrease in nonaccrual loans. Nonaccrual loans were$2.2 million atDecember 31, 2022 and$2.7 million at the end of 2021. The gross amount of interest income that would have been recognized on nonaccrual loans was$93 thousand for 2022 and$133 thousand for 2021. None of this interest income was included in net income for 2022 or 2021. A total of 12 loans totaling$544 thousand were placed on nonaccrual during 2022. The balance of these loans added to nonaccrual status during 2022 ranged from$1 thousand to$300 thousand with the average outstanding balance being$45 thousand . In addition, five loans totaling$688 thousand were removed from nonaccrual status during 2022. Of the$688 thousand in loans removed from nonaccrual status betweenDecember 31, 2021 andDecember 31, 2022 , two loans were paid off, one loan was discharged in bankruptcy, one loan was charged off and one loan was returned to accrual status. The remainder of the decrease in nonaccrual loans was due to paydowns of loans that remained in nonaccrual status betweenDecember 31, 2021 andDecember 31, 2022 . Management evaluates the financial condition of these borrowers and the value of any collateral on these loans. The results of these evaluations are used to estimate the amount of losses which may be realized on the disposition of these nonaccrual loans. Nonaccrual loans that were evaluated for impairment atDecember 31, 2022 totaled$2.2 million and had$73 thousand in specific allocations assigned. Other real estate owned increased from zero atDecember 31, 2021 to$108 thousand atDecember 31, 2022 . One property was foreclosed on during 2022. The difference between the amount of other real estate owned and the settlement proceeds is recognized as a gain or loss on the sale of other real estate owned. A net loss of$201 thousand was recognized on other real estate owned during 2021.
Nonperforming and Other Assets
Nonperforming assets consist of nonaccrual loans, loans past due 90 days and accruing interest, other real estate owned (foreclosed properties), and repossessed assets. The table titled "Nonperforming Assets and Credit Ratios" shows the amount of nonperforming assets and loans past due 90 days and accruing interest outstanding for the past two years. The table also shows the ratios for the allowance for loan losses as a percentage of nonperforming assets and nonperforming assets as a percentage of loans outstanding and other real estate owned. Loans are placed on non-accrual status when collection of principal and interest is doubtful, generally when a loan becomes 90 days past due. There are three negative implications for earnings when a loan is placed on non-accrual status. First, all interest accrued but unpaid at the date that the loan is placed on non-accrual status is either deducted from interest income or written off as a loss. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Finally, there may be actual losses that require additional provisions for loan losses to be charged against earnings. For real estate loans, upon foreclosure, the properties are recorded at the fair value of the property based on current appraisals and other current market trends, less selling costs. If a write down of the OREO property is necessary at the time of foreclosure, the amount is charged-off against the allowance for loan losses. A review of the recorded property value is performed in conjunction with normal loan reviews, and if market conditions indicate that the recorded value exceeds the fair value, additional write downs of the property value are charged directly to operations. Gains on properties acquired through foreclosure where the fair value less costs to sell exceeds the related loan balance and there have been no prior charge-offs are recorded to current earnings. In addition, the Company may, under certain circumstances, restructure loans in troubled debt restructurings as a concession to a borrower when the borrower is experiencing financial distress. Each loan considered for restructuring is evaluated based on customer circumstances and may include modifications to one or more loan provisions. Such restructured loans are included in impaired loans. AtDecember 31, 2022 and 2021, the Company had$4.6 million and$2.7 million in restructured loans, respectively. 41 -------------------------------------------------------------------------------- Nonperforming Assets and Credit Ratios (dollars in thousands) December 31, 2022 2021 Nonaccrual loans$ 2,162 $ 2,723 Loans past due 90 days and accruing interest 318
43
Other real estate owned and repossessed assets 108 - Total nonperforming assets$ 2,588 $ 2,766 Allowance for loan losses$ 11,218 $ 8,787 Gross loans$ 1,323,783 $ 985,720 Allowance for loan losses to nonperforming assets 433 %
318 %
Allowance for loan losses to total loans 0.85 %
0.89 %
Allowance for loan losses to nonaccrual loans 519 %
323 %
Nonaccrual loans to total loans 0.19 %
0.28 %
Non-performing assets to period end loans and other real estate owned 0.20 % 0.28 % Other potential problem loans are defined as performing loans that possess certain risks that management has identified that could result in the loans not being repaid in accordance with their terms. Accordingly, these loans are risk rated at a level of substandard or lower. AtDecember 31, 2022 , other potential problem loans totaled$9.6 million . Of the total other potential problem loans,$4.5 million are currently considered impaired and are disclosed in Note 4 to the Consolidated Financial Statements.
Allowance for Loan Losses
The purpose and the methods for measuring the allowance for loans are discussed in the Critical Accounting Policies section above.
Charged-off loans were$659 thousand and$110 thousand for 2022 and 2021, respectively. Recoveries were$1.3 million and$318 thousand for 2022 and 2021, respectively. Net recoveries were$601 thousand for 2022. Net recoveries were$208 thousand for 2021. This represents a increase in net recoveries of$393 thousand or 189% for 2022. The allowance for loan losses as a percentage of loans was 0.85% and 0.89% at the end of 2022 and 2021, respectively. Excluding outstanding PPP loans of$74 thousand and$15.9 million as ofDecember 31, 2022 and 2021, respectively, the allowance for loan losses as a percentage of total loans was 0.85% and 0.91% as ofDecember 31, 2022 and 2021, respectively. The slight decline in the allowance percentage year over year was attributable in large part to the concentration of loan growth during the period in segments which carry lower reserves. Despite a significant increase in classified loans, the allowance for loan losses as a percentage of loans excluding PPP loans declined slightly. The majority of the increase in classified loans was due to the downgrade of loans where current financial information has not been provided, per loan policy. These loans have not been identified as impaired or nonperforming loans. The ratio of net (recoveries) to average loans was (0.05%) for 2022 and (0.02%) for 2021. The provision for loan losses for the years endedDecember 31, 2022 and 2021 was$1.8 million and$1.5 million , respectively. The provision for loan losses in 2022 and 2021 reflected mainly loan growth in the portfolio. The table titled "Allocation of Allowance for Loan Losses" shows the amount of the allowance for loan losses which is allocated to the indicated loan categories, along with that category's percentage of total loans, atDecember 31, 2022 and 2021. The amount of allowance for loan losses allocated to each loan category is based on the amount of delinquent loans in that loan category, the status of nonperforming assets in that loan category, the historical losses for that loan category, the evaluation of qualitative factors impacting the portfolio and the financial condition of certain borrowers whose financial conditional is monitored on a periodic basis. Management believes that the allowance for loan losses is adequate based on the loan portfolio's current risk characteristics. 42 -------------------------------------------------------------------------------- Analysis of Allowance for Loan Losses (dollars in thousands) Years Ended December 31, 2022 2021 Net Net charge-offs charge-offs (recoveries) (recoveries) Average loans to average to average Net charge-offs outstanding loans Net charge-offs Average loans loans (recoveries) (1)
outstanding (recoveries) outstanding (1) outstanding Construction and Farmland $
(9 ) $ 83,928 (0.01 )% $ (12 ) $ 69,792 (0.02 )%
Residential Real Estate (879 ) 312,177 (0.28 )% (227 ) 274,449 (0.08 )%
Commercial Real Estate (197 ) 451,649 (0.04 )% (7 ) 355,976 (0.00 )%
Commercial 191 175,813 0.11 % (8 ) 143,450 (0.01 )%
Consumer 35 94,545 0.04 % (10 ) 44,661 (0.02 )%
All Other Loans 258 11,338 2.28 % 56 11,465 0.49 %
Total $ (601 ) $ 1,129,450 (0.05 )% $ (208 ) $ 899,793 (0.02 )%
(1)Averages as disclosed are based on the outstanding balances of the loans in each segment. These averages do not include net deferred costs and premiums
Allocation of Allowance for Loan Losses
(dollars in thousands)
December 31, 2022 December 31, 2021
Percent of Loans Percent of Loans
Allowance for in Category to Allowance for in Category to
Loan Losses Total Loans Loan Losses Total LoansConstruction and Farmland$ 2,714 6.8 % $ 2,794 8.6 % Residential Real Estate 1,847 25.9 % 1,750 29.8 % Commercial Real Estate 2,109 38.6 % 1,650 38.4 % Commercial 2,936 18.8 % 1,656 14.6 % Consumer 1,140 8.9 % 646 6.8 % All Other Loans 472 1.0 % 291 1.7 % Total$ 11,218 100 % $ 8,787 100 % DuringJune 2016 , theFinancial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." The ASU, as amended, requires an entity to measure expected credit losses for financial assets carried at amortized cost based on historical experience, current conditions, and reasonable and supportable forecasts. Among other things, the ASU also amended the impairment model for available for sale securities and addressed purchased financial assets with deterioration. Refer to Note 1 of the consolidated financial statements in Item 8 of this report for additional information. 43
--------------------------------------------------------------------------------
Deposits
Total deposits were
Average Deposits and Rates Paid
(dollars in thousands)
Years Ended December 31,
2022 2021
Amount Rate Amount Rate
Noninterest-bearing $ 485,061 $ 443,662
Interest-bearing:
NOW accounts 173,843 0.38 % 145,652 0.21 %
Money market accounts 270,725 0.43 % 225,960 0.26 %
Regular savings accounts 179,709 0.07 % 156,861 0.06 %
Time deposits:
$250,000 and more 62,757 0.89 % 67,287 0.61 %
Less than $250,000 62,907 0.69 % 58,565 0.48 %
Total interest-bearing $ 749,941 0.39 % $ 654,325 0.26 %
Total deposits $ 1,235,002 $ 1,097,987
Noninterest-bearing demand deposits, which are comprised of checking accounts,
increased $8.4 million or 1.78% from $470.4 million at December 31, 2021 to
$478.8 million at December 31, 2022 . Interest-bearing deposits, which include
NOW accounts, money market accounts, regular savings accounts and time deposits,
increased $78.4 million or 11.10% from $706.9 million at December 31, 2021 to
$785.3 million at December 31, 2022 . Total money market account balances
decreased $31.4 million or 12.45% from $251.9 million at December 31, 2021 to
$220.5 million at December 31, 2022 ; however, regular savings accounts increased
$71.0 million or 42.07% from $168.7 million at December 31, 2021 to $239.7
million at December 31, 2022 . Reciprocal deposit accounts balances (included in
total money market account and NOW account balances) increased from $42.2
million to $59.5 million at December 31, 2021 and December 31, 2022 ,
respectively. The reciprocal deposits balance at December 31, 2022 and December
31, 2021 consists of money market and NOW accounts obtained through the ICS
network. The growth in deposits was mainly organic growth as we expand and grow
into newer market areas. Time deposits increased $34.3 million or 27.76% from
$123.6 million at December 31, 2021 to $157.9 million at December 31, 2022 .
Total estimated uninsured deposits at December 31, 2022 and December 31, 2021
were $322.5 million and $356.3 million , respectively.
The Company attempts to fund asset growth with deposit accounts and focus upon
core deposit growth as its primary source of funding. Core deposits consist of
checking accounts, NOW accounts, money market accounts, regular savings
accounts, and time deposits of less than $250,000 . Core deposits totaled $1.19
billion or 93.88% and $1.11 billion or 94.47% of total deposits at December 31,
2022 and 2021, respectively.
The table titled "Maturities of Certificates of Deposit and Other Time Deposits
of $250,000 and Greater" shows the amount of certificates of deposit of $250,000
and more maturing within the time periods indicated at December 31, 2022 . The
total amount maturing within one year is $66.1 million or 93.96% of the total
amount outstanding.
Maturities of Certificates of Deposit and Other Time Deposits of $250,000 and
Greater
(dollars in thousands)
Within Three Six to Over Percent
Three to Six Twelve One of Total
Months Months Months Year Total Deposits
December 31, 2022 $ 5,522 $ 4,846 $ 55,747 $ 4,248 $ 70,363 5.57 %
44-------------------------------------------------------------------------------- The table titled "Certificates of Deposit and Other Time Deposits Otherwise Uninsured" shows the balances of certificates of deposit that were in excess of theFDIC insurance limit atDecember 31, 2022 . The total amount maturing within one year is$54.6 million or 97.33% of the total amount outstanding.
Certificates of Deposit and Other Time Deposits Otherwise Uninsured (dollars in thousands)
Within Three Six to Over Percent
Three to Six Twelve One of Total
Months Months Months Year Total Deposits
4.44 %
CAPITAL RESOURCES
Total shareholders' equity on December 31, 2022 was $101.7 million , reflecting a
percentage of total assets of 6.29% as compared to $110.3 million and 8.46% at
December 31, 2021 . The common stock's book value per share decreased $2.78 or
8.70% to $29.15 per share at December 31, 2022 from $31.93 per share at December
31, 2021 . During 2022, the Company paid $1.15 per share in dividends as compared
to $1.10 per share for 2021. The Company has a Dividend Investment Plan that
allows participating shareholders to reinvest the dividends in Company stock.
During 2022, the Company purchased 4,442 shares of its Common Stock under its
stock repurchase program at an average price of $34.79 . During 2021, the Company
purchased 4,479 shares of its Common Stock under its stock repurchase program at
an average price of $31.26 . At December 31, 2022 , and 2021, Management believes
the Bank met all capital adequacy requirements to which it was subject.
Additionally, at December 31, 2022 , the most recent notification from the
Federal Reserve categorized the Bank as well-capitalized under the regulatory
framework for prompt corrective action. There are no conditions or events since
the notification that management believes have changed the Bank's category.
Federal regulatory risk-based capital guidelines require percentages to be
applied to various assets, including off-balance sheet assets, based on their
perceived risk in order to calculate risk-weighted assets. Tier 1 capital
consists of total shareholders' equity plus qualifying trust preferred
securities outstanding less net unrealized gains and losses on available for
sale securities, goodwill and other intangible assets. Total capital is
comprised of Tier 1 capital plus the allowable portion of the allowance for loan
losses and any excess trust preferred securities that do not qualify as Tier 1
capital.
Effective January 1, 2015 , the Federal Reserve issued final risk-based capital
rules to align with the Basel III regulatory capital framework and meet certain
requirements of the Dodd-Frank Act. The final rules require the Bank to comply
with the following minimum capital ratios: (i) a common equity Tier 1 capital
ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of
risk-weighted assets; (iii) a total capital ratio of 8.0% of risk-weighted
assets; and (iv) a leverage ratio of 4.0% of total assets. In addition, a
capital conservation buffer requirement was phased in beginning January 1, 2016 ,
at 0.625% of risk-weighted assets, increased by the same amount each year until
it was fully implemented at 2.5% effective January 1, 2019 . The capital
conservation buffer is designed to absorb losses during periods of economic
stress. Banking institutions with any ratio (excluding the leverage ratio) above
the minimum but below the conservation buffer will face constraints on
dividends, equity repurchases, and compensation based on the amount of the
shortfall. As fully phased in effective January 1, 2019 , the rules require the
Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted
assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (which is
added to the 4.5% common equity Tier 1 ratio, effectively resulting in a minimum
ratio of common equity Tier 1 to risk-weighted assets of at least 7.0%), (ii) a
minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus
the 2.5% capital conservation buffer (which is added to the 6.0% Tier 1 capital
ratio, effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a
minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus
the 2.5% capital conservation buffer (which is added to the 8.0% total capital
ratio, effectively resulting in a minimum total capital ratio of 10.5%), and
(iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital
to average assets.
Pursuant to the Federal Reserve's Small Bank Holding Company and Savings and
Loan Holding Company Policy Statement, qualifying bank holding companies with
total consolidated assets of less than $3 billion , such as the Company, are not
subject to consolidated regulatory capital requirements.
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In 2019, the federal banking agencies jointly issued a final rule that provides
for an optional, simplified measure of capital adequacy, the Community Bank
Leverage Ratio framework (CBLR), for qualifying community banking organizations,
consistent with Section 201 of the Economic Growth, Regulatory Relief, and
Consumer Protection Act. The final rule became effective on January 1, 2020 . The
CBLR removes the requirement for qualifying banking organizations to calculate
and report risk-based capital but rather only requires a Tier 1 to average
assets (leverage) ratio. Qualifying banking organizations that elect to use the
CBLR and that maintain a leverage ratio of greater than the required minimum
will be considered to have satisfied the generally applicable risk-based and
leverage capital requirements in the agencies' capital rules and, if applicable,
will be considered to have met the well-capitalized ratio requirements for
purposes of section 38 of the Federal Deposit Insurance Act. Under the
regulatory capital rules, an institution electing to use the CBLR must maintain
a minimum leverage ratio of 9%. Qualifying institutions are allowed a
two-quarter grace period to correct a ratio that falls below the required
amount, provided the institution maintains a ratio of more than 8%. At December
31, 2022 , the Bank was a qualifying institution and elected to utilize the CBLR
to measure capital adequacy. As such, the related amounts and ratios for
December 31, 2022 , are presented below using the CLBR. As the Bank did not elect
to utilize the CBLR at December 31, 2021 , the amounts and ratios are presented
using the risk-based capital framework.
Analysis of Bank Capital
(dollars in thousands)
December 31,
December 31, 2022 2021
Tier 1 Capital:
Common stock $ 1,682 $ 1,682
Capital surplus 29,773 9,773
Retained earnings 111,759 96,115
Total Tier 1 capital $ 143,214 $ 107,570
Common equity tier 1 capital $ 107,570
Tier 2 Capital:
Allowance for loan losses and reserves for off-balance
sheet commitments $ 8,850
Total Tier 2 capital $ 8,850
Total risk-based capital $ 116,420
Risk weighted assets $ 1,030,262
Capital Ratios:
Common equity Tier 1 capital ratio n/a 10.44 %
Tier 1 risk-based capital ratio n/a 10.44 %
Total risk-based capital ratio n/a 11.30 %
Tier 1 leverage ratio 9.19 % 8.84 %
Note 15 to the Consolidated Financial Statements provides additional discussion and analysis of regulatory capital requirements.
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--------------------------------------------------------------------------------LIQUIDITY
Liquidity management involves meeting the present and future financial obligations of the Company with the sale or maturity of assets or with the occurrence of additional liabilities. Liquidity needs are met with cash on hand, deposits in banks, federal funds sold, securities classified as available for sale and loans maturing within one year. AtDecember 31, 2022 liquid assets totaled$317.1 million as compared to$365.1 million atDecember 31, 2021 . These amounts represent 20.93% and 30.61% of total liabilities atDecember 31, 2022 and 2021, respectively. Securities provide a constant source of liquidity through paydowns and maturities. Also, the Company maintains short-term borrowing arrangements, namely federal funds lines of credit, with larger financial institutions as an additional source of liquidity. The Bank's membership with theFederal Home Loan Bank of Atlanta also provides a source of borrowings with numerous rate and term structures. AtDecember 31, 2022 and 2021, the Company had remaining credit availability in the amounts of$105.7 million and$244.3 million , respectively, with theFederal Home Loan Bank of Atlanta . The Company also had unused lines of credit with financial institutions of$78.0 million atDecember 31, 2022 and 2021. The Company's senior management monitors the liquidity position regularly and attempts to maintain a position which utilizes available funds most efficiently. As a result of the Company's management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors' requirements and meet its customers' credit needs.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL OBLIGATIONS
Note 18 to the Consolidated Financial Statements provides information about the
off-balance sheet arrangements which arise through the lending activities of the
Company. These arrangements increase the degree of both credit and interest rate
risk beyond that which is recognized through the financial assets and
liabilities on the consolidated balance sheets.
47
--------------------------------------------------------------------------------Item 7A. Quantitative and Qualitative Disclosures about Market Risk
As the holding company of the Bank, the Company's primary component of market
risk is interest rate volatility. Interest rate fluctuations will impact the
amount of interest income and expense the Bank receives or pays on almost all of
its assets and liabilities and the market value of its interest-earning assets
and interest-bearing liabilities, excluding those which have a very short term
until maturity. Interest rate risk exposure of the Company is, therefore,
experienced at the Bank level. Asset / liability management attempts to maximize
the net interest income of the Company by adjusting the volume and price of rate
sensitive assets and liabilities. The Company does not subject itself to foreign
currency exchange or commodity price risk due to prohibition through policy and
the current nature of operations. Derivative instruments and hedging activities
of the Company have historically been minimal.
The Bank's interest rate management strategy is designed to maximize net
interest income and preserve the capital of the Company. The Bank's financial
instruments are periodically subjected to various simulations whose results are
discussed in the following paragraphs. These models are based on actual data
from the Bank's financial statements and assumptions about the performance of
certain financial instruments. Prepayment assumptions are applied to all
mortgage related assets, which includes real estate loans and mortgage-backed
securities. Prepayment assumptions are based on a median rate at which principal
payments are received on these assets over their contractual term. The rate of
principal payback is assumed to increase when rates fall and decrease when rates
rise. Term assumptions are applied to non-maturity deposits, which includes
demand deposits, NOW accounts, savings accounts, and money market accounts.
Demand deposits and NOW accounts are generally assumed to have a term greater
than one year since the total amount outstanding does not fluctuate with changes
in interest rates. Savings accounts and money market accounts are assumed to be
more interest rate sensitive, therefore, a majority of the amount outstanding is
assumed to have a term of less than one year.
The simulation analysis evaluates the potential effect of upward and downward
changes in market interest rates on future net interest income. The Bank views
the immediate shock of rates as a more effective measure of interest rate risk
exposure. The analysis assesses the impact on net interest income over a 12
month period after an immediate increase or "shock" in rates, of 100 basis
points up to 400 basis points. The simulation analysis results are presented in
the table below:
Year 1 Net Interest Income Simulation
(dollars in thousands)
Change in
Net Interest Income
Assumed Market Interest Rate Shock Dollars Percent Change
-400 BP $ (5,133 ) (9.99 )%
-300 BP (3,939 ) (7.67 )%
-200 BP (2,748 ) (5.35 )%
-100 BP (1,238 ) (2.41 )%
+100 BP 645 1.26 %
+200 BP (118 ) (0.23 )%
+300 BP (1,432 ) (2.79 )%
+400 BP (3,055 ) (5.94 )%
The Bank uses simulation analysis to assess earnings at risk and economic value
of equity ("EVE") analysis to assess economic value at risk. This analysis
method allows management to regularly monitor the direction and magnitude of the
Bank's interest rate risk exposure. The modeling techniques cannot be measured
with complete precision. Maturity and repricing characteristics of assets and
liabilities, prepayments on amortizing assets, non-maturity deposit sensitivity
and loan and deposit pricing are key assumptions used in acquiring this
analysis. There is a realm of uncertainty in using these assumptions but the
analysis does provide the Bank with the ability to estimate interest rate risk
position over time.
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The table below examines the EVE. The EVE of the balance sheet is defined as the
discounted present value of expected asset cash flows minus the discounted
present value of the expected liability cash flows. The analysis involves
changing the interest rates used in determining the expected cash flows and in
discounting the cash flows. The model indicates an exposure to falling interest
rates. These results are driven primarily by the relative change in value of the
Bank's core deposit base as rates rise.
Static EVE Change
(dollars in thousands)
Change in EVE
Assumed Market Interest Rate Shift Dollars Percent Change
-400 BP Shock $ (121,984 ) (55.90 )%
-300 BP Shock (69,185 ) (31.71 )%
-200 BP Shock (34,924 ) (16.01 )%
-100 BP Shock (9,046 ) (4.15 )%
+100 BP Shock 520 0.24 %
+200 BP Shock (6,974 ) (3.20 )%
+300 BP Shock (10,537 ) (4.83 )%
+400 BP Shock (14,959 ) (6.86 )%
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