MID-SOUTHERN BANCORP, INC. Safe Harbor Statement for Forward-Looking Statements
This Quarterly Report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by use of the words "expects," "believes," "anticipates," "intends," "could," "should" and similar expressions. Forward-looking statements also include, but are not limited to, statements regarding estimated cost savings, plans and objectives for future operations, and the Company's business and growth strategies. These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated or implied by our forward-looking statements, including, but not limited to:
the effect of the COVID-19 pandemic, including on the Company's credit quality
and business operations, as well as its impact on general economic and
? financial market conditions and other uncertainties resulting from the COVID-19
pandemic, such as the extent and duration of the impact on public health, the
economic activity, employment levels and market liquidity;
? changes in economic conditions, either nationally or in our market area;
? fluctuations in interest rates;
the risks of lending and investing activities, including changes in the level
? and direction of loan delinquencies and write-offs and changes in estimates of
the adequacy of our allowance for loan losses;
? the possibility of other-than-temporary impairments of securities held in our
securities portfolio;
? our ability to access cost-effective funding;
fluctuations in the demand for loans, the number of unsold homes, land and
? other properties, and fluctuations in real estate values and both residential
and commercial and multifamily real estate market conditions in our market
area;
? secondary market conditions for loans and our ability to originate loans for
sale and sell loans in the secondary market;
? our ability to attract and retain deposits;
our ability to successfully integrate any assets, liabilities, customers,
? systems and management personnel we may acquire into our operations and our
ability to realize related revenue synergies and expected cost savings and
other benefits within the anticipated time frames or at all;
legislative or regulatory changes that adversely affect our business including
? changes in regulatory policies and principles, or the interpretation of
regulatory capital or other rules;
? monetary and fiscal policies of the
other governmental initiatives affecting the financial services industry;
results of examinations of
by our regulators, including the possibility that the regulators may, among
? other things, require us to increase our allowance for loan losses or to
write-down assets, change
position or affect our ability to borrow funds or maintain or increase
deposits, which could adversely affect our liquidity and earnings;
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? our ability to control operating costs and expenses;
the use of estimates in determining fair value of certain of our assets, which
? estimates may prove to be incorrect and result in significant declines in
valuation;
? difficulties in reducing risks associated with the loans on our balance sheet;
staffing fluctuations in response to product demand or the implementation of
? corporate strategies that affect our workforce and potential associated
charges;
disruptions, security breaches, or other adverse events, failures or
? interruptions in, or attacks on, our information technology systems or on the
third-party vendors
? our ability to retain key members of our senior management team;
? costs and effects of litigation, including settlements and judgments;
? our ability to implement our business strategies;
? increased competitive pressures among financial services companies;
? changes in consumer spending, borrowing and savings habits;
? the availability of resources to address changes in laws, rules, or regulations
or to respond to regulatory actions;
? our ability to pay dividends on our common stock;
? adverse changes in the securities markets;
? the inability of key third-party providers to perform their obligations to us;
? statements with respect to our intentions regarding disclosure and other
changes resulting from the JOBS Act;
changes in accounting policies and practices, as may be adopted by the
? financial institution regulatory agencies or the Financial Accounting Standards
Board, including additional guidance and interpretation on accounting issues
and details of the implementation of new accounting methods; and
other economic, competitive, governmental, regulatory, and technological
? factors affecting our operations, pricing, products and services, including the
CARES Act and the other risks described from time to time in our filings with
the
Any of the forward-looking statements that we make in this report and in other public statements we make may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Any of the forward-looking statements are based upon management's beliefs and assumptions at the time they are made. Except as required by applicable law, we undertake no obligation to publicly update or revise any forward-looking statements included in this report or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur and you should not put undue reliance on any forward-looking statements.
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As used throughout this report, the terms "we," "our," "us," or the "Company"
refer to
Significant Developments and the Impact of COVID-19
COVID-19 was declared a pandemic by the
Our commercial and banking products are offered primarily in the
The COVID-19 pandemic and related economic developments could have an adverse impact on our business. The extent and duration of the COVID-19 economic impact is difficult to quantify, however our financial condition, capital levels and results of operations could be materially adversely affected. While the ultimate impact of the crisis is difficult to predict, we believe the Company is well-capitalized and has the financial stability to continue to responsibly serve its customers and communities during this unprecedented time.
In response to the pandemic, we have undertaken several actions to address the needs of our employees, our customers and our communities. We continue to follow CDC and state health office guidelines and respond to new developments.
Overview
Our principal business consists of attracting retail deposits from the general public and investing those funds, along with borrowed funds, in loans secured by first and second mortgages on one- to four-family residences (including home equity loans and lines of credit), commercial and multifamily, consumer and commercial business loans and, to a lesser extent, construction and land loans. We offer a wide variety of consumer loan products, including automobile loans, boat loans, manufactured homes not secured by permanent dwellings and recreational vehicle loans. We intend to continue emphasizing our residential mortgage, home equity and consumer lending, while also expanding our emphasis in commercial and multifamily and commercial business lending.
Our operating revenues are derived principally from earnings on interest earning
assets, service charges and fees. Our primary sources of funds are deposits,
Summary of Significant Accounting Policies
The discussion and analysis of the financial condition and results of operations
are based on our financial statements, which are prepared in conformity with
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contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be significant accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.
The following represent our significant accounting policies:
Allowance for Loan Losses. The allowance for loan losses represents management's estimate of losses inherent in the loan portfolio as of the date of the consolidated balance sheet and it is recorded as a reduction of loans. The allowance is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan and the entire allowance is available to absorb all loan losses.
The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified impaired, an allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than the carrying value of that loan.
The general component covers pools of loans, by loan class, including commercial loans not considered impaired, as well as smaller balance homogenous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based on historical loss rates for each of these categories of loans, which are adjusted for qualitative factors. The qualitative factors include:
? Lending policies and procedures, including underwriting standards and
collection, charge-off and recovery practices;
? National, regional and local economic and business conditions as well as the
condition of various market segments;
? Nature and volume of the portfolio and terms of the loans;
? Experience, ability and depth of the lending management and staff;
? Changes in the value of underlying collateral for collateral-dependent loans;
? The existence and effect of any concentrations of credit, and changes in the
level of such concentrations;
The effect of other external factors such as competition and legal and
? regulatory requirements on the level of estimated credit losses in the
institution's existing portfolio;
? Volume and severity of past due, classified and non-accrual loans, as well as
other loan modifications; and
? Quality of our loan review system and the degree of oversight by our board of
directors.
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Each factor is assigned a value to reflect improving, stable or declining conditions based on management's best judgment using relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation of changes in conditions in a narrative accompanying the allowance for loan loss analysis and calculation.
In addition, various bank regulatory agencies periodically review the allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs based on their judgment about information available to them at the time of their examination.
Income Taxes. Income taxes are provided for the tax effects of certain transactions reported in the consolidated financial statements. Income taxes consist of taxes currently due plus deferred taxes related primarily to temporary differences between the financial reporting and income tax basis of the allowance for loan losses, premises and equipment, certain state tax credits, and deferred loan origination costs. The deferred tax assets and liabilities represent the future tax return consequences of the temporary differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Estimation of Fair Values. Fair values for securities available-for-sale are obtained from an independent third-party pricing service. Where available, fair values are based on quoted prices on a nationally recognized securities exchange. If quoted prices are not available, fair values are measured using quoted market prices for similar benchmark securities. Management generally makes no adjustments to the fair value quotes provided by the pricing source. The fair values of foreclosed real estate and the underlying collateral value of impaired loans are typically determined based on evaluations by third parties, less estimated costs to sell. When necessary, appraisals are updated to reflect changes in market conditions.
Non-GAAP Financial Measures
Certain non-GAAP measures are used by management to supplement the evaluation of the Company's performance. These measures - Net interest income (tax-equivalent basis), yield on interest-earning assets (tax-equivalent basis), net interest spread (tax-equivalent basis) and net interest margin (tax-equivalent basis) - include the effects of taxable-equivalent adjustments using a federal income tax rate prevalent during the relevant year to increase tax-exempt interest income to a tax-equivalent basis. Interest income earned on certain assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments.
Net interest income (tax-equivalent basis), yield on interest-earning assets (tax-equivalent basis), net interest spread (tax-equivalent basis) and net interest margin (tax-equivalent basis). Net interest income (tax-equivalent basis) is a non-GAAP measure that adjusts for the tax-favored status of net interest income from certain loans and investments and is not permitted under GAAP in the consolidated statements of income. We believe this measure to be the preferred industry measurement of net interest income, and that it enhances comparability of net interest income arising from taxable and tax-exempt sources. The most directly comparable financial measure calculated in accordance with GAAP is net interest income. Yield on interest-earning assets (tax-equivalent basis) is the ratio of interest income earned from interest-earning assets, adjusted on a tax-equivalent basis, and average interest-earning assets. The most directly comparable financial measure in accordance with GAAP is yield on interest-earning assets. Net interest spread (tax-equivalent basis) is the difference in the average yield on average earning assets on a tax-equivalent basis and the average rate paid on average interest-bearing liabilities. The most directly comparable financial measure calculated in accordance with GAAP is net interest spread. Net interest margin (tax-equivalent basis) is the ratio of net interest income (tax-equivalent basis) to average earning assets. The most directly comparable financial measure in accordance with GAAP is net interest margin.
These non-GAAP financial measures should not be considered alternatives to GAAP-basis financial statements, and other bank holding companies may define these non-GAAP measures or similar measures differently. The following table presents the reconciliation of net interest income to net interest income adjusted to a fully taxable-equivalent basis
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assuming a relevant marginal tax for interest earned on tax-exempt assets such as municipal loans and investment securities (dollars in thousands), along with the calculation of yield on interest-earning assets (tax-equivalent basis), net interest spread (tax-equivalent basis) and net interest margin (tax-equivalent basis).
Three Months Ended Nine Months Ended
September 30, September 30,
Net interest income, yield on
interest-earning assets, net interest
spread, net interest margin (tax-equivalent
basis): 2022 2021 2022 2021
Net interest income (GAAP) $ 2,000 $ 1,739 $ 5,713 $ 5,142
Tax-equivalent adjustments: (1)
Loans - 4 4 6
Tax-exempt investment securities 114 101 328 300
Net interest income (tax-equivalent basis)
Average interest-earning assets (2)$ 267,946 $ 238,659 $ 260,380 $ 234,997 Yield on interest-earning assets 3.42 % 3.19 % 3.24 % 3.20 % Yield on interest-earning assets (tax-equivalent basis) 3.59 % 3.37 % 3.41 % 3.38 % Net interest spread 2.85 % 2.81 % 2.82 % 2.81 %
Net interest spread (tax-equivalent basis) 3.02 % 2.99 % 2.99 % 2.99 %
Net interest margin 2.99 % 2.92 % 2.93 % 2.92 %
Net interest margin (tax-equivalent basis) 3.16 % 3.09 % 3.10 % 3.09 %
(1) - Tax-exempt income has been adjusted to a tax-equivalent basis using the federal marginal tax rate of 21% for 2022 and 2021.
(2) - Investment securities, which are included in interest-earning assets, are based on amortized cost and do not give effect to changes in fair value that are reflected in Accumulated Other Comprehensive Income / Loss.
Comparison of Financial Condition at
Total assets increased
Cash and Cash Equivalents. Cash and cash equivalents decreased
Loans. Our primary lending activity is the origination of loans secured by real
estate. We originate one-to-four family residential loans, multifamily
residential loans, commercial real estate loans and construction loans, as well
as commercial business loans and consumer loans. Net loans receivable increased
Securities Available for Sale. Our available for sale securities portfolio
consists primarily of
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Securities Held to Maturity. Our held to maturity securities portfolio consists
of
Other Assets. Other assets increased
Deposits. Deposit accounts, primarily obtained from individuals and businesses
throughout our local market area, are the primary source of funds for our
lending and investments. Our deposit accounts are comprised of
noninterest-bearing checking, interest-bearing checking, savings, and money
market accounts and certificates of deposit. Deposits increased
Borrowings. In order to meet daily liquidity needs and to fund growth in
earning assets, the Company utilizes short-term advances from the FHLB. On
Stockholders' Equity. Stockholders' equity decreased
Comparison of Results of Operations for the Three and Nine Months Ended
Net Income. Net income was
Net Interest Income. Net interest income after provision for loan losses
increased
Total interest income increased
(1) Refer to "Non-GAAP Financial Measures" and "Reconciliation of Non-GAAP Financial Measures" above for more information and for a reconciliation of this non-GAAP financial measure to the nearest GAAP financial measure.
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Total interest expense increased
Net interest income after provision for loan losses increased
Total interest income was
Total interest expense increased
Provision for Loan Losses. Non-performing loans increased to
Noninterest Income. Noninterest income decreased
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Noninterest income increased
Noninterest Expense. Noninterest expense increased
Noninterest expense increased
Income Tax Expense. The Company recorded an income tax expense of
Liquidity and Capital Resources
Liquidity management is both a daily and longer-term function of management. Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds. On a longer-term basis, we maintain a strategy of investing in various lending products and investment securities, including municipal and mortgage-backed securities. We use our sources of funds primarily to meet ongoing commitments, pay maturing deposits, fund deposit withdrawals and fund loan commitments.
We maintain cash and investments that qualify as liquid assets to maintain
adequate liquidity to ensure safe and sound operation and meet demands for
customer funds (particularly withdrawals of deposits). At
Liquidity management involves the matching of cash flow requirements of
customers,
We believe that the COVID-19 pandemic could place potential stresses on our liquidity management. As our customers manage their liquidity issues, we could experience an increase in the utilization of existing lines of credit and or deposit outflows. We continually monitor our liquidity for signs of stress resulting from the COVID-19 pandemic and intend to respond consistent with our asset/liability objectives.
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The Company is a separate legal entity from
Our primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans and mortgage-backed securities, maturities of investment securities and other short-term investments and funds provided from operations. While scheduled payments from the amortization of loans and mortgage-backed securities and maturing investment securities and short-term investments are relatively predictable sources of funds, deposit flows and loan prepayments, which also provide liquidity to meet lending requirements, are greatly influenced by general interest rates. We also generate cash through borrowings. We utilize FHLB advances to leverage our capital base and provide funds for our lending and investment activities, and to enhance our interest rate risk management.
We use our sources of funds primarily to meet ongoing commitments, to pay
maturing deposits and fund withdrawals, and to fund loan commitments. At
The Bank is subject to minimum capital requirements imposed by the
The Bank elected to use the Community Bank Leverage Ratio ("CBLR") effective
The Bank was considered well-capitalized under applicable federal regulatory
capital guidelines with a CBLR of 15.4% at
For a bank holding company with less than
Off-Balance Sheet Arrangements
In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with GAAP, are not recorded on the Company's financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are primarily used to manage customers' requests for funding and take the form of loan commitments and letters of credit.
For the three and nine months ended
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