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FIRST US BANCSHARES, INC. – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
DESCRIPTION OF THE BUSINESS
First US Bancshares, Inc. , aDelaware corporation ("Bancshares" and, together with its subsidiaries, the "Company"), is a bank holding company with its principal offices inBirmingham, Alabama . Bancshares operates one commercial banking subsidiary,First US Bank (the "Bank"). As ofMarch 31, 2022 , the Bank operated and served its customers through 15 banking offices located inBirmingham ,Butler ,Calera ,Centreville ,Gilbertown ,Grove Hill ,Harpersville ,Jackson ,Thomasville ,Tuscaloosa andWoodstock, Alabama ;Knoxville andPowell, Tennessee ; andRose Hill, Virginia . In addition, the Bank operates loan production offices inMobile, Alabama and theChattanooga, Tennessee area. The Bank provides a wide range of commercial banking services to small- and medium-sized businesses, property managers, business executives, professionals and other individuals. The Bank also performs indirect lending through third-party retailers and currently conducts this lending in 12 states, includingAlabama ,Florida ,Georgia ,Kentucky ,Mississippi ,Missouri ,North Carolina ,Oklahoma ,South Carolina ,Tennessee ,Texas andVirginia . The Bank owns all of the stock ofAcceptance Loan Company, Inc. , anAlabama corporation ("ALC"). ALC is a finance company headquartered inMobile, Alabama . During the third quarter of 2021, ALC ceased new business development and permanently closed its 20 branch lending locations inAlabama andMississippi to the public.FUSB Reinsurance, Inc. , anArizona corporation and a wholly-owned subsidiary of the Bank ("FUSB Reinsurance"), reinsures or "underwrites" credit life and credit accident and health insurance policies sold to the Bank's and ALC's consumer loan customers. FUSB Reinsurance is responsible for the first level of risk on these policies up to a specified maximum amount, and a primary third-party insurer retains the remaining risk. A third-party administrator is also responsible for performing most of the administrative functions of FUSB Reinsurance on a contractual basis. Delivery of the best possible financial services to customers remains an overall operational focus of the Company. The Company recognizes that attention to detail and responsiveness to customers' desires are critical to customer satisfaction. The Company continues to upgrade technology, both in its financial services and in the training of its 161 full-time equivalent employees (as ofMarch 31, 2022 ), to ensure customer satisfaction and convenience. The preparation of the Company's consolidated financial statements requires management to make subjective judgments associated with estimates. These estimates are necessary to comply with accounting principles generally accepted inthe United States of America ("U.S. GAAP") and general banking practices. These estimates include accounting for the allowance for loan and lease losses, the right-of-use asset and lease liability, the value of other real estate owned and certain collateral-dependent loans, consideration related to goodwill impairment testing and deferred tax asset valuation. A description of these estimates, which significantly affect the determination of the Company's consolidated financial position, results of operations and cash flows, is set forth in Note 2, "Summary of Significant Accounting Policies," of the Notes to Consolidated Financial Statements in Bancshares' Annual Report on Form 10-K as of and for the year endedDecember 31, 2021 .
The emphasis of this discussion is a comparison of assets, liabilities and
shareholders' equity as of
income and expense for the three-month periods ended
All yields and ratios presented and discussed herein are recorded and presented
on the accrual basis and not on the tax-equivalent basis, unless otherwise
indicated.
This information should be read in conjunction with the Company's unaudited condensed consolidated financial statements and related notes appearing elsewhere in this report and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in Bancshares' Annual Report on Form 10-K as of and for the year endedDecember 31, 2021 . As used in the following discussion, the words "we," "us," "our" and the "Company" refer to Bancshares and its consolidated subsidiaries, unless the context indicates otherwise. 39
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RECENT MARKET CONDITIONS
During the first three months of 2022, general economic conditions benefited from declining COVID-19 cases and the related lifting of COVID-19 restrictions throughoutthe United States . However, economic concerns remain due to uncertainty that persists with respect to the long-term effectiveness of efforts to reduce the impact of COVID-19 both globally and domestically. In addition, economic uncertainty emerged from geopolitical developments surrounding the invasion ofUkraine byRussia and further COVID-19 lockdowns inChina . Furthermore, inflation has reached a 40-year high during 2022, and market rates of interest have risen after a prolonged period at historical lows. InMarch 2022 , theFederal Reserve Board (FRB) raised the target federal funds rate for the first time in three years to a range of 0.25% to 0.50%. InMay 2022 , the FRB again raised the target federal funds rate to a range of 0.75% to 1.00%, and signaled the possibility of additional rate increases throughout 2022. The prolonged period of reduced interest rates has and may continue to have an adverse effect on net interest income, margins and profitability for financial institutions, including the Company. As interest rates increase, competitive pressures on deposit pricing are also expected to increase. The pace and magnitude of changes in interest rates, or the impact that such changes will have on the Company's operating results cannot be fully predicted. Further, as the rate of inflation accelerates, the Company's operations could be impacted by, among other things, accelerating cost of goods and services, including the cost of salaries and benefits. Additionally, the Company's borrowers could be negatively impacted by rising expense levels, leading to deterioration of credit quality and/or reductions in the Company's lending activity.
EXECUTIVE OVERVIEW
Update on Strategic Initiatives
Beginning in 2021, the Company originated certain strategic initiatives designed to improve the Company's operating efficiency, focus the Company's loan growth activities, and fortify asset quality. The discussion below provides an update regarding the Company's ongoing strategic initiatives.
Cessation of Business at ALC
OnSeptember 3, 2021 , ALC ceased new business development and permanently closed its 20 branch lending locations inAlabama andMississippi to the public. This initiative assisted the Company in reducing non-interest expense through the reduction of personnel, branch leases, technology and other overhead expenses beginning in the fourth quarter of 2021. ALC's non-interest expense totaled$0.5 million for the three months endedMarch 31, 2022 , compared to$1.8 million for the three months endedMarch 31, 2021 . As ofMarch 31, 2022 , ALC employed eight full-time equivalent employees that continued to collect payments on loans through ALC'sMobile, Alabama headquarters office. Management expects that the majority of ALC's loans will be paid off by the end of 2023. While this strategy is expected to provide ongoing expense reductions, interest income earned on ALC's loans will also continue to decline in future periods as the loans pay down. For the three-months endedMarch 31, 2022 , interest income earned on ALC's loans totaled$1.6 million , compared to$2.4 million for the three months endedMarch 31, 2021 . Accordingly, the Company's focus remains on continued loan growth in other areas of the Bank's portfolio, as well as efforts to continue to simplify the Company's ongoing operations and reduce expenses further. Over time, the reduction of loans at ALC is expected to improve the Company's asset quality significantly. ALC's loans, and in particular, its direct consumer portfolio, have historically had the Company's highest level of losses. Approximately 98.4% and 68.9% of the Company's net charge-offs were related to loans in ALC's portfolio during the three months endedMarch 31, 2022 andMarch 31, 2021 , respectively. Organizational Efforts InJanuary 2022 , management reorganized the Bank's retail banking, technology and deposit operations functions under a single organizational structure. Under this structure, management expects to further improve the efficiency of its retail banking operation, while also improving the promotion and deployment of the Bank's digital products and services.
In addition, the Company continues to evaluate opportunities throughout the
organization to improve its processes and simplify business models.
Financial Highlights
The Company earned net income of$1.4 million , or$0.20 per diluted common share, during the three months endedMarch 31, 2022 , compared to$950 thousand , or$0.14 per diluted common share, for the three months endedMarch 31, 2021 . Growth in the Company's net income resulted from reductions in both non-interest expense and, to a lesser extent, interest expense, comparing the three months endedMarch 31, 2022 to the three months endedMarch 31, 2021 . The non-interest expense reductions were driven by the strategic initiatives executed by the Company in 2021, primarily the ALC business cessation strategy. 40
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Summarized condensed consolidated statements of operations are included below
for the three-month periods ended
Three Months Ended
March 31, March 31,
2022 2021
(Dollars in Thousands)
Interest income $ 9,381 $ 9,845
Interest expense 672 781
Net interest income 8,709 9,064
Provision for loan and lease losses 721
401
Net interest income after provision for loan and lease losses 7,988 8,663 Non-interest income 829 951 Non-interest expense 7,056 8,396 Income before income taxes 1,761 1,218 Provision for income taxes 400 268 Net income$ 1,361 $ 950 Basic net income per share$ 0.22 $ 0.15 Diluted net income per share$ 0.20 $ 0.14 Dividends per share$ 0.03 $ 0.03
Net Interest Income and Margin
Net interest income decreased by$0.4 million comparing the three months endedMarch 31, 2022 to the three months endedMarch 31, 2021 . The most significant driver of the decrease in net interest income was the reduction of interest and fees on ALC loans in connection with the ALC business cessation strategy. Interest and fees on ALC loans decreased by$0.8 million during the three months endedMarch 31, 2022 , compared to the three months endedMarch 31, 2021 . This reduction was partially offset by increased interest income in the Bank's other loan portfolios, as well as an increase in investment security interest income and a reduction in interest expense on deposits. As ALC's loan portfolio continues to pay down, there will be continued reduction in interest and fees attributable to ALC's loans. These reductions are expected to continue to put downward pressure on total loan yield and net interest margin. As a result of the changing mix of loans, the Company's net interest margin was reduced to 3.97% during the three months endedMarch 31, 2022 , compared to 4.40% during the three months endedMarch 31, 2021 . Historically, ALC's loan portfolio has represented both the Company's highest yielding loans, as well as the portfolio with the highest level of credit losses. Accordingly, while interest earned on these loans is expected to decrease over time, loan loss provision expense is also expected to decrease as the portfolio pays down.
Provision for Loan and Lease Losses
The provision for loan and lease losses was$0.7 million during the three months endedMarch 31, 2022 , compared to$0.4 million during the three months endedMarch 31, 2021 . The increase in provision expense during the three months endedMarch 31, 2022 , compared to the three months endedMarch 31, 2021 reflected both an increase in charge-offs associated with ALC's loan portfolio, as well as qualitative adjustments applied to ALC's portfolio in response to heightened inflationary trends and other economic uncertainties that emerged during the quarter. In management's view, the combination of the business cessation strategy, coupled with deteriorating economic conditions, including elevated inflation levels, increased overall credit risk in ALC's loan portfolio as ofMarch 31, 2022 , compared toDecember 31, 2021 . 41 --------------------------------------------------------------------------------
Non-interest Income
Non-interest income decreased by$0.1 million comparing the three months endedMarch 31, 2022 to the three months endedMarch 31, 2021 . The reduction resulted primarily from decreases in miscellaneous revenue sources, including credit insurance income associated with ALC's loans.
Non-interest Expense
Non-interest expense decreased by$1.3 million comparing the three months endedMarch 31, 2022 to the three months endedMarch 31, 2021 . The decrease in 2022 resulted primarily from implementation of the ALC strategy, as well as other efficiency efforts conducted at the Bank. As a result of these efforts, significant expense reductions were realized associated with salaries and employee benefits, occupancy and equipment, as well as other expenses associated with technology and professional services. Non-interest expense during the three months endedMarch 31, 2022 was reduced by$0.2 million in nonrecurring net gains on the sale of other real estate owned (OREO).
Balance Sheet Growth
As ofMarch 31, 2022 , the Company's assets totaled$968.6 million , compared to$958.3 million as ofDecember 31, 2021 , an increase of 1.1%. Compared toMarch 31, 2021 , the Company's total assets increased by$42.1 million , or 4.5%.
Loans
Total loans decreased by$30.9 million , or 4.3% as ofMarch 31, 2022 , compared toDecember 31, 2021 . Loan volume decreases were most pronounced in the Bank's commercial real estate (secured by non-farm, non-residential properties) and construction categories. The decreases in these loan categories was generally consistent with historic first quarter seasonality, and a portion of the reduction was attributable to the payoff of loans in accordance with contractual terms as financed construction projects were completed. In addition, the ALC business cessation strategy resulted in decreases primarily in the direct consumer and branch retail loan categories. Loan volume reductions were partially offset by growth in the Bank's indirect and multi-family portfolios.
Asset Quality
The Company's nonperforming assets, including loans in non-accrual status and OREO, totaled$3.1 million as ofMarch 31, 2022 , compared to$4.2 million as ofDecember 31, 2021 . The reduction in nonperforming assets during the three months endedMarch 31, 2022 resulted from the sale of OREO properties during the quarter. Reductions in OREO totaled$1.3 million and included the sale of banking centers that were closed by the Company in 2021. As a percentage of total assets, non-performing assets totaled 0.32% as ofMarch 31, 2022 , compared to 0.43% as ofDecember 31, 2021 .
Deposit Growth and Deployment of Funds
Deposits increased by$15.0 million , or 1.8%, as ofMarch 31, 2022 , compared toDecember 31, 2021 . In the current environment, management has continued to focus on minimizing deposit expense and deploying excess cash balances into earning assets that meet the Company's established credit standards, while maintaining appropriate levels of liquidity in accordance with projected funding needs. Total average funding costs, including both interest- and noninterest-bearing liabilities and borrowings, was reduced to 0.32% for the three months endedMarch 31, 2022 , compared to 0.39% for the three months endedMarch 31, 2021 . Given the increasing interest rate environment during the first quarter of 2022, management continued to deploy a portion of excess funds into the investment securities portfolio. Investment securities, including both the available-for-sale and held-to-maturity portfolios totaled$137.7 million as ofMarch 31, 2022 , compared to$134.3 million as ofDecember 31, 2021 . The expected average life of securities in the investment portfolio as ofMarch 31, 2022 was 3.5 years, compared to 3.7 years as ofDecember 31, 2021 . Management maintains the portfolio with average durations that are expected to provide monthly cash flows that can be utilized to reinvest in earning assets at current market rates.
Shareholders' Equity
Shareholders' equity decreased by$2.3 million , or 2.5%, as ofMarch 31, 2022 , compared toDecember 31, 2021 . The decrease in shareholders' equity resulted primarily from increases in accumulated other comprehensive loss due to declines in the market value of the Company's available-for-sale investment portfolio. The market value declines were the direct result of the increasing interest rate environment during the three months endedMarch 31, 2022 . No other-than-temporary impairment was recognized in the investment portfolio during the three months endedMarch 31, 2022 , and the Company has both the intent and ability to retain the investments for a period of time sufficient to allow for the full recovery of all market value decreases. The market value decrease in available-for-sale securities was partially offset by an increase in the market value of cash flow derivative instruments that hedge certain deposits and borrowings on the Company's balance sheet.
During the three months endedMarch 31, 2022 , the Bank continued to maintain capital ratios at higher levels than required to be considered a "well-capitalized" institution under applicable banking regulations. As ofMarch 31, 2022 , the Bank's common equity Tier 1 capital and Tier 1 risk-based capital ratios were each 11.82%. Its total capital ratio was 12.95%, and its Tier 1 leverage ratio was 9.38%. 42
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Liquidity
The Company continues to maintain excess funding capacity to provide adequate liquidity for loan growth, capital expenditures and ongoing operations. The Company benefits from a strong deposit base, a liquid investment securities portfolio and access to funding from a variety of sources, including federal funds lines,Federal Home Loan Bank ("FHLB") advances and brokered deposits.
Cash Dividend
The Company declared a cash dividend of
during both three-month periods ended
Share Repurchases
During the three months endedMarch 31, 2022 , the Company completed share repurchases totaling 87,600 shares of its common stock at a weighted average price of$10.94 per share. The repurchases were completed under the Company's existing share repurchase program, which was amended inApril 2021 to allow for the repurchase of additional shares throughDecember 31, 2022 . As ofMarch 31, 2022 , a total of 921,613 shares remained available for repurchase under the program. 43 --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Net Interest Income
Net interest income is calculated as the difference between interest and fee income generated from earning assets and the interest expense paid on deposits and borrowed funds. Fluctuations in interest rates, as well as volume and mix changes in earning assets and interest-bearing liabilities, can materially impact net interest income. The Company's earning assets consist of loans, taxable and tax-exempt investments,Federal Home Loan Bank stock, federal funds sold by the Bank and interest-bearing deposits in banks. Interest-bearing liabilities consist of interest-bearing demand deposits and savings and time deposits, as well as short-term borrowings. The following tables show the average balances of each principal category of assets, liabilities and shareholders' equity for the three-month periods endedMarch 31, 2022 and 2021. Additionally, the tables provide an analysis of interest revenue or expense associated with each category, along with the accompanying yield or rate percentage. Net interest margin is calculated for each period presented as net interest income divided by average total interest-earning assets. Three Months Ended Three Months Ended March 31, 2022 March 31, 2021 Annualized Annualized Average Yield/ Average Yield/ Balance Interest Rate % Balance Interest Rate % (Dollars in Thousands) ASSETS Interest-earning assets: Total loans (Note A)$ 696,695 $ 8,847 5.15 %$ 652,886 $ 9,490 5.89 % Taxable investment securities 130,306 485 1.51 % 83,151 306 1.49 % Tax-exempt investment securities 2,771 12 1.76 % 3,522 16 1.84 % Federal Home Loan Bank stock 879 8 3.69 % 1,106 9 3.30 % Federal funds sold 81 - 0.00 % 84 - 0.00 % Interest-bearing deposits in banks 57,859 29 0.20 % 95,303 24 0.10 % Total interest-earning assets 888,591 9,381 4.28 % 836,052 9,845 4.78 % Non interest-earning assets 64,958 68,838 Total$ 953,549 $ 904,890 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing deposits: Demand deposits$ 250,612 $ 126 0.20 %$ 225,152 $ 139 0.25 % Savings deposits 197,016 140 0.29 % 174,678 145 0.34 % Time deposits 210,727 249 0.48 % 238,659 459 0.78 % Total interest-bearing deposits 658,355 515 0.32 % 638,489 743 0.47 % Non interest-bearing demand deposits 175,285 - - 159,208 - - Total deposits 833,640 515 0.25 % 797,697 743 0.38 % Borrowings 20,715 157 3.07 % 10,016 38 1.54 % Total funding costs 854,355 672 0.32 % 807,713 781 0.39 % Other non interest-bearing liabilities 9,692 9,720 Shareholders' equity 89,502 87,457 Total$ 953,549 $ 904,890 Net interest income (Note B)$ 8,709
$ 9,064 Net interest margin 3.97 % 4.40 %
Note A - For the purpose of these computations, non-accruing loans are included in
the average loan amounts outstanding. These loans averaged
and
respectively.
Note B - Loan fees are included in the interest amounts presented. Loan fees
totaled
March 31, 2022 and 2021, respectively. 44
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The following tables summarize the impact of variances in volume and rate of
interest-earning assets and interest-bearing liabilities on components of net
interest income.
Three Months Ended March 31, 2022 Three Months Ended March 31, 2021
Compared to Compared to
Three Months Ended March 31, 2021 Three Months Ended March 31, 2020
Increase (Decrease) Increase (Decrease)
Due to Change In: Due to Change In:
Average Average
Volume Rate Net Volume Rate Net
(Dollars in Thousands)
Interest earned on:
Total loans $ 637 $ (1,280 ) $ (643 ) $ 1,843 $ (1,992 ) $ (149 )
Taxable investment securities 174 5 179 (107 ) (118 ) (225 )
Tax-exempt investment securities (3 ) (1 ) (4 ) 20 (14 ) 6
Federal Home Loan Bank stock (2 ) 1 (1 ) - (5 ) (5 )
Federal funds sold - - - (42 ) - (42 )
Interest-bearing deposits in
banks (9 ) 14 5 134 (271 ) (137 )
Total interest-earning assets 797 (1,261 ) (464 ) 1,848 (2,400 ) (552 )
Interest expense on:
Demand deposits 16 (29 ) (13 ) 58 (94 ) (36 )
Savings deposits 19 (24 ) (5 ) 18 (186 ) (168 )
Time deposits (54 ) (156 ) (210 ) 2 (530 ) (528 )
Borrowings 41 78 119 - 2 2
Total interest-bearing
liabilities 22 (131 ) (109 ) 78 (808 ) (730 )
Increase (decrease) in net
interest income $ 775 $ (1,130 ) $ (355 ) $ 1,770 $ (1,592 ) $ 178
Net interest income for the three months ended March 31, 2022 decreased by $0.4
million compared to the three months ended March 31, 2021 . The decrease in net
interest income comparing the two periods resulted from a decrease in interest
and fees on loans, partially offset by an increase in interest on investment
securities and a decrease in interest expense. Average yield on interest-earning
assets decreased to 4.28% in the first quarter of 2022, compared to 4.78% for
the corresponding quarter of 2021, while aggregate funding costs, including
noninterest-bearing deposits and borrowings, decreased to 0.32% in the first
quarter of 2022, compared to 0.39% in the first quarter of 2021. Net interest
margin was reduced by 43 basis points to 3.97% during the first quarter of 2022,
compared to 4.40% during the first quarter of 2021.
During the first quarter of 2022, both interest income and interest expense
continued to be impacted by the relatively low interest rate environment that
began in early 2020 at the onset of the COVID-19 pandemic. However, a number of
benchmark interest rates increased during the first quarter of 2022, and it is
expected that the Company's net interest income will continue to be impacted by
changes in the interest rate environment. Management's interest rate risk
modeling generally indicates that both net interest margin and net interest
income would benefit over time in a rising interest rate environment and would
decrease in a reducing interest rate environment. In addition, the Company's
strategy to cease new business development at ALC is expected to reduce average
yields on loans in the near term until the ALC portfolio has paid down to
nominal levels. Management expects that growth in loan volume with loans of
sufficient credit quality will enhance net interest income as earning assets are
shifted from lower earning cash and federal funds sold balances into loan
assets. However, the environment for both loan and deposit generation is highly
competitive and subject to the interest rate environment. Reductions in either
loan volume or deposit levels could result in downward pressure on net interest
income.
The Federal Open Market Committee raised the federal funds rate by 25 basis
points in March of 2022 and by an additional 50 basis points in May of 2022, and
statements by the Federal Reserve chair have indicated that further interest
rate increases may be expected in 2022 to address inflationary
pressures. Although, as described above, the Company's interest margin generally
will benefit from rising interest rates, rates may rise in an uneven manner
causing unpredictable effects, and higher rates could negatively affect the
economy, loan demand and borrowers' financial position, and could cause
additional declines in the market value of the Company's investment securities.
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Provision for Loan and Lease Losses
The provision for loan and lease losses was$0.7 million during the first quarter of 2022, compared to$0.4 million during the first quarter of 2021. The increase in the provision, comparing the two quarters, resulted from both an increase in charge-offs associated with ALC's runoff loan portfolio, as well as qualitative adjustments applied to ALC's portfolio in response to heightened inflationary trends and other economic uncertainties that emerged during the first quarter of 2022. In management's view, the combination of the business cessation strategy, coupled with deteriorating economic conditions, including elevated inflation levels, increased overall credit risk in ALC's loan portfolio as ofMarch 31, 2022 , compared toDecember 31, 2021 . The loan loss provision recorded by the Company during the first quarter of 2022 included$0.8 million associated with ALC's portfolio, partially offset by a$0.1 million net decrease in provision in the Bank's other loan categories due to overall reduction in loan volume associated with those categories. The Company's net charge-offs totaled$0.6 million during the first quarter of 2022, compared to$0.4 million during the first quarter of 2021. The majority of the Company's charge-offs in both 2022 and 2021 were associated with loans in ALC's portfolio. Management believes that the allowance for loan and lease losses as ofMarch 31, 2022 , which was calculated under an incurred loss model, was sufficient to absorb losses in the Company's loan portfolio based on circumstances existing as of the balance sheet date. Management will continue to closely monitor the impact of changing economic circumstances on the Company's loan portfolio and will adjust the allowance accordingly. In accordance with relevant accounting guidance for smaller reporting companies, the Company has not yet adopted the Current Expected Credit Loss (CECL) accounting model for the calculation of credit losses and is currently evaluating the impact that adopting CECL will have on the Company's financial statements. Due to its classification as a smaller reporting company by theSecurities and Exchange Commission , the Company is not required to implement the CECL model untilJanuary 1, 2023 .
Non-Interest Income
Non-interest income represents fees and income derived from sources other than
interest-earning assets. The following table presents the major components of
non-interest income for the periods indicated:
Three Months Ended March 31,
2022 2021 $ Change
% Change
(Dollars in Thousands)
Service charges and other fees on
deposit accounts$ 299 $ 266 $ 33 12.4 % Bank-owned life insurance 110 108 2 1.9 % Lease income 214 209 5 2.4 % Other income 206 368 (162 ) (44.0 )% Total non-interest income$ 829 $ 951 $ (122 ) (12.8 )% The Company's non-interest income decreased during the first quarter of 2022 by$0.1 million compared to the first quarter of 2021 due to a decrease in the other income category that resulted primarily from reductions in credit insurance commissions and fees. The reduction in credit insurance revenue is commensurate with the overall reduction in ALC's loan volume since implementation of the cessation of business strategy at ALC. We expect continued declines in this revenue as the ALC loan portfolio runs out. The decrease in other non-interest income comparing the first quarter of 2022 to the first quarter of 2021 was partially offset by increases in service charges and other fees on deposit accounts that were volume driven. Non-interest revenues earned from service charges and other fees on deposit accounts have generally declined during recent years based on changes in depositor preferences for liquidity, particularly during the pandemic. Management continues to evaluate opportunities to add new non-interest revenue streams or to grow existing streams; however, significant growth in non-interest income is not expected in the near term. 46
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Non-Interest Expense
Non-interest expense represents expenses incurred from sources other than
interest-bearing liabilities. The following table presents the major components
of non-interest expense for the periods indicated:
Three Months Ended March 31,
2022 2021 $ Change % Change
(Dollars in Thousands)
Salaries and employee benefits
Net occupancy and equipment expense
766 1,039$ (273 ) (26.3 )% Computer services 377 465$ (88 ) (18.9 )% Insurance expense and assessments 367 316$ 51 16.1 % Fees for professional services 268 357$ (89 ) (24.9 )% Postage, stationery and supplies 164 215$ (51 ) (23.7 )% Telephone/data communications 171 232$ (61 ) (26.3 )% Other real estate/foreclosure (income) expense, net (145 ) 7$ (152 ) NM Other expense 758 851$ (93 ) (10.9 )% Total non-interest expense$ 7,056 $ 8,396 $ (1,340 ) (16.0 )% NM: Not Meaningful Non-interest expense decreased$1.3 million comparing the first quarter of 2022 to the first quarter of 2021. Implementation of the ALC cessation of business strategy, combined with Bank branch closures that occurred in the third quarter of 2021 and other operational efficiency efforts, led to significant reductions in the Company's personnel levels, reduced levels of occupancy and equipment expense, and decreases in various other expense categories. As ofMarch 31, 2022 , the Company employed 161 full-time equivalent employees (including 153 at the Bank and eight at ALC), compared to 175 as ofDecember 31, 2021 , and 265 as ofMarch 31, 2021 . The reduction in occupancy and equipment expense resulted primarily from the termination of the majority of ALC's lease contracts following cessation of business at its branches, as well as the closure of four bank branches in the third quarter of 2021. As ofMarch 31, 2022 , all previously existing ALC leases had been terminated except for the ongoing lease of ALC's headquarters office that continues to house the remaining ALC staff. During the first quarter of 2022, non-interest expenses were reduced by one-time net gains on the sale of OREO that totaled$0.2 million . The gains were primarily generated by the sale of the Bank's closed branch assets. As ofMarch 31, 2022 , all branches closed by the Bank during the third quarter of 2021 had been sold. Reductions in most expense categories were partially offset by an increase in insurance expense and assessments due primarily to growth in the Company's total assets which resulted in increased regulatory assessments. The decrease in non-interest expense was partially offset by$0.1 million in restructuring charges associated with the ALC cessation of business strategy recorded during the first quarter of 2022. As ofMarch 31, 2022 , the majority of estimated restructuring charges associated with the ALC strategy have been incurred. The strategic initiatives implemented in 2021 are expected to continue to reduce the Company's expense structure in the near term, although the reductions may be partially offset by inflationary pressures affecting the Company's ongoing operations. One of management's primary focuses continues to be business simplification and process improvements in an effort to continue improving the Company's overall efficiency levels.
Provision for Income Taxes
The provision for income taxes was
three-month periods ended
Company's effective tax rate was 22.7% and 22.0%, respectively, for the same
periods.
The effective tax rate is impacted by recurring items, such as changes in tax-exempt interest income earned from bank-qualified municipal bonds and loans and the cash surrender value of bank-owned life insurance. Management makes decisions about whether to invest in tax-exempt instruments on a case-by-case basis after considering a number of factors, including investment return, credit quality and the consistency of such investments with the Company's overall strategy. The Company's effective tax rate is expected to fluctuate commensurate with the level of these investments as compared to total pre-tax income.
BALANCE SHEET ANALYSIS
The investment securities portfolio is used by management to provide liquidity, to generate interest income and for use as collateral for public deposits and wholesale funding. Risk and return can be adjusted by altering the duration, composition and/or balance of the portfolio. The expected average life of securities in the investment portfolio was 3.5 years and 3.7 years as ofMarch 31, 2022 andDecember 31, 2021 , respectively. 47 -------------------------------------------------------------------------------- Available-for-sale securities are recorded at estimated fair value, with unrealized gains or losses recognized, net of taxes, in accumulated other comprehensive income, a separate component of shareholders' equity. As ofMarch 31, 2022 , available-for-sale securities totaled$135.0 million , or 98.0% of the total investment portfolio, compared to$130.9 million , or 97.4% of the total investment portfolio, as ofDecember 31, 2021 . Available-for-sale securities consisted of residential and commercial mortgage-backed securities,U.S. Treasury securities, corporate bonds and obligations of state and political subdivisions. Held-to-maturity securities are recorded at amortized cost and represent securities that the Company both intends and has the ability to hold to maturity. As ofMarch 31, 2022 , held-to-maturity securities totaled$2.7 million , or 2.0% of the total investment portfolio, compared to$3.4 million , or 2.6% of the total investment portfolio, as ofDecember 31, 2021 . Held-to-maturity securities consisted of commercial mortgage-backed securities, obligations ofU.S. government-sponsored agencies and obligations of states and political subdivisions. Due to the increasing interest rate environment, during the first quarter of 2022, gross unrealized losses increased significantly, particularly within the Company's available-for-sale portfolio. Gross unrealized losses in the investment portfolio totaled$4.9 million as ofMarch 31, 2022 , compared to$0.8 million as ofDecember 31, 2021 . Management evaluated unrealized losses as ofMarch 31, 2022 , and determined that no losses within the portfolio were other-than-temporary. Accordingly, no losses were realized during the first quarter of 2022. Unrealized losses within the available-for-sale portfolio were recognized, net of tax, in accumulated other comprehensive income.
Loans and Allowance for Loan and Lease Losses
The Company's total loan portfolio decreased by$30.9 million , or 4.3%, as ofMarch 31, 2022 , compared toDecember 31, 2021 . Loan volume decreases were most pronounced in the Bank's commercial real estate (secured by non-farm, non-residential properties) and construction categories. The decrease in these loan categories was generally consistent with historic first quarter seasonality, and a portion of the reduction was attributable to the payoff of loans in accordance with contractual terms as financed construction projects were completed. In addition, the ALC business cessation strategy resulted in decreases primarily in the direct consumer and branch retail loan categories. Loan volume reductions were partially offset by growth in the Bank's indirect and multi-family portfolios. The indirect portfolio has experienced significant growth in recent quarters and is focused on consumer lending secured by collateral that includes recreational vehicles, campers, boats, horse trailers and cargo trailers. The Bank now operates indirect lending in a 12-state footprint primarily in the southeasternUnited States .
The tables below summarize loan balances by portfolio category at the end of
each of the most recent five quarters as of
Quarter Ended
2022 2021
March December September June March
31, 31, 30, 30, 31,
(Dollars in Thousands)
Real estate loans:
Construction, land development and
other land loans $ 52,817 $ 67,048 $ 58,175 $ 53,425 $ 48,491
Secured by 1-4 family residential
properties 69,760 72,727 73,112 78,815 82,349
Secured by multi-family residential
properties 50,796 46,000 51,420 53,811 54,180
Secured by non-farm,
non-residential properties 177,752 197,901 198,745 191,398 193,626
Commercial and industrial loans 68,098 73,947 77,679 77,359 79,838
Consumer loans:
Direct consumer 18,023 21,689 25,845 26,937 26,998
Branch retail 21,891 25,692 29,764 31,688 31,075
Indirect 220,931 205,940 194,154 176,116 153,940
Total loans $ 680,068 $ 710,944 $ 708,894 $ 689,549 $ 670,497
Less unearned interest, fees and
deferred cost 1,738 2,594 3,729 4,067 3,792
Allowance for loan and lease losses 8,484 8,320 8,193 7,726 7,475
Net loans $ 669,846 $ 700,030 $ 696,972 $ 677,756 $ 659,230
48
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The tables below summarize changes in the allowance for loan and lease losses
for each of the most recent five quarters as of
Quarter Ended
2022 2021
March December September June March
31, 31, 30, 30, 31,
(Dollars in Thousands)
Balance at beginning of period $ 8,320 $ 8,193 $ 7,726 $ 7,475 $ 7,470
Charge-offs:
Real estate loans:
Construction, land development and
other land loans - (1 ) - (1 ) (21 )
Secured by 1-4 family residential
properties (2 ) (6 ) (1 ) 4 (9 )
Secured by multi-family residential
properties - - - - -
Secured by non-farm,
non-residential properties - - - - -
Commercial and industrial loans,
including PPP loans - - (6 ) - -
Consumer loans:
Direct consumer (557 ) (437 ) (222 ) (278 ) (348 )
Branch retail (145 ) (23 ) (77 ) (92 ) (130 )
Indirect (25 ) (118 ) (55 ) (193 ) (117 )
Total charge-offs (729 ) (585 ) (361 ) (560 ) (625 )
Recoveries 172 219 210 313 229
Net charge-offs (557 ) (366 ) (151 ) (247 ) (396 )
Provision for loan and lease losses 721 493 618 498 401
Ending balance $ 8,484 $ 8,320 $ 8,193 $ 7,726 $ 7,475
Ending balance as a percentage of
loans 1.25 % 1.17 % 1.16 % 1.13 % 1.12 %
Net charge-offs as a percentage of
average loans 0.32 % 0.20 %
0.09 % 0.15 % 0.25 %
Charge-offs increased during the first quarter of 2022 in the direct consumer and branch retail categories due to charge-offs associated with ALC's loan portfolio. In management's view, the combination of the ALC business cessation strategy, coupled with deteriorating economic conditions, including elevated inflation levels, increased overall credit risk in ALC's loan portfolio as ofMarch 31, 2022 , compared toDecember 31, 2021 . The increase in provision expense in the first quarter of 2022 reflected the impact of these changing circumstances on ALC's portfolio.
Nonperforming Assets
Nonperforming assets at the end of the five most recent quarters as ofMarch 31, 2022 were as follows: Quarter Ended 2022 2021 March December September June March 31, 31, 30, 30, 31, (Dollars in Thousands) Non-accrual loans$ 2,228 $ 2,008 $ 969 $ 1,279 $ 2,509 Other real estate owned 874 2,149 2,373 846 942 Total$ 3,102 $ 4,157 $ 3,342 $ 2,125 $ 3,451 Nonperforming assets as a percentage of total assets 0.32 % 0.43 %
0.35 % 0.22 % 0.37 %
The decrease in OREO as of
resulted primarily from the sale of banking centers that were closed in 2021.
49 --------------------------------------------------------------------------------
Allocation of Allowance for Loan and Lease Losses
While no portion of the allowance for loan and lease losses is in any way restricted to any individual loan or group of loans and the entire allowance is available to absorb losses from any and all loans, the following table shows an allocation of the allowance for loan and lease losses as ofMarch 31, 2022 andDecember 31, 2021 : March 31, 2022 December 31, 2021 Percent of Percent of Percent of Percent of Allowance Loans Allowance Loans in Each in Each in Each in Each Category Category Category Category Allocation to Total to Total Allocation to Total to Total Allowance Allowance Loans Allowance Allowance Loans (Dollars in Thousands) Real estate loans: Construction, land development and other land loans$ 487 5.8 % 7.7 %$ 628 7.5 % 9.4 % Secured by 1-4 family residential properties 684 8.1 % 10.3 % 690 8.3 % 10.2 % Secured by multi-family residential properties 484 5.7 % 7.5 % 437 5.3 % 6.5 % Secured by non-farm, non-residential properties 1,774 20.9 % 26.1 % 1,958 23.5 % 27.8 % Commercial and industrial loans 889 10.5 % 10.0 % 860 10.3 % 10.4 % Consumer loans: Direct consumer 1,064 12.5 % 2.7 % 1,004 12.1 % 3.1 % Branch retail 521 6.1 % 3.2 % 304 3.7 % 3.6 % Indirect 2,581 30.4 % 32.5 % 2,439 29.3 % 29.0 % Total loans$ 8,484 100.0 % 100.0 %$ 8,320 100.0 % 100.0 % Deposits Total deposits increased to$853.1 million as ofMarch 31, 2022 , from$838.1 million as ofDecember 31, 2021 , an increase of 1.8%. Core deposits, which exclude time deposits of$250 thousand or more, provide a relatively stable funding source that supports earning assets. Core deposits increased to$791.6 million , or 92.8% of total deposits, as ofMarch 31, 2022 , compared to$775.1 million , or 92.5% of total deposits, as ofDecember 31, 2021 . Core deposits, have historically been the Company's primary source of funding and have enabled the Company to successfully meet both short-term and long-term liquidity needs. Management anticipates that core deposits will continue to be the Company's primary source of funding in the future. Management will continue to monitor deposit levels closely to help ensure an adequate level of funding for the Company's activities. However, various economic and competitive factors could affect this funding source in the future, including increased competition from other financial institutions in deposit gathering, national and local economic conditions and interest rate policies adopted by theFederal Reserve and other central banks.
Average Daily Amount of Deposits and Rates
The average daily amount of deposits and rates paid on such deposits are
summarized for the periods indicated in the following table:
Three Months Ended
March 31, 2022 March 31, 2021
Average Average
Amount Rate Amount Rate
(Dollars in Thousands)
Non-interest-bearing demand deposit accounts $ 175,285 - $ 159,208 -
Interest-bearing demand deposit accounts 250,612 0.20 % 225,152 0.25 %
Savings deposits 197,016 0.29 % 174,678 0.34 %
Time deposits 210,727 0.48 % 238,659 0.78 %
Total deposits $ 833,640 0.25 % $ 797,697 0.38 %
Total interest-bearing deposits $ 658,355 0.32 % $
638,489 0.47 %
Other Interest-Bearing Liabilities
Other interest-bearing liabilities consist of federal funds purchased,
securities sold under agreements to repurchase, FHLB advances, and subordinated
debt that are used by the Company as an alternative source of funds. During the
first quarter of 2022, other interest-bearing liabilities represented 3.1% of
average interest-bearing liabilities, compared to 1.5% in the first quarter of
2021.
50
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Shareholders' Equity
As ofMarch 31, 2022 , shareholders' equity totaled$87.8 million , or 9.1% of total assets, compared to$90.1 million , or 9.4% of total assets, as ofDecember 31, 2021 . Management believes that this level of equity is an indicator of the financial soundness of the Company and the Company's ability to sustain future growth and profitability. The decrease in shareholders' equity as ofMarch 31, 2022 , compared toDecember 31, 2021 , was due primarily to an increase in accumulated other comprehensive loss associated with unrealized losses on available-for-sale investment securities. The increase in unrealized losses within the securities portfolio resulted from significant increases in interest rates during the quarter which reduced security valuations. The reductions in security valuations were partially offset by increases in the fair value of cash flow hedges during the quarter. Changes in both the fair value of the available-for-sales investment securities portfolio and changes in the fair value of cash flow hedges are recorded, net of tax, in accumulated other comprehensive income. During both of the three-month periods endedMarch 31, 2022 and 2021, the Company declared a dividend of$0.03 per common share, or approximately$0.2 million in aggregate amount. Bancshares' Board of Directors evaluates dividend payments based on the Company's level of earnings and the desire to maintain a strong capital base, as well as regulatory requirements relating to the payment of dividends. During the first quarter of 2022, the Company completed repurchases of 87,600 shares of its common stock at a weighted average price of$10.94 per share, or$1.0 million in aggregate. The shares were repurchased under the Company's existing share repurchase program that was amended by the Board of Directors inApril 2021 and will expire onDecember 31, 2022 . Share repurchases under the program may be made through open market and privately negotiated transactions at times and in such amounts as management deems appropriate, subject to applicable regulatory requirements. The repurchase program does not obligate the Company to acquire any particular number of shares and may be suspended at any time at the Company's discretion. As ofMarch 31, 2022 , 921,613 shares remained available for repurchase under the program. As ofMarch 31, 2022 andDecember 31, 2021 , a total of 119,270 and 117,825 shares of stock, respectively, were deferred in connection with Bancshares' Non-Employee Directors' Deferred Compensation Plan. The plan permits non-employee directors to invest their directors' fees and to receive the adjusted value of the deferred amounts in cash or shares of Bancshares common stock. All deferred fees, whether in the form of cash or shares of Bancshares common stock, are reflected as compensation expense in the period earned. The Company classifies all deferred directors' fees allocated to be paid in shares of stock as equity additional paid-in capital. The Company may use issued shares or shares of treasury stock to satisfy these obligations when due.
LIQUIDITY AND CAPITAL RESOURCES
The asset portion of the balance sheet provides liquidity primarily from the following sources: (1) excess cash and interest-bearing deposits in banks, (2) federal funds sold, (3) principal payments and maturities of loans and (4) principal payments and maturities from the investment portfolio. Loans maturing or repricing in one year or less amounted to$130.0 million as ofMarch 31, 2022 and$102.4 million as ofDecember 31, 2021 . Investment securities forecasted to mature or reprice in one year or less were estimated to be$14.8 million and$9.5 million of the investment portfolio as ofMarch 31, 2022 andDecember 31, 2021 , respectively. Although some securities in the investment portfolio have legal final maturities exceeding 10 years, a substantial percentage of the portfolio provides monthly principal and interest payments and consists of securities that are readily marketable and easily convertible into cash on short notice. The investment securities portfolio had an estimated average life of 3.5 years and 3.7 years as ofMarch 31, 2022 andDecember 31, 2021 , respectively. However, management does not rely solely upon the investment portfolio to generate cash flows to fund loans, capital expenditures, dividends, debt repayment and other cash requirements. These activities are also funded by cash flows from loan payments, as well as increases in deposits and short-term borrowings. The liability portion of the balance sheet provides liquidity through interest-bearing and non-interest-bearing deposit accounts, which represent the Company's primary sources of funds. In addition, federal funds purchased, FHLB advances, securities sold under agreements to repurchase and short-term and long-term borrowings are additional sources of available liquidity. Liquidity management involves the continual monitoring of the sources and uses of funds to maintain an acceptable cash position. Long-term liquidity management focuses on considerations related to the total balance sheet structure. The Bank manages the pricing of its deposits to maintain a desired deposit balance. As of bothMarch 31, 2022 andDecember 31, 2021 , the Company had$10.0 million of outstanding borrowings under FHLB advances. In addition, onOctober 1, 2021 , the Company completed a private placement of$11.0 million in aggregate principal amount of fixed-to-floating rate subordinated notes that will mature onOctober 1, 2031 . Net of unamortized debt issuance costs, the subordinated notes were recorded as long-term borrowings totaling$10.7 million as of bothMarch 31, 2022 andDecember 31, 2021 . The Company had up to$237.5 million and$237.0 million in remaining unused credit from the FHLB (subject to available collateral) as ofMarch 31, 2022 andDecember 31, 2021 , respectively. In addition, the Company had$45.9 million and$46.0 million in unused established federal funds lines as ofMarch 31, 2022 andDecember 31, 2021 , respectively.
Management believes that the Company has adequate sources of liquidity to cover
its contractual obligations and commitments over the next twelve months.
51
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