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FIRST US BANCSHARES, INC. – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Edgar Glimpses
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 ofJune 30, 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 contract 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 156 full-time equivalent employees (as ofJune 30, 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 six months 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. 41 --------------------------------------------------------------------------------
RECENT MARKET CONDITIONS
During the first six 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 uncertainty remains 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, with additional increases in May, June andJuly 2022 . Further increases are expected during the remainder of 2022 as the FRB attempts to reduce inflation. The prolonged period of reduced interest rates from 2020 until the first quarter of 2022 had an adverse effect on net interest income, margins and profitability for financial institutions, including the Company, and the effects of that period continue to have an adverse affect as the Company adjusts to the higher interest rate environment. 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. During this still-ongoing and still-volatile transition period, the yield curve has flattened and modestly inverted at times. Unusual yield curve effects, including inversion, may continue. 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. The higher interest rate environment has also led to unrealized losses in the Company's investment portfolio, which consists primarily of fixed rate instruments. 42 --------------------------------------------------------------------------------
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. As ofJune 30, 2022 , ALC employed eight full-time equivalent employees that continued to collect payments on loans through ALC'sMobile, Alabama headquarters office. The objectives of this initiative include the simplification of the Company's business processes, reduction of non-interest expense, and the improvement of the Company's asset quality. The timing of the Company's ability to achieve each of these objectives will be different with some objectives being achieved relatively quickly after execution of the initiative, while others will take more time as ALC's loan portfolio continues to pay down. For example, a significant reduction of non-interest expense was achieved beginning in the fourth quarter of 2021 and has continued in 2022 due to the reduction of personnel, termination of branch leases, and reduction of technology and other overhead expenses. During the six months endedJune 30, 2022 , non-interest expense at ALC totaled$1.0 million , compared to$3.6 million during the same period of 2021. Though the initiative resulted in non-interest expense reductions relatively early in its execution, it has also resulted in increased expense related to loan loss provisioning. As a result of branch closures, charge-offs associated with ALC loans have increased since the inception of the initiative compared to prior periods. Net charge-offs at ALC totaled$1.9 million during the six months endedJune 30, 2022 , compared to$0.4 million during the six months endedJune 30, 2021 . In addition, in management's view, the economic uncertainties that have emerged in 2022, including elevated inflation levels, have increased overall credit risk related to ALC's loan portfolio. Accordingly, qualitative economic factors associated with ALC's loan loss reserves have worsened, resulting in additional loan loss provisions. For the six months endedJune 30, 2022 , loan loss provisions specific to ALC's loans totaled$1.3 million , compared to$0.1 million for the corresponding period of 2021. 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 93.4% and 57.5% of the Company's total net charge-offs were associated with ALC's loan portfolio during the six months endedJune 30, 2022 and 2021, respectively. As ofJune 30, 2022 , ALC's remaining loans net of unearned interest and fees totaled$28.1 million , compared to$40.8 million as ofDecember 31, 2021 . 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 six months endedJune 30, 2022 , interest income earned on ALC's loans totaled$2.9 million , compared to$4.7 million for the six months endedJune 30, 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. 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$0.22 per diluted common share, during the three months endedJune 30, 2022 , compared to$953 thousand , or$0.14 per diluted common share, for the three months endedJune 30, 2021 . For the six months endedJune 30, 2022 , net income totaled$2.8 million , or$0.42 per diluted common share, compared to$1.9 million , or$0.28 per diluted common share, for the six months endedJune 30, 2021 . Earnings improvement, comparing both the three and six months endedJune 30, 2022 to the corresponding periods in 2021, was driven primarily by reductions in non-interest expense resulting from the strategic initiatives that were initiated by the Company beginning in 2021, and in particular the ALC cessation of business initiative. Non-interest expense was reduced by$1.5 million , or 18.1%, comparing the three months endedJune 30, 2022 to the three months endedJune 30, 2021 , and by$2.9 million , or 17.0%, comparing the six months endedJune 30, 2022 , to the corresponding period of 2021. 43 --------------------------------------------------------------------------------
Summarized condensed consolidated statements of operations are included below
for the three and six months ended
Three Months Ended Six Months Ended
June 30, June 30, June 30, June 30,
2022 2021 2022 2021
(Dollars in Thousands)
Interest income $ 9,525 $ 10,059 $ 18,906 $ 19,904
Interest expense 699 747 1,371 1,528
Net interest income 8,826 9,312 17,535 18,376
Provision for loan and lease
losses 895 498 1,616 899
Net interest income after
provision for loan and lease
losses 7,931 8,814 15,919 17,477
Non-interest income 856 809 1,685 1,760
Non-interest expense 6,878 8,399 13,934 16,795
Income before income taxes 1,909 1,224 3,670 2,442
Provision for income taxes 494 271 894 539
Net income $ 1,415 $ 953 $ 2,776 $ 1,903
Basic net income per share $ 0.23 $ 0.15 $ 0.45 $ 0.30
Diluted net income per share $ 0.22 $ 0.14 $ 0.42 $ 0.28
Dividends per share $ 0.03 $ 0.03 $ 0.06 $ 0.06
The following discussion summarizes the most significant activity that drove
changes in the Company's net income during the six months ended June 30, 2022 ,
as compared to the six months ended June 30, 2021 .
Net Interest Income and Margin
Net interest income decreased by$0.8 million comparing the six months endedJune 30, 2022 to the six months endedJune 30, 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$1.9 million during the six months endedJune 30, 2022 , compared to the six months endedJune 30, 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 3.94% during the six months endedJune 30, 2022 , compared to 4.35% during the six months endedJune 30, 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 after the portfolio pays down. As the pay down of ALC's loans continues, management remains focused on efforts to grow earning assets in the Bank's other loan and investment categories, while at the same time maintaining pricing discipline on deposit and borrowing costs. As part of its overall interest rate risk management program, the Company has entered into forward interest rate swap contracts on certain variable rate deposit products and borrowings. During the six months endedJune 30, 2022 , the Company terminated one interest rate swap associated with aFederal Home Loan Bank borrowing and recorded a deferred gain associated with the termination of$0.3 million . The gain will be recognized over the remaining 27-month term of the original swap agreement.
Provision for Loan and Lease Losses
The provision for loan and lease losses was$1.6 million during the six months endedJune 30, 2022 , compared to$0.9 million during the six months endedJune 30, 2021 . The increase in provision expense during the six months endedJune 30, 2022 , compared to the six months endedJune 30, 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 ofJune 30, 2022 , compared toDecember 31, 2021 . 44 --------------------------------------------------------------------------------
Non-interest Income
Non-interest income decreased by
primarily from decreases in miscellaneous revenue sources, including credit
insurance income associated with ALC's loans.
Non-interest Expense
Non-interest expense decreased by$2.9 million comparing the six months endedJune 30, 2022 to the six months endedJune 30, 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 six months endedJune 30, 2022 was reduced by$0.3 million in nonrecurring net gains on the sale of other real estate owned (OREO).
Balance Sheet Levels
As ofJune 30, 2022 , the Company's assets totaled$955.4 million , compared to$958.3 million as ofDecember 31, 2021 , a decrease of 0.3%. Compared toJune 30, 2021 , the Company's total assets increased by$8.4 million , or 0.9%.
Loans
Total loans increased by$4.8 million , or 0.7% as ofJune 30, 2022 , compared toDecember 31, 2021 . Loan volume increases included growth in the Bank's indirect and multi-family residential categories. Growth in these categories was consistent with continued growth in consumer spending and robust economic activity, particularly in the larger metropolitan markets the Bank serves.
Asset Quality
The Company's nonperforming assets, including loans in non-accrual status and OREO, totaled$1.7 million as ofJune 30, 2022 , compared to$4.2 million as ofDecember 31, 2021 . The reduction in nonperforming assets during the six months endedJune 30, 2022 resulted from the sale of OREO properties during the period. Reductions in OREO totaled$1.9 million and included the sale of banking centers that were closed by the Company in 2021. As a percentage of total assets, nonperforming assets totaled 0.18% as ofJune 30, 2022 compared to 0.43% as ofDecember 31, 2021 .
Deposit Growth and Deployment of Funds
Deposits increased by$6.2 million , or 0.7%, as ofJune 30, 2022 , compared toDecember 31, 2021 . During the first six months of 2022, management 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 six months endedJune 30, 2022 , compared to 0.37% for the six months endedJune 30, 2021 . Given the increasing interest rate environment during the first six months 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$152.5 million as ofJune 30, 2022 , compared to$134.3 million as ofDecember 31, 2021 . The expected average life of securities in the investment portfolio as ofJune 30, 2022 was 3.4 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$7.5 million , or 8.3%, as ofJune 30, 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 six months endedJune 30, 2022 . No other-than-temporary impairment was recognized in the investment portfolio during the six months endedJune 30, 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. 45 --------------------------------------------------------------------------------
During the six months endedJune 30, 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 ofJune 30, 2022 , the Bank's common equity Tier 1 capital and Tier 1 risk-based capital ratios were each 11.45%. Its total capital ratio was 12.56%, and its Tier 1 leverage ratio was 9.33%.
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 cash dividends totaling
during both six-month periods ended
Share Repurchases
During the six months endedJune 30, 2022 , the Company completed share repurchases totaling 348,400 shares of its common stock at a weighted average price of$10.99 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 ofJune 30, 2022 , a total of 660,813 shares remained available for repurchase under the program. 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- and long-term borrowings. The following tables show the average balances of each principal category of assets, liabilities and shareholders' equity for the three and six months endedJune 30, 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. 46 --------------------------------------------------------------------------------
Three Months Ended Three Months Ended
June 30, 2022 June 30, 2021
Annualized Annualized
Average Yield/ Average Yield/
Balance Interest Rate % Balance Interest Rate %
ASSETS
Interest-earning assets:
Total loans (Note A) $ 698,696 $ 8,742 5.02 % $ 673,676 $ 9,668 5.76 %
Taxable investment securities 147,799 663 1.80 % 97,237 344 1.42 %
Tax-exempt investment securities 2,540 11 1.74 % 3,506 16 1.83 %
Federal Home Loan Bank stock 798 8 4.02 % 870 8 3.69 %
Federal funds sold 81 1 4.95 % 83 - -
Interest-bearing deposits in banks 54,753 100 0.73 % 91,340 23 0.10 %
Total interest-earning assets 904,667 9,525 4.22 % 866,712 10,059 4.66 %
Noninterest-earning assets 66,990 68,237
Total $ 971,657 $ 934,949
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
Demand deposits $ 253,887 $ 130 0.21 % $ 235,493 $ 145 0.25 %
Savings deposits 209,982 210 0.40 % 187,655 148 0.32 %
Time deposits 205,790 244 0.48 % 230,473 412 0.72 %
Total interest-bearing deposits 669,659 584 0.35 % 653,621 705 0.43 %
Noninterest-bearing demand deposits 189,600 - - 173,842 - -
Total deposits 859,259 584 0.27 % 827,463 705 0.34 %
Borrowings 17,569 115 2.63 % 10,017 42 1.68 %
Total funding costs 876,828 699 0.32 % 837,480 747 0.36 %
Other noninterest-bearing liabilities 8,179 8,991
Shareholders' equity 86,650 88,478
Total $ 971,657 $ 934,949
Net interest income (Note B) $ 8,826
$ 9,312 Net interest margin 3.91 % 4.31 %
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 interest amounts presented. Loan fees totaled
$0.3 million and$0.5 million for the three months endedJune 30, 2022 and 2021, respectively. 47
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Six Months Ended Six Months Ended
June 30, 2022 June 30, 2021
Annualized Annualized
Average Yield/ Average Yield/
Balance Interest Rate % Balance Interest Rate %
ASSETS
Interest-earning assets:
Total loans (Note A) $ 697,701 $ 17,589 5.08 % $ 663,338 $ 19,158 5.82 %
Taxable investment securities 139,101 1,148 1.66 % 90,233 650 1.45 %
Tax-exempt investment securities 2,655 23 1.75 % 3,514 32 1.84 %
Federal Home Loan Bank stock 839 16 3.85 % 987 17 3.47 %
Federal funds sold 81 1 2.49 % 84 - -
Interest-bearing deposits in banks 56,297 129 0.46 % 93,311 47 0.10 %
Total interest-earning assets 896,674 18,906 4.25 % 851,467 19,904 4.71 %
Noninterest-earning assets 65,978 68,536
Total $ 962,652 $ 920,003
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
Demand deposits $ 252,259 $ 256 0.20 % $ 230,351 $ 284 0.25 %
Savings deposits 203,535 351 0.35 % 181,202 293 0.33 %
Time deposits 208,245 493 0.48 % 234,544 871 0.75 %
Total interest-bearing deposits 664,039 1,100 0.33 % 646,097 1,448 0.45 %
Noninterest-bearing demand deposits 182,482 - - 166,566 - -
Total deposits 846,521 1,100 0.26 % 812,663 1,448 0.36 %
Borrowings 19,133 271 2.86 % 10,017 80 1.61 %
Total funding costs 865,654 1,371 0.32 % 822,680 1,528 0.37 %
Other noninterest-bearing liabilities 8,930 9,353
Shareholders' equity 88,068 87,970
Total $ 962,652 $ 920,003
Net interest income (Note B) $ 17,535
$ 18,376 Net interest margin 3.94 % 4.35 %
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 interest amounts presented. Loan fees totaled
$0.5 million and $0.8 million for the six months ended June 30, 2022 and
2021, respectively.
48
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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 June 30, 2022 Six Months Ended June 30, 2022
Compared to Compared to
Three Months Ended June 30, 2021 Six Months Ended June 30, 2021
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 $ 359 $ (1,285 ) $ (926 ) $ 992 $ (2,561 ) $ (1,569 )
Taxable investment
securities 179 140 319 352 146 498
Tax-exempt investment
securities (4 ) (1 ) (5 ) (8 ) (1 ) (9 )
Federal Home Loan Bank
stock (1 ) 1 - (3 ) 2 (1 )
Federal funds sold - 1 1 - 1 1
Interest-bearing
deposits in banks (9 ) 86 77 (19 ) 101 82
Total interest-earning
assets 524 (1,058 ) (534 ) 1,314 (2,312 ) (998 )
Interest expense on:
Demand deposits 11 (26 ) (15 ) 27 (55 ) (28 )
Savings deposits 18 44 62 36 22 58
Time deposits (44 ) (124 ) (168 ) (98 ) (280 ) (378 )
Borrowings 32 41 73 73 118 191
Total interest-bearing
liabilities 17 (65 ) (48 ) 38 (195 ) (157 )
Increase (decrease) in
net interest income $ 507 $ (993 ) $ (486 ) $ 1,276 $ (2,117 ) $ (841 )
Net interest income totaled $8.8 million for the three months ended June 30,
2022 , compared to $9.3 million for the three months ended June 30, 2021 . For the
six months ended June 30, 2022 , net interest income totaled $17.5 million ,
compared to $18.4 million for the six months ended June 30, 2021 . Compared to
both 2021 periods, the decrease in net interest income was primarily
attributable to reductions in interest and fees on ALC loans in connection with
the ALC cessation of business strategy. Interest and fees on ALC loans decreased
in the second quarter of 2022 by $1.0 million , compared to the second quarter of
2021, and by $1.9 million comparing the six months ended June 30, 2022 to the
corresponding period of 2021. The decreases were partially offset by interest
income in the Bank's other earning asset categories, which increased by $0.5
million on a net basis, comparing the second quarter of 2022 to the second
quarter of 2021, and by $0.9 million , comparing the six months ended June 30,
2022 to the six months ended June 30, 2021 . 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
earning assets, the Company's net interest margin was reduced to 3.91% during
the three months ended June 30, 2022 , compared to 4.31% during the three months
ended June 30, 2021 . For the six months ended June 30, 2022 , net interest margin
was 3.94%, compared to 4.35% for the six months ended June 30, 2021 . Though net
interest income and margin are expected to decrease as a result of the cessation
of business strategy at ALC, significant expense savings have developed, or are
expected to develop, as a result of the strategy. 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 after the portfolio pays down. As
the pay down continues, management is continuing efforts to grow earning assets
in the Bank's other loan and investment categories, while at the same time
maintaining pricing discipline on deposit and borrowing costs.
Beginning in March of 2022 and through its July 2022 meeting, the Federal Open
Market Committee has raised the federal funds rate by 225 basis points.
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.
Provision for Loan and Lease Losses
The provision for loan and lease losses was$1.6 million during the six months endedJune 30, 2022 , compared to$0.9 million during the six months endedJune 30, 2021 . The increase in the provision, comparing the two periods, 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 six months endedJune 30, 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 ofJune 30, 2022 , compared toDecember 31, 2021 . The loan loss provision recorded by the Company during the six 49 -------------------------------------------------------------------------------- months endedJune 30, 2022 included$1.3 million associated with ALC's portfolio and$0.3 million associated with the Bank's other loan categories due to an overall increase in loan volume associated with those categories. The Company's net charge-offs totaled$1.2 million during the six months endedJune 30, 2022 , compared to$0.6 million during the six months endedJune 30, 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 ofJune 30, 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 June 30, Six Months Ended June 30,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
(Dollars in Thousands)
(Dollars in Thousands) Service charges and other fees on deposit accounts$ 294 $ 240 $ 54 22.5 %$ 593 $ 506 $ 87 17.2 % Bank-owned life insurance 113 109 4 3.7 % 223 217 6 2.8 % Net gain on sale and prepayment of investment securities - 22 (22 ) NM - 22 (22 ) NM Lease income 211 202 9 4.5 % 425 411 14 3.4 % Other income 238 236 2 0.8 % 444 604 (160 ) (26.5 )% Total non-interest income$ 856 $ 809 $ 47 5.8 %$ 1,685 $ 1,760 $ (75 ) (4.3 )% NM: Not meaningful The Company's non-interest income decreased during the six months endedJune 30, 2022 by$75 thousand compared to the six months endedJune 30, 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 six months endedJune 30, 2022 to the six months endedJune 30, 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.
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 June 30, Six Months Ended June 30,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
(Dollars in Thousands) (Dollars in Thousands)
Salaries and employee
benefits $ 4,052 $ 4,992 $ (940 ) (18.8 )% $ 8,382 $ 9,906 $ (1,524 ) (15.4 )%
Net occupancy and
equipment expense 841 1,020 $ (179 ) (17.5 )% 1,607 2,059 (452 ) (22.0 )%
Computer services 430 485 $ (55 ) (11.3 )% 807 950 (143 ) (15.1 )%
Insurance expense and
assessments 293 329 $ (36 ) (10.9 )% 660 645 15 2.3 %
Fees for professional
services 280 354 $ (74 ) (20.9 )% 548 711 (163 ) (22.9 )%
Postage, stationery and
supplies 141 197 $ (56 ) (28.4 )% 305 412 (107 ) (26.0 )%
Telephone/data
communications 188 227 $ (39 ) (17.2 )% 359 459 (100 ) (21.8 )%
Other real
estate/foreclosure
(income) expense, net (170 ) (20 ) $ (150 ) NM (315 ) (13 ) (302 ) NM
Other expense 823 815 $ 8 1.0 % 1,581 1,666 (85 ) (5.1 )%
Total non-interest expense
NM: Not meaningful
50
-------------------------------------------------------------------------------- Non-interest expense decreased by$2.9 million comparing the six months endedJune 30, 2022 to the six months endedJune 30, 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 ofJune 30, 2022 , the Company employed 156 full-time equivalent employees (including 148 at the Bank and eight at ALC), compared to 175 as ofDecember 31, 2021 , and 259 as ofJune 30, 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 ofJune 30, 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 six months endedJune 30, 2022 , non-interest expenses were reduced by one-time net gains on the sale of OREO that totaled$0.3 million . The gains were primarily generated by the sale of the Bank's closed branch assets. As ofJune 30, 2022 , all branches closed by the Bank during the third quarter of 2021 had been sold. During the six months endedJune 30, 2022 , 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$0.2 million in restructuring charges associated with the ALC cessation of business strategy recorded during the first six months of 2022. As ofJune 30, 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$0.9 million and$0.5 million for the six months endedJune 30, 2022 and 2021, respectively, and the Company's effective tax rate was 24.4% and 22.1%, 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 3.4 years and 3.7 years as ofJune 30, 2022 andDecember 31, 2021 , respectively. 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 ofJune 30, 2022 , available-for-sale securities totaled$150.2 million , or 98.5% 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, obligations ofU.S. government-sponsored agencies, 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 ofJune 30, 2022 , held-to-maturity securities totaled$2.3 million , or 1.5% 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 state and political subdivisions. Due to the increasing interest rate environment, during the six months endedJune 30, 2022 , gross unrealized losses increased significantly, particularly within the Company's available-for-sale portfolio. Gross unrealized losses in the investment portfolio totaled$9.6 million as ofJune 30, 2022 , compared to$0.8 million as ofDecember 31, 2021 . Management evaluated unrealized losses as ofJune 30, 2022 , and determined that no losses within the portfolio were other-than-temporary. Accordingly, no losses were realized during the second quarter of 2022. Unrealized losses within the available-for-sale portfolio were recognized, net of tax, in accumulated other comprehensive income. 51 --------------------------------------------------------------------------------
Loans and Allowance for Loan and Lease Losses
The Company's total loan portfolio increased by$4.8 million , or 0.7%, as ofJune 30, 2022 , compared toDecember 31, 2021 . The tables below summarize loan balances by portfolio category at the end of each of the most recent five quarters as ofJune 30, 2022 : Quarter Ended 2022 2021 June March December September June 30, 31, 31, 30, 30, (Dollars in Thousands) Real estate loans: Construction, land development and other land loans$ 40,625 $ 52,817 $ 67,048 $ 58,175 $ 53,425 Secured by 1-4 family residential properties 69,098 69,760 72,727 73,112 78,815 Secured by multi-family residential properties 66,848 50,796 46,000 51,420 53,811 Secured by non-farm, non-residential properties 187,041 177,752 197,901 198,745 191,398 Commercial and industrial loans, including PPP loans 65,908 68,098 73,947 77,679 77,359 Consumer loans: Direct consumer 15,419 18,023 21,689 25,845 26,937 Branch retail 18,634 21,891 25,692 29,764 31,688 Indirect 252,206 220,931 205,940 194,154 176,116 Total loans$ 715,779 $ 680,068 $ 710,944 $ 708,894 $ 689,549 Less unearned interest, fees and deferred cost 1,142 1,738 2,594 3,729 4,067 Allowance for loan and lease losses 8,751 8,484 8,320 8,193 7,726 Net loans$ 705,886 $ 669,846 $ 700,030 $ 696,972 $ 677,756
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
June March December September June
30, 31, 31, 30, 30,
(Dollars in Thousands)
Balance at beginning of period $ 8,484 $ 8,320 $ 8,193 $ 7,726 $ 7,475
Charge-offs:
Real estate loans:
Construction, land development
and other land loans - - (1 ) - (1 )
Secured by 1-4 family
residential properties (5 ) (2 ) (6 ) (1 ) 4
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 (532 ) (557 ) (437 ) (222 ) (278 )
Branch retail (177 ) (145 ) (23 ) (77 ) (92 )
Indirect (77 ) (25 ) (118 ) (55 ) (193 )
Total charge-offs (791 ) (729 ) (585 ) (361 ) (560 )
Recoveries 163 172 219 210 313
Net charge-offs (628 ) (557 ) (366 ) (151 ) (247 )
Provision for loan and lease
losses 895 721 493 618 498
Ending balance $ 8,751 $ 8,484 $ 8,320 $ 8,193 $ 7,726
Ending balance as a percentage
of loans 1.22 % 1.25 % 1.17 % 1.16 % 1.13 %
Net charge-offs as a percentage
of average loans 0.36 % 0.32 % 0.20 % 0.09 % 0.15 %
Charge-offs increased during the first six months 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 of
June 30, 2022 , compared to December 31, 2021 . The increase in provision expense
in the first six months of 2022 reflected the impact of these changing
circumstances on ALC's portfolio.
52
--------------------------------------------------------------------------------
Nonperforming Assets
Nonperforming assets at the end of the five most recent quarters as ofJune 30, 2022 were as follows: Quarter Ended 2022 2021 June March December September June 30, 31, 31, 30, 30, (Dollars in Thousands) Non-accrual loans$ 1,455 $ 2,228 $ 2,008 $ 969 $ 1,279 Other real estate owned 276 874 2,149 2,373 846 Total$ 1,731 $ 3,102 $ 4,157 $ 3,342 $ 2,125 Nonperforming assets as a percentage of total assets 0.18 % 0.32 % 0.43 % 0.35 % 0.22 %
The decrease in OREO as of
resulted primarily from the sale of banking centers that were closed in 2021.
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 ofJune 30, 2022 andDecember 31, 2021 : June 30, 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$ 373 4.3 % 5.7 %$ 628 7.5 % 9.4 % Secured by 1-4 family residential properties 673 7.7 % 9.7 % 690 8.3 % 10.2 % Secured by multi-family residential properties 636 7.3 % 9.3 % 437 5.3 % 6.5 % Secured by non-farm, non-residential properties 1,867 21.3 % 26.1 % 1,958 23.5 % 27.8 % Commercial and industrial loans, including PPP loans 810 9.3 % 9.2 % 860 10.3 % 10.4 % Consumer loans: Direct consumer 892 10.2 % 2.2 % 1,004 12.1 % 3.1 % Branch retail 558 6.3 % 2.6 % 304 3.7 % 3.6 % Indirect 2,942 33.6 % 35.2 % 2,439 29.3 % 29.0 % Total loans$ 8,751 100.0 % 100.0 %$ 8,320 100.0 % 100.0 % Deposits Total deposits increased to$844.3 million as ofJune 30, 2022 , from$838.1 million as ofDecember 31, 2021 , an increase of 0.7%. 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$782.5 million , or 92.7% of total deposits, as ofJune 30, 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. 53 --------------------------------------------------------------------------------
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 second quarter of 2022, other interest-bearing liabilities represented 2.6% of average interest-bearing liabilities, compared to 1.5% in the second quarter of 2021. Shareholders' Equity As ofJune 30, 2022 , shareholders' equity totaled$82.6 million , or 8.6% of total assets, compared to$90.1 million , or 9.4% of total assets, as ofDecember 31, 2021 . The decrease in shareholders' equity as ofJune 30, 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 six months endedJune 30, 2022 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 six month periods endedJune 30, 2022 and 2021, the Company declared dividends totaling$0.06 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 six months endedJune 30, 2022 the Company completed repurchases of 348,400 shares of its common stock at a weighted average price of$10.99 per share, or$3.8 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 ofJune 30, 2022 , 660,813 shares remained available for repurchase under the program.
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$157.3 million as ofJune 30, 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$10.7 million and$9.5 million of the investment portfolio as ofJune 30, 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 3.4 years and 3.7 years as ofJune 30, 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 bothJune 30, 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 bothJune 30, 2022 andDecember 31, 2021 . 54
-------------------------------------------------------------------------------- The Company had up to$250.4 million and$237.0 million in remaining unused credit from the FHLB (subject to available collateral, which may include eligible investment securities and loans) as ofJune 30, 2022 andDecember 31, 2021 , respectively. In addition, the Company had$46.2 million and$46.0 million in unused established federal funds lines as ofJune 30, 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.
55
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