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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 ofSeptember 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. ALC continues to service its remaining portfolio of loans from its headquarters inMobile, Alabama .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 155 full-time equivalent employees (as ofSeptember 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
comparing income and expense for the nine months ended
2021.
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. 43 --------------------------------------------------------------------------------
RECENT MARKET CONDITIONS
During the nine months endedSeptember 30, 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, July andSeptember 2022 . Further increases are expected during the remainder of 2022 as the FRB attempts to reduce inflation. As interest rates increase, competitive pressures on both loan and 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, at times, become inverted. 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. 44
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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 ofSeptember 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 included 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 nine months endedSeptember 30, 2022 , non-interest expense at ALC totaled$1.4 million , compared to$5.7 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$1.5 million during the nine months endedSeptember 30, 2022 , compared to$0.5 million during the nine months endedSeptember 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 nine months endedSeptember 30, 2022 , loan loss provisions specific to ALC's loans totaled$1.6 million , compared to$0.2 million for the corresponding period of 2021. Over time, the reduction of loans at ALC is expected to improve the Company's asset quality. ALC's loans and, in particular, its direct consumer portfolio have historically had the Company's highest level of losses. Approximately 89.0% and 61.0% of the Company's total net charge-offs were associated with ALC's loan portfolio during the nine months endedSeptember 30, 2022 and 2021, respectively. As ofSeptember 30, 2022 , ALC's remaining loans net of unearned interest and fees totaled$23.8 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 nine months endedSeptember 30, 2022 , interest income earned on ALC's loans totaled$3.9 million , compared to$7.0 million for the nine months endedSeptember 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$1.9 million , or$0.29 per diluted common share, during the three months endedSeptember 30, 2022 , compared to$0.8 million , or$0.13 per diluted common share, for the three months endedSeptember 30, 2021 . For the nine months endedSeptember 30, 2022 , net income totaled$4.6 million , or$0.71 per diluted common share, compared to$2.7 million , or$0.41 per diluted common share, for the nine months endedSeptember 30, 2021 . 45 -------------------------------------------------------------------------------- Earnings improvement, comparing both the three and nine months endedSeptember 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 17.7%, comparing the three months endedSeptember 30, 2022 to the three months endedSeptember 30, 2021 , and by$4.4 million , or 17.3%, comparing the nine months endedSeptember 30, 2022 , to the corresponding period of 2021.
Summarized condensed consolidated statements of operations are included below
for the three and nine months ended
Three Months Ended
Nine Months Ended
September 30, September 30, September 30, September 30,
2022 2021 2022 2021
(Dollars in Thousands)
Interest income $ 10,670 $ 10,030 $ 29,576 $ 29,934
Interest expense 1,155 695 2,526 2,223
Net interest income 9,515 9,335 27,050 27,711
Provision for loan and lease
losses 1,165 618 2,781 1,517
Net interest income after
provision for loan and lease
losses 8,350 8,717 24,269 26,194
Non-interest income 1,088 896 2,773 2,656
Non-interest expense 7,032 8,547 20,966 25,342
Income before income taxes 2,406 1,066 6,076 3,508
Provision for income taxes 546 229 1,440 768
Net income $ 1,860 $ 837 $ 4,636 $ 2,740
Basic net income per share $ 0.31 $ 0.13 $ 0.76 $ 0.43
Diluted net income per share $ 0.29 $ 0.13 $ 0.71 $ 0.41
Dividends per share $ 0.03 $ 0.03 $ 0.09 $ 0.09
The following discussion summarizes the most significant activity that drove
changes in the Company's net income during the nine months ended September 30,
2022 , as compared to the nine months ended September 30, 2021 .
Net Interest Income and Margin
Net interest income decreased by$0.7 million comparing the nine months endedSeptember 30, 2022 to the nine months endedSeptember 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$3.1 million during the nine months endedSeptember 30, 2022 , compared to the nine months endedSeptember 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. 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 4.00% during the nine months endedSeptember 30, 2022 , compared to 4.29% during the nine months endedSeptember 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 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 fixed rate commercial real estate loans. During the nine months endedSeptember 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 24-month term of the original swap agreement. 46 --------------------------------------------------------------------------------
Provision for Loan and Lease Losses
The provision for loan and lease losses was$2.8 million during the nine months endedSeptember 30, 2022 , compared to$1.5 million during the nine months endedSeptember 30, 2021 . The increase in provision expense during the nine months endedSeptember 30, 2022 , compared to the nine months endedSeptember 30, 2021 reflected both an increase in charge-offs associated with ALC's loan portfolio, as well as qualitative adjustments applied to the portfolio in response to heightened inflationary trends and other economic uncertainties that emerged during the period. 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 ofSeptember 30, 2022 , compared toDecember 31, 2021 .
Non-interest Income
Non-interest income increased by$0.1 million comparing the nine months endedSeptember 30, 2022 to the nine months endedSeptember 30, 2021 . The increase resulted primarily from increased service and other charges on deposit accounts comparing the two periods. Non-interest Expense Non-interest expense decreased by$4.4 million comparing the nine months endedSeptember 30, 2022 to the nine months endedSeptember 30, 2021 . The decrease in 2022 resulted primarily from implementation of the ALC business cessation 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 both the nine-month periods endedSeptember 30, 2022 and 2021 was reduced by$0.3 million and$0.4 million in net gains on the sale of other real estate owned (OREO), respectively.
Balance Sheet Levels
As ofSeptember 30, 2022 , the Company's assets totaled$989.3 million , compared to$958.3 million as ofDecember 31, 2021 , an increase of 3.2%. Compared toSeptember 30, 2021 , the Company's total assets increased by$33.9 million , or 3.5%. Loans Total loans increased by$40.9 million , or 5.8% as ofSeptember 30, 2022 , compared toDecember 31, 2021 . Loan volume increases included growth in the Bank's indirect, residential (secured by multi-family and 1-4 family residential properties) and commercial real estate (secured by nonfarm, nonresidential properties). Growth in these categories was consistent with continued robust commercial economic activity and resiliency in consumer demand during the period.
Asset Quality
The Company's nonperforming assets, including loans in non-accrual status and OREO, totaled$2.8 million as ofSeptember 30, 2022 , compared to$4.2 million as ofDecember 31, 2021 . The reduction in nonperforming assets during the nine months endedSeptember 30, 2022 resulted from the sale of OREO properties during the period. Reductions in OREO totaled$1.5 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 0.28% as ofSeptember 30, 2022 compared to 0.43% as ofDecember 31, 2021 .
Deposit Growth and Deployment of Funds
Deposits increased by$8.4 million , or 1.0%, as ofSeptember 30, 2022 , compared toDecember 31, 2021 . During the first nine 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, were 0.39% for the nine months endedSeptember 30, 2022 , compared to 0.36% for the nine months endedSeptember 30, 2021 . Given the increasing interest rate environment during the first nine months 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$145.9 million as ofSeptember 30, 2022 , compared to$134.3 million as ofDecember 31, 2021 . The expected average life of securities in the investment portfolio as ofSeptember 30, 2022 was 3.6 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. 47
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Shareholders' Equity
Shareholders' equity decreased by$7.0 million , or 7.7%, as ofSeptember 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 nine months endedSeptember 30, 2022 . No other-than-temporary impairment was recognized in the investment portfolio during the nine months endedSeptember 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.
During the nine months endedSeptember 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 ofSeptember 30, 2022 , the Bank's common equity Tier 1 capital and Tier 1 risk-based capital ratios were each 11.09%. Its total capital ratio was 12.23%, and its Tier 1 leverage ratio was 9.23%.
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 nine-month periods ended
Share Repurchases
During the nine months endedSeptember 30, 2022 , the Company completed share repurchases totaling 412,400 shares of its common stock at a weighted average price of$10.87 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 ofSeptember 30, 2022 , a total of 596,813 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 nine months endedSeptember 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. 48 --------------------------------------------------------------------------------
Three Months Ended Three Months Ended
September 30, 2022 September 30, 2021
Annualized Annualized
Average Yield/ Average Yield/
Balance Interest Rate % Balance Interest Rate %
ASSETS
Interest-earning assets:
Total loans (Note A) $ 743,145 $ 9,750 5.21 % $ 691,435 $ 9,568 5.49 %
Taxable investment securities 148,964 748 1.99 % 119,943 409 1.35 %
Tax-exempt investment securities 2,322 8 1.37 % 3,367 15 1.77 %
Federal Home Loan Bank stock 1,808 17 3.73 % 870 8 3.65 %
Federal funds sold 1,984 11 2.20 % 86 - -
Interest-bearing deposits in banks 23,166 136 2.33 % 73,490 30 0.16 %
Total interest-earning assets 921,389 10,670 4.59 % 889,191 10,030 4.48 %
Noninterest-earning assets 64,593 67,067
Total $ 985,982 $ 956,258
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
Demand deposits $ 243,131 $ 182 0.30 % $ 239,188 $ 141 0.23 %
Savings deposits 211,724 342 0.64 % 208,187 160 0.30 %
Time deposits 209,361 340 0.64 % 223,988 351 0.62 %
Total interest-bearing deposits 664,216 864 0.52 % 671,363 652 0.39 %
Noninterest-bearing demand deposits 183,612 - - 176,102 - -
Total deposits 847,828 864 0.40 % 847,465 652 0.31 %
Borrowings 45,427 291 2.54 % 10,032 43 1.70 %
Total funding costs 893,255 1,155 0.51 % 857,497 695 0.32 %
Other noninterest-bearing liabilities 8,642 9,158
Shareholders' equity 84,085 89,603
Total $ 985,982 $ 956,258
Net interest income (Note B) $ 9,515
$ 9,335 Net interest margin 4.10 % 4.17 %
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
$0.1 million and$0.4 million for the three months endedSeptember 30, 2022 and 2021, respectively. 49
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Nine Months Ended Nine Months Ended
September 30, 2022 September 30, 2021
Annualized Annualized
Average Yield/ Average Yield/
Balance Interest Rate % Balance Interest Rate %
ASSETS
Interest-earning assets:
Total loans (Note A) $ 713,015 $ 27,339 5.13 % $ 672,807 $ 28,726 5.71 %
Taxable investment securities 142,425 1,896 1.78 % 100,245 1,059 1.41 %
Tax-exempt investment securities 2,543 31 1.63 % 3,464 47 1.81 %
Federal Home Loan Bank stock 1,165 33 3.79 % 948 25 3.53 %
Federal funds sold 853 12 1.88 % 84 - -
Interest-bearing deposits in banks 45,133 265 0.79 % 86,632 77 0.12 %
Total interest-earning assets 905,134 29,576 4.37 % 864,180 29,934 4.63 %
Noninterest-earning assets 65,379 68,041
Total $ 970,513 $ 932,221
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing deposits:
Demand deposits $ 249,183 $ 438 0.24 % $ 233,329 $ 425 0.24 %
Savings deposits 206,294 693 0.45 % 190,296 453 0.32 %
Time deposits 208,621 833 0.53 % 230,986 1,222 0.71 %
Total interest-bearing deposits 664,098 1,964 0.40 % 654,611 2,100 0.43 %
Noninterest-bearing demand deposits 182,862 - - 169,780 - -
Total deposits 846,960 1,964 0.31 % 824,391 2,100 0.34 %
Borrowings 27,994 562 2.68 % 10,022 123 1.64 %
Total funding costs 874,954 2,526 0.39 % 834,413 2,223 0.36 %
Other noninterest-bearing liabilities 8,833 9,288
Shareholders' equity 86,726 88,520
Total $ 970,513 $ 932,221
Net interest income (Note B) $ 27,050
$ 27,711 Net interest margin 4.00 % 4.29 %
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
$0.4 million and$1.3 million for the nine months endedSeptember 30, 2022 and 2021, respectively. 50
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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 September 30, 2022 Nine Months Ended September 30, 2022
Compared to Compared to
Three Months Ended September 30, 2021 Nine Months Ended September 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 $ 716 $ (534 ) $ 182 $ 1,717 $ (3,104 ) $ (1,387 )
Taxable investment
securities 99 240 339 446 391 837
Tax-exempt investment
securities (5 ) (2 ) (7 ) (12 ) (4 ) (16 )
Federal Home Loan Bank
stock 9 - 9 6 2 8
Federal funds sold - 11 11 - 12 12
Interest-bearing
deposits in banks (21 ) 127 106 (37 ) 225 188
Total interest-earning
assets 798 (158 ) 640 2,120 (2,478 ) (358 )
Interest expense on:
Demand deposits 2 39 41 29 (16 ) 13
Savings deposits 3 179 182 38 202 240
Time deposits (23 ) 12 (11 ) (118 ) (271 ) (389 )
Borrowings 152 96 248 221 218 439
Total interest-bearing
liabilities 134 326 460 170 133 303
Increase (decrease) in
net interest income $ 664 $ (484 ) $ 180 $ 1,950 $ (2,611 ) $ (661 )
Net interest income totaled $9.5 million for the three months ended September
30, 2022 , compared to $9.3 million for the three months ended September 30,
2021 . The increase resulted primarily from loan growth and, to a lesser extent,
increased yield on the investment portfolio and interest-bearing deposits in
banks. For the nine months ended September 30, 2022 , net interest income totaled
$27.1 million , compared to $27.7 million for the nine months ended September 30,
2021 . The decrease 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 by $3.1 million comparing the nine months ended
September 30, 2022 to the corresponding period of 2021. The decrease related to
ALC loans was partially offset by interest income in the Bank's other earning
asset categories, which increased by $2.7 million on a net basis, comparing the
nine months ended September 30, 2022 to the nine months ended September 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 4.10% during the three months ended
September 30, 2022 , compared to 4.17% during the three months ended September
30, 2021 . For the nine months ended September 30, 2022 , net interest margin was
4.00%, compared to 4.29% for the nine months ended September 30, 2021 . Though
net interest income and margin are expected to continue to decrease as a result
of the cessation of business strategy at ALC, significant non-interest 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 costs and earning asset yields consistent with the current interest rate
environment.
Beginning in March of 2022 and through its November 2022 meeting, the Federal
Open Market Committee has raised the federal funds rate by 375 basis points.
Statements by the Federal Reserve chair have indicated that further interest
rate increases may be expected in 2022 and into 2023 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$2.8 million during the nine months endedSeptember 30, 2022 , compared to$1.5 million during the nine months endedSeptember 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 the portfolio in response to heightened inflationary trends and other economic uncertainties that emerged during the nine months endedSeptember 30, 2022 . In management's view, the combination of the ALC business cessation strategy, coupled with deteriorating economic conditions, including elevated inflation levels, 51 -------------------------------------------------------------------------------- increased overall credit risk, particularly in ALC's loan portfolio, as ofSeptember 30, 2022 , compared toDecember 31, 2021 . The loan loss provision recorded by the Company during the nine months endedSeptember 30, 2022 included$1.6 million associated with ALC's portfolio and$1.2 million associated with the Bank's portfolio. The Company's net charge-offs totaled$2.3 million during the nine months endedSeptember 30, 2022 , compared to$1.5 million during the nine months endedSeptember 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 ofSeptember 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 September 30, Nine Months Ended September 30,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
(Dollars in Thousands) (Dollars in Thousands)
Service charges and other fees on deposit accounts$ 311 $ 271 $ 40 14.8 %$ 904 $ 777 $ 127 16.3 %
Bank-owned
life insurance 112 110 2 1.8 % 335 327 8 2.4 % Lease income 210 208 2 1.0 % 635 619 16 2.6 % Other income 455 307 148 48.2 % 899 933 (34 ) (3.6 )%
Total
non-interest
income$ 1,088 $ 896 $ 192 21.4 %$ 2,773 $ 2,656 $ 117 4.4 % Non-interest income increased in both the three- and nine-month periods endedSeptember 30, 2022 , compared to the corresponding periods of 2021. For the three months endedSeptember 30, 2022 , the increase resulted primarily from nonrecurring gains on sale of premises and equipment and other assets that exceeded the three months endedSeptember 30, 2021 by$0.2 million . For the nine months endedSeptember 30, 2022 , the increase was due primarily to 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 September 30, Nine Months Ended September 30,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
(Dollars in Thousands) (Dollars in Thousands)
Salaries and employee
benefits $ 4,007 $ 5,045 $ (1,038 ) (20.6 )% $ 12,389 $ 14,951 $ (2,562 ) (17.1 )%
Net occupancy and equipment
expense 861 1,259 (398 ) (31.6 )% 2,468 3,318 (850 ) (25.6 )%
Computer services 417 461 (44 ) (9.5 )% 1,224 1,411 (187 ) (13.3 )%
Insurance expense and
assessments 310 340 (30 ) (8.8 )% 970 985 (15 ) (1.5 )%
Fees for professional
services 263 292 (29 ) (9.9 )% 811 1,003 (192 ) (19.1 )%
Postage, stationery and
supplies 164 206 (42 ) (20.4 )% 469 618 (149 ) (24.1 )%
Telephone/data
communications 159 283 (124 ) (43.8 )% 518 742 (224 ) (30.2 )%
Other real
estate/foreclosure (income)
expense, net (5 ) (273 ) 268 NM (320 ) (286 ) (34 ) NM
Other expense 856 934 (78 )
(8.4 )% 2,437 2,600 (163 ) (6.3 )%
Total non-interest expense
NM: Not meaningful Non-interest expenses were reduced in both the three- and nine-month periods endedSeptember 30, 2022 compared to the corresponding periods of 2021 due primarily to the strategic initiatives executed by the Company beginning in the third quarter of 2021. The initiatives, which included the ALC cessation of business strategy, Bank branch closures and other operational efficiency efforts at the Bank, led to significant reductions in the Company's personnel levels, reduced levels of occupancy and equipment expense, and decreases in various other expense categories. 52 -------------------------------------------------------------------------------- Salaries and employee benefits expense reductions have been achieved through the reduction of employee levels, the most notable of which was realized during the third quarter of 2021 following implementation of the ALC business cessation strategy. Further reductions of employee levels have been achieved through the Company's ongoing efficiency efforts. As ofSeptember 30, 2022 , the Company employed 155 full-time equivalent employees (including 147 at the Bank and eight at ALC), compared to 175 as ofDecember 31, 2021 , 187 as ofSeptember 30, 2021 , and 259 as ofJune 30, 2021 (the quarter-end date immediately prior to execution of the strategic initiatives). 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 ofSeptember 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 nine months endedSeptember 30, 2022 , non-interest expense was also 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.
Due to the strategic initiatives, additional expense reductions were also
realized related to telephone/data communications, computer services,
professional services, postage and supplies and various other expense
categories, comparing both the three- and nine-month periods ended
2022
Both nine-month periods presented included certain one-time restructuring charges associated with the ALC cessation of business strategy. These charges included expenses associated with employee severances, termination of leases and technology contracts fixed asset valuation adjustments, and miscellaneous other expenses. The restructuring charges totaled$0.2 million during the nine months endedSeptember 30, 2022 , compared to$0.5 million during the nine months endedSeptember 30, 2021 . No restructuring charges were incurred during the three months endedSeptember 30, 2022 , while$0.5 million in restructuring charges were incurred during the three months endedSeptember 30, 2021 . As ofSeptember 30, 2022 , the majority of estimated restructuring charges associated with the ALC strategy have been incurred. The strategic initiatives are expected to continue to reduce the Company's expense structure in the near term, although the reductions may be 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
months ended
effective tax rate was 23.7% and 21.9%, 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 3.6 years and 3.7 years as ofSeptember 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 ofSeptember 30, 2022 , available-for-sale securities totaled$143.8 million , or 98.6% 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 ofSeptember 30, 2022 , held-to-maturity securities totaled$2.1 million , or 1.4% 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. 53
-------------------------------------------------------------------------------- Due to the increasing interest rate environment, during the nine months endedSeptember 30, 2022 , gross unrealized losses increased significantly, particularly within the Company's available-for-sale portfolio. Gross unrealized losses in the available-for-sale portfolio totaled$11.0 million as ofSeptember 30, 2022 , compared to$0.8 million as ofDecember 31, 2021 . Management evaluated unrealized losses as ofSeptember 30, 2022 , and determined that no losses within the portfolio were other-than-temporary. 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 increased by$40.9 million , or 5.8%, as ofSeptember 30, 2022 , compared toDecember 31, 2021 . The tables below summarize loan balances by portfolio category at the end of each of the most recent five quarters as ofSeptember 30, 2022 : Quarter Ended 2022 2021 September June March December September 30, 30, 31, 31, 30, (Dollars in Thousands) Real estate loans: Construction, land development and other land loans$ 36,740 $ 40,625 $ 52,817 $ 67,048 $ 58,175 Secured by 1-4 family residential properties 84,911 69,098 69,760 72,727 73,112 Secured by multi-family residential properties 72,446 66,848 50,796 46,000 51,420 Secured by non-farm, non-residential properties 200,505 187,041 177,752 197,901 198,745 Commercial and industrial loans, including PPP loans 65,951 65,908 68,098 73,947 77,679 Consumer loans: Direct consumer 12,279 15,419 18,023 21,689 25,845 Branch retail 16,278 18,634 21,891 25,692 29,764 Indirect 262,742 252,206 220,931 205,940 194,154 Total loans$ 751,852 $ 715,779 $ 680,068 $ 710,944 $ 708,894 Less unearned interest, fees and deferred cost 1,581 1,142 1,738 2,594 3,729 Allowance for loan and lease losses 9,373 8,751 8,484 8,320 8,193 Net loans$ 740,898 $ 705,886 $ 669,846 $ 700,030 $ 696,972
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
September June March December September
30, 30, 31, 31, 30,
(Dollars in Thousands)
Balance at beginning of period
$ 8,193 $ 7,726 Charge-offs: Real estate loans: Construction, land development and other land loans - - - (1 ) - Secured by 1-4 family residential properties (3 ) (5 ) (2 ) (6 ) (1 ) 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 (417 ) (532 ) (557 ) (437 ) (222 ) Branch retail (200 ) (177 ) (145 ) (23 ) (77 ) Indirect (136 ) (77 ) (25 ) (118 ) (55 ) Total charge-offs (756 ) (791 ) (729 ) (585 ) (361 ) Recoveries 213 163 172 219 210 Net charge-offs (543 ) (628 ) (557 ) (366 ) (151 ) Provision for loan and lease losses 1,165 895 721 493 618 Ending balance$ 9,373 $ 8,751 $ 8,484 $ 8,320 $ 8,193 Ending balance as a percentage of loans 1.25 % 1.22 % 1.25 % 1.17 % 1.16 % Net charge-offs as a percentage of average loans 0.29 % 0.36 % 0.32 % 0.20 % 0.09 % 54
-------------------------------------------------------------------------------- Charge-offs increased during the nine months endedSeptember 30, 2022 primarily 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 ofSeptember 30, 2022 , compared toDecember 31, 2021 . The increase in provision expense in the nine months endedSeptember 30, 2022 primarily reflected the impact of these changing circumstances on ALC's portfolio and the overall changing economic conditions discussed above.
Nonperforming Assets
Nonperforming assets at the end of the five most recent quarters as ofSeptember 30, 2022 were as follows: Quarter Ended 2022 2021 September June March December September 30, 30, 31, 31, 30, (Dollars in Thousands) Non-accrual loans$ 2,077 $ 1,455 $ 2,228 $ 2,008 $ 969 Other real estate owned 686 276 874 2,149 2,373 Total$ 2,763 $ 1,731 $ 3,102 $ 4,157 $ 3,342 Nonperforming assets as a percentage of total assets 0.28 % 0.18 % 0.32
% 0.43 % 0.35 %
The decrease in OREO as ofSeptember 30, 2022 , compared toDecember 31, 2021 , resulted primarily from the sale of banking centers that were closed in 2021. The increase in non-accrual loans during the three-months endedSeptember 30, 2022 resulted primarily from one commercial loan that moved to non-accrual status.
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 ofSeptember 30, 2022 andDecember 31, 2021 : September 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$ 384 4.1 % 5.7 %$ 628 7.5 % 9.4 % Secured by 1-4 family residential properties 792 8.4 % 9.7 % 690 8.3 % 10.2 % Secured by multi-family residential properties 647 6.9 % 9.3 % 437 5.3 % 6.5 % Secured by non-farm, non-residential properties 1,992 21.3 % 26.1 % 1,958 23.5 % 27.8 % Commercial and industrial loans, including PPP loans 1,104 11.8 % 9.2 % 860 10.3 % 10.4 % Consumer loans: Direct consumer 948 10.1 % 2.2 % 1,004 12.1 % 3.1 % Branch retail 423 4.5 % 2.6 % 304 3.7 % 3.6 % Indirect 3,083 32.9 % 35.2 % 2,439 29.3 % 29.0 % Total allowance for loan and lease losses$ 9,373 100.0 % 100.0 %$ 8,320 100.0 % 100.0 % Deposits Total deposits increased to$846.5 million as ofSeptember 30, 2022 , from$838.1 million as ofDecember 31, 2021 , an increase of 1.0%. 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$791.4 million , or 93.5% of total deposits, as ofSeptember 30, 2022 , compared to$775.1 million , or 92.5% of total deposits, as ofDecember 31, 2021 . 55 -------------------------------------------------------------------------------- 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.
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 third quarter of 2022, other interest-bearing liabilities represented 6.4% of average interest-bearing liabilities, compared to 1.5% in the third quarter of 2021. Shareholders' Equity As ofSeptember 30, 2022 , shareholders' equity totaled$83.1 million , or 8.4% of total assets, compared to$90.1 million , or 9.4% of total assets, as ofDecember 31, 2021 . The decrease in shareholders' equity as ofSeptember 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 and a Company share repurchase program completed during the nine months endedSeptember 30, 2022 . The increase in unrealized losses within the securities portfolio resulted from significant increases in interest rates during the nine months endedSeptember 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 the nine months endedSeptember 30, 2022 the Company completed repurchases of 412,400 shares of its common stock at a weighted average price of$10.87 per share, or$4.5 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 ofSeptember 30, 2022 , 596,813 shares remained available for repurchase under the program. During both the nine months endedSeptember 30, 2022 and 2021, the Company declared dividends totaling$0.09 per common share, or approximately$0.5 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.
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$183.4 million as ofSeptember 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$10.0 million and$9.5 million of the investment portfolio as ofSeptember 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 3.6 years and 3.7 years as ofSeptember 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. The Company had$40.0 million and$10.0 million of outstanding borrowings under FHLB advances as ofSeptember 30, 2022 andDecember 31, 2021 , respectively. 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 bothSeptember 30, 2022 andDecember 31, 2021 . 56 -------------------------------------------------------------------------------- The Company had up to$206.6 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 ofSeptember 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 ofSeptember 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.
57
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