Form 10-Q FIRST NATIONAL CORP /VA/ For: Mar 31
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
| | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended
or
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number:
(Exact name of registrant as specified in its charter)
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| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
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(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading symbol(s) | Name of each exchange on which registered |
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
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| Emerging growth company |
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. As of May 11, 2022,
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| Item 1. |
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Consolidated Balance Sheets as of March 31, 2022 (unaudited) and December 31, 2021 |
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Consolidated Statements of Income for the three months ended March 31, 2022 and 2021 (unaudited) |
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Consolidated Statements of Cash Flows for the three months ended March 31, 2022 and 2021 (unaudited) |
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Management’s Discussion and Analysis of Financial Condition and Results of Operations |
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PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
FIRST NATIONAL CORPORATION
Consolidated Balance Sheets
(in thousands, except share and per share data)
| (unaudited) | ||||||||
| March 31, | December 31, | |||||||
| 2022 | 2021* | |||||||
| Assets | ||||||||
| Cash and due from banks | $ | $ | ||||||
| Interest-bearing deposits in banks | ||||||||
| Securities available for sale, at fair value | ||||||||
| Securities held to maturity, at amortized cost (fair value, 2022, $; 2021, $) | ||||||||
| Restricted securities, at cost | ||||||||
| Loans, net of allowance for loan losses, 2022, $; 2021, $ | ||||||||
| Other real estate owned, net of valuation allowance | ||||||||
| Premises and equipment, net | ||||||||
| Accrued interest receivable | ||||||||
| Bank owned life insurance | ||||||||
| Goodwill | ||||||||
| Core deposit intangibles, net | ||||||||
| Other assets | ||||||||
| Total assets | $ | $ | ||||||
| Liabilities and Shareholders’ Equity | ||||||||
| Liabilities | ||||||||
| Deposits: | ||||||||
| Noninterest-bearing demand deposits | $ | $ | ||||||
| Savings and interest-bearing demand deposits | ||||||||
| Time deposits | ||||||||
| Total deposits | $ | $ | ||||||
| Subordinated debt, net of issuance cost | ||||||||
| Junior subordinated debt, net of issuance cost | ||||||||
| Accrued interest payable and other liabilities | ||||||||
| Total liabilities | $ | $ | ||||||
| Commitments and contingencies | ||||||||
| Shareholders’ Equity | ||||||||
| Preferred stock, par value $ per share; authorized shares; issued and outstanding | $ | $ | ||||||
| Common stock, par value $ per share; authorized shares; issued and outstanding, 2022, shares; 2021, shares | ||||||||
| Surplus | ||||||||
| Retained earnings | ||||||||
| Accumulated other comprehensive (loss) income, net | ( | ) | ||||||
| Total shareholders’ equity | $ | $ | ||||||
| Total liabilities and shareholders’ equity | $ | $ | ||||||
*Derived from audited consolidated financial statements.
See Notes to Consolidated Financial Statements
Consolidated Statements of Income (Unaudited)
(in thousands, except per share data)
| Three Months Ended | ||||||||
| March 31, | March 31, | |||||||
| 2022 | 2021 | |||||||
| Interest and Dividend Income | ||||||||
| Interest and fees on loans | $ | $ | ||||||
| Interest on deposits in banks | ||||||||
| Interest and dividends on securities: | ||||||||
| Taxable interest | ||||||||
| Tax-exempt interest | ||||||||
| Dividends | ||||||||
| Total interest and dividend income | $ | $ | ||||||
| Interest Expense | ||||||||
| Interest on deposits | $ | $ | ||||||
| Interest on subordinated debt | ||||||||
| Interest on junior subordinated debt | ||||||||
| Total interest expense | $ | $ | ||||||
| Net interest income | $ | $ | ||||||
| Provision for loan losses | ||||||||
| Net interest income after provision for loan losses | $ | $ | ||||||
| Noninterest Income | ||||||||
| Service charges on deposit accounts | $ | $ | ||||||
| ATM and check card fees | ||||||||
| Wealth management fees | ||||||||
| Fees for other customer services | ||||||||
| Brokered mortgage fees | ||||||||
| Income from bank owned life insurance | ||||||||
| Net gains on securities available for sale | ||||||||
| Net gains on sale of mortgage loans held for sale | ||||||||
| Other operating income | ||||||||
| Total noninterest income | $ | $ | ||||||
| Noninterest Expense | ||||||||
| Salaries and employee benefits | $ | $ | ||||||
| Occupancy | ||||||||
| Equipment | ||||||||
| Marketing | ||||||||
| Supplies | ||||||||
| Legal and professional fees | ||||||||
| ATM and check card expense | ||||||||
| FDIC assessment | ||||||||
| Bank franchise tax | ||||||||
| Data processing expense | ||||||||
| Amortization expense | ||||||||
| Other real estate owned expense, net | ||||||||
| Other operating expense | ||||||||
| Total noninterest expense | $ | $ | ||||||
See Notes to Consolidated Financial Statements
FIRST NATIONAL CORPORATION
Consolidated Statements of (Loss) Income (Unaudited)
(Continued)
(in thousands, except per share data)
| Three Months Ended | ||||||||
| March 31, | March 31, | |||||||
| 2022 | 2021 | |||||||
| Income before income taxes | $ | $ | ||||||
| Income tax expense | ||||||||
| Net income | $ | $ | ||||||
| Earnings per common share | ||||||||
| Basic | $ | $ | ||||||
| Diluted | $ | $ | ||||||
See Notes to Consolidated Financial Statements
Consolidated Statements of Comprehensive (Loss) Income (Unaudited)
(in thousands)
| Three Months Ended | ||||||||
| March 31, | March 31, | |||||||
| 2022 | 2021 | |||||||
| Net income | $ | $ | ||||||
| Other comprehensive (loss), net of tax, | ||||||||
| Unrealized holding gains (losses) on available for sale securities, net of tax ($) and ($) for the three months ended March 31, 2022 and 2021, respectively | ( | ) | ( | ) | ||||
| Reclassification adjustment for gains included in net income, net of tax $ and ($) for the three months ended March 31, 2022 and 2021, respectively | ( | ) | ||||||
| Change in fair value of cash flow hedges, net of tax $ and $ for the three months ended March 31, 2022 and 2021, respectively | ||||||||
| Total other comprehensive (loss) | ( | ) | ( | ) | ||||
| Total comprehensive (loss) income | $ | ( | ) | $ | ||||
See Notes to Consolidated Financial Statements
Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
| Three Months Ended | ||||||||
| March 31, | March 31, | |||||||
| 2022 | 2021 | |||||||
| Cash Flows from Operating Activities | ||||||||
| Net income | $ | $ | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Depreciation and amortization of premises and equipment | ||||||||
| Amortization of core deposit intangibles | ||||||||
| Amortization of debt issuance costs | ||||||||
| Origination of mortgage loans held for sale | ( | ) | ||||||
| Proceeds from sale of mortgage loans held for sale | ||||||||
| Net gains on sales of mortgage loans held for sale | ( | ) | ||||||
| Net gains on securities available for sale | ( | ) | ||||||
| Net losses on sale of other real estate owned | ||||||||
| Increase in cash value of bank owned life insurance | ( | ) | ( | ) | ||||
| Accretion of discounts and amortization of premiums on securities, net | ||||||||
| Accretion of premium on time deposits | ( | ) | ( | ) | ||||
| Accretion of certain acquisition-related loan discounts, net | ( | ) | ||||||
| Stock-based compensation | ||||||||
| Excess tax benefits on stock-based compensation | ||||||||
| Losses (gains) on disposal of premises and equipment, net | ( | ) | ||||||
| Deferred income tax benefit | ( | ) | ||||||
| Changes in assets and liabilities: | ||||||||
| (Increase) decrease in interest receivable | ( | ) | ||||||
| Decrease (increase) in other assets | ( | ) | ||||||
| (Decrease) increase in accrued interest payable and other liabilities | ( | ) | ||||||
| Net cash provided by operating activities | $ | $ | ||||||
| Cash Flows from Investing Activities | ||||||||
| Proceeds from maturities, calls, principal payments, and sales of securities available for sale | $ | $ | ||||||
| Proceeds from maturities, calls, and principal payments of securities held to maturity | ||||||||
| Purchases of securities available for sale | ( | ) | ( | ) | ||||
| Purchases of securities held to maturity | ( | ) | ||||||
| Net (purchase) redemption of restricted securities | ( | ) | ||||||
| Purchase of premises and equipment | ( | ) | ( | ) | ||||
| Proceeds from sale of premises and equipment | ||||||||
| Proceeds from sale of other real estate owned | ||||||||
| Net increase in loans | ( | ) | ( | ) | ||||
| Net cash used in investing activities | $ | ( | ) | $ | ( | ) | ||
See Notes to Consolidated Financial Statements
FIRST NATIONAL CORPORATION
Consolidated Statements of Cash Flows (Unaudited)
(Continued)
(in thousands)
| Three Months Ended | ||||||||
| March 31, | March 31, | |||||||
| 2022 | 2021 | |||||||
| Cash Flows from Financing Activities | ||||||||
| Net increase in demand deposits and savings accounts | $ | $ | ||||||
| Net decrease in time deposits | ( | ) | ( | ) | ||||
| Repayment of subordinated debt, net of issuance costs | ( | ) | ||||||
| Cash dividends paid on common stock, net of reinvestment | ( | ) | ( | ) | ||||
| Repurchase of common stock, stock incentive plan | ( | ) | ( | ) | ||||
| Net cash provided by financing activities | $ | $ | ||||||
| Increase in cash and cash equivalents | $ | ( | ) | $ | ||||
| Cash and Cash Equivalents | ||||||||
| Beginning | $ | $ | ||||||
| Ending | $ | $ | ||||||
| Supplemental Disclosures of Cash Flow Information | ||||||||
| Cash payments for: | ||||||||
| Interest | $ | $ | ||||||
| Supplemental Disclosures of Noncash Investing and Financing Activities | ||||||||
| Unrealized (losses) gains on securities available for sale | $ | ( | ) | $ | ( | ) | ||
| Change in fair value of cash flow hedges | $ | $ | ||||||
| Transfer from other real estate owned to premises and equipment | $ | $ | ||||||
| Issuance of common stock, dividend reinvestment plan | $ | $ | ||||||
See Notes to Consolidated Financial Statements
Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)
(in thousands, except share and per share data)
| Common Stock | Surplus | Retained Earnings | Accumulated Other Comprehensive Income | Total | ||||||||||||||||
| Balance, December 31, 2020 | $ | $ | $ | $ | $ | |||||||||||||||
| Net income | ||||||||||||||||||||
| Other comprehensive income | ( | ) | ( | ) | ||||||||||||||||
| Cash dividends on common stock ($0.12 per share) | ( | ) | ( | ) | ||||||||||||||||
| Stock-based compensation | ||||||||||||||||||||
| Issuance of 2,211 shares common stock, dividend reinvestment plan | ||||||||||||||||||||
| Issuance of 8,073 shares common stock, stock incentive plan | ( | ) | ||||||||||||||||||
| Repurchase of 2,221 shares common stock, stock incentive plan | ( | ) | ( | ) | ( | ) | ||||||||||||||
| Balance, March 31, 2021 | $ | $ | $ | $ | $ | |||||||||||||||
| Common Stock | Surplus | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Total | ||||||||||||||||
| Balance, December 31, 2021 | $ | $ | $ | $ | $ | |||||||||||||||
| Net income | ||||||||||||||||||||
| Other comprehensive (loss) | ( | ) | ( | ) | ||||||||||||||||
| Cash dividends on common stock ($0.14 per share) | ( | ) | ( | ) | ||||||||||||||||
| Stock-based compensation | ||||||||||||||||||||
| Issuance of 2,757 shares common stock, dividend reinvestment plan | ||||||||||||||||||||
| Issuance of 27,134 shares common stock, stock incentive plan | ( | ) | ||||||||||||||||||
| Repurchase of 8,283 shares common stock, stock incentive plan | ( | ) | ( | ) | ( | ) | ||||||||||||||
| Balance, March 31, 2022 | $ | $ | $ | $ | ( | ) | $ | |||||||||||||
See Notes to Consolidated Financial Statements
Notes to Consolidated Financial Statements (Unaudited)
Note 1. General
The accompanying unaudited consolidated financial statements of First National Corporation (the Company) and its subsidiary, First Bank (the Bank), have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and in accordance with guidance provided by the SEC. Accordingly, they do not include all of the information and footnotes required by GAAP for annual year-end financial statements. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications of a normal and recurring nature considered necessary to present fairly the financial positions at March 31, 2022 and December 31, 2021, the statements of income and comprehensive (loss) income for the three months ended March 31, 2022 and 2021, the cash flows for the three months ended March 31, 2022 and 2021, and the changes in shareholders’ equity for the three months ended March 31, 2022 and 2021. The statements should be read in conjunction with the consolidated financial statements and related notes included in the Annual Report on Form 10-K for the year ended December 31, 2021. Operating results for the three months ended March 31, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022.
Risks and Uncertainties
The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company. The spread of the outbreak has caused disruptions in the U.S. economy. While there has been no material impact to the Company’s employees to date, COVID-19 could also potentially create widespread business continuity issues for the Company.
Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security (CARES) Act was signed into law in March 2020 as a $2 trillion legislative package, and the American Rescue Plan Act of 2021 was signed into law in March 2021 providing an additional $1.9 trillion in spending to address the continued impact of COVID-19. The goal of these legislative measures is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts may have a material impact on the Company’s operations.
The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full universe or extent that the impact of COVID-19, and resulting measures to curtail its spread, will have on the Company’s operations, the Company is disclosing potentially material items of which it is aware.
Notes to Consolidated Financial Statements (Unaudited)
Capital and Liquidity
While the Company believes it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by provision for loan losses in future periods. Larger amounts of provision for loan losses may result from factors including higher specific reserves on newly identified and existing impaired loans, higher levels of net charge-offs, and additional adjustments to qualitative factors in the general reserve component of the Bank’s allowance for loan losses. In March 2020, the Company suspended future stock repurchases under its stock repurchase program due to the economic uncertainty caused by the pandemic, and the program remained suspended for the remainder of the year until it ended on December 31, 2020. In June 2020, the Company issued $
The Company maintains access to multiple sources of liquidity. While wholesale funding markets have remained open, interest rates for short term funding could become volatile. If funding costs would become elevated for an extended period of time, it may have an adverse effect on the Company’s net interest margin. If an
extended recession causes large numbers of the Company’s deposit customers to withdraw their funds, the Company could become more reliant on volatile or more expensive sources of funding.
Asset Quality
The economic impact of the pandemic had an unfavorable impact on the financial condition of certain Bank customers. The Bank entered into loan modification agreements in the fourth quarter of 2020 to provide relief to certain customers that were continuing to experience temporary business interruptions from the pandemic.
The modifications were designed to help borrowers continue their business operations while minimizing potential loan charge-offs. The magnitude of the potential decline in the Bank’s loan quality will likely depend on the length and extent that the Bank’s customers experience business interruptions from the pandemic.
Notes to Consolidated Financial Statements (Unaudited)
Adoption of New Accounting Pronouncements
In March 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2022-01, “Derivatives and Hedging (Topic 815), Fair Value Hedging—Portfolio Layer Method.” ASU 2022-01 clarifies the guidance in ASC 815 on fair value hedge accounting of interest rate risk for portfolios of financial assets and is intended to better align hedge accounting with an organization’s risk management strategies. In 2017, FASB issued ASU 2017-12 to better align the economic results of risk management activities with hedge accounting. One of the major provisions of that standard was the addition of the last-of-layer hedging method. For a closed portfolio of fixed-rate prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, such as mortgages or mortgage-backed securities, the last-of-layer method allows an entity to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows. ASU 2022-01 renames that method the portfolio layer method. For public business entities, ASU 2022-01 is effective for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. The Company does not expect the adoption of ASU 2022-01 to have a material impact on its consolidated financial statements.
In March 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2022-02, “Financial Instruments-Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures.” ASU 2022-02 addresses areas identified by the FASB as part of its post-implementation review of the credit losses standard (ASU 2016-13) that introduced the CECL model. The amendments eliminate the accounting guidance for troubled debt restructurings by creditors that have adopted the CECL model and enhance the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty. In addition, the amendments require a public business entity to disclose current-period gross write-offs for financing receivables and net investment in leases by year of origination in the vintage disclosures. For entities that have adopted ASU 2016-13, ASU 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For entities that have not yet adopted ASU 2016-13, the effective dates for ASU 2022-02 are the same as the effective dates in ASU 2016-13. Early adoption is permitted if an entity has adopted ASU 2016-13. The Company is currently assessing the impact that ASU 2022-02 will have on its consolidated financial statements.
Recent Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes” (ASU 2019-12). The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. ASU 2019-12 was effective for the Company on January 1, 2021. The adoption of this standard did not have a material effect on the Company's consolidated financial statements.
In January 2020, the FASB issued ASU No. 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815” (ASU 2020-01). The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. ASU 2020-01 was effective for the Company on January 1, 2021. The adoption of this standard did not have a material effect on the Company's consolidated financial statements.
In October 2020, the FASB issued ASU No. 2020-08, “Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable fees and Other Costs” (ASU 2020-08). This ASU clarifies that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. ASU 2020-08 was effective for the Company on January 1, 2021. The adoption of this standard did not have a material effect on the Company's consolidated financial statements.
In December 2020, the Consolidated Appropriations Act of 2021 (CAA) was passed. Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the CARES Act, including the PPP loan program and treatment of certain loan modifications related to the COVID-19 pandemic. For information about the impact of the COVID-19 pandemic on the Company, see "Risks and Uncertainties" above.
In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (ASU 2016-13). The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASU’s 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASU’s have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (SEC), such as the Company, and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company has formed a committee to address the compliance requirements of this ASU, which has analyzed gathered data, defined loan pools and segments, and selected methods for applying the concepts included in this ASU. The Company is in the process of testing selected models, building policy and processing documentation, modeling the impact of the ASU on the capital and strategic plans, performing model validation, and finalizing policies and procedures. This guidance may result in material changes in the Company's accounting for credit losses of financial instruments.
Notes to Consolidated Financial Statements (Unaudited)
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.
In March 2020, the FASB issued ASU No. 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” (ASU 2020-04). These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the FASB issued ASU No. 2021-01 “Reference Rate Reform (Topic 848): Scope” (ASU 2021-01). This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company has identified loans and other financial instruments that are directly or indirectly influenced by LIBOR. The Company is assessing ASU 2020-04 and its impact on the Company's transition away from LIBOR for its loan and other financial instruments.
Notes to Consolidated Financial Statements (Unaudited)
Note 2. Securities
The Company invests in U.S. Treasury securities, U.S. agency and mortgage-backed securities, obligations of state and political subdivisions, and corporate debt securities. Amortized costs and fair values of securities at March 31, 2022 and December 31, 2021 were as follows (in thousands):
| March 31, 2022 | ||||||||||||||||
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized (Losses) | Fair Value | |||||||||||||
| Securities available for sale: | ||||||||||||||||
| U.S. Treasury securities | $ | $ | $ | ( | ) | $ | ||||||||||
| U.S. agency and mortgage-backed securities | ( | ) | ||||||||||||||
| Obligations of states and political subdivisions | ( | ) | ||||||||||||||
| Corporate debt securities | ( | ) | ||||||||||||||
| Total securities available for sale | $ | $ | $ | ( | ) | $ | ||||||||||
| Securities held to maturity: | ||||||||||||||||
| U.S. agency and mortgage-backed securities | $ | $ | $ | ( | ) | $ | ||||||||||
| Obligations of states and political subdivisions | ( | ) | ||||||||||||||
| Corporate debt securities | ||||||||||||||||
| Total securities held to maturity | $ | $ | $ | ( | ) | $ | ||||||||||
| Total securities | $ | $ | $ | ( | ) | $ | ||||||||||
| December 31, 2021 | ||||||||||||||||
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized (Losses) | Fair Value | |||||||||||||
| Securities available for sale: | ||||||||||||||||
| U.S. Treasury securities | $ | $ | $ | ( | ) | $ | ||||||||||
| U.S. agency and mortgage-backed securities | ( | ) | ||||||||||||||
| Obligations of states and political subdivisions | ( | ) | ||||||||||||||
| Corporate debt securities | ||||||||||||||||
| Total securities available for sale | $ | $ | $ | ( | ) | $ | ||||||||||
| Securities held to maturity: | ||||||||||||||||
| U.S. agency and mortgage-backed securities | $ | $ | $ | ( | ) | $ | ||||||||||
| Obligations of states and political subdivisions | ( | ) | ||||||||||||||
| Total securities held to maturity | $ | $ | $ | ( | ) | $ | ||||||||||
| Total securities | $ | $ | $ | ( | ) | $ | ||||||||||
Notes to Consolidated Financial Statements (Unaudited)
At March 31, 2022 and December 31, 2021, investments in an unrealized loss position that were temporarily impaired were as follows (in thousands):
| March 31, 2022 | ||||||||||||||||||||||||
| Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
| Fair Value | Unrealized (Loss) | Fair Value | Unrealized (Loss) | Fair Value | Unrealized (Loss) | |||||||||||||||||||
| Securities available for sale: | ||||||||||||||||||||||||
| U.S. Treasury securities | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | ||||||||||||||
| U.S. agency and mortgage-backed securities | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Obligations of states and political subdivisions | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Corporate debt securities | ( | ) | ( | ) | ||||||||||||||||||||
| Total securities available for sale | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||||
| Securities held to maturity: | ||||||||||||||||||||||||
| U.S. agency and mortgage-backed securities | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | ||||||||||||||
| Obligations of states and political subdivisions | ( | ) | ( | ) | ||||||||||||||||||||
| Total securities held to maturity | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | ||||||||||||||
| Total securities | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||
| Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
| Fair Value | Unrealized (Loss) | Fair Value | Unrealized (Loss) | Fair Value | Unrealized (Loss) | |||||||||||||||||||
| Securities available for sale: | ||||||||||||||||||||||||
| U.S. Treasury securities | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | ||||||||||||||
| U.S. agency and mortgage-backed securities | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Obligations of states and political subdivisions | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Total securities available for sale | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||||
| Securities held to maturity: | ||||||||||||||||||||||||
| U.S. agency and mortgage-backed securities | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | ||||||||||||||
| Obligations of states and political subdivisions | ( | ) | ( | ) | ||||||||||||||||||||
| Total securities held to maturity | $ | $ | ( | ) | $ | $ | $ | $ | ( | ) | ||||||||||||||
| Total securities | $ | $ | ( | ) | $ | $ | ( | ) | $ | $ | ( | ) | ||||||||||||
The tables above provide information about securities that have been in an unrealized loss position for less than twelve consecutive months and securities that have been in an unrealized loss position for twelve consecutive months or more. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Impairment is considered to be other-than-temporary if the Company (1) intends to sell the security, (2) more likely than not will be required to sell the security before recovering its cost, or (3) does not expect to recover the security’s entire amortized cost basis. Presently, the Company does not intend to sell any of these securities, does not expect to be required to sell these securities, and expects to recover the entire amortized cost of all the securities.
Notes to Consolidated Financial Statements (Unaudited)
At March 31, 2022, there were
The amortized cost and fair value of securities at March 31, 2022 by contractual maturity are shown below (in thousands). Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without call or prepayment penalties.
| Available for Sale | Held to Maturity | |||||||||||||||
| Amortized Cost | Fair Value | Amortized Cost | Fair Value | |||||||||||||
| Due within one year | $ | $ | $ | $ | ||||||||||||
| Due after one year through five years | ||||||||||||||||
| Due after five years through ten years | ||||||||||||||||
| Due after ten years | ||||||||||||||||
| $ | $ | $ | $ | |||||||||||||
Federal Home Loan Bank, Federal Reserve Bank, and Community Bankers’ Bank stock are generally viewed as long-term investments and as restricted securities, which are carried at cost, because there is a minimal market for the stock. Therefore, when evaluating restricted securities for impairment, their value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. The Company does not consider these investments to be other-than-temporarily impaired at March 31, 2022, and
The composition of restricted securities at March 31, 2022 and December 31, 2021 was as follows (in thousands):
| March 31, 2022 | December 31, 2021 | |||||||
| Federal Home Loan Bank stock | $ | $ | ||||||
| Federal Reserve Bank stock | ||||||||
| Community Bankers’ Bank stock | ||||||||
| $ | $ | |||||||
The Company also holds limited partnership investments in Small Business Investment Companies (SBICs), which are included in other assets in the Consolidated Balance Sheets. The limited partnership investments are measured as equity investments without readily determinable fair values at their cost, less any impairment. The amounts included in other assets for the limited partnership investments were $
Notes to Consolidated Financial Statements (Unaudited)
Note 3. Loans
Loans at March 31, 2022 and December 31, 2021 are summarized as follows (in thousands):
| March 31, 2022 | December 31, 2021 | |||||||
| Real estate loans: | ||||||||
| Construction and land development | $ | $ | ||||||
| Secured by 1-4 family residential | ||||||||
| Other real estate loans | ||||||||
| Commercial and industrial loans | ||||||||
| Consumer and other loans | ||||||||
| Total loans | $ | $ | ||||||
| Allowance for loan losses | ( | ) | ( | ) | ||||
| Loans, net | $ | $ | ||||||
Net deferred loan fees included in the above loan categories were $
Risk characteristics of each loan portfolio class that are considered by the Company include:
| • | 1-4 family residential mortgage loans carry risks associated with the continued creditworthiness of the borrower and changes in the value of the collateral. |
| • | Real estate construction and land development loans carry risks that the project may not be finished according to schedule, the project may not be finished according to budget, and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure or other factors unrelated to the project. |
| • | Other real estate loans carry risks associated with the successful operation of a business or a real estate project, in addition to other risks associated with the ownership of real estate, because repayment of these loans may be dependent upon the profitability and cash flows of the business or project. |
| • | Commercial and industrial loans carry risks associated with the successful operation of a business because repayment of these loans may be dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much reliability. |
| • | Consumer and other loans carry risk associated with the continued creditworthiness of the borrower and the value of the collateral, if any. Consumer loans are typically either unsecured or secured by rapidly depreciating assets such as automobiles. They are also likely to be immediately and adversely affected by job loss, divorce, illness, personal bankruptcy, or other changes in circumstances. Consumer and other loans also include purchased consumer loans which could have been originated outside of the Company's market area. Other loans included in this category include loans to states and political subdivisions. |
Loans acquired in business combinations are recorded in the Consolidated Balance Sheets at fair value at the acquisition date under the acquisition method of accounting. The outstanding principal balance and the carrying amount at March 31, 2022 of loans acquired in business combinations were as follows:
| Acquired Loans- | ||||
| Purchased | ||||
| (Dollars in thousands) | Performing | |||
| Outstanding principal balance | $ | |||
| Carrying amount | ||||
| Real estate loans: | ||||
| Construction and land development | $ | |||
| Secured by 1-4 family residential | ||||
| Other real estate loans | ||||
| Commercial and industrial loans | ||||
| Consumer and other loans | ||||
| Total acquired loans | $ | |||
Notes to Consolidated Financial Statements (Unaudited)
The following tables provide a summary of loan classes and an aging of past due loans as of March 31, 2022 and December 31, 2021 (in thousands):
| March 31, 2022 | ||||||||||||||||||||||||||||||||
| 30-59 Days Past Due | 60-89 Days Past Due | > 90 Days Past Due | Total Past Due | Current | Total Loans | Non-accrual Loans | 90 Days or More Past Due and Accruing | |||||||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||||||||||||||
| Construction and land development | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Secured by 1-4 family residential | ||||||||||||||||||||||||||||||||
| Other real estate loans | ||||||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||||||
| Consumer and other loans | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||||||||||
| 30-59 Days Past Due | 60-89 Days Past Due | > 90 Days Past Due | Total Past Due | Current | Total Loans | Non-accrual Loans | 90 Days or More Past Due and Accruing | |||||||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||||||||||||||
| Construction and land development | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Secured by 1-4 family residential | ||||||||||||||||||||||||||||||||
| Other real estate loans | ||||||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||||||
| Consumer and other loans | ||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Credit Quality Indicators
As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators including trends related to the risk grading of specified classes of loans. The Company utilizes a risk grading matrix to assign a rating to each of its loans. The loan ratings are summarized into the following categories: pass, special mention, substandard, doubtful, and loss. Pass rated loans include all risk rated credits other than those included in special mention, substandard, or doubtful. Loans classified as loss are charged-off. Loan officers assign risk grades to loans at origination and as renewals arise. The Bank’s Credit Administration department reviews risk grades for accuracy on a quarterly basis and as credit issues arise. In addition, a certain amount of loans are reviewed each year through the Company’s internal and external loan review process. A description of the general characteristics of the loan grading categories is as follows:
Pass – Loans classified as pass exhibit acceptable operating trends, balance sheet trends, and liquidity. Sufficient cash flow exists to service the loan. All obligations have been paid by the borrower as agreed.
Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the Bank’s credit position at some future date.
Notes to Consolidated Financial Statements (Unaudited)
Substandard – Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The Company considers all doubtful loans to be impaired and places the loan on non-accrual status.
Loss – Loans classified as loss are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.
The following tables provide an analysis of the credit risk profile of each loan class as of March 31, 2022 and December 31, 2021 (in thousands):
| March 31, 2022 | ||||||||||||||||||||
| Pass | Special Mention | Substandard | Doubtful | Total | ||||||||||||||||
| Real estate loans: | ||||||||||||||||||||
| Construction and land development | $ | $ | $ | $ | $ | |||||||||||||||
| Secured by 1-4 family residential | ||||||||||||||||||||
| Other real estate loans | ||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Consumer and other loans | ||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | |||||||||||||||
| December 31, 2021 | ||||||||||||||||||||
| Pass | Special Mention | Substandard | Doubtful | Total | ||||||||||||||||
| Real estate loans: | ||||||||||||||||||||
| Construction and land development | $ | $ | $ | $ | $ | |||||||||||||||
| Secured by 1-4 family residential | ||||||||||||||||||||
| Other real estate loans | ||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||
| Consumer and other loans | ||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | |||||||||||||||
Notes to Consolidated Financial Statements (Unaudited)
Note 4. Allowance for Loan Losses
The following tables present, as of March 31, 2022, December 31, 2021 and March 31, 2021, the total allowance for loan losses, the allowance by impairment methodology, and loans by impairment methodology (in thousands):
| March 31, 2022 | ||||||||||||||||||||||||
| Construction and Land Development | Secured by 1-4 Family Residential | Other Real Estate | Commercial and Industrial | Consumer and Other Loans | Total | |||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||
| Beginning Balance, December 31, 2021 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||
| Provision for (recovery of) loan losses | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Ending Balance, March 31, 2022 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Ending Balance: | ||||||||||||||||||||||||
| Individually evaluated for impairment | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||
| Loans: | ||||||||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Individually evaluated for impairment | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||
| Construction and Land Development | Secured by 1-4 Family Residential | Other Real Estate | Commercial and Industrial | Consumer and Other Loans | Total | |||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||
| Beginning Balance, December 31, 2020 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||
| Recoveries | ||||||||||||||||||||||||
| Provision for (recovery of) loan losses | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
| Ending Balance, December 31, 2021 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Ending Balance: | ||||||||||||||||||||||||
| Individually evaluated for impairment | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||
| Loans: | ||||||||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Individually evaluated for impairment | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||
| March 31, 2021 | ||||||||||||||||||||||||
| Construction and Land Development | Secured by 1-4 Family Residential | Other Real Estate | Commercial and Industrial | Consumer and Other Loans | Total | |||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||
| Beginning Balance, December 31, 2020 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Charge-offs | ( | ) | ( | ) | ||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||
| Provision for (recovery of) loan losses | ( | ) | ( | ) | ||||||||||||||||||||
| Ending Balance, March 31, 2021 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Ending Balance: | ||||||||||||||||||||||||
| Individually evaluated for impairment | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||
| Loans: | ||||||||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
| Individually evaluated for impairment | ||||||||||||||||||||||||
| Collectively evaluated for impairment | ||||||||||||||||||||||||
Notes to Consolidated Financial Statements (Unaudited)
Impaired loans and the related allowance at March 31, 2022, December 31, 2021 and March 31, 2021, were as follows (in thousands):
| March 31, 2022 | ||||||||||||||||||||||||||||
| Unpaid Principal Balance | Recorded Investment with No Allowance | Recorded Investment with Allowance | Total Recorded Investment | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||||||||||
| Secured by 1-4 family residential | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Other real estate loans | ||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||
| Total | ||||||||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||||||
| Unpaid Principal Balance | Recorded Investment with No Allowance | Recorded Investment with Allowance | Total Recorded Investment | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||||||||||
| Construction and land development | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Secured by 1-4 family residential | ||||||||||||||||||||||||||||
| Other real estate loans | ||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| March 31, 2021 | ||||||||||||||||||||||||||||
| Unpaid Principal Balance | Recorded Investment with No Allowance | Recorded Investment with Allowance | Total Recorded Investment | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||||||||
| Real estate loans: | ||||||||||||||||||||||||||||
| Construction and land development | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
| Secured by 1-4 family residential | ||||||||||||||||||||||||||||
| Other real estate loans | ||||||||||||||||||||||||||||
| Commercial and industrial | ||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
The “Recorded Investment” amounts in the table above represent the outstanding principal balance on each loan represented in the table. The “Unpaid Principal Balance” represents the outstanding principal balance on each loan represented in the table plus any amounts that have been charged off on each loan and/or payments that have been applied towards principal on non-accrual loans. Only loan classes with balances are included in the tables above.
As of March 31, 2022, loans classified as troubled debt restructurings (TDRs) and included in impaired loans in the disclosure above totaled $
For the three months ended March 31, 2022 and 2021, there were
Notes to Consolidated Financial Statements (Unaudited)
During the fourth quarter of 2020, the Company modified terms of certain loans for customers that continued to be negatively impacted by the COVID-19 pandemic. The loan modifications lowered borrower loan payments by allowing interest only payments for periods ranging between
Note 5. Other Real Estate Owned (OREO)
Changes in the balance for OREO during the three months ended March 31, 2022 and the year ended December 31, 2021 are as follows (in thousands):
| Three Months Ended | Year Ended | |||||||
| March 31, 2022 | December 31, 2021 | |||||||
| Balance at the beginning of year | $ | $ | ||||||
| Transfers in | ||||||||
| Transfers to premises and equipment | ( | ) | ||||||
| Acquired in merger | ||||||||
| Sales proceeds | ( | ) | ( | ) | ||||
| (Loss) gain on disposition | ( | ) | ||||||
| Balance at the end of period | $ | $ | ||||||
There were
Net expenses applicable to OREO, other than the valuation allowance and (loss) gain on disposition, were $
Note 6. Other Borrowings
The Company had an unsecured line of credit totaling $
The Bank had unused lines of credit totaling $
Notes to Consolidated Financial Statements (Unaudited)
Note 7. Capital Requirements
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total (as defined), Tier 1 (as defined), and common equity Tier 1 capital (as defined) to risk-weighted assets (as defined), and of Tier 1 capital to average assets. Management believes, as of March 31, 2022 and December 31, 2021, that the Bank met all capital adequacy requirements to which it is subject.
As of March 31, 2022, the most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum risk-based capital and leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s category.
A comparison of the capital of the Bank at March 31, 2022 and December 31, 2021 with the minimum regulatory guidelines were as follows (dollars in thousands):
| Actual | Minimum Capital Requirement | Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions | ||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
| March 31, 2022 | ||||||||||||||||||||||||
| Total Capital (to Risk-Weighted Assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
| Tier 1 Capital (to Risk-Weighted Assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
| Common Equity Tier 1 Capital (to Risk-Weighted Assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
| Tier 1 Capital (to Average Assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||
| Total Capital (to Risk-Weighted Assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
| Tier 1 Capital (to Risk-Weighted Assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
| Common Equity Tier 1 Capital (to Risk-Weighted Assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
| Tier 1 Capital (to Average Assets) | $ | % | $ | % | $ | % | ||||||||||||||||||
In addition to the regulatory minimum risk-based capital amounts presented above, the Bank must maintain a capital conservation buffer as required by the Basel III final rules. Accordingly, the Bank was required to maintain a capital conservation buffer of
Notes to Consolidated Financial Statements (Unaudited)
Note 8. Subordinated Debt
On October 30, 2015, the Company entered into a Subordinated Loan Agreement (the Agreement) pursuant to which the Company issued an interest only subordinated term note due 2025 in the aggregate principal amount of $
On June 29, 2020, the Company issued an interest only subordinated term note due 2030 in the aggregate principal amount of $
Note 9. Junior Subordinated Debt
On June 8, 2004, First National (VA) Statutory Trust II (Trust II), a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable capital securities, commonly known as trust preferred securities. On June 17, 2004, $
On July 24, 2006, First National (VA) Statutory Trust III (Trust III), a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable capital securities. On July 31, 2006, $
Note 10. Benefit Plans
401(k) Plan
The Company maintains a 401(k) plan (the Plan) for all eligible employees. Participating employees may elect to contribute up to the maximum percentage allowed by the Internal Revenue Service, as defined in the Plan. The Company makes matching contributions, on a dollar-for dollar basis, for the first percent of an employee’s compensation contributed to the Plan and fifty cents for each dollar of the employee’s contribution between percent and percent. The Company also makes an additional contribution based on years of service to participants who have completed at least hours of service during the year and who are employed on the last day of the Plan Year. All employees who are age or older are eligible. Employee contributions vest immediately. Employer matching contributions vest after Plan service years with the Company. The Company has the discretion to make a profit sharing contribution to the Plan each year based on overall performance, profitability, and other economic factors. For the three months ended March 31, 2022 and 2021, expense attributable to the Plan amounted to $
Notes to Consolidated Financial Statements (Unaudited)
Supplemental Executive Retirement Plans
On March 15, 2019, the Company entered into supplemental executive retirement plans and participation agreements with of its employees. The retirement benefits are fixed and provide for retirement benefits payable in
Note 11. Earnings per Common Share
Basic earnings per common share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.
The following table presents the computation of basic and diluted earnings per share for the three months ended March 31, 2022 and 2021 (dollars in thousands, except per share data):
| Three Months Ended | ||||||||
| March 31, 2022 | March 31, 2021 | |||||||
| (Numerator): | ||||||||
| Net income | $ | $ | ||||||
| (Denominator): | ||||||||
| Weighted average shares outstanding – basic | ||||||||
| Potentially dilutive common shares – restricted stock units | ||||||||
| Weighted average shares outstanding – diluted | ||||||||
| Income per common share | ||||||||
| Basic | $ | $ | ||||||
| Diluted | $ | $ | ||||||
Restricted stock units for
Note 12. Fair Value Measurements
Determination of Fair Value
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the “Fair Value Measurement and Disclosures” topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
Notes to Consolidated Financial Statements (Unaudited)
Fair Value Hierarchy
In accordance with this guidance, the Company groups its assets and liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
| Level 1 - | Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. |
| Level 2 - | Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability. |
| Level 3 - | Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires a significant management judgment or estimation. |
An instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a recurring basis in the financial statements:
Securities available for sale
Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).
Derivative asset/liability - cash flow hedges
Cash flow hedges are recorded at fair value on a recurring basis. The fair value of the Company's cash flow hedges is determined by a third party vendor using the discounted cash flow method (Level 2).
Notes to Consolidated Financial Statements (Unaudited)
The following tables present the balances of assets measured at fair value on a recurring basis as of March 31, 2022 and December 31, 2021 (in thousands).
| Fair Value Measurements at March 31, 2022 | ||||||||||||||||
| Description | Balance as of March 31, 2022 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Assets: | ||||||||||||||||
| Securities available for sale | ||||||||||||||||
| U.S. Treasury securities | $ | $ | $ | $ | ||||||||||||
| U.S. agency and mortgage-backed securities | ||||||||||||||||
| Obligations of states and political subdivisions | ||||||||||||||||
| Corporate debt securities | ||||||||||||||||
| Total securities available for sale | $ | $ | $ | $ | ||||||||||||
| Derivatives - cash flow hedges | ||||||||||||||||
| Total assets | $ | $ | $ | $ | ||||||||||||
| Fair Value Measurements at December 31, 2021 | ||||||||||||||||
| Description | Balance as of December 31, 2021 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Assets: | ||||||||||||||||
| Securities available for sale | ||||||||||||||||
| U.S. Treasury securities | $ | $ | $ | $ | ||||||||||||
| U.S. agency and mortgage-backed securities | ||||||||||||||||
| Obligations of states and political subdivisions | ||||||||||||||||
| Corporate debt securities | ||||||||||||||||
| Total securities available for sale | $ | $ | $ | $ | ||||||||||||
| Derivatives - cash flow hedges | ||||||||||||||||
| Total assets | $ | $ | $ | $ | ||||||||||||
Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
Loans held for sale
Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. nonrecurring fair value adjustments were recorded on loans held for sale during the three months ended March 31, 2022 and the year ended December 31, 2021.
Impaired Loans
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreements will not be collected. The measurement of loss associated with impaired loans can be based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the observable market price of the loan, or the fair value of the collateral less estimated costs to sell. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the Company’s collateral is real estate. The value of real estate collateral is determined utilizing a market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2) within the last twelve months. However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than one year old and not solely based on observable market comparables or management determines the fair value of the collateral is further impaired below the appraised value, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
Notes to Consolidated Financial Statements (Unaudited)
The following tables summarize the Company’s assets that were measured at fair value on a nonrecurring basis during the periods (dollars in thousands):
| Fair Value Measurements at March 31, 2022 | ||||||||||||||||
| Description | Balance as of March 31, 2022 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Other real estate owned | $ | $ | $ | $ | ||||||||||||
| Fair Value Measurements at December 31, 2021 | ||||||||||||||||
| Description | Balance as of December 31, 2021 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | ||||||||||||
| Other real estate owned | $ | $ | $ | $ | ||||||||||||
| Impaired loans, net | ||||||||||||||||
| Quantitative information about Level 3 Fair Value Measurements for March 31, 2022 | ||||||||||||||
| Fair Value | Valuation Technique | Unobservable Input | Range (Weighted Average) (1) | |||||||||||
| Other real estate owned | $ | Property appraisals | Selling cost | % | ||||||||||
| Quantitative information about Level 3 Fair Value Measurements for December 31, 2021 | ||||||||||||||
| Fair Value | Valuation Technique | Unobservable Input | Range (Weighted Average) (1) | |||||||||||
| Other real estate owned | $ | Property appraisals | Selling cost | % | ||||||||||
| Impaired loans, net | Present value of cash flows | Discount rate | % | |||||||||||
| (1) | Unobservable inputs were weighted by the relative fair value of the instruments. |
Notes to Consolidated Financial Statements (Unaudited)
Accounting guidance requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The carrying values and estimated fair values of the Company’s financial instruments at March 31, 2022 and December 31, 2021 are as follows (in thousands):
| Fair Value Measurements at March 31, 2022 Using | ||||||||||||||||||||
| Carrying Amount | Quoted Prices in Active Markets for Identical Assets Level 1 | Significant Other Observable Inputs Level 2 | Significant Unobservable Inputs Level 3 | Fair Value | ||||||||||||||||
| Financial Assets | ||||||||||||||||||||
| Cash and interest-bearing deposits in banks | $ | $ | $ | $ | $ | |||||||||||||||
| Securities available for sale | ||||||||||||||||||||
| Securities held to maturity | ||||||||||||||||||||
| Restricted securities | ||||||||||||||||||||
| Loans, net | ||||||||||||||||||||
| Bank owned life insurance | ||||||||||||||||||||
| Accrued interest receivable | ||||||||||||||||||||
| Derivatives - cash flow hedges | ||||||||||||||||||||
| Financial Liabilities | ||||||||||||||||||||
| Deposits | $ | $ | $ | $ | $ | |||||||||||||||
| Subordinated debt | ||||||||||||||||||||
| Junior subordinated debt | ||||||||||||||||||||
| Accrued interest payable | ||||||||||||||||||||
| Fair Value Measurements at December 31, 2021 Using | ||||||||||||||||||||
| Carrying Amount | Quoted Prices in Active Markets for Identical Assets Level 1 | Significant Other Observable Inputs Level 2 | Significant Unobservable Inputs Level 3 | Fair Value | ||||||||||||||||
| Financial Assets | ||||||||||||||||||||
| Cash and interest-bearing deposits in banks | $ | $ | $ | $ | $ | |||||||||||||||
| Securities available for sale | ||||||||||||||||||||
| Securities held to maturity | ||||||||||||||||||||
| Restricted securities | ||||||||||||||||||||
| Loans held for sale | ||||||||||||||||||||
| Loans, net | ||||||||||||||||||||
| Bank owned life insurance | ||||||||||||||||||||
| Accrued interest receivable | ||||||||||||||||||||
| Derivatives - cash flow hedges | ||||||||||||||||||||
| Financial Liabilities | ||||||||||||||||||||
| Deposits | $ | $ | $ | $ | $ | |||||||||||||||
| Subordinated debt | ||||||||||||||||||||
| Junior subordinated debt | ||||||||||||||||||||
| Accrued interest payable | ||||||||||||||||||||
Notes to Consolidated Financial Statements (Unaudited)
The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
Note 13. Stock Compensation Plans
On May 13, 2014, the Company’s shareholders approved the First National Corporation 2014 Stock Incentive Plan, which makes available up to
Stock Awards
Whenever the Company deems it appropriate to grant a stock award, the recipient receives a specified number of unrestricted shares of employer stock. Stock awards may be made by the Company at its discretion without cash consideration and may be granted as settlement of a performance-based compensation award.
Compensation expense related to stock awards totaled $
Restricted Stock Units
Restricted stock units are an award of units that correspond in number and value to a specified number of shares of employer stock which the recipient receives according to a vesting plan and distribution schedule after achieving required performance milestones or upon remaining with the employer for a particular length of time. Each restricted stock unit that vests entitles the recipient to receive one share of common stock on a specified issuance date.
During the first quarter of 2022,
A summary of the activity for the Company’s restricted stock units for the period indicated is presented in the following table:
| Three Months Ended | ||||||||
| March 31, 2022 | ||||||||
| Shares | Weighted Average Grant Date Fair Value | |||||||
| Unvested, beginning of year | $ | |||||||
| Granted | ||||||||
| Vested | ( | ) | ||||||
| Forfeited | ||||||||
| Unvested, end of period | $ | |||||||
At March 31, 2022, based on restricted stock unit awards outstanding at that time, the total unrecognized pre-tax compensation expense related to unvested restricted stock unit awards was $
Notes to Consolidated Financial Statements (Unaudited)
Note 14. Accumulated Other Comprehensive (Loss) Income
Changes in each component of accumulated other comprehensive (loss) income were as follows (in thousands):
| Net Unrealized Gains (Losses) on Securities | Change in Fair Value of Cash Flow Hedges | Accumulated Other Comprehensive (Loss) Income | ||||||||||
| Balance at December 31, 2020 | $ | $ | $ | |||||||||
| Unrealized holding losses (net of tax, ) | ( | ) | ( | ) | ||||||||
| Reclassification adjustment (net of tax, ) | ( | ) | ( | ) | ||||||||
| Change in fair value (net of tax, $) | ||||||||||||
| Change during period | ( | ) | ( | ) | ||||||||
| Balance at March 31, 2021 | $ | $ | $ | |||||||||
| Balance at December 31, 2021 | $ | ( | ) | $ | $ | |||||||
| Unrealized holding losses (net of tax, ) | ( | ) | ( | ) | ||||||||
| Change in fair value of cash flow hedge (net of tax, $) | ||||||||||||
| Change during period | ( | ) | ( | ) | ||||||||
| Balance at March 31, 2022 | $ | ( | ) | $ | $ | ( | ) | |||||
The following table presents information related to reclassifications from accumulated other comprehensive (loss) income for the three months ended March 31, 2022 and 2021 (in thousands):
| Details About Accumulated Other Comprehensive (Loss) Income | Amount Reclassified from Accumulated Other Comprehensive (Loss) Income | Affected Line Item in the Consolidated Statements of Income | |||||||
| Three Months Ended | |||||||||
| March 31, 2022 | March 31, 2021 | ||||||||
| Securities available for sale: | |||||||||
| Net securities gains reclassified into earnings | $ | $ | ( | ) | Net gains on securities available for sale | ||||
| Related income tax expense | Income tax expense | ||||||||
| Total reclassifications | $ | $ | ( | ) | Net of tax | ||||
Notes to Consolidated Financial Statements (Unaudited)
Note 15. Revenue Recognition
Most revenue associated with financial instruments, including interest income, loan origination fees, and credit card fees, is outside the scope of ASC topic 606. Gains and losses on investment securities, derivatives, financial guarantees, and sales of financial instruments are similarly excluded from the scope. The guidance is
applicable to noninterest revenue streams such as service charges on deposit accounts, ATM and check card fees, wealth management fees, and fees for other customer services. Noninterest revenue streams within the scope of Topic 606 are discussed below.
Service charges on deposit accounts
Service charges on deposit accounts consist of monthly service fees, overdraft and nonsufficient funds fees, and other deposit account related fees. The Company's performance obligation for monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers' accounts. Overdraft and nonsufficient funds fees and other deposit account related fees are transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue recognized, at a point in time.
ATM and check card fees
ATM fees are primarily generated when a Company cardholder uses a non-Company ATM or a non-Company cardholder uses a Company ATM. ATM fees are transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue recognized, at a point in time. Check card fees are primarily comprised of interchange fee income. Interchange fees are earned whenever the Company's debit cards are processed through card payment networks, such as Visa. The Company's performance obligation for interchange fee income is largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. In compliance with Topic 606, debit card fee income is presented net of associated expense.
Wealth management fees
Wealth management fees are primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Company's performance obligation is generally satisfied over time and the resulting fees are primarily recognized monthly, based upon the month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month-end through a direct charge to customers' accounts. Estate management fees are based upon the size of the estate. Revenue for estate management fees are recorded periodically, according to a fee schedule, and are based on the services that have been provided.
Brokered mortgage fees
Brokered mortgage fees are comprised of loan fee income earned from generating loans in the secondary market. Brokered mortgage fee income is recognized at loan closing.
Fees for other customer services
Fees for other customer services include fees for brokered loans, check ordering charges, merchant services income, safe deposit box rental fees, and other service charges. Check ordering charges are transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue recognized, at a point in time. Merchant services income mainly represent fees charged to merchants to process their debit and credit card transactions. The Company's performance obligation for merchant services income is largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.
The following table presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three months ended March 31, 2022 and 2021 (in thousands):
| Three Months Ended | ||||||||
| March 31, 2022 | March 31, 2021 | |||||||
| Noninterest Income | ||||||||
| Service charges on deposit accounts | $ | $ | ||||||
| ATM and check card fees | ||||||||
| Wealth management fees | ||||||||
| Brokered mortgage fees | ||||||||
| Fees for other customer services | ||||||||
| Noninterest income (in-scope of Topic 606) | $ | $ | ||||||
| Noninterest income (out-of-scope of Topic 606) | ||||||||
| Total noninterest income | $ | $ | ||||||
Notes to Consolidated Financial Statements (Unaudited)
Note 16. Derivative Financial Instruments
On April 21, 2020, the Company entered into interest rate swap agreements related to its outstanding junior subordinated debt. One swap agreement was related to the Company’s junior subordinated debt with a redemption date of June 17, 2034, which became effective on March 17, 2020. The notional amount of the interest rate swap was $
The Company entered into interest rate swaps to reduce interest rate risk and to manage interest expense. By entering into these agreements, the Company converted variable rate debt into fixed rate debt. Alternatively, the Company may enter into interest rate swap agreements to convert fixed rate debt into variable rate debt. Interest differentials paid or received under interest rate swap agreements are reflected as adjustments to interest expense. The Company designated the interest rate swaps as hedging instruments in qualifying cash flow hedges. Changes in fair value of these designated hedging instruments is reported as a component of other comprehensive (loss) income. Interest rate swaps designated as cash flow hedges are expected to be highly effective in offsetting the effect of changes in interest rates on the amount of variable rate interest payments, and the Company assesses the effectiveness of each hedging relationship quarterly. If the Company determines that a cash flow hedge is no longer highly effective, future changes in the fair value of the hedging instrument would be reported as earnings. As of March 31, 2022, the Company has designated cash flow hedges to manage its exposure to variability in cash flows on certain variable rate borrowings for periods that end between June 2034 and October 2036. The notional amounts of the interest rate swaps were not exchanged and do not represent exposure to credit loss. In the event of default by a counterparty, the risk in these transactions is the cost of replacing the agreements at current market rates.
All interest rate swaps were entered into with counterparties that met the Company's credit standards and the agreements contain collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in these derivative contracts is not significant.
Unrealized gains or losses recorded in other comprehensive (loss) income related to cash flow hedges are reclassified into earnings in the same period(s) during which the hedged interest payments affect earnings. When a designated hedging instrument is terminated and the hedged interest payments remain probable of occurring, any remaining unrecognized gain or loss in other comprehensive (loss) income is reclassified into earnings in the period(s) during which the forecasted interest payments affect earnings. Amounts reclassified into earnings and interest receivable or payable under designated interest rate swaps are reported in interest expense. The Company does not expect any unrealized losses related to cash flow hedges to be reclassified into earnings in the next twelve months.
The following table summarizes key elements of the Company's derivative instruments at March 31, 2022 (in thousands):
| March 31, 2022 | ||||||||||||||||
| Notional Amount | Assets | Liabilities | Collateral Pledged(1) | |||||||||||||
| Cash Flow Hedges | ||||||||||||||||
| Interest rate swap contracts | $ | $ | $ | $ | ||||||||||||
|
| ||||||||||||||||
| December 31, 2021 | ||||||||||||||||
| Notional Amount | Assets | Liabilities | Collateral Pledged(1) | |||||||||||||
| Cash Flow Hedges | ||||||||||||||||
| Interest rate swap contracts | $ | $ | $ | $ | ||||||||||||
| (1) | Collateral pledged may be comprised of cash or securities. |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement Regarding Forward-Looking Statements
First National Corporation (the Company) makes forward-looking statements in this Form 10-Q that are subject to risks and uncertainties. These forward-looking statements include, but are not limited to, statements regarding profitability, liquidity, adequacy of capital, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and the impact of the Company’s acquisitions of The Bank of Fincastle (Fincastle) and the SmartBank loan portfolio, including the expected benefits of the acquisition of Fincastle (Merger) and the potential impact of the acquisitions on the Company’s and First Bank’s (the Bank) financial and other goals. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements. These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:
| • | the ability of the Company and the Bank to realize the anticipated benefits of the Merger, including expected revenue synergies and cost savings that may not be fully realized or realized within the expected time frame; |
| • | expected revenue synergies and cost savings from the Merger that may not be fully realized or realized within the expected time frame; |
| • | revenues following the Merger that may be lower than expected; |
| • | customer and employee relationships and business operations as a result of disruptions caused by the Merger; |
| • | the effects of the COVID-19 pandemic, including its potential adverse effect on economic conditions and the Company's employees, customers, credit quality, and financial performance; |
| • |
general business conditions, as well as conditions within the financial markets; |
| • |
general economic conditions, including unemployment levels, inflation and slowdowns in economic growth; |
| • |
the Company’s branch and market expansions, technology initiatives and other strategic initiatives; |
| • |
the impact of competition from banks and non-banks, including financial technology companies (Fintech); |
| • |
the composition of the loan and deposit portfolio, including the types of accounts and customers, may change, which could impact the amount of net interest income and noninterest income in future periods, including revenue from service charges on deposits; |
| • |
limited availability of financing or inability to raise capital; |
| • |
reliance on third parties for key services; |
| • |
the Company’s credit standards and its on-going credit assessment processes might not protect it from significant credit losses; |
| • |
the quality of the loan portfolio and the value of the collateral securing those loans; |
|
| • | demand for loan products; | |
| • | deposit flows; |
| • |
the level of net charge-offs on loans and the adequacy of the allowance for loan losses; |
| • |
the concentration in loans secured by real estate may adversely affect earnings due to changes in the real estate markets; |
| • |
the value of securities held in the Company's investment portfolio; |
| • |
legislative or regulatory changes or actions, including the effects of changes in tax laws; |
| • |
accounting principles, policies and guidelines and elections made by the Company thereunder; |
| • |
cyber threats, attacks or events; |
| • |
the ability to maintain adequate liquidity by retaining deposit customers and secondary funding sources, especially if the Company’s reputation would become damaged; |
| • |
monetary and fiscal policies of the U.S. Government, including policies of the U.S. Department of the Treasury and the Federal Reserve Board, and the effect of those policies on interest rates and business in the Company's markets; |
| • |
changes in interest rates could have a negative impact on the Company’s net interest income and an unfavorable impact on the Company’s customers’ ability to repay loans; |
|
| • | geopolitical conditions, including acts or threats of terrorism, international hostilities, or actions taken by the U.S. or other governments in response to acts or threats of terrorism and/or military conflicts, which could impact business and economic conditions in the U.S. and abroad; and |
| • |
other factors identified in Item 1A. Risk Factors of the Company’s Form 10-K for the year ending December 31, 2021. |
Because of these and other uncertainties, actual results may be materially different from the results indicated by these forward-looking statements. In addition, past results of operations do not necessarily indicate future results. The following discussion and analysis of the financial condition at March 31, 2022 and statements of income of the Company for the three months ended March 31, 2022 and 2021 should be read in conjunction with the consolidated financial statements and related notes included in Part I, Item 1, of this Form 10-Q and in Part II, Item 8, of the Form 10-K for the period ending December 31, 2021. The statements of income for thethree months ended March 31, 2022 may not be indicative of the results to be achieved for the year.
Executive Overview
The Company
First National Corporation (the Company) is the bank holding company of:
| • |
First Bank (the Bank). The Bank owns: |
| • |
First Bank Financial Services, Inc. |
| • | Bank of Fincastle Services, Inc. | |
| • | ESF, LLC | |
| • |
Shen-Valley Land Holdings, LLC |
| • |
First National (VA) Statutory Trust II (Trust II) |
| • |
First National (VA) Statutory Trust III (Trust III and, together with Trust II, the Trusts) |
First Bank Financial Services, Inc. invests in entities that provide title insurance and investment services. Bank of Fincastle Services, Inc. owns an entity that provides mortgage services. Shen-Valley Land Holdings, LLC and ESF, LLC were formed to hold other real estate owned and future office sites. The Trusts were formed for the purpose of issuing redeemable capital securities, commonly known as trust preferred securities and are not included in the Company’s consolidated financial statements in accordance with authoritative accounting guidance because management has determined that the Trusts qualify as variable interest entities.
Products, Services, Customers and Locations
The Bank offers loan, deposit, and wealth management products and services. Loan products and services include consumer loans, residential mortgages, home equity loans, and commercial loans. Deposit products and services include checking accounts, treasury management solutions, savings accounts, money market accounts, certificates of deposit, and individual retirement accounts. Wealth management services include estate planning, investment management of assets, trustee under an agreement, trustee under a will, individual retirement accounts, and estate settlement. Customers include small and medium-sized businesses, individuals, estates, local governmental entities, and non-profit organizations. The Bank’s office locations are well-positioned in attractive markets along the Interstate 81, Interstate 66, and Interstate 64 corridors in the Shenandoah Valley, the Roanoke Valley, central regions of Virginia, and the city of Richmond. Within these markets, there are diverse types of industry including medical and professional services, manufacturing, retail, warehousing, Federal government, hospitality, and higher education. The Bank’s products and services are delivered through 20 bank branch offices, a loan production office and customer service centers in two retirement villages. For the location and general character of each of these offices, see Item 2 of Form 10-K. Many of the Bank’s services are also delivered through the Bank’s mobile banking platform, its website, www.fbvirginia.com, and a network of ATMs located throughout its market area.
Revenue Sources and Expense Factors
The primary source of revenue is from net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense and typically represents between 70% and 80% of the Company’s total revenue. Interest income is determined by the amount of interest-earning assets outstanding during the period and the interest rates earned on those assets. The Bank’s interest expense is a function of the amount of interest-bearing liabilities outstanding during the period and the interest rates paid. In addition to net interest income, noninterest income is the other source of revenue for the Company. Noninterest income is derived primarily from service charges on deposits, fee income from wealth management services, and ATM and check card fees.
Primary expense categories are salaries and employee benefits, which comprised 59% of noninterest expenses for the three months ended March 31, 2022, followed by occupancy and equipment expense, which comprised 13% of noninterest expenses. The provision for loan losses is also typically a primary expense of the Bank. The provision is determined by factors that include net charge-offs, asset quality, economic conditions, and loan growth. Changing economic conditions caused by inflation, recession, unemployment, or other factors beyond the Company’s control have a direct correlation with asset quality, net charge-offs, and ultimately the required provision for loan losses.
Overview of Quarterly Financial Performance
Net income increased by $1.3 million to $3.7 million, or $0.60 per diluted share, for the three months ended March 31, 2022, compared to $2.4 million, or $0.50 per diluted share, for the same period in 2021. Return on average assets was 1.06% and return on average equity was 13.40% for the first quarter of 2022, compared to 1.00% and 11.53%, respectively, for the same period in 2021.
The increase in net income resulted primarily from a $3.0 million, or 40%, increase in net interest income and a $568 thousand, or 27%, increase in total noninterest income, which were partially offset by a $2.0 million, or 30%, increase in total noninterest expense.
The $3.0 million increase in net interest income resulted from a $2.9 million increase in total interest income and a $107 thousand decrease in total interest expense. Although the net interest margin decreased by 8-basis points to 3.19%, net interest income increased as the impact of the lower net interest margin was offset by a $415.1 million, or 44%, increase in average earning assets, and $367 thousand of accretion of loan discounts, net of premium amortization, on acquired loans. Total interest expense decreased by $107 thousand, or 18%, primarily from a decrease in interest expense on deposits as the Bank lowered interest rates paid on deposit accounts. The merger of The Bank of Fincastle with and into First Bank on July 1, 2021 and growth in deposits contributed to the increase in average earning assets.
There was no provision for loan losses for the first quarter of 2022. During the quarter, a $173 thousand increase in the general reserve component of the allowance for losses was offset by a $55 thousand decrease in the specific reserve component of the allowance for loan losses and $118 thousand of net recoveries of loans previously charged off. The allowance for loan losses totaled $5.8 million, or 0.70% of total loans at March 31, 2022, compared to 0.69% of total loans at December 31, 2021. There was also no provision for loan losses for the same period of 2021.
The $568 thousand increase in noninterest income was primarily a result of increases in service charges on deposits, ATM and check card fees, income from bank-owned life insurance and fees for other customer services. The merger with Fincastle contributed to increases in all noninterest income categories, except for wealth management fees, which increased $160 thousand, or 25%.
The $2.0 million increase in noninterest expense was primarily attributable to the acquisition of Fincastle and the acquisition of the loan portfolio, branch assets and addition of the employees from SmartBank. Merger expenses totaled $20 thousand and $405 thousand for the three-month periods ending March 31, 2022, and 2021, respectively.
For a more detailed discussion of the Company's quarterly performance, see "Net Interest Income,” “Provision for Loan Losses,” "Noninterest Income," "Noninterest Expense" and "Income Taxes" below.
Acquisition of The Bank of Fincastle
On July 1, 2021, the Company completed the acquisition of The Bank of Fincastle for an aggregate purchase price of $33.8 million of cash and stock. The Company paid cash consideration of $6.8 million and issued 1,348,065 shares of its common stock to the shareholders of Fincastle. Upon completion of the transaction, Fincastle was merged with and into First Bank. At the time of closing of the acquisition, The Bank of Fincastle had six bank branch offices operating in the Roanoke Valley region of Virginia and reported total assets of $267.9 million, total loans of $194.5 million and total deposits of $236.3 million. For the three months ended March 31, 2022, the Company recorded merger related expenses of $20 thousand in connection with the acquisition of Fincastle. After the merger, the former Fincastle branches continued to operate as The Bank of Fincastle, a division of First Bank, until the systems were converted on October 16, 2021. All branch offices have been operating as First Bank since the system conversion.
Purchased performing loans were recorded at fair value, including a credit discount. The fair value discount will be accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan losses on the purchased loans is expected in future periods as the accretion decreases the fair value discount amount. A
provision may also be required for any deterioration in these loans in future periods. The Company expects cost savings to be realized as Fincastle's operations are fully integrated during 2022.
Acquisition of SmartBank Loan Portfolio
On September 30, 2021, the Bank acquired $82.0 million of loans and certain fixed assets from SmartBank related to its Richmond area branch, located in Glen Allen, Virginia. First Bank paid cash consideration of $83.7 million for the loans and fixed assets. Additionally, an experienced team of bankers based out of the SmartBank location have transitioned to become employees of First Bank. First Bank did not assume any deposit liabilities from SmartBank in connection with the transaction, and SmartBank closed their branch operation on December 31, 2021. First Bank assumed the facility lease and acquired the remaining assets at the branch on December 31, 2021 and now operates a loan production office in the location of the former SmartBank branch. The Company incurred expenses totaling $101 thousand related to the acquisition of loans and fixed assets of SmartBank in the fourth quarter of 2021.
Purchased performing loans were recorded at fair value, including a credit discount. The fair value discount will be accreted as an adjustment to yield over the estimated lives of the loans. A provision for loan losses may be required as fair value discounts accrete to lower amounts than the required reserves for purchased loans and for any deterioration in these loans in future periods.
Non-GAAP Financial Measures
This report refers to the efficiency ratio, which is computed by dividing noninterest expense, excluding amortization of intangibles, net gains on disposal of premises and equipment, and merger related expenses, by the sum of net interest income on a tax-equivalent basis and noninterest income, excluding securities gains. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. Such information is not prepared in accordance with GAAP and should not be construed as such. Management believes, however, such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP. The Company, in referring to its net income, is referring to income under GAAP. The components of the efficiency ratio calculation are summarized in the following table (dollars in thousands).
| Efficiency Ratio |
||||||||
| Three Months Ended |
||||||||
| March 31, 2022 |
March 31, 2021 |
|||||||
| Noninterest expense |
$ | 8,644 | $ | 6,650 | ||||
| Add/(Subtract): other real estate owned (expense)/income, net |
(28 | ) | — | |||||
| Subtract: amortization of intangibles |
(4 | ) | (14 | ) | ||||
| Subtract: loss on disposal of premises and equipment, net |
0 | — | ||||||
| Subtract: merger related expenses |
(20 | ) | (405 | ) | ||||
| $ | 8,592 | $ | 6,231 | |||||
| Tax-equivalent net interest income |
$ | 10,634 | $ | 7,568 | ||||
| Noninterest income |
2,711 | 2,143 | ||||||
| Subtract: gain on disposal of premises and equipment, net |
— | (12 | ) | |||||
| Subtract: securities gains, net |
— | (37 | ) | |||||
| $ | 13,345 | $ | 9,662 | |||||
| Efficiency ratio |
64.38 | % | 64.49 | % | ||||
This report also refers to net interest margin, which is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for both 2022 and 2021 is 21%. The reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below (in thousands).
| Reconciliation of Net Interest Income to Tax-Equivalent Net Interest Income |
||||||||
| Three Months Ended |
||||||||
| March 31, 2022 |
March 31, 2021 |
|||||||
| GAAP measures: |
||||||||
| Interest income – loans |
$ | 9,496 | $ | 7,143 | ||||
| Interest income – investments and other |
1,528 | 952 | ||||||
| Interest expense – deposits |
(340 | ) | (363 | ) | ||||
| Interest expense – subordinated debt |
(69 | ) | (154 | ) | ||||
| Interest expense – junior subordinated debt |
(67 | ) | (66 | ) | ||||
| Total net interest income |
$ | 10,548 | $ | 7,512 | ||||
| Non-GAAP measures: |
||||||||
| Tax benefit realized on non-taxable interest income – loans |
$ | 8 | $ | 8 | ||||
| Tax benefit realized on non-taxable interest income – municipal securities |
81 | 48 | ||||||
| Total tax benefit realized on non-taxable interest income |
$ | 89 | $ | 56 | ||||
| Total tax-equivalent net interest income |
$ | 10,637 | $ | 7,568 | ||||
Critical Accounting Policies
General
The Company’s consolidated financial statements and related notes are prepared in accordance with GAAP. The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset, or relieving a liability. The Bank uses historical losses as one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from the historical factors used. In addition, GAAP itself may change from one previously acceptable method to another. Although the economics of transactions would be the same, the timing of events that would impact transactions could change.
Presented below is a discussion of those accounting policies that management believes are the most important (Critical Accounting Policies) to the portrayal and understanding of the Company’s financial condition and results of operations. The Critical Accounting Policies require management’s most difficult, subjective, and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management determines that the loan balance is uncollectible. Subsequent recoveries, if any, are credited to the allowance. For further information about the Company’s loans and the allowance for loan losses, see Notes 3 and 4 to the Consolidated Financial Statements included in this Form 10-Q.
The allowance for loan losses is evaluated on a quarterly basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The Company performs regular credit reviews of the loan portfolio to review credit quality and adherence to underwriting standards. The credit reviews consist of reviews by its internal credit administration department and reviews performed by an independent third party. Upon origination, each loan is assigned a risk rating ranging from one to nine, with loans closer to one having less risk. This risk rating scale is the Company's primary credit quality indicator. The Company has various committees that review and ensure that the allowance for loans losses methodology is in accordance with GAAP and loss factors used appropriately reflect the risk characteristics of the loan portfolio.
The allowance represents an amount that, in management’s judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of the collateral, overall portfolio quality, and review of specific potential losses. The evaluation also considers the following risk characteristics of each loan portfolio class:
| • |
1-4 family residential mortgage loans carry risks associated with the continued creditworthiness of the borrower and changes in the value of the collateral. |
| • |
Real estate construction and land development loans carry risks that the project may not be finished according to schedule, the project may not be finished according to budget, and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure or other factors unrelated to the project. |
| • |
Other real estate loans carry risks associated with the successful operation of a business or a real estate project, in addition to other risks associated with the ownership of real estate, because repayment of these loans may be dependent upon the profitability and cash flows of the business or project. |
| • |
Commercial and industrial loans carry risks associated with the successful operation of a business because repayment of these loans may be dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much reliability. |
| • |
Consumer and other loans carry risk associated with the continued creditworthiness of the borrower and the value of the collateral, if any. Consumer loans are typically either unsecured or secured by rapidly depreciating assets such as automobiles. These loans are also likely to be immediately and adversely affected by job loss, divorce, illness, personal bankruptcy, or other changes in circumstances. Other loans included in this category include loans to states and political subdivisions. |
The allowance for loan losses consists of specific and general components. The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows, fair value of collateral less estimated costs to sell, or observable market price of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal is ordered if a current one is not on file. Appraisals are typically performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions among other considerations.
The general component covers loans that are not considered impaired and is based on historical loss experience adjusted for qualitative factors. The historical loss experience is calculated by loan type and uses an average loss rate during the preceding twelve quarters. The qualitative factors are assigned by management based on delinquencies and asset quality, national and local economic trends, effects of the changes in the value of underlying collateral, trends in volume and nature of loans, effects of changes in the lending policy, the experience and depth of management, concentrations of credit, quality of the loan review system, and the effect of external factors such as competition and regulatory requirements. The factors assigned differ by loan type. The general allowance estimates losses whose impact on the portfolio has yet to be recognized by a specific allowance. Allowance factors and the overall size of the allowance may change from period to period based on management’s assessment of the above described factors and the relative weights given to each factor. For further information regarding the allowance for loan losses, see Note 4 to the Consolidated Financial Statements included in this Form 10-Q.
Loans acquired from Fincastle and SmartBank were recorded at fair value. There was $350 thousand of allowance for loan losses attributable to purchased loans at March 31, 2022.
Loans Acquired in a Business Combination
Acquired loans are classified as either (i) purchased credit-impaired (PCI) loans or (ii) purchased performing loans and are recorded at fair value on the date of acquisition.
Goodwill and Other Intangible Assets
Goodwill arises from business combinations and is determined as the excess fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed. The Company has selected June 30 as the date to perform the annual impairment test. Intangible assets with finite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on the balance sheet.
Other intangible assets consist of core deposit intangible assets arising from whole bank and branch acquisitions and are amortized on an accelerated method over their estimated useful lives, which range from 6 to 10 years.
Lending Policies
General
In an effort to manage risk, the Bank’s loan policy gives loan amount approval limits to individual loan officers based on their position within the Bank and level of experience. The Management Loan Committee can approve new loans up to the Bank's legal lending limit. The Board Loan Committee reviews all loans greater than $1.0 million. The Board Loan Committee currently consists of six directors, five of which are non-management directors. The Board Loan Committee approves the Bank’s Loan Policy and reviews risk management reports, including watch list reports and concentrations of credit. The Board Loan Committee meets at least two times per quarter and the Chairman of the Committee then reports to the Board of Directors.
Residential loan originations are primarily generated by mortgage loan officer solicitations and referrals by employees, real estate professionals, and customers. Commercial real estate loan originations and commercial and industrial loan originations are primarily obtained through direct solicitation and additional business from existing customers. All completed loan applications are reviewed by the Bank’s loan officers. As part of the application process, information is obtained concerning the income, financial condition, employment, and credit history of the applicant. The Bank also participates in commercial real estate loans and commercial and industrial loans originated by other financial institutions that are typically outside its market area. In addition, the Bank has purchased consumer loans originated by other financial institutions that are typically outside its market area. Loan quality is analyzed based on the Bank’s experience and credit underwriting guidelines depending on the type of loan involved. Except for loan participations with other financial institutions, real estate collateral is valued by independent appraisers who have been pre-approved by the Board Loan Committee.
As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio, certain appraisals are analyzed by management or by an outsourced appraisal review specialist throughout the year in order to ensure standards of quality are met. The Company also obtains an independent review of loans within the portfolio on an annual basis to analyze loan risk ratings and validate specific reserves on impaired loans.
In the normal course of business, the Bank makes various commitments and incurs certain contingent liabilities which are disclosed but not reflected in its financial statements, including commitments to extend credit. At March 31, 2022, commitments to extend credit, stand-by letters of credit, and rate lock commitments totaled $195.6 million.
Construction and Land Development Lending
The Bank makes local construction loans, including residential and land acquisition and development loans. These loans are secured by the property under construction and the underlying land for which the loan was obtained. The majority of these loans mature in one year. Construction lending entails significant additional risks, compared with residential mortgage lending. Construction and land development loans sometimes involve larger loan balances concentrated with single borrowers or groups of related borrowers. Another risk involved in construction and land development lending is the fact that loan funds are advanced upon the security of the land or property under construction, which value is estimated based on the completion of construction. Thus, there is risk associated with failure to complete construction and potential cost overruns. To mitigate the risks associated with this type of lending, the Bank generally limits loan amounts relative to the appraised value and/or cost of the collateral, analyzes the cost of the project and the creditworthiness of its borrowers, and monitors construction progress. The Bank typically obtains a first lien on the property as security for its construction loans, typically requires personal guarantees from the borrower’s principal owners, and typically monitors the progress of the construction project during the draw period.
1-4 Family Residential Real Estate Lending
1-4 family residential lending activity may be generated by Bank loan officer solicitations and referrals by real estate professionals and existing or new bank customers. Loan applications are taken by a Bank loan officer. As part of the application process, information is gathered concerning income, employment, and credit history of the applicant. Residential mortgage loans generally are made on the basis of the borrower’s ability to make payments from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In addition to the Bank’s underwriting standards, loan quality may be analyzed based on guidelines issued by a secondary market investor. The valuation of residential collateral is generally provided by independent fee appraisers who have been approved by the Board Loan Committee. In addition to originating mortgage loans with the intent to sell to correspondent lenders or broker to wholesale lenders, the Bank also originates and retains certain mortgage loans in its loan portfolio.
Commercial Real Estate Lending
Commercial real estate loans are secured by various types of commercial real estate typically in the Bank’s market area, including multi-family residential buildings, office and retail buildings, hotels, industrial buildings, and religious facilities. Commercial real estate loan originations are primarily obtained through direct solicitation of customers and potential customers. The valuation of commercial real estate collateral is provided by independent appraisers who have been approved by the Board Loan Committee. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economy in general. The Bank’s commercial real estate loan underwriting criteria require an examination of debt service coverage ratios, the borrower’s creditworthiness, prior credit history, and reputation. The Bank typically requires personal guarantees of the borrowers’ principal owners and considers the valuation of the real estate collateral.
Commercial and Industrial Lending
Commercial and industrial loans generally have a higher degree of risk than loans secured by real estate, but typically have higher yields. Commercial and industrial loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business. The loans may be unsecured or secured by business assets, such as accounts receivable, equipment, and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, any collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much reliability as real estate.
Also included in this category are loans originated under the SBA's PPP. PPP loans are fully guaranteed by the SBA, and in some cases borrowers may be eligible to obtain forgiveness of the loans, in which case loans would be repaid by the SBA.
Consumer Lending
Loans to individual borrowers may be secured or unsecured, and include unsecured consumer loans and lines of credit, automobile loans, deposit account loans, and installment and demand loans. These consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciating assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss, or depreciation. Consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
The underwriting standards employed by the Bank for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on a proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income.
Also included in this category are loans purchased through a third-party lending program. These portfolios include consumer loans and carry risks associated with the borrower, changes in the economic environment, and the vendor itself. The Company manages these risks through policies that require minimum credit scores and other underwriting requirements, robust analysis of actual performance versus expected performance, as well as ensuring compliance with the Company's vendor management program.
Results of Operations
General
Net interest income represents the primary source of earnings for the Company. Net interest income equals the amount by which interest income on interest-earning assets, predominantly loans and securities, exceeds interest expense on interest-bearing liabilities, including deposits, other borrowings, subordinated debt, and junior subordinated debt. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, are the components that impact the level of net interest income. The net interest margin is calculated by dividing tax-equivalent net interest income by average earning assets. The provision for loan losses, noninterest income, and noninterest expense are the other components that determine net income. Noninterest income and expense primarily consists of income from service charges on deposit accounts, revenue from wealth management services, ATM and check card income, revenue from other customer services, income from bank owned life insurance, general and administrative expenses, amortization expense, and other real estate owned expense.
Net Interest Income
For the three-month period ending March 31, 2022, net interest income increased $3.0 million, or 40%, compared to the same period of 2021. The increase resulted from a $2.9 million, or 36% increase in total interest and dividend income and a $107 thousand, or 18%, decrease in total interest expense. Net interest income was favorably impacted by a $415.1 million, or 44%, increase in average earning assets, which was partially offset by an 8-basis point decrease in the net interest margin to 3.19% when comparing the periods. The acquisition of The Bank of Fincastle on July 1, 2021 and an increase in average deposit balances resulted in growth of average earning assets. The decrease in the net interest margin was primarily attributable to the change in the composition of average earning assets. Average loans, which was the highest yielding category, decreased to 61% of average earning assets for the first quarter of 2022, compared to 68% for the first quarter of 2021. Although average loans increased $193.3 million, lower yielding categories experienced higher growth, as average securities increased $187.2 million and Federal funds sold and interest-bearing deposits in other banks combined increased $34.6 million.
Accretion of PPP income, net of costs, and accretion of discounts on purchased loans, net of premiums, were included in interest and fees on loans. Accretion of PPP income totaled $323 thousand in the first quarter of 2022, compared to $599 thousand for the same period of 2021. Accretion of discounts on purchased loans totaled $367 thousand in the first quarter of 2022. There were no purchased loans in the first quarter of 2021, and as a result, there was no accretion of discounts on purchased loans during the period.
Total interest expense decreased by $107 thousand, or 18%, comparing the three month period ending March 31, 2022 to the same period of 2021, which also contributed to the increase in net interest income. Interest expense on deposits decreased $23 thousand, or 6%, from a 8-basis point decrease in the cost of interest-bearing deposits and was partially offset by a 46% increase in average interest-bearing deposit balances. The decrease in the cost of interest-bearing deposits was attributable to a reduction in interest rates paid on checking, money market and time deposits. Interest expense on subordinated debt also decreased by $85 thousand, or 55%, due to the January 1, 2022 repayment of $5.0 million of subordinated debt.
The following tables show interest income on earning assets and related average yields as well as interest expense on interest-bearing liabilities and related average rates paid for the periods indicated (dollars in thousands):
Average Balances, Income and Expenses, Yields and Rates (Taxable Equivalent Basis)
| Three Months Ended |
||||||||||||||||||||||||
| March 31, 2022 |
March 31, 2021 |
|||||||||||||||||||||||
| Average Balance | Interest Income/Expense | Yield/Rate | Average Balance | Interest Income/Expense | Yield/Rate | |||||||||||||||||||
| Assets |
||||||||||||||||||||||||
| Securities: |
||||||||||||||||||||||||
| Taxable |
$ | 284,016 | $ | 1,132 | 1.62 | % | $ | 123,201 | $ | 717 | 2.36 | % | ||||||||||||
| Tax-exempt (1) |
61,308 | 386 | 2.55 | % | 34,947 | 228 | 2.65 | % | ||||||||||||||||
| Restricted |
1,825 | 21 | 4.72 | % | 1,848 | 22 | 4.94 | % | ||||||||||||||||
| Total securities |
$ | 347,149 | $ | 1,539 | 1.80 | % | $ | 159,996 | $ | 967 | 2.45 | % | ||||||||||||
| Loans: (2) |
||||||||||||||||||||||||
| Taxable |
$ | 824,988 | $ | 9,477 | 4.66 | % | $ | 630,463 | $ | 7,113 | 4.58 | % | ||||||||||||
| Tax-exempt (1) |
2,223 | 27 | 4.49 | % | 3,423 | 38 | 4.49 | % | ||||||||||||||||
| Total loans |
$ | 827,211 | $ | 9,504 | 4.66 | % | $ | 633,886 | $ | 7,151 | 4.58 | % | ||||||||||||
| Federal funds sold |
— | — | 0.00 | % | 134 | — | 0.10 | % | ||||||||||||||||
| Interest-bearing deposits with other institutions |
177,951 | 70 | 0.16 | % | 143,183 | 33 | 0.90 | % | ||||||||||||||||
| Total earning assets |
$ | 1,352,311 | $ | 11,113 | 3.33 | % | $ | 937,199 | $ | 8,151 | 3.53 | % | ||||||||||||
| Less: allowance for loan losses |
(5,766 | ) | (7,484 | ) | ||||||||||||||||||||
| Total non-earning assets |
83,979 | 58,609 | ||||||||||||||||||||||
| Total assets |
$ | 1,430,524 | $ | 988,324 | ||||||||||||||||||||
| Liabilities and Shareholders’ Equity |
||||||||||||||||||||||||
| Interest bearing deposits: |
||||||||||||||||||||||||
| Checking |
$ | 289,475 | $ | 100 | 0.14 | % | $ | 227,691 | $ | 117 | 0.21 | % | ||||||||||||
| Regular savings |
206,798 | 25 | 0.05 | % | 126,213 | 19 | 0.06 | % | ||||||||||||||||
| Money market accounts |
246,958 | 52 | 0.08 | % | 155,314 | 43 | 0.11 | % | ||||||||||||||||
| Time deposits: |
||||||||||||||||||||||||
| $100,000 and over |
64,515 | 83 | 0.52 | % | 42,586 | 98 | 0.93 | % | ||||||||||||||||
| Under $100,000 |
78,124 | 78 | 0.41 | % | 55,851 | 85 | 0.62 | % | ||||||||||||||||
| Brokered |
562 | 2 | 1.94 | % | 594 | 1 | 0.66 | % | ||||||||||||||||
| Total interest-bearing deposits |
$ | 886,432 | $ | 340 | 0.16 | % | $ | 608,249 | $ | 363 | 0.24 | % | ||||||||||||
| Federal funds purchased |
— | — | — | % | 2 | — | 0.47 | % | ||||||||||||||||
| Subordinated debt |
6,244 | 69 | 4.50 | % | 9,992 | 154 | 6.23 | % | ||||||||||||||||
| Junior subordinated debt |
9,279 | 67 | 2.91 | % | 9,279 | 66 | 2.91 | % | ||||||||||||||||
| Total interest-bearing liabilities |
$ | 901,955 | $ | 476 | 0.21 | % | $ | 627,522 | $ | 583 | 0.38 | % | ||||||||||||
| Non-interest bearing liabilities |
||||||||||||||||||||||||
| Demand deposits |
411,576 | 272,026 | ||||||||||||||||||||||
| Other liabilities |
4,171 | 3,068 | ||||||||||||||||||||||
| Total liabilities |
$ | 1,317,702 | $ | 902,616 | ||||||||||||||||||||
| Shareholders’ equity |
112,822 | 85,708 | ||||||||||||||||||||||
| Total liabilities and Shareholders’ equity |
$ | 1,430,524 | $ | 988,324 | ||||||||||||||||||||
| Net interest income |
$ | 10,637 | $ | 7,568 | ||||||||||||||||||||
| Interest rate spread |
3.12 | % | 3.15 | % | ||||||||||||||||||||
| Cost of funds |
0.15 | % | 0.26 | % | ||||||||||||||||||||
| Interest expense as a percent of average earning assets |
0.14 | % | 0.25 | % | ||||||||||||||||||||
| Net interest margin |
3.19 | % | 3.27 | % | ||||||||||||||||||||
| (1) |
Income and yields are reported on a taxable-equivalent basis assuming a federal tax rate of 21%. The tax-equivalent adjustment was $89 and $56 thousand for the three months ended March 31, 2022 and 2021, respectively. |
| (2) |
Loans on non-accrual status are reflected in the balances. |
Provision for Loan Losses
There was no provision for loan losses recorded for the first quarter of 2022. During the quarter, the general reserve component of the allowance for losses increased $173 thousand and was offset by a $55 thousand decrease in the specific reserve component and $118 thousand of net recoveries of loans previously charged off. The increase in the general reserve resulted from loan growth which was partially offset by an adjustment to a qualitative factor related to economic conditions. The allowance for loan losses totaled $5.8 million, or 0.70% of total loans at March 31, 2022, compared to $5.7 million, or 0.69% of total loans at December 31, 2021, and $7.5 million, or 1.17% of total loans at March 31, 2021. There was no provision for loan losses for the same period of 2021.
A provision for loan losses was not recorded for the first quarter of 2021 as an increase in the general reserve component of the allowance for loan losses was offset by a decrease in the specific reserve component. The general reserve component of the allowance for loan losses increased primarily from the impact of an
increase in loan balances during the quarter. The decrease in the specific reserve component of the allowance for loan losses resulted from a decrease in a reserve on a loan evaluated in a prior period. There were no changes to qualitative factors during the first quarter of 2021.
Noninterest Income
Noninterest income increased $568 thousand, or 27%, to $2.7 million for the three-month period ended March 31, 2022, compared to the same period of 2021. Wealth management fees increased $160 thousand, or 25%, and was attributable to an increase in assets under management from growth in account values and from an increase in the number of clients served by the wealth management division. Service charges on deposits increased $167 thousand, or 38%, ATM and check card fees increased $149 thousand, or 25%, income from bank-owned life insurance increased $31 thousand, or 27%, and fees for other customer services increased $51 thousand, or 28%, comparing the same periods. The increases were primarily attributable to the acquisition of Fincastle.
Noninterest Expense
Noninterest expense increased $2.0 million, or 30%, to $8.6 million for the three-month period ended March 31, 2022, compared to the same period one year ago. The increase was primarily attributable to a $1.6 million, or 44%, increase in salaries and employee benefits, a $125 thousand, or 28%, increase in occupancy expense, a $128 thousand, or 30%, increase in equipment expense, an $83 thousand, or 120%, increase in FDIC assessment, and a $227 thousand, or 38%, increase in other operating expense. The increases were primarily attributable to the increase in the number of employees, branch offices and customers that resulted from the acquisition of Fincastle and the acquisition of the loan portfolio, branch assets and addition of the employees from SmartBank. The increased expenses were partially offset by a $404 thousand decrease in legal and professional fees, which was attributable to merger related costs in the first quarter of 2021. Merger expenses totaled $20 thousand and $405 thousand for the three-month periods ending March 31, 2022 and 2021, respectively.
Income Taxes
Income tax expense increased $317 thousand for the first quarter of 2022, compared to the same period one year ago. The Company’s income tax expense differed from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the three months ended March 31, 2022 and 2021. The difference was a result of net permanent tax deductions, primarily comprised of tax-exempt interest income and income from bank owned life insurance. A more detailed discussion of the Company’s tax calculation is contained in Note 11 to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.
Financial Condition
General
Total assets increased $28.2 million to $1.4 billion at March 31, 2022, compared to December 31, 2021. The increase was primarily attributable to an $11.2 million, or 1.4%, increase in loans, net of allowance for loan losses, and a $48.2 million, or 144.1%, increase in securities held to maturity. These increases were partially offset by a decrease in interest-bearing deposits in banks of $27.5 million, or 17.5%, during the first quarter of 2022.
At March 31, 2022, total liabilities increased $38.7 million to $1.3 billion compared to December 31, 2021. The increase was primarily attributable to an increase in savings and interest-bearing demand deposits of $44.1 million. These increases were partailly offset by the Company's repayment of $5.0 million of subordinated debt on January 1, 2022.
Total shareholders’ equity decreased $10.5 million to $106.6 million at March 31, 2022, compared to $117.0 million at December 31, 2021. This was primarily attributable to a $13.7 million decrease in accumulated other comprehensive (loss) income (AOCI). The decrease in AOCI is related to unrealized losses in the securities portfolio stemming from market rate increases during the first quarter. This decrease was partially offset by a $2.9 million increase in retained earnings. The Company's capital ratios continued to exceed the minimum capital requirements for regulatory purposes.
Loans
Loans, net of the allowance for loan losses, increased $11.2 million to $830.6 million at March 31, 2022, compared to $819.4 million at December 31, 2021. Commercial real estate and commercial and industrial loans increased by $19.4 million and $3.9 million, respectively, during the first quarter of 2022. Construction loans, consumer and other loans, and residential real estate loans decreased by $6.4 million, $3.8 million and $1.6 million, respectively during the first quarter of 2022.
The Bank actively participated as a lender in the U.S. Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”) to support local small businesses and non-profit organizations by providing forgivable loans. Loan fees received from the SBA are accreted by the Bank into income evenly over the life of the loans, net of loan origination costs, through interest and fees on loans. PPP loans totaled $2.5 million at March 31, 2022, with $52 thousand scheduled to mature in the second and third quarters of 2022, and $2.4 million scheduled to mature in the first and second quarters of 2026. The Company believes the majority of these loans will ultimately be forgiven and repaid by the SBA in accordance with the terms of the program. It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan losses through additional provision for loan losses charged to earnings. The Bank recognized $323 thousand and $599 thousand of accretion on deferred PPP income, net of origination costs, through interest and fees on loans for the three month periods ended March 31, 2022 and 2021, respectivley. The total amount of deferred PPP income, net of origination costs, that has not yet been recognized through interest and fees on loans totaled $44 thousand at March 31, 2022.
During the fourth quarter of 2020, the Bank modified terms of certain loans for customers that continued to be negatively impacted by the pandemic. The loan modifications lowered borrower loan payments by allowing interest only payments for periods ranging between 6 and 24 months. All loans modified were in the lodging sector of the Bank’s commercial real estate loan portfolio and totaled $8.9 million at March 31, 2022. All modified loans were performing under their modified terms at March 31, 2022.
The Company, through its banking subsidiary, grants mortgage, commercial, and consumer loans to customers. The Bank segments its loan portfolio into real estate loans, commercial and industrial loans, and consumer and other loans. Real estate loans are further divided into the following classes: Construction and Land Development; 1-4 Family Residential; and Other Real Estate Loans. Descriptions of the Company’s loan classes are as follows:
Real Estate Loans – Construction and Land Development: The Company originates construction loans for the acquisition and development of land and construction of commercial buildings, condominiums, townhomes, and one-to-four family residences.
Real Estate Loans – 1-4 Family: This class of loans includes loans secured by one-to-four family homes. In addition to traditional residential mortgage loans secured by a first or junior lien on the property, the Bank offers home equity lines of credit.
Real Estate Loans – Other: This loan class consists primarily of loans secured by various types of commercial real estate typically in the Bank’s market area, including multi-family residential buildings, office and retail buildings, industrial and warehouse buildings, hotels, and religious facilities.
Commercial and Industrial Loans: Commercial loans may be unsecured or secured with non-real estate commercial property. The Company's banking subsidiary makes commercial loans to businesses located within its market area and also to businesses outside of its market area through loan participations with other financial institutions. Loans originated under the SBA's PPP are also included in this loan class.
Consumer and Other Loans: Consumer loans include all loans made to individuals for consumer or personal purposes. They include new and used automobile loans, unsecured loans, and lines of credit. The Company's banking subsidiary makes consumer loans to individuals located within its market area. The Bank has also made loans to individuals outside of its market area through the purchase of loans from another financial institution. Other loans in this category include loans to state and political subdivisions.
A substantial portion of the loan portfolio is represented by residential and commercial loans secured by real estate throughout the Bank's market area. The ability of the Bank’s debtors to honor their contracts may be impacted by the real estate and general economic conditions in this area.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances less the allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued and credited to income based on the unpaid principal balance. Loan origination fees, net of certain origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. Interest income includes amortization of purchase premiums and discounts, recognized evenly over the life of the loans.
A loan’s past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on non-accrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. Loans greater than 90 days past due and still accruing totaled $53 thousand at March 31, 2022. There were no loans greater than 90 days past due and still accruing at December 31, 2021. For those loans that are carried on non-accrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. These policies are applied consistently across the loan portfolio.
All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. When a loan is returned to accrual status, interest income is recognized based on the new effective yield to maturity of the loan.
Any unsecured loan that is deemed uncollectible is charged-off in full. Any secured loan that is considered by management to be uncollectible is partially charged-off and carried at the fair value of the collateral less estimated selling costs. This charge-off policy applies to all loan segments.
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value (net of selling costs), and the probability of collecting scheduled principal and interest payments when due. Additionally, management generally evaluates substandard and doubtful loans greater than $250 thousand for impairment. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair market value of the collateral, net of selling costs, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company typically does not separately identify individual consumer, residential, and certain small commercial loans that are less than $250 thousand for impairment disclosures, except for troubled debt restructurings (TDRs) as noted below. The recorded investment in impaired loans totaled $2.1 million and $2.2 million at March 31, 2022 and December 31, 2021, respectively.
Troubled Debt Restructurings (TDR)
In situations where, for economic or legal reasons related to a borrower’s financial condition, management grants a concession to the borrower that it would not otherwise consider, the related loan is classified as a TDR. TDRs are considered impaired loans. Upon designation as a TDR, the Company evaluates the borrower’s payment history, past due status, and ability to make payments based on the revised terms of the loan. If a loan was accruing prior to being modified as a TDR and if the Company concludes that the borrower is able to make such payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the loan will remain on an accruing status. If a loan was on non-accrual status at the time of the TDR, the loan will remain on non-accrual status following the modification and may be returned to accrual status based on the policy for returning loans to accrual status as noted above. There were $1.6 million in loans classified as TDRs as of March 31, 2022 and $1.6 million as of December 31, 2021.
Asset Quality
Management classifies non-performing assets as non-accrual loans and OREO. OREO represents real property taken by the Bank when its customers do not meet the contractual obligation of their loans, either through foreclosure or through a deed in lieu thereof from the borrower and properties originally acquired for branch operations or expansion but no longer intended to be used for that purpose. OREO is recorded at the lower of cost or fair value, less estimated selling costs, and is marketed by the Bank through brokerage channels. The Bank had $1.8 million in assets classified as OREO at March 31, 2022 and December 31, 2021.
Non-performing assets totaled $3.9 million and $4.2 million at March 31, 2022 and December 31, 2021, representing approximately 0.27% and 0.30% of total assets, respectively. Non-performing assets consisted of OREO and non-accrual loans at March 31, 2022 and December 31, 2021. Non-performing assets included $1.8 million in properties formerly classified as bank premises by the Bank of Fincastle which are now classified as held for sale.
At March 31, 2022, 1% of non-performing assets were commercial real estate loans, 38% were commercial and industrial loans, and 16% were residential real estate loans. Additionally, 45% was related to properties acquired from the Bank of Fincastle which will not be used in the Company's operations and are classified as held for sale. Non-performing assets could increase due to other loans identified by management as potential problem loans. Other potential problem loans are defined as performing loans that possess certain risks, including the borrower’s ability to pay and the collateral value securing the loan, that management has identified that may result in the loans not being repaid in accordance with their terms. Other potential problem loans totaled $311 thousand and $1.1 million at March 31, 2022 and December 31, 2021, respectively. The amount of other potential problem loans in future periods may be dependent on economic conditions and other factors influencing a customers’ ability to meet their debt requirements.
Loans greater than 90 days past due and still accruing totaled $53 thousand at March 31, 2022. There were no loans greater than 90 days past due and still accruing at December 31, 2021.
The allowance for loan losses represents management’s analysis of the existing loan portfolio and related credit risks. The provision for loan losses is based upon management’s current estimate of the amount required to maintain an adequate allowance for loan losses reflective of the risks in the loan portfolio. The allowance for loan losses totaled $5.8 million at March 31, 2022 and $5.7 million December 31, 2021, representing 0.70% and 0.69% of total loans, respectively. For further discussion regarding the allowance for loan losses, see “Provision for Loan Losses” above.
Recoveries of loan losses of $4 thousand, $5 thousand, $2 thousand, $140 thousand, and $73 thousand were recorded in the construction and land development, 1-4 family residential, other real estate, commercial and industrial loan classes, and consumer and other loans classes respectively, during the three months ended March 31, 2022. There was no provision for loan loss recorded at March 31, 2022. For more detailed information regarding the (recovery of) provision for loan losses, see Note 4 to the Consolidated Financial Statements.
Impaired loans totaled $2.1 million and $2.3 million at March 31, 2022 and December 31, 2021, respectively. There was no related allowance for loan losses recorded for these loans at March 31, 2022. The related allowance for loan losses provided for these loans totaled $55 thousand at December 31, 2021. The average recorded investment in impaired loans during the three months ended March 31, 2022 and the year ended December 31, 2021 was $2.3 million and $4.5 million, respectively. Included in the impaired loans total are loans classified as TDRs totaling $1.6 million at March 31, 2022 and December 31, 2021. Loans classified as TDRs represent situations in which a modification to the contractual interest rate or repayment structure has been granted to address a financial hardship. As of March 31, 2022, none of these TDRs were performing under the restructured terms and all were considered non-performing assets.
Management believes, based upon its review and analysis, that the Bank has sufficient reserves to cover losses inherent within the loan portfolio. For each period presented, the provision for loan losses charged to expense was based on management’s judgment after taking into consideration all factors connected with the collectability of the existing portfolio. Management considers economic conditions, historical loss factors, past due percentages, internally generated loan quality reports, and other relevant factors when evaluating the loan portfolio. There can be no assurance, however, that an additional provision for loan losses will not be required in the future, including as a result of changes in the qualitative factors underlying management’s estimates and judgments, changes in accounting standards, adverse developments in the economy, on a national basis or in the Company’s market area, loan growth, or changes in the circumstances of particular borrowers. For further discussion regarding the allowance for loan losses, see “Critical Accounting Policies” above.
Securities
The securities portfolio plays a primary role in the management of the Company’s interest rate sensitivity and serves as a source of liquidity. The portfolio is used as needed to meet collateral requirements, such as those related to secure public deposits and balances with the Reserve Bank. The investment portfolio consists of held to maturity, available for sale, and restricted securities. Securities are classified as available for sale or held to maturity based on the Company’s investment strategy and management’s assessment of the intent and ability to hold the securities until maturity. Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Company has the ability at the time of purchase to hold the investment securities to maturity, they are classified as investment securities held to maturity and are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Investment securities which the Company may not hold to maturity are classified as investment securities available for sale, as management has the intent and ability to hold such investment securities for an indefinite period of time, but not necessarily to maturity. Securities available for sale may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, general liquidity needs and other similar factors and are carried at estimated fair value. Restricted securities, including Federal Home Loan Bank, Federal Reserve Bank, and Community Bankers’ Bank stock, are generally viewed as long-term investments because there is minimal market for the stock and are carried at cost.
Securities at March 31, 2022 totaled $366.5 million, an increase of $43.6 million, or 14.0%, from $322.9 million at December 31, 2021. Investment securities are comprised of U.S. agency and mortgage-backed securities, obligations of state and political subdivisions, corporate debt securities, and restricted securities. As of March 31, 2022, neither the Company nor the Bank held any derivative financial instruments in their respective investment security portfolios. Gross unrealized gains in the available for sale portfolio totaled $288 thousand and $2.0 million at March 31, 2022 and December 31, 2021, respectively. Gross unrealized losses in the available for sale portfolio totaled $18.9 million and $2.6 million at March 31, 2022 and December 31, 2021, respectively. Gross unrealized gains in the held to maturity portfolio totaled $12 thousand and $242 thousand at March 31, 2022 and December 31, 2021, respectively. Gross unrealized losses in the held to maturity portfolio totaled $3.4 million and $66 thousand at March 31, 2022 and December 31, 2021. Investments in an unrealized loss position were considered temporarily impaired at March 31, 2022 and December 31, 2021. The change in the unrealized gains and losses of investment securities from December 31, 2021 to March 31, 2022 was related to changes in market interest rates and was not related to credit concerns of the issuers.
At March 31, 2022, the securities portfolio was comprised of $284.9 million of securities available for sale and $81.6 million of securities held to maturity compared to $289.5 million and $33.4 million at December 31, 2021, respectively. Securities held to maturity increased by $48.2 million during the first quarter of 2022 as a part of the Company's strategy to mitigate the risk of potential fluctuations in value and the related impact on shareholders' equity.
Deposits
At March 31, 2022, deposits totaled $1.3 billion, an increase of $44.1 million, from $1.2 billion at December 31, 2021. There was a slight change in the deposit mix when comparing the periods. At March 31, 2022, noninterest-bearing demand deposits, savings and interest-bearing demand deposits, and time deposits composed 32%, 57%, and 11% of total deposits, respectively, compared to 33%, 55%, and 12% at December 31, 2021.
Liquidity
Liquidity represents the ability to meet present and future financial obligations through either the sale or maturity of existing assets or with borrowings from correspondent banks or other deposit markets. The Company classifies cash, interest-bearing and noninterest-bearing deposits with banks, federal funds sold, investment securities, and loans maturing within one year as liquid assets. As part of the Bank’s liquidity risk management, stress tests and cash flow modeling are performed quarterly.
As a result of the Bank’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Bank maintains overall liquidity sufficient to satisfy its depositors’ requirements and to meet its customers’ borrowing needs.
At March 31, 2022, cash, interest-bearing and noninterest-bearing deposits with banks, securities, and loans maturing within one year totaled $235.3 million. At March 31, 2022, 9.8% or $81.7 million of the loan portfolio matured within one year. Non-deposit sources of available funds totaled $247.1 million at March 31, 2022, which included $147.7 million of secured funds available from Federal Home Loan Bank of Atlanta (FHLB), $48 million of secured funds available through the Federal Reserve Discount Window, and $51.0 million of unsecured federal funds lines of credit with other correspondent banks.
Capital Resources
The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Company’s asset and liability levels and consistent with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses. The Company meets eligibility criteria of a small bank holding company in accordance with the Federal Reserve Board’s Small Bank Holding Company Policy Statement issued in February 2015 and is not obligated to report consolidated regulatory capital.
Effective January 1, 2015, the Bank became subject to capital rules adopted by federal bank regulators implementing the Basel III regulatory capital reforms adopted by the Basel Committee on Banking Supervision (the Basel Committee), and certain changes required by the Dodd-Frank Act.
The minimum capital level requirements applicable to the Bank under the final rules are as follows: a new common equity Tier 1 capital ratio of 4.5%; a Tier 1 capital ratio of 6%; a total capital ratio of 8%; and a Tier 1 leverage ratio of 4% for all institutions. The final rules also established a “capital conservation buffer” above the new regulatory minimum capital requirements. The capital conservation buffer was phased-in over four years and, as fully implemented effective January 1, 2019, requires a buffer of 2.5% of risk-weighted assets. This results in the following minimum capital ratios beginning in 2019: a common equity Tier 1 capital ratio of 7.0%, a Tier 1 capital ratio of 8.5%, and a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions. Management believes, as of March 31, 2022 and December 31, 2021, that the Bank met all capital adequacy requirements to which it is subject, including the capital conservation buffer.
The following table shows the Bank’s regulatory capital ratios at March 31, 2022:
| First Bank |
||||
| Total capital to risk-weighted assets |
14.44 | % | ||
| Tier 1 capital to risk-weighted assets |
13.79 | % | ||
| Common equity Tier 1 capital to risk-weighted assets |
13.79 | % | ||
| Tier 1 capital to average assets |
8.61 | % | ||
| Capital conservation buffer ratio(1) |
6.44 | % | ||
| (1) |
Calculated by subtracting the regulatory minimum capital ratio requirements from the Company’s actual ratio for Common equity Tier 1, Tier 1, and Total risk based capital. The lowest of the three measures represents the Bank’s capital conservation buffer ratio. |
The prompt corrective action framework is designed to place restrictions on insured depository institutions if their capital levels begin to show signs of weakness. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following capital level requirements in order to qualify as “well capitalized:” a common equity Tier 1 capital ratio of 6.5%; a Tier 1 capital ratio of 8%; a total capital ratio of 10%; and a Tier 1 leverage ratio of 5%. The Bank met the requirements to qualify as "well capitalized" as of March 31, 2022 and December 31, 2021.
On September 17, 2019 the FDIC finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations (i.e., the community bank leverage ratio (CBLR) framework), as required by the Economic Growth Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.
In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio greater than 9%, less than $10 billion in total consolidated assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities. The CARES Act temporarily lowered the tier 1 leverage ratio requirement to 8% until December 31, 2020. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the "well-capitalized" ratio requirements under the prompt corrective action regulations and will not be required to report or calculate risk-based capital. Although, the Company did not opt into the CBLR framework at March 31, 2022, it may opt into the CBLR framework in a future quarterly period.
During the fourth quarter of 2019, the Board of Directors of the Company authorized a stock repurchase plan pursuant to which the Company was authorized to repurchase up to $5.0 million of the Company’s outstanding common stock through December 31, 2020. During 2020, the Company repurchased and retired 129,035 shares at an average price paid per share of $16.05, for a total of $2.1 million. The Company’s stock repurchase plan was suspended in the second quarter of 2020, and remained suspended until it ended on December 31, 2020. The Company has not authorized another stock repurchase plan as of March 31, 2022.
Contractual Obligations
There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.
Off-Balance Sheet Arrangements
The Company, through the Bank, is a party to credit related financial instruments with risk not reflected in the consolidated financial statements in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss is represented by the contractual amount of these commitments. The Bank follows the same credit policies in making commitments as it does for on-balance sheet instruments.
Commitments to extend credit, which amounted to $167.1 million at March 31, 2022, and $161.4 million at December 31, 2021, are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Bank, is based on management’s credit evaluation of the customer.
Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized as deemed necessary and may or may not be drawn upon to the total extent to which the Bank is committed.
Commercial and standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral supporting those commitments if deemed necessary. At March 31, 2022 and December 31, 2021, the Bank had $17.6 million and $18.9 million in outstanding standby letters of credit, respectively.
At March 31, 2022, the Bank had $10.9 million in locked-rate commitments to originate mortgage loans. Risks arise from the possible inability of counterparties to meet the terms of their contracts. The Bank does not expect any counterparty to fail to meet its obligations.
On April 21, 2020, the Company entered into interest rate swap agreements related to its outstanding junior subordinated debt. The Company uses derivatives to manage exposure to interest rate risk through the use of interest rate swaps. Interest rate swaps involve the exchange of fixed and variable rate interest payments between two parties, based on a common notional principal amount and maturity date with no exchange of underlying principal amounts.
The interest rate swaps qualified and are designated as cash flow hedges. The Company’s cash flow hedges effectively modify the Company’s exposure to interest rate risk by converting variable rates of interest on $9.0 million of the Company’s junior subordinated debt to fixed rates of interest. The cash flow hedges end and the junior subordinated debt matures between June 2034 and October 2036. The cash flow hedges’ total notional amount is $9.0 million. At March 31, 2022, the cash flow hedges had a fair value of $1.6 million, which is recorded in other assets. The net gain/loss on the cash flow hedges is recognized as a component of other comprehensive (loss) income and reclassified into earnings in the same period(s) during which the hedged transactions affect earnings. The Company’s derivative financial instruments are described more fully in Note 16 to the Consolidated Financial Statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not required.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to provide assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods required by the SEC and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. An evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of March 31, 2022 was carried out under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based on and as of the date of such evaluation, the aforementioned officers concluded that the Company’s disclosure controls and procedures were effective.
The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company is a party or to which the property of the Company is subject.
There were no material changes to the Company’s risk factors as disclosed in its Annual Report on Form 10-K for the year ended December 31, 2021.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Mine Safety Disclosures
None
None
The following documents are attached hereto as Exhibits:
| 31.1 |
Certification of Chief Executive Officer, Section 302 Certification. |
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| 31.2 |
Certification of Chief Financial Officer, Section 302 Certification. |
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| 32.1 |
Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350. |
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| 32.2 |
Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350. |
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| 101 |
The following materials from First National Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2022 formatted in Inline eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive (Loss) Income (iv) Consolidated Statements of Cash Flows, (v) Consolidated Statements of Shareholders’ Equity, and (vi) Notes to Consolidated Financial Statements. |
| 104 | The cover page from First National Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 2022, formatted in Inline XBRL (included with Exhibit 101). |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| FIRST NATIONAL CORPORATION |
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| (Registrant) |
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| /s/ Scott C. Harvard |
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May 16, 2022 |
| Scott C. Harvard |
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Date |
| President and Chief Executive Officer |
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| /s/ M. Shane Bell |
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May 16, 2022 |
| M. Shane Bell |
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Date |
| Executive Vice President and Chief Financial Officer |
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