BAY BANKS OF VIRGINIA, INC. The following discussion is intended to assist in understanding the results of operations and the financial condition ofBay Banks of Virginia, Inc. (the "Company"), the holding company forVirginia Commonwealth Bank (the "Bank") andVCB Financial Group, Inc. This discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q and in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2019 (the "2019 Form 10-K").
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains statements concerning the Company's expectations, plans, objectives, future financial performance, and other statements that are not historical facts. These statements may constitute "forward-looking statements" as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. These forward-looking statements include statements about the Company's plans, obligations, expectations and intentions, and other statements that are not historical facts. Words such as "anticipates," "believes," "intends," "should," "expects," "will," and variations of similar expressions are intended to identify forward-looking statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to: the effect of the COVID-19 pandemic, including its potential adverse effect on economic conditions, and the Company's employees, customers, loan losses, and financial performance; changes in interest rates, general economic conditions, the legislative/regulatory climate, monetary and fiscal policies of theU.S. Government , including policies of theU.S. Treasury and theBoard of Governors of theFederal Reserve System (the "Federal Reserve"); the quality or composition of the loan and investment portfolios; demand for loan products; deposit flows; competition; expansion activities; demand for financial services in the Company's market area; accounting principles, policies, and guidelines; changes in banking, tax, and other laws and regulations and interpretations or guidance thereunder; and other factors detailed in the Company's publicly filed documents, including the factors described in Item 1A., "Risk Factors," in the 2019 Form 10-K and in this Quarterly Report on Form 10-Q. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements, which speak only as of the date they are made.
GENERAL
All dollar amounts included in the tables of this discussion are in thousands, except per share data, unless otherwise stated. There were no changes to the Critical Accounting Policies disclosed in Item 7 of the 2019 Form 10-K. The principal source of earnings for the Company is net interest income. Net interest income is the amount by which interest income exceeds interest expense. Net interest margin is net interest income expressed as a percentage of average interest-earning assets. Changes in the volume and/or mix of interest-earning assets and interest-bearing liabilities, the associated yields and rates, the level of noninterest-bearing deposits, and the volume of nonperforming assets have an effect on net interest income, net interest margin, and net income.
OVERVIEW OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
• Net (loss) income for the three months ended
share was (
for the three months ended
months ended
respectively. The net loss in both the three and six months ended
2020 included a
addition to the goodwill impairment charge, net loss for the three and six
months ended
million and
related to estimated reserve needs as a result of the COVID-19 pandemic. The
impairment assessment triggered primarily by the adverse effect the
deterioration of the macroeconomic environment due to the COVID-19 pandemic
has had on the Company's market value relative to its book value.
• (Loss) income before income taxes was (
the three months ended
million for the six months ended
decrease of
• Return (loss) on average assets (annualized) decreased to (2.64%) and
(1.37%) for the three and six months ended
0.62% and 0.59% for the comparable 2019 periods.
• Return (loss) on average equity (annualized) decreased to (25.40%) and
(12.77)% for the three and six months ended
from 5.72% and 5.39% for the comparable 2019 periods.
30
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• Total assets increased
from
• Loans, net of allowance for loan losses were
2020 compared to
("PPP") loans originated in the second quarter of 2020. Excluding PPP loans,
net loan growth for the first half of 2020 was
rate of 15%.
• Beginning on
under the Coronavirus Aid, Relief, and Economic Security Act, closing nearly
680 loans totaling
fees in the second quarter of 2020. Of the processing fees received,
thousand were recognized in interest income in the second quarter of 2020.
Through the PPP, the federal government partnered with banks, including the
Bank, to provide over
and other operating expenses.
• Allowance for loan losses increased
of gross loans, as of
loans, as of
allowance for loan losses to total gross loans for the first half of 2020
was primarily due to qualitative loss factors applied to the majority of the
Company's loan portfolio for higher state unemployment rates, particularly
in
to have been incurred as of
borrowers are facing due to the pandemic, evidenced, in part, by loan
deferrals and modifications granted to these borrowers.
• Total deposits increased by
million increase in deposits in the first half of 2020, $47.3 million and
$30.4 million was attributable to higher noninterest-bearing account
balances and savings and interest-bearing demand deposit accounts,respectively, the growth of which was partially attributable to PPP loans,
which were funded in these accounts.
• The ratio of nonperforming assets to total assets increased to 1.15% as of
primarily attributable to higher nonaccrual loan balances of
mainly commercial and industrial loans and commercial mortgages (non-owner
occupied) to borrowers adversely affected by the COVID-19 pandemic.
• Capital levels and regulatory capital ratios for the Bank were above
regulatory minimums for well-capitalized banks as of
total capital ratio and tier 1 leverage ratio of 13.38% and 10.25%,
respectively.
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RESULTS OF OPERATIONS
NET INTEREST INCOME AND NET INTEREST MARGIN
The following table presents average interest-earning assets and interest-bearing liabilities, taxable-equivalent yields on such assets, and rates (costs) paid on such liabilities, net interest margin ("NIM"), and net interest spread, as of and for the periods stated. Yields and costs are annualized.
Average Balances, Income and Expense, Yields and Rates
As of and For the Three Months Ended
2020 2019 2020 Compared to 2019
Income/
Average Income/ Yield/ Average Income/ Yield/ Expense Variance Attributable to (8)
Balance Expense Cost Balance Expense Cost Variance Rate Volume
INTEREST-EARNING ASSETS:
Taxable securities $ 81,241 $ 573 2.84 % $ 69,617 $ 577 3.32 % $ (4 ) $ (100 ) $ 96
Tax-exempt securities (1) 14,570 113 3.11 % 17,001 123 2.90 % (10 ) 7 (18 )
Total securities 95,811 686 2.88 % 86,618 700 3.24 % (14 ) (93 ) 79
Gross loans (2) (3) 1,025,249 11,289 4.43 % 917,474 11,458 5.01 % (169 ) (1,511 ) 1,342
Interest-earning deposits and
federal funds sold 34,472 8 0.09 % 29,719 170 2.29 % (162 ) (189 ) 27
Certificates of deposits 2,716 14 2.07 % 3,716 19 2.05 % (5 ) 0 (5 )
Total interest-earning assets $ 1,158,248 $ 11,997 4.17 % $ 1,037,527 $ 12,347 4.77 % $ (350 ) $ (1,793 ) $ 1,443
Noninterest-earning assets 72,001 67,884
Total average assets $ 1,230,249 $ 1,105,411
INTEREST-BEARING LIABILITIES:
Savings deposits $ 60,961 $ 22 0.15 % $ 57,670 $ 45 0.31 % $ (23 ) $ (26 ) $ 3
Demand deposits 80,104 21 0.11 % 74,045 35 0.19 % (14 ) (17 ) 3
Time deposits (4) 412,279 1,915 1.87 % 383,783 2,048 2.14 % (133 ) (285 ) 152
Money market deposits 267,682 453 0.68 % 240,831 960 1.60 % (507 ) (614 ) 107
Total deposits 821,026 2,411 1.18 % 756,329 3,088 1.64 % (677 ) (941 ) 264
Securities sold under repurchase
agreements 1,187 1 0.34 % 6,594 4 0.24 % (3 ) - (3 )
Subordinated notes and ESOP debt 32,463 509 6.31 % 8,586 138 6.45 % 371 (12 ) 383
FHLB advances 37,472 90 0.97 % 85,846 614 2.87 % (524 ) (179 ) (345 )
FRB advances 22,684 20 0.35 % - - 0.00 % 20 20 -
Total interest-bearing liabilities $ 914,832 $ 3,031 1.33 % $ 857,355 $ 3,844 1.80 % $ (813 ) $ (1,111 ) $ 298
Noninterest-bearing deposits 175,881 115,547
Other noninterest-bearing
liabilities 11,576 11,950
Total average liabilities 1,102,289 984,852
Average shareholders' equity 127,960 120,559
Total average liabilities and
shareholders' equity $ 1,230,249 $ 1,105,411
Net interest income and NIM (5) $ 8,966 3.11 % $ 8,503 3.29 % $ 463 $ (682 ) $ 1,145
Total cost of funds (6) 1.12 % 1.58 %
Net interest spread (7) 2.83 % 2.97 %
(1) Income and yield on tax-exempt securities assumes a federal income tax rate
of 21%.
(2) Includes loan fees and nonaccrual loans.
(3) Includes accretion of fair value discounts on loans acquired in the Merger of
2019, respectively.
(4) Includes amortization of fair value adjustments on time deposits assumed in
the Merger of
30, 2020 and 2019, respectively.
(5) Net interest margin is net interest income divided by average
interest-earning assets.
(6) Cost of funds is total interest expense divided by total average
interest-bearing liabilities and noninterest-bearing deposits.
(7) Net interest spread is the yield on average interest-earning assets less the
cost of average interest-bearing liabilities.
(8) Change in income/expense due to both volume and rates has been allocated in
proportion to the absolute dollar amounts of the change in each.
32
-------------------------------------------------------------------------------- Interest income, on a taxable-equivalent basis, for the three months endedJune 30, 2020 was$12.0 million , a decrease of$350 thousand from the second quarter of 2019, primarily attributable to lower yields on loans and lower accretion of acquired loan discounts in the 2020 period. The decline in yields and accretion income was partially offset by higher average interest-earning assets of$1.16 billion in the 2020 period compared to$1.04 billion in the 2019 period, an increase of$120.7 million ($107.8 million attributable to gross loans). Yields on average interest-earning assets were 4.17% and 4.77% for the second quarters of 2020 and 2019, respectively. Yields on average interest-earning assets in the second quarter of 2020 were negatively affected by lower yields on loans originated, the repricing of variable rate loans due to the decline in market index rates, the addition of lower yielding PPP loans, which had a negative 3 basis point effect on yield, and lower accretion of acquired loan discounts, which also had a negative 3 basis point effect. OnApril 1, 2017 , the Company completed a merger withVirginia BanCorp, Inc. ("Virginia BanCorp"), a bank holding company conducting substantially all of its operations through its subsidiary,Virginia Commonwealth Bank . Immediately following the Company's merger with Virginia BanCorp, Virginia BanCorp's subsidiary bank was merged with and into the Company's banking subsidiary,Bank of Lancaster (collectively, the "Merger").Bank of Lancaster then changed its name toVirginia Commonwealth Bank . Loans acquired in the Merger were discounted to estimated fair value (for credit losses and interest rates) as of the effective date of the Merger. A portion of the acquisition accounting adjustments (discounts) to record the acquired loans at estimated fair value is being recognized (accreted) into interest income over the estimated remaining life of the loans for those loans that were deemed to be, as of the Merger date, purchased performing and over the period of expected cash flows from the loans that were deemed to be purchased credit-impaired ("PCI"), as of the Merger date. The amount of accretion income recognized within a period is based on many factors, including among other factors, loan prepayments and curtailments; therefore, amounts recognized are subject to volatility. Accretion of discounts on acquired loans was$93 and$197 thousand in the second quarters of 2020 and 2019, respectively.
Average interest-earning assets comprised 94.1% and 93.8% of the Company's
average assets for the three months ended
Interest expense for the three months endedJune 30, 2020 was$3.0 million , a decrease of$813 thousand from the second quarter of 2019, primarily attributable to lower cost of funds, which was 1.12% in the 2020 period compared to 1.58% in the 2019 period. Average interest-bearing liabilities increased by$57.5 million to$914.8 million in the 2020 period from$857.4 million in the 2019 period. Cost of deposits was 0.97% for the second quarter of 2020, down 45 basis points from 1.42% for the second quarter of 2019, reflective of the Company's efforts to reduce deposit rates, and higher average balances noninterest-bearing demand deposit accounts in the 2020 period of$60.3 million , partially attributable to PPP loans funded in these accounts.
Net interest income, on a taxable-equivalent basis, for the three months ended
33
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Net interest margin was 3.11% for the second quarter of 2020 compared to 3.29%
for the second quarter of 2019. The decrease in NIM was primarily attributable
to lower yields on loans originated in the second quarter of 2020, including PPP
loans, and the repricing of variable rate loans, partially offset by lower cost
of funds.
Average Balances, Income and Expense, Yields and Rates
As of and For the Six Months Ended
2020 2019 2020 Compared to 2019
Income/
Average Income/ Yield/ Average Income/ Yield/ Expense Variance Attributable to (8)
Balance Expense Cost Balance Expense Cost Variance Rate Volume
INTEREST-EARNING ASSETS:
Taxable securities $ 84,619 $ 1,225 2.91 % $ 69,937 $ 1,172 3.38 % $ 53 $ (194 ) $ 247
Tax-exempt securities (1) 14,925 232 3.12 % 18,123 271 3.01 % (39 ) 9 (48 )
Total securities 99,544 1,457 2.94 % 88,060 1,443 3.30 % 14 (185 ) 199
Gross loans (2) (3) 981,937 22,642 4.64 % 912,568 22,919 5.06 % (277 ) (2,024 ) 1,747
Interest-earning deposits and
federal funds sold 34,584 114 0.66 % 26,470 312 2.38 % (198 ) (294 ) 96
Certificates of deposits 2,735 28 2.06 % 3,731 39 2.11 % (11 ) (1 ) (10 )
Total interest-earning assets 1,118,800 24,241 4.36 % 1,030,829 24,713 4.83 % $ (472 ) $ (2,504 ) $ 2,031
Noninterest-earning assets 68,206 66,079
Total average assets $ 1,187,006 $ 1,096,908
INTEREST-BEARING LIABILITIES:
Savings deposits $ 59,060 $ 57 0.19 % $ 57,586 $ 87 0.30 % $ (30 ) $ (32 ) $ 2
Demand deposits 76,280 45 0.12 % 74,652 70 0.19 % (25 ) (27 ) 2
Time deposits (4) 409,559 3,981 1.95 % 376,745 3,873 2.07 % 108 (230 ) 338
Money market deposits 262,405 1,177 0.90 % 238,628 1,866 1.58 % (689 ) (875 ) 186
Total deposits 807,304 5,260 1.31 % 747,611 5,896 1.59 % (636 ) (1,164 ) 528
Securities sold under repurchase
agreements 2,714 3 0.22 % 6,406 7 0.22 % (4 ) - (4 )
Subordinated notes and ESOP debt 32,487 1,021 6.32 % 8,592 275 6.45 % 746 (21 ) 767
FHLB advances 39,368 324 1.66 % 92,884 1,319 2.86 % (995 ) (233 ) (762 )
FRB advances 11,342 20 0.35 % - - 0.00 % 20 20 -
Total interest-bearing liabilities 893,215 6,628 1.49 % 855,493 7,497 1.77 % $ (869 ) $ (1,398 ) $ 529
Noninterest-bearing deposits 154,467 112,250
Other noninterest-bearing
liabilities 11,364 9,829
Total average liabilities 1,059,046 977,572
Average shareholders' equity 127,960 119,336
Total average liabilities and
shareholders' equity $ 1,187,006 $ 1,096,908
Net interest income and NIM (5) $ 17,613 3.17 % $ 17,216 3.37 % $ 397 $ (1,105 ) $ 1,502
Total cost of funds (6) 1.27 % 1.56 %
Net interest spread (7) 2.86 % 3.06 %
(1) Income and yield on tax-exempt securities assumes a federal income tax rate
of 21%.
(2) Includes loan fees and nonaccrual loans.
(3) Includes accretion of fair value discounts on loans acquired in the Merger of
2019, respectively.
(4) Includes amortization of fair value adjustments on time deposits assumed in
the Merger of
2020 and 2019, respectively.
(5) Net interest margin is net interest income divided by average
interest-earning assets.
(6) Cost of funds is total interest expense divided by total average
interest-bearing liabilities and noninterest-bearing deposits.
(7) Net interest spread is the yield on average interest-earning assets less the
cost of average interest-bearing liabilities.
(8) Change in income/expense due to both volume and rates has been allocated in
proportion to the absolute dollar amounts of the change in each.
Interest income, on a taxable-equivalent basis, for the six months endedJune 30, 2020 was$24.2 million , a decrease of$472 thousand from the six months endedJune 30, 2019 , primarily attributable to lower yields on loans and lower accretion of acquired loan discounts in the 2020 period. Yields on average interest-earning assets were 4.36% and 4.83% for the first halves of 2020 and 2019, respectively. The lower yield on average interest-earning assets in the 2020 period was primarily due to lower yields on loans originated, the repricing of variable rate loans, the addition of lower yielding PPP loans, which had a negative 2 basis point effect on yield, and lower accretion of acquired loan discounts (of$354 thousand ), which had a negative 6 basis point effect. Partially offsetting these negative effects was higher average balances of gross loans of$69.4 million in the 2020 period compared to the 2019 period. 34 --------------------------------------------------------------------------------
Average interest-earning assets comprised 94.3% and 94.0% of the Company's
average assets for the six months ended
Interest expense for the six months endedJune 30, 2020 was$6.6 million , a decrease of$869 thousand from the six months endedJune 30, 2019 , primarily attributable to lower cost of funds of 1.27% in the 2020 period compared to 1.56% in the 2019 period, partially offset by higher average interest-bearing liabilities of$37.7 million in the 2020 period compared to the 2019 period. Lower cost of funds in the first half of 2020 was primarily reflective of the company's efforts to reduce deposit rates since mid-2019, lower borrowing costs, particularlyFederal Home Loan Bank of Atlanta ("FHLB") advances, and higher average balances of noninterest-bearing demand accounts of$42.2 million in the 2020 period. Net interest income, on a taxable-equivalent basis, for the six months endedJune 30, 2020 was$17.6 million , an increase of$397 thousand from$17.2 million for the six months endedJune 30, 2019 . NIM was 3.17% for the first half of 2020 compared to 3.37% for the first half of 2019. Lower NIM in the 2020 period was primarily due to lower yields on average interest-earning assets, primarily loans, and lower accretion of acquired loan discounts, partially offset by lower cost of funds. The Company expects NIM to continue to be negatively affected in the periods subsequent toJune 30, 2020 , as a result of declines in market interest rates, most notably the federal funds rate, which has been lowered 200 basis points sinceJune 30, 2019 . PROVISION FOR LOAN LOSSES
Provision for loan losses was
Of the second quarter of 2020 amount, approximately$1.4 million was attributable to qualitative loss factors to provide for losses estimated to have been incurred as ofJune 30, 2020 , as a result of challenges certain borrowers are facing due to the pandemic, evidenced, in part, by loan deferrals and modifications granted to these borrowers. The remaining provision for loan losses in the second quarter of 2020 was due to gross loan growth of$27.0 million , excluding PPP loans, and higher specific reserves. No provision for loan losses was recorded on PPP loans as these loans are subject to a fullU.S. government guarantee. Provision for loans losses for the first half of 2020 was primarily attributable to qualitative loss factors due to the COVID-19 pandemic, gross loan growth of approximately$73.2 million , excluding PPP loans, and higher specific reserves.
NONINTEREST INCOME
The following table presents a summary of noninterest income and the dollar and percentage change for the periods presented.
Three Months Ended
June 30, 2020 June 30, 2019 $ Change % Change
Trust management 203 206 (3 ) (1.5 %)
Service charges and fees on deposit 137 246 (109 )
accounts (44.3 %)
Wealth management 228 262 (34 ) (13.0 %)
Interchange fees, net 130 121 9 7.4 %
Other service charges and fees 28 27 1 3.7 %
Secondary market sales and servicing 731 267 464 173.8 %
Increase in cash surrender value of bank 116 121 (5 )
owned life insurance (4.1 %)
Net gains (losses) on sales and calls of 3 (2 ) 5
available-for-sale securities (250.0 %)
Net gains (losses) on disposition of 1 (1 ) 2 (200.0 %)
other assets
Net gains on rabbi trust assets 114 40 74 185.0 %
Referral fees 496 - 496 100.0 %
Other 7 8 (1 ) (12.5 %)
Total noninterest income $ 2,194 $ 1,295 $ 899 69.4 %
35
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Six Months Ended
June 30, 2020 June 30, 2019 $ Change % Change
Trust management 396 420 (24 ) (5.7 %)
Service charges and fees on deposit 373 484 (111 )
accounts (22.9 %)
Wealth management 475 469 6 1.3 %
Interchange fees, net 228 222 6 2.7 %
Other service charges and fees 61 56 5 8.9 %
Secondary market sales and servicing 933 339 594 175.2 %
Increase in cash surrender value of bank 233 240 (7 )
owned life insurance (2.9 %)
Net gains (losses) on sales and calls of 29 (2 ) 31
available-for-sale securities n/m
Net losses on disposition of other (7 ) (1 ) (6 ) n/m
assets
Net (losses) gains on rabbi trust assets (150 ) 130 (280 ) (215.4 %) Referral fees 966 - 966 100.0 % Other 46 28 18 64.3 %
Total noninterest income $ 3,583 $ 2,385$ 1,198 50.2 % Higher noninterest income in the three months endedJune 30, 2020 , compared to the three months endedJune 30, 2019 , was primarily due to higher secondary market sales and servicing income of$464 thousand , driven by an increase in the demand for purchase money and refinance mortgages, and$496 thousand of fee income for referring loan customers to a third-party financial institution to execute interest rate swaps, while the second quarter of 2019 included no income from such activities. Partially offsetting these increases were lower service charges and fees on deposit accounts in the second quarter of 2020 of$109 thousand , primarily due to a lower volume of fee-based transactions. Higher noninterest income in the six months endedJune 30, 2020 , compared to the six months endedJune 30, 2019 , was primarily attributable to$966 thousand of fee income for referring loan customers to a third-party financial institution to execute interest rate swaps, while the 2019 period included no income from such activities. Additionally, the first half of 2020 period included higher secondary market sales and servicing income of approximately$594 thousand . Partially offsetting these increases was a$150 net unrealized loss in the 2020 period compared to a$130 net unrealized gain in the 2019 period on rabbi trust assets for the benefit of participants in the Company's deferred compensation plan. NONINTEREST EXPENSE
The following table presents a summary of noninterest expense and the dollar and percentage change for the periods presented.
Three Months Ended
June 30, 2020 June 30, 2019 $ Change % Change
Salaries and employee benefits $ 3,839 $ 3,892 $ (53 ) (1.4 %)
Occupancy 705 837 (132 ) (15.8 %)
Data processing 498 609 (111 ) (18.2 %)
Bank franchise tax 257 230 27 11.7 %
Telecommunications and other technology 371 262 109 41.6 %
FDIC assessments 147 162 (15 ) (9.3 %)
Foreclosed property 28 19 9 47.4 %
Consulting 70 147 (77 ) (52.4 %)
Advertising and marketing 26 109 (83 ) (76.1 %)
Directors' fees 188 213 (25 ) (11.7 %)
Audit and accounting 170 189 (19 ) (10.1 %)
Legal 154 27 127 n/m
Core deposit intangible amortization 142 173 (31 ) (17.9 %)
Net other real estate owned losses 81 72 9 12.5 %
Goodwill impairment 10,374 - 10,374 100.0 %
Other 403 651 (248 ) (38.1 %)
Total noninterest expense $ 17,453 $ 7,592 $ 9,861 129.9 %
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Six Months Ended
June 30, 2020 June 30, 2019 $ Change % Change
Salaries and employee benefits 7,466 7,893 (427 ) (5.4 %)
Occupancy 1,456 1,705 (249 ) (14.6 %)
Data processing 1,035 1,197 (162 ) (13.5 %)
Bank franchise tax 514 446 68 15.2 %
Telecommunications and other technology 780 469 311 66.3 %
FDIC assessments 295 378 (83 ) (22.0 %)
Foreclosed property 35 62 (27 ) (43.5 %)
Consulting 141 262 (121 ) (46.2 %)
Advertising and marketing 93 176 (83 ) (47.2 %)
Directors' fees 381 377 4 1.1 %
Audit and accounting 310 393 (83 ) (21.1 %)
Legal 346 110 236 214.5 %
Core deposit intangible amortization 291 353 (62 ) (17.6 %)
Net other real estate owned losses 80 66 14 21.2 %
Goodwill impairment 10,374 - 10,374 100.0 %
Other 1,163 1,335 (172 ) (12.9 %)
Total noninterest expense $ 24,760 $ 15,222 $ 9,538 62.7 %
Higher noninterest expense in the three months ended June 30, 2020 , compared to
the three months ended June 30, 2019 , was primarily attributable to the goodwill
impairment charge of $10.4 million . Excluding the $10.4 million goodwill
impairment charge, noninterest expenses decreased $513 thousand , or 6.7%, on a
comparative period basis, reflective of the Company's ongoing efforts to reduce
operating costs.
Higher noninterest expense in the six months ended June 30, 2020 , compared to
the six months ended June 30, 2019 , was primarily attributable to the goodwill
impairment charge of $10.4 million . Excluding the goodwill impairment charge,
noninterest expenses decreased $836 thousand , 5.5%, on a comparative period
basis, reflective of the Company's ongoing efforts to reduce operating costs.
Partially offsetting these reductions, were higher expenses in
telecommunications and other technology due to infrastructure investments. The
Company consolidated one branch in the first quarter of 2020 and one in the
first quarter of 2019.
The following table presents income tax (benefit) expense and effective income tax rates for the periods presented.
Three Months Ended Six Months Ended
June 30, 2020 June 30, 2019 June 30, 2020 June 30, 2019
Income tax
(benefit) expense $ (217 ) $ 395 $ (276 ) $ 732
Effective income
tax rate 2.6 % 18.6 % 3.3 % 18.6 %
The income tax benefit and effective income tax rate for the three and six
months ended June 30, 2020 were a result of income tax expense before the
goodwill impairment charge of $10.4 million , offset by an income tax benefit
(reversal of a deferred tax liability) of $590 thousand related to a portion of
the goodwill.
ASSET QUALITY
Loans charged-off during the second quarter of 2020, net of recoveries, totaled
$192 thousand compared to $441 thousand for the second quarter of 2019. This
resulted in a decrease in the annualized net charge-off ratio to 0.08% for the
second quarter of 2020 compared to 0.19% for the second quarter of 2019. For the
first half of 2020, the annualized net charge off ratio was 0.07% compared to
0.18% for the first half of 2019. The higher net charge ratios for the 2019
periods were primarily attributable to charge-offs of a select portfolio of
acquired consumer debt consolidation loans, as previously reported.
The ratio of allowance for loan losses to gross loans was 1.14% as of June 30,
2020 compared to 0.82% as of December 31, 2019 , an increase of 32 basis points.
The majority of this increase is attributable to qualitative loss factors for
increases in state unemployment rates, including Virginia , and a qualitative
loss factor to provide for losses estimated to have been incurred as of June 30,
2020 , as a result of challenges certain borrowers are facing due to the
pandemic, evidenced, in part, by loan deferrals and modifications granted to
these borrowers.
37
-------------------------------------------------------------------------------- In the first quarter of 2020, the Company downgraded risk ratings on$88.5 million of loans to businesses in industries highly affected by the COVID-19 pandemic. During the second quarter of 2020, risk ratings for certain loans in these segments were adjusted as additional information became available. Management believes that these, or a portion of these, loans may require further downgrades and/or other loans to borrowers adversely affected by the COVID-19 pandemic may require risk rating downgrades. Additionally, loan modifications granted do not necessarily represent that these borrowers will be able to pay amounts deferred or any amounts owed to the Company. The length of the economic slow-down, including the pace at which the economy recovers once governmental mandates are lifted, could have a material adverse effect on the Company's asset quality and the amount of ALL required. The following table presents industry segments the Company believes may be negatively affected by the pandemic and the balances of loans and numbers in each segment. Loans to borrowers in these segments totaled approximately$148.2 million , or 14.1% of the Company's gross loans as ofJune 30, 2020 . Industry Segment Loan Count Principal Balance Hotels and motels 22 $ 61,770 Restaurants and related services 53 20,557 Retail and retail services 98 56,213 Churches, assisted living, and other 25 9,645 Total 198 $ 148,185 The following table presents certain asset quality measures as of the dates stated. June 30, 2020 December 31, 2019 Loans past due 90 days or more and still accruing (1) $ - $ - Nonaccrual loans (1) 12,279 4,476 Total nonperforming loans 12,279 4,476 Other real estate owned, net 1,903 1,916 Total nonperforming assets$ 14,182 $ 6,392 Allowance for loan losses$ 12,007 $ 7,562 Gross loans 1,052,855 924,190 Total assets 1,238,226 1,131,923 Allowance for loan losses to gross loans 1.14 % 0.82 % Allowance for loan losses to nonperforming loans 97.8 % 168.9 % Nonperforming assets to total assets 1.15 % 0.56 % Nonperforming loans to gross loans 1.17 % 0.48 % (1) Excludes PCI loans.
The increase in nonperforming assets from
FINANCIAL CONDITION
Total assets increased by$106.3 million to$1.24 billion as ofJune 30, 2020 from$1.13 billion as ofDecember 31, 2019 , primarily due to net loan growth of$124.2 million in the first half of 2020. The following tables present information about the securities portfolio on a taxable-equivalent basis as of the dates stated. As ofJune 30, 2020 andDecember 31, 2019 , available-for-sale securities represented 8.2% and 8.8% of total assets, respectively. June 30, 2020 Weighted Average Life in Weighted Amortized Cost Fair Value Years Average YieldU.S. Government agencies and mortgage backed securities$ 54,516 $ 55,902 5.3 2.04 % State and municipal obligations 16,951 17,671 4.7 3.11 % Corporate bonds 19,171 18,987 6.0 5.28 % Total available-for-sale securities 90,638 92,560 5.4 2.81 % Restricted securities 5,327 5,327 n/a 5.34 % Total securities$ 95,965 $ 97,887 2.94 % 38
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December 31, 2019
Weighted
Average
Life in Weighted
Amortized Cost Fair Value Years Average Yield
U.S. Government agencies and mortgage
backed securities $ 67,491 $ 67,597 6.1 2.18 %
State and municipal obligations 16,238 16,576 5.4 3.16 %
Corporate bonds 15,165 15,281 3.8 5.61 %
Total available-for-sale securities 98,894 99,454 5.1 2.92 %
Restricted securities 5,706 5,706 n/a 6.30 %
Total securities $ 104,600 $ 105,160 3.18 %
The following table presents the composition of loans in dollar amounts and as a percentage of total loans as of the dates stated.
June 30, 2020 December 31, 2019
Amount Percent of Total Amount Percent of Total
Mortgage loans on real estate:
Residential first mortgages $ 293,449 27.9 % $ 293,913 31.8 %
Commercial mortgages (non-owner
occupied) 273,814 25.9 % 196,143 21.2 %
Construction, land and land
development 128,463 12.2 % 126,010 13.6 %
Commercial mortgages (owner
occupied) 73,550 7.0 % 82,829 9.0 %
Residential revolving and junior
mortgages 28,833 2.7 % 31,893 3.4 %
Commercial and industrial 193,740 18.3 % 181,730 19.7 %
Paycheck Protection Program 55,496 5.3 % - 0.0 %
Consumer 7,855 0.7 % 11,985 1.3 %
Total loans 1,055,200 100.0 % 924,503 100.0 %
Net unamortized deferred loan fees (2,345 ) (313 )
Allowance for loan losses (12,007 ) (7,562 )
Loans receivable, net $ 1,040,848 $ 916,628
During the six months ended June 30, 2020 , gross loans increased by $128.7
million , or 13.9%, from December 31, 2019 . The largest components of this
increase were a $77.7 million increase in commercial mortgages (non-owner
occupied) and $55.5 million of PPP loans originated in the second quarter of
2020. Net unamortized deferred loan fees increased approximately $2.0 million
during the first half of 2020, primarily attributable to $2.3 million of PPP
loan processing fees received in the second quarter of 2020, of which $246
thousand was recognized in interest income in the period.
The following table presents the Company's ALL by loan type and the percent of loans in each category to total loans as of the dates stated.
June 30, 2020 December 31, 2019
Percent of Percent of
loans in loans in
each each
category to category to
Amount total loans Amount total loans
Mortgage loans on real estate $ 8,863 75.7 % $ 5,372 79.0 %
Commercial and industrial 2,626 18.3 % 1,571 19.7 %
Paycheck Protection Program - 5.3 % - 0.0 %
Consumer 518 0.7 % 619 1.3 %
Total allowance for loan losses $ 12,007 100.0 % $ 7,562 100.0 %
Allowance for loan losses increased $4.4 million from December 31, 2019 to $12.0
million as of June 30, 2020 . The majority of the increase in the first half of
2020 was primarily due to qualitative loss factors applied to the majority of
the company's loan portfolio for higher state unemployment rates, particularly
in Virginia , and a qualitative loss factor to estimate reserve needs for
modified loans, as noted previously. Also contributing to the increase in the
allowance for loan losses since December 31, 2019 was gross loan growth
(excluding PPP loans), and higher specific reserves. Due to the full U.S.
government guarantee on PPP loans, the Company has recorded no allowance for
loan losses for the $55.5 million of PPP loans outstanding as of June 30, 2020 .
In future periods, the Company may be required to establish an allowance for
loan losses for these loans, which would result in a provision for loan losses
charged to earnings.
As of
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As of June 30, 2020 , total deposits were $1.00 billion compared to
$910.4 million at December 31, 2019 , a $96.5 million increase. Of the increase,
$47.3 million and $30.4 million was attributable to higher noninterest-bearing
deposit account balances and savings and interest-bearing demand deposit
accounts. Higher noninterest-bearing deposit balances were partially
attributable to PPP loans, which were funded in these accounts.
Maturities of large denomination time deposits (equal to or greater than
Percent of
Within 3 Months 3-6 Months 6-12 Months
Over 12 Months Total Total Deposits
Time deposits $ 50,722
$ 114,474 $ 260,940 25.9 % As ofJune 30, 2020 , the Company had three fixed rate FHLB advances totaling of$25.0 million and one variable rate FHLB advance totaling$10.0 million outstanding. As ofDecember 31, 2019 , the Company had three fixed rate FHLB advances totaling$35.0 million and one variable rate FHLB advance of$10.0 million outstanding. Beginning in the second quarter of 2020, the Company accessed theFederal Reserve Bank of Richmond's ("FRB") PPP Liquidity Facility ("PPPLF"), which provides funding for PPP loans at a fixed rate of 35 basis points per year over the term the funded PPP loan is outstanding. PPP loans securing the PPPLF are afforded preferential regulatory capital treatment. As ofJune 30, 2020 the Company had PPPLF advances totaling$33.2 million . The following table presents various information regarding FHLB and FRB advances as of and for the periods presented. Three Months Ended June 30, 2020 Twelve Months Ended December 31, 2019 Highest Highest Month-End Average Weighted Month-End Average Weighted Period-End Balance Balance Balance Average Rate Period-End Balance Balance Balance Average Rate FHLB advances $ 35,000$ 45,000 $ 37,472 0.97 % $ 45,000$ 100,000 $ 76,181 2.74 % FRB advances 33,160 33,557 22,684 0.35 % - - - 0.00 % LIQUIDITY Liquidity represents an institution's ability to meet present and future financial obligations (such as commitments to fund loans or meet depositors' requirements) through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-earning deposits with other banks, federal funds sold, and investments and loans maturing within one year. The Company's ability to obtain deposits and purchase funds at favorable rates are major factors for liquidity. Management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors' requirements and its customers' credit needs. As ofJune 30, 2020 , cash and cash equivalents totaled$39.4 million ; investment securities maturing in one year or less totaled$11.8 million ; and loans maturing in one year or less totaled$109.3 million . This resulted in a liquidity ratio as ofJune 30, 2020 of 13.0% compared to 21.5% as ofDecember 31, 2019 . The Company determines this ratio by dividing the sum of cash and cash equivalents, and investment securities and loans maturing in one year or less, by total assets. As ofJune 30, 2020 , the Company had a secured borrowing line with the FHLB of$294.7 million , with$228.7 million available, and unsecured federal funds lines of credit with various correspondent banks totaling$41.0 million . Federal funds lines of credit are uncommitted and can be cancelled at any time by the lending bank. As noted previously, the Company pledged PPP loans for FRB advances of an equal amount. Additional borrowing availability under the PPPLF, with the pledging of PPP loans, was approximately$22.3 million , as ofJune 30, 2020 . As ofJune 30, 2020 , other than the potential effect on liquidity of the COVID-19 pandemic, the Company was not aware of any other known trends, events, or uncertainties that have or are reasonably likely to have a material effect on liquidity. Management has and continues to monitor the effects of the COVID-19 pandemic on the Company's liquidity. For example, management monitors for unusual changes in deposit balances, access to funding sources, draws, amortization of loan balances, and the various liquidity programs offered by the FRB in response to the pandemic. As ofJune 30, 2020 , management believes the COVID-19 pandemic has not had an adverse effect on the Company's liquidity.
CAPITAL RESOURCES
Capital resources represent funds, earned or obtained, over which a financial
institution can exercise greater long-term control in comparison with deposits
and borrowed funds. The adequacy of the Company's capital is reviewed by
management on an ongoing basis with reference to size, composition, and quality
of the Company's resources, and consistency 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 to
absorb potential losses yet allows management to effectively leverage its
capital to maximize return to shareholders. The Company's capital, also known as
shareholders' equity, is comprised primarily of outstanding common stock,
additional paid-in capital, and retained earnings.
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Shareholders' equity is primarily affected by net income and net unrealized
gains or losses on available-for-sale securities, net of taxes. The
available-for-sale securities portfolio is reported at fair value with
unrealized gains or losses, net of taxes, recognized as accumulated other
comprehensive income on the Company's consolidated balance sheets. Another
factor affecting accumulated other comprehensive income is changes in the fair
value of the Company's pension and post-retirement benefit plans and changes in
said plan obligations. Shareholders' equity before accumulated other
comprehensive income, net of taxes, was $118.5 million as of June 30, 2020
compared to $126.1 million as of December 31, 2019 . The decrease of $7.6 million
was primarily attributable to the $8.1 million net loss for the six months ended
June 30, 2020 , including the $9.8 million after-tax goodwill impairment charge.
Accumulated other comprehensive income, net of taxes, increased by $1.1 million
from December 31, 2019 to June 30, 2020 , due to an increase in net unrealized
gains, net of taxes, in the Company's available-for-sale securities portfolio.
Book value per share of the Company's common stock, including accumulated other
comprehensive income, net of tax, decreased to $8.98 as of June 30, 2020 from
$9.51 as of December 31, 2019 . This decrease was primarily attributable to the
net loss of $8.1 million for the six months ended June 30, 2020 .
The Company and the Bank are subject to minimum regulatory capital ratios as
defined by the Federal Reserve . As of June 30, 2020 , the Company and the Bank's
capital ratios continue to be in excess of regulatory minimums and the Bank was
"well capitalized" by these guidelines.
The Bank is subject to capital rules adopted by federal bank regulators
implementing the Basel III regulatory capital reforms adopted by the Basel
Committee, and certain changes required by the Dodd-Frank Act. These rules
require the Bank to comply with the following minimum capital ratios: (i) a
Common Equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier
1 capital ratio of 6.0% of risk-weighted assets; (iii) a total capital ratio of
8.0% of risk-weighted assets; and (iv) a leverage ratio of 4.0% of average
adjusted assets. The following additional capital requirements related to the
capital conservation buffer (promulgated by the Basel III regulatory capital
rules) require the Bank to maintain (i) a minimum ratio of Common Equity Tier 1
to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation
buffer" (resulting in a minimum ratio of Common Equity Tier 1 to risk-weighted
assets of at least 7.0%), (ii) a minimum ratio of Tier 1 capital to
risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer
(resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of
total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital
conservation buffer (resulting in a minimum total capital ratio of 10.5%), and
(iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital
to average assets. The capital conservation buffer is designed to absorb losses
during periods of economic stress. Banking institutions with a ratio of Common
Equity Tier 1 to risk-weighted assets above the minimum but below the
conservation buffer will be subject to constraints on dividends, equity
repurchases, and discretionary compensation paid to certain officers, based on
the amount of the shortfall. As of June 30, 2020 and December 31, 2019 , capital
ratios of the Bank were in excess of the regulatory conservation buffer levels.
The following tables present capital ratios for the Bank, minimum capital ratios
required with conservation buffer, and ratios defined as "well capitalized" by
the Bank's regulators as of the dates stated.
Minimum Capital Minimum
Actual Requirement Ratio to be Well
As of June 30, 2020 Ratio with Conservation Buffer Capitalized
Total risk-based capital 13.38 % 10.50 % 10.00 %
Tier 1 capital 12.18 % 8.50 % 8.00 %
Common equity tier 1 12.18 % 7.00 % 6.50 %
Tier 1 leverage ratio 10.25 % 4.00 % 5.00 %
Minimum Capital Minimum
Actual Requirement Ratio to be Well
As of December 31, 2019 Ratio with Conservation Buffer Capitalized
Total risk-based capital 13.07 % 10.50 % 10.00 %
Tier 1 capital 12.26 % 8.50 % 8.00 %
Common equity tier 1 12.26 % 7.00 % 6.50 %
Tier 1 leverage ratio 10.42 % 4.00 % 5.00 %
OFF BALANCE SHEET COMMITMENTS AND CONTINGENCIES
In the normal course of business, the Company offers various financial products
to our customers to meet their credit and liquidity needs. These instruments may
involve elements of liquidity, credit, and interest rate risk in excess of the
amount recognized in the Company's consolidated balance sheets. The Company's
exposure to credit loss in the event of nonperformance by the other party to the
financial instruments for commitments to extend credit and stand-by letters of
credit is represented by the contractual amount of these instruments. Subject to
normal credit standards and risk monitoring procedures, the Company makes
contractual commitments to extend credit. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee.
Since many of the commitments may expire without being completely drawn upon,
the total commitment amounts do not necessarily represent future cash
requirements. Conditional commitments are issued by the Company in the form of
performance stand-by letters of credit, which guarantee the performance of a
customer to a third party. The credit risk of issuing letters of credit is
essentially the same as that involved in extending loans to customers.
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The following table presents off balance sheet commitments as of the dates
stated.
June 30, 2020 December 31, 2019
Total loan commitments outstanding $ 150,816 $ 164,751
Stand-by letters of credit 7,231 6,118
CONTRACTUAL OBLIGATIONS
There have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company's 2019 Form 10-K.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 2, Amendments to the Accounting Standards Codification, in the Notes to the Consolidated Financial Statements contained in Item 1 of this report, for information related to the adoption of amendments to the Accounting Standards Codification.
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