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").
ANTICIPATED MERGER WITH BLUE RIDGE BANKSHARES, INC.
OnAugust 12, 2020 , the Company and Blue Ridge Bankshares, Inc. ("Blue Ridge") entered into a definitive merger agreement pursuant to which the companies will combine in an all-stock merger (the " BlueRidge Merger ") to create a leadingVirginia -based community bank. Under the terms of the merger agreement, shareholders of the Company will receive 0.50 shares of Blue Ridge common stock for each share of the Company's common stock they own. Upon completion of the BlueRidge Merger , the Company's shareholders will own approximately 54% and Blue Ridge shareholders will own approximately 46% of the combined company's stock. The BlueRidge Merger is subject to customary closing conditions, including regulatory approvals and approval from the shareholders of both companies. The Company anticipates the BlueRidge Merger will close in the first quarter of 2021.
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 ability to close the BlueRidge Merger on the expected terms and schedule; difficulties, delays and unforeseen costs in completing the BlueRidge Merger and in integrating the Company's and Blue Ridge's businesses; the ability to realize cost savings and other benefits of the BlueRidge Merger ; business disruption during the pendency of or following the BlueRidge Merger ; 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 income for the three months ended
million and
for the three months ended
three months ended
ended
respectively. The results of operations for the nine months ended September
30, 2020 included a
addition to the goodwill impairment charge, net income (loss) for the three
and nine months ended
expense of
portion of which related to estimated reserve needs as a result of the
COVID-19 pandemic. The
30
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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. For the
three months ended
million of expenses incurred in connection with the anticipated Blue Ridge
Merger.
• Income before income taxes was
months ended September 30, 2020 and 2019, respectively, a decrease of $141
thousand . (Loss) income before income taxes was $(6.3) million and $6.2
million for the nine months ended
a decrease of
impairment charge and higher loan loss provision expense reported in the
2020 period.
• Return (loss) on average assets (annualized) decreased to 0.48% and (0.73%)
for the three and nine months ended September 30, 2020 , respectively, from
0.66% and 0.61% for the comparable 2019 periods.
• Return (loss) on average equity (annualized) decreased to 4.95% and (7.08%)
for the three and nine months ended September 30, 2020 , respectively, from
5.97% and 5.65% for the comparable 2019 periods.
• Total assets increased
2020 from
• Loans, net of allowance for loan losses were
30, 2020 compared to
("PPP") loans originated in the second and third quarters of 2020. Excluding
PPP loans, net loan growth for the first nine months of 2020 was
million, an annualized growth rate of 10%.
• The Company has participated in the PPP under the Coronavirus Aid, Relief,
and Economic Security Act, closing nearly 700 loans totaling
and receiving
received,
in the third quarter and year-to-date period ended
respectively, while the remaining fees were deferred and will be recognized
over the life of the loans, accelerated for pre-payments.
• Allowance for loan losses increased
of gross loans, as of September 30, 2020 from $7.6 million , or 0.82% of
gross loans, as of December 31, 2019 . The 40 basis point increase in the
ratio of allowance for loan losses to total gross loans for the first ninemonths of 2020 was primarily due to a qualitative loss factor to provide for
losses estimated to have been incurred as of
of challenges certain borrowers are facing due to the pandemic, evidenced,
in part, by loan deferrals and modifications granted to these borrowers,
gross loan growth, excluding PPP loans, general reserves for higher
unemployment rates in the 2020 period, particularly in
specific reserves on impaired loans.
• Total deposits increased by
2020,
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 1.46% 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
with a total capital ratio and tier 1 leverage ratio of 13.68% and 10.47%,
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
ASSETS:
Taxable securities $ 83,990 $ 596 2.82 % $ 71,752 $ 553 3.06 % $ 43 $ (51 ) $ 94
Tax-exempt securities (1) 14,558 111 3.04 % 16,086 143 3.53 % (32 ) (18 ) (14 )
Total securities 98,548 707 2.86 % 87,838 696 3.14 % 11 (69 ) 81
Gross loans (2) (3) 1,057,005 11,371 4.28 % 923,606 11,930 5.12 % (559 ) (2,277 ) 1,718
Interest-earning deposits and
federal funds sold 35,336 6 0.07 % 28,301 151 2.12 % (145 ) (182 )
37
Certificates of deposits 1,781 9 2.01 % 3,498 18 2.04 % (9 ) (0 ) (9 )
Total interest-earning assets
$ 1,828 Noninterest-earning assets 54,319 62,168 Total average assets$ 1,246,989 $ 1,105,411 LIABILITIES: Savings deposits$ 64,852 $ 17 0.10 %$ 57,770 $ 40 0.27 %$ (23 ) $ (28 ) $ 5 Demand deposits 86,863 22 0.10 % 71,905 26 0.14 % (4 ) (9 ) 5 Time deposits (4) 407,866 1,743 1.70 % 392,868 2,163 2.18 % (420 ) (502 ) 82 Money market deposits 266,691 322 0.48
% 241,360 894 1.47 % (572 ) (666 )
94
Total interest-bearing deposits 826,272 2,104 1.01 % 763,903 3,123 1.62 % (1,019 ) (1,205 )
186
Securities sold under repurchase
agreements 1,097 1 0.36 % 6,439 4 0.25 % (3 ) - (3 )
Subordinated notes and ESOP debt 32,436 510 6.24 % 8,550 142 6.59 % 367 (29 ) 396
FHLB advances 33,370 50 0.60 % 72,500 465 2.54 % (415 ) (165 ) (250 )
FRB advances 32,637 29 0.35 % - - 0.00 % 29 29 -
Total interest-bearing liabilities $ 925,812 $ 2,694 1.16 % $ 851,392 $ 3,734 1.74 % $ (1,040 ) $ (1,369 ) $ 328
Noninterest-bearing deposits 188,852 123,541
Other noninterest-bearing
liabilities 11,755 9,919
Total average liabilities 1,126,419 984,852
Average shareholders' equity 120,570 120,559
Total average liabilities and
shareholders' equity $ 1,246,989 $ 1,105,411
Net interest income and NIM (5) $ 9,399 3.14 % $ 9,061 3.45 % $ 338 $ (1,160 ) $ 1,499
Total cost of funds (6) 0.96 % 1.52 %
Net interest spread (7) 2.88 % 3.13 %
(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
BanCorp Merger of
(4) Includes amortization of fair value adjustments on time deposits assumed in
the Virginia BanCorp Merger of
months ended
(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 endedSeptember 30, 2020 was$12.1 million , a decrease of$702 thousand from the third quarter of 2019, primarily attributable to lower yields on loans and lower accretion of acquired loan discounts in the 2020 period, discussed below. The decline in yields and accretion income was partially offset by higher average balances of interest-earning assets of$1.19 billion in the 2020 period compared to$1.04 billion in the 2019 period, an increase of$149.4 million ($133.4 million attributable to gross loans). Yields on average interest-earning assets were 4.03% and 4.87% for the third quarters of 2020 and 2019, respectively. Yields on average interest-earning assets in the third quarter of 2020 were negatively affected by lower yields on loans originated, including PPP loans, the repricing of variable rate loans, and lower accretion of loans acquired in the Company'sApril 2017 merger withVirginia BanCorp, Inc. ("Virginia BanCorp Merger"), which had a negative 10 basis point effect. Accretion of discounts on loans acquired in the Virginia BanCorp Merger was$97 and$357 thousand in the third quarters of 2020 and 2019, respectively.
Average interest-earning assets comprised 95.6% and 94.4% of the Company's
average assets for the three months ended
Interest expense for the three months endedSeptember 30, 2020 was$2.7 million , a decrease of$1.04 million from the third quarter of 2019, primarily attributable to lower cost of funds (primarily cost of deposits), which was 0.96% in the 2020 period compared to 1.52% in the 2019 period. The decrease in cost of funds was reflective of the Company's efforts to reduce deposit rates, and higher average balances noninterest-bearing demand deposit accounts in the 2020 period of$65.3 million . Average interest-bearing liabilities increased by$74.4 million to$925.8 million in the 2020 period from$851.4 million in the 2019 period. Net interest income, on a taxable-equivalent basis, for the three months endedSeptember 30, 2020 , was$9.4 million , an increase of$338 thousand from the three months endedSeptember 30, 2019 . Net interest margin was 3.14% for the third quarter of 2020 compared to 3.45% for the third quarter of 2019. The decrease in NIM was primarily attributable to lower yields on loans, partially offset by lower cost of funds. 33 -------------------------------------------------------------------------------- Average Balances, Income and Expense, Yields and Rates As of and For the Nine Months Ended September 30, 2020 2019 2020 Compared to 2019 Income/ Average Income/ Yield/ Average Income/ Yield/ Expense Variance Attributable to (8) Balance Expense Cost Balance Expense Cost Variance Rate Volume ASSETS: Taxable securities$ 84,408 $ 1,821 2.88 %$ 70,549 $ 1,725 3.27 %$ 96 $ (243 ) $ 339 Tax-exempt securities (1) 14,802 343 3.10 % 17,436 414 3.17 % (71 ) (8 ) (63 ) Total securities 99,210 2,164 2.91 % 87,985 2,139 3.25 % 25 (251 ) 277 Gross loans (2) (3) 1,007,142 34,013 4.51 % 916,289 34,849 5.08 % (836 ) (4,295 ) 3,459 Interest-earning deposits and federal funds sold 34,836 119 0.46 % 27,088 463 2.29 % (344 ) (476 ) 133 Certificates of deposits 2,415 37 2.05 % 3,653 57 2.09 % (20 ) (1 ) (19 ) Total interest-earning assets 1,143,603 36,333 4.24 % 1,035,015 37,508 4.85 %$ (1,175 ) $ (5,022 ) $ 3,848 Noninterest-earning assets 63,543 61,893 Total average assets$ 1,207,146 $ 1,096,908 LIABILITIES: Savings deposits$ 61,005 $ 74 0.16 %$ 57,648 $ 128 0.30 %$ (54 ) $ (61 ) $ 7 Demand deposits 79,833 67 0.11 % 73,727 95 0.17 % (28 ) (36 ) 8 Time deposits (4) 408,990 5,724 1.87 % 382,179 6,036 2.11 % (312 ) (736 ) 424 Money market deposits 263,845 1,499 0.76 % 239,548 2,760 1.54 % (1,261 ) (1,541 ) 280 Total interest-bearing deposits 813,673 7,364 1.21 % 753,102 9,019 1.60 % (1,655 ) (2,374 ) 719 Securities sold under repurchase agreements 2,171 3 0.18 % 6,418 11 0.23 % (8 ) - (8 ) Subordinated notes and ESOP debt 32,470 1,531 6.30 % 8,578 417 6.50 % 1,114 (49 ) 1,163 FHLB advances 37,354 374 1.34 % 86,015 1,784 2.77 % (1,410 ) (400 ) (1,010 ) FRB advances 18,492 49 0.35 % - - 0.00 % 49 49 - Total interest-bearing liabilities 904,160 9,321 1.38 % 854,113 11,231 1.76 %$ (1,910 ) $ (2,774 ) $ 863 Noninterest-bearing deposits 166,012 116,055 Other noninterest-bearing liabilities 11,829 7,404 Total average liabilities 1,082,001 977,572 Average shareholders' equity 125,145 119,336 Total average liabilities and shareholders' equity$ 1,207,146 $ 1,096,908 Net interest income and NIM (5)$ 27,012 3.16 %$ 26,277 3.39 %$ 735 $ (2,249 ) $ 2,985 Total cost of funds (6) 1.16 % 1.55 % Net interest spread (7) 2.87 % 3.09 %
(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
BanCorp Merger of
(4) Includes amortization of fair value adjustments on time deposits assumed in
the Virginia BanCorp Merger of
months ended
(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.
34
-------------------------------------------------------------------------------- Interest income, on a taxable-equivalent basis, for the nine months endedSeptember 30, 2020 was$36.3 million , a decrease of$1.2 million from the nine months endedSeptember 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 4.24% and 4.85% for the nine months endedSeptember 30, 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 during the period, the repricing of variable rate loans, 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 had a negative 8 basis point effect on yield. Partially offsetting these negative effects were higher average balances of gross loans in the 2020 period of$90.9 million .
Average interest-earning assets comprised 94.7% and 94.4% of the Company's total
average assets for the nine months ended
Interest expense for the nine months endedSeptember 30, 2020 was$9.3 million , a decrease of$1.9 million from the nine months endedSeptember 30, 2019 , primarily attributable to lower cost of funds of 1.16% in the 2020 period compared to 1.55% in the 2019 period, partially offset by higher average interest-bearing liabilities of$50.0 million in the 2020 period. Lower cost of funds in the first nine months 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$50.0 million in the 2020 period. Net interest income, on a taxable-equivalent basis, for the nine months endedSeptember 30, 2020 was$27.0 million , an increase of$735 thousand from$26.2 million for the nine months endedSeptember 30, 2019 . NIM was 3.16% for the first nine months of 2020 compared to 3.39% for the same period in 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 toSeptember 30, 2020 , as a result of declines in market interest rates, most notably the federal funds rate, and competition among financial institutions to attract the most credit-worthy borrowers.
PROVISION FOR LOAN LOSSES
Provision for loan losses was
Provision for loan losses was$5.7 million and$871 thousand for the first nine months of 2020 and 2019, respectively. Provision for loan losses in the 2020 period was primarily attributable to qualitative loss factors for increases in state unemployment rates, includingVirginia , and for losses estimated to have been incurred as ofSeptember 30, 2020 as a result of challenges certain borrowers are facing due to the COVID-19 pandemic, evidenced, in part, by loan deferrals and modifications granted to these borrowers. Also contributing to higher provision in the 2020 period was gross loan growth, excluding PPP loans, of approximately$71.9 million , and higher specific reserves on impaired loans. The Company recorded no provision for loan losses for PPP loans due to theU.S. government guarantee. 35
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NONINTEREST INCOME
The following table presents a summary of noninterest income and the dollar and percentage change for the periods presented.
Three Months Ended
September 30, 2020 September 30, 2019 $ Change % Change
Trust management 220 201 19 9.5 %
Service charges and fees on deposit 155 243 (88 )
accounts (36.2 %)
Wealth management 350 185 165 89.2 %
Interchange fees, net 149 108 41 38.0 %
Other service charges and fees 33 32 1 3.1 %
Secondary market sales and servicing 1,082 293 789 269.3 %
Increase in cash surrender value of bank 117 122 (5 )
owned life insurance (4.1 %)
Net gains on sales and calls of - 1 (1 )
available-for-sale securities (100.0 %)
Net gains on disposition of other assets 12 - 12 100.0 %
Net gains on rabbi trust assets 74 - 74 100.0 %
Referral fees 86 - 86 100.0 %
Other 8 15 (7 ) (46.7 %)
Total noninterest income $ 2,286 $ 1,200 $ 1,086 90.5 %
Nine Months Ended
September 30, 2020 September 30, 2019 $ Change % Change
Trust management 615 621 (6 ) (1.0 %)
Service charges and fees on deposit 529 727 (198 )
accounts (27.2 %)
Wealth management 824 654 170 26.0 %
Interchange fees, net 378 330 48 14.5 %
Other service charges and fees 94 88 6 6.8 %
Secondary market sales and servicing 2,015 632 1,383 218.8 %
Increase in cash surrender value of bank 351 362 (11 )
owned life insurance (3.0 %)
Net gains (losses) on sales and calls of 29 (1 ) 30
available-for-sale securities n/m
Net gains (losses) on disposition of 5 (2 ) 7 n/m
other assets
Net (losses) gains on rabbi trust assets (76 ) 130 (206 ) (158.5 %)
Referral fees 1,052 - 1,052 100.0 %
Other 54 44 10 22.7 %
Total noninterest income $ 5,870 $ 3,585 $ 2,285 63.7 %
Higher noninterest income in the three months ended September 30, 2020 , compared
to the three months ended September 30, 2019 , was primarily due to higher
secondary market sales and servicing income of $789 thousand , driven by an
increase in the demand for purchase money and refinance mortgages, and higher
wealth management fee income of $165 thousand . Additionally, the third quarter
of 2020 included $86 thousand of fee income for referring loan customers to a
third-party financial institution to execute interest rate swaps, while the
third quarter of 2019 included no income from such activities. Referral fees are
earned at the consummation of the swap transaction on a loan-by-loan bases. The
amount earned per transaction is based on the pricing of the particular interest
rate swap. Partially offsetting these increases were lower service charges and
fees on deposit accounts in the third quarter of 2020 of $88 thousand , primarily
due to a lower volume of fee-based deposit transactions.
Higher noninterest income in the nine months ended September 30, 2020 , compared
to the nine months ended September 30, 2019 , was primarily attributable to $1.1
million 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 nine months of 2020 period
included higher secondary market sales and servicing income of approximately
$1.4 million , due to the previously stated reasons. Partially offsetting these
increases was a $76 thousand net unrealized loss in the 2020 period compared to
a $130 thousand net unrealized gain in the 2019 period on rabbi trust assets
held 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.
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Three Months Ended
September 30, 2020 September 30, 2019 $ Change % Change
Salaries and employee benefits $ 3,801 $ 3,666 $ 135 3.7 %
Occupancy 700 805 (105 ) (13.0 %)
Data processing 491 541 (50 ) (9.2 %)
Bank franchise tax 256 209 47 22.5 %
Telecommunications and other technology 396 258 138 53.5 %
FDIC assessments 262 (7 ) 269 n/m
Foreclosed property 22 48 (26 ) (54.2 %)
Consulting 54 156 (102 ) (65.4 %)
Advertising and marketing 47 124 (77 ) (62.1 %)
Directors' fees 187 148 39 26.4 %
Audit and accounting 92 193 (101 ) (52.3 %)
Legal (210 ) 20 (230 ) n/m
Core deposit intangible amortization 134 164 (30 ) (18.3 %)
Net other real estate owned losses 176 375 (199 ) (53.1 %)
Merger-related 1,456 - 1,456 100.0 %
Other 782 747 35 4.7 %
Total noninterest expense $ 8,646 $ 7,447 $ 1,199 16.1 %
Nine Months Ended
September 30, 2020 September 30, 2019 $ Change % Change
Salaries and employee benefits 11,267 11,532 (265 ) (2.3 %)
Occupancy 2,156 2,510 (354 ) (14.1 %)
Data processing 1,526 1,738 (212 ) (12.2 %)
Bank franchise tax 770 655 115 17.6 %
Telecommunications and other technology 1,176 727 449 61.8 %
FDIC assessments 557 371 186 50.1 %
Foreclosed property 58 110 (52 ) (47.3 %)
Consulting 195 418 (223 ) (53.3 %)
Advertising and marketing 140 300 (160 ) (53.3 %)
Directors' fees 568 525 43 8.2 %
Audit and accounting 402 586 (184 ) (31.4 %)
Legal 135 130 5 3.8 %
Core deposit intangible amortization 425 517 (92 ) (17.8 %)
Net other real estate owned losses 256 441 (185 ) (42.0 %)
Goodwill impairment 10,374 - 10,374 100.0 %
Merger-related 1,456 - 1,456 100.0 %
Other 1,947 2,108 (161 ) (7.6 %)
Total noninterest expense $ 33,408 $ 22,668 $ 10,740 47.4 %
Higher noninterest expense in the three months ended September 30, 2020 ,
compared to the three months ended September 30, 2019 , was primarily
attributable to merger-related expenses of $1.5 million incurred in connection
with the anticipated Blue Ridge Merger , expected to close in the first quarter
of 2021. Of the $1.5 million of merger-related expenses reported in the three
months ended September 30, 2020 , $226 thousand was previously reported as legal
expense in the Company's Forms 10-Q for the periods ended March 31, 2020 and
June 30, 2020 and reclassified as merger-related for the three and nine months
ended September 30, 2020 , resulting in the $210 thousand credit to legal
expense. Excluding the $1.5 million in merger-related expenses and the
associated reclassification of legal expense, noninterest expenses decreased
$483 thousand , or 6.5%, on a comparative period basis. This decline was
primarily due to the Company's efforts to reduce operating costs, including the
consolidation of a branch in the first quarter of 2020, partially offset by
higher Federal Deposit Insurance Corporation ("FDIC") assessments in the 2020
period, as the 2019 period included a small bank assessment credit of $171
thousand .
Higher noninterest expense in the nine months ended September 30, 2020 , compared
to the nine months ended September 30, 2019 , was primarily attributable to a
goodwill impairment charge of $10.4 million in the second quarter of 2020 and
$1.5 million in merger-related expenses. Excluding the goodwill impairment
charge and merger-related expenses, noninterest expenses decreased $1.1 million
in the first nine months of 2020, or 4.8%, on a comparative period basis. Lower
noninterest expense in a number of categories
37
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was partially offset by higher telecommunications and other technology expenses
and higher FDIC assessments in the 2020 period, as the 2019 period included the
small bank FDIC assessment credit, as noted previously.
The following table presents income tax expense and effective income tax rates
for the periods presented.
Three Months Ended Nine Months Ended
September 30, 2020 September 30, 2019 September 30, 2020 September 30, 2019
Income tax expense $ 655 $ 448 $ 378 $ 1,180
Effective income
tax rate 30.5 % 19.6 % 6.0 % 18.9 %
The effective income tax rate for the three months ended September 30, 2020 was
higher than the statutory federal income tax rate of 21% primarily as a result
of nondeductible expenses incurred in connection with the anticipated Blue Ridge
Merger . Income tax expense and the effective income tax rate for the nine months
ended September 30, 2020 were a result of income tax expense before the goodwill
impairment charge of $10.4 million , partially offset by an income tax benefit
for the reversal of a related deferred tax liability, and the effect of
nondeductible Blue Ridge Merger -related expenses.
ASSET QUALITY
Net loans charged-off (recovered) during the third quarter of 2020 totaled($23) thousand compared to$478 thousand for the third quarter of 2019. This resulted in a decrease in the annualized net charge-off (recovery) ratio to (0.01%) for the third quarter of 2020 compared to 0.21% for the third quarter of 2019. For the nine months endedSeptember 30, 2020 , the annualized net charge-off ratio was 0.14% compared to 0.19% for the similar 2019 period. The higher net charge-off 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 1.22% as ofSeptember 30, 2020 compared to 0.82% as ofDecember 31, 2019 , an increase of 40 basis points. The majority of this increase is attributable to qualitative loss factors to provide for losses estimated to have been incurred as ofSeptember 30, 2020 , as a result of challenges certain borrowers are facing due to the COVID-19 pandemic, evidenced, in part, by loan deferrals and modifications granted to these borrowers, general reserves for higher unemployment rates in the 2020 period, particularly inVirginia , and higher specific reserves on impaired loans. 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. 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. During the third quarter of 2020, an additional$4.7 million of loans were downgraded from pass grades to special mention or substandard. 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. From the onset of the global COVID-19 pandemic, the Company has proactively addressed the needs of its commercial and individual borrowers by modifying loans allowing for the short-term deferral of principal payments or of principal and interest payments. All loan modifications were made on a good faith basis to borrowers who were current in their payments prior to the modifications ("COVID-19 Loan Modifications"). COVID-19 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 following table presents, as ofSeptember 30, 2020 , the loan balances and number by loan type and the percentage these loans comprise within each loan type for which COVID-19 Loan Modifications were made. Of the following balances,$39.5 million were to borrowers in the hotel/motel industry,$18.6 million were to borrowers in the restaurant and restaurant-related industry, and$9.3 million were to borrowers in the retail industry. Loan Count Principal Balance % of Loan Type Mortgage loans on real estate: Residential first mortgages 14 $ 2,886 1% Commercial mortgages (non-owner occupied) 23 47,102 17% Construction, land and land development 13 22,879 17% Commercial mortgages (owner occupied) 17 10,520 14% Residential revolving and junior mortgages 1 257 1% Commercial and industrial 87 17,575 9% Consumer 2 8 0% Total 157 $ 101,227 10% 38
-------------------------------------------------------------------------------- As ofOctober 31, 2020 ,$63.8 million of the$101.2 million of loan balances in the table above reached the end of their respective modification periods and had resumed their original contractually scheduled payments. The following table presents certain asset quality measures as of the dates stated. September 30, 2020 December 31, 2019 Loans past due 90 days or more and still accruing (1) $ - $ - Nonaccrual loans (1) 17,198 4,476 Total nonperforming loans 17,198 4,476 Other real estate owned, net 1,113 1,916 Total nonperforming assets $ 18,311 $ 6,392 Allowance for loan losses $ 12,899 $ 7,562 Gross loans 1,054,610 924,190 Total assets 1,251,582 1,131,923 Allowance for loan losses to gross loans 1.22 % 0.82 % Allowance for loan losses to nonperforming loans 75.0 % 168.9 % Nonperforming assets to total assets 1.46 % 0.56 % Nonperforming loans to gross loans 1.63 % 0.48 % (1) Excludes PCI loans. The increase in nonperforming assets fromDecember 31, 2019 toSeptember 30, 2020 was primarily attributable to$12.7 million of higher nonaccrual loan balances, mainly commercial and industrial loans and commercial mortgages (non-owner occupied) to borrowers adversely affected by the COVID-19 pandemic. Of the increase in nonaccrual loan balances,$5.7 million was attributable to nationally-syndicated commercial credits to companies in which the Bank owns a small percentage of the respective loans. The$5.7 million of loans were contractually current as ofSeptember 30, 2020 ; however, the borrowers are experiencing financial strain and the loans were individually evaluated for impairment. As a result, a total of$745 thousand of specific reserves was recorded as of and for the nine months endedSeptember 30, 2020 for these loans. Another$5.6 million of the increase in nonaccrual loans was attributable to commercial mortgages (non-owner occupied) to borrowers in the hotel and retail landlord industries, industries adversely affected by the COVID-19 pandemic. While these loans were contractually current as ofSeptember 30, 2020 , management believes future debt service capabilities of the borrowers have been negatively affected by lower occupancy rates and the loans were individually evaluated for impairment. As a result, specific reserves totaling$593 thousand were recorded as of and for the nine months endedSeptember 30, 2020 for these loans. FINANCIAL CONDITION
Total assets increased by
The following tables present information about the securities portfolio on a taxable-equivalent basis as of the dates stated. As ofSeptember 30, 2020 andDecember 31, 2019 , available-for-sale securities represented 7.0% and 8.8% of total assets, respectively. September 30, 2020 Weighted Average Life in Weighted Amortized Cost Fair Value Years Average YieldU.S. Government agencies and mortgage backed securities$ 47,598 $ 48,870 5.1 2.00 % State and municipal obligations 18,116 18,846 4.8 3.04 % Corporate bonds 20,154 20,137 6.0 5.18 % Total available-for-sale securities 85,868 87,853 5.3 2.80 % Restricted securities 5,022 5,022 n/a 4.98 % Total securities$ 90,890 $ 92,875 2.91 % 39
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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.
September 30, 2020 December 31, 2019
Amount Percent of Total Amount Percent of Total
Mortgage loans on real estate:
Residential first mortgages $ 286,127 27.2 % $ 293,913 31.8 %
Commercial mortgages (non-owner
occupied) 282,378 26.7 % 196,143 21.2 %
Construction, land and land
development 132,502 12.5 % 126,010 13.6 %
Commercial mortgages (owner
occupied) 76,225 7.2 % 82,829 9.0 %
Residential revolving and junior
mortgages 29,051 2.7 % 31,893 3.4 %
Commercial and industrial 187,219 17.6 % 181,730 19.7 %
Paycheck Protection Program 56,788 5.4 % - 0.0 %
Consumer 6,443 0.7 % 11,985 1.3 %
Total loans 1,056,733 100.0 % 924,503 100.0 %
Net unamortized deferred loan fees (2,123 ) (313 )
Allowance for loan losses (12,899 ) (7,562 )
Loans receivable, net $ 1,041,711 $ 916,628
During the nine months ended September 30, 2020 , gross loans increased by $130.4
million , or 14.1%, from December 31, 2019 . The largest components of this
increase were a $86.2 million increase in commercial mortgages (non-owner
occupied) and $56.8 million of PPP loans originated in the second and third
quarters of 2020. Net unamortized deferred loan fees increased approximately
$1.8 million during the first nine months of 2020, primarily attributable to
$2.4 million of PPP loan processing fees received, of which $532 thousand was
recognized in interest income in the same 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.
September 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 $ 9,587 76.3 % $ 5,372 79.0 %
Commercial and industrial 2,889 17.6 % 1,571 19.7 %
Paycheck Protection Program - 5.4 % - 0.0 %
Consumer 423 0.7 % 619 1.3 %
Total allowance for loan losses $ 12,899 100.0 % $ 7,562 100.0 %
Allowance for loan losses increased $5.3 million from December 31, 2019 to $12.9
million as of September 30, 2020 . The majority of the increase in the first nine
months of 2020 was due to qualitative loss factors to estimate the reserve
needs, as of period end, for borrowers adversely impacted by the COVID-19
pandemic, including those for which loan payments have been deferred and/or
modified. Also contributing to the increase in the allowance for loan losses in
the 2020 period was gross loan growth (excluding PPP loans) and higher specific
reserves on impaired loans. Due to the full U.S. government guarantee on PPP
loans, the Company has recorded no allowance for loan losses. In future periods,
the Company may be required to establish an allowance for loan losses for these
loans, if, for example, the U.S. government were to eliminate or reduce the
guarantee on individual or groups of PPP loans, which would result in a
provision for loan losses charged to earnings.
As of
40
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As of September 30, 2020 , total deposits were $1.03 billion compared to
$910.4 million as of December 31, 2019 , a $117.2 million increase. Of the
increase, $52.9 million was attributable to higher noninterest-bearing deposit
account balances, and $41.4 million was attributable to savings and
interest-bearing demand deposit accounts, 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 $ 91,632 $ 31,254 $ 46,697 $ 100,295 $ 269,878 26.3 %
As of September 30, 2020 , the Company had two fixed rate FHLB advances totaling
of $15.0 million and one variable rate FHLB advance totaling $10.0 million
outstanding. As of December 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 third quarter of 2020, the Company
accessed the Federal Reserve Bank of Richmond's ("FRB") PPP Liquidity Facility
("PPPLF"), which provides funding for PPP loans at a fixed annual rate of 35
basis points over the term the funded PPP loan is outstanding. PPP loans
securing the PPPLF are afforded preferential regulatory capital treatment. As of
September 30, 2020 the Company had PPPLF advances totaling $32.6 million . The
following table presents various information regarding FHLB and FRB advances as
of and for the periods presented.
Nine Months Ended September 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 $ 25,000 $ 50,000 $ 37,354 1.34 % $ 45,000 $ 100,000 $ 76,181 2.74 %
FRB advances 32,637 33,557 18,492 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 of September 30, 2020 , cash and cash equivalents totaled $59.4 million ;
investment securities maturing in one year or less totaled $10.6 million ; and
loans maturing in one year or less totaled $110.0 million . This resulted in a
liquidity ratio as of September 30, 2020 of 14.4% compared to 21.5% as of
December 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 of September 30, 2020 , the Company had a secured borrowing line with the FHLB
of $308.4 million , with $252.4 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 additional PPP loans, was approximately $24.2 million , as
of September 30, 2020 .
As of September 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 of September 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 $120.2 million as of September 30, 2020
compared to $126.1 million as of December 31, 2019 . The decrease of $5.9 million
was primarily attributable to the ($6.6) million net loss for the nine months
ended September 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 September 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 $9.10 as of September 30, 2020
from $9.51 as of December 31, 2019 . This decrease was primarily attributable to
the net loss of ($6.6) million for the nine months ended September 30, 2020 ,
which included the goodwill impairment charge.
The Company and the Bank are subject to minimum regulatory capital ratios as
defined by the Federal Reserve . As of September 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 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%), and (iii) a minimum ratio of total
capital ratio of at least 8.0%, plus the 2.5% capital conservation buffer
(resulting in a minimum total capital ratio of 10.5%). 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 September 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 September 30, 2020 Ratio with Conservation Buffer Capitalized
Total risk-based capital 13.68 % 10.50 % 10.00 %
Tier 1 capital 12.43 % 8.50 % 8.00 %
Common equity tier 1 12.43 % 7.00 % 6.50 %
Tier 1 leverage ratio 10.47 % 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.
42
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The following table presents off balance sheet commitments as of the dates
stated.
September 30, 2020 December 31, 2019
Total loan commitments outstanding $ 172,304 $ 164,751
Stand-by letters of credit 6,778 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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