GUARANTY FEDERAL BANCSHARES, INC. GENERAL
The primary activity of the Company is to oversee its investment in the Bank. The Company engages in few other activities, and the Company has no significant assets other than its investment in the Bank. For this reason, unless otherwise specified, references to the Company include the operations of the Bank. The Company's principal business consists of attracting deposits from the general public and using such deposits to originate multi-family, construction, agriculture,Small Business Administration ("SBA"), commercial real estate loans, mortgage loans secured by one- to four-family residences, and consumer and business loans. The Company also uses these funds to purchase government sponsored mortgage-backed securities, US government and agency obligations, and other permissible securities. When cash outflows exceed inflows, the Company uses borrowings and brokered deposits as additional financing sources. The Company derives revenues principally from interest earned on loans and investments and, to a lesser extent, from fees charged for services. General economic conditions and policies of the financial institution regulatory agencies, including theMissouri Division of Finance ("MDF") and theFederal Deposit Insurance Corporation ("FDIC"), significantly influence the Company's operations. Interest rates on competing investments and general market interest rates influence the Company's cost of funds. Lending activities are affected by the interest rates at which such financing may be offered. The Company intends to focus on commercial, one- to four-family residential and consumer lending throughout southwesternMissouri . The Company has one active wholly-owned subsidiary other than the Bank: Guaranty Statutory Trust II, aDelaware statutory trust. Guaranty Statutory Trust II was formed inDecember 2005 . The exclusive purpose of the Trust was issuing trust preferred securities to acquire junior subordinated debentures issued by the Company. The Company's banking operation conducted through the Bank is the Company's only reportable segment. See also the discussion contained in the section captioned "Segment Information" in Note 1 of the Notes to Consolidated Financial Statements in this report. A second subsidiary is a service corporation which has been inactive sinceFebruary 1, 2003 . FORWARD-LOOKING STATEMENTS The Company may from time to time make written or oral "forward-looking statements", including statements contained in the Company's filings with theSecurities and Exchange Commission (including this Annual Report on Form 10-K and the exhibits thereto), in its reports to stockholders and in other communications by the Company, which are made in good faith by the Company pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. When used in this Annual Report on Form 10-K, words such as "anticipates," "estimates," "believes," "expects," and similar expressions are intended to identify such forward-looking statements but are not the exclusive means of identifying such statements. 48 -------------------------------------------------------------------------------- These forward-looking statements involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations, estimates and intentions that are subject to change based on various important factors (some of which are beyond the Company's control). The following factors, among others, could cause the Company's financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the severity, magnitude and duration of COVID-19 and the direct and indirect impact of COVID-19, as well as responses to COVID-19 by the government, businesses and consumers; the disruption of global, national, state and local economies associated with COVID-19; the strength ofthe United States economy in general and the strength of the real estate values and the local economies in which the Company conducts operations; future mergers or acquisitions; the impact of recent and potential future changes in the laws, rules, regulations, interpretations and policies relating to financial institutions, accounting, tax, monetary and fiscal matters and their application by our regulators; the effects of, and changes in, trade, monetary and fiscal policies and laws, changes in interest rates; changes in LIBOR; the impact of the possible elimination of LIBOR and resultant transition to a new benchmark; the timely development of and acceptance of new products and services of the company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors' products and services; the impact of changes in financial services' laws and regulations (including laws concerning taxes, banking, securities and insurance); asset quality deterioration; environmental liability associated with real estate collateral; technological changes and cybersecurity risks; acquisitions; employee retention; the success of the Company at managing the risks resulting from these factors; and other factors set forth in reports and other documents filed by the Company with theSEC from time to time. For further information about these and other risks, uncertainties and factors, please review the disclosure included in Item 1A. "Risk Factors" of this report. The Company cautions that the listed factors are not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.
Impacts from COVID-19 on Our Financial Statements and Results of Operations
The spread of the COVID-19 pandemic has created a global public health crisis that has resulted in unprecedented uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity inthe United States , including the markets that we serve. Governmental responses to the pandemic have included orders closing businesses not deemed essential and directing individuals to restrict their movements, observe social distancing and shelter in place. These actions, together with responses to the pandemic by businesses and individuals, have resulted in rapid decreases in commercial and consumer activity, temporary closures of many businesses that have led to a loss of revenues and a rapid increase in unemployment, disrupted supply chains, market downturns and volatility, changes in consumer behavior related to pandemic fears, related emergency response legislation. Financial Impacts to the Bank: The markets in which we operate continue to be impacted by the ongoing effects of the COVID-19 pandemic, both by the effects of ongoing infections and changing community health guidelines. These effects may have a material impact on our financial condition and results of operations. Due to segments of our loan portfolio experiencing weakness as a result of COVID-19-related economic slowdowns and travel restrictions, we recorded a significant increase in our provision for loan losses in 2020. The provision for loan losses during 2021 totaled$800,000 , compared to$3,600,000 for 2020. While the Company has seen overall improvements in 2021, we expect to continue working with impacted customers on a case-by-case basis based on their specific circumstances. Market interest rates have declined significantly and these reductions, have adversely affected and if prolonged, could continue to adversely affect our net interest income, net interest margin and overall earnings. Paycheck Protection Program (PPP) Activity: In response to COVID-19, the Federal government approved various stimulus packages to assist small businesses, individuals, health care entities, education systems and certain governmental entities. One of the most notable programs was the Coronavirus Aid, Relief and Economic Security (CARES) Act which initially made over$600 billion in funds available in 2020 to small businesses throughSmall Business Administration (SBA) PPP loans that, based on certain qualifications, provided funds to qualified borrowers for payroll and certain other costs with portions or all of such loans potentially forgiven if used on certain expenses and provided other criteria were met. In lateDecember 2020 , an additional$284 billion in PPP funds was approved for eligible entities based on certain qualifications. The PPP funding programs were heavily utilized by businesses leading to robust activity at many financial institutions. The Bank approved and funded 661 PPP loans during 2020 totaling$55.1 million and impacting nearly 8,400 jobs in the communities we serve. The Bank approved and funded 366 PPP loans totaling$18.2 million during the first half of 2021 in the second round of funding. As ofDecember 31, 2021 ,$1.3 million in PPP loans were included in the commercial loan portfolio. As ofDecember 31, 2021 , PPP loans totaling$72.2 million had already been granted forgiveness by the SBA. The Bank is continually monitoring regulatory guidelines that will impact PPP loans that we are involved with along with any additional governmental programs that could materially impact our customers and the Bank's financial situation. Market Volatility Risk: As noted herein, the COVID-19 pandemic has led to disruption and volatility in the global capital markets. These conditions may require us to recognize an elevated level of other than temporary impairments on investment securities in our portfolio as issues of these securities are negatively impacted by the economic slowdown. Declines in fair value of investment securities in our portfolio could also reduce the unrealized
gains reported as part of our consolidated comprehensive income.
Loan Modifications: As previously mentioned, increased loan payment deferrals and other loan modifications have adversely impacted, and we expect that they will continue to adversely impact, the performance of our loan portfolio. Based on guidance by federal banking regulators, theSecurities and Exchange Commission (SEC), theFinancial Accounting Standards Board (FASB) and provisions within the CARES Act, short-term loan modifications made in response to COVID-19 to borrowers with a current payment status are not to be considered troubled debt restructurings (TDRs) for reporting purposes. As ofDecember 31, 2021 , the Company did not have any loans remaining modified in response to COVID-19 compared to 20 loans with an aggregate balance of$28.6 million atDecember 31, 2020 . All loans that were previous modified have returned to their pre-established contractual payment terms. 49 --------------------------------------------------------------------------------
FINANCIAL CONDITION FromDecember 31, 2020 toDecember 31, 2021 , the Company's total assets increased$26,657,365 (2%) to$1,172,910,304 , liabilities increased$18,161,600 (2%) to$1,075,446,173 , and stockholders' equity increased$8,495,765 (10%) to$97,464,131 . The ratio of stockholders' equity to total assets was 8.3% and 7.8% atDecember 31, 2021 and 2020, respectively. FromDecember 31, 2020 toDecember 31, 2021 , available-for-sale securities decreased$12,718,371 (8%). DuringSeptember 2021 , the Company executed a de-leveraging transaction utilizing the proceeds from the sale of$43 million in investment securities and$7 million of excess cash to terminate an interest rate swap and pay off$50 million in higher-cost FHLB advances. The$2.7 million of gains recognized on the investment sales were used to offset the prepayment loss on the interest rate swap of$2.6 million . During 2021, the Company purchased$77,446,328 of investments while having sales, calls and principal payments received of$88,209,689 . The Company had net unrealized gains of$517,286 atDecember 31, 2021 compared to net unrealized gains of$4,871,052 atDecember 31, 2020 . FromDecember 31, 2020 toDecember 31, 2021 , net loans receivable increased by$69,363,341 (9%) to$811,512,612 . During the year, commercial real estate loans increased$75,446,000 (25%), construction loans increased$54,001,000 (76%), commercial business loans decreased$28,532,000 (20%), multi-family loans decreased$13,464,000 (15%), permanent 1-4 family loans decreased$13,008,000 (11%) and consumer and other loans decreased$5,266,000 (20%). Commercial business loans decreased during the year primarily due to the forgiveness and repayment of approximately$35,954,000 in PPP loans, net of new PPP originations in 2021. The Company continues to focus its lending efforts in the commercial and small business lending categories. As ofDecember 31, 2021 , management identified loans totaling$10,008,000 as impaired with a related allowance for loan losses of$851,000 . Impaired loans decreased by$9,006,000 during 2021, compared to the balance of$19,014,000 atDecember 31, 2020 . The decrease was primarily due to the result of one larger relationship paying off during the year for$4,092,000 and a second relationship with reductions in balances of$3,343,000 during 2021. FromDecember 31, 2020 toDecember 31, 2021 , the allowance for loan losses increased$971,538 (10%) to$10,588,562 . In addition to the provision for loan losses of$800,000 recorded by the Company during the year endedDecember 31, 2021 , loan recoveries of specific loans (previously classified as nonperforming) exceeded charge-offs by$171,537 for the year endedDecember 31, 2021 . The expense recognized primarily relates to loan portfolio growth, offset by reductions in non-performing loans, delinquent loans and loans impacted by COVID-19. The allowance for loan losses, as a percentage of gross loans outstanding (excluding mortgage loans held for sale), as ofDecember 31, 2021 andDecember 31, 2020 was 1.29% and 1.28%, respectively. The allowance for loan losses, as a percentage of nonperforming loans outstanding, as ofDecember 31, 2021 andDecember 31, 2020 was 108.9% and 51.6%, respectively. Management believes the allowance for loan losses is at a level to be sufficient in providing for potential loan losses in the Bank's existing loan portfolio. FromDecember 31, 2020 toDecember 31, 2021 , deposits increased$77,646,214 (8%) to$1,016,318,755 . Checking and savings transaction balances increased by$117,746,481 (16%) and certificates of deposit decreased by$40,100,267 (22%). The increase in transaction balances was primarily due to the addition of new public fund customers and increased balances from nearly all depositor groups during 2021.Federal Home Loan Bank advances decreased$50,000,000 (76%) from$66,000,000 as ofDecember 31, 2020 to$16,000,000 as ofDecember 31, 2021 . The decrease was due to the full repayment inSeptember 2021 of short-term fixed rate advances that were due inNovember 2021 . Subordinated debentures issued to Capital Trusts decreased$5,155,000 (33%) due to the full redemption inMay 2021 of fixed rate junior subordinated debt securities that were due in 2036. These securities were originally issued in conjunction with an offering of trust preferred securities during 2005. FromDecember 31, 2020 toDecember 31, 2021 , stockholders' equity (including accumulated comprehensive loss, net of tax) increased$8,495,765 (10%) to$97,464,131 . Net income for the year endedDecember 31, 2021 exceeded dividends paid or declared by$8,007,492 . The equity portion of the Company's unrealized losses on available-for-sale securities and effects of interest rate swaps decreased by$2,951 during 2021. On a per common share basis, stockholders' equity increased from$20.51 as ofDecember 31, 2020 to$22.42 as ofDecember 31, 2021 . 50
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AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS
The following table shows the balances as ofDecember 31, 2021 of various categories of interest-earning assets and interest-bearing liabilities and the corresponding yields and costs, and, for the periods indicated: (1) the average balances of various categories of interest-earning assets and interest-bearing liabilities, (2) the total interest earned or paid thereon, and (3) the resulting weighted average yields and costs. In addition, the table shows the Company's rate spreads and net yields. Average balances are based on daily balances. Tax-free income is not material; accordingly, interest income and related average yields have not been calculated on a tax equivalent basis. Average loan balances include non-accrual loans. Dollar amounts are expressed in thousands. Year Ended Year Ended December 31, 2021 December 31, 2020 Average Yield / Average Yield / Balance Interest Cost Balance Interest Cost ASSETS Interest-earning: Loans$ 791,355 $ 36,381 4.60 %$ 764,707 $ 36,226 4.74 % Investment securities 175,381 4,352 2.48 % 143,380 3,843 2.68 % Other assets 163,547 462 0.28 % 112,333 801 0.71 % Total interest-earning 1,130,283 41,195 3.64 % 1,020,420 40,870 4.01 % Noninterest-earning 73,339 71,326$ 1,203,622 $ 1,091,746 LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing: Savings accounts$ 56,652 $ 70 0.12 %$ 45,894 $ 79 0.17 % Transaction accounts 551,323 1,809 0.33 % 511,357 2,949 0.58 % Certificates of deposit 163,148 2,131 1.31 % 192,412 3,897 2.03 % FHLB advances 53,263 889 1.67 % 60,467 1,178 1.95 % Subordinated debentures issued to Capital Trusts 12,428 569 4.58 % 15,465 785 5.08 % Subordinated notes, net 19,585 1,050 5.36 % 8,238 443 5.38 % Other borrowed funds 558 7 1.25 % 6,599 280 4.24 % Total interest-bearing 856,957 6,525 0.76 % 840,432 9,611 1.14 % Noninterest-bearing 252,839 164,302 Total liabilities 1,109,796 1,004,734 Stockholders' equity 93,826 87,012$ 1,203,622 $ 1,091,746 Net earning balance$ 273,326 $ 179,988 Earning yield less costing rate 2.88 % 2.86 % Net interest income, and net yield spread on interest-earning assets$ 34,670 3.07 %$ 31,259 3.06 % Ratio of interest-earning assets to interest-bearing liabilities 132 % 121 % 51
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The following table sets forth information regarding changes in interest income
and interest expense for the periods indicated resulting from changes in average
balances and average rates shown in the previous table. For each category of
interest-earning assets and interest-bearing liabilities information is provided
with respect to changes attributable to: (i) changes in balance (change in
balance multiplied by the old rate), (ii) changes in interest rates (change in
rate multiplied by the old balance); and (iii) the combined effect of changes in
balance and interest rates (change in balance multiplied by change in rate).
Dollar amounts are expressed in thousands.
Year ended Year ended
December 31, 2021 versus December 31, 2020 December 31, 2020 versus December 31, 2019
Average Interest Rate & Average Interest Rate &
Balance Rate Balance Total Balance Rate Balance Total
Interest income:
Loans $ 1,262 $ (1,070 ) $ (37 ) $ 155 $ 138 $ (5,129 ) $ (17 ) $ (5,008 )
Investment
securities 858 (285 ) (64 ) 509 1,239 (130 ) (58 ) 1,051
Other assets 365 (484 ) (220 ) (339 ) 1,253 (809 ) (844 ) (400 )
Net change in
interest income 2,485 (1,839 ) (321 ) 325 2,630 (6,068 ) (919 ) (4,357 )
Interest expense:
Savings accounts 19 (23 ) (5 ) (9 ) 17 (51 ) (7 ) (41 )
Transaction
accounts 230 (1,271 ) (99 ) (1,140 ) 983 (3,602 ) (576 ) (3,195 ) Certificates of deposit (593 ) (1,384 ) 211 (1,766 ) (762 ) (81 ) 13 (830 ) FHLB advances (140 ) (169 ) 20 (289 ) 168 (169 ) (24 ) (25 ) Subordinated debentures issued to Capital Trusts (154 ) (77 ) 15 (216 ) (189 ) 5 (1 ) (185 )
Subordinated
notes, net 610 (1 ) (2 ) 607 - - 443 443 Other borrowed funds (256 ) (197 ) 180 (273 ) (63 ) (34 ) 6 (91 ) Net change in interest expense (284 ) (3,122 ) 320 (3,086 ) 154 (3,932 ) (146 ) (3,924 )
Change in net
interest income
RESULTS OF OPERATIONS - COMPARISON OF YEAR ENDEDDECEMBER 31, 2021 ANDDECEMBER 31, 2020 Interest Rates Average for the Year Shown Ten-Year One-Year Prime Treasury Treasury December 31, 2021 3.25 % 1.45 % 0.10 % December 31, 2020 3.54 % 0.89 % 0.37 % Change in rates -0.29 % 0.56 % -0.27 % The Bank charges borrowers and pays depositors interest rates that are largely a function of the general level of interest rates. The above table sets forth the weekly average interest rates for the 52 weeks endingDecember 31, 2021 andDecember 31, 2020 as reported by theFederal Reserve . The Bank typically indexes its adjustable rate commercial loans to prime and its adjustable rate mortgage loans to the one-year Treasury Rate. The ten-year Treasury Rate is a proxy for 30-year fixed rate home mortgage loans. Interest Income. Total interest income increased$325,474 (1%). A decline in key interest rates over the past year compressed yields on new and existing earning assets and negatively impacted the yields. The average balance of interest-earning assets increased$109,863,000 (11%), while the yield on average interest earning assets decreased 37 basis points to 3.64%. 52 -------------------------------------------------------------------------------- Interest income on loans increased$154,974 (less than 1%). The slight increase was due to increased loan balances and$1,911,000 of loan fees recognized from the origination and forgiveness of PPP loans (compared to$1,120,000 in 2020). Offsetting these increases was the lower offering rates on new and renewing credits. The average balance of loans increased$26,648,000 (3%) in 2021, while the average yield decreased 14 basis points to 4.60%. Pricing on loans continues to be challenging due to significant competition on new and renewing credits and the low rate environment. Interest Expense. Total interest expense decreased$3,086,247 (32%). The decrease was primarily driven by lower rates across all deposit products due to the previously mentionedFOMC action to cut benchmark interest rates inMarch 2020 . The average balance of interest-bearing liabilities increased$16,525,000 (2%) despite the average cost of interest-bearing liabilities decreasing 38 basis points to 0.76% as many customers maintained elevated cash balances during the year. Specifically, interest expense on deposits decreased$2,914,510 (42%) during 2021 as the average balance of interest-bearing deposits increased$21,460,000 (3%), while the average interest rate paid to depositors decreased 40 basis points to 0.52%. To fund its asset growth going forward, the Company intends to continue to utilize a cost-effective mix of retail and commercial core deposits along with non-core, wholesale funding (including brokered and internet deposits when deemed appropriate). Interest expense on FHLB advances decreased$288,816 (25%) during 2021 as the average balance of advances decreased$7,204,000 (12%), while the average interest rate paid on the advances decreased 28 basis points to 1.67%. The lower average amount of borrowings with FHLB was due to full repayment of$50,000,000 inSeptember 2021 of short-term fixed rate advances that were due inNovember 2021 . Interest expense on subordinated debentures and notes increased$390,904 (32%) during 2021 as the Company issued$20.0 million of Notes during the third quarter of 2020. These Notes carry a fixed rate of 5.25% with proceeds being used to pay off an existing line of credit and note payable with another financial institution. Partially offsetting the increased interest expense from the Notes was a decrease of$272,737 (100%) experienced from the payoff of the note payable and line of credit items.
Net Interest Income. The Company's net interest income increased
Provision for Loan Losses. Provisions for loan losses are charged or credited to earnings to bring the total allowance for loan losses to a level considered adequate by the Company to provide for potential loan losses in the existing loan portfolio. When making its assessment, the Company considers prior loss experience, volume and type of lending, local banking trends and impaired and past due loans in the Company's loan portfolio. In addition, the Company considers general economic conditions and other factors related to collectability of the Company's loan portfolio. Based on its internal analysis and methodology, management recorded a provision for loan losses of$800,000 and$3,600,000 for the years endedDecember 31, 2021 and 2020, respectively. The expense amount was considered necessary primarily due to loan portfolio growth, offset by reductions in non-performing loans, delinquent loans and loans impacted by COVID-19. The Bank will continue to monitor its allowance for loan losses and make future additions based on economic and regulatory conditions. Management may need to increase the allowance for loan losses through charges to the provision for loan losses if anticipated growth in the Bank's loan portfolio increases or if other circumstances warrant. See further discussions of the allowance for loan losses under "Financial Condition" above. 53 -------------------------------------------------------------------------------- Although the Bank maintains its allowance for loan losses at a level which it considers to be sufficient to provide for potential loan losses in its existing loan portfolio, there can be no assurance that future loan losses will not exceed internal estimates. In addition, the amount of the allowance for loan losses is subject to review by regulatory agencies which can order the establishment of additional loan loss provisions. Non-Interest Income. Non-interest income increased$3,598,988 (36%) when compared to 2020. A significant portion of the change is due to an increase in gains recognized on available-for-sale securities of$2,279,312 (494%) due to the de-leveraged transaction discussed above, increased gains on sale of SBA loans of$1,329,521 (215%), increased service charges of$335,775 (23%) and increased gains from the sale of mortgage loans held for sale of$329,599 (9%).
The increases in non-interest income were partially offset by reduced fees from
commercial loan swap products of
Non-Interest Expense. Non-interest expense increased
A significant portion of the increase was due to the$2,580,000 (100%) prepayment loss recognized during the third quarter on the termination of an interest rate swap discussed further in Note 21 to the Consolidated Financial Statements.
One-time merger expenses of
Salaries and employee benefits increased$969,654 (6%) which was primarily due to the hiring of new commercial banking executive and relationship managers in the commercial banking area and increased commissions and incentives related to strong mortgage lending activity.FDIC insurance premiums increased$282,462 (90%) compared to 2020 primarily due to previously awarded credits completely offsetting fees in the beginning of 2020. Income Taxes. The provision for income taxes increased$1,444,607 (117%) from 2020 which was primarily due to the increase of pre-tax income compared to the prior year and effective tax rate from the reduced availability and utilization of various federal and state income tax credits. Cash Dividends Paid. The Company paid dividends of$0.15 per share onApril 15, 2021 to stockholders of record as ofMarch 26, 2021 ,$0.15 per share onJuly 16, 2021 , to stockholders of record as ofJune 25, 2021 , and$0.15 per share onOctober 22, 2021 , to stockholders of record as ofOctober 1, 2021 . The Company also declared a cash dividend of$0.15 per share onDecember 31, 2021 , which was paid onJanuary 21, 2022 , to stockholders of record onJanuary 11, 2021 . During 2021, 2020 and 2019, the Company paid$2,627,916 ,$2,615,028 and$2,313,661 in dividends on common stock. RESULTS OF OPERATIONS - COMPARISON OF YEAR ENDEDDECEMBER 31, 2020 ANDDECEMBER 31, 2019 Interest Rates Average for the Year Shown Ten-Year One-Year Prime Treasury Treasury December 31, 2020 3.54 % 0.89 % 0.37 % December 31, 2019 5.28 % 2.05 % 2.14 % Change in rates -1.74 % -1.16 % -1.77 % 54
-------------------------------------------------------------------------------- The Bank charges borrowers and pays depositors interest rates that are largely a function of the general level of interest rates. The above table sets forth the weekly average interest rates for the 52 weeks endingDecember 31, 2020 andDecember 31, 2019 as reported by theFederal Reserve . The Bank typically indexes its adjustable rate commercial loans to prime and its adjustable rate mortgage loans to the one-year Treasury Rate. The ten-year Treasury Rate is a proxy for 30-year fixed rate home mortgage loans. In response to an expected economic downturn due to COVID-19 impacts, the Federal Reserve Open Market Committee ("FOMC") decreased the discount rate by 150 basis points inMarch 2020 . Rates remained low for the remainder of 2020 with guidance from theFOMC that a lower rate environment will likely continue for the near future. As ofDecember 31, 2020 , the prime rate was 3.25% which is a 150 basis point decrease fromDecember 31, 2019 . Interest Income. Total interest income decreased$4,356,627 (10%). The decrease was primarily driven by lower interest rates on interest-earning assets and increased balances in cash and investment securities compared to the loan portfolio. The average balance of interest-earning assets increased$103,986,000 (11%), while the yield on average interest earning assets decreased 93 basis points to 4.01%. Interest income on loans decreased$5,007,727 (12%). The decrease was primarily due to lower loan offering rates on new credit, the repricing downward of existing adjustable rate loans and an influx of PPP loans added to the portfolio during the year at rates well below standard offering rates. Loan accretion income of$407,000 fell by 73% when compared to the 2019 amount of$1,489,000 as loans from our 2018 Hometown acquisition continued to pay off or amortize steadily during the year. Offsetting the decline in accretion income from purchased loans was$1,120,000 of fee income generated on PPP loan originations. The average balance of loans increased only$2,548,000 (less than 1%) in 2020, while the average yield decreased 67 basis points to 4.74%. Pricing on loans continues to be challenging due to significant competition on new and renewing credits. Interest Expense. Total interest expense decreased$3,923,813 (29%). The decrease was primarily driven by lower rates across all deposit products due to the previously mentionedFOMC action to cut benchmark interest rates inMarch 2020 . The average balance of interest-bearing liabilities increased$49,714,000 (6%) despite the average cost of interest-bearing liabilities decreasing 57 basis points to 1.14% as many customers maintained elevated cash balances during the year. Specifically, interest expense on deposits decreased$4,066,627 (37%) during 2020 as the average balance of interest-bearing deposits increased$39,156,000 (6%), while the average interest rate paid to depositors decreased 62 basis points to 0.93%. To fund its asset growth going forward, the Company intends to continue to utilize a cost-effective mix of retail and commercial core deposits along with non-core, wholesale funding (including brokered and internet deposits when deemed appropriate).
Interest expense on FHLB advances decreased
Interest expense on subordinated debentures and notes increased$258,142 (27%) during 2020 as the Company issued$20.0 million of Notes during the third quarter. These Notes carry a fixed rate of 5.25% with proceeds being used to pay off an existing line of credit and note payable with another financial institution. Partially offsetting the increased interest expense from the Notes was a decrease of$90,111 (24%) experienced from the payoff of the note payable and line of credit items.
Net Interest Income. The Company's net interest income decreased
55
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Provision for Loan Losses. Provisions for loan losses are charged or credited to
earnings to bring the total allowance for loan losses to a level considered
adequate by the Company to provide for potential loan losses in the existing
loan portfolio. When making its assessment, the Company considers prior loss
experience, volume and type of lending, local banking trends and impaired and
past due loans in the Company's loan portfolio. In addition, the Company
considers general economic conditions and other factors related to
collectability of the Company's loan portfolio.
Based on its internal analysis and methodology, management recorded a provision
for loan losses of $3,600,000 and $200,000 for the years ended December 31, 2020
and 2019, respectively. The Company's increase in the provision for loan losses
was primarily due to elevated risk of losses from loans to borrowers operating
in industries hardest hit by COVID-19 restrictions and maintaining general
portfolio reserves at a level deemed appropriate in accordance with its
methodology. The Bank will continue to monitor its allowance for loan losses and
make future additions based on economic and regulatory conditions. Management
may need to increase the allowance for loan losses through charges to the
provision for loan losses if anticipated growth in the Bank's loan portfolio
increases if COVID-19 continues to negatively impact the Market Area in which
our borrowers operate or other circumstances warrant. See further discussions of
the allowance for loan losses under "Financial Condition" above.
Although the Bank maintains its allowance for loan losses at a level which it
considers to be sufficient to provide for potential loan losses in its existing
loan portfolio, there can be no assurance that future loan losses will not
exceed internal estimates. In addition, the amount of the allowance for loan
losses is subject to review by regulatory agencies which can order the
establishment of additional loan loss provisions.
Non-Interest Income. Non-interest income increased $2,968,551 (42%) when
compared to 2019. Primary drivers leading to this increase were increased gains
on mortgage loans sold of $1,479,565 (67%) due to record volumes of refinance
activity, increased fees from a new commercial loan product of $1,148,681
(100%), a reduction in losses on foreclosed assets by $271,451 (115%) and
increased realized gains from the sale of investment securities of $371,465
(415%).
The increases in non-interest income were offset by reduced service charge
income of $237,277 (14%) due to lower fee-based transaction activity compared to
2019 and lower SBA lending income of $411,443 (40%) as a result of efforts to
fund SBA PPP loans taking precedence over typical SBA activity during periods of
2020.
Non-Interest Expense. Non-interest expense increased
Salaries and employee benefits increased
Data processing expenses increased
Income Taxes. The provision for income taxes decreased$447,980 (27%) from 2019 which was primarily due to the reduction of pre-tax income compared to the prior year. However, the overall effective tax rate did increase slightly during the year due to the reduction in federal and state income tax credits available. 56
-------------------------------------------------------------------------------- Cash Dividends Paid. The Company paid dividends of$0.15 per share onApril 17, 2020 to stockholders of record as ofApril 7, 2020 ,$0.15 per share onJuly 17, 2020 , to stockholders of record as ofJuly 7, 2020 , and$0.15 per share onOctober 16, 2020 , to stockholders of record as ofOctober 6, 2020 . The Company also declared a cash dividend of$0.15 per share onDecember 18, 2020 , which was paid onJanuary 15, 2021 , to stockholders of record onJanuary 5, 2021 . During 2020, 2019 and 2018, the Company paid$2,615,028 ,$2,313,661 and$2,132,221 in dividends on common stock. LIQUIDITY Liquidity refers to the ability to manage future cash flows to meet the needs of depositors and borrowers and fund operations. Maintaining appropriate levels of liquidity allows the Company to have sufficient funds available for customer demand for loans, withdrawal of deposit balances and maturities of deposits and other liabilities. The Company's primary sources of liquidity include cash and cash equivalents, available-for-sale securities, customer deposits and FHLB borrowings. The Company also has established a borrowing line with theFederal Reserve Bank which is considered a secondary source of funds. The Company's most liquid assets are cash and cash equivalents, which are cash on hand, amounts due from financial institutions, and certificates of deposit with other financial institutions that have an original maturity of three months or less. The levels of such assets are dependent on the Bank's operating, financing, and investment activities at any given time. The Company's cash and cash equivalents totaled$130,646,039 as ofDecember 31, 2021 and$148,422,908 as ofDecember 31, 2020 , representing a decrease of$17,776,869 (12%). The variations in levels of cash and cash equivalents are influenced by deposit flows and anticipated future deposit flows, which are subject to, and influenced by, many factors. The Bank has$110,871,794 in certificates of deposit that are scheduled to mature in one year or less. Management anticipates that the majority of these certificates will renew in the normal course of operations. Based on existing collateral as well as the FHLB's limitation of advances to 45% of assets, the Bank had the ability to borrow an additional$145,858,000 from the FHLB, as ofDecember 31, 2021 . Based on existing collateral, the Bank had the ability to borrow$57,185,000 from theFederal Reserve Bank as ofDecember 31, 2021 . The Bank plans to maintain itsFHLB andFederal Reserve Bank borrowings at a level that will provide a borrowing capacity sufficient to provide for contingencies. Management has many policies and controls in place to attempt to manage the appropriate level of liquidity. CAPITAL REQUIREMENTS The Company meets the eligibility criteria of a small bank holding company in accordance with theFederal Reserve's SmallBank Holding Company Policy Statement issued inFebruary 2015 , and is no longer obligated to report consolidated regulatory capital. The Bank continues to be subject to various capital requirements administered by banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and discretionary actions by regulators that could have a direct material effect on the Company's financial statements. The Bank's capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors. 57
-------------------------------------------------------------------------------- The Bank is classified as "well capitalized" under current regulatory guidelines. See also additional information provided under the caption "Regulatory Matters" in Note 1 of the Notes to Consolidated Financial Statements. The final CBLR rule went into effect onJanuary 1, 2020 . Qualifying community banking organizations that elect to use the CBLR framework and that maintain a leverage ratio greater than 9 percent are considered to have satisfied the risk-based and leverage capital requirements in the generally applicable capital rule. During the first quarter of 2020, the CARES Act introduced interim CBLR provisions that allow institutions that fall below the 9.0 percent threshold to gradually increase their ratio from minimums of 8.0 percent in 2020, 8.5 percent in 2021 and 9.0 percent in 2022. Additionally, federal banking guidelines provide that financial institutions experiencing significant growth could be expected to maintain capital levels above the minimum requirements without significant reliance on intangible assets. Additionally, higher capital levels could be required under certain circumstances, such as situations involving interest rate risk, risk from concentrations of credit, or nontraditional activities. Accordingly, the Company and the Bank could be required to maintain higher capital levels in the future even if we otherwise fully comply with the CBLR rule. The Company adopted the CBLR framework during 2020 with no material impact on the financial results of the Company.
OFF-BALANCE SHEET ARRANGEMENTS
Various commitments and contingent liabilities arise in the normal course of business, which are not required to be recorded on the balance sheet. The most significant of these are loan commitments, lines of credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. As ofDecember 31, 2021 , and 2020, the Bank had outstanding commitments to originate loans of approximately$12,292,000 and$32,095,000 , respectively. Lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. As ofDecember 31, 2021 , and 2020, unused lines of credit to borrowers aggregated approximately$140,403,000 and$107,444,000 , respectively, for commercial lines and$22,187,000 and$24,746,000 , respectively, for open-end consumer lines. Since a portion of the loan commitment and line of credit may expire without being drawn upon, the total unused commitments and lines do not necessarily represent future cash requirements. Standby letters of credit are irrevocable conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers. The Bank had total outstanding standby letters of credit amounting to$8,430,000 and$10,256,000 as ofDecember 31, 2021 and 2020, respectively. The commitments extend over varying periods of time. Within our loan portfolio, the Bank offers certain loan customers the ability to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. This is accomplished by the Bank entering into variable-rate loan agreements with loan customers, and the customer simultaneously entering into an interest swap agreement directly with a counterparty. In the event that the customer defaults and the termination value, based on current rates, is in a loss position, the Bank could potentially be liable for termination amounts owed to the counterparty. In connection with the Company's issuance of the GFED Trust Preferred Securities and pursuant to one remaining guarantee agreement by and between the Company andWilmington Trust Company , the Company issued a limited, irrevocable guarantee of the obligations of the Trust under the GFED Trust Preferred Securities whereby the Company has guaranteed any and all payment obligations of the Trust related to the GFED Trust Preferred Securities including distributions on, and the liquidation or redemption price of, the GFED Trust Preferred Securities to the extent the Trust does not have funds available. 58 --------------------------------------------------------------------------------
AGGREGATE CONTRACTUAL OBLIGATIONS
The following table summarizes the Company's fixed and determinable contractual
obligations by payment date as of
Payments Due By Period
One Year One to Three to More than
Contractual Obligations Total or less Three Years Five Years Five Years
Deposits without stated
maturity $ 871,467 $ 871,467 $ - $ - $ -
Time and brokered certificates
of deposit 144,851 110,872 24,591 4,833 4,555
FHLB advances 16,000 6,500 6,500 3,000 -
Subordinated debentures issued
to Capital Trusts 10,310 - - - 10,310
Subordinated notes 19,610 - - - 19,610
Leases 12,587 1,280 2,190 1,642 7,476
Other long term obligations 559 559 - - -
Total $ 1,075,384 $ 990,678 $ 33,281 $ 9,475 $ 41,951 IMPACT OF INFLATION AND CHANGING PRICES
The Company prepared the consolidated financial statements and related data presented herein in accordance with accounting principles generally accepted inthe United States of America which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most companies, the assets and liabilities of a financial institution are primarily monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services, since such prices are affected by inflation. In the current interest rate environment, liquidity and the maturity structure of the Bank's assets and liabilities are critical to the maintenance of acceptable performance levels. CRITICAL ACCOUNTING POLICIES Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon the Company's consolidated financial statements and the notes thereto, which have been prepared in accordance with accounting principles generally accepted inthe United States of America . The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported periods. On an on-going basis, management evaluates its estimates and judgments. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurance that actual results will not differ from those estimates. If actual results are different than management's judgments and estimates, the Company's financial results could change, and such change could be material to the Company. 59
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Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of loans acquired with the possibility of impairment and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans and fair values. In connection with the determination of the allowance for loan losses and the valuation of foreclosed assets held for sale, management obtains independent appraisals for significant properties.Goodwill and intangible assets that have indefinite useful lives are subject to periodic impairment testing. This testing is to be performed annually, or more frequently if events occur that lead to the possibility that the valuation of such assets could be considered unrecoverable. The Company has identified the accounting policies for the allowance for loan losses, goodwill and intangible assets, related significant estimates and judgments as critical to its business operations and the understanding of its results of operations. For a detailed discussion on the application of these significant estimates and judgments and our accounting policies, also see Note 1 of the "Notes to Consolidated Financial Statements" in this report.
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