NEW PEOPLES BANKSHARES, INC. Caution About Forward-Looking Statements
We make forward-looking statements in this quarterly report on Form 10-Q that are subject to risks and uncertainties. These forward-looking statements include statements regarding expectations, intentions, projections and beliefs concerning our profitability, liquidity, and allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or other similar words or terms are intended to identify forward looking statements. The forward-looking information is based on various factors and was derived using numerous assumptions. Important factors that may cause actual results to differ from projections include:
º the success or failure of our efforts to implement our business plan;
º any required increase in our regulatory capital ratios;
º satisfying other regulatory requirements that may arise from examinations,
changes in the law and other similar factors;
º deterioration of asset quality;
º changes in the level of our nonperforming assets and charge-offs;
º fluctuations of real estate values in our markets;
º our ability to attract and retain talent;º demographical changes in our markets which negatively impact the local
economy;
º the uncertain outcome of current or future legislation or regulations or
policies of state and federal regulators;
º the successful management of interest rate risk;
º the successful management of liquidity;
º changes in general economic and business conditions in our market area and
º credit risks inherent in making loans such as changes in a borrower's
ability to repay and our management of such risks;
º competition with other banks and financial institutions, and companies
outside of the banking industry, including online lenders and those
companies that have substantially greater access to capital and other
resources;
º demand, development and acceptance of new products and services we have
offered or may offer;
º the effects of, and changes in, trade, monetary and fiscal policies and
laws, including interest rate policies of the
interest rate, market and monetary fluctuations;
º the occurrence of significant natural disasters, including severe weather
conditions, floods, health related issues (including the ongoing novel
coronavirus (COVID-19) outbreak and the associated efforts to limit the
spread of the disease), and other catastrophic events;
º technology utilized by us;
º our ability to successfully manage cybersecurity;
º our reliance on third-party vendors and correspondent banks;
º changes in generally accepted accounting principles;º changes in governmental regulations, tax rates and similar matters; and,
º other risks, which may be described, from time to time, in our filings with
the
Because of these uncertainties, our actual future results may be materially
different from the results indicated by these forward-looking statements. In
addition, our past results of operations do not necessarily indicate our future
results. We expressly disclaim any obligation to update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise, except as required by law.
25
Critical Accounting Policies
For discussion of our significant accounting policies, see our Annual Report on
Form 10-K for the year ended December 31, 2021 (the 2021 Form 10-K). Certain
critical accounting policies affect the more significant judgments and estimates
used in the preparation of our financial statements. Our most critical
accounting policies relate to our provision for loan losses and the calculation
of our deferred tax asset.
The allowance represents an amount that, in the Company's judgment, will be
adequate to absorb probable and estimable losses inherent in the loan portfolio.
The judgment in determining the level of the allowance is based on evaluations
of the collectability of loans while taking into consideration such factors as
trends in delinquencies and charge-offs for relevant periods of time, changes in
the nature and volume of the loan portfolio, current economic conditions that
may affect a borrower's ability to repay and the value of collateral, overall
portfolio quality and review of specific potential losses. This evaluation is
inherently subjective because it requires estimates that are susceptible to
significant revision as more information becomes available.
Deferred tax assets or liabilities are computed based upon the difference
between financial statement and income tax bases of assets and liabilities using
the enacted marginal tax rate. In the past, the Company provided a valuation
allowance on its net deferred tax assets where it was deemed more likely than
not such assets would not be realized. At September 30, 2022 and December 31,
2021 , the Company had no valuation allowance on its net deferred tax assets.
The Company recognizes the tax benefit from an uncertain tax position only if it
is more likely than not the tax position will be sustained on examination by the
taxing authorities, based on the technical merits of the position. The tax
benefits recognized in the financial statements from such positions are then
measured based on the largest benefit that has a greater than 50% likelihood of
being realized upon settlement.
For further discussion of the deferred tax asset and valuation allowance, we refer you to the section on "Deferred Tax Asset and Income Taxes" below.
Overview and Highlights For the three months endedSeptember 30, 2022 , net income of$2.0 million was recorded; an increase of$141,000 , or 7.6%, from the same period in 2021. The primary driver for the improved earnings was a decrease in total noninterest expense of$1.5 million due largely to the$1.0 million decline in occupancy expenses. This year-over-year decrease in occupancy expenses offset decreases in net interest income and noninterest income of$218,000 and$781,000 , respectively. Net interest income decreased$218,000 , a result of deferred loan fees earned from the forgiveness of Paycheck Protection Program (PPP) loans of$1.1 million during the third quarter of 2021 not being replicated in 2022, resulting in a net decrease in interest and fees on loans of$592,000 , or 7.8%. The decrease in loan fees was largely offset by increased earnings on interest bearing deposits in banks and investments, which increased$531,000 and$117,000 , respectively. For the comparative three-month periods of 2022 and 2021, interest expense increased$284,000 , as interest on borrowed funds increased$388,000 , offset by a decrease in interest expense on deposits of$104,000 . For the nine months endedSeptember 30, 2022 , net income totaled$5.8 million or$0.24 per share compared to$5.1 million or$0.21 per share for the same nine-month period in 2021. Interest income was slightly higher and interest expense was slightly lower, resulting in an improvement of$183,000 in net interest income. Other drivers of the improvement were reduced noninterest expense, which declined$1.4 million , due largely to charges foe the write down of closed and former branch office sites during the third quarters of 2022 and 2021. Updated valuations of the two branch offices closed in 2022, resulted in a charge of$195,000 that is included in noninterest expense. During the same period in 2021, three former branch office sites were sold, resulting in gains of$190,000 , and three more former branch office sites were transferred to other real estate owned, resulting in a combined loss of$1.1 million . OnJune 15, 2022 , we experienced a cybersecurity incident that temporarily interrupted the operability of our computer systems. Limited operations were restoredJune 17, 2022 , and full operations were restoredJune 21, 2022 . OnJune 29, 2022 , we issued a press release outlining the timeline, restoration efforts and communications, services and safeguards being offered to our customers in response to this incident, and filed a Current Report on Form 8-K relating to the incident. Since that date, restoration efforts have been completed and normal operations have resumed. Reference to the cybersecurity event is made throughout this Management's Discussion and Analysis of Financial Condition
and Results of Operations. The balance sheet grew to$828.6 million as ofSeptember 30, 2022 , from$794.6 million as ofDecember 31, 2021 , due toFederal Home Loan Bank advances taken, in the second quarter of 2022, as a precautionary measure in response to the cybersecurity incident. Total deposits increased$16.4 million to$723.9 million atSeptember 30, 2022 from$707.5 million atDecember 31, 2021 . Loans decreased$13.9 million to$579.9 million during the first nine months of 2022, due to repayments of several large commercial real estate loans combined with PPP loan repayments of approximately$6.1 million . 26
In August of 2022, branch offices in
During the second quarter of 2022, we initiated a previously announced stock
repurchase program. Through
Comparison of the Three Months ended
Quarter-to-date highlights include:
· Returns on average assets and equity of 0.94% and 13.70 % for the third quarter
of 2022, compared to 0.91% and 11.75% for the third quarter of 2021,
respectively;
· Net interest income was
of
· Provision for loan losses was
for the third quarter of 2021;
· Noninterest income was
during the third quarter of 2022 compared to the third quarter of 2021; and
· Noninterest expense was
the third quarter of 2022 compared to the third quarter of 2021. The Company's primary source of income is net interest income, which decreased by$218 thousand , or 2.9%, to$7.2 million for the third quarter of 2022 compared to$7.4 million for the third quarter of 2021. Interest income increased$66 thousand due to a$56 million increase in the average balance of earning assets, a shift of funds to higher-yielding investment securities; and increased interest earning deposits with banks funded from FHLB advances as we maintained additional liquidity as we monitored customer reaction to the cybersecurity incident. Additionally, the 2022 increases in the fed funds rate partially offset the decline in accelerated fee recognition when PPP loans are forgiven. Total interest expense increased$284 thousand driven primarily by a$388 thousand increase in interest on borrowed funds due to the FHLB advances combined with increased interest rates paid on trust preferred securities. Increased borrowing expenses were partially offset by a decrease in interest on deposits which decreased$104 thousand , or 19.9%, for the three months endedSeptember 30, 2022 compared to the three months endedSeptember 30, 2021 . The lower deposit interest expense resulted largely from reduced time deposit interest expense due to a decrease in both volume and interest rates. Overall there was a 12 basis-point increase in the cost of funds to 46 bps while the net interest margin decreased 38 bps to 3.55%. During the third quarter of 2022, theFederal Reserve's Open Market Committee (FOMC) increased the discount rate two times for a total of 150 bps, bringing the number of rate increases for the first nine months of 2022 to five, totaling 300 bps. The Company experienced benefits of the rate increases during the third quarter, but the full impact will be somewhat lagging as certain loans, investments, and trust preferred securities will not reprice until the individual instruments next interest rate repricing date. Deposit rates have not yet been significantly impacted by the rate increases, but the Company continues to evaluate rate adjustments for factors, including competitive pressure within the local markets, funding needs to support growth and other needs. During the third quarter of 2022, in response to rising interest rates, we initiated some promotional time deposit products. 27
The following table shows the rates paid on earning assets and interest-bearing liabilities for the periods indicated:
Net Interest Margin Analysis
Average Balances, Income and Expense, and Yields and Rates
(Dollars in thousands)
Three Months Ended September 30,
2022 2021
Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rates Balance Expense Rates
ASSETS
Loans (1) (2) (3) $ 590,090 $ 7,010 4.72% Federal funds sold 353 2 2.34% 209 - 0.12%
Interest bearing deposits in other banks 98,657 559 2.25%
72,549 28 0.15%
Taxable investment securities 117,628 539 1.83%
96,136 414 1.72%
Total earning assets 806,728 8,110 3.99%
750,411 8,044 4.26%
Less: Allowance for loans losses (6,738) (6,778)
Non-earning assets 41,134 58,972
Total Assets $ 841,124 $ 802,605 LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing demand deposits$ 75,151 $ 23 0.12%
Savings and money market deposits 192,550 52 0.11%
184,155 36 0.08%
Time deposits 181,480 343 0.75%
212,712 471 0.88%
Total interest-bearing deposits 449,181 418 0.37% 457,156 522 0.45%
Short-term borrowings 46,793 287 2.40% - - -%
Trust preferred securities 16,496 205 4.85% 16,496 104 2.47%Total interest-bearing liabilities 512,470 910 0.70%
473,652 626 0.52%
Non-interest-bearing deposits 262,244 - -% 258,251 - - %
Total deposit liabilities and cost of
funds 774,714 910 0.46%
731,903 626 0.34%
Other liabilities 8,904 8,399
Total Liabilities 783,618 740,302
Shareholders' Equity 57,506 62,303Total Liabilities and Shareholders'
Equity $ 841,124 $ 802,605
Net Interest Income $ 7,200 $ 7,418
Net Interest Margin 3.55% 3.93%
Net Interest Spread 3.29% 3.74%
(1) Nonaccrual loans and loans held for sale have been included in average loan balances (2) Tax exempt income is not significant and has been treated as fully taxable (3) Includes mortgage loans held for sale Net interest income is affected by changes in both average interest rates and average volumes (balances) of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total changes in interest income and interest expense which can be attributed to rates and volume for the three months endedSeptember 30, 2022 , as compared to the three months endedSeptember 30, 2021 . 28 Volume and Rate Analysis Increase (decrease) Three Months Ended
Change in
Interest
Income/(Dollars in thousands) Volume Effect Rate Effect Expense Interest Income: Loans$ (972 ) $ 380 $ (592 ) Federal funds sold - 2 2
Interest bearing deposits in other banks 13
518 531 Taxable investment securities 92 33 125 Total Earning Assets (867 ) 933 66 Interest Expense:
Interest-bearing demand deposits 5 3 8 Savings and money market deposits 3
13 16 Time deposits (65 ) (63 ) (128 ) Short-term borrowings 287 - 287 Trust preferred securities - 101 101
Total Interest-bearing Liabilities 230
54 284 Change in Net Interest Income$ (1,097 ) $ 879 $ (218 )
Based on our current assessment of the loan portfolio, a provision of$225 thousand was made in the third quarter of 2022, compared to zero for the third quarter of 2021, due to a combination of factors, including the rising interest rate environment, overdraft charge-offs related to the cybersecurity incident realized during the third quarter of 2022, and uncertain economic trends. The allowance for loan losses as a percentage of loans increased from 1.13% atDecember 31, 2021 to 1.14% as ofSeptember 30, 2022 . For a discussion of the factors affecting the allowance for loan losses, including provision expense, refer to Note 7, Allowance for Loan Losses, in Item 1 of this Form 10-Q. Total noninterest income decreased$781,000 in the third quarter of 2022 compared to the third quarter of 2021. The primary drivers of the quarter-over-quarter decline were$322,000 of gains on sales of investment securities and$190,000 of gains on sale of bank premises in 2021 that were not repeated in 2022. In addition, the Company recorded a$100,000 write-down of bank owned life insurance (BOLI) and a period-over-period decrease in gains and commissions on mortgage loan originations of$82,000 , during the third quarter of 2022. The BOLI charge resulted from a decrease in the market value of the underlying investments supporting the policy due to increased interest rates. Service charge revenue increased$68 thousand , or 6.8%, to$1.1 million for the comparative three-month periods endedSeptember 30, 2022 and 2021 as operations returned to normal operations after the cybersecurity incident. Card processing and interchange revenue decreased$67 thousand for the three months endedSeptember 30, 2022 , as compared to the same period in 2021, due to a decline in transaction volume. The increased interest rate environment also contributed to the reduced mortgage revenue as mortgage originations and refinancings have slowed. Total noninterest expense decreased$1.5 million in the third quarter of 2022 compared to the same period of 2021, due primarily to charges recorded in 2021 of$1.1 million related to the transfer of three former branch office locations to other real estate owned, which is reflected in occupancy and equipment expense, and$395,000 of write-downs on OREO, which is reflected in other operating expense. These charges more than exceeded the$195,000 charge related to the closure of two branch offices during the third quarter of 2022, which is included in occupancy expenses. Salaries and benefits remained virtually flat for the comparative three-month period in 2022 versus 2021. This was due in part to an adjustment to reduce the liability for our self-insured insurance plan of$100,000 during the third quarter of 2022, based on a rolling assessment of claims made against the plan. This liability adjustment offset employee appreciation bonus payments, totaling$89,000 , during the third quarter in recognition of employee response to the cybersecurity incident in June of 2022. The efficiency ratio, a non-GAAP measure, which is defined as noninterest expense divided by the sum of net interest income plus noninterest income, improved to 70.3% for third quarter of 2022 from 77.6% for the third quarter of 2021. We continue to assess our operational procedures and structure to improve efficiencies and contain costs. A review of deposit operations was performed during the third quarter of 2022, and based on this assessment, several processes will be modified or reassigned to improve operational efficiencies. 29 InAugust 2022 , the Bank closed branch offices inBig Stone Gap andChilhowie, Virginia . Accounts serviced at these offices were transferred to nearby branches, and employees were reassigned to other positions or offices, as available. Interactive teller machines at these locations will remain in service for the foreseeable future. This restructuring of the branch network should improve the efficiency of services to the customers of these communities. Income tax expense for the third quarter of 2022 totaled$579 thousand , an increase of$103 thousand , or 21.6% from the$476 thousand recorded during the same period in 2021. The effective tax rate for the three months endedSeptember 30, 2022 , was 22.6%, compared to 20.5% for the same period in 2021. The year-over-year, quarterly increase generally approximates the percentage increase of pre-tax earnings.
Comparison of the Nine Months ended
Year-to-date highlights include:
· Net interest income improved to
2022, an improvement of
months of 2021;
· Net interest margin was 3.53% for the first nine months of 2022, a decrease of
15 bps compared to 3.68% for the first nine months of 2021;
· Provision for loans losses was
an increase of
2021;
· Noninterest income was
compared to the first nine months of 2021;
· Salaries and employee benefits expense was
thousand, or 5.6%, compared to the first nine months of 2021; and
· Total noninterest expense was
6.8%, compared to the first nine months of 2021. Overall, during the nine months endedSeptember 30, 2022 , compared to the same period in 2021, net income improved 14.5% to$5.8 million from$5.1 million . Although interest income was virtually unchanged, increasing$116 thousand , reduced interest expense of$67 thousand contributed to an improvement of$183 thousand in net interest income. The following table presents the rates earned on earning assets and paid on interest-bearing liabilities for the periods
indicated.
30
Net Interest Margin Analysis
Average Balances, Income and Expense, and Yields and Rates
(Dollars in thousands)
Nine Months Ended September 30,
2022 2021
Average Income/ Yields/ Average Income/ Yields/
Balance Expense Rates Balance Expense Rates
ASSETS
Loans (1) (2) (3) $ 594,593 $ 20,476 4.61% Federal funds sold 254 3 1.36% 208 - 0.09%
Interest bearing deposits in other banks 73,752 738 1.34%
83,153 69 0.11%
Taxable investment securities 115,349 1,510 1.74%
72,958 1,059 1.94%
Total earning assets 783,948 22,727 3.88%
744,402 22,611 4.06%
Less: Allowance for loans losses (6,824) (7,143)
Non-earning assets 44,582 59,984
Total Assets $ 821,706 $ 797,243 LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing demand deposits$ 71,420 $ 58 0.11%
Savings and money market deposits 194,691 130 0.09%
175,668 109 0.08%
Time deposits 188,497 1,064 0.75%
222,186 1,626 0.98%
Total interest-bearing liabilities 454,608 1,252 0.37%
455,460 1,780 0.52%
Short-term borrowings 20,000 358 2.36% 3,308 33 1.35%
Trust preferred securities 16,496 452 3.61% 16,496 316 2.52%Total interest-bearing liabilities 491,104 2,062 0.56%
475,264 2,129 0.60%
Non-interest-bearing deposits 263,083 - -% 252,985 - - %
Total deposit liabilities and cost of
funds 754,187 2,062 0.36%
728,249 2,129 0.39%
Other liabilities 8,235 8,726
Total Liabilities 762,422 736,975
Shareholders' Equity 59,284 60,268Total Liabilities and Shareholders'
Equity $ 821,706 $ 794,243
Net Interest Income $ 20,665 $ 20,482
Net Interest Margin 3.53% 3.68%
Net Interest Spread 3.32% 3.46%
(1) Nonaccrual loans and loans held for sale have been included in average loan balances (2) Tax exempt income is not significant and has been treated as fully taxable
(3) Includes mortgage loans held for sale
Net interest income is affected by changes in both average interest rates and average volumes (balances) of interest-earning assets and interest-bearing liabilities. The following table sets forth the amounts of the total changes in interest income and interest expense which can be attributed to rates and volume for the nine months endedSeptember 30, 2022 , as compared to the nine months endedSeptember 30, 2021 . 31 Volume and Rate Analysis Increase (decrease) Nine Months Ended
Change in
Interest Income/
(Dollars in thousands) Volume Effect Rate Effect Expense
Interest Income:
Loans $ (1,382 ) $ 375 $ (1,007 )
Federal funds sold - 3 3Interest bearing deposits in other banks (9 ) 678 669 Taxable investment securities 484 (33 ) 451 Total Earning Assets (907 ) 1,023 116 Interest Expense: Interest-bearing demand deposits 13 - 13 Savings and money market deposits 15
6 21
Time deposits (226 ) (336 ) (562 )
Short-term borrowings 284 41 325Trust preferred securities - 136 136 Total Interest-bearing Liabilities 86 (153 ) (67 ) Change in Net Interest Income $ (993 ) $
1,176 $ 183 During the first nine months of 2022 compared to the same period of 2021, net interest income increased$183 thousand primarily due to a reduction in interest expense on deposits of$528 thousand , largely offset by increases to the cost of borrowed funds of$461 thousand . The increase in expense for borrowed funds was due to$95 million of FHLB advances taken during the second quarter, combined with rate increases on trust preferred securities. The reduction in interest expense on deposits was driven mainly by a reduction in the average cost of retail time deposits, which declined 23 basis points, to 0.75% from 0.98%, plus a decrease in average balances of$33.7 million . There was a modest increase in interest income of$116 thousand due to increases to the investment portfolio and increased rates paid on deposits with other banks. These improvements offset reductions in loan interest and fees due principally to the reduction in fees from PPP loan repayments as these fees fell$1.6 million during the comparative nine-month periods. As a result, the net interest margin for the first nine months of 2022 was 3.53%, a reduction of 15 bps compared to 3.68% for the first nine months of 2021.
During the first nine months of 2022, theFOMC increased the discount rate five times for a total of 300 bps. This increased interest rate environment has improved returns on certain assets that immediately adjust as these changes are made, such as interest-bearing deposits in other banks, credit cards, home equity lines of credit and certain commercial and commercial real estate loans. It is anticipated that yields on these assets will improve moving forward. Conversely, it is expected that there will be a need to adjust, upward, rates paid on deposit accounts, which will increase our overall cost of funds. Additionally, in response to theJune 2022 cybersecurity incident, during the third quarter of 2022, we began offering a customer appreciation time deposit product to recognize the patience and loyalty of our customers. This promotional product pays a higher rate than is currently offered on similar non-promotional products and is expected to contribute to an increased cost of funds going forward. Based on our current assessment of the loan portfolio,$400 thousand was provided to the allowance for loan losses during the first nine months of 2022 compared to$372 thousand provided during the same period in 2021. For more information on the factors affecting the allowance for loan losses, including provision expense, refer to Note 7, Allowance for loan Losses, in Item 1 of this Form 10-Q. Depending on changes to economic conditions and the impact those changes may have on individual borrowers, it is possible that additional provisions may be needed beyond those necessary to support organic growth of the loan portfolio. Total noninterest income decreased$571,000 for the first nine months of 2022, compared to the same period in 2021, to$6.9 million . Net gains on the sale of investment securities and a gain on the sale of bank premises in 2021 account for$322,000 and$190,000 , respectively, of the decrease, as those earnings were not replicated in 2022. Additionally, a BOLI adjustment of$100,000 was recorded in 2022, as previously discussed. Aside from these individual events, financial services and secondary market mortgage lending activities were impacted by the cybersecurity event and the rising interest rate environment, showing year-over-year revenue declines of$74,000 and$116,000 , respectively. These declines were offset by increased service charge revenue which increased$299,000 , despite a period during the cybersecurity event where service charges were waived for all accounts. 32 For the nine months endedSeptember 30, 2022 , compared to the same period in 2021, total noninterest expense decreased$1.4 million to$19.7 million , primarily due to a$1.4 million decrease in occupancy and equipment expense that was driven nearly entirely by the$1.1 million in losses on three former branch office locations discussed above, which were transferred into other real estate owned in 2021, partially offset by a similar$195,000 charge recorded in 2022. Due to the reduction in the number of branch office locations, year-over-year depreciation expense decreased$286,000 . Salaries and benefits increased$530,000 , or 5.6%, to$9.9 million for the comparative nine-month period of 2022 versus 2021, as salary adjustments, accruals for performance bonus and profit sharing programs, along with costs for new or amended benefits, accounted for approximately$485,000 of the increase, along with approximately$89,000 of employee appreciation bonus payments, made to all employees, as a result of their efforts in addressing the cybersecurity incident.
Income taxes increased
The efficiency ratio, a non-GAAP measure, improved to 71.4% for the first nine months of 2022 from 77.6.% for the same period of 2021.
Balance Sheet Total assets increased$33.9 million , or 4.3%, to$828.6 million atSeptember 30, 2022 from$794.6 million atDecember 31, 2021 . This growth was primarily driven by the FHLB advances, now totaling$25.0 million , and total deposits which increased$16.4 million , as noninterest-bearing deposits increased$17.8 million while interest-bearing deposits decreased$1.4 million . The year-to-date deposit activity is due to a combination of factors including customer reaction to the cybersecurity incident, time deposit customers seeking higher interest rates and actions taken by customers at the two branch locations closed inAugust 2022 . The FHLB advance funds were transferred to interest bearing deposits with other banks which increased$51.6 million year-to-date. Total investments decreased$8.5 million , or 7.9%, to$98.8 million atSeptember 30, 2022 due primarily to an increase of$16.4 million in net unrealized losses and$11.5 million of repayments and maturities, which more than offset purchases of$19.8 million . Future purchases of investment securities will depend on a number of factors, including changes in loans and deposits, liquidity needs and the results of the Company's interest rate risk modeling. Loans decreased$13.9 million , or 2.3% during the first nine months of 2022. Commercial real estate and multifamily loans decreased$8.1 million or 3.9% and$4.0 million or 12.1% to$198.1 million and$29.1 million , respectively atSeptember 30, 2022 , as several large commercial loan borrowers liquidated their holdings in projects we financed and repaid the corresponding loans. These repayments were partially offset by increases in construction and development loans, and residential real estate which increased$6.3 million , or 19.4%, and$2.2 million , or 1.0%, respectively. Commercial loans decreased$9.2 million or 16.9% to$45.1 million atSeptember 30, 2022 , due largely to repayments and forgiveness of PPP loans which declined$6.1 million during the first nine months of 2022. AtSeptember 30, 2022 , PPP loans totaled$298 thousand and no longer represent a significant component of our loan portfolio. Loan originations, specifically commercial real estate and multi-family loans, continue to be positively impacted by ourBoone, NC , loan production office, as well as originations in theKingsport andJohnson City, Tennessee markets. Total deposits increased$16.4 million , or 2.3%, to$723.9 million atSeptember 30, 2022 from$707.5 million atDecember 31, 2021 , as noninterest bearing deposits increased$17.8 million , or 7.1%. The increase in noninterest bearing deposits more than offset a decrease in interest bearing deposits which declined$1.4 million , or 0.3% during the first nine months of 2022. Despite the net increase in deposits, we experienced some deposit runoff in response to the cybersecurity incident. Additionally, other factors also influenced customers' deposit activities, including interest rates available for time deposits and the closure of two branch offices inAugust 2022 . Since the closure of the two branch offices, runoff of accounts from those offices has been minimal, totaling approximately$555 thousand throughSeptember 30, 2022 . Additionally, some of this deposit activity is due to normal churn of deposit accounts and depositors. Specifically, time deposit runoff totaled$16.6 million , or 8.4%, during the first nine months of 2022. The decrease in time deposits was offset by increases in non-interest bearing and interest-bearing transaction accounts which increased$17.8 million , or 7.1%, and$15.3 million , or 5.9%, during the nine months endedSeptember 30, 2022 . Another factor influencing deposit retention is the dissipation of liquidity experienced by depositors, as stimulus and other economic support funds distributed during the height of the COVID-19 pandemic are spent or otherwise distributed. While it is likely that recent and expected increases to the federal funds rate will, at some point, impact liquidity, we continue to maintain core deposits through attractive consumer and commercial deposit products and strong ties with our customer base and communities. 33
AtSeptember 30, 2022 , FHLB advances totaling$25 million were outstanding. As previously discussed, overnight and term advances totaling$95 million were taken inJune 2022 , as a precautionary measure related to the cybersecurity incident with$60 million outstanding as ofJune 30, 2022 . During the third quarter of 2022, an advance totaling$20.0 million matured and was repaid, and a$15.0 million partial prepayment was made on the remaining$40.0 million advance which matures inDecember 2022 . We anticipate repaying the$25.0 million outstanding advance at maturity. Trust preferred securities of$16.5 million atSeptember 30, 2022 were unchanged compared toDecember 31, 2021 . Total equity atSeptember 30, 2022 was$55.2 million , a decrease of$8.4 million , or 13.2%, compared to$63.6 million atDecember 31, 2021 . As discussed previously and in the Capital Resources section below, the primary driver of the decline was the$12.9 million net increase in the accumulated other comprehensive loss, related to the unrealized loss on available for sale investment securities, along with a cash dividend payment and repurchases of common shares. The increase in other accumulated comprehensive loss is related to the recent increase in interest rates and is not related to any deterioration in the credit quality of any investment securities held. Asset Quality Nonperforming assets include nonaccrual loans, other real estate owned (OREO) and loans past due more than 90 days which are still accruing interest. Our policy is to place loans on nonaccrual status once they reach 90 days past due. The makeup of the nonaccrual loans is primarily those secured by residential mortgages and commercial real estate. OREO is primarily made up of farmland
and residential lots. Nonperforming assets decreased$275 thousand , or 6.4%, during the first nine months of 2022, driven by a decrease in OREO of$1.0 million , which offset an increase in nonaccrual loans of$765 thousand . The increase in nonaccrual loans is attributed to a single credit for a commercial construction loan. This account has been assessed as part of our determination of the adequacy of the allowance for loan losses, and collection efforts are ongoing. No loans 90 days or more past due are accruing interest. As a result, the ratio of nonperforming assets to total assets decreased to 0.49% atSeptember 30, 2022 compared to 0.54% atDecember 31, 2021 . AtSeptember 30, 2022 , OREO is primarily made up of farmland and land acquired through foreclosure. During 2022, two former branch sites that had been transferred to OREO in 2021, were sold bringing our OREO balance down to$321 thousand . We continue extensive and aggressive measures to work through problem credits and liquidate foreclosed properties in an effort to reduce nonperforming assets. We remain mindful of the impact on earnings and capital as we work to achieve our goal to reduce nonperforming assets. However, we may recognize some losses and reductions in the allowance for loan loss as we expedite the resolution of these problem assets.
For detailed information for nonaccrual loans and other real estate owned as of
Loans rated substandard or below totaled$3.7 million atSeptember 30, 2022 , an increase of$788 thousand from$2.9 million atDecember 31, 2021 . Total past due loans increased slightly to$3.8 million atSeptember 30, 2022 from$3.4 million atDecember 31, 2021 . The past due loans atSeptember 30, 2022 , represent a decrease of$6.3 million , or 62.4%, from the$10.0 million reported atJune 30, 2022 , as delays in loan billing and notice presentation related to the cybersecurity incident, during the second quarter of 2022, were addressed during the third quarter. Our allowance for loan losses atSeptember 30, 2022 was$6.6 million , or 1.14% of total loans, as compared to$6.7 million , or 1.13% of total loans, atDecember 31, 2021 . Impaired loans totaled$3.1 million with an estimated related specific allowance of$269 thousand atSeptember 30, 2022 , as compared to$2.8 million of impaired loans with an estimated related allowance of$166 thousand at the end of 2021. A provision of$400 thousand was recorded for the first nine months of 2022 compared to$372 thousand during the first nine months of 2021. In the first nine months of 2022, net charge-offs totaled$542 thousand , or 0.12% of average loans, annualized, as compared to$906 thousand , or 0.21% of average loans, for the same period in 2021. Of the net charge-offs recorded in 2022, approximately$320 thousand represents overdraft charge-offs resulting from customer activity during the several days of the cybersecurity event when we increased daily transaction limits for debit card and ATM activity to meet customer needs while core services were restored. The allowance for loan losses is maintained at a level that management deems appropriate to absorb any potential future losses and known impairments within the loan portfolio, whether or not the losses are actually ever realized. Through our quarterly assessment, we continue to adjust the allowance for loan loss model to best reflect the risks in the portfolio and the improvements made in our internal policies and procedures; however, future provisions may be deemed necessary. During the first nine months of 2022, we adjusted our external qualitative factors to reflect positive employment and home sales statistics, along with adjusting for the impact of historically high inflation. Those changes along with the assessment of the inherent and specific risks associated with the loan portfolio resulted in a provision to the allowance of$400 thousand for the first nine months 2022. The following table summarizes components of the allowance for loan losses and related loans as ofSeptember 30, 2022 andDecember 31, 2021 : 34 Selected Credit Ratios September 30, December 31, (Dollars in thousands) 2022 2021 Allowance for loan losses$ 6,593 $ 6,735 Total loans 579,874 593,744
Allowance for loan losses to total loans 1.14 % 1.13 % Nonaccrual loans$ 3,706 $ 2,941 Nonaccrual loans to total loans 0.64 %
0.50 %
Ratio of allowance for loan losses to nonaccrual loans 1.78 X 2.29 X Charge-offs net of recoveries $ 542 $ 828 Average loans$ 594,534 $ 586,963
Net charge-offs to average loans 0.12 %
0.14 %
We are in the process of implementing the Current Expected Credit Loss (CECL)
model to replace our legacy loan loss model. While we had estimated we would be
running concurrent models by June 30, 2022 , due to the cybersecurity incident,
we delayed the start of parallel runs, which began late in the third quarter of
2022. Initial CECL model runs have occurred using only historical loss
information. Initial assumptions have been input and are being layered onto the
initial runs of historical loan and loss activity. The Company will run the new
methodology parallel to the current allowance methodology for the first three
quarters of 2022 before full implementation. In addition, we have retained a
third-party vendor to perform a validation of the CECL model implementation.
Deferred Tax Asset and Income Taxes
Due to timing differences between book and tax treatment of several income and expense items, a net deferred tax asset, excluding the deferred tax asset on the unrealized loss on securities available for sale, of$916 thousand and$1.5 million existed atSeptember 30, 2022 andDecember 31, 2021 , respectively. Our income tax expense was computed at the corporate income tax rate of 21% of taxable income. We have no significant nontaxable income or nondeductible expenses. Capital Resources
Total shareholders' equity atSeptember 30, 2022 was$55.2 million compared to$63.6 million atDecember 31, 2021 , a decrease of$8.4 million , or 13.2%. As previously discussed, this decline was driven by the$12.9 million net increase in the accumulated other comprehensive loss related to the unrealized loss on investment securities available-for-sale. Excluding the impact of the unrealized loss, equity increased$4.5 million , due to net income of$5.8 million less the cash dividend payment of$1.2 million and$103 thousand used for share repurchases. The Company meets the eligibility criteria to be classified as a small bank holding company in accordance with theFederal Reserve's Small Bank Holding Company Policy Statement issued inFebruary 2015 and is therefore not obligated to report consolidated regulatory capital. The Bank continues to be subject to various capital requirements administered by banking agencies.
The Bank's capital ratios along with the minimum regulatory thresholds to be considered well-capitalized are presented at Note 4 in Item 1 of this Form 10-Q.
AtSeptember 30, 2022 , the Bank remains well capitalized under the regulatory framework for prompt corrective action. The ratios mentioned above for the Bank comply with theFederal Reserve rules to align with theBasel III Capital requirements. Book value per common share was$2.31 atSeptember 30, 2022 , and$2.66 atDecember 31, 2021 . Excluding the impact of the accumulated other comprehensive loss, book value per share was$2.89 and$2.69 atSeptember 30, 2022 andDecember 31, 2021 , respectively. Other key performance indicators are as follows: 35 Three months ended September 30, Nine months ended September 30, 2022 2021 2022 2021 Return on average assets1 0.94% 0.91% 0.95% 0.85% Return on average equity1 13.70% 11.75% 13.15% 11.30% Average equity to average assets 6.84% 7.76% 7.21% 7.56% 1 - Annualized
Under current economic conditions, we believe it is prudent to continue to retain capital sufficient to support planned asset growth while being able to absorb potential losses that may occur if asset quality deteriorates, and based upon projections, we believe our current capital levels will be sufficient. During the first quarter of 2022, the Company paid its first cash dividend of$0.05 per common share to our shareholders. Earnings will continue to be retained to provide capital to support the planned growth and operations of the Company and to continue to pay any future dividends to shareholders. During the second quarter of 2022, the board of directors of the Company authorized the repurchase of up to 500,000 shares of the Company's outstanding common stock throughMarch 31, 2023 . The actual means and timing of any purchases, number of shares and prices or range of prices will be determined by the Company in its discretion and will depend on a number of factors, including the market price of the Company's common stock, general market and economic conditions, and applicable legal and regulatory requirements. During the third quarter of 2022, 26,831 shares were purchased at an average price of$2.32 per share; bringing the total shares repurchased throughSeptember 30, 2022 to 44,485 at an average price of$2.30 per share. There is no assurance that the Company will purchase any additional shares under this program. Liquidity
As discussed previously, in response to the cybersecurity incident, during the second quarter of 2022, we took efforts to increase on balance sheet liquidity through a series of FHLB advances transferred to our account atFederal Reserve Bank and pledging additional investment securities as collateral against unused funding sources for emergency needs. The deposit runoff since the cybersecurity incident has not been significant. Based on the customer response and an assessment of our overall liquidity, during the third quarter of 2022, we repaid a maturing FHLB advance totaling$20.0 million , and partially prepaid$15.0 million on the remaining$40.0 million advance. We closely monitor our liquidity and our liquid assets in the form of cash, due from banks, federal funds sold, and unpledged available for sale investments. Collectively, those balances were$185.5 million atSeptember 30, 2022 , an increase of$26.2 million from$159.3 million atDecember 31, 2021 . A surplus of short-term assets is maintained at levels management deems adequate to meet potential liquidity needs during 2022. AtSeptember 30, 2022 , all of our investment securities were classified as available-for-sale. These investments provide a source of liquidity in the amount of$70.5 million , which is net of the$28.3 million of securities pledged as collateral. Investment securities available for sale serve as a source of liquidity while yielding a higher return versus other short-term investment options, such as federal funds sold and overnight deposits with theFederal Reserve Bank . Due to the increase in the unrealized loss on securities available for sale, the sale of investments would not be considered a primary source of liquidity due to the immediate impact on regulatory capital; however, the majority of the portfolio is considered high credit quality investments and would be available to pledge against borrowings. Our loan to deposit ratio was 80.1% atSeptember 30, 2022 and 83.9% atDecember 31, 2021 . We anticipate this ratio to remain at or below 90% for the foreseeable future. Available third-party sources of liquidity atSeptember 30, 2022 include the following: a line of credit with the FHLB, access to brokered certificates of deposit markets and the discount window at theFederal Reserve Bank . We also have the ability to borrow$30.0 million in unsecured federal funds through credit facilities extended by correspondent banks. The Bank's line of credit with the FHLB is$211.7 million , with unused availability atSeptember 30, 2022 of$179.7 million . FHLB advances totaling$25 million were outstanding atSeptember 30, 2022 , but the credit line also secures a letter of credit totaling$7.0 million . The available line and the outstanding letters of credit are secured by a blanket lien on our residential real estate loans which amounted to$123.2 million atSeptember 30, 2022 . 36 The Bank also has access to the brokered deposits market and the Certificate of Deposit Registry Service (CDARS). AtSeptember 30, 2022 , we held no brokered deposits while$2.8 million in CDARS reciprocal time deposits and$23.1 million in ICS reciprocal interest-bearing demand deposits are outstanding.
Additional liquidity is available through the
With the on-balance sheet liquidity and other external sources of funding, we believe the Bank has adequate liquidity and capital resources to meet our requirements and needs for the foreseeable future. However, liquidity can be further affected by a number of factors such as counterparty willingness or ability to extend credit, regulatory actions and customer preferences, etc., some of which are beyond our control. The bank holding company has approximately$371 thousand in cash on deposit at the Bank atSeptember 30, 2022 . The holding company receives periodic dividend payments from the Bank which are used to pay operating expenses, to pay trust preferred interest payments, and to fund dividend payments to shareholders and repurchase shares. The Company makes quarterly interest payments on the trust preferred securities. As discussed in the Capital Resources section, the Company authorized the repurchase of up to 500,000 shares of the Company's outstanding common stock throughMarch 31, 2023 . Payments for any repurchases will be distributed from available funds, or from dividend payments from the Bank, and are not expected to have a material impact on available liquidity.
Off Balance Sheet Items and Contractual Obligations
There have been no material changes during the nine months endedSeptember 30, 2022 , to the off-balance sheet items and the contractual obligations disclosed in our 2021 Form 10-K.
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