PRIME MERIDIAN HOLDING COMPANY Certain information in this report may include "forward-looking statements" as defined by federal securities law. Words such as "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," "project," "is confident that," and similar expressions are intended to identify these forward-looking statements. These forward-looking statements involve risk and uncertainty and a variety of factors could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in these forward-looking statements. We do not have a policy of updating or revising forward-looking statements except as otherwise required by law, and silence by management over time should not be construed to mean that actual events are occurring as estimated in such forward-looking statements. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could have a material adverse effect on our operations and the operations of our subsidiary,Prime Meridian Bank , include, but are not limited to, changes in the following: ? local, regional, and national economic and business conditions; ? banking laws, compliance, and the regulatory environment;
? unanticipated changes in the
debt markets, and other capital markets;
? monetary and fiscal policies of the
? litigation, tax, and other regulatory matters;
? demand for banking services, both loan and deposit products in our market
area;
? quality and composition of our loan or investment portfolios;
? risks inherent in making loans such as repayment risk and fluctuating
collateral values;
? competition;
? attraction and retention of key personnel, including our management team
and directors;? technology, product delivery channels, and end user demands and acceptance
of new products;
? fraud committed by our clients or persons doing business with our clients;
? consumer spending, borrowing and savings habits;
? any failure or breach of our operational systems, information systems or
infrastructure, or those of our third-party vendors and other service
providers, including cyber-attacks;? application and interpretation of accounting principles and guidelines;
? natural disasters, public unrest, adverse weather, public health and other
conditions impacting our or our clients' operations;
? and other economic, competitive, governmental, regulatory, or technological
factors affecting us.
General
The following discussion and analysis present our financial condition and
results of operations on a consolidated basis. However, because we conduct all
of our material business operations through the Bank, the discussion and
analysis relate to activities primarily conducted at the subsidiary level. The
following discussion should be read in conjunction with the Company's
consolidated financial statements.
As a one-bank holding company, we generate most of our revenue from interest on
loans and investments. Our primary source of funding for our loans is deposits.
Our largest expenses are interest on those deposits, salaries plus related
employee benefits, and occupancy and equipment. We measure our performance
through our net interest margin, return on average assets, return on average
equity, and ratio of nonperforming assets to total assets, while maintaining
appropriate regulatory leverage and risk-based capital ratios.
Application of Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted inthe United States ("GAAP") and with prevailing practices within the banking industry. Application of these principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes; therefore, our financial condition and results of operations are sensitive to accounting measurements and estimates of matters that are inherently uncertain. When applying accounting policies in areas that are subjective in nature, the Bank must use its best judgment to arrive at the carrying value of certain assets. The most critical accounting policy applied is the valuation of our subsidiary bank's loan portfolio. A variety of estimates impact the carrying value of the loan portfolio including the calculation of the allowance for loan losses, the valuation of underlying collateral, the timing of loan charge-offs, and the amount and amortization of loan fees and deferred origination costs. 24 -------------------------------------------------------------------------------- We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under current circumstances. These assumptions form the basis for our judgments about the carrying values of assets and liabilities that are not readily available from independent, objective sources. We evaluate our estimates on an ongoing basis. Use of alternative assumptions may have resulted in significantly different estimates and actual results may differ from these estimates. We have identified the following accounting policy and estimate as critical. In order to understand our financial condition and results of operations, it is important to comprehend how these assumptions apply to our consolidated financial statements. Allowance for Loan Losses. Our allowance for loan losses ("ALLL") is established through a provision for loan losses charged to earnings as specific loan losses are identified by management and as inherent loan losses are determined to exist. Loan losses are charged against the ALLL when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL. Our ALLL is evaluated for adequacy by management on a monthly basis and is based upon management's periodic review of the collectability of the loan portfolio in light of historical experience in the industry, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, prevailing economic conditions and industry standards. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Specific loan losses are identified and evaluated in accordance with ASC 310-10 - "Receivables." A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment status include payment status and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not considered as impaired. We look at the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. When a loan is considered impaired, the amount of the impairment is measured on a loan-by-loan basis by comparing the recorded investment in the loan to any of the following measurements: the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. If the recorded investment in the loan is higher than the calculated impairment basis, the difference is maintained as a specific loan loss allocation, or it is charged off if the amount is determined to be uncollectible. As the Bank grows, management may elect to collectively evaluate large groups of smaller balance homogeneous loans for impairment, instead of on a loan-by-loan basis. Inherent loan losses are evaluated in accordance with ASC 450-20 - "Contingencies." Management currently uses three years of historical loan loss data; however, because of limited loss experience we also take into account the following qualitative factors: (i) changes in lending policies and procedures, risk selection and underwriting standards; (ii) changes in national, regional and local economic conditions that affect the collectability of the loan portfolio; (iii) changes in the experience, ability, and depth of lending management and other relevant staff; (iv) changes in the volume and severity of past due loans, nonaccrual loans or loans classified "Special Mention," "Substandard," "Doubtful" or "Loss;" (v) the quality of loan review; (vi) changes in the nature and volume of the loan portfolio and terms of loans; (vii) the existence and effect of any concentrations of credit and changes in the level of such concentrations; (viii) changes in collateral dependent loans; and (ix) the effect of other external factors, trends or uncertainties that could affect management's estimate of probable losses, such as competition and industry conditions. As evidence of inherent loan loss increases, the appropriate qualitative risk factors may be increased to support any additional risk in the portfolio. Recent Interest-Rate Trends Like many other financial institutions, our results of operations are dependent on net interest income. Net interest income is the difference between interest received on interest-earning assets, such as loans and securities, and interest paid on interest-bearing liabilities, namely deposits and borrowings. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control including inflation, economic conditions, unemployment, money supply, domestic and international events, and changes inthe United States and other financial markets. Our net interest income may be reduced if (i) more interest-earning assets than interest-earning liabilities reprice or mature during a time when interest rates are declining, or (ii) more interest-bearing liabilities than interest-earning assets reprice or mature during a time when interest rates are rising. We measure the potential adverse impacts of changing interest rates by shocking average interest rates up or down 100 to 400 basis points and calculating the potential impacts on our net interest income, liquidity, and EVE. We utilize the results of these simulations to determine whether to increase or decrease our fixed rate loan portfolio, to adjust our investment in assets such as bonds, or to take other action in order to maintain or improve our net interest margin given the trending or expected interest rate changes. 25
-------------------------------------------------------------------------------- As ofDecember 31, 2022 ,$418.3 million , or 70.2%, of our loan portfolio consisted of adjustable-rate loans, meaning these loans will adjust with changes in interest rates and pose less interest rate risk in a rising interest rate environment. Of these, loans totaling$396.0 million , or approximately 66.5% of the total loan portfolio, have interest rate floors which will help protect our net interest margin in a decreasing rate environment. On the other hand,$129.4 million , or 21.7% have interest rate ceilings in place which protects the borrower from interest rates rising beyond a certain level. The majority of our loans with ceilings in place are residential mortgage loans with additional repricing ability of 3.00% - 5.00% until a ceiling will be reached. Also as ofDecember 31, 2022 ,$171.0 million , or 28.7%, of the total loan portfolio was scheduled to mature in five years or less, which helps mitigate the risks of the fixed-rate portion of our loan portfolio in a rising interest rate environment.
If interest rates increase, borrowers may be less inclined to seek new loans. In addition, higher interest rates could adversely affect an adjustable-rate borrower's ability to continue servicing debt.
Furthermore, our ability to originate new loans may be further impeded by increased competition for high quality borrowers which leads to downward pricing pressure on loans, a general consumer and business bias towards reducing debt levels, and the effects of a potential economic recession in the future on the financial condition of both consumers and businesses which could make the underwriting of new loans more challenging. Interest Rate Sensitivity A principal objective of the Bank's asset liability management strategy is to manage its exposure to changes in interest rates within Board approved policy limits by matching the maturity and re-pricing characteristics of interest-earning assets and interest-bearing liabilities. This strategy is overseen through the direction of the Bank'sAsset and Liability Committee ("ALCO"), which establishes policies and monitors results to control interest rate sensitivity. We model our current interest rate exposure in various rate scenarios, review our model assumptions, and then stress test those assumptions. Based on the results, we then formulate strategies regarding asset generation, funding sources and their pricing parameters, as well as evaluate off-balance sheet commitments in order to maintain interest rate risk within Board approved target limits. We utilize industry recognized asset liability models driven by third-party providers to analyze the Bank's interest rate sensitivity. From these externally generated reports, ALCO can estimate both the effect on net interest income and the effect on EVE in various interest rate scenarios. As a part of the Bank's Interest Rate Risk Management Policy, our ALCO examines the extent to which the Bank's assets and liabilities are "interest rate sensitive" and monitors its interest rate sensitivity. An asset or liability is considered to be interest rate sensitive, for income purposes, if its projected income/expense amount will change if interest rates change. Likewise, it is considered interest rate sensitive for EVE if its economic value will change if interest rates change.
In an asset sensitive portfolio, the Bank's net income and EVE will increase in a rising rate environment as assets will re-price faster than liabilities. Conversely, if the Bank is liability sensitive and the liabilities re-price faster than the assets, net income and EVE will fall in a rising rate environment.
In modeling the Bank's interest rate exposure, the Bank makes a number of important assumptions about the behavior of assets and liabilities. The critical assumptions fall into three main categories, nonmaturity deposit assumptions, asset prepayment assumptions, and optionality. Currently, the most significant assumption which affects the Bank's interest rate sensitivity is the nonmaturity deposit assumption, followed by the asset prepayment assumptions and optionality.
Nonmaturity Deposit Assumptions
Nonmaturity Deposit Betas - The beta of a nonmaturity deposit is a measure of the anticipated pricing behavior of the deposit. Based on the Bank's own historical experience, the Bank determines how much the price of a deposit will change as a percentage of the change in the market rates. For example, a 50% beta means that the deposit price will change by 50% of the market rate change. Nonmaturity Decay - We determine how "sticky" deposits are by assigning a 120-month "maturity" to our nonmaturity transaction deposit accounts. These assumptions are based on our own experience by looking at both the age of the current deposit base and the historic monthly account closing and balance migration experience. The lower the beta (more fixed rate nature) and the higher the decay (longer duration), the less interest rate sensitive a bank becomes, from an EVE perspective, in a rising interest rate environment. Conversely, higher betas combined with lower decay rates results in higher interest rate sensitivity in a rising interest rate environment. Asset Prepayment Assumptions We also determine how likely each earning asset is to prepay prior to its contracted maturity date. As refinancing rates become increasingly attractive, prepayment speeds increase as clients are able to prepay loans and refinance at lower rates. Conversely, prepayments decrease in a rising rate environment. Loan prepayment speed changes are not linear; they will continue to increase as rates fall but will plateau as rates rise. Therefore, the Bank's asset prices will not change linearly with market rate changes. The higher the prepayment speed of assets, the more liability sensitive the Bank becomes. The Bank monitors its prepayments and updates the assumptions used in the risk models on an annual basis. In addition, certain balance sheet instruments such as interest-rate floors or caps on loans, be they periodic or lifetime, and other optionality on investments such as call features on debt securities, limit or increase income and create value changes of the instrument as interest rates change. Option Risk
We monitor our exposure to option-type effects and manage our option risk. The amount of option risk, aside from prepayment risk, is minimal.
We monitor our exposure on a monthly basis under thirteen different rate scenarios, including rates rising or declining by up to 4% and the current yield curve flattening or steepening. We compare these results to the Board's established limits to determine if a limit has been compromised. If a limit is exceeded, we have policies and strategies in place to reduce the exposure to acceptable levels. In addition, we also stress test all of our assumptions under these rate scenarios to determine at what point the Board approved target limits would be compromised, even if they are not currently compromised using the historically determined assumptions. If the limits are in danger of being compromised with relatively small assumption changes, we would adjust our strategy to reduce exposure. All of these assumptions, reports, stress tests, and strategies are reviewed by ALCO at least quarterly and all limit exceptions are reported to the Board monthly. Our strategy is to maintain an interest rate risk position within the tolerance limits set by the Board of Directors in order to protect our net interest margin under extreme market fluctuations. Principal among our asset liability management strategies has been the emphasis on reducing exposure during periods of fluctuating interest rates. We believe that the type and amount of our interest rate sensitive liabilities should reduce the potential impact that a rise in interest rates might have on our net interest income. We look to maintain a core deposit base by providing quality services to our clients, without significantly increasing our cost of funds or operating expenses. We anticipate that these accounts will continue to comprise a significant portion of the Bank's total deposit base. We also maintain a portfolio of liquid assets in order to reduce overall exposure to changes in market interest rates. Likewise, we maintain a "floor," or minimum rate, on certain of our floating or published base rate loans. These floors allow us to continue to earn a higher rate when the floating rate falls below the established floor rate. All interest rate ceilings and floors are clearly and closely related to the loan agreement; therefore, they are not bifurcated and valued separately. AtDecember 31, 2022 , both our EVE and one-year net interest income sensitivity position were slightly liability sensitive in most of the measured interest rate scenarios, such that an immediate and parallel shift in interest rates beyond the forward rate curve would have a negative impact on our EVE and one-year net interest income over the next twelve months. Our ALCO model shows that the effects would be minimal and fall within Board approved limits for all interest rate scenarios. 26
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RESULTS OF OPERATIONS Net interest income constitutes the principal source of income for the Bank and results from the excess of interest income on interest-earning assets over interest expense on interest-bearing liabilities. The principal interest-earning assets are investment securities and loans. Interest-bearing liabilities primarily consist of time deposits, interest-bearing checking accounts, savings deposits, money-market accounts, and other borrowings. Funds attracted by these interest-bearing liabilities are invested in interest-earning assets. Accordingly, net interest income depends upon the volume of average interest-earning assets and average interest-bearing liabilities and the interest rates earned or paid on these assets and liabilities. The table below sets forth information regarding: (i) the total dollar amount of interest and dividend income of the Bank from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average costs; (iii) net interest income; (iv) interest rate spread; (v) net interest margin; and (vi) weighted-average yields and rates. Yields and costs were derived by dividing annualized income or expense by the average balance of assets or liabilities. The yields and costs depicted in the table include the amortization of fees, which are considered to constitute adjustments to yields (dollars in thousands). As shown in the table below, year over year, the yield on the average balance of interest-earning assets increased 39 basis points, while the average balance of interest-earning assets increased$92.7 million , or 12.9%. The average rate paid on interest-bearing liabilities increased 6 basis points while the average balance of total interest-bearing liabilities increased 17.7%, or$84.9 million . The noticeable lag in rising deposit costs started to dissipate in the fourth quarter of 2022 as competition from higher-yielding investment alternatives intensified. For the Year Ended December 31, 2022 2021 Interest Interest Average and Yield/ Average and Yield/ (dollars in thousands) Balance Dividends Rate Balance Dividends Rate Interest-earning assets: Loans(1)$ 537,304 $ 25,803 4.80 %$ 480,606 $ 22,598 4.70 % Loans held for sale 9,852 418 4.24 13,066 452 3.46 Debt securities 126,102 2,938 2.33 64,125 1,086 1.69 Other(2) 139,614 1,581 1.13 162,417 268 0.17 Total interest-earning assets 812,872$ 30,740 3.78 % 720,214$ 24,404 3.39 % Noninterest-earning assets 39,400 31,362 Total assets$ 852,272 $ 751,576 Interest-bearing liabilities: Savings, NOW and money-market deposits$ 518,777 $ 2,315 0.45 % $
427,284$ 1,653 0.39 % Time deposits 42,536 264 0.62 51,371 369 0.72 Total interest-bearing deposits 561,313 2,579 0.46 478,655 2,022 0.42 Other borrowings 4,016 200 4.98 1,770 58 3.28 Total interest-bearing liabilities 565,329$ 2,779 0.49 % 480,425$ 2,080 0.43 %
Noninterest-bearing deposits 213,570 200,713 Noninterest-bearing liabilities 7,824 5,259 Stockholders' equity 65,549 65,179 Total liabilities and stockholders' equity$ 852,272 $ 751,576 Net earning assets$ 247,543 $ 239,789 Net interest income$ 27,961 $ 22,324 Interest rate spread(3) 3.29 % 2.96 % Net interest margin(4) 3.44 % 3.10 % Ratio of average interest-earning assets to average interest-bearing liabilities 1.44 1.50 (1) Includes nonaccrual loans (2) Other interest-earning assets include federal funds sold, interest-bearing deposits and FHLB stock. (3) Net interest spread is the difference between the total interest-earning asset yield and the rate paid on total interest (4) Net interest margin is net interest income divided by total average interest-earning assets. 27
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Comparison of the years ended
Year ended December 31, Change 2022 vs. 2021 (dollars in thousands) 2022 2021 Amount Percent Net Interest Income$ 27,961 $ 22,324 $ 5,637 25.3 % Provision (credit) for loan losses 890 (104 ) 994 (955.8 ) Noninterest income 1,934 2,506 (572 ) (22.8 ) Noninterest expense 16,268 14,070 2,198 15.6 Income Taxes 3,056 2,517 539 21.4 Net earnings$ 9,681 $ 8,347 $ 1,334 16.0 % Compared to 2021, the$1.3 million , or 16.0%, increase in net earnings in 2022 is primarily attributed to a higher volume of loans and securities, and secondarily, to higher yields on interest-earning assets. The increase in provision expense is mostly attributed to funded loan growth. The decrease in noninterest income primarily reflects an industry-wide decline in mortgage banking activity due to the rising rate environment while approximately 70% of the increase in noninterest expense can be tied to higher salaries and employee benefits. Income tax expense increased due to higher income before taxes in 2022 and a higher tax rate (24.0% in 2022 compared to 23.2% in 2021.) Net Interest Income Our operating results depend primarily on our net interest income, which is the difference between interest and dividend income on interest-earning assets such as loans and investments, and interest expense on interest-bearing liabilities such as deposits and borrowings. Net interest income was$28.0 million for the year endedDecember 31, 2022 , compared to$22.3 million for the year endedDecember 31, 2021 . Year ended December 31, Change 2022 vs. 2021 (dollars in thousands) 2022 2021 Amount Percent Interest income: Loans$ 26,221 $ 23,050 $ 3,171 13.8 % Securities 2,938 1,086 1,852 170.5 Other 1,581 268 1,313 489.9 Total interest income$ 30,740 $ 24,404 $ 6,336 26.0 % Interest expense: Deposits 2,579 2,022 557 27.5 % Other borrowings 200 58 142 244.8 Total interest expense 2,779 2,080 699 33.6 Net interest income$ 27,961 $ 22,324 $ 5,637 25.3 % Year over year, the$6.3 million , or 26.0%, increase in total interest income is predominantly due to higher average balances and higher yields on loans and debt securities. Higher yields on all categories of interest-earning assets, particularly cash, also played a material role, partially offset by a$2.6 million decrease in interest and fee income from PPP loans. Total interest expense was impacted by higher average balances of savings, NOW, and money-market deposit accounts and increased other borrowings as well as higher rates on these two categories. Provision for Loan Losses
The
28
--------------------------------------------------------------------------------Noninterest Income Year ended December 31, Change 2022 vs. 2021 (dollars in thousands) 2022 2021 Amount Percent Service charges and fees on deposit accounts$ 302 $ 245 $ 57 23.3 % Debit card/ATM revenue, net 540 470 70 14.9 Mortgage banking revenue, net 473 1,174 (701 ) (59.7 ) Income from bank-owned life insurance 379 271 108 39.9 Gain on sale of debt securities available for sale - 108 (108 ) N/A Other income 240 238 2 0.8 Total noninterest income$ 1,934 $ 2,506 $ (572 ) -22.83 % The decline in noninterest income is primarily attributed to lower mortgage banking revenue due to a decline in new mortgage loans and refinancings resulting from the rising interest rate environment in 2022. Increases in service charges and fees on deposit accounts and fee income from debit cards and ATM mostly reflect the Bank's growing number of accounts. Increases in income from bank-owned life insurance follows the Bank's larger investment in this asset in 2021 while other income stayed relatively flat. Noninterest Expense Year ended December 31, Change 2022 vs. 2021 (dollars in thousands) 2022 2021 Amount Percent Salaries and employee benefits$ 9,627 $ 8,093$ 1,534 19.0 % Occupancy and equipment 1,621 1,546$ 75 4.9 Professional fees 514 483$ 31 6.4 Marketing 793 707$ 86 12.2 FDIC Assessment 360 316$ 44 13.9 Software maintenance, amortization and other 1,162 975$ 187 19.2 Other 2,191 1,950$ 241 12.4 Total noninterest expense$ 16,268 $ 14,070$ 2,198 15.6 % The$2.2 million increase in total noninterest expense is predominantly a function of higher salaries and employee benefits due to higher headcount (the Company reported 107 full-time equivalents (FTEs) at the end of 2022 compared to 94 at the end of 2021), annual raises, higher incentive accrual and lower deferred loan costs. Marketing costs increased in 2022 largely due to a strategic campaign initiated in the fourth quarter to retain deposit accounts. Higher software, maintenance, amortization and other expense reflects technology investments that will help the Bank become more effective and efficient while the increase in other noninterest expense is largely attributed to higher travel expense and board related expenses. Income Taxes The provision for income taxes increased$539,000 to$3.1 million for the year endedDecember 31, 2022 , compared to the year endedDecember 31, 2021 , attributed to higher earnings before taxes in 2022. The Company's effective income tax rate in 2022 was 24.0%, compared to 23.2% in 2021. A lower effective state income tax rate in 2021 also benefited net earnings for that year. 29
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Rate/Volume Analysis
The following table sets forth certain information regarding changes in interest
income and interest expense for the years indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to: (i) changes in rate (change in rate
multiplied by prior volume); (ii) changes in volume (changes in volume
multiplied by prior rate); and (iii) changes in rate-volume (change in rate
multiplied by change in volume). As disclosed in the table below, the higher
volume of loans was the primary driver of the increase in net interest income in
2022.
Year Ended December 31, 2022 versus 2021
Rate Volume Rate/Volume Total
(in thousands)
Interest-earning assets:
Loans $ 608 $ 2,497 $ 66 $ 3,171
Securities 408 1,050 394 1,852
Other interest-earning assets 1,571 (38 ) (220 ) 1,313
Total $ 2,587 $ 3,509 $ 240
Interest-bearing liabilities: Savings, NOW and money-market deposits$ 254 $ 354 $ 54$ 662 Time deposits (50 ) (64 ) 9 (105 ) Total Deposits 204 290 63 557 Other borrowings 30 74 38 142 Total$ 234 $ 364 $ 101$ 699 Total change in net interest income$ 2,353 $ 3,145 $ 139$ 5,637 30
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FINANCIAL CONDITION
Average interest-earning assets increased
Investment Securities Our investment securities portfolio is a significant part of our operations and a key component of our asset/liability management. Our primary objective in managing our investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns. We use the investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate and prepayment risk, to generate interest and dividend income, to provide liquidity to meet funding requirements, and to provide collateral for pledging of public funds. We manage our investment portfolio according to a written investment policy approved by our Board of Directors in order to accomplish these goals. Currently, two types of classifications are approved for investment securities in our portfolio - Available-for-Sale and Held-to-Maturity. Adjustments are sometimes necessary in the portfolio to provide liquidity for funding loan demand and deposit fluctuations and to control interest rate risk. Therefore, from time to time, management may sell certain securities prior to their maturity. AtDecember 31, 2022 , our available-for-sale investment portfolio includedU.S. government treasury and agency securities, municipal securities,U.S. agency mortgage-backed securities, and asset-backed securities and had a fair market value of$129.4 million . Our held-to-maturity portfolio included municipal securities andU.S. agency mortgage-backed securities and had a fair market value of$9.9 million . AtDecember 31, 2022 and 2021, our investment securities portfolio represented approximately 17.3% and 8.8% of our total assets, respectively. The average balance of investment securities nearly doubled from$64.1 million in 2021 to$126.1 million in 2022, while the average yield on investment securities increased from 1.69% for the year endedDecember 31, 2021 to 2.33% for the year endedDecember 31, 2022 . AtDecember 31, 2021 , we had no securities classified as held-to-maturity. The following table sets forth the carrying amount of the investment portfolio as of the dates indicated: At December 31, 2022 2021 (in thousands) Available for Sale: U.S. Government treasury and agency securities$ 45,905 $ 2,919 Municipal securities 19,464 17,769 U.S. agency mortgage-backed securities 60,502 48,465 Asset backed securities 3,565 4,610
Total debt securities available for sale
Held to Maturity: Municipal securities$ 9,215 $ - U.S. agency mortgage-backed securities 2,590 - Total debt securities held to maturity$ 11,805 $ - The carrying amount and weighted average yields for investments as ofDecember 31, 2022 are shown below: U.S. Government Mortgage- Weighted-Average (dollars in thousands) Agency Municipal Backed Asset-Backed Total Yields Available for Sale: Due within one year$ 1,967 $ - $ - $ -$ 1,967 2.42 % Due in one to five years 41,993 3,554 - - 45,547 2.37 Due in five to ten years 1,945 13,920 - - 15,865 2.13 Due after ten years - 1,990 - 3,565 5,555 4.50 U.S. agency mortgage-backed securities - - 60,502 - 60,502 2.27 Total debt securities available for sale$ 45,905 $ 19,464 $ 60,502 $ 3,565 $ 129,436 2.39 % Held to Maturity: Due in five to ten years $ -$ 2,023 $ - $ -$ 2,023 3.71 % Due after ten years - 7,192 - - 7,192 3.27 U.S. agency mortgage-backed securities - - 2,590 - 2,590 3.66 Total debt securities held to maturity $ -$ 9,215 $ 2,590 $ -$ 11,805 3.43 %
* All securities are listed at actual yield and not on a tax-equivalent basis.
Cash Surrender Value of Bank-Owned Life Insurance
We recorded investments of$16.5 million and$16.2 million in bank-owned life insurance policies atDecember 31, 2022 and 2021, respectively, due to attractive risk-adjusted returns and for protection against the loss of key executives, including our Chief Executive OfficerSammie D. Dixon and all of our Executive Vice Presidents- Senior Lender,Chris L. Jensen , Jr., Chief Banking Officer,Kyle D. Phelps ,Chief Risk Officer ,Susan Payne Turner , Chief Financial Officer,Clint F. Weber , and Chief Information Officer,Monte L Ward . The Company increased its investment in bank-owned life insurance in 2021 in order to expand coverage to additional key personnel. Loans Our primary earning asset is our loan portfolio and our primary source of income is the interest earned on the loan portfolio. Our loan portfolio is divided into three portfolio segments - real estate mortgage loans, commercial loans and consumer and other loans - and five portfolio classes - commercial real estate loans, residential and home equity loans, construction loans, commercial loans, and consumer and other loans. We work diligently to attract new lending clients through direct solicitation by our loan officers, utilizing relationship networks from existing clients and community involvement, competitive pricing, and innovative structure. Evidence of this effort is seen in the organic growth in our loan portfolio where we saw growth across the all of the Bank's portfolio classes in 2022. As ofDecember 31, 2022 , the Bank's gross loans were$595.6 million , representing 73.1% of total assets, compared to gross loans of$496.9 million as ofDecember 31, 2021 , representing 59.1% of total assets. These loans were priced based upon the degree of risk, collateral, loan amount, and maturity. 31 -------------------------------------------------------------------------------- The composition of our loan portfolio as of the dates indicated was as follows: As of December 31, 2022 2021 2020 (dollars in thousands) Amount % of Total Amount % of Total Amount % of Total Real estate mortgage loans: Commercial$ 202,263 34.0 %$ 156,306 31.5 %$ 133,473 27.6 % Residential and home equity 224,211 37.6 183,536 36.9 158,120 32.7 Construction 75,151 12.6 71,164 14.3 44,466 9.2 Total real estate mortgage loans 501,625 84.2 411,006 82.7 336,059 69.5 Commercial 86,308 14.5 78,584 15.8 141,542 29.2 Consumer and other loans 7,698 1.3 7,283 1.5 6,312 1.3 Total loans 595,631 100.0 % 496,873 100.0 % 483,913 100.0 % Less: Net deferred loan costs (fees) 229 (701 ) (1,160 ) Allowance for loan losses (7,145 ) (5,974 ) (6,092 ) Loans, net$ 588,715 $ 490,198 $ 476,661 Maturities of Loans The following tables show the contractual maturities of the Bank's loan portfolio atDecember 31, 2022 . Loans with scheduled maturities are reported in the maturity category in which the payment is due. Demand loans with no stated maturity and overdrafts are reported in the "due one year or less" category. Loans that have adjustable rates are shown as amortizing to final maturity rather than when the interest rates are next subject to change. The tables do not include prepayment or scheduled principal repayments. Due in One Due in One to Five Due After (in thousands) Year or Less Years Five Years Total Type of loans Real estate mortgage loans: Commercial$ 2,107 $ 36,995 $ 163,161 $ 202,263 Residential and home equity 4,466 12,184 207,561 224,211 Construction 32,157 13,488 29,506 75,151 Total real estate mortgage loans 38,730 62,667 400,228 501,625 Commercial 26,251 36,115 23,942 86,308 Consumer and other loans 4,232 3,031 435 7,698 Total loans$ 69,213 $ 101,813 $ 424,605 $ 595,631 32
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Sensitivity. For loans due after one year or more, the following table presents
the sensitivities to changes in interest rates at
Fixed Floating
(in thousands) Interest Rate Interest Rate Total
Type of loans
Real estate mortgage loans:
Commercial $ 90,668 $ 109,488 $ 200,156
Residential and home equity 32,400 187,345 219,745
Construction 7,844 35,150 42,994
Total real estate mortgage loans 130,912 331,983 462,895
Commercial 35,999 24,058 60,057
Consumer and other loans 1,711 1,755 3,466
Total loans $ 168,622 $ 357,796 $ 526,418
Nonperforming Assets
Nonperforming assets consist of nonperforming loans and other real estate owned
("OREO"). Nonperforming loans include loans that are on nonaccrual status and
loans past due greater than 90 days and still accruing interest. OREO consists
of real property acquired through foreclosure. We account for troubled debt
restructurings in accordance with ASC 310, "Receivables."
We generally place loans on nonaccrual status when they become 90 days or more
past due, unless they are well secured and in the process of collection. We also
place loans on nonaccrual status if they are less than 90 days past due if the
collection of principal or interest is in doubt. When a loan is placed on
nonaccrual status, any interest previously accrued, but not collected, is
reversed from income.
Accounting standards require the Bank to identify loans as impaired loans when,
based on current information and events, it is probable that the Bank will be
unable to collect the scheduled payments of principal or interest when due
according to the contractual terms of the loan agreement. These standards
require that impaired loans be valued at the present value of expected future
cash flows, discounted at the loan's effective interest rate, using one of the
following methods: the observable market price of the loan or the fair value of
the underlying collateral if the loan is collateral dependent. We implement
these standards in our monthly review of the adequacy of the allowance for loan
losses and identify and value impaired loans in accordance with guidance on
these standards.
Our goal is to maintain a high quality of loans through sound underwriting and
lending practices. As of December 31, 2022 , 2021, and, 2020, approximately
84.2%, 82.7%, and 69.5%, respectively, of the total loan portfolio were
collateralized by commercial and residential real estate mortgages. The level of
nonperforming loans and OREO is relevant to the credit quality of a loan
portfolio. As of December 31, 2022 , nonperforming loans totaled $747,000
compared to none at December 31, 2021 and $1.3 million as of December 31, 2020 .
We had no OREO at December 31, 2022 , 2021, or 2020.
33
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The goal of the loan review process is to identify and address classified and
nonperforming loans as early as possible. The following table sets forth certain
information on nonperforming loans and OREO, the ratio of such loans and
foreclosed assets to total assets as of the dates indicated, and certain other
related information.
At December 31,
2022 2021 2020
(dollars in thousands)
Total nonperforming loans $ 747 $ - $ 1,251
OREO - - -
Total nonperforming loans and foreclosed
assets $ 747 $ - $ 1,251
Total nonperforming loans as a percentage of
total loans 0.13 % - 0.26 %
Total nonperforming assets as a percentage
of total assets 0.09 % - 0.19 %
Loans restructured as troubled debt restructurings $ 2 $ 4$ 65 Troubled debt restructurings to loans 0.00 % 0.00 % 0.01 % Allowance for Loan Losses As ofDecember 31, 2022 , our ALLL was allocated to inherent loan losses using historical loss experience and qualitative risk factors. The$559,000 unallocated reserve that was established in 2020 in connection to the COVID-19 pandemic was gradually released in 2021. Our ALLL was allocated as follows, as of the indicated dates. As of December 31, 2022 2021 2020 % of Loans to % of Loans to % of Loans to Amount Total Loans Amount Total Loans Amount Total Loans (dollars in thousands) Commercial real estate$ 2,303 34.0 %$ 1,762 31.5 %$ 1,500 27.6 % Residential real estate and home equity 2,607 37.6 2,139 36.9 1,827 32.7 Construction 922 12.6 857 14.3 539 9.2 Commercial 1,223 14.5 1,125 15.8 1,592 29.2 Consumer 90 1.3 91 1.5 75 1.3 Unallocated reserve - - - - 559 - Total loans$ 7,145 100.0 %$ 5,974 100.0 %$ 6,092 100.0 %
The following table sets forth certain information with respect to activity in our ALLL during the years indicated:
Year Ended December 31,
(dollars in thousands) 2022 2021 2020
ALLL at beginning of year $ 5,974 $ 6,092 $ 4,414
Charge-offs:
Residential and home equity - (49 ) (48 )
Commercial - - (1,088 )
Consumer (49 ) (34 ) (69 )
Total charge-offs (49 ) (83 ) (1,205 )
Recoveries:
Residential and home equity - 39 -
Commercial 299 23 17
Consumer 31 7 16
Total recoveries 330 69 33
Provision (credit) for loan losses charged
to earnings 890 (104 ) 2,850
ALLL at end of year $ 7,145 $ 5,974 $ 6,092
Ratio of net (charge-offs) recoveries during
the year to average loans outstanding during
the year (0.05 )% - (0.27 )%
ALLL as a percentage of total loans at end
of year 1.20 % 1.20 % 1.26 %
ALLL as a percentage of nonperforming loans 956.49 % - 486.90 %
We believe that our ALLL at December 31, 2022 , appropriately reflected the risk
inherent in the portfolio as of that date. The methodologies used in the
calculation are in compliance with regulatory policy and GAAP. Beginning in
2023, we will apply CECL in calculating our provision and ALLL. We do not
anticipate this having a material impact on the amount of our provision expense,
but we cannot be sure of the ultimate impact of CECL until we implement it and
evaluate our results under its standards. The Company currently expects that the
initial adjustment to the allowance for loan losses will be a decrease of
approximately $1.9 million , net of taxes, bringing the ratio of allowance to
total loans from 1.20% to 0.76%.
34
--------------------------------------------------------------------------------Deposits The major source of the Bank's funds for lending and other investment purposes are deposits, in particular core deposits and non-maturity deposits. Substantially all of our depositors are residents in our primary market areas. Total deposits were$731.5 million atDecember 31, 2022 , compared to$762.9 million atDecember 31, 2021 , a$31.4 million , or 4.1%, decrease. Noninterest-bearing deposits decreased by$11.4 million , while the net decrease in interest-bearing deposits was$20.0 million . The decrease in deposits is mostly attributed to the movement of personal interest-bearing accounts into higher yielding investments outside of the Bank as competitive rate pressures intensified in the fourth quarter of 2022. The following table sets forth the distribution by type of our deposit accounts at the dates indicated: As of December 31, 2022 2021 (dollars in thousands) Amount % of Deposits Amount % of Deposits Deposit Types Noninterest-bearing$ 197,987 27.1 %$ 209,351 27.4 % Money-market accounts 282,678 38.6 329,802 43.2 NOW 175,200 23.9 144,898 19.0 Savings 35,561 4.9 29,059 3.8 Subtotal 691,426 94.5 713,110 93.4 Time deposits: 0.00 - 0.50 % 17,261 2.4 44,727 5.9 0.51 - 1.00 % 4,174 0.6 631 0.1 1.01 - 1.50 % 6,678 0.9 1,538 0.2 1.51 - 2.00 % 1,000 0.1 720 0.1 2.01 - 2.50 % 7,862 1.1 - - 2.51 - 3.00 % 2,634 0.3 2,216 0.3 4.01-4.50 % 500 0.1 - - Total time deposits 40,109 5.5 49,832 6.6 Total deposits$ 731,535 100.0 %$ 762,942 100.0 %
The following table presents the maturities of our time deposits greater than
(in thousands) Time Deposits >$250,000 Due in three months or less$ 350 Due from three months to six months 9,566 Due from six months to one year 3,623 Due over one year 557 Total$ 14,096 Borrowings Deposits are the primary source of funds for our lending and investment activities and general business purposes. However, as an alternate source of liquidity, the Bank may obtain advances from theFederal Home Loan Bank of Atlanta ("FHLB") sell investment securities subject to our obligation to repurchase them, purchase federal funds from designated correspondent banks, and engage in overnight borrowings from theFederal Reserve , correspondent banks, or client repurchase agreements. The level of short-term borrowings can fluctuate on a daily basis depending on funding needs and the source of the funds to satisfy the needs.
The Bank has an agreement with the FHLB and pledges its qualified loans as
collateral which would allow the Bank, as of
During the third quarter of 2020, the Company entered into a Promissory Note (the "Note") and a Security Agreement withThomasville National Bank ("TNB") which is headquartered inThomasville, Georgia . Pursuant to the Note, the Company obtained a$15 million revolving line of credit with a 5-year term. The interest rate adjusts daily to the then-current Wall Street Journal Prime Rate. AtDecember 31, 2022 the interest rate on the line of credit was 7.50%. Pursuant to the Security Agreement, the Company has pledged to TNB all of the outstanding shares of common stock of the Company's wholly-owned subsidiary, the Bank. As ofDecember 31, 2022 , the Company had an outstanding loan balance under this line of$4.275 million and total interest expense of$200,000 for the year endedDecember 31, 2022 . 35
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Capital Adequacy Stockholders' equity was$67.1 million as ofDecember 31, 2022 , compared to$67.0 million as ofDecember 31, 2021 . The Company announced inJanuary 2023 , an annual dividend of$0.22 per share of common stock payable onFebruary 28, 2023 to stockholders of record onFebruary 9, 2023 . As ofDecember 31, 2022 , the Bank was considered to be "well capitalized" with a 9.70% Tier 1 Leverage ratio, a 12.90% Common Equity Tier 1 Risk-based Capital ratio and Tier 1 Risk-based Capital ratio, and a 14.04% Total Risk-based Capital ratio. Actual For Capital Adequacy Purposes For Well Capitalized Purposes (dollars in thousands) Amount Percentage Amount Percentage Amount Percentage As of December 31, 2022 Tier 1 Leverage ratio to Average Assets$ 81,100 9.70 %$ 33,461 4.00 %$ 41,826 5.00 % Common Equity Tier 1 Capital to Risk-Weighted Assets 81,100 12.90 28,290 4.50 40,863 6.50 Tier 1 Capital to Risk-Weighted Assets 81,100 12.90 37,720 6.00 50,294 8.00 Total Capital to Risk-Weighted Assets 88,245 14.04 50,294 8.00 62,867 10.00 As of December 31, 2021 Tier 1 Leverage ratio to Average Assets$ 70,548 8.53 %$ 33,071 4.00 %$ 41,338 5.00 % Common Equity Tier 1 Capital to Risk-Weighted Assets 70,548 13.45 23,596 4.50 34,083 6.50 Tier 1 Capital to Risk-Weighted Assets 70,548 13.45 31,461 6.00 41,948 8.00 Total Capital to Risk-Weighted Assets 76,522 14.59 41,948 8.00 52,435 10.00 Threshold Ratios Common Equity Total Tier 1 Tier 1 Tier 1 Capital Risk-Based Risk-Based Risk-Based Leverage Category Capital Ratio Capital Ratio
Capital Ratio Capital Ratio
Well capitalized 10.00% 8.00% 6.50% 5.00% Adequately Capitalized 8.00% 6.00% 4.50% 4.00% Undercapitalized <8.00% <6.00% <4.50% <4.00% Significantly Undercapitalized <6.00% <4.00% <3.00% <3.00% Critically Undercapitalized Tangible Equity/Total Assets ? 2% The Federal banking regulatory agencies adopted a rule to simplify the methodology for measuring capital adequacy for smaller, uncomplicated banks. The CBLR is calculated as the ratio of tangible equity capital divided by average total consolidated assets. CBLR tangible equity is defined as total equity capital, prior to including minority interests, and excluding accumulated other comprehensive income, deferred tax assets arising from net operating loss and tax credit carryforwards, goodwill, and other intangible assets (other than mortgage servicing assets. Beginning in 2020, a qualifying organization may elect to use the CBLR framework if its CBLR is greater than 9%. The Bank has not elected to use the CBLR framework because it would not receive any material benefit with respect to compliance or reporting. Liquidity Liquidity describes our ability to meet financial obligations, including lending commitments and contingencies, which arise during the normal course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of the Company's clients, as well as meet the Company's current and planned expenditures. Management monitors the liquidity position daily. PMHG has a$15,000,000 revolving line of credit, with a five-year term, with TNB. AtDecember 31, 2022 , the Company's outstanding borrowings under this line totaled$4.275 million . The Bank's liquidity is derived primarily from our deposit base, scheduled amortization and prepayments of loans and investment securities, funds provided by operations, and capital. Additionally, as a commercial bank, we are expected to maintain an adequate liquidity position. The liquidity position may consist of cash on hand, cash on demand deposit with correspondent banks, federal funds sold, and marketable securities such asUnited States government treasury and agency securities, municipal securities,U.S. agency mortgage-backed securities and asset-backed securities. Our primary liquid assets, excluding pledged securities, accounted for 19.1% and 35.1% of total assets atDecember 31, 2022 and 2021, respectively. The Bank also has external sources of funds through the FHLB, unsecured lines of credit with correspondent banks, and theState of Florida's Qualified Public Deposit Program ("QPD"). AtDecember 31, 2022 , the Bank had access to approximately$100.8 million of available lines of credit secured by qualifying collateral with the FHLB, in addition to$59.0 million in unsecured federal funds lines of credit maintained with correspondent banks. As ofDecember 31, 2022 , we had no borrowings under any of these lines. Some of our securities are pledged to collateralize certain deposits through our participation in theState of Florida's QPD program. The market value of securities pledged to the QPD program was$13.3 million atDecember 31, 2022 . 36 -------------------------------------------------------------------------------- Our core deposits consist of noninterest-bearing accounts, NOW accounts, money-market accounts, time deposits and savings accounts. We closely monitor our level of certificates of deposit$250,000 and greater and other large deposits. AtDecember 31, 2022 , total deposits were$731.5 million , of which$14.1 million was in certificates of deposits greater than$250,000 . We maintain a Contingency Funding Plan ("CFP") that identifies liquidity needs and weighs alternate courses of action designed to address those needs in emergency situations. We perform a monthly cash flow analysis and stress test the CFP to evaluate the expected funding needs and funding capacity during various liquidity stress scenarios. We believe that the sources of available liquidity are adequate to meet all reasonably immediate short-term and intermediate-term demands and do not know of any trends, events, or uncertainties that may result in a significant adverse effect on our liquidity position.
Off-Balance Sheet Arrangements
In the normal course of business, we enter into various transactions that are not included in our consolidated balance sheets in accordance with GAAP. These transactions include commitments to extend credit in the ordinary course of business to approved clients, construction loans in process, unused lines of credit, guaranteed accounts, and standby performance and financial letters of credit. These instruments may involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. Generally, loan commitments have been granted on a temporary basis for working capital or commercial real estate financing requirements or may be reflective of loans in various stages of funding. These commitments are recorded on our financial statements as they are funded. Commitments typically have fixed expiration dates or other termination clauses and may require payment of a fee. Loan commitments include unused commitments for open-end lines secured by one-to-four family residential properties and commercial properties, commitments to fund loans secured by commercial real estate, construction loans, business lines of credit and other unused commitments. Guaranteed accounts are irrevocable standby letters of credit issued by us to guarantee a client's credit line with our third-party credit card company,First Arkansas Bank & Trust . As a part of this agreement, we are responsible for the established credit limit on the particular account plus 10%. The maximum potential amount of future payments we could be required to make is represented by the dollar amount disclosed in the table below. Standby letters of credit are written conditional commitments issued by us to guarantee the client will fulfill his or her contractual financial obligations to a third party. In the event the client does not perform in accordance with the terms of the agreement with the third party, we would be required to fund the commitment. The maximum potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we would be entitled to seek repayment from the client. We minimize our exposure to loss under loan commitments, guaranteed accounts, and standby letters of credit by subjecting them to credit approval and monitoring procedures. The effect on our revenues, expenses, cash flows, and liquidity of the unused portions of these commitments cannot be reasonably predicted because there is no guarantee that the lines of credit will be used.
The following is a summary of the total contractual amount of commitments
outstanding at
At December 31,
2022 2021
(in thousands)
Commitments to extend credit $ 10,667 $ 5,400
Construction loans in process 61,991 63,552
Unused lines of credit 77,268 72,886Standby financial letters of credit 3,319 2,938 Standby performance letters of credit
- 100
Guaranteed accounts 1,425 1,367
Total off-balance sheet instruments
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