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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

(Mark One)

 

 

 

 

 

 

 

 

 

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended June 30, 2020

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the transition period from ___________ to ___________

 

Commission File Number  001-36613

 

Middlefield Banc Corp.

(Exact Name of Registrant as Specified in its Charter)

 

Ohio

 

34-1585111

State or Other Jurisdiction of 

 

I.R.S. Employer Identification No.

Incorporation or Organization

 

 

 

15985 East High Street, Middlefield, Ohio

 

44062-0035

Address of Principal Executive Offices

 

Zip Code

 

 

 

 

 

 

440-632-1666

 

 

 

 

 

 

 

 

 

Registrant’s Telephone Number, Including Area Code

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report

 

Securities Registered Pursuant to Section 12(b) of The Act:

 

Title of Each Class

Trading Symbol(s)

Name of Each Exchange on Which Registered

 

 

Common Stock, Without Par Value

MBCN

The NASDAQ Stock Market, LLC

(NASDAQ Capital Market)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes      No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes     No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

Large accelerated filer ☐

 

 

 

 

 

Accelerated filer 

 

 

 

 

Non-accelerated filer ☐  

 

 

 

 

 

Smaller reporting company 

 

 

 

Emerging growth company   

 

 

 

 

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes     No  

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Outstanding at August 4, 2020:  6,378,110

 

1

 

 

MIDDLEFIELD BANC CORP.

 

INDEX

 

Part I – Financial Information  
       
  Item 1. Financial Statements (unaudited)  
       
    Consolidated Balance Sheet as of June 30, 2020 and December 31, 2019  3
       
    Consolidated Statement of Income for the Three and Six Months ended June 30, 2020 and 2019 4
       
    Consolidated Statement of Comprehensive Income for the Three and Six Months ended June 30, 2020 and 2019 5
       
    Consolidated Statement of Changes in Stockholders' Equity for the Three and Six Months ended June 30, 2020 and 2019 6
       
    Consolidated Statement of Cash Flows for the Six Months ended June 30, 2020 and 2019 8
       
    Notes to Unaudited Consolidated Financial Statements  10
       
  Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations  33
       
  Item 3. Quantitative and Qualitative Disclosures about Market Risk 45
       
  Item 4. Controls and Procedures 46
       
Part II – Other Information  
       
  Item 1. Legal Proceedings  47
       
  Item 1a. Risk Factors 47
       
  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  48
       
  Item 3. Defaults by the Company on its Senior Securities 48
       
  Item 4. Mine Safety Disclosures 48
       
  Item 5. Other Information 48
       
  Item 6. Exhibits and Reports on Form 8-K 49
       
Signatures    54
     
Exhibit 31.1    
     
Exhibit 31.2     
     
Exhibit 32    

 

2

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED BALANCE SHEET

(Dollar amounts in thousands, except share data)

(Unaudited)

 

  

June 30,

  

December 31,

 
  

2020

  

2019

 
         

ASSETS

        

Cash and due from banks

 $55,766  $35,113 

Federal funds sold

  2,520   - 

Cash and cash equivalents

  58,286   35,113 

Equity securities, at fair value

  581   710 

Investment securities available for sale, at fair value

  112,529   105,733 

Loans held for sale

  4,151   1,220 

Loans:

        

Commercial real estate:

        

Owner occupied

  110,134   102,386 

Non-owner occupied

  300,577   302,180 

Multifamily

  37,604   62,028 

Residential real estate

  227,427   234,798 

Commercial and industrial

  240,096   89,527 

Home equity lines of credit

  117,196   112,248 

Construction and other

  66,015   66,680 

Consumer installment

  11,210   14,411 

Total loans

  1,110,259   984,258 

Less: allowance for loan and lease losses

  10,210   6,768 

Net loans

  1,100,049   977,490 

Premises and equipment, net

  18,962   17,874 

Goodwill

  15,071   15,071 

Core deposit intangibles

  1,890   2,056 

Bank-owned life insurance

  16,723   16,511 

Accrued interest receivable and other assets

  15,078   10,697 
         

TOTAL ASSETS

 $1,343,320  $1,182,475 
         

LIABILITIES

        

Deposits:

        

Noninterest-bearing demand

 $270,738  $191,370 

Interest-bearing demand

  136,722   107,844 

Money market

  168,842   160,826 

Savings

  218,545   192,003 

Time

  363,420   368,800 

Total deposits

  1,158,267   1,020,843 

Short-term borrowings:

        

Federal funds purchased

  -   75 

Federal Home Loan Bank advances

  20,417   5,000 

Total short-term borrowings

  20,417   5,075 

Other borrowings

  17,162   12,750 

Accrued interest payable and other liabilities

  6,779   6,032 

TOTAL LIABILITIES

  1,202,625   1,044,700 
         

STOCKHOLDERS' EQUITY

        

Common stock, no par value; 10,000,000 shares authorized, 7,298,829 and 7,294,792 shares issued; 6,369,467 and 6,423,630 shares outstanding

  86,722   86,617 

Retained earnings

  67,150   65,063 

Accumulated other comprehensive income

  3,761   1,842 

Treasury stock, at cost; 929,362 and 871,162 shares

  (16,938)  (15,747)

TOTAL STOCKHOLDERS' EQUITY

  140,695   137,775 
         

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

 $1,343,320  $1,182,475 

 

See accompanying notes to unaudited consolidated financial statements.

 

3

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF INCOME  

(Dollar amounts in thousands, except per share data)

(Unaudited)

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2020

   

2019

   

2020

   

2019

 

INTEREST AND DIVIDEND INCOME

                               

Interest and fees on loans

  $ 12,281     $ 12,706     $ 24,359     $ 25,194  

Interest-earning deposits in other institutions

    7       169       101       356  

Federal funds sold

    -       25       21       32  

Investment securities:

                               

Taxable interest

    206       214       363       393  

Tax-exempt interest

    634       553       1,263       1,118  

Dividends on stock

    27       53       57       111  

Total interest and dividend income

    13,155       13,720       26,164       27,204  
                                 

INTEREST EXPENSE

                               

Deposits

    2,336       3,277       5,201       6,222  

Short-term borrowings

    32       79       67       292  

Other borrowings

    62       95       138       191  

Total interest expense

    2,430       3,451       5,406       6,705  
                                 

NET INTEREST INCOME

    10,725       10,269       20,758       20,499  
                                 

Provision for loan losses

    1,000       110       3,740       350  
                                 

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

    9,725       10,159       17,018       20,149  
                                 

NONINTEREST INCOME

                               

Service charges on deposit accounts

    566       530       1,119       1,038  

Investment securities gains on sale, net

    -       190       -       190  

Gain (loss) on equity securities

    31       (14 )     (129 )     44  

Earnings on bank-owned life insurance

    105       109       212       214  

Gain on sale of loans

    381       98       495       157  

Other income

    412       386       872       788  

Total noninterest income

    1,495       1,299       2,569       2,431  
                                 

NONINTEREST EXPENSE

                               

Salaries and employee benefits

    4,076       4,078       7,600       8,202  

Occupancy expense

    483       496       1,033       1,049  

Equipment expense

    307       291       580       526  

Data processing costs

    684       549       1,350       1,014  

Ohio state franchise tax

    281       261       549       520  

Federal deposit insurance expense

    74       100       197       230  

Professional fees

    369       403       718       834  

Advertising expense

    217       200       426       403  

Software amortization expense

    74       48       215       191  

Core deposit intangible amortization

    83       85       166       170  

Other expense

    1,041       971       2,107       1,843  

Total noninterest expense

    7,689       7,482       14,941       14,982  
                                 

Income before income taxes

    3,531       3,976       4,646       7,598  

Income taxes

    565       686       639       1,297  
                                 

NET INCOME

  $ 2,966     $ 3,290     $ 4,007     $ 6,301  
                                 

EARNINGS PER SHARE

                               

Basic

  $ 0.47     $ 0.51     $ 0.63     $ 0.97  

Diluted

  $ 0.46     $ 0.50     $ 0.62     $ 0.97  

 

See accompanying notes to unaudited consolidated financial statements.

 

4

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Dollar amounts in thousands)

(Unaudited)

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2020

   

2019

   

2020

   

2019

 
                                 

Net income

  $ 2,966     $ 3,290     $ 4,007     $ 6,301  
                                 

Other comprehensive income:

                               

Net unrealized holding gain on available-for-sale investment securities

    7,592       1,122       2,429       2,128  

Tax effect

    (1,594 )     (236 )     (510 )     (447 )
                                 

Reclassification adjustment for investment securities gains included in net income

    -       (190 )     -       (190 )

Tax effect

    -       40       -       40  
                                 

Total other comprehensive income

    5,998       736       1,919       1,531  
                                 

Comprehensive income

  $ 8,964     $ 4,026     $ 5,926     $ 7,832  

 

See accompanying notes to unaudited consolidated financial statements.

 

5

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollar amounts in thousands, except share and per share data)

(Unaudited)

 

              

Accumulated

         
              

Other

      

Total

 
  

Common Stock

  

Retained

  

Comprehensive

  

Treasury

  

Stockholders'

 
  

Shares

  

Amount

  

Earnings

  

Income (Loss)

  

Stock

  

Equity

 
                         

Balance, March 31, 2020

  7,298,829  $86,722  $65,140  $(2,237) $(16,938) $132,687 
                         

Net income

          2,966           2,966 

Other comprehensive income

              5,998       5,998 

Cash dividends ($0.15 per share)

          (956)          (956)
                         

Balance, June 30, 2020

  7,298,829  $86,722  $67,150  $3,761  $(16,938) $140,695 

 

              

Accumulated

         
              

Other

      

Total

 
  

Common Stock

  

Retained

  

Comprehensive

  

Treasury

  

Stockholders'

 
  

Shares

  

Amount

  

Earnings

  

Income

  

Stock

  

Equity

 
                         

Balance, March 31, 2019

  7,285,070  $86,437  $58,139  $641  $(13,518) $131,699 
                         

Net income

          3,290           3,290 

Other comprehensive income

              736       736 

Dividend reinvestment and purchase plan

  7,524   149               149 

Stock options exercised

  400   4               4 

Treasury shares acquired (35,494)

                  (706)  (706)

Cash dividends ($0.14 per share)

          (912)          (912)
                         

Balance, June 30, 2019

  7,292,994  $86,590  $60,517  $1,377  $(14,224) $134,260 

 

(continued on following page)

See accompanying notes to unaudited consolidated financial statements.

 

6

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Dollar amounts in thousands, except share and per share data)

(Unaudited, continued from previous page)

 

              

Accumulated

         
              

Other

      

Total

 
  

Common Stock

  

Retained

  

Comprehensive

  

Treasury

  

Stockholders'

 
  

Shares

  

Amount

  

Earnings

  

Income

  

Stock

  

Equity

 
                         

Balance, December 31, 2019

  7,294,792  $86,617  $65,063  $1,842  $(15,747) $137,775 
                         

Net income

          4,007           4,007 

Other comprehensive income

              1,919       1,919 

Stock-based compensation, net

  4,037   105               105 

Treasury shares acquired (58,200)

                  (1,191)  (1,191)

Cash dividends ($0.30 per share)

          (1,920)          (1,920)
                         

Balance, June 30, 2020

  7,298,829  $86,722  $67,150  $3,761  $(16,938) $140,695 

 

              

Accumulated

         
              

Other

      

Total

 
  

Common Stock

  

Retained

  

Comprehensive

  

Treasury

  

Stockholders'

 
  

Shares

  

Amount

  

Earnings

  

Income (Loss)

  

Stock

  

Equity

 
                         

Balance, December 31, 2018

  7,260,994  $85,925  $56,037  $(154) $(13,518) $128,290 
                         

Net income

         6,301         6,301 

Other comprehensive income

            1,531      1,531 

Dividend reinvestment and purchase plan

  16,568   345            345 

Stock options exercised

  400   4            4 

Stock-based compensation, net

  15,032   316            316 

Treasury shares acquired (35,494)

               (706)  (706)

Cash dividends ($0.28 per share)

         (1,821)        (1,821)
                         

Balance, June 30, 2019

  7,292,994  $86,590  $60,517  $1,377  $(14,224) $134,260 

 

See accompanying notes to unaudited consolidated financial statements.

 

7

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS

(Dollar amounts in thousands)

(Unaudited)

 

  

Six Months Ended

 
  

June 30,

 
  

2020

  

2019

 

OPERATING ACTIVITIES

        

Net income

 $4,007  $6,301 

Adjustments to reconcile net income to net cash provided by operating activities:

        

Provision for loan losses

  3,740   350 

Investment securities gains on sale, net

  -   (190)

Loss (gain) on equity securities

  129   (44)

Depreciation and amortization of premises and equipment, net

  437   524 

Software amortization expense

  215   191 

Financing lease amortization expense

  131   173 

Gain on sale of premises and equipment

  (27)  - 

Amortization of premium and discount on investment securities, net

  190   176 

Accretion of deferred loan fees, net

  (1,108)  (429)

Amortization of core deposit intangibles

  166   170 

Stock-based compensation (income) expense, net

  (8)  186 

Origination of loans held for sale

  (21,051)  (6,781)

Proceeds from sale of loans

  18,615   7,104 

Gain on sale of loans

  (495)  (157)

Earnings on bank-owned life insurance

  (212)  (214)

Deferred income tax

  (534)  183 

Net gain on other real estate owned

  (62)  (106)

(Increase) decrease in accrued interest receivable

  (2,070)  66 

(Decrease) increase in accrued interest payable

  (18)  292 

Other, net

  508   (2,885)

Net cash provided by operating activities

  2,553   4,910 
         

INVESTING ACTIVITIES

        

Investment securities available for sale:

        

Proceeds from repayments and maturities

  7,745   6,851 

Proceeds from sale of securities

  -   11,807 

Purchases

  (12,302)  (17,193)

Increase in loans, net

  (125,775)  (6,206)

Proceeds from the sale of other real estate owned

  114   325 

Net purchase of premises and equipment

  (646)  (681)

Proceeds from the disposal of premises and equipment

  27   - 

Purchase of restricted stock

  (1,600)  (29)

Net cash used in investing activities

  (132,437)  (5,126)
         

FINANCING ACTIVITIES

        

Net increase in deposits

  137,424   35,440 

Increase (decrease) in borrowings, net

  18,744   (5,553)

Restricted stock cash portion

  -   (44)

Stock options exercised

  -   4 

Proceeds from dividend reinvestment and purchase plan

  -   345 

Repurchase of treasury shares

  (1,191)  (706)

Cash dividends

  (1,920)  (1,821)

Net cash provided by financing activities

  153,057   27,665 
         

Increase in cash and cash equivalents

  23,173   27,449 
         

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

  35,113   107,933 
         

CASH AND CASH EQUIVALENTS AT END OF PERIOD

 $58,286  $135,382 

 

See accompanying notes to unaudited consolidated financial statements.

 

8

 

   

Six Months Ended

 
   

June 30,

 
   

2020

   

2019

 

SUPPLEMENTAL INFORMATION

               

Cash paid during the year for:

               

Interest on deposits and borrowings

  $ 5,424     $ 6,413  

Income taxes

    -       1,330  
                 

Noncash operating transactions:

               

Operating lease assets added to other, net

  $ -     $ (1,071 )

Operating lease liabilities added to other, net

    -       1,071  

Noncash investing transactions:

               

Transfers from loans to other real estate owned

  $ 584     $ 38  

Finance lease assets added to premises and equipment

    (1,010 )     (3,801 )

Noncash financing transactions:

               

Finance lease liabilities added to borrowed funds

  $ 1,010     $ 3,801  

 

See accompanying notes to unaudited consolidated financial statements.

 

9

 

MIDDLEFIELD BANC CORP.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

 

NOTE 1 - BASIS OF PRESENTATION

 

The consolidated financial statements of Middlefield Banc Corp. ("Company") include its bank subsidiary, The Middlefield Banking Company (“MBC” or “Middlefield Bank”), and a nonbank asset resolution subsidiary EMORECO, Inc. The consolidated financial statements also include the accounts of MBC’s subsidiary, Middlefield Investments, Inc. (MI), established March 13, 2019. All significant inter-company items have been eliminated.

 

The unaudited condensed consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements.  The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Form 10-K for the year ended December 31, 2019.  The interim consolidated financial statements include all adjustments (consisting of only normal recurring items) that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented.  The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year.  

 

In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from those estimates.

 

Recently Issued Accounting Pronouncements

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments (“CECL”), which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be affected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. With certain exceptions, transition to the new requirements will be through a cumulative-effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. In November 2019, the FASB issued ASU 2019-10, Financial Instruments ‒ Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842). This Update defers the effective date of ASU 2016-13 for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies, to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Management will continue to monitor model output throughout the deferral period.

 

In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. The effective dates in this Update are the same as those applicable for ASU 2019-10. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.    

 

In March 2020, the FASB issued ASU 2020-3, Codification Improvements to Financial Instruments. This ASU was issued to improve and clarify various financial instruments topics, including the current expected credit losses (CECL) standard issued in 2016. The ASU includes seven issues that describe the areas of improvement and the related amendments to GAAP; they are intended to make the standards easier to understand and apply and to eliminate inconsistencies, and they are narrow in scope and are not expected to significantly change practice for most entities. Among its provisions, the ASU clarifies that all entities, other than public business entities that elected the fair value option, are required to provide certain fair value disclosures under ASC 825, Financial Instruments, in both interim and annual financial statements. It also clarifies that the contractual term of a net investment in a lease under Topic 842 should be the contractual term used to measure expected credit losses under Topic 326. Amendments related to ASU 2019-04 are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is not permitted before an entity’s adoption of ASU 2016-01. Amendments related to ASU 2016-13 for entities that have not yet adopted that guidance are effective upon adoption of the amendments in ASU 2016-13. Early adoption is not permitted before an entity’s adoption of ASU 2016-13. Amendments related to ASU 2016-13 for entities that have adopted that guidance are effective for fiscal years beginning after December 15, 2019, including interim periods within those years. Other amendments are effective upon issuance of this ASU. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s financial position or results of operations.

 

Reclassification of Comparative Amounts

 

Certain comparative amounts for prior years have been reclassified to conform to current-year presentations. Such reclassifications did not affect net income or retained earnings.

 

10

 

 

NOTE 2 REVENUE RECOGNITION

 

In accordance with ASC Topic 606, management determined that the primary sources of revenue, which emanate from interest income on loans and investments, along with noninterest revenue resulting from investment security gains, gains on the sale of loans, and BOLI income, are not within the scope of ASC 606. These revenue sources cumulatively comprise 92.4% of the total revenue of the Company.

 

The main types of noninterest income within the scope of the standard are as follows:

 

Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if the account balance falls below predetermined levels defined as compensating balances. These agreements can be cancelled at any time by either the Company or the deposit customer. Revenue from these transactions is recognized on a monthly basis as the Company has an unconditional right to the fee consideration. The Company also has transaction fees related to specific customer requests or activities that include overdraft fees, online banking fees, and other transaction fees. All of these fees are attributable to specific performance obligations of the Company where the revenue is recognized at a defined point in time, which is completion of the requested service/transaction.

 

Gains (losses) on sale of other real estate owned (OREO) – Gains and losses are recognized at the completion of the property sale when the buyer obtains control of the real estate and all of the performance obligations of the Company have been satisfied. Evidence of the buyer obtaining control of the asset include transfer of the property title, physical possession of the asset, and the buyer obtaining control of the risks and rewards related to the asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract for sale identifies the buyer and seller, the asset to be transferred and the payment terms, that the contract has a true commercial substance and that amounts due from the buyer are reasonable. In situations where financing terms are not reflective of current market terms, the transaction price is discounted, impacting the gain/loss and the carrying value of the asset.

 

The following table depicts the disaggregation of revenue derived from contracts with customers to depict the nature, amount, timing, and uncertainty of revenue and cash flows:

 

   

For the Three Months

Ended June 30,

   

For the Six Months

Ended June 30,

 

Noninterest Income

  2020    

2019

   

2020

   

2019

 

(Dollar amounts in thousands)

                               
Service charges on deposit accounts:                                

Overdraft fees

  $ 122     $ 190     $ 312     $ 438  

ATM banking fees

    263       241       473       435  

Service charges and other fees

    181       99       334       165  

Investment securities gains on sale, net (a)

    -       190       -       190  

Gain (loss) on equity securities (a)

    31       (14 )     (129 )     44  

Earnings on bank-owned life insurance (a)

    105       109       212       214  

Gain on sale of loans (a)

    381       98       495       157  

Revenue from investment services

    137       124       268       262  

Other income

    275       262       604       526  

Total noninterest income

  $ 1,495     $ 1,299     $ 2,569     $ 2,431  
                                 

Net gain on other real estate owned

  $ 62     $ 63     $ 62     $ 106  

 

(a)  Not within scope of ASC 606

 

11

 
 

NOTE 3 - STOCK-BASED COMPENSATION

 

The Company had no nonvested stock options outstanding as of June 30, 2020 and 2019.

 

Stock option activity during the six months ended June 30, 2020 is as follows:

 

      

Weighted-

 
      

average

 
      

Exercise Price

 
  

Shares

  

Per Share

 
         

Outstanding, January 1, 2020

  14,500  $8.78 

Exercised

  (1,000)  8.78 
         

Outstanding, June 30, 2020

  13,500  $8.78 
         

Exercisable, June 30, 2020

  13,500  $8.78 

 

The following table presents the activity during the six months ended June 30, 2020 related to awards of restricted stock:

 

      

Weighted-

 
      

average

 
      

Grant Date Fair

 
  

Units

  

Value Per Unit

 
         

Nonvested at January 1, 2020

  61,040  $21.73 

Granted

  23,648   26.09 

Nonvested at June 30, 2020

  84,688  $22.94 
         

Expected to vest as of June 30, 2020

  1,000  $22.65 

 

The Company recognizes restricted stock forfeitures in the period they occur.

 

Share-based compensation expense of $294,000 and $0 was recognized for the three-month periods ended June 30, 2020 and 2019, respectively. Share-based compensation expense of ($113,000) and $90,000 was recognized for the six-month periods ended June 30, 2020 and 2019, respectively. The expense recorded for the six-month period ended June 30, 2020 is the result of the decrease in the market valuations of the plans for December 31, 2019. Vesting of shares under the plan is contingent on a combination of service period and a performance condition tied to the total shareholder return on the Company’s stock. Due to the change in market conditions during the first quarter of 2020, there was a significant decrease in the probability of the achievement of the performance condition which resulted in a decrease in the liability related to the plan and a reversal of compensation expense. Since the shares of restricted stock are historically paid out at the vesting date in a combination of shares and cash, the Company has recorded a liability related to this plan which totals $581,000 and $236,000 at June 30, 2020 and 2019, respectively. When the shares vest, the amount distributed in shares is transferred to common stock and the remainder is distributed in cash.

 

Total unrecognized stock compensation cost related to nonvested share-based compensation on restricted stock as of June 30, 2020 totals $374,000, of which $124,000 is estimated for the rest of 2020, $180,000 for 2021, $63,000 for 2022, and $7,000 for 2023.

 

12

 

 

NOTE 4 - EARNINGS PER SHARE

 

The Company provides dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated by dividing net income by the average shares outstanding. Diluted earnings per share adds the dilutive effects of stock options and restricted stock to average shares outstanding.

 

The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings-per-share computation.

 

  

For the Three

  

For the Six

 
  

Months Ended

  

Months Ended

 
  

June 30,

  

June 30,

 
  

2020

  

2019

  

2020

  

2019

 
                 

Weighted-average common shares issued

  7,298,829   7,286,542   7,298,785   7,278,620 
                 

Average treasury stock shares

  (929,362)  (784,034)  (905,497)  (778,214)
                 

Weighted-average common shares and common stock equivalents used to calculate basic earnings per share

  6,369,467   6,502,508   6,393,288   6,500,406 
                 

Additional common stock equivalents (stock options and restricted stock) used to calculate diluted earnings per share

  18,651   12,438   19,297   12,644 
                 

Weighted-average common shares and common stock equivalents used to calculate diluted earnings per share

  6,388,118   6,514,946   6,412,585   6,513,050 

 

Options to purchase 13,500 shares of common stock at $8.78 per share were outstanding during the three and six months ended June 30, 2020. Also outstanding were 84,688 shares of restricted stock, 73,147 shares of which were anti-dilutive.

 

Options to purchase 14,500 shares of common stock at $8.78 per share were outstanding during the three and six months ended June 30, 2019. Also outstanding were 61,334 shares of restricted stock. None of the outstanding options or restricted stock were anti-dilutive.

 

When shares recognized as equity are repurchased, the amount of the consideration paid, which includes directly attributable costs, is recognized as a deduction from equity. Repurchased shares are classified as treasury shares and are presented in the treasury share reserve. The reserve for the Company’s treasury shares comprises the cost of the Company’s shares held by the Company. As of June 30, 2020, the Company held 929,362 of the Company’s shares, which is an increase of 58,200 from the 871,162 shares held as of December 31, 2019.

 

 

NOTE 5 - FAIR VALUE MEASUREMENTS

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants at the measurement date. GAAP establishes a fair value hierarchy that prioritizes the use of inputs used in valuation methodologies into the following levels:

 

Level I:

Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

 

Level II:

Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

 

13

 

Level III:

Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

 

This hierarchy requires the use of observable market data when available.

 

The following tables present the assets measured on a recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

      

June 30, 2020

     

(Dollar amounts in thousands)

 

Level I

  

Level II

  

Level III

  

Total

 

Assets measured on a recurring basis:

                

Subordinated debt

 $-  $11,289  $-  $11,289 

Obligations of states and political subdivisions

  -   84,540   -   84,540 

Mortgage-backed securities in government-sponsored entities

  -   16,700   -   16,700 

Total debt securities

  -   112,529   -   112,529 

Equity securities in financial institutions

  581   -   -   581 

Total

 $581  $112,529  $-  $113,110 

 

      

December 31, 2019

     

(Dollar amounts in thousands)

 

Level I

  

Level II

  

Level III

  

Total

 

Assets measured on a recurring basis:

                

Subordinated debt

 $-  $4,126  $-  $4,126 

Obligations of states and political subdivisions

  -   82,977   -   82,977 

Mortgage-backed securities in government-sponsored entities

  -   18,630   -   18,630 

Total debt securities

  -   105,733   -   105,733 

Equity securities in financial institutions

  710   -   -   710 

Total

 $710  $105,733  $-  $106,443 

 

Investment Securities Available for Sale - The Company obtains fair values from an independent pricing service which represent quoted prices for similar assets, fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level II).

 

Equity Securities - Equity securities that are traded on a national securities exchange are valued at their last reported sales price as of the measurement date. Equity securities traded in the over-the-counter (“OTC”) markets and listed securities for which no sale was reported on that date are generally valued at their last reported “bid” price if held long, and last reported “ask” price if sold short. To the extent equity securities are actively traded and valuation adjustments are not applied, they are categorized in Level I of the fair value hierarchy.

 

14

 

The following tables present the assets measured on a non-recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Collateral-dependent impaired loans are carried at fair value if they have been charged down to fair value or if a specific valuation allowance has been established. A new cost basis is established at the time a property is initially recorded in OREO. OREO properties are carried at fair value if a devaluation has been taken to the property’s value at initial foreclosure or subsequent to the initial measurement. No such devaluation occurred in the six months ended June 30, 2020.

 

      

June 30, 2020

     

(Dollar amounts in thousands)

 

Level I

  

Level II

  

Level III

  

Total

 

Assets measured on a non-recurring basis:

                

Impaired loans

 $-  $-  $4,729  $4,729 

 

      

December 31, 2019

     

(Dollar amounts in thousands)

 

Level I

  

Level II

  

Level III

  

Total

 

Assets measured on a non-recurring basis:

                

Impaired loans

 $-  $-  $5,166  $5,166 

 

Impaired Loans – The Company has measured impairment on collateral-dependent impaired loans generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management makes estimates about expected costs to sell the property which are also included in the net realizable value. If the fair value of the collateral-dependent loan is less than the carrying amount of the loan, a specific reserve for the loan is made in the allowance for loan losses or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the above table as a Level III measurement. If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the above table as it is not currently being carried at its fair value. The fair values in the above table exclude estimated selling costs of $2.1 million as of June 30, 2020 and December 31, 2019.

 

The following tables present additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company uses Level III inputs to determine fair value:

 

  

Quantitative Information about Level III Fair Value Measurements

 

(Dollar amounts in thousands)

 

 

 

 

Range (Weighted

  

Fair Value Estimate

 Valuation TechniquesUnobservable Input Average) 

June 30, 2020

           

Impaired loans

 $4,729 

Appraisal of collateral (1)

Appraisal adjustments (2)

 29.8%to46.2%(34.7%)

 

  

Quantitative Information about Level III Fair Value Measurements

 

(Dollar amounts in thousands)

 

 

 

 

Range (Weighted

  

Fair Value Estimate

 Valuation TechniquesUnobservable Input Average) 

December 31, 2019

           

Impaired loans

 $5,166 

Appraisal of collateral (1)

Appraisal adjustments (2)

 40.3%to47.4%(41.8%)

 

 

(1)

Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level III inputs which are not identifiable, less any associated allowance.

 

 

(2)

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

 

15

 

The estimated fair value of the Company’s financial instruments not recorded at fair value on a recurring basis is as follows:

 

  

June 30, 2020

 
  

Carrying

              

Total

 
  

Value

  

Level I

  

Level II

  

Level III

  

Fair Value

 
  

(Dollar amounts in thousands)

 

Financial assets:

                    

Cash and cash equivalents

 $58,286  $58,286  $-  $-  $58,286 

Loans held for sale

  4,151   -   4,151   -   4,151 

Net loans

  1,100,049   -   -   1,100,623   1,100,623 

Bank-owned life insurance

  16,723   16,723   -   -   16,723 

Federal Home Loan Bank stock

  5,448   5,448   -   -   5,448 

Accrued interest receivable

  5,541   5,541   -   -   5,541 
                     

Financial liabilities:

                    

Deposits

 $1,158,267  $794,847  $-  $369,173  $1,164,020 

Short-term borrowings

  20,417   20,417   -   -   20,417 

Other borrowings

  17,162   -   -   13,211   13,211 

Accrued interest payable

  899   899   -   -   899 

 

  December 31, 2019 
  

Carrying

              

Total

 
  

Value

  

Level I

  

Level II

  

Level III

  

Fair Value

 
  

(Dollar amounts in thousands)

 

Financial assets:

                    

Cash and cash equivalents

 $35,113  $35,113  $-  $-  $35,113 

Loans held for sale

  1,220   -   1,220   -   1,220 

Net loans

  977,490   -   -   974,213   974,213 

Bank-owned life insurance

  16,511   16,511   -   -   16,511 

Federal Home Loan Bank stock

  3,848   3,848   -   -   3,848 

Accrued interest receivable

  3,471   3,471   -   -   3,471 
                     

Financial liabilities:

                    

Deposits

 $1,020,843  $652,043  $-  $371,193  $1,023,236 

Short-term borrowings

  5,075   5,075   -   -   5,075 

Other borrowings

  12,750   -   -   12,783   12,783 

Accrued interest payable

  917   917   -   -   917 

 

All financial instruments included in the above tables, with the exception of net loans, deposits, and other borrowings, are carried at cost, which approximates the fair value of the instrument.

 

16

 
 

NOTE 6 – ACCUMULATED OTHER COMPREHENSIVE INCOME

 

The following table presents the changes in accumulated other comprehensive income (“AOCI”) by component net of tax for the three and six months ended June 30, 2020 and 2019, respectively:

 

(Dollars in thousands)  

Unrealized gains/(losses)

on available-for-sale

securities (a)

 

Balance as of March 31, 2020

  $ (2,237 )

Other comprehensive income

    5,998  

Balance at June 30, 2020

  $ 3,761  
         

Balance as of December 31, 2019

  $ 1,842  

Other comprehensive income

    1,919  

Balance at June 30, 2020

  $ 3,761  

 

(Dollars in thousands)  

Unrealized gains/(losses)

on available-for-sale

securities (a)

 

Balance as of March 31, 2019

  $ 641  

Other comprehensive income

    886  

Amount reclassified from accumulated other comprehensive income

    (150 )

Period change

    736  

Balance at June 30, 2019

  $ 1,377  
         

Balance as of December 31, 2018

  $ (154 )

Other comprehensive income

    1,681  

Amount reclassified from accumulated other comprehensive income

    (150 )

Period change

    1,531  

Balance at June 30, 2019

  $ 1,377  

 

 

(a)

All amounts are net of tax. Amounts in parentheses indicate debits to AOCI.

 

The following tables present significant amounts reclassified from or to each component of AOCI:

 

   

Amounts Reclassified from Accumulated Other

 

Affected Line Item in

    Comprehensive Income  

the Statement Where

(Dollars in thousands)

  For the Three and Six Months Ended  

Net Income is

Details about other comprehensive income

 

June 30, 2020

   

June 30, 2019

 

Presented

Unrealized gains on available-for-sale securities (a)

                 
    $ -     $ 190  

Investment securities gains on sale, net

      -       (40 )

Income taxes

    $ -     $ 150    

 

 

(a)

For unrealized gains on available-for-sale securities, amounts in parentheses indicate expenses and other amounts indicate income.

 

17

 
 

NOTE 7 INVESTMENT AND EQUITY SECURITIES

 

The amortized cost and fair values of investment securities available for sale are as follows:

 

  

June 30, 2020

 
      

Gross

  

Gross

     
  

Amortized

  

Unrealized

  

Unrealized

  

Fair

 

(Dollar amounts in thousands)

 

Cost

  

Gains

  

Losses

  

Value

 
                 

Subordinated debt

 $11,050  $239  $-  $11,289 

Obligations of states and political subdivisions:

                

Taxable

  500   2   -   502 

Tax-exempt

  80,155   3,883   -   84,038 

Mortgage-backed securities in government-sponsored entities

  16,063   637   -   16,700 

Total

 $107,768  $4,761  $-  $112,529 

 

  

December 31, 2019

 
      

Gross

  

Gross

     
  

Amortized

  

Unrealized

  

Unrealized

  

Fair

 

(Dollar amounts in thousands)

 

Cost

  

Gains

  

Losses

  

Value

 
                 

Subordinated debt

 $4,000  $126  $-  $4,126 

Obligations of states and political subdivisions:

                

Taxable

  500   1   -   501 

Tax-exempt

  80,436   2,065   (25)  82,476 

Mortgage-backed securities in government-sponsored entities

  18,465   274   (109)  18,630 

Total

 $103,401  $2,466  $(134) $105,733 

 

The Company recognized a net gain (loss) on equity investments of $31,000 and ($129,000), respectively, for the three and six months ended June 30, 2020. The Company recognized a net (loss) gain on equity investments of ($14,000) and $44,000, respectively, for the three and six months ended June 30, 2019. No net gains or losses on sold equity securities were realized during these periods.

 

The amortized cost and fair value of debt securities at June 30, 2020, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

  

Amortized

  

Fair

 

(Dollar amounts in thousands)

 

Cost

  

Value

 
         

Due in one year or less

 $3  $3 

Due after one year through five years

  887   911 

Due after five years through ten years

  22,176   22,713 

Due after ten years

  84,702   88,902 

Total

 $107,768  $112,529 

 

18

 

Proceeds from the sales of investment securities and the gross realized gains and losses are as follows:

 

(Dollars amounts in thousands) 

For the Three Months Ended June 30,

  

For the Six Months Ended June 30,

 
  

2020

  

2019

  

2020

  

2019

 

Proceeds from sales

 $-  $11,807  $-  $11,807 

Gross realized gains

  -   223   -   223 

Gross realized losses

  -   (33)  -   (33)

 

There were no securities sold during the six months ended June 30, 2020.

 

Investment securities with an approximate carrying value of $53.6 million and $55.6 million at June 30, 2020 and December 31, 2019, respectively, were pledged to secure deposits and for other purposes as required by law.

 

The following table shows the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

 

  

December 31, 2019

 
  

Less than Twelve Months

  

Twelve Months or Greater

  

Total

 
      

Gross

      

Gross

      

Gross

 
  

Fair

  

Unrealized

  

Fair

  

Unrealized

  

Fair

  

Unrealized

 

(Dollar amounts in thousands)

 

Value

  

Losses

  

Value

  

Losses

  

Value

  

Losses

 
                         

Obligations of states and political subdivisions:

                        

Tax-exempt

 $4,324  $(25) $-  $-  $4,324  $(25)

Mortgage-backed securities in government-sponsored entities

  1,409   (2)  8,223   (107)  9,632   (109)

Total

 $5,733  $(27) $8,223  $(107) $13,956  $(134)

 

There were no securities in a gross unrealized loss position at June 30, 2020.

 

There were no securities considered temporarily impaired at June 30, 2020.

 

On a quarterly basis, the Company performs an assessment to determine whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered other-than-temporary impairment (“OTTI”). A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. The Company assesses whether the unrealized loss is other than temporary.

 

OTTI losses are recognized in earnings when the Company has the intent to sell the debt security or it is more likely than not that it will be required to sell the debt security before recovery of its amortized cost basis. However, even if the Company does not expect to sell a debt security, it must evaluate expected cash flows to be received and determine if a credit loss has occurred.

 

An unrealized loss is generally deemed to be other than temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. As a result, the credit loss of an OTTI is recorded as a component of investment securities gains (losses) in the accompanying Consolidated Statement of Income, while the remaining portion of the impairment loss is recognized in other comprehensive income, provided the Company does not intend to sell the underlying debt security and it is “more likely than not” that the Company will not have to sell the debt security prior to recovery.

 

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 90% of the total available-for-sale portfolio as of June 30, 2020 and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of prolonged unrealized loss positions within the obligations of the state and political subdivisions security portfolio. The Company considers the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

 

 

The length of time and the extent to which the fair value has been less than the amortized cost basis;

 

19

 
 

Changes in the near-term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions;

 

The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and

 

Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

 

For the six months ended June 30, 2020 and 2019, there were no available-for-sale debt securities with an unrealized loss that suffered OTTI. Management does not believe any individual unrealized loss as of June 30, 2020 or December 31, 2019 represented an other-than-temporary impairment. The unrealized losses on debt securities are primarily the result of interest rate changes. These conditions will not prohibit the Company from receiving its contractual principal and interest payments on these debt securities. The fair value of these debt securities is expected to recover as payments are received on these securities and they approach maturity. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified.

 

 

NOTE 8 - LOANS AND RELATED ALLOWANCE FOR LOAN AND LEASE LOSSES

 

The Company’s primary business activity is with customers located within its local Northeastern Ohio trade area, eastern Geauga County, and contiguous counties. The Company also serves the central Ohio market with offices in Dublin, Plain City, Powell, Sunbury, and Westerville, Ohio. Commercial, residential, consumer, and agricultural loans are granted. Although the Company has a diversified loan portfolio, loans outstanding to individuals and businesses are dependent upon the local economic conditions in the Company’s immediate trade area.

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances net of the allowance for loan and lease losses. Interest income is recognized on the accrual method. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of interest is doubtful. Interest payments received on nonaccrual loans are applied against the unpaid principal balance until accrual status is restored.

 

Loan origination fees and certain direct loan origination costs are deferred with the net amount amortized over the contractual life of the loan as an adjustment of the related loan’s yield.

 

The following tables summarize the primary segments of the loan portfolio and allowance for loan and lease losses (in thousands):

 

June 30, 2020

 

Impairment Evaluation

 
  

Individually

  

Collectively

  

Total Loans

 

Loans:

            

Commercial real estate:

            

Owner occupied

 $3,486  $106,648  $110,134 

Non-owner occupied

  14,685   285,892   300,577 

Multifamily

  -   37,604   37,604 

Residential real estate

  1,259   226,168   227,427 

Commercial and industrial

  1,127   238,969   240,096 

Home equity lines of credit

  347   116,849   117,196 

Construction and other

  -   66,015   66,015 

Consumer installment

  -   11,210   11,210 

Total

 $20,904  $1,089,355  $1,110,259 

 

20

 

December 31, 2019

 

Impairment Evaluation

 
  

Individually

  

Collectively

  

Total Loans

 

Loans:

            

Commercial real estate:

            

Owner occupied

 $3,474  $98,912  $102,386 

Non-owner occupied

  7,084   295,096   302,180 

Multifamily

  -   62,028   62,028 

Residential real estate

  1,278   233,520   234,798 

Commercial and industrial

  882   88,645   89,527 

Home equity lines of credit

  351   111,897   112,248 

Construction and other

  -   66,680   66,680 

Consumer installment

  1   14,410   14,411 

Total

 $13,070  $971,188  $984,258 

 

The amounts above include net deferred loan origination costs of $4.7 million and $1.3 million at June 30, 2020 and December 31, 2019, respectively. The net deferred loan origination costs at June 30, 2020 include $4.0 million of unearned deferred fees from PPP loans.

 

June 30, 2020

 

Ending Allowance Balance Attributable to Loans:

 
  

Individually

Evaluated

for

Impairment

  

Collectively

Evaluated

for

Impairment

  

Total

Allocation

 

Loans:

            

Commercial real estate:

            

Owner occupied

 $10  $1,028  $1,038 

Non-owner occupied

  1,874   3,285   5,159 

Multifamily

  -   291   291 

Residential real estate

  22   1,145   1,167 

Commercial and industrial

  43   1,062   1,105 

Home equity lines of credit

  27   1,176   1,203 

Construction and other

  -   236   236 

Consumer installment

  -   11   11 

Total

 $1,976  $8,234  $10,210 

 

21

 

December 31, 2019

 

Ending Allowance Balance Attributable to Loans:

 
  

Individually

Evaluated

for

Impairment

  

Collectively

Evaluated

for

Impairment

  

Total

Allocation

 

Loans:

            

Commercial real estate:

            

Owner occupied

 $45  $756  $801 

Non-owner occupied

  582   2,800   3,382 

Multifamily

  -   340   340 

Residential real estate

  28   698   726 

Commercial and industrial

  3   453   456 

Home equity lines of credit

  2   930   932 

Construction and other

  -   103   103 

Consumer installment

  -   28   28 

Total

 $660  $6,108  $6,768 

 

The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial Real Estate (“CRE”) which is further segmented into Owner Occupied (“CRE OO”), Non-owner Occupied (“CRE NOO”), and Multifamily Residential, Residential Real Estate (“RRE”), Commercial and Industrial (“C&I”), Home Equity Lines of Credit (“HELOC”), Construction and Other (“Construction”), and Consumer Installment Loans. The commercial real estate loan segments consist of loans made for the purpose of financing the activities of commercial real estate owners and operators. The residential real estate and HELOC loan segments consist of loans made for the purpose of financing the activities of residential homeowners. The C&I loan segment consists of loans made for the purpose of financing the activities of commercial customers. Although PPP loans are included with C&I loans, the nature of PPP loans differs considerably from the rest of the category. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts. The increases in the allowance for loan loss for the CRE, RRE, C&I, HELOC, and Construction portfolios were partially offset by a decrease in the allowance for the Consumer Installment portfolios.

 

Management evaluates individual loans in all of the commercial segments for possible impairment based on guidance established by the Board of Directors. Loans are considered to be impaired when, based on current information and events, it is probable that the Company 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 evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines 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. The Company does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of a larger relationship that is impaired, or the loan was modified in a troubled debt restructuring.

 

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of the following methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis. The evaluation of the need and amount of a specific allocation of the allowance and whether a loan can be removed from impairment status is made on a quarterly basis. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

 

22

 

The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):

 

June 30, 2020

 

Impaired Loans

 
      

Unpaid

     
  

Recorded

  Principal  

Related

 
  

Investment

  Balance  

Allowance

 

With no related allowance recorded:

            

Commercial real estate:

            

Owner occupied

 $3,028  $3,033  $- 

Non-owner occupied

  7,538   7,538   - 

Residential real estate

  781   908   - 

Commercial and industrial

  659   1,148   - 

Home equity lines of credit

  179   189   - 

Total

 $12,185  $12,816  $- 
             

With an allowance recorded:

            

Commercial real estate:

            

Owner occupied

 $458  $458  $10 

Non-owner occupied

  7,147   7,147   1,874 

Residential real estate

  478   478   22 

Commercial and industrial

  468   468   43 

Home equity lines of credit

  168   168   27 

Total

 $8,719  $8,719  $1,976 
             

Total:

            

Commercial real estate:

            

Owner occupied

 $3,486  $3,491  $10 

Non-owner occupied

  14,685   14,685   1,874 

Residential real estate

  1,259   1,386   22 

Commercial and industrial

  1,127   1,616   43 

Home equity lines of credit

  347   357   27 

Total

 $20,904  $21,535  $1,976 

 

23

 

December 31, 2019

 

Impaired Loans

 
      

Unpaid

     
  

Recorded

  Principal  

Related

 
  

Investment

  Balance  

Allowance

 

With no related allowance recorded:

            

Commercial real estate:

            

Owner occupied

 $1,772  $1,772  $- 

Non-owner occupied

  3,845   3,845   - 

Residential real estate

  759   829   - 

Commercial and industrial

  747   1,524   - 

Home equity lines of credit

  220   228   - 

Consumer installment

  1   1   - 

Total

 $7,344  $8,199  $- 
             

With an allowance recorded:

            

Commercial real estate:

            

Owner occupied

 $1,702  $1,713  $45 

Non-owner occupied

  3,239   3,239   582 

Residential real estate

  519   569   28 

Commercial and industrial

  135   135   3 

Home equity lines of credit

  131   131   2 

Total

 $5,726  $5,787  $660 
             

Total:

            

Commercial real estate:

            

Owner occupied

 $3,474  $3,485  $45 

Non-owner occupied

  7,084   7,084   582 

Residential real estate

  1,278   1,398   28 

Commercial and industrial

  882   1,659   3 

Home equity lines of credit

  351   359   2 

Consumer installment

  1   1   - 

Total

 $13,070  $13,986  $660 

 

The tables above include troubled debt restructuring totaling $3.2 million and $3.6 million as of June 30, 2020 and December 31, 2019, respectively. The amounts allocated within the allowance for losses for troubled debt restructurings was $37,000 and $33,000 at June 30, 2020 and December 31, 2019, respectively.

 

24

 

The following tables present the average balance and interest income by class, recognized on impaired loans (in thousands):

 

  

For the Three Months Ended June 30, 2020

  

For the Six Months Ended June 30, 2020

 
  

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Average

Recorded

Investment

  

Interest

Income

Recognized

 
                 

Commercial real estate:

                

Owner occupied

 $3,459  $32  $3,464  $65 

Non-owner occupied

  10,864   209   9,604   258 

Residential real estate

  1,206   14   1,230   25 

Commercial and industrial

  1,019   11   973   21 

Home equity lines of credit

  347   2   348   4 

Consumer installment

  1   -   1   - 

Total

 $16,896  $268  $15,620  $373 

 

  

For the Three Months Ended June 30, 2019

  

For the Six Months Ended June 30, 2019

 
  

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Average

Recorded

Investment

  

Interest

Income

Recognized

 
                 

Commercial real estate:

                

Owner occupied

 $3,819  $35  $4,014  $72 

Non-owner occupied

  6,419   50   5,989   100 

Residential real estate

  1,716   15   1,761   27 

Commercial and industrial

  1,970   23   2,170   45 

Home equity lines of credit

  104   -   109   - 

Construction and other

  1,620   -   1,080   - 

Consumer installment

  2   -   2   - 

Total

 $15,650  $123  $15,125  $244 

 

Management uses a nine-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized and are aggregated as Pass rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but have potential weaknesses, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. Any portion of a loan that has been charged off is placed in the Loss category.  

 

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Company has a structured loan-rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as payment delinquency, bankruptcy, repossession, or death, occurs to raise awareness of a possible credit quality event.  The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis.  The Credit Department performs an annual review of all commercial relationships with loan balances of $500,000 or greater.  Confirmation of the appropriate risk grade is included in the review on an ongoing basis.  The Company engages an external consultant to conduct loan reviews on a semiannual basis. Generally, the external consultant reviews commercial relationships greater than $250,000 and criticized relationships greater than $150,000.  Detailed reviews, including plans for resolution, are performed on criticized loans on at least a quarterly basis.  Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

 

25

 

The primary risk of commercial and industrial loans is related to deterioration in the cash flow of the business that may result in the liquidation of the business assets securing the loan. C&I loans are, by nature, secured by less substantial collateral than real estate-secured loans. The primary risk of real estate construction loans is potential delays and disputes during the completion process. The primary risk of residential real estate loans is current economic uncertainties. The primary risk of commercial real estate loans is loss of income of the owner or occupier of the property and the inability of the market to sustain rent levels. Consumer installment loans historically have experienced higher delinquency rates. Consumer installments are typically secured by less substantial collateral than other types of credits.

 

The following tables present the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the internal risk-rating system (in thousands):

 

      

Special

          

Total

 

June 30, 2020

 

Pass

  

Mention

  

Substandard

  

Doubtful

  

Loans

 
                     

Commercial real estate:

                    

Owner occupied

 $103,644  $3,042  $3,448  $-  $110,134 

Non-owner occupied

  270,678   3,749   26,150   -   300,577 

Multifamily

  37,604   -   -   -   37,604 

Residential real estate

  224,316   410   2,701   -   227,427 

Commercial and industrial

  235,535   2,658   1,903   -   240,096 

Home equity lines of credit

  115,617   -   1,579   -   117,196 

Construction and other

  66,015   -   -   -   66,015 

Consumer installment

  11,191   -   19   -   11,210 

Total

 $1,064,600  $9,859  $35,800  $-  $1,110,259 

 

      

Special

          

Total

 

December 31, 2019

 

Pass

  

Mention

  

Substandard

  

Doubtful

  

Loans

 
                     

Commercial real estate:

                    

Owner occupied

 $95,518  $3,951  $2,917  $-  $102,386 

Non-owner occupied

  292,192   3,038   6,950   -   302,180 

Multifamily

  62,028   -   -   -   62,028 

Residential real estate

  231,633   420   2,745   -   234,798 

Commercial and industrial

  84,136   3,619   1,772   -   89,527 

Home equity lines of credit

  111,354   -   894   -   112,248 

Construction and other

  66,680   -   -   -   66,680 

Consumer installment

  14,398   -   13   -   14,411 

Total

 $957,939  $11,028  $15,291  $-  $984,258 

 

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due.

 

Nonperforming assets are nonaccrual loans including nonaccrual troubled debt restructurings (“TDR”), loans 90 days or more past due, other real estate owned, and repossessed assets. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of principal and interest is doubtful.  Payments received on nonaccrual loans are applied against the principal balance.

 

26

 

The following tables present the aging of the recorded investment in past-due loans by class of loans (in thousands):

 

      

30-59 Days

  

60-89 Days

  

90 Days+

  

Total

  

Total

 

June 30, 2020

 

Current

  

Past Due

  

Past Due

  

Past Due

  

Past Due

  

Loans

 
                         

Commercial real estate:

                        

Owner occupied

 $108,989  $-  $350  $795  $1,145  $110,134 

Non-owner occupied

  295,729   -   742   4,106   4,848   300,577 

Multifamily

  37,604   -   -   -   -   37,604 

Residential real estate

  223,820   1,539   893   1,175   3,607   227,427 

Commercial and industrial

  239,836   160   -   100   260   240,096 

Home equity lines of credit

  116,818   189   50   139   378   117,196 

Construction and other

  60,524   5,491   -   -   5,491   66,015 

Consumer installment

  10,977   -   1   232   233   11,210 

Total

 $1,094,297  $7,379  $2,036  $6,547  $15,962  $1,110,259 

 

      

30-59 Days

  

60-89 Days

  

90 Days+

  

Total

  

Total

 

December 31, 2019

 

Current

  

Past Due

  

Past Due

  

Past Due

  

Past Due

  

Loans

 
                         

Commercial real estate:

                        

Owner occupied

 $101,264  $64  $-  $1,058  $1,122  $102,386 

Non-owner occupied

  298,941   -   -   3,239   3,239   302,180 

Multifamily

  62,028   -   -   -   -   62,028 

Residential real estate

  232,518   1,439   34   807   2,280   234,798 

Commercial and industrial

  88,965   190   66   306   562   89,527 

Home equity lines of credit

  111,792   274   29   153   456   112,248 

Construction and other

  66,680   -   -   -   -   66,680 

Consumer installment

  13,378   622   216   195   1,033   14,411 

Total

 $975,566  $2,589  $345  $5,758  $8,692  $984,258 

 

The following tables present the recorded investment in nonaccrual loans and loans past due over 89 days and still on accrual by class of loans (in thousands):

 

      

90+ Days Past Due

 

June 30, 2020

 

Nonaccrual

  and Accruing 
         

Commercial real estate:

        

Owner occupied

 $1,266  $- 

Non-owner occupied

  4,106   - 

Residential real estate

  2,646   - 

Commercial and industrial

  519   - 

Home equity lines of credit

  1,021   - 

Consumer installment

  245   - 

Total

 $9,803  $- 

 

27

 
      

90+ Days Past Due

 

December 31, 2019

 

Nonaccrual

  and Accruing 
         

Commercial real estate:

        

Owner occupied

 $1,162  $- 

Non-owner occupied

  3,289   - 

Residential real estate

  2,576   - 

Commercial and industrial

  946   - 

Home equity lines of credit

  709   - 

Consumer installment

  197   - 

Total

 $8,879  $- 

 

Interest income that would have been recorded had these loans not been placed on nonaccrual status was $128,000 for the three months ended June 30, 2020 and $47,000 for the three months ended December 31, 2019. Interest income that would have been recorded had these loans not been placed on nonaccrual status was $228,000 for the six months ended June 30, 2020 and $342,000 for the year ended December 31, 2019.

 

An allowance for loan and lease losses (“ALLL”) is maintained to absorb losses from the loan portfolio.  The ALLL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of nonperforming loans.

 

The Company’s methodology for determining the ALLL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Company’s ALLL. Management also performs impairment analyses on TDRs, which may result in specific reserves.

 

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate.  For general allowances, historical loss trends are used in the estimation of losses in the current portfolio.  These historical loss amounts are modified by other qualitative factors.

 

The classes described above, which are based on the purpose code assigned to each loan, provide the starting point for the ALLL analysis.  Management tracks the historical net charge-off activity at the call code level. The historical charge-off factor was calculated using the last twelve consecutive historical quarters.

 

Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and nonaccrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and geographic standpoint.

 

Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALLL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALLL.

 

28

 

The following tables summarize the primary segments of the loan portfolio and the activity within those segments (in thousands):

 

  

For the six months ended June 30, 2020

 
  

Allowance for Loan and Lease Losses

 
  

Balance

              

Balance

 
  

December 31, 2019

  

Charge-offs

  

Recoveries

  

Provision

  

June 30, 2020

 

Loans:

                    

Commercial real estate:

                    

Owner occupied

 $801  $(50) $14  $273  $1,038 

Non-owner occupied

  3,382   -   74   1,703   5,159 

Multifamily

  340   -   -   (49)  291 

Residential real estate

  726   (51)  30   462   1,167 

Commercial and industrial

  456   (170)  239   580   1,105 

Home equity lines of credit

  932   (54)  16   309   1,203 

Construction and other

  103   -   34   99   236 

Consumer installment

  28   (391)  11   363   11 

Total

 $6,768  $(716) $418  $3,740  $10,210 

 

  

For the six months ended June 30, 2019

 
  

Allowance for Loan and Lease Losses

 
  

Balance

              

Balance

 
  

December 31, 2018

  

Charge-offs

  

Recoveries

  

Provision

  

June 30, 2019

 

Loans:

                    

Commercial real estate:

                    

Owner occupied

 $1,315  $(32) $2  $(419) $866 

Non-owner occupied

  2,862   -   -   726   3,588 

Multifamily

  474   -   -   (62)  412 

Residential real estate

  761   -   39   (53)  747 

Commercial and industrial

  969   (355)  40   (115)  539 

Home equity lines of credit

  820   (138)  7   247   936 

Construction and other

  100   -   45   (48)  97 

Consumer installment

  127   (88)  6   74   119 

Total

 $7,428  $(613) $139  $350  $7,304 

 

  

For the three months ended June 30, 2020

 
  

Allowance for Loan and Lease Losses

 
  

Balance

              

Balance

 
  

March 31, 2020

  

Charge-offs

  

Recoveries

  

Provision

  

June 30, 2020

 

Loans:

                    

Commercial real estate:

                    

Owner occupied

 $1,099  $(50) $11  $(22) $1,038 

Non-owner occupied

  4,364   -   -   795   5,159 

Multifamily

  386   -   -   (95)  291 

Residential real estate

  1,164   (5)  -   8   1,167 

Commercial and industrial

  716   (109)  132   366   1,105 

Home equity lines of credit

  1,240   (41)  12   (8)  1,203 

Construction and other

  254   -   17   (35)  236 

Consumer installment

  21   (3)  2   (9)  11 

Total

 $9,244  $(208) $174  $1,000  $10,210 

 

29

 
  

For the three months ended June 30, 2019

 
  

Allowance for Loan and Lease Losses

 
  

Balance

              

Balance

 
  

March 31, 2019

  

Charge-offs

  

Recoveries

  

Provision

  

June 30, 2019

 

Loans:

                    

Commercial real estate:

                    

Owner occupied

 $830  $-  $1  $35  $866 

Non-owner occupied

  2,857   -   -   731   3,588 

Multifamily

  492   -   -   (80)  412 

Residential real estate

  773   -   30   (56)  747 

Commercial and industrial

  586   (9)  24   (62)  539 

Home equity lines of credit

  832   (48)  3   149   936 

Construction and other

  748   -   23   (674)  97 

Consumer installment

  88   (41)  5   67   119 

Total

 $7,206  $(98) $86  $110  $7,304 

 

The provision fluctuations during the six-month period ended June 30, 2020 allocated to:

 

a $2.2 million increase in all lending categories’ qualitative factors during the second quarter of 2020 due to the economic uncertainty resulting from the COVID-19 pandemic.

 

non-owner occupied portfolio are due to the increase of specific reserves for two relationships totaling $1.3 million.

 

commercial and industrial loans are due to growth in loan volume along with an allocation for the PPP loans in the amount of $423,000.

 

The provision fluctuations during the six-month period ended June 30, 2019 allocated to:

 

commercial and industrial loans are due to the charge-off of a large relationship of $336,000 from a previous reserve of $358,000 in the first quarter.

 

residential real estate and home equity lines of credit loans are due to charge-offs and portfolio growth.

 

non-owner occupied loans are due to the reclassification of a large construction loan, with a first quarter reserve of $661,000, from construction and other.

 

The provision fluctuations during the three-month period ended June 30, 2020 allocated to:

 

non-owner occupied portfolio are due to the increase of specific reserves for two relationships totaling $776,000.

 

commercial and industrial loans are due to growth in loan volume along with an allocation for the PPP loans in the amount of $423,000.

 

The provision fluctuation during the three-month period ended June 30, 2019 allocated to:

 

non-owner occupied loans are due to the reclassification of a large construction loan, with a first quarter reserve of $661,000, from construction and other.

 

 

TDR describes loans on which the bank has granted concessions for reasons related to the customer’s financial difficulties. Such concessions may include one or more of the following:

 

reduction in the interest rate to below-market rates

 

extension of repayment requirements beyond normal terms

 

reduction of the principal amount owed

 

reduction of accrued interest due

 

acceptance of other assets in full or partial payment of a debt

 

In each case, the concession is made due to deterioration in the borrower’s financial condition, and the new terms are less stringent than those required on a new loan with similar risk.

 

On April 7, 2020, federal banking regulators issued a revised interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs.

 

30

 

The following tables summarize troubled debt restructurings (in thousands):

 

  

For the Six Months Ended

 
  

June 30, 2020

 
  

Number of Contracts

  

Pre-Modification

  

Post-Modification

 

 

 

Term

          Outstanding Recorded  Outstanding Recorded 
Troubled Debt Restructurings Modification  

Other

  

Total

  Investment  Investment 

Residential real estate

  1   -   1  $39  $39 

Commercial and industrial

  2   -   2   118   117 

 

 

  

For the Three and Six Months Ended

 
  

June 30, 2019

 
  

Number of Contracts

  

Pre-Modification

  

Post-Modification

 

 

 

Term

          Outstanding Recorded  Outstanding Recorded 
Troubled Debt Restructurings Modification  

Other

  

Total

  Investment  Investment 

Residential real estate

  -   1   1  $85  $140 

 

There were no troubled debt restructurings during the three-month period ended June 30, 2020.

 

There were no subsequent defaults of troubled debt restructurings for the three-month periods ended June 30, 2020 and June 30, 2019, or for the six-month periods ended June 30, 2020 and June 30, 2019.

 

 

NOTE 9STOCK SPLIT DISCLOSURE

 

On October 9, 2019, the Board of Directors of Middlefield Banc Corp. authorized a two-for-one stock split. Each shareholder of record at the close of business on October 25, 2019, received one additional share for every outstanding share held on the record date. The additional shares were paid on November 8, 2019. As a result, all share and earnings per share information have been retroactively adjusted to reflect the stock split.

 

With respect to the June 30, 2020 and 2019 financial statements, the effect of the stock split on June 30, 2019 amounts was recognized retroactively in the stockholders’ equity accounts in the Consolidated Balance Sheets, and in all share data in the Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations. The effect of the stock split on per share amounts and weighted average common shares outstanding for the three and six months ended June 30, 2019 is as follows:

 

   

For the three months ended

   

For the six months ended

 
   

June 30, 2019

   

June 30, 2019

 

Restated net income per common share - basic

  $ 0.51     $ 0.97  

Restated net income per common share - diluted

  $ 0.50     $ 0.97  

Restated weighted-average common shares issued

    7,286,542       7,278,620  

Restated average treasury stock shares

    784,034       778,214  

Restated average shares outstanding - basic

    6,502,508       6,500,406  

Restated stock options and restricted stock

    12,438       12,644  

Restated average shares outstanding - diluted

    6,514,946       6,513,050  

Restated period ending shares outstanding

    6,485,170       6,485,170  

Restated treasury shares outstanding

    807,824       807,824  

 

31

 
 

NOTE 10RISKS AND UNCERTAINTIES

 

COVID-19 Update

 

The following table provides information with respect to our commercial loans by type at June 30, 2020 that management considers to be at the highest exposure to risk related to the COVID-19 pandemic.

 

At Risk Loans at June 30, 2020

 

Loan Type

 

Number of

Loans

   

Balance
(in thousands)

   

% of Total

Loans

 

Retail

    270     $ 195,550       17.6 %

Multifamily & Residential NOO

    354       120,697       10.9 %

Ambulatory Care, Nursing/Rehabilitation and Social Assistance

    218       81,491       7.3 %

Hospitality and tourism

    58       44,923       4.1 %

Restaurant/food service/bar

    136       24,938       2.2 %

Other

    219       20,208       1.8 %

Total

    1,255     $ 487,807       43.9 %

 

The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law on March 27, 2020, and authorized the Small Business Administration (“SBA”) to temporarily guarantee loans under a new 7(a) loan program called the Paycheck Protection Program (“PPP”). As a qualified SBA lender, we were automatically authorized to originate PPP loans.

 

As of June 30, 2020, we approved 1,343 applications for up to $142.7 million of loans under the PPP.

 

As of June 30, 2020, we modified 362 loans aggregating $214.8 million primarily consisting of the deferral of principal and interest payments and the extension of the maturity date for up to three months.

 

Details with respect to actual commercial loan deferrals are as follows:

 

 

Type

 

Number of

Loans

   

Balance
(in thousands)

   

% of Total

Loans

 

Retail

    58     $ 89,438       8.1 %

Hospitality and tourism

    23       35,700       3.2 %

Ambulatory Care, Nursing/Rehabilitation and Social Assistance

    10       22,456       2.0 %

Multifamily & Residential NOO

    16       7,628       0.7 %

Restaurant/food service/bar

    10       5,216       0.5 %

Other

    245       54,379       4.9 %

Total

    362     $ 214,817       19.4 %

 

An eligible business can apply for a PPP loan up to the greater of: (1) 2.5 times its average monthly payroll costs; or (2) $10.0 million. PPP loans will have: (a) an interest rate of 1.0%, (b) a two-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP so long as employee and compensation levels of the business are maintained and 75% of the loan proceeds are used for payroll expenses, with the remaining 25% of the loan proceeds used for other qualifying expenses.

 

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As of June 30, 2020, PPP loan amounts that could be forgiven under this provision are as follows:

 

   

Number of

Loans

   

Loan Balance
(in thousands)

 

> $2 million

    6     $ 14,774  

$350,000 - $2 million

    92       69,361  

$150,000 - $350,000

    96       20,768  

< $150,000

    1,108       36,397  

Total

    1,302     $ 141,300  

 

Since the opening of the PPP, several larger banks have been subject to litigation regarding the process and procedures that those banks used in processing applications for the PPP. Middlefield Bank may be exposed to the risk of similar litigation, from both customers and non-customers that approached the bank regarding PPP loans, regarding the process and procedures used in processing applications for the PPP. If any such litigation is filed against Middlefield Bank and is not resolved in a manner favorable to Middlefield Bank, it may result in significant financial liability or adversely affect Middlefield Bank’s reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP-related litigation could have a material adverse impact on our business, financial condition and results of operations.

 

Middlefield Bank also has credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by Middlefield Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by Middlefield Bank, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from Middlefield Bank.

 

COVID-19 Loan Forbearance Programs. Section 4013 of the CARES Act provides that banks may elect not to categorize a loan modification as a TDR if the loan modification is (1) related to COVID-19; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date on which the national emergency concerning the novel coronavirus disease (COVID–19) outbreak declared by the President on March 13, 2020, under the National Emergencies Act terminates, or (B) December 31, 2020. According to the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (Revised) issued by the federal bank regulatory agencies on April 7, 2020, short-term loan modifications not otherwise eligible under Section 4013 that are made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. See Note 8 of the financial statements for additional disclosure of TDRs at June 30, 2020.

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management’s discussion and analysis (MD&A) provides further detail to the financial condition and results of operations of the Company. The MD&A should be read in conjunction with the notes and financial statements presented in this report.

 

The information contained or incorporated by reference in this report on Form 10-Q contains forward-looking statements, including certain plans, expectations, goals, and projections, which are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those contained or implied by such statements for a variety of factors, including: changes in economic conditions; movements in interest rates; competitive pressures on product pricing and services; success and timing of business strategies; the nature, extent, and timing of government actions and reforms; and extended disruption of vital infrastructure and the potential impact of the COVID-19 pandemic. All forward-looking statements included in this report on Form 10-Q are based on information available at the time of the report. Middlefield Banc Corp. assumes no obligation to update any forward-looking statement.

 

CHANGES IN FINANCIAL CONDITION

 

General. The Company’s total assets ended the June 30, 2020 quarter at $1.34 billion, an increase of $160.8 million from December 31, 2019. For the same time period, cash and cash equivalents increased $23.2 million, or 66.0%, while net loans increased $122.6 million, or 12.5%. Total liabilities increased $157.9 million or 15.1%, while stockholders’ equity increased $2.9 million, or 2.1%.

 

Cash and cash equivalents. Cash and cash equivalents increased $23.2 million, or 66.0%, to $58.3 million at June 30, 2020 from $35.1 million at December 31, 2019. Deposits from customers into savings and checking accounts, loan and securities repayments, and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, purchases of investment securities and repayments of borrowed funds.    

 

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The Company will continue to hold elevated levels of cash and cash equivalents to meet the demands of customers during the economic downturn. The Company monitors cash and cash equivalents on a daily basis to ensure adequate liquidity positions are maintained.    

 

Investment securities. Investment securities available for sale on June 30, 2020 totaled $112.5 million, an increase of $6.8 million, or 6.4%, from $105.7 million at December 31, 2019. During this period, the Company recorded repayments, calls, and maturities of $7.8 million and a net unrealized holding gain through AOCI of $2.4 million. Securities purchased were $12.3 million, and there were no sales of securities for the six months ended June 30, 2020. The Company recorded $129,000 in losses on equity securities as of June 30, 2020 on the Company’s Consolidated Statement of Income and Consolidated Statement of Cash Flows. The loss on equity securities is the result of remeasurements of fair value of the equity securities held during this six-month period.

 

Periodically, management reviews the entire municipal bond portfolio to assess credit quality. Each security held in this portfolio is assessed on attributes that have historically influenced default incidence in the municipal market, such as: sector, security, impairment filing, timeliness of disclosure, external credit assessment(s), credit spread, state, vintage, and underwriter. Municipal bonds compose 75% of the overall portfolio. While these investments have historically proven to have extremely low credit risk, the current economic environment may pose a threat to the cash flows of these governmental entities. The March 31, 2020 review shows portfolio credit quality to be strong with 99.5% of the portfolio having an assigned investment-grade rating or secured by an escrow of US government or agency securities, 80% of the portfolio is either pre-refunded or rated in the broad rating categories of AA or AAA. While not included in the assessment of the credit quality of portfolio holdings, 17.6% benefit from a bond insurance policy, which provides an additional layer of payment support for the securities.

 

Loans receivable. The loans receivable category consists primarily of single-family mortgage loans used to purchase or refinance personal residences located within the Company’s market area, commercial and industrial loans, home equity lines of credit, and commercial real estate loans used to finance properties that are used in the borrowers’ businesses, or to finance investor-owned rental properties, and, to a lesser extent, construction and consumer loans. The portfolio is well disbursed, geographically, with the five branches in the central Ohio market comprising 23.6% of the Company’s total loans. Net loans receivable increased $122.6 million, or 12.5%, to $1.10 billion as of June 30, 2020 from $977.5 million at December 31, 2019. Included in the total increase for loans receivable were increases in the commercial and industrial, CRE owner occupied, and home equity lines of credit portfolios of $150.6 million, or 168.2%, $7.8 million, or 7.6%, and $5.0 million, or 4.4%, respectively. This increase is net of decreases in the construction and other, CRE non-owner occupied, consumer installment, residential real estate, and CRE multifamily portfolios of $665,000, or 1.0%, $1.6 million, or 0.5%, $3.2 million, or 22.2%, $7.4 million, or 3.1%, and $24.4 million, or 39.4%, respectively. The increase in the commercial and industrial portfolio includes the PPP loans issued as of June 30, 2020 of $142.7 million.

 

The Company’s Mortgage Banking operation generates loans for sale to the Federal Home Loan Mortgage Corporation (“Freddie Mac”). Loans held for sale on June 30, 2020 totaled $4.2 million, an increase of $2.9 million, or 240.2%, from December 31, 2019. This increase is the result of more saleable loans being held at quarter end. The Company recorded proceeds from the sale of $18.6 million of these loans for $495,000 in gains on sale of loans as of June 30, 2020 on the Company’s Consolidated Statement of Cash Flows.

 

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced growth in its commercial real estate portfolio in recent years. At June 30, 2020 non-owner-occupied commercial real estate loans (including construction, land and land development loans) represent 295.5% of total risk-based capital. Construction, land and land development loans represent 46.1% of total risk-based capital. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, and strong underwriting criteria with respect to its commercial real estate portfolio. Loan monitoring practices include but are not limited to periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. Nevertheless, we may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital, and may adversely affect shareholder returns. The Company has an extensive capital planning policy, which includes pro forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are in excess of well-capitalized ratios.

 

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The Company monitors daily fluctuations in unused commitments as a means of identifying potentially material drawdowns on existing lines of credit. At June 30, 2020, unused line of credit commitments is unchanged from December 31, 2019.

 

Allowance for Loan and Lease Losses and Asset Quality. The allowance for loan and lease losses increased $3.4 million, or 50.9%, to $10.2 million at June 30, 2020 from $6.8 million at December 31, 2019. For the three months ended June 30, 2020, net loan charge-offs totaled $34,000, or 0.01% of average loans, compared to net charge-offs of $12,000 for the same period in 2019. To maintain the allowance for loan and lease losses, the Company recorded a provision for loan loss of $1.0 million in the three-month period ended June 30, 2020. For the six months ended June 30, 2020, net loan charge-offs totaled $298,000, or 0.06% of average loans, compared to net charge-offs of $474,000, or 0.10% of average loans, for the same period in 2019. To maintain the allowance for loan and lease losses, the Company recorded a provision for loan loss of $3.7 million in the six-month period ended June 30, 2020. The ratio of the allowance for loan and lease losses to nonperforming loans was 104.2% for the three-month period ended June 30, 2020, compared to 68.1% for the same period in the prior year. This is due to an increase in impaired loans and the allowance being adjusted to address the economic slowdown during the six months ended June 30, 2020. See additional discussions on the provision for loan losses section below.

 

Management analyzes the adequacy of the allowance for loan and lease losses regularly through reviews of the performance of the loan portfolio considering economic conditions, changes in interest rates and the effect of such changes on real estate values, and changes in the amount and composition of the loan portfolio. The allowance for loan and lease losses is a significant estimate that is particularly susceptible to changes in the near term. Management’s analysis includes a review of all loans designated as impaired, historical loan loss experience, the estimated fair value of the underlying collateral, economic conditions, current interest rates, trends in the borrower’s industry and other factors that management believes warrant recognition in providing for an appropriate allowance for loan and lease losses. Future additions or reductions to the allowance for loan and lease losses will be dependent on these factors. Additionally, the Company uses an outside party to conduct an independent review of commercial and commercial real estate loans that is designed to validate management conclusions of risk ratings and the appropriateness of the allowance allocated to these loans. The Company uses the results of this review to help determine the effectiveness of policies and procedures and to assess the adequacy of the allowance for loan and lease losses allocated to these types of loans. Management believes the allowance for loan and lease losses is appropriately stated at June 30, 2020. Based on the variables involved and management’s judgments about uncertain outcomes, the determination of the allowance for loan and lease losses is considered a critical accounting policy.

 

Goodwill. The Company considers the negative economic impact resulting from the COVID-19 shutdowns to be a triggering event necessitating a mid-cycle analysis for impairment. Based on the analysis performed as of March 31, 2020, the Company determined that goodwill was not impaired.

 

Accrued Interest Receivable and Other Assets. Accrued interest receivable and other assets increased $4.4 million, or 41.0%, to $15.1 million at June 30, 2020 from $10.7 million at December 31, 2019. Income receivable on loans has increased $2.1 million as a result of the COVID-19 payment deferral program. Also included in this increase are increases in FHLB stock owned of $1.6 million, other real estate owned of $532,000, and an increase in the holding company franchise tax asset of $551,000.

 

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Nonperforming assets. Nonperforming assets include nonaccrual loans, loans 90 days or more past due, other real estate owned, and repossessed assets. Real estate owned is written down to fair value at its initial recording and continually monitored for changes in fair value. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that collection of principal and interest is doubtful. Payments received on nonaccrual loans are applied against principal until doubt about collectability ceases.

 

   

Asset Quality History

 
                                         

(Dollar amounts in thousands)

 

June 30, 2020

   

March 31, 2020

   

December 31, 2019

   

September 30, 2019

   

June 30, 2019

 
                                         

Nonperforming loans

  $ 9,803     $ 8,405     $ 8,879     $ 10,053     $ 10,729  

Other real estate owned

    687       456       155       89       89  
                                         

Nonperforming assets

  $ 10,490     $ 8,861     $ 9,034     $ 10,142     $ 10,818  
                                         

Allowance for loan and lease losses

    10,210       9,244       6,768       7,001       7,304  
                                         

Ratios:

                                       

Nonperforming loans to total loans

    0.88 %     0.84 %     0.90 %     1.01 %     1.07 %

Nonperforming assets to total assets

    0.78 %     0.73 %     0.76 %     0.79 %     0.84 %

Allowance for loan and lease losses to total loans

    0.92 %     0.93 %     0.69 %     0.70 %     0.73 %

Allowance for loan and lease losses to nonperforming loans

    104.15 %     109.98 %     76.22 %     69.64 %     68.08 %

 

Nonperforming loans exclude TDRs that are performing in accordance with their terms over a prescribed period of time. TDRs are those loans which the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. The Company has 25 TDRs accruing interest with a balance of $2.8 million as of June 30, 2020. A TDR that yields a market interest rate at the time of restructuring and is in compliance with its modified terms is no longer reported as a TDR in calendar years after the year in which the restructuring took place. To be in compliance with its modified terms, a loan that is a TDR must not be in nonaccrual status and must be current or less than 30 days past due on its contractual principal and interest payments under the modified repayment terms. Nonperforming loans secured by real estate totaled $9.1 million as of June 30, 2020, an increase of $1.3 million from $7.8 million at December 31, 2019.

 

A major factor in determining the appropriateness of the allowance for loan and lease losses is the type of collateral which secures the loans. Of the total nonperforming loans at June 30, 2020, 93.3% were secured by real estate. Although this does not insure against all losses, real estate typically provides for at least partial recovery, even in a distressed-sale and declining-value environment. The Company’s objective is to minimize the future loss exposure of the Company.

 

The allowance for loan and lease losses to total loans ratio increased from 0.69% as of December 31, 2019 to 0.92% as of June 30, 2020.

 

Deposits. The Company considers various sources when evaluating funding needs, including but not limited to deposits, which are a significant source of funds, totaling $1.16 billion or 103.9% of the Company’s total average funding sources at June 30, 2020. Total deposits increased $137.4 million, or 13.5%, at June 30, 2020 from $1.02 billion at December 31, 2019. The total increase in deposits is the net of increases in noninterest-bearing demand deposits, interest-bearing demand deposits, savings, and money market deposits of $79.4 million, or 41.5%, $28.9 million, or 26.8%, $26.5 million, or 13.8%, and $8.0 million, or 5.0%, respectively, and a decrease in time deposits of $5.4 million, or 1.5%, at June 30, 2020, as some maturing certificates are not being renewed in the current low interest rate environment. Included in the net increase are $58.8 million of new PPP deposits. The Company uses certain non-core funding instruments in order to grow the balance sheet and maintain liquidity. These deposits, either from a broker or a listing service, were $54.9 million at June 30, 2020, as compared to $117.1 million at December 31, 2019.

 

Borrowed funds. The Company uses short-term and long-term borrowings as another source of funding for asset growth and liquidity needs. These borrowings primarily include FHLB advances, junior subordinated debt, short-term borrowings from other banks, and federal funds purchased. Short-term borrowings increased $15.3 million to $20.4 million as of June 30, 2020. Other borrowings increased $4.4 million, or 34.6%, to $17.2 million as of June 30, 2020 from $12.8 million as of December 31, 2019.

 

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Stockholders’ equity. Stockholders’ equity increased $2.9 million, or 2.1%, to $140.7 million at June 30, 2020 from $137.8 million at December 31, 2019. This increase was the result of increases in retained earnings of $2.1 million, AOCI of $1.9 million, and common stock of $105,000. This increase is net of an increase in treasury stock of $1.2 million, or 7.6%, to $16.9 million as of June 30, 2020, from $15.7 million as of December 31, 2019. The change in retained earnings is due to the year-to-date net income offset by dividends paid, the change in AOCI is due to fair value adjustments of available-for-sale securities, and the change in treasury stock is due to the Company repurchasing 58,200 of its outstanding shares during the six months ended June 30, 2020.

 

The Company suspended its stock repurchase program as a result of the economic slowdown and the focus on capital preservation. The suspension will continue until economic clarity arises and the Company is certain it is the best use of capital.

 

RESULTS OF OPERATIONS

 

General. Net income for the three months ended June 30, 2020, was $3.0 million, a $324,000, or 9.8%, decrease from the amount earned during the same period in 2019. Diluted earnings per share for the quarter decreased to $0.46, compared to $0.50 from the same period in 2019. Net income for the six months ended June 30, 2020, was $4.0 million, a $2.3 million, or 36.4%, decrease from the amount earned during the same period in 2019. Diluted earnings per share for this six-month period decreased to $0.62, compared to $0.97 from the same period in 2019.

 

The Company’s annualized return on average assets (“ROA”) and return on average equity (“ROE”) for the quarter were 0.90% and 8.56%, respectively, compared with 1.09% and 9.79% for the same period in 2019. The Company’s ROA and ROE for the six-month period were 0.78% and 5.79%, respectively, compared with 1.05% and 9.58% for the same period in 2019.

 

Net interest income. Net interest income, the primary source of revenue for the Company, is determined by the interest rate spread, which is defined as the difference between income on earning assets and the cost of funds supporting those assets, and the relative amounts of interest-earning assets and interest-bearing liabilities. Management periodically adjusts the mix of assets and liabilities, as well as the rates earned or paid on those assets and liabilities, in order to manage and improve net interest income. The level of interest rates and changes in the amount and composition of interest-earning assets and liabilities affect the Company’s net interest income. Management’s goal is to maintain a balance between steady net interest income growth and the risks associated with interest rate fluctuations.

 

Net interest income for the three months ended June 30, 2020 totaled $10.7 million, an increase of 4.4% from that reported in the comparable period of 2019. The net interest margin was 3.49% for the second quarter of 2020, a decrease from the 3.65% reported for the same quarter of 2019. The decline in the net interest margin is attributable to a 56 basis point decrease in loans receivable yield along with a 198 basis point decrease in the yield on interest-earning deposits with other banks. This decline was partially offset by an increase in average loan balances of $89.8 million or 9.0%. PPP loans reduced the net interest margin for the second quarter by 10 basis points from the first quarter of 2020. Net interest income for the six months ended June 30, 2020 totaled $20.8 million, an increase of 1.3% from that reported in the comparable period of 2019. The net interest margin was 3.56% for the six-month period ended June 30, 2020, a decrease from the 3.67% reported for the comparable period of 2019. The decline in the net interest margin is attributable to a 35 basis point decrease in loans receivable yield along with a 152 basis point decrease in the yield on interest-earning deposits with other banks. This decline was partially offset by an increase in average loan balances of $36.7 million or 3.7%. The Company’s net interest margin may be subject to further decline as a result of the abrupt decrease in interest rates during the first quarter of 2020, the reduced interest income on floating-rate commercial loans, and the business disruptions caused by the COVID-19 pandemic. As the Company is in an asset-sensitive position, reductions in market interest rates have a negative impact on margin as the Company’s interest-earning assets reprice faster than its interest-bearing liabilities. Much of our asset-sensitivity is due to commercial and consumer loans that have variable interest rates. Both loan types have floor rates. The benefit of these floors will become more evident in future quarters if the Federal Reserve maintains short-term interest rates at the low level established in March 2020. For the three months ended June 30, 2020, the decrease in yield on interest-earning deposits with other banks led to a $213,000 decline in interest income. The $565,000 overall decrease in interest income was offset by a $1.0 million decrease in interest expense. For the six months ended June 30, 2020, the decrease in yield on interest-earning deposits with other banks led to a $320,000 decline in interest income. The $1.0 million overall decrease in interest income was offset by a $1.3 million decrease in interest expense.

 

Interest and dividend income. Interest and dividend income decreased $565,000, or 4.1%, for the three months ended June 30, 2020, compared to the same period in the prior year. This is attributable to a decrease in interest and fees on loans of $425,000. Interest and dividend income decreased $1.0 million, or 3.8%, for the six months ended June 30, 2020, compared to the same period in the prior year. This is attributable to a decrease in interest and fees on loans of $835,000.

 

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Interest and fees earned on loans receivable decreased $425,000, or 3.3%, for the three months ended June 30, 2020, compared to the same period in the prior year. This is attributable to a 56 basis point decrease in the average yield to 4.53%, partially offset by an increase in average loan balances of $89.8 million. Interest and fees earned on loans receivable decreased $835,000, or 3.3%, for the six months ended June 30, 2020, compared to the same period in the prior year. This is attributable to a 35 basis point decrease in the average yield to 4.73%, partially offset by an increase in average loan balances of $36.7 million. The increase in the average loan balance is due in part to the issuance of PPP loans in 2020, the related income of which was $927,000 as of June 30, 2020.

 

Net interest earned on securities increased by $73,000 for the three months ended June 30, 2020 when compared to the same period in the prior year. The average balance of investment securities increased $8.7 million, or 8.8%, while the 3.76% yield on the investment portfolio increased by 6 basis points, from 3.70%, for the same period in the prior year. Net interest earned on securities increased by $115,000 for the six months ended June 30, 2020 when compared to the same period in the prior year. The average balance of investment securities increased $8.6 million, or 8.7%, while the 3.69% yield on the investment portfolio decreased by 2 basis points, from 3.71%, for the same period in the prior year.

 

 

Interest expense. Interest expense decreased $1.0 million, or 29.6%, for the three months ended June 30, 2020, compared to the same period in the prior year. The decrease is attributable to a decrease in the average balance of certificates of deposits of $40.7 million, or 10.4%, and is further attributable to decreases of 214, 48, 47, and 35 basis points in short-term borrowings, savings, money market deposits, and certificates of deposits cost. This decrease was partially offset by an increase in the average balance of short-term borrowings of $42.6 million, or 319.2%. Interest expense decreased $1.3 million, or 19.4%, for the six months ended June 30, 2020, compared to the same period in the prior year. The decrease is attributable to decreases in the average balances of money market deposits and savings deposits of $15.8 million, or 8.9%, and $10.6 million, or 5.3%, respectively. This decrease is further attributable to decreases in costs of 204, 90, 40, 33, and 21 basis points in short-term borrowings, other borrowings, savings, money market deposits, and certificates of deposits costs. This decrease was partially offset by an increase in the average balance of short-term borrowings of $11.0 million, or 45.2%.

 

The decreases in costs were primarily due to decreasing interest rates on all deposit products in response to the unprecedented decrease in the targeted federal funds rate in March 2020. The COVID-19 pandemic could result in lower levels of deposits in future periods, which could decrease our average interest-bearing deposits for the remainder of 2020. Also, as a result of the reductions in the targeted federal funds interest rate, as well as the impact of the COVID-19 pandemic, we expect that our net interest income and net interest margin could decrease in future periods.

 

Provision for loan losses. The provision for loan losses represents the charge to income necessary to adjust the allowance for loan and lease losses to an amount that represents management’s assessment of the estimated probable incurred credit losses inherent in the loan portfolio. Each quarter, management performs a review of estimated probable incurred credit losses in the loan portfolio. Based on this review, a provision for loan losses of $1.0 million was recorded for the quarter ended June 30, 2020, an increase of $890,000 from the quarter ended June 30, 2019. A provision for loan losses of $3.7 million was recorded for the six-month period ended June 30, 2020, an increase of $3.4 million from the same period in 2019. The Company remains confident in the conservative and disciplined approach to credit and risk management. However, the economic challenges caused by the COVID-19 crisis has an immediate impact on credit quality.

 

At June 30, 2020, we considered the effect of the economic shutdown to combat COVID-19 on our borrowers and local economy. Although stimulus and mitigation efforts are expected to reduce the impact, we believe a 20 basis point increase to the economic qualitative factor was warranted. Most of the increased provision is the result of increases to the current economic condition’s qualitative factors. The impact of those increases for the six months ended June 30, 2020 is (in thousands):

 

Commercial real estate:

       

Owner occupied

  $ 191  

Non-owner occupied

    542  

Multifamily

    63  

Residential real estate

    458  

Commercial and industrial

    646  

Home equity lines of credit

    228  

Construction and other

    112  

Consumer installment

    8  

Total

  $ 2,248  

 

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Nonperforming loans were $9.8 million, or .88%, of total loans at June 30, 2020 compared with $10.7 million, or 1.07%, at June 30, 2019. For the three months ended June 30, 2020, net loan charge-offs totaled $34,000, or 0.01% of average loans, compared to net charge-offs of $12,000, for the second quarter of 2019. For the six months ended June 30, 2020, net loan charge-offs totaled $298,000, or 0.06% of average loans, compared to net charge-offs of $474,000, or 0.10% of average loans, for the same period in 2019.

 

Noninterest income. Noninterest income increased $196,000, or 15.1%, for the three months ended June 30, 2020 over the comparable 2019 period. This increase was the result of an increase in gains on sale of loans of $283,000, or 288.8%, partially offset by a decrease in investment securities gains on sale, net, of $190,000. The increase in gains on sale of loans is due to an increase in refinancing of mortgages due to a decrease in rates. Noninterest income increased $138,000, or 5.7%, during the six months ended June 30, 2020 over the comparable 2019 period. This increase was the result of an increase in gains on sale of loans of $338,000, or 215.3%, partially offset by decreases in investment securities gains on sale, net, and gains on equity securities (Note 7) of $190,000, and $173,000, respectively. The increase in gains on sale of loans is due to an increase in saleable loans being sold during this time period. The decrease in investment securities gains on sale is due to no available-for-sale securities being sold during the second quarter of 2020.

 

Noninterest expense.  Noninterest expense of $7.7 million for the second quarter 2020 was 2.8%, or $207,000, higher than the second quarter of 2019.  Data processing costs and other expenses increased $135,000, or 24.6%, and $70,000, or 7.2%, respectively.  The increase in data processing costs is due to new and increased costs of processing agreements.  The increase in other expense is due to increases in directors' fees, miscellaneous loan expenses, sundry gains and losses, and pandemic response-related expenses.  Noninterest expense of $14.9 million for the six-month period ended June 30, 2020 was 0.3%, or $41,000, lower than the same period in 2019.  Data processing costs and other expense increased $336,000, or 33.1%, and $264,000, or 14.3%, respectively.  These increases were offset by a decrease in salaries and employee benefits of $602,000, or 7.3%.  The increase in data processing costs is due to new and increased costs of processing agreements, and the increase in other expense is due to increases in miscellaneous loan expenses, postage, sundry gains and losses, and fewer offsetting gains on sales of OREO properties.  The decrease in salary expense is due to the valuation adjustment for share-based compensation liability (see Note 3), as well as a decrease in profit sharing expense recorded.

 

Provision for income taxes. The Company recognized $565,000 in income tax expense, which reflected an effective tax rate of 16.0% for the three months ended June 30, 2020, as compared to $686,000 with an effective tax rate of 17.3% for the comparable 2019 period. The Company recognized $639,000 in income tax expense, which reflected an effective tax rate of 13.8% for the six months ended June 30, 2020, as compared to $1.3 million with an effective tax rate of 17.1% for the comparable 2019 period. The decrease in the effective tax rate is due to the reduction of net income.

 

39

 

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include nonaccrual loans and exclude the allowance for loan and lease losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities and loans (tax exempt for federal income tax purposes) are shown on a fully tax-equivalent basis utilizing a federal tax rate of 21%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.

 

   

For the Three Months Ended June 30,

 
   

2020

   

2019

 
                                                 
   

Average

           

Average

   

Average

           

Average

 

(Dollars in thousands)

 

Balance

   

Interest

   

Yield/Cost

   

Balance

   

Interest

   

Yield/Cost

 

Interest-earning assets:

                                               

Loans receivable (3)

  $ 1,092,095     $ 12,281       4.53 %   $ 1,002,346     $ 12,706       5.09 %

Investment securities (3)

    107,765       840       3.76 %     99,022       767       3.70 %

Interest-earning deposits with other banks (4)

    58,541       34       0.23 %     44,747       247       2.21 %

Total interest-earning assets

    1,258,401       13,155       4.27 %     1,146,115       13,720       4.86 %

Noninterest-earning assets

    62,976                       61,267                  

Total assets

  $ 1,321,377                     $ 1,207,382                  

Interest-bearing liabilities:

                                               

Interest-bearing demand deposits

  $ 129,917     $ 112       0.35 %   $ 98,929     $ 88       0.36 %

Money market deposits

    164,434       381       0.93 %     159,705       558       1.40 %

Savings deposits

    198,967       104       0.21 %     195,451       336       0.69 %

Certificates of deposit

    350,298       1,739       2.00 %     390,997       2,295       2.35 %

Short-term borrowings

    55,973       32       0.23 %     13,354       79       2.37 %

Other borrowings

    15,615       62       1.60 %     12,489       95       3.05 %

Total interest-bearing liabilities

    915,204       2,430       1.07 %     870,925       3,451       1.59 %

Noninterest-bearing liabilities:

                                               

Noninterest-bearing demand deposits

    262,575                       198,234                  

Other liabilities

    4,311                       3,387                  

Stockholders' equity

    139,287                       134,836                  

Total liabilities and stockholders' equity

  $ 1,321,377                     $ 1,207,382                  

Net interest income

          $ 10,725                     $ 10,269          

Interest rate spread (1)

                    3.20 %                     3.27 %

Net interest margin (2)

                    3.49 %                     3.65 %

Ratio of average interest-earning assets to average interest-bearing liabilities

                    137.50 %                     131.60 %

 


(1) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(2) Net interest margin represents net interest income as a percentage of average interest-earning assets.

(3) Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were $190 and  $168 for the three months ended June 30, 2020 and 2019, respectively.

(4) Includes dividends received on restricted stock.  

 

40

 

Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the three-month periods ended June 30, 2020 and 2019, in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances.

 

   

2020 versus 2019

 
                         
   

Increase (decrease) due to

 

(Dollars in thousands)

 

Volume

   

Rate

   

Total

 
                         

Interest-earning assets:

                       

Loans receivable

  $ 1,136     $ (1,561 )   $ (425 )

Investment securities

    80       (7 )     73  

Interest-earning deposits with other banks

    76       (289 )     (213 )

Total interest-earning assets

    1,292       (1,857 )     (565 )
                         
                         

Interest-bearing liabilities:

                       

Interest-bearing demand deposits

    28       (4 )     24  

Money market deposits

    16       (193 )     (177 )

Savings deposits

    6       (238 )     (232 )

Certificates of deposit

    (238 )     (318 )     (556 )

Short-term borrowings

    251       (298 )     (47 )

Other borrowings

    24       (57 )     (33 )

Total interest-bearing liabilities

    87       (1,108 )     (1,021 )
                         
                         

Net interest income

  $ 1,205     $ (749 )   $ 456  

 

41

 

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the resultant average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages and the average loan balances include nonaccrual loans and exclude the allowance for loan and lease losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities and loans (tax exempt for federal income tax purposes) are shown on a fully tax-equivalent basis utilizing a federal tax rate of 21%. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.

 

   

For the Six Months Ended June 30,

 
   

2020

   

2019

 
   

Average

           

Average

   

Average

           

Average

 

(Dollars in thousands)

 

Balance

   

Interest

   

Yield/Cost

   

Balance

   

Interest

   

Yield/Cost

 

Interest-earning assets:

                                               

Loans receivable (3)

  $ 1,038,064     $ 24,359       4.73 %   $ 1,001,344     $ 25,194       5.08 %

Investment securities (3)

    106,829       1,626       3.69 %     98,253       1,511       3.71 %

Interest-earning deposits with other banks (4)

    50,129       179       0.72 %     45,015       499       2.24 %

Total interest-earning assets

    1,195,022       26,164       4.47 %     1,144,612       27,204       4.85 %

Noninterest-earning assets

    63,990                       60,912                  

Total assets

  $ 1,259,012                     $ 1,205,524                  

Interest-bearing liabilities:

                                               

Interest-bearing demand deposits

  $ 121,804       229       0.38 %   $ 96,594     $ 160       0.33 %

Money market deposits

    161,221       934       1.17 %     176,970       1,313       1.50 %

Savings deposits

    191,052       331       0.35 %     201,650       753       0.75 %

Certificates of deposit

    362,082       3,707       2.06 %     355,620       3,996       2.27 %

Short-term borrowings

    35,390       67       0.38 %     24,372       292       2.42 %

Other borrowings

    14,159       138       1.96 %     13,473       191       2.86 %

Total interest-bearing liabilities

    885,708       5,406       1.23 %     868,679       6,705       1.56 %

Noninterest-bearing liabilities:

                                               

Noninterest-bearing demand deposits

    228,993                       199,332                  

Other liabilities

    5,024                       4,870                  

Stockholders' equity

    139,287                       132,643                  

Total liabilities and stockholders' equity

  $ 1,259,012                     $ 1,205,524                  

Net interest income

          $ 20,758                     $ 20,499          

Interest rate spread (1)

                    3.24 %                     3.29 %

Net interest margin (2)

                    3.56 %                     3.67 %

Ratio of average interest-earning assets to average interest-bearing liabilities

                    134.92 %                     131.76 %

 


(1) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(2) Net interest margin represents net interest income as a percentage of average interest-earning assets.

(3) Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were $379 and  $338 for the six months ended June 30, 2020 and 2019, respectively.

(4) Includes dividends received on restricted stock.  

 

42

 

Analysis of Changes in Net Interest Income. The following table analyzes the changes in interest income and interest expense, between the six-month periods ended June 30, 2020 and 2019, in terms of: (1) changes in volume of interest-earning assets and interest-bearing liabilities and (2) changes in yields and rates. The table reflects the extent to which changes in the Company’s interest income and interest expense are attributable to changes in rate (change in rate multiplied by prior period volume), changes in volume (changes in volume multiplied by prior period rate) and changes attributable to the combined impact of volume/rate (change in rate multiplied by change in volume). The changes attributable to the combined impact of volume/rate are allocated on a consistent basis between the volume and rate variances.

 

   

2020 versus 2019

 
                         
   

Increase (decrease) due to

 

(Dollars in thousands)

 

Volume

   

Rate

   

Total

 
                         

Interest-earning assets:

                       

Loans receivable

  $ 928     $ (1,763 )   $ (835 )

Investment securities

    158       (43 )     115  

Interest-earning deposits with other banks

    57       (377 )     (320 )

Total interest-earning assets

    1,143       (2,183 )     (1,040 )
                         
                         

Interest-bearing liabilities:

                       

Interest-bearing demand deposits

    41       28       69  

Money market deposits

    (117 )     (262 )     (379 )

Savings deposits

    (40 )     (382 )     (422 )

Certificates of deposit

    73       (362 )     (289 )

Short-term borrowings

    133       (358 )     (225 )

Other borrowings

    10       (63 )     (53 )

Total interest-bearing liabilities

    100       (1,399 )     (1,299 )
                         
                         

Net interest income

  $ 1,043     $ (784 )   $ 259  

 

43

 

LIQUIDITY

 

Management's objective in managing liquidity is maintaining the ability to continue meeting the cash flow needs of banking customers, such as borrowings or deposit withdrawals, as well as the Company’s own financial commitments. The principal sources of liquidity are net income, loan payments, maturing and principal reductions on securities and sales of securities available for sale, federal funds sold and cash and deposits with banks. The Company offers a line of retail deposit products created to more closely align with customer expectations while expanding the Company’s core funding base. Along with its liquid assets, the Company has additional sources of liquidity available to ensure that adequate funds are available as needed. These include, but are not limited to, the purchase of federal funds, the ability to borrow funds under line of credit agreements with correspondent banks and a borrowing agreement with the Federal Home Loan Bank of Cincinnati (the “FHLB”), and the adjustment of interest rates to obtain depositors. Management believes the Company has the capital adequacy, profitability and reputation to meet the current and projected needs of its customers.

 

At June 30, 2020, additional borrowing capacity at the FHLB was $383.3 million, as compared to $273.4 million at December 31, 2020. This increase was the result of collateralizing additional assets. For the six months ended June 30, 2020, wholesale funding decreased $52.2 million. The Company also has the option of borrowing from the Federal Reserve discount window with any assets not currently pledged elsewhere. Management believes that the combination of high levels of potentially liquid assets, cash flows from operations, and additional borrowing capacity provided Middlefield Bank with strong liquidity as of June 30, 2020. Management plans to continually monitor liquidity in future periods to look for signs of stress resulting from the COVID-19 pandemic.

 

For the six months ended June 30, 2020, the adjustments to reconcile net income to net cash from operating activities consisted mainly of depreciation and amortization of premises and equipment and software, the provision for loan losses, net amortization of securities, earnings on bank-owned life insurance, accretion of net deferred loan fees, and net changes in other assets and liabilities. For a more detailed illustration of sources and uses of cash, refer to the Condensed Consolidated Statements of Cash Flows.

 

INFLATION

 

Substantially all of the Company's assets and liabilities relate to banking activities and are monetary in nature. The consolidated financial statements and related financial data are presented in accordance with GAAP. GAAP currently requires the Company to measure the financial position and results of operations in terms of historical dollars, with the exception of securities available for sale, impaired loans and other real estate loans that are measured at fair value. Changes in the value of money due to rising inflation can cause purchasing power loss.

 

Management's opinion is that movements in interest rates affect the financial condition and results of operations to a greater degree than changes in the rate of inflation. It should be noted that interest rates and inflation do affect each other, but do not always move in correlation with each other. The Company's ability to match the interest sensitivity of its financial assets to the interest sensitivity of its liabilities in its asset/liability management may tend to minimize the effect of changes in interest rates on the Company's performance.

 

REGULATORY MATTERS

 

The Company is subject to the regulatory requirements of the Federal Reserve System as a bank holding company. The bank subsidiary is subject to regulations of the Federal Deposit Insurance Corporation (“FDIC”) and the Ohio Division of Financial Institutions.

 

The Federal Reserve Board and the FDIC have extensive authority to prevent and to remedy unsafe and unsound practices and violations of applicable laws and regulations by institutions and holding companies. The agencies may assess civil money penalties, issue cease-and-desist or removal orders, seek injunctions, and publicly disclose those actions. In addition, the Ohio Division of Financial Institutions possesses enforcement powers to address violations of Ohio banking law by Ohio-chartered banks.

 

44

 

REGULATORY CAPITAL REQUIREMENTS

 

Financial institution regulators have established guidelines for minimum capital ratios for banks, thrifts and bank and thrift holding companies. The net unrealized gain or loss on available-for-sale securities is generally not included in computing regulatory capital. In order to avoid limitations on capital distributions, including dividend payments, Middlefield Bank and the Company must each hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The implementation of the capital ratio buffer began January 1, 2016 at the 0.625% level and has been fully phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reached 2.5% on January 1, 2019). Within the tabular presentation that follows is the adequately capitalized ratio plus capital conservation buffer that includes the fully phased-in 2.50% buffer.

 

Middlefield Bank and the Company met each of the well-capitalized ratio guidelines at June 30, 2020. The following table indicates the capital ratios for Middlefield Bank and Company at June 30, 2020 and December 31, 2019.

 

   

As of June 30, 2020

 
           

Tier 1 Risk

   

Common

   

Total Risk

 
   

Leverage

    Based     Equity Tier 1     Based  

The Middlefield Banking Company

    9.64 %     11.13 %     11.13 %     12.04 %

Middlefield Banc Corp.

    10.28 %     11.34 %     10.63 %     12.24 %

Adequately capitalized ratio

    4.00 %     6.00 %     4.50 %     8.00 %

Adequately capitalized ratio plus fully phased-in capital conservation buffer

    4.00 %     8.50 %     7.00 %     10.50 %

Well-capitalized ratio (Bank only)

    5.00 %     8.00 %     6.50 %     10.00 %

 

   

As of December 31, 2019

 
           

Tier 1 Risk

   

Common

   

Total Risk

 
   

Leverage

    Based     Equity Tier 1     Based  

The Middlefield Banking Company

    10.35 %     12.12 %     12.12 %     12.79 %

Middlefield Banc Corp.

    10.23 %     12.56 %     11.77 %     13.23 %

Adequately capitalized ratio

    4.00 %     6.00 %     4.50 %     8.00 %

Adequately capitalized ratio plus fully phased-in capital conservation buffer

    4.00 %     8.50 %     7.00 %     10.50 %

Well-capitalized ratio (Bank only)

    5.00 %     8.00 %     6.50 %     10.00 %

 

While we believe that Middlefield Bank is well prepared to weather the COVID-19 global pandemic, Middlefield Bank’s regulatory capital ratios could be adversely affected by credit losses and other adverse consequences associated with the pandemic.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

ASSET AND LIABILITY MANAGEMENT

 

The primary objective of the Company’s asset and liability management function is to maximize the Company’s net interest income while simultaneously maintaining an acceptable level of interest rate risk given the Company’s operating environment, capital and liquidity requirements, performance objectives and overall business focus. The principal determinant of the exposure of the Company’s earnings to interest rate risk is the timing difference between the re-pricing or maturity of interest-earning assets and the re-pricing or maturity of interest-bearing liabilities. The Company’s asset and liability management policies are designed to decrease interest rate sensitivity primarily by shortening the maturities of interest-earning assets while at the same time extending the maturities of interest-bearing liabilities. The Board of Directors of the Company continues to believe in a strong asset/liability management process in order to insulate the Company from material and prolonged increases in interest rates.

 

The Company’s Board of Directors has established an Asset and Liability Management Committee consisting of outside directors and senior management. This committee, which meets quarterly, generally monitors various asset and liability management policies and strategies.

 

45

 

Interest Rate Sensitivity Simulation Analysis

 

The Company engages an external consultant to facilitate income simulation modeling on a quarterly basis. This modeling measures interest rate risk and sensitivity. The Asset and Liability Management Committee of the Company believes the various rate scenarios of the simulation modeling enable the Company to more accurately evaluate and manage the exposure of interest rate fluctuations on net interest income, the yield curve, various loan and mortgage-backed security prepayments, and deposit decay assumptions.

 

Earnings simulation modeling and assumptions about the timing and volatility of cash flows are critical in net portfolio equity valuation analysis. Particularly important are the assumptions driving mortgage prepayments and expected attrition of the core deposit portfolios. These assumptions are based on the Company’s historical experience and industry standards and are applied consistently across all rate risk measures.

 

The Company has established the following guidelines for assessing interest rate risk:

 

Net interest income simulation (“NII”) - Projected net interest income over the next twelve months will not be reduced by more than 10% given a gradual shift (i.e., over 12 months) in interest rates of up to 200 basis points (+ or -) and assuming no balance sheet growth.

 

Portfolio equity simulation - Portfolio equity is the net present value of the Company’s existing assets and liabilities. The Company uses an Economic Value of Equity (“EVE”) analysis which shows the estimated changes in portfolio equity taking certain long-term shock rates into consideration. Given a 200 basis point immediate and permanent increase in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 20% of stockholders’ equity. Given a 100 basis point immediate and permanent decrease in market interest rates, portfolio equity may not correspondingly decrease or increase by more than 10% of stockholders’ equity.

 

The following table presents the simulated impact of a 200 basis point upward or 100 basis point downward shift of market interest rates on net interest income, and the change in portfolio equity. This analysis was done assuming the interest-earning asset and interest-bearing liability levels at June 30, 2020 and December 31, 2019 remained constant. The impact of the market rate movements was developed by simulating the effects of rates changing gradually over a one-year period from the June 30, 2020 and December 31, 2019 levels for net interest income and portfolio equity. The impact of market rate movements was developed by simulating the effects of an immediate and permanent change in rates at June 30, 2020 and December 31, 2019 for portfolio equity:  

 

   

June 30, 2020

   

December 31, 2019

 

Change in Rates

 

% Change in NII

   

% Change in EVE

   

% Change in NII

   

% Change in EVE

 

+200bp

    (0.30

)%

    4.90

%

    0.20

%

    6.20

%

-100bp

    0.20

%

    (17.50

)%

    (0.60

)%

    (9.40

)%

 

CRITICAL ACCOUNTING ESTIMATES

 

The Company’s critical accounting estimates involving the more significant judgments and assumptions used in the preparation of the consolidated financial statements as of June 30, 2020, have remained unchanged from December 31, 2019.

 

Item 4. Controls and Procedures

 

Controls and Procedures Disclosure

 

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

As of the end of the period covered by this quarterly report, an evaluation was carried out under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934). Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Subsequent to the date of their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that there were no significant changes in internal control or in other factors that could significantly affect the Company’s internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.

 

46

 

A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 2), or a combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by management or employees in the normal course of performing their assigned functions.

 

Changes in Internal Control over Financial Reporting

 

There have not been any changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings

 

From time to time, the Company and MBC may be involved in litigation relating to claims arising out of their normal course of business. Currently, the Company and MBC are not involved in any legal proceedings the outcome of which, in management’s opinion, would be material to their financial condition or results of operations.

 

Item 1a. Risk Factors

 

In addition to the other information contained in this Quarterly Report on Form 10-Q, the following risk factor represents material updates and additions to the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 as filed with the Securities and Exchange Commission. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations. Further, to the extent that any of the information contained in this Quarterly Report on Form 10-Q constitutes forward-looking statements, the risk factor set forth below also is a cautionary statement identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.

 

The economic impact of the novel COVID-19 outbreak could adversely affect our financial condition and results of operations. 

 

In December 2019, a novel coronavirus (COVID-19) was reported in China, and, in March 2020, the World Health Organization declared it a pandemic. On March 12, 2020, the President of the United States declared the COVID-19 outbreak in the United States a national emergency. The COVID-19 pandemic has caused significant economic dislocation in the United States as many state and local governments have ordered non-essential businesses to close and residents to shelter in place at home. This has resulted in an unprecedented slow-down in economic activity and a related increase in unemployment. Since the COVID-19 outbreak, more than 32 million people have filed claims for unemployment. In response to the COVID-19 outbreak, the Federal Reserve Board has reduced the benchmark federal funds rate to a target range of 0% to 0.25%, and the yields on 10 and 30-year treasury notes have declined to historic lows. Various state governments and federal agencies have encouraged lenders to provide forbearance and other relief to borrowers (e.g., waiving late payment and other fees). The federal banking agencies encouraged financial institutions to prudently work with affected borrowers and issued guidance providing relief from reporting loan classifications due to modifications related to the COVID-19 outbreak. Certain industries have been particularly hard-hit, including the travel and hospitality industry, the restaurant industry and the retail industry. Finally, the spread of the coronavirus has caused us to modify our business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences. We may take further actions as may be required by government authorities or that we determine are in the best interests of our employees, customers and business partners.

 

47

 

Given the ongoing and dynamic nature of the circumstances, it is difficult to predict the full impact of the COVID-19 outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when COVID-19 can be controlled and when and how the economy may be reopened. As the result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:

 

 

demand for our products and services may decline, making it difficult to increase our assets and income;

 

 

if the economy is unable to substantially reopen, and high levels of unemployment continue for an extended period of time, loan delinquencies, nonperforming assets, and foreclosures may increase, resulting in increased loan charge-offs and additions to loan loss reserves and reduced income;

 

 

collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase;

 

 

our allowance for loan losses may have to be increased if borrowers experience financial difficulties beyond forbearance periods, which will adversely affect our net income;

 

 

the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us;

 

 

as the result of the decline in the Federal Reserve Board’s target federal funds rate, the yield on our assets may decline to a greater extent than the decline in our cost of interest-bearing liabilities, reducing our net interest margin and spread and reducing net income;

 

 

a material decrease in net income or a net loss over several quarters could result in a decrease in the rate of our quarterly cash dividend;

 

 

we rely on third party vendors for certain services and the unavailability of a critical service due to the COVID-19 outbreak could have an adverse effect on us; and

 

 

Federal Deposit Insurance Corporation premiums may increase if the agency experiences additional resolution costs for bank failures.

 

Any one or a combination of the factors identified above could negatively impact our business, financial condition and results of operations and prospects.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

 None 

 

Item 3. Defaults by the Company on its Senior Securities

 

None

 

Item 4. Mine Safety Disclosures

 

N/A

 

Item 5. Other information

 

None

 

48

 

Item 6.    Exhibits

 

Exhibit list for Middlefield Banc Corp.’s Form 10-Q Quarterly Report for the Period Ended June 30, 2020

 

Exhibit

Number

 

Description

 

Location

3.1

 

Second Amended and Restated Articles of Incorporation of Middlefield Banc Corp., as amended

 

Incorporated by reference to Exhibit 3.1 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Fiscal Year Ended December 31, 2005, filed on March 29, 2006

 

 

 

 

 

3.2

 

Regulations of Middlefield Banc Corp.

 

Incorporated by reference to Exhibit 3.2 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001

 

 

 

 

 

4

 

Specimen stock certificate

 

Incorporated by reference to Exhibit 4 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001

 

 

 

 

 

4.1

 

Amended and Restated Trust Agreement, dated as of December 21, 2006, between Middlefield Banc Corp., as Depositor, Wilmington Trust Company, as Property trustee, Wilmington Trust Company, as Delaware Trustee, and Administrative Trustees

 

Incorporated by reference to Exhibit 4.1 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 27, 2006

 

 

 

 

 

4.2

 

Junior Subordinated Indenture, dated as of December 21, 2006, between Middlefield Banc Corp. and Wilmington Trust Company

 

Incorporated by reference to Exhibit 4.2 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 27, 2006

 

 

 

 

 

4.3

 

Guarantee Agreement, dated as of December 21, 2006, between Middlefield Banc Corp. and Wilmington Trust Company

 

Incorporated by reference to Exhibit 4.3 of Middlefield Banc Corp.’s Form 8-K Current Report filed on December 27, 2006

 

 

 

 

 

10.1.0*

 

2017 Omnibus Equity Plan

 

Incorporated by reference to Middlefield Banc Corp.’s definitive proxy statement for the 2017 Annual Meeting of Shareholders, Appendix A, filed on April 4, 2017

 

 

 

 

 

10.1.1*

 

2007 Omnibus Equity Plan

 

Incorporated by reference to Middlefield Banc Corp.’s definitive proxy statement for the 2008 Annual Meeting of Shareholders, Appendix A, filed on April 7, 2008

 

 

 

 

 

10.2*

 

Change in Control Agreement between Middlefield Banc Corp. and Thomas G. Caldwell

 

Incorporated by reference to Exhibit 10.2 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 12, 2019

 

 

 

 

 

10.3*

 

Change in Control Agreement between Middlefield Banc Corp. and James R. Heslop, II

 

Incorporated by reference to Exhibit 10.3 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 12, 2019

 

49

 

10.4

 

Federal Home Loan Bank of Cincinnati Agreement for Advances and Security Agreement dated September 14, 2000

 

Incorporated by reference to Exhibit 10.4 of Middlefield Banc Corp.’s registration statement on Form 10 filed on April 17, 2001

 

 

 

 

 

10.4.1*

 

Severance Agreement between Middlefield Banc Corp. and Teresa M. Hetrick, dated January 7, 2008

 

Incorporated by reference to Exhibit 10.4.1 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008

 

 

 

 

 

10.4.2*

 

Change in Control Agreement between Middlefield Banc Corp. and Charles O. Moore

 

Incorporated by reference to Exhibit 10.4.2 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 12, 2019

 

 

 

 

 

10.4.3*

 

Change in Control Agreement between Middlefield Banc Corp. and Donald L. Stacy

 

Incorporated by reference to Exhibit 10.4.3 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 12, 2019

 

 

 

 

 

10.4.4*

 

Severance Agreement between Middlefield Banc Corp. and Alfred F. Thompson, Jr., dated January 7, 2008

 

Incorporated by reference to Exhibit 10.4.4 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008

 

 

 

 

 

10.4.5*

 

Change in Control Agreement between Middlefield Banc Corp. and Michael L. Allen

 

Incorporated by reference to Exhibit 10.4.5 of Middlefield Banc Corp.’s Form 10-Q Current Report filed on November 5, 2019

 

 

 

 

 

10.4.6*

 

Change in Control Agreement between Middlefield Banc Corp. and John D. Lane

 

Incorporated by reference to Exhibit 10.4.6 of Middlefield Banc Corp.’s Form 10-Q Current Report filed on November 5, 2019

 

 

 

 

 

10.5

 

[reserved]

 

 

 

 

 

 

 

 

 

 

 

 

10.6*

 

Amended Director Retirement Agreement with Richard T. Coyne

 

Incorporated by reference to Exhibit 10.6 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008

 

 

 

 

 

10.7*

 

Amended Director Retirement Agreement with Frances H. Frank

 

Incorporated by reference to Exhibit 10.7 of Middlefield Banc Corp.’s Form 8-K Current Report filed on January 9, 2008

 

 

 

 

 

10.8

 

[reserved]

 

 

 

 

 

 

 

10.9

 

[reserved]

 

 

 

 

 

 

 

10.1

 

[reserved]

 

 

 

 

 

 

 

10.11*

 

Director Retirement Agreement with Martin S. Paul

 

Incorporated by reference to Exhibit 10.11 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2001, filed on March 28, 2002

10.12

 

[reserved]

 

 

 

 

 

 

 

10.13

 

[reserved]

 

 

 

50

 

10.14*

 

Executive Survivor Income Agreement (aka DBO agreement [death benefit only]) with Donald L. Stacy

 

Incorporated by reference to Exhibit 10.14 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004

 

 

 

 

 

10.15*

 

DBO Agreement with Jay P. Giles

 

Incorporated by reference to Exhibit 10.15 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004

 

 

 

 

 

10.16*

 

DBO Agreement with Alfred F. Thompson, Jr.

 

Incorporated by reference to Exhibit 10.16 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004

 

 

 

 

 

10.17*

 

DBO Agreement with Teresa M. Hetrick

 

Incorporated by reference to Exhibit 10.18 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004

 

 

 

 

 

10.18 *

 

Executive Deferred Compensation Agreement with Jay P. Giles

 

Incorporated by reference to Exhibit 10.18 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2011, filed on March 20, 2012

10.19

 

[reserved]

 

 

 

 

 

 

 

10.20*

 

DBO Agreement with James R. Heslop, II

 

Incorporated by reference to Exhibit 10.20 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004

 

 

 

 

 

10.21*

 

DBO Agreement with Thomas G. Caldwell

 

Incorporated by reference to Exhibit 10.21 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2003, filed on March 30, 2004

 

 

 

 

 

10.22*

 

Annual Incentive Plan

 

Incorporated by reference to Exhibit 10.22 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 12, 2019

 

 

 

 

 

10.22.1

 

[reserved]

 

 

 

 

 

 

 

10.23**

 

Amended Executive Deferred Compensation Agreement with Thomas G. Caldwell

 

Incorporated by reference to Exhibit 10.23 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020

 

51

 

10.24**

 

Amended Executive Deferred Compensation Agreement with James R. Heslop, II

 

Incorporated by reference to Exhibit 10.24 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020

 

 

 

 

 

10.25**

 

Amended Executive Deferred Compensation Agreement with Donald L. Stacy

 

Incorporated by reference to Exhibit 10.25 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020

 

 

 

 

 

10.26**

 

Executive Variable Benefit Deferred Compensation Agreement with James R. Heslop, II

 

Incorporated by reference to Exhibit 10.26 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020

 

 

 

 

 

10.27**

 

Executive Variable Benefit Deferred Compensation Agreement with Donald L. Stacy

 

Incorporated by reference to Exhibit 10.27 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020

 

 

 

 

 

10.28**

 

Executive Deferred Compensation Agreement with Charles O. Moore

 

Incorporated by reference to Exhibit 10.28 of Middlefield Banc Corp.’s Annual Report on Form 10-K for the Year Ended December 31, 2019, filed on March 4, 2020

 

 

 

 

 

10.29*

 

Form of conditional stock award under the 2007 Omnibus Equity Plan

 

Incorporated by reference to Exhibit 10.29 of Middlefield Banc Corp.’s Form 8-K Current Report filed on March 4, 2016

 

 

 

 

 

10.29.1

 

Form of conditional stock award under the 2017 Omnibus Equity Plan

 

Incorporated by reference to Exhibit 10.29 of Middlefield Banc Corp.’s Form 8-K Current Report filed on July 24, 2017

 

 

 

 

 

10.30**

 

Executive Deferred Compensation Agreement with Michael L. Allen

 

Incorporated by reference to Exhibit 10.30 of Middlefield Banc Corp.’s Form 10-Q Current Report filed on May 7, 2019

 

 

 

 

 

10.31**

 

Executive Deferred Compensation Agreement with John D. Lane

 

Incorporated by reference to Exhibit 10.31 of Middlefield Banc Corp.’s Form 10-Q Current Report filed on May 7, 2019

 

 

 

 

 

31.1

 

Rule 13a-14(a) certification of Chief Executive Officer

 

filed herewith

 

 

 

 

 

31.2

 

Rule 13a-14(a) certification of Chief Financial Officer

 

filed herewith

 

 

 

 

 

32

 

Rule 13a-14(b) certification

 

filed herewith

 

 

 

 

 

99.1

 

Form of Indemnification Agreement with directors of Middlefield Banc Corp. and with executive officers of Middlefield Banc Corp. and The Middlefield Banking Company

 

Incorporated by reference to Exhibit 99.1 of Middlefield Banc Corp.’s registration statement on Form 10, Amendment No. 1, filed on June 14, 2001

 

52

 

101.INS***

 

Inline XBRL Instance

 

furnished herewith

 

 

 

 

 

101.SCH***

 

Inline XBRL Taxonomy Extension Schema

 

furnished herewith

 

 

 

 

 

101.CAL***

 

Inline XBRL Taxonomy Extension Calculation

 

furnished herewith

 

 

 

 

 

101.DEF***

 

Inline XBRL Taxonomy Extension Definition

 

furnished herewith

 

 

 

 

 

101.LAB***

 

Inline XBRL Taxonomy Extension Labels

 

furnished herewith

 

 

 

 

 

101.PRE***

 

Inline XBRL Taxonomy Extension Presentation

 

furnished herewith

         
104   Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)    

 

* management contract or compensatory plan or arrangement

 

** management contract or compensatory plan or arrangement, a schedule has been omitted pursuant to Item 601(a)(5) of Regulation S-K and will be provided on a supplemental basis to the Securities and Exchange Commission upon request

 

*** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections

 

53

 

 

SIGNATURES

 

 

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned and hereunto duly authorized.

 

 

 

  MIDDLEFIELD BANC CORP.  
     
     
     
Date: August 4, 2020 By: /s/Thomas G. Caldwell  
     
     
  Thomas G. Caldwell  
     
  President and Chief Executive Officer  

 

 

 

Date: August 4, 2020 By: /s/Donald L. Stacy  
     
     
  Donald L. Stacy  
     
  Principal Financial and Accounting Officer  

 

54