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Net charge-offs are on an annualized basis. Includes current and past due loans in nonaccrual status. Includes impaired loans in nonaccrual status. The Company defines nonperforming loans as nonaccrual loans and restructured loans that are nonaccrual. Nonperforming loans do not include loans 90 days past due and still accruing or accruing restructured loans. Recorded investment is net of charge-offs and interest paid while a loan is in nonaccrual status. 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Table of Contents



 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended September 30, 2020

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

For the transition period from ________ to ________

 

NATIONAL BANKSHARES, INC.

 (Exact name of registrant as specified in its charter)

Commission File Number 0-15204

 

Virginia

(State or other jurisdiction of incorporation or organization)

54-1375874

(I.R.S. Employer Identification No.)

 

101 Hubbard Street

Blacksburg, Virginia 24062-9002

(Address of principal executive offices, including zip code)

 

(540) 951-6300

(Registrant’s telephone number, including area code)

 

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, par value $1.25 per share

NKSH

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, a 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. ☐ Yes ☐ No

 

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 shares of common stock at November 6, 2020
6,478,997

 

 

 
 

 

NATIONAL BANKSHARES, INC.

Form 10-Q

Index

 

Part I – Financial Information

Page

     

Item 1

Financial Statements

3

     
 

Consolidated Balance Sheets, September 30, 2020 (Unaudited) and December 31, 2019

3

     
 

Consolidated Statements of Income for the Three Months Ended September 30, 2020 and 2019 (Unaudited)

4

     
 

Consolidated Statements of Comprehensive Income for the Three Months Ended September 30, 2020 and 2019 (Unaudited)

5

     
 

Consolidated Statements of Income for the Nine Months Ended September 30, 2020 and 2019 (Unaudited)

6

     
 

Consolidated Statements of Comprehensive Income for the Nine Months Ended September 30, 2020 and 2019 (Unaudited)

7

     
 

Consolidated Statements of Changes in Stockholders’ Equity for the Three Months Ended September 30, 2020 and 2019 (Unaudited)

8

     
 

Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2020 and 2019 (Unaudited)

8

 

 

 
 

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2020 and 2019 (Unaudited)

9 – 10

 

 

 
 

Notes to Consolidated Financial Statements (Unaudited) 

11 – 38

     

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

39

     

Item 3

Quantitative and Qualitative Disclosures About Market Risk  

63

     

Item 4

Controls and Procedures

63-64

     

Part II – Other Information

 
     

Item 1

Legal Proceedings

64

     

Item 1A

Risk Factors

64-65

     

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds 

65

     

Item 3

Defaults Upon Senior Securities

65

 

 

 

Item 4

Mine Safety Disclosures

65

 

 

 

Item 5

Other Information

65

     

Item 6

Exhibits 

65

     

Index of Exhibits

66

   

Signatures

67

     

Certifications

68 – 71

 

2

 

 
Item 1. Financial Statements

Part I
Financial Information
National Bankshares, Inc.

Consolidated Balance Sheets

 

     

  

(Unaudited)

     
  

September 30,

  

December 31,

 

(in thousands, except share and per share data)

 

2020

  

2019

 

Assets

        

Cash and due from banks

 $10,593  $10,290 

Interest-bearing deposits

  68,779   76,881 

Securities available for sale, at fair value

  487,351   435,263 

Restricted stock, at cost

  1,279   1,220 

Loans held for sale

  3,690   905 

Loans:

        

Loans, net of unearned income and deferred fees and costs

  800,654   733,451 

Less allowance for loan losses

  (8,428

)

  (6,863

)

Loans, net

  792,226   726,588 

Premises and equipment, net

  10,024   8,919 

Accrued interest receivable

  5,238   4,285 

Other real estate owned, net

  1,553   1,612 

Goodwill

  5,848   5,848 

Bank-owned life insurance

  36,226   35,567 

Other assets

  12,691   14,459 

Total assets

 $1,435,498  $1,321,837 
         

Liabilities and Stockholders' Equity

        

Noninterest-bearing demand deposits

 $270,237  $201,866 

Interest-bearing demand deposits

  676,162   643,482 

Savings deposits

  164,175   146,377 

Time deposits

  103,008   128,028 

Total deposits

  1,213,582   1,119,753 

Accrued interest payable

  86   144 

Other liabilities

  19,636   18,214 

Total liabilities

  1,233,304   1,138,111 

Commitments and contingencies

          

Stockholders' Equity

        

Preferred stock, no par value, 5,000,000 shares authorized; none issued and outstanding

  ---   --- 

Common stock of $1.25 par value. Authorized 10,000,000 shares; issued and outstanding 6,489,574 shares at September 30, 2020 and December 31, 2019

  8,112   8,112 

Retained earnings

  190,901   184,120 

Accumulated other comprehensive income (loss), net

  3,181   (8,506

)

Total stockholders' equity

  202,194   183,726 

Total liabilities and stockholders' equity

 $1,435,498  $1,321,837 

 

See accompanying notes to consolidated financial statements.

 

3

 

 

National Bankshares, Inc.

Consolidated Statements of Income

Three Months Ended September 30, 2020 and 2019

(Unaudited)

 

(in thousands, except share and per share data)

 

September 30, 2020

   

September 30, 2019

 

Interest Income

               

Interest and fees on loans

  $ 8,606     $ 8,548  

Interest on interest-bearing deposits

    17       407  

Interest on securities – taxable

    1,572       1,565  

Interest on securities – nontaxable

    513       768  

Total interest income

    10,708       11,288  
                 

Interest Expense

               

Interest on time deposits

    395       523  

Interest on other deposits

    1,025       1,342  

Total interest expense

    1,420       1,865  

Net interest income

    9,288       9,423  

Provision for loan losses

    154       95  

Net interest income after provision for loan losses

    9,134       9,328  
                 

Noninterest Income

               

Service charges on deposit accounts

    471       643  

Other service charges and fees

    37       46  

Credit and debit card fees

    339       350  

Trust income

    423       440  

BOLI income

    219       230  

Other income

    423       227  

Realized securities gain, net

    14       162  

Total noninterest income

    1,926       2,098  
                 

Noninterest Expense

               

Salaries and employee benefits

    3,211       3,540  

Occupancy, furniture and fixtures

    452       468  

Data processing and ATM

    799       823  

FDIC assessment

    87       ---  

Net cost of other real estate owned

    18       17  

Franchise tax

    331       343  

Other operating expense

    1,222       1,195  

Total noninterest expense

    6,120       6,386  

Income before income tax

    4,940       5,040  

Income tax expense

    772       788  

Net Income

  $ 4,168     $ 4,252  

Basic net income per common share

  $ 0.64     $ 0.65  

Fully diluted net income per common share

  $ 0.64     $ 0.65  

Weighted average number of common shares outstanding– basic and diluted

    6,489,574       6,499,957  

Dividends declared per common share

    ---       ---  

 

See accompanying notes to consolidated financial statements.

 

4

 

 

National Bankshares, Inc.

Consolidated Statements of Comprehensive Income

Three Months Ended September 30, 2020 and 2019

(Unaudited)

 

  

September 30,

  

September 30,

 

(in thousands)

 

2020

  

2019

 

Net Income

 $4,168  $4,252 
         

Other Comprehensive Income, Net of Tax

        

Unrealized holding gain on available for sale securities net of tax of $601 and $146 for the periods ended September 30, 2020 and September 30, 2019, respectively

  2,256   544 

Reclassification adjustment for gain included in net income, net of tax of ($3) and ($34) for the periods ended September 30, 2020 and September 30, 2019, respectively

  (11

)

  (128

)

Other comprehensive income, net of tax

  2,245   416 

Total Comprehensive Income

 $6,413  $4,668 

 

See accompanying notes to consolidated financial statements.

 

5

 

 

National Bankshares, Inc.

Consolidated Statements of Income

Nine Months Ended September 30, 2020 and 2019

(Unaudited)

 

(in thousands, except share and per share data)

 

September 30, 2020

   

September 30, 2019

 

Interest Income

               

Interest and fees on loans

  $ 25,491     $ 25,277  

Interest on interest-bearing deposits

    248       1,048  

Interest on securities – taxable

    5,791       4,851  

Interest on securities – nontaxable

    1,316       2,543  

Total interest income

    32,846       33,719  
                 

Interest Expense

               

Interest on time deposits

    1,476       1,239  

Interest on other deposits

    3,338       4,333  

Total interest expense

    4,814       5,572  

Net interest income

    28,032       28,147  

Provision for loan losses

    1,985       350  

Net interest income after provision for loan losses

    26,047       27,797  
                 

Noninterest Income

               

Service charges on deposit accounts

    1,430       1,840  

Other service charges and fees

    113       149  

Credit and debit card fees

    1,031       1,015  

Trust income

    1,244       1,208  

BOLI income

    659       681  

Other income

    1,233       1,368  

Realized securities gain, net

    96       182  

Total noninterest income

    5,806       6,443  
                 

Noninterest Expense

               

Salaries and employee benefits

    10,882       11,163  

Occupancy, furniture and fixtures

    1,360       1,410  

Data processing and ATM

    2,396       2,363  

FDIC assessment

    127       167  

Net cost of other real estate owned

    36       45  

Franchise tax

    1,009       990  

Other operating expense

    2,854       3,166  

Total noninterest expense

    18,664       19,304  

Income before income tax

    13,189       14,936  

Income tax expense

    2,060       2,247  

Net Income

  $ 11,129     $ 12,689  

Basic net income per common share

  $ 1.71     $ 1.92  

Fully diluted net income per common share

  $ 1.71     $ 1.92  

Weighted average number of common shares outstanding – basic and diluted

    6,489,574       6,611,354  

Dividends declared per common share

  $ 0.67     $ 0.67  

 

See accompanying notes to consolidated financial statements.

 

6

 

 

National Bankshares, Inc.

Consolidated Statements of Comprehensive Income

Nine Months Ended September 30, 2020 and 2019

(Unaudited)

 

  

September 30,

  

September 30,

 

(in thousands)

 

2020

  

2019

 

Net Income

 $11,129  $12,689 
         

Other Comprehensive Income, Net of Tax

        

Unrealized holding gain on available for sale securities net of tax of $3,127 and $2,149 for the periods ended September 30, 2020 and September 30, 2019, respectively

  11,763   8,089 

Reclassification adjustment for gain included in net income, net of tax of ($20) and ($38), for the periods ended September 30, 2020 and September 30, 2019, respectively

  (76

)

  (144

)

Other comprehensive income, net of tax

  11,687   7,945 

Total Comprehensive Income

 $22,816  $20,634 

 

See accompanying notes to consolidated financial statements.

 

7

 

 

National Bankshares, Inc.

Consolidated Statements of Changes in Stockholders’ Equity

(Unaudited)

 

Three Months Ended September 30, 2020 and 2019

 

(in thousands)

 

Common
Stock

  

Retained
Earnings

  

Accumulated
Other
Comprehensive
Income (Loss)

  

Total

 

Balances at June 30, 2019

 $8,132  $180,272  $(4,556

)

 $183,848 

Net income

  ---   4,252   ---   4,252 

Common stock repurchased, 16,000 shares

  (20

)

  (508

)

  ---   (528

)

Other comprehensive income, net of tax of $112

  ---   ---   416   416 

Balances at September 30, 2019

 $8,112   184,016   (4,140

)

  187,988 
                 

Balances at June 30, 2020

 $8,112  $186,733  $936  $195,781 

Net income

  ---   4,168   ---   4,168 

Other comprehensive income, net of tax of $598

  ---   ---   2,245   2,245 

Balances at September 30, 2020

 $8,112  $190,901  $3,181  $202,194 

 

See accompanying notes to consolidated financial statements.

 

 

Nine Months Ended September 30, 2020 and 2019

 

(in thousands)

 

Common
Stock

  

Retained
Earnings

  

Accumulated
Other
Comprehensive
Income (Loss)

  

Total

 

Balances at December 31, 2018

 $8,698  $193,625  $(12,085

)

 $190,238 

Net income

  ---   12,689   ---   12,689 

Common stock, repurchased, 468,400 shares

  (586

)

  (17,939

)

  ---   (18,525

)

Dividends $0.67 per share

  ---   (4,359

)

  ---   (4,359

)

Other comprehensive income, net of tax of $2,111

  ---   ---   7,945   7,945 

Balances at September 30, 2019

 $8,112   184,016   (4,140

)

  187,988 
                 

Balances at December 31, 2019

 $8,112  $184,120  $(8,506

)

 $183,726 

Net income

  ---   11,129   ---   11,129 

Dividends $0.67 per share

  ---   (4,348

)

  ---   (4,348

)

Other comprehensive income, net of tax of $3,107

  ---   ---   11,687   11,687 

Balances at September 30, 2020

 $8,112  $190,901  $3,181  $202,194 

 

See accompanying notes to consolidated financial statements.

 

8

 

 

National Bankshares, Inc.

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2020 and 2019

(Unaudited)

 

   

September 30,

   

September 30,

 

(in thousands)

 

2020

   

2019

 

Cash Flows from Operating Activities

               

Net income

  $ 11,129     $ 12,689  

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

               

Provision for loan losses

    1,985       350  

Depreciation of bank premises and equipment

    529       552  

Amortization of premiums and accretion of discounts, net

    1,016       52  

Gains on disposal of fixed assets

    (2

)

    (6

)

Gain on sales and calls of securities available for sale, net

    (96

)

    (182

)

Loss (gain) and write-down on other real estate owned, net

    (13

)

    5  

Loss on sale of repossessed assets, net

    1       4  

Increase in cash value of bank-owned life insurance

    (659

)

    (681

)

Origination of mortgage loans held for sale

    (27,929

)

    (15,191

)

Proceeds from sale of mortgage loans held for sale

    25,560       13,127  

Gain on sale of mortgage loans held for sale

    (416

)

    (197

)

Net change in:

               

Accrued interest receivable

    (953

)

    927  

Other assets

    (136

)

    416  

Accrued interest payable

    (58

)

    44  

Other liabilities

    192       452  

Net cash provided by operating activities

    10,150       12,361  
                 

Cash Flows from Investing Activities

               

Net change in interest-bearing deposits

    8,102       (91,999

)

Proceeds from calls, principal payments, sales and maturities of securities available for sale

    116,567       235,900  

Purchase of securities available for sale

    (154,781

)

    (134,854

)

Net change in restricted stock

    (59

)

    ---  

Purchase of loan participations

    (4,273

)

    (673

)

Collection of loan participations

    122       3,219  

Loan originations and principal collections, net

    (63,695

)

    (15,788

)

Proceeds from sale of other real estate owned

    72       592  

Proceeds from sale of repossessed assets

    30       40  

Recoveries on loans charged off

    219       218  

Proceeds from sale and purchases of premises and equipment, net

    (1,632

)

    (893

)

Net cash used in investing activities

    (99,328

)

    (4,238

)

 

(continued)

 

9

 

Cash Flows from Financing Activities

        

Net change in time deposits

  (25,020

)

  22,787 

Net change in other deposits

  118,849   (6,702

)

Common stock repurchased

  ---   (18,525

)

Cash dividends paid

  (4,348

)

  (4,359

)

Net cash provided by (used in) financing activities

  89,481   (6,799

)

Net change in cash and due from banks

  303   1,324 

Cash and due from banks at beginning of period

  10,290   12,882 

Cash and due from banks at end of period

 $10,593  $14,206 
         

Supplemental Disclosures of Cash Flow Information

        

Interest paid on deposits

 $4,872  $5,528 

Income taxes paid

  2,785   1,756 
         

Supplemental Disclosure of Noncash Activities

        

Loans charged against the allowance for loan losses

 $639  $696 

Loans transferred to repossessed assets

  4   15 

Unrealized gain on securities available for sale

  14,794   10,056 

Increase in operating lease right-of-use asset during the period

  23   1,837 

Increase in operating lease liability during the period

  23   1,837 

 

See accompanying notes to consolidated financial statements.

 

10

 

National Bankshares, Inc.

Notes to Consolidated Financial Statements

September 30, 2020

(Unaudited)

 

$ in thousands, except per share data

 

 

Note 1: General

 

The consolidated financial statements of National Bankshares, Inc. (“NBI”) and its wholly-owned subsidiaries, The National Bank of Blacksburg (the “Bank” or “NBB”) and National Bankshares Financial Services, Inc. (“NBFS”) (collectively, the “Company”), conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”) and to general practices within the banking industry. The accompanying interim period consolidated financial statements are unaudited; however, in the opinion of management, all adjustments consisting of normal recurring adjustments, which are necessary for a fair presentation of the consolidated financial statements, have been included.  The results of operations for the three and nine month periods ended September 30, 2020 are not necessarily indicative of results of operations for the full year or any other interim period.  The interim period consolidated financial statements and financial information included in this Form 10-Q should be read in conjunction with the notes to consolidated financial statements included in the Company’s 2019 Form 10-K.  The Company posts all reports required to be filed under the Securities Exchange Act of 1934 on its web site at www.nationalbankshares.com.

 

Reclassifications

 

Certain amounts reported in prior years have been reclassified to conform to the current year’s presentation. These reclassifications had no effect on the Company’s results of operations, financial position, or net cash flow.

 

Risks and Uncertainties

 

The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company. The World Health Organization declared COVID-19 to be a global pandemic and almost all public commerce and related business activities have been, to varying degrees, curtailed in order to reduce the rate of new infections. The pandemic and efforts to reduce its spread have caused significant disruptions in the U.S. economy and negatively impacted financial activity in the Company’s market. The Company’s employees have not experienced a high level of infection, however a large outbreak amongst employees could create widespread business continuity issues for the Company.

The Congress of the United States, along with the President of the United States and the Federal Reserve have taken historic actions. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 and provided $2 trillion to cushion the economic fallout. The CARES Act employed various measures in an attempt to prevent a severe economic downturn, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also included extensive emergency funding for hospitals and providers. Certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts have had and are expected to have a material impact on the Company’s operations. The Company is monitoring talks for the potential of additional government aid, and will evaluate the impact if passed.

The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. If the global response to contain COVID-19 escalates further or is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full extent of the impact COVID-19 will have on the Company’s operations, the Company is disclosing potentially material items of which it is aware.

 

Financial position and results of operations

The Company’s fee income has been negatively impacted during 2020 and may experience further declines. Deposit customers have reduced instances of overdraft activity, reducing this fee source. Additionally, the Company may waive various deposit and lending fees for customers impacted by the COVID-19 pandemic. The Company is continuously monitoring the situation and expects to continue to work with affected customers throughout the crisis in order to preserve its customer base. The Company will resume normal practices related to fees when the crisis eases. At this time, the Company is unable to project the materiality of such an impact, but recognizes the economic impact on fee income will extend to future periods.

The Company’s interest income has declined during 2020 and the Company expects that interest income may continue at a lower than normal level. The decline stems from the low rate environment and accommodations the Company provided to qualifying borrowers experiencing pandemic related financial distress. To ease the impact of the pandemic, the Federal Reserve cut rates in March 2020. Low rates have resulted in lower pricing on new loans and a large increase in refinancing activity.

 

11

 

In keeping with guidance from regulators, the Company has actively worked with COVID-19 affected borrowers to provide short-term payment relief, including providing payment extensions, interest-only periods and rate reductions. For certain real estate secured loans, payment extensions result in reversal of previously accrued interest, immediately reducing interest income. Interest begins accruing again at the next payment date and the reversed interest will be recognized at the end of the loan term. Accrued interest on other loans is not reversed when the payment is extended. If eventual credit losses are identified on any loan that has received a payment extension or interest only period, interest and fee income accrued pursuant to U.S. GAAP accounting would be reversed at the time the loss is identified. In such a scenario, interest income in future periods could be negatively impacted. At this time, the Company is unable to project the materiality of such an impact, but recognizes economic declines may affect its borrowers’ ability to repay in future periods.

 

Capital and Liquidity

While the Company believes that it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by further credit losses.

The Company maintains access to multiple sources of liquidity. Wholesale funding markets are currently available to the Company. If the uncertainty caused by the COVID-19 pandemic results in volatile or elevated funding costs for an extended period of time and if it becomes necessary for the Company to access wholesale funding, the Company’s net interest margin could be adversely affected. Currently, depositors have responded to the pandemic by increasing deposits, however if an extended recession causes large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.

 

Asset valuation

Currently, the Company does not expect COVID-19 to affect its ability to account timely for the assets on its balance sheet; however if the impact of the pandemic worsens, valuation procedures in future periods could be negatively affected. While certain valuation assumptions and judgments will change to account for pandemic-related circumstances, such as widening credit spreads, the Company does not anticipate significant changes in methodology used to determine the fair value of assets measured in accordance with U.S. GAAP.

The Company tests goodwill for impairment annually, usually during the fourth quarter using September 30 information, unless facts and circumstances indicate the need for more frequent impairment testing. Impairment testing considers three techniques. The first technique uses the Company’s market capitalization as an estimate of fair value; the second technique estimates fair value using current market pricing multiples for companies comparable to the Company; while the third technique uses current market pricing multiples for change-of-control transactions involving companies comparable to the Company.

The COVID-19 pandemic has caused significant stock market volatility which adversely impacted the Company’s stock price. As a result of this volatility and impact on the market, management determined that a triggering event occurred. Management performed an interim quantitative goodwill impairment analysis as of March 30, 2020 and June 30, 2020. Management has contracted a third party expert to perform a quantitative goodwill impairment analysis as of September 30, 2020 during the fourth quarter 2020.

If in the future the pandemic or other adverse events cause a sustained decline in the Company’s stock price or the occurrence of what management deems to be a triggering event, under certain circumstances prescribed by U.S. GAAP, the Company will perform goodwill impairment testing as needed, which may be more frequently than annually. In the event that testing indicates that all or a portion of goodwill is impaired, a non-cash charge for the amount of such impairment would be recorded to earnings.

 

Processes, controls and business continuity plan

In response to the pandemic, the Company deployed its business continuity plan, including a remote working strategy for certain employees. The Company does not anticipate incurring additional material cost related to its continued deployment of the remote working strategy. The Company has assessed the risks associated with the remote working strategy and implemented mitigation strategies. No material operational or internal control challenges or risks have been identified to date. The Company does not anticipate significant challenges to its ability to maintain its systems and controls in light of the measures the Company has taken to prevent the spread of COVID-19. The Company does not currently face any material resource constraint through the implementation of its business continuity plans.

 

12

 

Lending operations and accommodations to borrowers

In keeping with regulatory guidance to work with borrowers during this unprecedented situation and as outlined in the CARES Act, the Company has provided modifications for its borrowers who are adversely affected by the pandemic. Depending on the demonstrated need of the borrower, the Company has provided payment extensions, granted periods of interest only payments to otherwise amortizing loans, and interest rate reductions. As of September 30, 2020, the Company has provided COVID-19 related accommodations on 361 loans with aggregate outstanding loan balances of $160,230. In accordance with the CARES act and interagency guidance issued in March 2020 and revised in April 2020, these short term extensions are not considered troubled debt restructurings (“TDRs”). The Company is monitoring loans with payment extensions, with special attention to loans with payment extensions that exceed 90 days, as well as subsequent requests for modifications to determine whether changes in risk rates, accrual status or TDR status is warranted.

With the passage of the Paycheck Protection Program (“PPP”), administered by the Small Business Administration (“SBA”), the Company is actively participating in assisting its customers through the program. Most of the PPP loans the Company made have a two-year term and earn interest at 1%. Guidance issued by the SBA during the second wave of funding provided terms of up to five years. If borrowers request a change from 2 years to 5 years, the Company will likely grant the request. The Company believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. As of September 30, 2020, the Company holds $56,260 PPP loans, net of deferred fees and costs. It is the Company’s understanding that loans funded through the PPP program are fully guaranteed by the U.S. government. Should those circumstances change, the Company could be required to establish additional allowance for loan loss through provision for loan loss charged to earnings.

 

Credit 

The Company is working with customers directly affected by COVID-19, providing short-term assistance in accordance with regulator guidelines. As a result of the current economic environment caused by the COVID-19 pandemic, the Company is engaging in more frequent communication with borrowers to better understand their situation and the challenges faced, allowing it to respond proactively as needs and issues arise. Should economic conditions worsen, the Company could experience further increases in its required allowance for loan loss and record additional loan loss expense. It is possible that the Company’s asset quality measures could worsen at future measurement periods if effects of the COVID-19 pandemic are prolonged.

 

 

Note 2:
 

Loan Portfolio

 

The loan portfolio, excluding loans held for sale, was comprised of the following.

 

   

September 30,

2020

   

December 31,

2019

 

Real estate construction

  $ 36,994     $ 42,303  

Consumer real estate

    178,546       181,472  

Commercial real estate

    393,704       365,373  

Commercial non real estate

    100,906       46,576  

Public sector and IDA

    59,035       63,764  

Consumer non real estate

    33,614       34,539  

Gross loans

    802,799       734,027  

Less unearned income and deferred fees and costs

    (2,145

)

    (576

)

Loans, net of unearned income and deferred fees and costs

  $ 800,654     $ 733,451  

 

 

Note 3:

Allowance for Loan Losses, Nonperforming Assets and Impaired Loans

 

The allowance for loan losses methodology incorporates individual evaluation of impaired loans and collective evaluation of groups of non-impaired loans. The Company performs ongoing analysis of the loan portfolio to determine credit quality and to identify impaired loans. Credit quality is rated based on the loan’s payment history, the borrower’s current financial situation and value of the underlying collateral.

 

13

 

Impaired Loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts will not be collected when due according to the contractual terms of the loan agreement. Impaired loans are those loans that have been modified in a TDR and larger, usually non-homogeneous loans that are in nonaccrual or exhibit payment history or financial status that indicate that collection probably will not occur when due according to the loan’s terms. Generally, impaired loans are given risk ratings that indicate higher risk, such as “classified” or “special mention.” Impaired loans are individually evaluated to determine appropriate reserves and are measured at the lower of the invested amount or the fair value. Impaired loans that are not TDRs and for which fair value measurement indicates an impairment loss are designated nonaccrual. A restructured loan that maintains current status for at least six months may be in accrual status. Please refer to the Company’s 2019 Form 10-K, Note 1: Summary of Significant Accounting Policies for additional information on evaluation of impaired loans and associated specific reserves, and policies regarding nonaccruals, past due status and charge-offs.

TDRs impact the estimation of the appropriate level of the allowance for loan losses. If the restructuring included forgiveness of a portion of principal or accrued interest, the charge-off is included in the historical charge-off rates applied to the collective evaluation methodology. Restructured loans are individually evaluated for impairment, and the amount of a restructured loan’s book value in excess of its fair value is accrued as a specific allocation in the allowance for loan losses. If a TDR loan payment exceeds 90 days past due, it is examined to determine whether the late payment indicates collateral dependency or cash flows below those that were used in the fair value measurement. TDRs, as well as all impaired loans, that are determined to be collateral dependent are charged down to fair value. Deficiencies indicated by impairment measurements for TDRs that are not collateral dependent may be accrued in the allowance for loan losses or charged off if deemed uncollectible.

 

Collectively-Evaluated Loans

The Company evaluated characteristics in the loan portfolio and determined major segments and smaller classes within each segment. These characteristics include collateral type, repayment sources, and (if applicable) the borrower’s business model. The methodology for calculating reserves for collectively-evaluated loans is applied at the class level.

 

Portfolio Segments and Classes

The segments and classes used in determining the allowance for loan losses are as follows.

Real Estate Construction

Construction, residential

Construction, other

 

Consumer Real Estate

Equity lines

Residential closed-end first liens

Residential closed-end junior liens

Investor-owned residential real estate

 

Commercial Real Estate

Multifamily real estate

Commercial real estate, owner-occupied

Commercial real estate, other

Commercial Non Real Estate

Commercial and industrial

 

Public Sector and IDA

State and political subdivisions

 

Consumer Non Real Estate

Credit cards

Automobile

Other consumer

 

Historical Loss Rates

The Company’s allowance methodology for collectively evaluated loans applies historical loss rates by class to current class balances as part of the process of determining required reserves. Class loss rates are calculated as the net charge-offs for the class as a percentage of average class balance. The Company averages loss rates for the most recent 8 quarters to determine the historical loss rate for each class.

Two loss rates for each class are calculated: total net charge-offs for the class as a percentage of average class loan balance (“class loss rate”), and total net charge-offs for the class as a percentage of average classified loans in the class (“classified loss rate”). Classified loans are those with risk ratings of “substandard” or lower. Net charge-offs in both calculations include charge-offs and recoveries of classified and non-classified loans as well as those associated with impaired loans. Class historical loss rates are applied to non-classified loan balances at the reporting date, and classified historical loss rates are applied to classified balances at the reporting date. 

 

Risk Factors

In addition to historical loss rates, risk factors pertinent to credit risk for each class are analyzed to estimate reserves for collectively evaluated loans. Factors include changes in national and local economic and business conditions, the nature and volume of classes within the portfolio, loan quality, loan officers’ experience, lending policies and the Company’s loan review system.

 

14

 

The analysis of certain factors results in standard allocations to all segments and classes. These factors include the risk from changes in lending policies, loan officers’ average years of experience, and economic factors including unemployment levels, bankruptcy rates, interest rate environment, and competition/legal/regulatory environments. Also applied to all segments and classes is an economic factor implemented to address COVID-19 uncertainty: national unemployment filings. Typically the Company applies to the allowance calculation economic data specific to its market area. However, historical analysis determined that local unemployment filings were closely correlated to national unemployment filings. Since local data is not available timely, the Company elected to use national unemployment filings.

Factors analyzed for each class, with resultant allocations based upon the level of risk assessed for each class, include the risk from changes in loan review, levels of past due loans, levels of nonaccrual loans, current class balance as a percentage of total loans, and the percentage of high risk loans within the class. Additionally, factors specific to each segment are analyzed and result in allocations to the segment. Please refer to the Company’s 2019 Form 10-K, Note 1: Summary of Significant Accounting Policies for a discussion of risk factors pertinent to each class.

Real estate construction loans are subject to general risks from changing commercial building and housing market trends and economic conditions that may impact demand for completed properties and the costs of completion. These risks are measured by market-area unemployment rates, bankruptcy rates, building market trends, and interest rates.

The credit quality of consumer real estate is subject to risks associated with the borrower’s repayment ability and collateral value, measured generally by analyzing local unemployment and bankruptcy trends, local housing market trends, and interest rates.

The commercial real estate segment includes loans secured by multifamily residential real estate, commercial real estate occupied by the owner/borrower, and commercial real estate leased to non-owners. Loans in the commercial real estate segment are impacted by economic risks from changing commercial real estate markets, rental markets for multi-family housing and commercial buildings, business bankruptcy rates, local unemployment and interest rate trends that would impact the businesses housed by the commercial real estate.

Commercial non-real estate loans are secured by collateral other than real estate, or are unsecured. Credit risk for commercial non-real estate loans is subject to economic conditions, generally monitored by local business bankruptcy trends, and interest rates. Included in this segment are the SBA-guaranteed PPP loans, which are assumed to be not subject to credit risk.

Public sector and Industrial Development Authority (“IDA”) loans are extended to municipalities and related entities. Credit risk is based upon the entity’s ability to repay and interest rate trends.

Consumer non-real estate includes credit cards, automobile and other consumer loans. Credit cards and certain other consumer loans are unsecured, while collateral is obtained for automobile loans and other consumer loans. Credit risk stems primarily from the borrower’s ability to repay, measured by average unemployment, average personal bankruptcy rates and interest rates.

Factor allocations applied to each class are increased for loans rated special mention and increased to a greater extent for loans rated classified. The Company allocates additional reserves for “high risk” loans. High risk loans include junior liens, interest only and high loan to value loans.

A detailed analysis showing the allowance roll-forward by portfolio segment and related loan balance by segment follows.

 

  

Activity in the Allowance for Loan Losses for the Nine Months Ended September 30, 2020

 
  

Real Estate Construction

  

Consumer
Real Estate

  

Commercial
Real Estate

  

Commercial
Non Real
Estate

  

Public
Sector and
IDA

  

Consumer

Non Real

Estate

  

Unallocated

  

Total

 

Balance, December 31, 2019

 $400  $1,895  $2,559  $555  $478  $650  $326  $6,863 

Charge-offs

  ---   (62

)

  (15

)

  (372

)

  ---   (190

)

  ---   (639

)

Recoveries

  ---   18   53   6   ---   142   ---   219 

Provision for (recovery of) loan losses

  24   311   1,047   510   53   (5

)

  45   1,985 

Balance, September 30, 2020

 $424  $2,162  $3,644  $699  $531  $597  $371  $8,428 

 

15

 
  

Activity in the Allowance for Loan Losses for the Nine Months Ended September 30, 2019

 
  

Real Estate Construction

  

Consumer
Real Estate

  

Commercial
Real Estate

  

Commercial
Non Real
Estate

  

Public
Sector and
IDA

  

Consumer

Non Real

Estate

  

Unallocated

  

Total

 

Balance, December 31, 2018

 $398  $2,049  $2,798  $602  $583  $750  $210  $7,390 

Charge-offs

  ---   (147

)

  (150

)

  ---   ---   (399

)

  ---   (696

)

Recoveries

  ---   ---   37   ---   ---   181   ---   218 

Provision for (recovery of) loan losses

  56   199   14   (75

)

  (93

)

  156   93   350 

Balance, September 30, 2019

 $454  $2,101  $2,699  $527  $490  $688  $303  $7,262 

 

  

Activity in the Allowance for Loan Losses for the Year Ended December 31, 2019

 
  

Real Estate Construction

  

Consumer
Real Estate

  

Commercial
Real Estate

  

Commercial
Non Real
Estate

  

Public
Sector and
IDA

  

Consumer

Non Real

Estate

  

Unallocated

  

Total

 

Balance, December 31, 2018

 $398  $2,049  $2,798  $602  $583  $750  $210  $7,390 

Charge-offs

  ---   (192

)

  (150

)

  (47

)

  ---   (531

)

  ---   (920

)

Recoveries

  ---   ---   49   1   ---   217   ---   267 

Provision for (recovery of) loan losses

  2   38   (138

)

  (1

)

  (105

)

  214   116   126 

Balance, December 31, 2019

 $400  $1,895  $2,559  $555  $478  $650  $326  $6,863 

 

  

Allowance for Loan Losses as of September 30, 2020

  

Real Estate Construction

  

Consumer
Real Estate

  

Commercial
Real Estate

  

Commercial
Non Real
Estate

  

Public
Sector and
IDA

  

Consumer

Non Real

Estate

  

Unallocated

  

Total

 

Individually evaluated for impairment

 $---  $2  $---  $102  $---  $---  $---  $104 

Collectively evaluated for impairment

  424   2,160   3,644   597   531   597   371   8,324 

Total

 $424  $2,162  $3,644  $699  $531  $597  $371  $8,428 

 

  

Allowance for Loan Losses as of December 31, 2019

  

Real Estate Construction

  

Consumer
Real Estate

  

Commercial
Real Estate

  

Commercial
Non Real
Estate

  

Public
Sector and
IDA

  

Consumer

Non Real

Estate

  

Unallocated

  

Total

 

Individually evaluated for impairment

 $---  $2  $---  $108  $---  $---  $---  $110 

Collectively evaluated for impairment

  400   1,893   2,559   447   478   650   326   6,753 

Total

 $400  $1,895  $2,559  $555  $478  $650  $326  $6,863 

 

16

 
  

Loans as of September 30, 2020

  

Real Estate Construction

  

Consumer
Real Estate

  

Commercial
Real Estate

  

Commercial
Non Real
Estate

  

Public
Sector and
IDA

  

Consumer

Non Real

Estate

  

Unallocated

  

Total

 

Individually evaluated for impairment

 $---  $244  $3,887  $861  $---  $3  $---  $4,995 

Collectively evaluated for impairment

  36,994   178,302   389,817   100,045   59,035   33,611   ---   797,804 

Total

 $36,994  $178,546  $393,704  $100,906  $59,035  $33,614  $---  $802,799 

 

  

Loans as of December 31, 2019

  

Real Estate Construction

  

Consumer Real Estate

  

Commercial Real Estate

  

Commercial Non Real Estate

  

Public Sector and IDA

  

Consumer

Non Real

Estate

  

Unallocated

  

Total

 

Individually evaluated for impairment

 $---  $759  $3,608  $918  $---  $4  $---  $5,289 

Collectively evaluated for impairment

  42,303   180,713   361,765   45,658   63,764   34,535   ---   728,738 

Total

 $42,303  $181,472  $365,373  $46,576  $63,764  $34,539  $---  $734,027 

 

A summary of ratios for the allowance for loan losses follows.

 

  

As of and for the

 
  

Nine Months Ended

September 30,

  

Year Ended

December 31,

 
  

2020

  

2019

  

2019

 

Ratio of allowance for loan losses to the end of period loans, net of unearned income and deferred fees and costs(2)

  1.05

%

  1.01

%

  0.94

%

Ratio of net charge-offs to average loans, net of unearned income and deferred fees and costs(1)

  0.07

%

  0.09

%

  0.09

%

 

(1)

Net charge-offs are on an annualized basis.

(2)

The ratio of the allowance for loan losses to the end of period loans, net of unearned income and deferred fees and costs at September 30, 2020 includes government-guaranteed SBA PPP loans, which do not require an allowance for loan losses. Excluding the PPP loans, the ratio would be 1.13%.

 

A summary of nonperforming assets follows.

 

  

September 30,

  

December 31,

 
  

2020

  

2019

  

2019

 

Nonperforming assets:

            

Nonaccrual loans

 $736  $699  $164 

Restructured loans in nonaccrual

  2,866   3,377   3,211