CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including information included or incorporated by reference in this document, contains statements which constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1934. We desire to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1996 and are including this statement for the express purpose of availing the Company of protections of such safe harbor with respect to all "forward-looking statements" contained in this Form 10-Q. Forward -looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors that are beyond our control. The words "may," "would," "could," "should," "will," "expect," "anticipate," "predict," "project," "potential," "continue," "assume," "believe," "intend," "plan," "forecast," "goal," and "estimate," as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitations, those described under the "Cautionary Statement Regarding Forward-Looking Statements" section of Part 1 of our Annual Report on Form 10-K for the year endedDecember 31, 2020 as filed with theSEC and the following: ? Risk from changes in economic, monetary policy, and industry conditions
? Changes in interest rates, shape of the yield curve, deposit rates, the net
interest margin and funding sources
? Market risk (including net income at risk analysis and economic value of
equity risk analysis) and inflation
? Risk inherent in making loans including repayment risks and changes in the
value of collateral
? Loan growth, the adequacy of the allowance for loan losses, provisions for
loan losses, and the assessment of problem loans
? Level, composition, and re-pricing characteristics of the securities portfolio
? Deposit growth, change in the mix or type of deposit products and services
? Continued availability of senior management and ability to attract and retain
key personnel ? Technological changes ? Ability to control expense
? Ability to compete in our industry and competitive pressures among depository
and other financial institutions ? Changes in compensation
? Risks associated with income taxes including potential for adverse adjustments
? Changes in accounting policies and practices
? Changes in regulatory actions, including the potential for adverse adjustments
? Recently enacted or proposed legislation and changes in political conditions ? Reputational risk 30
? Pandemic risk, including COVID-19, and related quarantine and/or stay-at home
policies and restrictions ? Impact of COVID-19 on the collectability of loans ? Changes in legislation as related to PPP loans
? Credit risks, determination of deficiency, or complete loss if SBA denies PPP
loans
We will undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. In addition, certain statements in future filings with theSEC , in our press releases, and in oral and written statements, which are not statements of historical fact, constitute forward-looking statements. OverviewBank of South Carolina Corporation (the "Company") is a financial institution holding company headquartered inCharleston, South Carolina , with$691.8 million in assets as ofSeptember 30, 2021 . The Company offers a broad range of financial services through its wholly-owned subsidiary,The Bank of South Carolina (the "Bank"). The Bank is a state-chartered commercial bank which operates primarily in theCharleston ,Dorchester andBerkeley counties ofSouth Carolina . The Bank's original and current concept is to be a full-service financial institution specializing in personal service, responsiveness, and attention to detail to foster long standing relationships. We derive most of our income from interest on loans and investments (interest-earning assets). The primary source of funding for making these loans and investments is our interest and non-interest-bearing deposits. Consequently, one of the key measures of our success is the amount of net interest income, or the difference between the income on our interest-earning assets and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities. A consequence of lending activities is that we may incur credit losses. The amount of such losses will vary depending upon the risk characteristics of the loan and lease portfolio as affected by economic conditions such as rising interest rates and the financial performance of borrowers. The reserve for credit losses consists of the allowance for loan losses (the "allowance") and a reserve for unfunded commitments (the "unfunded reserve"). The allowance provides for probable and estimable losses inherent in our loan portfolio while the unfunded reserve provides for potential losses related to unfunded lending commitments. In addition to earning interest on loans and investments, we earn income through fees and other expenses we charge to the customer. The various components of non-interest income as well as non-interest expense are described in the following discussion. The discussion and analysis also identify significant factors that have affected our financial position and operating results as of and for the periods endingSeptember 30, 2021 andDecember 31, 2020 , and should be read in conjunction with the financial statements and the related notes included in this report. In addition, a number of tables have been included
to assist in the discussion. COVID-19
OnMarch 11, 2020 , theWorld Health Organization ("WHO") declared COVID-19 a pandemic. Due to orders issued by the governor ofSouth Carolina and in an abundance of caution for the health of our customers and employees, onMarch 23, 2020 the Bank closed lobbies to all 5 offices but remained fully operational. The Bank reopened lobbies onMay 3, 2021 . OnMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was signed into law, which established the Paycheck Protection Program ("PPP") and allocated$349.0 billion of loans to be issued by financial institutions. Under the program, theSmall Business Administration ("SBA") will forgive loans, in whole or in part, made by approved lenders to eligible borrowers for payroll and other permitted purposes in accordance with the requirements of the program. These loans carry a fixed rate of 1.00% and a term of two years, if not forgiven, in whole or in part. The loans are 100% guaranteed by the SBA and as long as the borrower submits its loan forgiveness application within ten months of completion of the covered period, the borrower is not required to make any payments until the forgiveness amount is remitted to the lender by the SBA. The Bank received a processing fee ranging from 1% to 5% based on the size of the loan from the SBA. The fees are deferred and amortized over the life of the loans in accordance with ASC 310-20. The Paycheck Protection Program and Health Care Enhancement Act ("PPP/ HCEA Act") was signed into law onApril 24, 2020 . The PPP/HCEA Act authorized additional funding under the CARES Act of$310.0 billion for PPP loans to be issued by financial institutions through the SBA. 31 OnDecember 27, 2020 , the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act ("Economic Aid Act") was enacted, which reauthorized lending under the PPP program throughMarch 31, 2021 , with an additional$325.0 billion . OnMarch 31, 2021 , the PPP Extension Act of 2021 was signed into law, which formally changed the PPP application deadline fromMarch 31, 2021 toMay 31, 2021 . Under the Economic Aid Act, the SBA will forgive loans, in whole or in part, made by approved lenders to eligible borrowers for payroll and other permitted purposes in accordance with the requirements of the program. These loans carry a fixed rate of 1.00% and a term of five years, if not forgiven, in whole or in part. The loans are 100% guaranteed by the SBA and as long as the borrower submits its loan forgiveness application within ten months of completion of the covered period, the borrower is not required to make any payments until the forgiveness amount is remitted to the lender by the SBA. The Bank will receive a processing fee based on the size of the loan from the SBA, based on a tiered structure. For loans up to$50,000 in principal, the lender processing fee will be the lesser of 50% of the principal amount or$2,500 . For loans between$50,000 and$350,000 in principal, the lender processing fee will be 5% of the principal amount. For loans$350,000 and above, the lender processing fee will be 3% of the principal amount. For loans of at least$2.0 million , the lender processing fee will be 1% of the principal amount. The fees are deferred and amortized over the life of the loans in accordance with ASC 310-20.
The Bank provided$37.8 million to 266 customers in the first round of PPP and$17.5 million to 214 customers in the second round of PPP. Because these loans are 100% guaranteed by the SBA and did not undergo the Bank's typical underwriting process, they are not graded and do not have an associated reserve. Borrowers must submit a forgiveness application within ten months of the completion of the covered period. Once the borrower has submitted the application, the Bank has 60 days to review, issue a lender decision, and submit the decision and application to the SBA. Once the application is submitted, the SBA has 90 days to review and remit the appropriate forgiveness amount to the Bank plus any interest accrued through the date of payment. The SBA began accepting PPP Forgiveness Applications onAugust 10, 2020 . As ofSeptember 30, 2021 , the Bank received 326 PPP forgiveness applications, in the amount of$43.6 million in principal, and submitted 306 applications and decisions to the SBA, in the amount of$41.5 million in principal. Of the 306 submissions, 300 loans, in the amount of$40.7 million , were forgiven as ofSeptember 30, 2021 . Upon forgiveness the Bank will recognize the deferred fee income in accordance with ASC 310-20. The Bank received$2.4 million in processing fees related to the PPP program. During the three months endedSeptember 30, 2021 and 2020, the Bank recognized$0.1 million and$0.2 million , respectively, in processing fees for the PPP program. During the nine months endedSeptember 30, 2021 and 2020, the Bank recognized$1.0 million and$0.3 million , respectively, in processing
fees for the PPP program. Regulatory agencies, as set forth in the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus (initially issued onMarch 22, 2020 and revised onApril 7, 2020 ), have encouraged financial institutions to work prudently with borrowerswho are or may be unable to meet their contractual payment obligations because of the effects of COVID-19. In this statement, the regulatory agencies expressed their view of loan modification programs as positive actions that may mitigate adverse effects on borrowers due to COVID-19 and that the agencies will not criticize institutions for working with borrowers in a safe and sound manner. Moreover, the revised statement provides that eligible loan modifications related to COVID-19 may be accounted for under section 4013 of the CARES Act or in accordance with ASC 310-40. Under Section 4013 of the CARES Act, banks may elect not to categorize loan modifications as TDRs if the modifications are related to COVID-19, executed on a loan that was not more than 30 days past due as ofDecember 31, 2020 , and executed betweenMarch 1, 2020 and the earlier ofDecember 31, 2020 or 60 days after the date of termination of the National Emergency. All short-term loan modifications made on a good faith basis in response to COVID-19 to borrowerswho were current prior to any relief are not considered TDRs. Beginning inMarch 2020 , the Bank provided payment accommodations to customers, consisting of 60-day principal deferral to borrowers negatively impacted by COVID-19. The Bank processed approximately$0.7 million in principal deferments to 84 loans, with an aggregate loan balance of$25.9 million , during year endedDecember 31, 2020 . The principal deferments represent 0.24% of our total loan portfolio as ofDecember 31, 2020 . In accordance with theFDIC guidance, borrowerswho were current prior to becoming affected by COVID-19, that received payment accommodations as a result of the pandemic, generally should not be reported as past due. There were no interest deferments granted and all loans given payment accommodations are still paying interest. There have been no payment accommodations granted during the nine months endedSeptember 30, 2021 . All loans granted payment accommodations during the year endedDecember 31, 2020 have commenced paying as agreed and are current as ofSeptember 30, 2021 . 32 Effects of COVID-19 may negatively impact management assumptions and estimates, such as the allowance for loan losses; however, to assess or predict how, and to what extent, COVID-19 will affect the Bank in the future will be difficult.
Critical Accounting Policies
Our critical accounting policies, which involve significant judgments and
assumptions that have a material impact on the carrying value of certain assets
and liabilities, and used in the preparation of the Consolidated Financial
Statements as of
Balance Sheet Cash and Cash Equivalents Total cash and cash equivalents increased 239.94% or$116.0 million to$164.3 million as ofSeptember 30, 2021 , from$48.3 million as ofDecember 31, 2020 . The increase in total cash and cash equivalents is primarily due to an increase in the balances of a related group of demand deposit accounts at the end of the quarter that are temporary in nature. Funds are placed in interest bearing deposits at theFederal Reserve until opportunities arise for investment in higher yielding assets.
Investment Securities Available for Sale
Our primary objective in managing the investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns. We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. We maintain investment balances based on continuing assessment of cash flows, the level of current and expected loan production, current interest rate risk strategies and the assessment of potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity and expected rate of return risk.
We use the investment securities portfolio to serve as a vehicle to manage interest rate and prepayment risk, to generate interest and dividend income from investment of funds, to provide liquidity to meet funding requirements, and to provide collateral for pledging of public funds. As ofSeptember 30, 2021 , our available for sale investment portfolio includedU.S. Treasury Notes,Government-Sponsored Enterprises andMunicipal Securities with a fair market value of$193.2 million and an amortized cost of$194.4 million for a net unrealized loss of approximately$1.2 million . As ofSeptember 30, 2021 andDecember 31, 2020 , our investment securities portfolio represented approximately 27.93% and 25.32% of our total assets, respectively. The average yield on our investment securities was 1.09% and 1.59% atSeptember 30, 2021 andDecember 31, 2020 , respectively.
Loans
We focus our lending activities on small and middle market businesses, professionals and individuals in our geographic markets. Substantially all of our loans are to borrowers located in our market area ofCharleston ,Dorchester andBerkeley counties ofSouth Carolina. Net loans decreased$8.1 million , or 2.57%, to$308.5 million as ofSeptember 30, 2021 from$316.6 million as ofDecember 31, 2020 . The decrease is primarily related to the forgiveness of PPP loans. InJanuary 2020 , the Bank began originating 30-year, fixed rate consumer mortgage loans in excess of the conforming loan amount which are held for investment rather than for sale in the secondary market. Prior to January, all consumer mortgage loans made by the Bank were originated for the purpose of sale and reflected on the consolidated balance sheet as mortgage loans held for sale. This new mortgage product has been well-received by the Bank's customers, and the associated volume of originations through the year has contributed to the increase inConsumer Real Estate lending. The following table is a summary of our loan portfolio composition (net of deferred fees and costs of$713,203 atSeptember 30, 2021 and$676,155 atDecember 31, 2020 , respectively) and the corresponding percentage of total loans as of the dates indicated. 33 September 30, 2021 December 31, 2020 Amount Percent Amount Percent Commercial$ 45,923,118 14.68 %$ 51,041,397 15.91 %
Commercial Real Estate Construction 10,802,322 3.45 %
14,813,726 4.62 % Commercial Real Estate Other 160,119,820 51.18 % 146,187,886 45.57 % Consumer Real Estate 77,530,313 24.78 % 71,836,041 22.39 % Consumer Other 4,576,146 1.47 % 4,480,491 1.40 % Payroll Protection Program 13,883,076 4.44 % 32,443,132 10.11 % Total loans 312,834,795 100.00 % 320,802,673 100.00 % Allowance for loan losses (4,368,457 ) (4,185,694 ) Total loans, net$ 308,466,338 $ 316,616,979 The increase in the deferred fees is directly associated with the processing fees the Bank received from the SBA for the PPP loans. The fees are deferred and amortized over the life of the loans in accordance with ASC 310-20.
Nonperforming Assets
Nonperforming Assets include real estate acquired through foreclosure or deed taken in lieu of foreclosure and loans on nonaccrual status. Generally, a loan is placed on nonaccrual status when it becomes 90 days past due as to principal or interest, or when we believe, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of the contractual principal or interest on the loan is doubtful. A payment of interest on a loan that is classified as nonaccrual is recognized as a reduction in principal when received. As ofSeptember 30, 2021 , there were no loans 90 days past due still accruing interest.
The following table is a summary of our Nonperforming Assets:
September 30, December 31, 2021 2020 Commercial$ 178,975 $ 178,975 Commercial Real Estate Other 926,808 923,828 Consumer Real Estate - 40,893 Consumer Other 10,337 12,234 Total nonaccruing loans 1,116,120 1,155,930 Other real estate owned - - Total nonperforming assets$ 1,116,120 $ 1,155,930 OnMarch 18, 2020 , in recognition of the difficulties of COVID-19, the Chief Justice ofSouth Carolina declared a statewide moratorium on evictions and foreclosures until directed by subsequent order of the Chief Justice.The South Carolina Supreme Court lifted its moratorium effectiveMay 15, 2020 . OnAugust 8, 2020 , the President ofthe United States of America issued an executive order that allows the Secretary ofHousing and Urban Development to take action, as appropriate and consistent with applicable law, to promote the ability of renters and homeowners to avoid foreclosure and eviction resulting from financial hardships related to COVID-19. OnAugust 27, 2020 , theFederal Housing Finance Authority and Department of Housing and Urban Development announced it would extend its foreclosure and eviction moratorium through the end of 2020, benefiting homeownerswho have mortgages guaranteed by Fannie Mae and Freddie Mac. OnMarch 29, 2021 , the federal eviction moratorium was extended again throughSeptember 30, 2021 . OnJune 24, 2021 , the federal eviction moratorium was extended again throughJuly 31, 2021 . OnAugust 3, 2021 , the CDC issued an eviction moratorium order in areas of substantial and high transmission that was subsequently lifted by theSupreme Court onAugust 26, 2021 . Allowance for Loan Losses
The allowance for loan losses was$4.4 million as ofSeptember 30, 2021 and$4.2 million as ofDecember 31, 2020 , or 1.46% and 1.45%, respectively, of outstanding loans, net of PPP loans. Because PPP loans are 100% guaranteed by the SBA and did not undergo the Bank's typical underwriting process, they are not graded and do not have an associated reserve. AtSeptember 30, 2021 andDecember 31, 2020 , the allowance for loan losses represented 391.40% and 362.11% of the total amount of nonperforming loans, respectively. Based on the level of coverage on nonperforming loans and analysis of our loan portfolio, we believe the allowance for loan losses atSeptember 30, 2021 is adequate. 34
AtSeptember 30, 2021 , impaired loans totaled$3.7 million , for which$0.2 million of these loans had a reserve of approximately$0.2 million allocated in the allowance for loan losses. Comparatively, impaired loans totaled$7.8 million as ofDecember 31, 2020 , and$1.0 million of these loans had a reserve of approximately$0.4 million allocated in the allowance for loan losses. During the three months endedSeptember 30, 2021 , we recorded$903 in charge-offs and$63,057 of recoveries on loans previously charged-off, for net recoveries of$62,154 . During the nine months endedSeptember 30, 2021 , we recorded$20,318 in charge-offs and$83,081 of recoveries on loans previously charged-off, for net recoveries of$62,763 .
Deposits
Deposits remain our primary source of funding for loans and investments. Average interest-bearing deposits provided funding for 56.67% of average earning assets for the nine months endedSeptember 30, 2021 , and 56.62% for the nine months endedSeptember 30, 2020 . The Company encounters strong competition from other financial institutions as well as consumer and commercial finance companies, insurance companies and brokerage firms located in the primary service area of the Bank. However, the percentage of funding provided by deposits has remained stable. The breakdown of total deposits by type and the respective percentage of total deposits are as follows: September 30, 2021 December 31, 2020 Amount Percent Amount Percent Deposits
Non-interest bearing demand
36.60 % Interest bearing demand 170,175,580 27.32 % 140,602,723 30.42 % Money market accounts 88,730,966 14.25 % 84,681,783 18.32 %
Time deposits over$250,000 7,462,857 1.20 % 4,493,189
0.97 % Other time deposits 14,296,961 2.30 % 16,205,942 3.51 % Other savings deposits 55,625,779 8.93 % 47,043,243 10.18 % Total deposits$ 622,791,279 100.00 %$ 462,197,631 100.00 %
Deposits increased 34.75% or
At
Comparison of Three Months Ended
Net income increased$0.02 million or 1.39% to$1.7 million , or basic and diluted earnings per share of$0.31 and$0.30 , respectively, for the three months endedSeptember 30, 2021 , from$1.7 million , or basic and diluted earnings per share of$0.31 and$0.30 , respectively, for the three months endedSeptember 30, 2020 . Our annualized returns on average assets and average equity for the three months endedSeptember 30, 2021 were 1.15% and 12.32%, respectively, compared with 1.28% and 12.34%, respectively, for the three months endedSeptember 30, 2020 . Net Interest Income Net interest income is affected by the size and mix of our balance sheet components as well as the spread between interest earned on assets and interest paid on liabilities. Net interest margin is a measure of the difference between interest income on earning assets and interest paid on interest bearing liabilities relative to the amount of interest-bearing assets. Net interest income remained consistent with the three months endedSeptember 30, 2020 , at$4.2 million for the three months endedSeptember 30, 2021 . Average loans decreased$7.8 million or 2.37% to$319.1 million for the three months endedSeptember 30, 2021 , compared to$326.9 million for the three months endedSeptember 30, 2020 . The yield on average loans (including fees) was 5.02% and 5.09% for the three months endedSeptember 30, 2021 andSeptember 30, 2020 , respectively. Interest income on loans decreased$0.2 million for the three months endedSeptember 30, 2021 to$3.6 million from$3.8 million for the three months endedSeptember 30, 2020 . 35 The average balance of interest bearing deposits at theFederal Reserve increased$18.1 million or 30.17% to$77.9 million for the three months endedSeptember 30, 2021 , with a yield of 0.16% as compared to$59.8 million for the three months endedSeptember 30, 2020 , with a yield of 0.11%.
Provision for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged as an expense on our consolidated statements of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of our allowance for loan losses. For the three months endedSeptember 30, 2021 , we had no provision of loan losses compared to a provision of$40,000 for the same period in the prior year. The decrease in the provision for loan losses was based on our analysis of the adequacy of the allowance for loan losses.
Non-Interest Income
Other income increased$0.1 million or 16.40% to$1.1 million for the three months endedSeptember 30, 2021 , from$1.0 million for the three months endedSeptember 30, 2020 . This increase was primarily due to gain on sales of investment securities. Three investment securities were sold during the quarter endedSeptember 30, 2021 , resulting in a gain on sale of$0.3 million .
Non-Interest Expense
Non-interest expense increased$0.1 million or 3.83% to$3.0 million for the three months endedSeptember 30, 2021 from$2.9 million for the three months endedSeptember 30, 2020 . This increase is related to increases in salaries and wages and net occupancy expenses during the three months endedSeptember 30, 2021 . Income Tax Expense
We incurred income tax expense of
Comparison of Nine Months Ended
Net income increased$0.5 million or 10.16% to$5.2 million , or basic and diluted earnings per share of$0.94 and$0.92 , respectively, for the nine months endedSeptember 30, 2021 , from$4.7 million , or basic and diluted earnings per share of$0.85 and$0.83 , respectively, for the nine months endedSeptember 30, 2020 . Our annualized returns on average assets and average equity for the nine months endedSeptember 30, 2021 were 1.23% and 12.64%, respectively, compared with 1.28% and 11.77%, respectively, for the nine months endedSeptember 30, 2020 . Net Interest Income Net interest income is affected by the size and mix of our balance sheet components as well as the spread between interest earned on assets and interest paid on liabilities. Net interest margin is a measure of the difference between interest income on earning assets and interest paid on interest bearing liabilities relative to the amount of interest-bearing assets. Net interest income increased$0.5 million or 4.10% to$13.1 million for the nine months endedSeptember 30, 2021 from$12.6 million for the nine months endedSeptember 30, 2020 . This increase was primarily due to the recognition of PPP processing fees. During the nine months endedSeptember 30, 2021 and 2020, the Bank recognized$1.0 million and$0.3 million , respectively, in processing fees
from the PPP program. The average balance of interest bearing deposits at theFederal Reserve increased$2.3 million or 103.75% to$62.2 million for the nine months endedSeptember 30, 2021 , with a yield of 0.12% as compared to$60.0 million for the nine months endedSeptember 30, 2020 , with a yield of 0.39%.
Provision for Loan Losses
We have established an allowance for loan losses through a provision for loan losses charged as an expense on our consolidated statements of income. We review our loan portfolio periodically to evaluate our outstanding loans and to measure both the performance of the portfolio and the adequacy of our allowance for loan losses. For the nine months endedSeptember 30, 2021 , we had a provision of loan losses of$120,000 compared to a provision of$40,000 for the same period in the prior year. The increase in the provision for loan losses was based on our analysis of the adequacy of the allowance for loan losses. 36 Non-Interest Income
Other income increased$0.7 million or 31.00% to$3.0 million for the nine months endedSeptember 30, 2021 , from$2.3 million for the nine months endedSeptember 30, 2020 . This increase was primarily due to gain on sales of investment securities as well as income from mortgage banking activity. Three investment securities were sold during the nine months endedSeptember 30, 2021 , resulting in a gain on sale of$0.3 million . The Bank sold mortgage loans held for sale in the amount of$141.6 million during the nine months endedSeptember 30, 2021 compared to$114.1 million during the nine months ended September
30, 2020. Non-Interest Expense Non-interest expense increased$0.5 million or 5.79% to$9.2 million for the nine months endedSeptember 30, 2021 from$8.7 million for the nine months endedSeptember 30, 2020 . This increase was primarily due to an increase inFDIC assessments as a result of the depletion of the FDIC Small Bank Assessment Credits used in 2020. Additionally, there was an increase in occupancy expenses resulting from contractual lease obligations.
Income Tax Expense
We incurred income tax expense of$1.6 million for the nine months endedSeptember 30, 2021 as compared to$1.4 million during the same period in 2020. Our effective tax rate was 23.58% and 23.32% for the nine months endedSeptember 30, 2021 and 2020, respectively.
Off-Balance Sheet Arrangements
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on our credit evaluation of the borrower. Collateral held varies but may include accounts receivable, negotiable instruments, inventory, property, plant and equipment, and real estate. Commitments to extend credit, including unused lines of credit, amounted to$118.4 million and$122.8 million atSeptember 30, 2021 andDecember 31, 2020 , respectively. Standby letters of credit represent our obligation to a third-party contingent upon the failure of our customer to perform under the terms of an underlying contract with the third party or obligates us to guarantee or stand as surety for the benefit of the third party. The underlying contract may entail either financial or nonfinancial obligations and may involve such things as the shipment of goods, performance of a contract, or repayment of an obligation. Under the terms of a standby letter, generally drafts will be drawn only when the underlying event fails to occur as intended. We can seek recovery of the amounts paid from the borrower. The majority of these standby letters of credit are unsecured. Commitments under standby letters of credit are usually for one year or less. The maximum potential amount of undiscounted future payments related to standby letters of credit atSeptember 30, 2021 andDecember 31, 2020 was$0.8 million and$0.8 million , respectively. We originate certain fixed rate residential loans and commit these loans for sale. The commitments to originate fixed rate residential loans and the sales commitments are freestanding derivative instruments. We had forward sales commitments on mortgage loans held for sale totaling$5.8 million and$13.0 million atSeptember 30, 2021 andDecember 31, 2020 , respectively. The fair value of these commitments was not significant atSeptember 30, 2021 orDecember 31, 2020 . We had no embedded derivative instruments requiring separate accounting treatment. Once we sell certain fixed rate residential loans, the loans are no longer reportable on our balance sheet. With most of these sales, we have an obligation to repurchase the loan in the event of a default of principal or interest on the loan. This recourse period ranges from three to nine months. Misrepresentation or fraud carries unlimited time for recourse. The unpaid principal balance of loans sold with recourse was$141.6 million atSeptember 30, 2021 and$57.2 million atDecember 31, 2020 . For the three and nine months endedSeptember 30, 2021 , there was one loan repurchased with a principal balance of$0.2 million . There were no loans repurchased during the three and nine months endedSeptember 30, 2020 . Liquidity Historically, we have maintained our liquidity at levels believed to be adequate to meet requirements of normal operations, potential deposit outflows and strong loan demand and still allow for optimal investment of funds and return on assets. 37 We manage our assets and liabilities to ensure there is sufficient liquidity to enable management to fund deposit withdrawals, loan demand, capital expenditures, reserve requirements, operating expenses, dividends and to manage daily operations on an ongoing basis. Funds are primarily provided by the Bank through customer deposits, principal and interest payments on loans, mortgage loan sales, the sale or maturity of securities, temporary investments and earnings. Proper liquidity management is crucial to ensure that we are able to take advantage of new business opportunities as well as meet the credit needs of our existing customers. Investment securities are an important tool in our liquidity management. Our primary liquid assets are cash and due from banks, interest-bearing deposits in other banks, federal funds sold, investments available for sale, other short-term investments and mortgage loans held for sale. Our primary liquid assets accounted for 52.51% and 36.83% of total assets atSeptember 30, 2021 andDecember 31, 2020 , respectively. Securities classified as available for sale, which are not pledged, may be sold in response to changes in interest rates and liquidity needs. All of the securities presently owned are classified as available for sale. Net cash provided by operations and deposits from customers have been the primary sources of liquidity. AtSeptember 30, 2021 , we had unused short-term lines of credit totaling approximately$41.0 million (which can be withdrawn at the lender's option). Additional sources of funds available to us for additional liquidity needs include borrowing on a short-term basis from theFederal Reserve System , increasing deposits by raising interest rates paid and sale of mortgage loans held for sale. We established a Borrower-In-Custody arrangement with theFederal Reserve . This arrangement permits us to retain possession of assets pledged as collateral to secure advances from the Federal Reserve Discount Window. AtSeptember 30, 2021 , we could borrow up to$67.0 million . There have been no borrowings under this arrangement. Our core deposits consist of non-interest-bearing accounts, NOW accounts, money market accounts, time deposits and savings accounts. We closely monitor our level of certificates of deposit greater than$250,000 and other large deposits. We maintain a Contingency Funding Plan ("CFP') that identifies liquidity needs and weighs alternate courses of action designed to address these needs in emergency situations. We perform a quarterly cash flow analysis and stress test the CFP to evaluate the expected funding needs and funding capacity during a liquidity stress event. We believe our liquidity sources are adequate to meet our operating needs and do not know of any trends, events or uncertainties that may result in a significant adverse effect on our liquidity position. AtSeptember 30, 2021 andDecember 31, 2020 , our liquidity ratio was 56.53% and 38.63%, respectively. Capital Resources Our capital needs have been met to date through the$10.6 million in capital raised in our initial offering, the retention of earnings less dividends paid and the exercise of stock options to purchase stock. Total shareholders' equity as ofSeptember 30, 2021 was$54.4 million . The rate of asset growth since our inception has not negatively impacted this capital base. OnMarch 26, 2020 , the Board of Directors of the Company approved a stock repurchase of up to$1.0 million throughMarch 2021 . The Company repurchased 25,067 shares for$0.4 million as a part of this plan, which expired inMarch 2021 . OnJuly 2, 2013 , theFederal Reserve Board approved the final rules implementing theBasel Committee on Banking Supervision's ("BCBS") capital guidelines for US banks ("Basel III"). Following the actions by theFederal Reserve , theFDIC also approved regulatory capital requirements onJuly 9, 2013 . TheFDIC's rule is identical in substance to the final rules issued by theFederal Reserve Bank . OnNovember 4, 2019 , the federal banking agencies jointly issued a final rule on an optional, simplified measure of capital adequacy for qualifying community banking organizations called the community bank leverage ratio ("CBLR") framework effective onJanuary 1, 2020 . The Bank adopted this rule as ofMarch 31, 2020 and will no longer be subject to other capital and leverage requirements. A qualifying community banking organization is defined as having less than$10 billion in total consolidated assets, a leverage ratio greater than 9%, off-balance sheet exposures of 25% or less of total consolidated assets, and trading assets and liabilities of 5% or less of total consolidated assets. OnOctober 9, 2020 , the federal banking agencies jointly issued a final rule on the CBLR framework effectiveNovember 9, 2020 . Under the final rule, the CBLR is 8.0% for the year endedDecember 31, 2020 , 8.5% for the year endedDecember 31, 2021 , and 9.0% thereafter to be considered well capitalized. Additionally, the qualifying community banking institution must be a non-advanced approachesFDIC supervised institution. The final rule adopts Tier 1 capital and existing leverage ratio into the CBLR framework. A bank meeting CBLR qualifying criteria is deemed to have met the "well capitalized" ratio requirements and be in compliance with the generally applicable capital rule. The Bank's CBLR as ofSeptember 30, 2021 andDecember 31, 2020 , was 9.40% and 10.19%, respectively. As ofSeptember 30, 2021 , the Company and the Bank were categorized as "well capitalized." 38 We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a material effect on the financial statements. We must meet specific capital guidelines that involve quantitative measures of our assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Current and previous quantitative measures established by regulation to ensure capital adequacy require that we maintain minimum amounts and ratios of total and Tier 1 capital to risk-weighted assets and to average assets. Management expects that the capital and leverage ratios for the Company and the Bank under CBLR will enable each of the Company and the Bank to continue to be categorized as "well capitalized."
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