RIVER FINANCIAL CORPORATION The following discussion and analysis of our financial condition and results of operations should be read together with our condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements and related notes thereto for the year endedDecember 31, 2020 , which are contained in the Annual Report on Form 10-K for the year endedDecember 31, 2020 . In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions that could cause actual results to differ materially from our expectations. Factors that could cause such differences are discussed in our 2020 Annual Report on Form 10-K under "Part I, Item 1A - Risk Factors." We assume no obligation to update any of these forward-looking statements.
The following discussion pertains to our historical results on a consolidated basis. However, because we conduct all of our material business operations through our subsidiaries, the discussion and analysis relates to activities primarily conducted at the subsidiary level.
All dollar amounts in the tables in this section are in thousands of dollars, except per share data, yields, percentages and rates or when specifically identified. As used in this Item, the words "we," "us," "our," the "Company," "RFC," "River" and similar terms refer toRiver Financial Corporation and its consolidated affiliate, unless the context indicates otherwise.
Current Developments regarding COVID-19
As a result of the COVID-19 pandemic, and the potential adverse effects it may have on our customers, including our loan and depositor relationships, we continue to assess how such developments could affect our business and operations. We have taken the following steps to operate in an environment that is safe for both our employees and customers (and the public in general) and have implemented guidelines and programs to assist our customers and help ensure the safe and sound operation of our Bank. Daily Operations 1. We have established social distancing policies in keeping with federal and state ofAlabama guidelines to help ensure the health of our employees. To the extent possible, we have encouraged our employees to work remotely, and we believe such steps have been welcomed by, and helpful to, our employees. 2. Currently, our lobbies at our main office and branches and public areas are open to walk-in business and other in-person visits by customers. As long as our social distancing policies are being complied with, customers may, among other things, have in-person meetings at our facilities and access to their safe deposit boxes. We have installed plexiglass in lobby areas for employees that have regular contact with customers and masks are available for both employees and customers as needed. 3. Our drive through facilities at all our locations remain open for customer service, and we believe that the drive-through option for customers has worked well and minimized unnecessary contact or exposure. All of our ATM locations are operative.
We expect to continue with the foregoing procedures until both the federal and state guidance provides comfort that a return to a more normal operation environment is advisable and we, too, are comfortable with such return.
Participation in Government Programs
We are participating in several government programs designed to assist customers, to bolster the economy and to provide protection for the Bank.
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--------------------------------------------------------------------------------Paycheck Protection Program
The Bank has participated as a lender in theSmall Business Administration's (SBA) Paycheck Protection Program (PPP) as established by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The PPP was established under the CARES Act to provide unsecured low interest rate loans to small businesses that have been impacted by the COVID-19 pandemic. The PPP loans are 100% guaranteed by the SBA. The loans have a fixed interest rate of 1% and payments of interest and principal are deferred until the earlier of the date the SBA remits the forgiveness amount to the lender, the forgiveness application is denied, or if no forgiveness application is filed, ten months from the end of the covered period. If originated beforeJune 5, 2020 , loans mature two years from origination and if origination occurs afterJune 5, 2020 , loans mature five years from origination. PPP loans are forgiven by the SBA (which makes forgiveness payments directly to the lender) to the extent the borrower uses the proceeds of the loan for certain purposes (primarily to fund payroll costs) during a certain time period following origination and maintains certain employee and compensation levels. Lenders receive processing fees from the SBA for originating the PPP loans which are based on a percentage of the loan amount. OnDecember 27, 2020 , legislation was enacted that renewed the PPP and allocated additional appropriations for both new first-time PPP loans under the existing PPP and second-draw PPP loans for certain eligible borrowers that had previously received a PPP loan. As ofMarch 31, 2021 , the Bank has made approximately 2,520 PPP loans in the aggregate amount of approximately$141.7 million still outstanding. Our Business We are a bank holding company headquartered inPrattville, Alabama . We engage in the business of banking through our wholly-owned banking subsidiary,River Bank & Trust , which we may refer to as the "Bank," or "River Bank ." Through the Bank, we provide a broad array of financial services to businesses, business owners, professionals, and consumers. As ofMarch 31, 2021 , we operated eighteen full-service banking offices inAlabama in the cities ofMontgomery ,Prattville ,Millbrook ,Wetumpka ,Auburn ,Opelika ,Gadsden ,Alexander City ,Daphne ,Clanton ,Dothan ,Enterprise ,Thorsby , andMobile, Alabama . We also have a loan production office inDecatur, Alabama . Segments While our chief decision makers monitor the revenue streams of the various banking products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all of the Company's banking operations are considered by management to be aggregated in one reportable operating segment. Because the overall banking operations comprise substantially all of the consolidated operations, no separate segment disclosures are presented in the accompanying consolidated financial statements.
Overview of First Quarter 2021 Results
Net income was$6.8 million in the quarter endedMarch 31, 2021 , compared with$3.7 million in the quarter endedMarch 31, 2020 . Several significant measures from the 2021 first quarter include:
• Net interest margin (taxable equivalent) of 3.64%, compared with 3.97% for
the first quarter of 2020.
• Net interest income increase of
31, 2021, representing a 30.30% rate of increase over the quarter ended
• Annualized return on average earning assets for the quarter ended March
31, 2021 of 1.50% compared with 1.18% for the quarter ended March 31,
2020 .
• Annualized return on average equity for the quarter ended
of 15.99% compared with 9.98% for the quarter ended
• Loan increase of
annualized growth rate.
• Securities available-for-sale increase of
quarter, representing a 122.17% annualized increase for the quarter.
• Deposit increase of
42.35% annualized growth rate.
• Stockholders' equity decrease of
representing a 0.90% annualized decline.
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• Book value per share of
share at
• Tangible book value per share of
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared based on the application of certain accounting policies, the most significant of which are described in the notes to the financial statements for the year endedDecember 31, 2020 , which are contained in our Annual Report filed on Form 10-K. Certain of these policies require numerous estimates and strategic or economic assumptions that may prove inaccurate or subject to variation and may significantly affect our reported results and financial position for the current period or future periods. The use of estimates, assumptions, and judgment is necessary when financial assets and liabilities are required to be recorded at or adjusted to reflect fair value. Assets carried at fair value inherently result in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices or are provided by other independent third-party sources, when available. When such information is not available, management estimates valuation adjustments. Changes in underlying factors, assumptions or estimates in any of these areas could have a material impact on our future financial condition and results of operations.
The following briefly describes the more complex policies involving a significant amount of judgments about valuation and the application of complex accounting standards and interpretations.
Allowance for Loan Losses
We record estimated probable inherent credit losses in the loan portfolio as an allowance for loan losses. The methodologies and assumptions for determining the adequacy of the overall allowance for loan losses involve significant judgments to be made by management. Some of the more critical judgments supporting our allowance for loan losses include judgments about: creditworthiness of borrowers, estimated value of underlying collateral, assumptions about cash flow, determination of loss factors for estimating credit losses, and the impact of current events, conditions and other factors impacting the level of inherent losses. Under different conditions or using different assumptions, the actual or estimated credit losses that we may ultimately realize may be different than our estimates. In determining the allowance, we estimate losses on individual impaired loans, or groups of loans that are not impaired, where the probable loss can be identified and reasonably estimated. On a quarterly basis, we assess the risk inherent in our loan portfolio based on qualitative and quantitative trends in the portfolio, including the internal risk classification of loans, historical loss rates, changes in the nature and volume of the loan portfolio, industry or borrower concentrations, delinquency trends, detailed reviews of significant loans with identified weaknesses and the impact of local, regional and national economic factors on the quality of the loan portfolio. Based on this analysis, we may record a provision for loan losses in order to maintain the allowance at appropriate levels. For a more complete discussion of the methodology employed to calculate the allowance for loan losses, see note 1 to our consolidated financial statements for the year endedDecember 31, 2020 , which are contained in our Annual Report on Form 10-K.
Investment Securities Impairment
We assess, on a quarterly basis, whether there have been any events or economic
circumstances to indicate that a security on which there is an unrealized loss
is impaired on an other-than-temporary basis. In such instance, we would
consider many factors, including the severity and duration of the impairment,
our intent and ability to hold the security for a period of time sufficient for
a recovery in value, recent events specific to the issuer or industry, and for
debt securities, external credit ratings and recent downgrades. Securities on
which there is an unrealized loss that is deemed to be other-than-temporary are
written down to fair value through current earnings.
Income Taxes
Deferred income tax assets and liabilities are computed using the asset and
liability method, which recognizes a liability or asset representing the tax
effects, based on current tax law, of future deductible or taxable amounts
attributable to events recognized in the financial statements. A valuation
allowance may be established to the extent necessary to reduce the deferred tax
asset to a level at which it is "more likely than not" that the tax assets or
benefits will be realized. Realization of tax benefits depends on having
sufficient taxable income, available tax loss carrybacks or credits, the
reversing of taxable temporary differences and/or tax planning strategies within
the reversal period, and whether current tax law allows for the realization of
recorded tax benefits.
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Business Combinations Assets purchased and liabilities assumed in a business combination are recorded at their fair value. The fair value of a loan portfolio acquired in a business combination requires greater levels of management estimates and judgment than the remainder of purchased assets or assumed liabilities. On the date of acquisition, when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments, the difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference. We must estimate expected cash flows at each reporting date. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges and adjusted accretable yield which will have a positive impact on interest income. In addition, purchased loans without evidence of credit deterioration are also handled under this method.
Comparison of the Results of Operations for the three months ended
The following is a narrative discussion and analysis of significant changes in our results of operations for the three months endedMarch 31, 2021 compared to the three months endedMarch 31, 2020 . Net Income During the three months endedMarch 31, 2021 , our net income was$6.8 million , compared to$3.7 million for the three months endedMarch 31, 2020 , an increase of$3.1 million , or 83.18%. The primary reason for the increase in net income for the three months endedMarch 31, 2021 as compared to the three months endedMarch 31, 2020 was an increase in both net interest income and noninterest income. During this period in 2021, net interest income was$16.0 million compared to$12.3 million for the same period in 2020, an increase of$3.7 million , or 30.30%. This increase is a result of higher levels of loan volume and other earning assets from organic growth as well as from the recognition of origination fee income from the SBA Paycheck Protection Program. The increase in interest income was accompanied by a corresponding decrease in interest expense that resulted from deposit rate reductions during the period. Total noninterest income for the first three months of 2021 was$3.7 million compared to$2.4 million in the first three months of 2020. This increase was primarily the result of the$1.1 million increase in in secondary market mortgage origination income. Total noninterest expense in the first three months of 2021 increased$1.1 million , or 12.50%, from the first three months of 2020. The most significant increase was an increase of$836 thousand in salaries and employee benefits. 33 --------------------------------------------------------------------------------
Net Interest Income and Net Interest Margin Analysis
The largest component of our net income is net interest income - the difference between the income earned on interest earning assets and the interest paid on deposits and borrowed funds used to support assets. Net interest income divided by average interest earning assets represents our net interest margin. The major factors that affect net interest income and net interest margin are changes in volumes, the yield on interest earning assets and the cost of interest bearing liabilities. Our net interest margin can also be affected by economic conditions, the competitive environment, loan demand, and deposit flow. Management's ability to respond to changes in these factors by using effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the primary source of earnings. This is discussed in greater detail under the heading "Interest Sensitivity and Market Risk".
Comparison of net interest income for the three months ended
The following table shows, for the three months endedMarch 31, 2021 and 2020, the average balances of each principal category of our earning assets and interest bearing liabilities and the average taxable equivalent yields on assets and average costs of liabilities. These yields and costs are calculated by dividing the income or expense by the average daily balance of the associated assets or liabilities (amounts in thousands). Three Months Ended March 31, 2021 Three Months Ended March 31, 2020 Interest Interest Average Income/ Average Average Income/ Average Balance Expense Yield/Rate Balance Expense Yield/Rate Interest earning assets Loans$ 1,186,902 $ 15,493 5.29 %$ 920,521 $ 12,732 5.55 % Mortgage loans held for sale 22,997 113 1.99 % 5,314 41 3.11 %
Investment securities:
Taxable securities 447,447 1,363 1.24 % 230,420 1,431 2.49 % Tax-exempt securities 88,808 677 3.09 % 67,136 557 3.33 % Interest bearing balances in other banks 48,034 29 0.24 % 34,986 130 1.50 % Federal funds sold 11,501 7 0.25 % - - 0.00 %
Total interest earning assets
3.97 %$ 1,258,377 $ 14,891 4.75 % Interest bearing liabilities Interest bearing transaction accounts$ 395,624 $ 82 0.08 %$ 273,852 $ 225 0.33 % Savings and money market accounts 579,361 380 0.27 % 368,525 748 0.81 % Time deposits 277,970 657 0.96 % 247,303 1,093 1.77 % Short-term debt 11,263 3 0.10 % 7,158 7 0.41 % Subordinated debt 9,333 102 4.25 % - - 0.00 % Note payable 16,453 246 6.18 % 23,374 355 6.26 %
Total interest bearing liabilities
0.46 %$ 920,212 $ 2,428 1.06 % Noninterest-bearing funding of earning assets 515,685 - 0.00 % 338,165 - 0.00 %
Total cost of funding earning assets
0.33 %$ 1,258,377 $ 2,428 0.77 % Net interest rate spread 3.51 % 3.69 % Net interest income/margin (taxable equivalent)$ 16,212 3.64 %$ 12,463 3.97 % Tax equivalent adjustment (194 ) (170 ) Net interest income/margin$ 16,018 3.60 %$ 12,293 3.96 % 34
-------------------------------------------------------------------------------- The following table reflects, for the three months endedMarch 31, 2021 and 2020, the changes in our net interest income due to variances in the volume of interest earning assets and interest bearing liabilities and variances in the associated rates earned or paid on these assets and liabilities (amounts in thousands). Three Months Ended March 31, 2021 vs. Three Months Ended March 31, 2020 Variance due to Volume Yield/Rate Total Interest earning assets Loans$ 3,522 $ (761 )$ 2,761 Mortgage loans held for sale 136 (64 ) 72 Investment securities: Taxable securities 1,311 (1,379 ) (68 ) Tax-exempt securities 173 (53 ) 120 Interest bearing balances in other banks 48 (149 ) (101 ) Federal funds sold - 7 7 Total interest earning assets$ 5,190 $
(2,399 )
Interest bearing liabilities Interest bearing transaction accounts $ 99 $ (242 )$ (143 ) Savings and money market accounts 421 (789 ) (368 ) Time deposits 133 (569 ) (436 ) Short-term debt 5 (9 ) (4 ) Subordinated debentures 4 98 102 Note payable (102 ) (7 ) (109 ) Total interest bearing liabilities$ 560 $
(1,518 )
Net interest income Net interest income (taxable equivalent)$ 4,630 $ (881 )$ 3,749 Taxable equivalent adjustment (40 ) 16 (24 ) Net interest income$ 4,590 $ (865 )$ 3,725 Total interest income for the three months endedMarch 31, 2021 was$17.5 million and total interest expense was$1.5 million , resulting in net interest income of$16.0 million for the period. For the same period of 2020, total interest income was$14.7 million and total interest expense was$2.4 million , resulting in net interest income of$12.3 million for the period. This represents a 30.30% increase in net interest income when comparing the same period from 2021 and 2020. When comparing the variances related to interest income for the three months endedMarch 31, 2021 and 2020, the increase was primarily attributed to increases in average volumes in loans and investment securities as well as from the recognition of origination fee income from the SBA Paycheck Protection Program. The volume related increase in interest income for the three months endedMarch 31, 2021 was accompanied by a decrease in the yield on loans and investment securities. When comparing variances related to interest expense for the three months endedMarch 31, 2021 and 2020, the decrease primarily resulted from a decrease in deposit rates beginning in 2020 and continuing into 2021. This decrease was partially offset by an increase in the average volume of non-maturity deposits and time deposits. 35 --------------------------------------------------------------------------------
Provision for Loan Losses The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management's evaluation, is adequate to provide coverage for estimated losses on outstanding loans and to provide for uncertainties in the economy. As a result of evaluating the allowance for loan losses atMarch 31, 2021 , management recorded a provision of$1.2 million in the first quarter of 2021 compared to a provision of$1.3 million in the first quarter of 2020. The provision allocated was primarily related to sustained economic uncertainty caused by the COVID-19 pandemic as well as the continued loan growth fromMarch 31, 2020 toMarch 31, 2021 . The allowance for loan losses is increased by a provision for loan losses, which is a charge to earnings, and it is decreased by loan charge-offs and increased by recoveries on loans previously charged off. In determining the adequacy of the allowance for loan losses, we consider our historical loan loss experience, the general economic environment, our overall portfolio composition and other relevant information. As these factors change, the level of loan loss provision changes. When individual loans are evaluated for impairment and impairment is deemed necessary, a specific allowance is required for the impaired portion of the loan amount. Subsequent changes in the impairment amount will generally cause corresponding changes in the allowance related to the impaired loan and corresponding changes to the loan loss provision. As ofMarch 31, 2021 , the recorded allowance related to impaired loans was$349 thousand . As ofMarch 31, 2020 , the recorded allowance related to impaired loans was$334 thousand .
Noninterest Income
In addition to net interest income, we generate various types of noninterest income from our operations. Our banking operations generate revenue from service charges and fees mainly on deposit accounts. Our mortgage division generates revenue from originating and selling mortgage loans. Our investment brokerage division generates revenue through a revenue-sharing relationship with a registered broker-dealer. We also own life insurance policies on several key employees and record income on the increase in the cash surrender value of these policies.
The following table sets forth the principal components of noninterest income for the periods indicated (amounts in thousands).
For the Three Months
Ended March 31,
2021 2020
Service charges and fees $ 1,342 $ 1,302
Investment brokerage revenue 63 35
Mortgage operations 1,848 734
Bank owned life insurance income 269 199
Net gain (loss) on sale of investment securities 7 (46 )
Other noninterest income 131 137
Total noninterest income $ 3,660 $2,361 Noninterest income for the three months endedMarch 31, 2021 was$3.7 million compared to$2.4 million for the same period in 2020. The most significant increase was a$1.1 million increase in secondary market mortgage operations income. Activity within the secondary market continues to be high due to the low interest rate environment. 36
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Noninterest Expense
Noninterest expenses consist primarily of salaries and employee benefits, building occupancy and equipment expenses, advertising and promotion expenses, data processing expenses, legal and professional services and miscellaneous other operating expenses.
The following table sets forth the principal components of noninterest expense for the periods indicated (amounts in thousands).
For the Three Months
Ended March 31,
2021 2020
Salaries and employee benefits $ 5,915 $ 5,079
Occupancy expenses 574 581
Equipment rentals, depreciation, and maintenance 275 298
Telephone and communications 177 117
Advertising and business development 136 143
Data processing 664 740
Foreclosed assets, net 41 87
Federal deposit insurance and other regulatory assessments 293 126
Legal and other professional services 279 189
Other operating expense 1,440 1,346
Total noninterest expense $ 9,794 $ 8,706
Noninterest expense for the three months ended March 31, 2021 totaled $9.8
million compared with $8.7 million for the same period of 2020. The overall
increase was primarily a result of increases in salaries and employee benefits.
Salaries and employee benefits increased $836 thousand , or 16.46%, to $5.9
million in the first quarter of 2021 from $5.1 million in the first quarter of
2020. The number of full-time equivalent employees increased from approximately
221 at March 31, 2020 to approximately 237 at March 31, 2021 for an increase of
approximately 7.24%. There was also a $167 thousand increase in Federal deposit
insurance and other regulatory assessments for the three months ended March 31,
2021 compared to the same period of 2020. The increase in federal deposit
insurance and other regulatory assessments was due to the tremendous deposit
growth over the last year.
Provision for Income Taxes
We recognized income tax expense of $1.9 million for the three months ended
March 31, 2021 , compared to $927 thousand for the three months ended March 31,
2020 . The increase of $984 thousand , or 106.15%, resulted from the increase in
net income before taxes of $4.1 million in the first three months of 2021 as
compared to the first three months of 2020. The effective tax rate for the three
months ended March 31, 2021 was 22.0% compared to 20.0% for the same period in
2020. The effective tax rate is affected by levels of items of income that are
not subject to federal and/or state taxation and by levels of items of expense
that are not deductible for federal and/or state income tax purposes.
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Comparison of Financial Condition at
Overview Our total assets increased$194.3 million , or 10.42%, fromDecember 31, 2020 toMarch 31, 2021 . Loans, net of deferred fees and discounts, increased$25.7 million , or 2.2%, fromDecember 31, 2020 toMarch 31, 2021 . Securities available-for-sale increased by$150.7 million , or 30.54%, fromDecember 31, 2020 toMarch 31, 2021 . Cash and cash equivalents increased$17.5 million , or 28.97% fromDecember 31, 2020 toMarch 31, 2021 . Total deposits increased$175.1 million , or 10.59%, fromDecember 31, 2020 toMarch 31, 2021 which funded our loan growth and purchase of securities. Total stockholders' equity decreased$375 thousand , or -0.23% fromDecember 31, 2020 toMarch 31, 2021 primarily due to a decrease in the net unrealized gain on securities available-for-sale and due to the dividend paid in the first quarter. These decreases were partially offset by strong earnings for the quarter.Investment Securities We use our securities portfolio primarily to enhance our overall yield on interest-earning assets, as a source of liquidity, as a tool to manage our balance sheet sensitivity and regulatory capital ratios, and as a base from which to pledge assets for public deposits. When our liquidity position exceeds current our needs and our expected loan demand, other investments are considered as a secondary earnings alternative. As investments mature or pay down, they are used to meet current cash needs, or they are reinvested to maintain our desired liquidity position. We have historically designated all our securities as available-for-sale to provide flexibility in case an immediate need for liquidity arises, and we believe that the composition of the portfolio offers needed flexibility in managing our liquidity position and interest rate sensitivity without adversely impacting our regulatory capital levels. Securities available-for-sale are reported at fair value, with unrealized gains or losses reported as a separate component of other comprehensive income, net of deferred taxes. Purchase premiums and discounts are recognized in income using the interest method over the terms of the securities. During the three months endedMarch 31, 2021 , we purchased investment securities totaling$196.0 million and sold investment securities with proceeds received of$4.4 million including net realized gains of$7 thousand . The following tables summarize the amortized cost, gross unrealized gains, gross unrealized losses, and fair value of securities available-for-sale atMarch 31, 2021 andDecember 31, 2020 (amounts in thousands). Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair ValueMarch 31, 2021 :
Securities available-for-sale:
Residential mortgage-backed$ 509,022 $ 4,220
U.S. govt. sponsored enterprises 28,667 943 - 29,610 State, county, and municipal 98,345 3,811
(478 ) 101,678
Corporate debt obligations 3,168 11 (102 ) 3,077
Totals $ 639,202 $ 8,985 $ (4,260 ) $ 643,927
Gross Gross
Amortized Unrealized Unrealized
Cost Gains Losses Fair Value
December 31, 2020:
Securities available-for-sale:
Residential mortgage-backed$ 346,001 $ 5,034
U.S. govt. sponsored enterprises 34,963 1,272
(4 ) 36,231
State, county, and municipal 98,026 5,220 (17 ) 103,229
Corporate debt obligations 3,166 51 - 3,217
Totals $ 482,156 $ 11,577 $ (459 ) $ 493,274
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Loans Loans are the largest category of interest earning assets and typically provide higher yields than other types of interest earning assets. Associated with the higher loan yields are the inherent credit and liquidity risks which management attempts to control and counterbalance. Total loans averaged$1.19 billion during the three months endedMarch 31, 2021 , or 65.7% of average interest earning assets, as compared to$920.5 million , or 73.2% of average interest earning assets, for the three months endedMarch 31, 2020 . AtMarch 31, 2021 , total loans, net of deferred loan fees and discounts, were$1.21 billion , compared to$1.19 billion atDecember 31, 2020 , an increase of$25.7 million , or 2.2% The organic, or non-acquired, growth in our loan portfolio is attributable to our ability to attract new customers from other financial institutions and overall growth in our markets. Much of our loan growth has come from moving customers from other financial institutions toRiver Bank . We have also been successful in building banking relationships with new customers. We have hired several new bankers in the markets that we serve, and these employees have been successful in transitioning their former clients and attracting new clients toRiver Bank . Our bankers are expected to be involved in their communities and to maintain business development efforts to develop relationships with clients, and our philosophy is to be responsive to customer needs by providing decisions in a timely manner. In addition to our business development efforts, many of the markets that we serve have shown signs of economic recovery over the last few years.
The following table provides a summary of the loan portfolio as of
March 31, 2021 December 31, 2020
Amount % of Total Amount % of Total
Residential real estate:
Closed-end 1-4 family - first lien $ 258,733 21.7 % $ 252,528 21.6 %
Closed-end 1-4 family - junior lien 7,826 0.7 % 8,343 0.7 %
Multi-family 10,972 0.9 % 10,817 0.9 %
Total residential real estate 277,531 23.3 % 271,688 23.2 %
Commercial real estate:
Nonfarm nonresidential 316,716 26.5 % 317,279 27.1 %
Farmland 38,527 3.2 % 34,586 3.0 %
Total commercial real estate 355,243 29.7 % 351,865 30.1 %
Construction and land development:
Residential 77,545 6.5 % 71,784 6.1 %
Other 83,979 7.0 % 78,818 6.7 %
Total construction and land development 161,524 13.5 % 150,602 12.8 %
Home equity lines of credit 41,675 3.5 % 43,424 3.7 %
Commercial loans:
Other commercial loans 289,382 24.3 % 279,385 23.9 %
Agricultural 27,104 2.3 % 29,854 2.6 %
State, county, and municipal loans 25,068 2.1 % 25,922 2.2 %
Total commercial loans 341,554 28.7 % 335,161 28.7 %
Consumer loans 43,123 3.6 % 40,646 3.5 %
Total gross loans 1,220,650 102.3 % 1,193,386 102.0 %
Allowance for loan losses (18,028 ) -1.5 % (16,803 ) -1.4 %
Net discounts (883 ) -0.1 % (1,010 ) -0.1 %
Net deferred loan fees (7,457 ) -0.7 % (5,794 ) -0.5 %
Net loans $ 1,194,282 100.0 % $ 1,169,779 100.0 %
In this context, a "real estate loan" is defined as any loan, secured by real
estate, regardless of the purpose of the loan. It is common practice for
financial institutions in our market areas, and for our Bank, to obtain a
security interest or lien in real estate whenever possible, in addition to any
other available collateral. This collateral is taken to reinforce the likelihood
of the ultimate repayment of the loan and tends to increase the magnitude of the
real estate loan portfolio component. In general, we prefer real estate
collateral to many other potential collateral sources, such as accounts
receivable, inventory and equipment.
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Real estate loans are the largest component of our loan portfolio and include
residential real estate loans, commercial real estate loans, and construction
and land development loans. At March 31, 2021 , this category totaled $794.3
million , or 65.07% of total gross loans, compared to $774.2 million , or 64.87%,
at December 31, 2020 . Real estate loans increased $20.1 million , or 2.60%,
during the period December 31, 2020 to March 31, 2021 . Commercial loans
increased $6.4 million , or 1.91% during the same period. Our management team and
lending officers have a great deal of experience and expertise in real estate
lending and commercial lending.
The federal regulatory agencies recently issued two "guidance" documents that
have a significant impact on real estate related lending and, thus, on the
operations of the Bank. One part of the guidance could require lenders to
restrict lending secured primarily by certain categories of commercial real
estate to a level of 300% of their capital or to raise additional capital. This
factor, combined with the current economic environment, could affect the Bank's
lending strategy away from, or to limit its expansion of, commercial real estate
lending, which has been a material part of River Financial Corporation's lending
strategy. This could also have a negative impact on our lending and
profitability. Management actively monitors the composition of the Bank's loan
portfolio, focusing on concentrations of credit, and the results of that
monitoring activity are periodically reported to the Board of Directors.
The other guidance relates to the structuring of certain types of mortgages that
allow negative amortization of consumer mortgage loans. Although the Bank does
not engage at present in lending using these types of instruments, the guidance
could have the effect of making the Bank less competitive in consumer mortgage
lending if the local market is driving the demand for such an offering.
Allowance for Loan Losses, Provision for Loan Losses and Asset Quality
Allowance for loan losses and provision for loan losses
The allowance for loan losses represents management's estimate of probable inherent credit losses in the loan portfolio. Management determines the allowance based on an ongoing evaluation of risk as it correlates to potential losses within the portfolio. Increases to the allowance for loan losses are made by charges to the provision for loan losses. Loans deemed to be uncollectible are charged against the allowance. Recoveries of previously charged-off amounts are credited to the allowance for loan losses. Management utilizes a review process for the loan portfolio to identify loans that are deemed to be impaired. A loan is considered impaired when it is probable that the Bank will be unable to collect the scheduled payments of principal and interest due under the contractual terms of the loan agreement or when the loan is deemed to be a troubled debt restructuring. For loans and loan relationships deemed to be impaired that are$100 thousand or greater, management determines the estimated value of the underlying collateral, less estimated costs to acquire and sell the collateral, or the estimated net present value of the cash flows expected to be received on the loan or loan relationship. These amounts are compared to the current investment in the loan and a specific allowance for the deficiency, if any, is specifically included in the analysis of the allowance for loan losses. For loans and loan relationships less than$100 thousand that are deemed to be impaired, management applies a general loss factor of 15% and includes that amount in the analysis of the allowance for loan losses rather than specifically measuring the impairment for each loan or loan relationship. All other loans are deemed to be unimpaired and are grouped into various homogeneous risk pools primarily utilizing regulatory reporting classification codes. The Bank's historical loss factors are calculated for each of the risk pools based on the percentage of net losses experienced as a percentage of the average loans outstanding. The time periods utilized in these historical loss factor calculations are subjective and vary according to management's estimate of the impact of current economic cycles. As every loan has a risk of loss, minimum loss factors are estimated based on long term trends for the Bank, the banking industry, and the economy. The greater of the calculated historical loss factors or the minimum loss factors are applied to the unimpaired loan amounts currently outstanding for the risk pool and included in the analysis of the allowance for loan losses. In addition, certain qualitative adjustments may be included by management as additional loss factors. These adjustments may include, among other things, changes in loan policy, loan administration, loan geographic or industry concentrations, loan growth rates, and experience levels of our lending officers. Although we have not seen any significant changes in credit quality as a result of the pandemic, management has added several significant qualitative adjustments to our allowance for loan loss calculation that are related to the uncertainties of how the pandemic will affect our loan quality. As a result of these qualitative adjustments, our provision for loan losses and the allowance for loan losses has increased significantly during the first quarter. The loss allocations for specifically impaired loans, smaller impaired loans not specifically measured for impairment, and unimpaired loans are totaled to determine the total required allowance for loan losses. This total is compared to the current allowance on the Bank's books and adjustments made accordingly by a charge or credit to the provision for loan losses.
Management believes the data it uses in determining the allowance for loan losses is sufficient to estimate potential losses in the loan portfolio; however, actual results could differ from management's estimate.
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--------------------------------------------------------------------------------The following table presents a summary of changes in the allowance for loan losses for the periods indicated (amounts in thousands).
As of and for the
Three Months Ended:
March 31 , March 31,
2021 2020
Allowance for loan losses at beginning of period
8,679
Charge-offs:
Mortgage loans on real estate: Residential real estate -
-
Commercial real estate -
-
Construction and land development -
-
Total mortgage loans on real estate -
-
Home equity lines of credit - - Commercial 40 62 Consumer 5 62 Total 45 124 Recoveries: Mortgage loans on real estate: Residential real estate -
1
Commercial real estate 31
4
Construction and land development -
5
Total mortgage loans on real estate 31 10 Home equity lines of credit - 1 Commercial 38 35 Consumer 15 16 Total 84 62 Net charge-offs (recoveries) (39 ) 62 Provision for loan losses 1,186 1,316 Allowance for loan losses at end of period$ 18,028 $
9,933
Total loans outstanding, net of deferred loan fees 1,212,310
939,477
Average loans outstanding, net of deferred loan fees 1,186,902
920,521
Allowance for loan losses to period end loans 1.49 % 1.06 %
Net charge-offs (recoveries) to average loans
(annualized) -0.01 % 0.03 %
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Allocation of the Allowance for Loan Losses
While no portion of the allowance for loans losses is in any way restricted to
any individual loan or group of loans and the entire allowance is available to
absorb losses from any and all loans, the following table represents
management's allocation of the allowance for loan losses to specific loan
categories as of the dates indicated (amounts in thousands).
March 31, 2021 December 31, 2020
Percent of Percent of
Amount Total Amount Total
Mortgage loans on real estate:
Residential real estate $ 1,800 10.0 % $ 1,676 10.0 %
Commercial real estate 7,625 42.3 % 6,807 40.5 %
Construction and land development 1,881 10.4 % 1,749 10.4 %
Total mortgage loans on real estate 11,306 62.7 % 10,232 60.9 %
Home equity lines of credit 255 1.4 % 268 1.6 %
Commercial 6,089 33.8 % 5,897 35.1 %
Consumer 378 2.1 % 406 2.4 %
Total $ 18,028 100.0 % $ 16,803 100.0 %
Nonperforming Assets
The following table presents our nonperforming assets as of the dates indicated
(amounts in thousands):
March 31, December 31,
2021 2020 2020
Nonaccrual loans $ 4,654 $ 2,945 $ 4,264
Accruing loans past due 90 days or more 174 - 398
Total nonperforming loans 4,828 2,945 4,662
Foreclosed assets 177 565 240
Total nonperforming assets $ 5,005 $ 3,510 $ 4,902
Allowance for loan losses to period end
loans 1.49 % 1.06 % 1.42 %
Allowance for loan losses to period end
nonperforming loans 373.41 % 337.28 % 360.42 %
Net charge-offs (recoveries) to average
loans (annualized) -0.01 % 0.03 % 0.05 %
Nonperforming assets to period end loans
and foreclosed property 0.41 % 0.37 % 0.41 %
Nonperforming loans to period end loans 0.40 % 0.31 % 0.39 %
Nonperforming assets to total assets 0.24 % 0.25 % 0.26 %
Period end loans 1,212,310 939,477 1,186,582
Period end total assets 2,058,927 1,417,421 1,864,650
Allowance for loan losses 18,028 9,933 16,803
Average loans for the period 1,186,902 920,521 1,087,007
Net charge-offs for the period (39 ) 62 491
Period end loans plus foreclosed property 1,212,487 940,042
1,186,822
Accrual of interest is discontinued on a loan when management believes, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition is such that the collection of interest is
doubtful. In addition to consideration of these factors, loans that are past due
90 days or more are generally placed on nonaccrual status. When a loan is placed
on nonaccrual status, all accrued interest on the loan is reversed and deducted
from earnings as a reduction of reported interest income. No additional interest
is accrued on the loan balance until collection of both principal and interest
becomes reasonably certain. Payments received while a loan is on nonaccrual
status will generally be applied to the outstanding principal balance. When a
problem loan is finally resolved, there may ultimately be an actual write-down
or charge-off of the principal balance of the loan that would necessitate
additional charges to the allowance for loan losses.
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--------------------------------------------------------------------------------Deposits Deposits, which include noninterest bearing demand deposits, interest bearing demand deposits, money market accounts, savings accounts, and time deposits, are the principal source of funds for the Bank. We offer a variety of products designed to attract and retain customers, with primary focus on building and expanding client relationships. Management continues to focus on establishing a comprehensive relationship with consumer and business borrowers, seeking deposits as well as lending relationships.
The following table details the composition of our deposit portfolio as of
March 31, 2021 December 31, 2020
Percent of Percent of
Amount Total Amount Total
Demand deposits, non-interest bearing $ 510,754 28.0 % $ 436,885 26.4 %
Demand deposits, interest bearing 436,059 23.8 % 377,745 22.8 %
Money market accounts 497,661 27.2 % 473,714 28.6 %
Savings deposits 100,165 5.5 % 89,914 5.4 %
Time certificates of $250 thousand or more 102,241 5.6 % 96,839 5.9 %
Other time certificates 181,854 9.9 % 178,538 10.9 %
Totals $ 1,828,734 100.0 % $ 1,653,635 100.0 %
Total deposits were $1.83 billion at March 31, 2021 , an increase of $175.1
million from December 31, 2020 with the increase resulting mainly in the
balances of money market accounts and demand deposit accounts. Some of our
demand deposit accounts are seasonal and have expected balance fluctuations. The
seasonality of these demand deposits is related to property tax collections and
to agricultural production. However, the third round of stimulus checks were
sent out in mid-March which led to an increase in deposits from year-end when we
would normally see a decrease from year-end.
The following table presents the Bank's time certificates of deposits by various
maturities as of
Time Deposits Time Deposits
All Time Deposits $100 or more less than $100
Three months or less $ 55,352 $ 37,156 $ 18,196
Greater than three months through six months 72,579 53,724 18,855
Greater than six months through one year 100,769 71,520 29,249
Greater than one year through three years 32,308 21,520 10,788
Greater than three years 23,087 17,760 5,327
Total $ 284,095 $ 201,680 $ 82,415
Other Funding Sources
We supplement our deposit funding with wholesale funding when needed for balance
sheet planning and management or when the terms are attractive and will not
disrupt our offering rates in our markets. A source we have used for wholesale
funding is the Federal Home Loan Bank of Atlanta (FHLB). The line of credit with
the FHLB is secured by pledges of various loans in our loan portfolio. At March
31, 2021 , the FHLB line of credit available was $230.2 million and at December
31, 2020 it was $214.4 million . As of March 31, 2021 and December 31, 2020 , we
have no Federal Home Loan Bank advances outstanding. We also have lines of
credit for federal funds borrowings with other banks that totaled $38.5 million
at March 31, 2021 and December 31, 2020 , respectively. Furthermore, we have
pledged certain loans to the Federal Reserve Bank (FRB) to secure a line of
credit. At March 31, 2021 , the FRB line of credit available was $125.9 million
and at December 31, 2020 , the FRB line of credit available was $123.3 million .
We have never drawn on the FRB line of credit and consider it a contingency line
of credit to be used only for emergency liquidity management.
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On October 31, 2018 , the Company entered into a loan agreement with CenterState
Bank for $27 million . The loan proceeds were drawn and received by the Company
on October 31, 2018 . The loan proceeds were used to fund the payment of the cash
consideration to the PSB Bancshares, Inc. shareholders of $24.5 million in
accordance with the PSB merger agreement and for general corporate purposes. The
loan carried a fixed interest rate of 6%. The loan was secured by all of the
common stock of the Bank. The balance at December 31, 2020 was $20.4 million .
This note was paid off in March 2021 when the Company issued a private placement
of $40 million fixed-to-floating rate subordinated debentures in March
2021 . Details of the subordinated debentures that were issued are outlined
below.
On March 9, 2021 , River Financial Corporation ("the Company") entered into a
Subordinated Note Purchase Agreement (the "Purchase Agreement") with the
purchasers signatory thereto providing for a private placement of $40 million in
aggregate principal amount of 4.00% fixed-to-floating rate Subordinated Notes
due March 15, 2031 (the "Notes"). The Notes were issued by the Company to the
purchasers at a price equal to 100% of their face amount. Interest on the Notes
will accrue from March 9, 2021 , and the Company will pay interest semi-annually
on March 15th and September 15th of each year, beginning on September 15, 2021 ,
until the Notes mature. The Notes will bear interest at a fixed rate of 4.00%
per year, from and including March 9, 2021 to, but excluding, March 15,
2026 . From and including March 15, 2026 , but excluding the maturity date or
early redemption date, the interest rate will reset quarterly at a variable rate
equal to the then current three-month term SOFR plus 342 basis points. The Notes
may not be prepaid by the Company prior to March 15, 2026 . From and after March
15, 2026 , the Company may prepay all or, from time to time, any part of the
Notes at 100% of the principal amount (plus accrued interest) without penalty,
subject to any requirement under Federal Reserve Board regulations to obtain
prior approval from the Board of Governors of the Federal Reserve System before
making any prepayment. The Notes may also be prepaid by the Company at any time
after the occurrence of an event that would preclude the Notes from being
included in the Tier 2 Capital of the Company. The Purchase Agreement contains
customary representations and warranties, events of default, and affirmative and
negative covenants, including the requirement that, subject to certain
limitations, the Company restructure any portion of the Notes that ceases to be
deemed Tier 2 Capital. The Company used approximately $19.7 million of the net
proceeds from the issuance of the Notes to pay off its note with CenterState
Bank dated October 31, 2018 , including interest accrued on such notes, and the
remaining proceeds for general corporate purposes, including providing capital
to support the organic growth of its bank subsidiary, River Bank .
Liquidity
Market and public confidence in our financial strength and financial institutions in general will largely determine our access to appropriate levels of liquidity. This confidence is significantly dependent on our ability to maintain sound asset quality and appropriate levels of capital reserves.
Liquidity is defined as the ability to meet anticipated customer demands for
funds under credit commitments and deposit withdrawals at a reasonable cost and
on a timely basis. We measure our liquidity position by giving consideration to
both on- and off-balance sheet sources of and demands for funds on a daily,
weekly and monthly basis.
Liquidity risk involves the risk of being unable to fund assets with the
appropriate duration and rate-based liabilities, as well as the risk of not
being able to meet unexpected cash needs. Liquidity planning and management are
necessary to ensure the ability to fund operations cost-effectively and to meet
current and future potential obligations such as loan commitments and unexpected
deposit outflows. In this process, we focus on assets and liabilities and on the
manner in which they combine to provide adequate liquidity to meet our needs.
Funds are available from a number of basic banking activity sources, including
the core deposit base, the repayment and maturity of loans, and investment cash
flows. Other funding sources include federal funds borrowings, brokered
certificates of deposit and borrowings from the FHLB and FRB.
44
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Cash and cash equivalents at March 31, 2021 and December 31, 2020 , were $77.7
million and $60.3 million , respectively. Based on recorded cash and cash
equivalents, management believes River Financial Corporation's liquidity
resources were sufficient at March 31, 2021 to fund loans and meet other cash
needs as necessary.
Off-Balance Sheet Arrangements
The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized by the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. In most cases, the Company requires collateral or other security to support financial instruments with credit risk.
Financial instruments whose contract amount represents credit risk at
March 31, 2021 December 31, 2020
Commitments to extend credit $ 261,067 $ 246,700
Stand-by and performance letters of credit 2,806 2,659
Total $ 263,873 $ 249,359
Contractual Obligations
While our liquidity monitoring and management considers both present and future
demands for and sources of liquidity, the following table of contractual
commitments focuses only on future obligations as of March 31, 2021 (amounts in
thousands).
Due after 1 Due after 3
Due in 1 through through Due after
year or less 3 years 5 years 5 years Total
Deposits without a stated maturity $ 1,544,639 $ - $ - $ - $ 1,544,639
Certificates of deposit of less than
$100 66,300 10,788 5,292 35 82,415
Certificates of deposit of $100 or
more 162,400 21,520 17,760 - 201,680
Securities sold under agreements to
repurchase 13,451 - - - 13,451
Subordinated debt, net of loan costs - - - 39,298 39,298
Operating leases 628 1,174 537 560 2,899
Total contractual obligations
Capital Position and Dividends
AtMarch 31, 2021 andDecember 31, 2020 , total stockholders' equity was$166.1 million and$166.4 million , respectively. The decrease of approximately$375 thousand resulted mainly from the net change in retained earnings and other comprehensive income for the three months endedMarch 31, 2021 . Retained earnings for the first three months of 2021 increased$4.2 million and other comprehensive income decreased$4.8 million . The ratio of stockholders' equity to total assets was 8.07% and 8.93% atMarch 31, 2021 andDecember 31, 2020 , respectively.River Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Certain items such as goodwill and other intangible assets are deducted from total capital in arriving at the various regulatory capital measures such as Common Equity Tier 1 capital, Tier 1 capital, and total risk-based capital. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect onRiver Financial Corporation's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action,River Bank must meet specific capital guidelines that involve quantitative measures of the bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory regulations and guidelines.River Bank's capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. 45
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Quantitative measures, established by regulation to ensure capital adequacy effectiveJanuary 1, 2015 , requireRiver Bank to maintain minimum amounts and ratios (set forth in the table below) of total risk based capital, Common Equity Tier 1 capital, and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined in the regulations), and of Tier 1 capital (as defined in the regulations) to average assets (as defined in the regulations). Management believes, as ofMarch 31, 2021 , that the Bank meets all capital adequacy requirements to which it is subject. The following table presents the Bank's capital amounts and ratios as ofMarch 31, 2021 with the required minimum levels for capital adequacy purposes including the phase in of the capital conservation buffer under Basel III and minimum levels to be well capitalized (as defined) under the regulatory prompt corrective action regulations.
As of
To Be Well Capitalized
Required For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Regulations
Amount Ratio Amount Ratio Amount Ratio
Total Capital (To Risk-Weighted
Assets) $ 181,052 14.585 % $ 130,345 >= 10.500% $ 124,138 >= 10.00%
Common Equity Tier 1 Capital (To
Risk-Weighted Assets) 165,504 13.332 % 86,897 >= 7.000% 80,690 >= 6.50%
Tier 1 Capital (To Risk-Weighted
Assets) 165,504 13.332 % 105,517 >= 8.500% 99,310 >= 8.00%
Tier 1 Capital (To Average
Assets) 165,504 8.697 % 76,118 >= 4.000% 95,148 >= 5.00%
Management believes, as of December 31, 2020 , that the Bank met all capital
adequacy requirements to which it was subject at the time. The following table
presents the Bank's capital amounts and ratios as of December 31, 2020 with the
required minimum levels for capital adequacy purposes and minimum levels to be
well capitalized (as defined) under the prompt corrective action regulations.
As of December 31, 2020 :
To Be Well Capitalized
Required For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Regulations
Amount Ratio Amount Ratio Amount Ratio
Total Capital (To Risk-Weighted
Assets) $ 161,566 13.548 % $ 125,219 >= 10.500% $ 119,256 >= 10.00%
Common Equity Tier 1 Capital (To
Risk-Weighted Assets) 146,636 12.296 % 83,479 >= 7.000% 77,516 >= 6.50%
Tier 1 Capital (To Risk-Weighted
Assets) 146,636 12.296 % 101,368 >= 8.500% 95,405 >= 8.00%
Tier 1 Capital (To Average
Assets) 146,636 8.229 % 71,277 >= 4.000% 89,096 >= 5.00%
River Financial Corporation's principal source of funds for dividend payments
and debt service is dividends received from River Bank . There are statutory
limitations on the payment of dividends by River Bank to River Financial
Corporation . As of March 31, 2021 , the maximum amount the Bank could dividend to
River Financial Corporation without prior regulatory authority approval was
approximately $39.0 million . In addition to dividend restrictions, federal
statutes prohibit unsecured loans from banks to bank holding companies.
During the three months ending March 31, 2021 there were 2,500 incentive stock
options issued with a weighted average exercise price of $26.23 per share.
During the same period, there were 3,950 incentive stock options exercised at a
weighted average exercise price of $15.25 per share. A total of 395,800
incentive stock options were outstanding as of March 31, 2021 with a weighted
average exercise price of $22.50 per share and a weighted average remaining life
of 6.50 years.
Interest Sensitivity and Market Risk
Management monitors and manages the pricing and maturity of our assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on net interest income. The principal monitoring technique employed by the Bank is simulation analysis.
In simulation analysis, we review each asset and liability category and its
projected behavior in various different interest rate environments. These
projected behaviors are based on management's past experience and on current
competitive environments, including the various environments in the different
markets in which we compete. Using projected behavior and differing rate
scenarios as inputs, the simulation analysis generates projections of net
interest income. We also periodically verify the validity of this approach by
comparing actual results with those that were projected in previous models.
46
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Another technique used in interest rate management, but to a lesser degree than
simulation analysis, is the measurement of the interest sensitivity "gap", which
is the positive or negative dollar difference between assets and liabilities
that are subject to interest rate repricing within a given period of time.
Interest rate sensitivity can be managed by repricing assets and liabilities,
selling securities available for sale, replacing an asset or liability at
maturity or by adjusting the interest rate during the life of an asset or
liability.
We evaluate interest rate sensitivity risk and then formulate guidelines
regarding asset generation and repricing, and sources and prices of off-balance
sheet commitments in order to maintain interest sensitivity risk at levels
deemed prudent by management. We use computer simulations to measure the net
income effect of various rate scenarios. The modeling reflects interest rate
changes and the related impact on net income over specified periods of time.
The following table illustrates our interest rate sensitivity at
0-1 Mos 1-3 Mos 3-12 Mos 1-2 Yrs 2-3 Yrs >3 Yrs Total
Interest earning assets
Loans $ 235,914 $ 106,272 $ 310,645 $ 161,596 $ 116,042 $ 281,841 $ 1,212,310
Securities 15,441 26,893 95,880 94,264 57,426 354,023 643,927
Certificates of deposit in
banks - 951 245 743 1,990 226 4,155
Cash balances in banks 46,630 - - - - - 46,630
Federal funds sold 11,500 - - - - - 11,500
Total interest earning assets
Interest bearing liabilities Interest bearing transaction accounts$ 177,527 $ 6,206 $ 27,924 $ 37,232 $ 37,232 $ 149,938 $ 436,059 Savings and money market accounts 342,634 7,942 35,736 47,649 47,649 116,216 597,826 Time deposits 22,539 31,679 172,489 22,092 10,093 25,203 284,095 Securities sold under agreements to repurchase 13,451 - - - - - 13,451 Subordinated debentures, net of loan costs - - - - - 39,298 39,298 Total interest bearing liabilities$ 556,151 $ 45,827 $ 236,149 $ 106,973 $ 94,974 $ 330,655 $ 1,370,729 Interest sensitive gap Period gap$ (246,666 ) $ 88,289 $ 170,621 $ 149,630 $ 80,484 $ 305,435 $ 547,793 Cumulative gap$ (246,666 ) $ (158,377 ) $ 12,244 $ 161,874 $ 242,358 $ 547,793 Cumulative gap - Rate Sensitive Assets/ Rate Sensitive Liabilities -12.9 % -8.3 % 0.6 % 8.4 % 12.6 % 28.6 % The Bank generally benefits from increasing market interest rates when it has an asset-sensitive gap (a positive number) and generally benefits from decreasing market interest rates when it is liability sensitive (a negative number). As shown in the table above, the Bank is liability sensitive on a cumulative basis throughout the one year time frame. The interest sensitivity analysis presents only a static view of the timing and repricing opportunities, without taking into consideration that changes in interest rates do not affect all assets and liabilities equally. For example, rates paid on a substantial portion of core deposits may change contractually within a relatively short time frame, but those are viewed by management as significantly less interest sensitive than market-based rates such as those paid on non-core deposits. For this and other reasons, management relies more upon the simulations analysis (as noted above) in managing interest rate risk. Net interest income may be impacted by other significant factors in a given interest rate environment, including changes in volume and mix of interest earning assets and interest bearing liabilities. The Bank's earnings are dependent, to a large degree, on its net interest income, which is the difference between interest income earned on all interest earning assets, primarily loans and securities, and interest paid on all interest bearing liabilities, primarily deposits. Market risk is the risk of loss from adverse changes in market prices and interest rates. Our market risk arises primarily from inherent interest rate risk in our lending, investing and deposit gathering activities. We seek to reduce our exposure to market risk through actively monitoring and managing interest rate risk. Management relies on simulations analysis to evaluate the impact of varying levels of prevailing interest rates and the sensitivity of specific earning assets and interest bearing liabilities to changes in those prevailing rates. Simulation analysis consists of evaluating the impact on net interest income given changes from 400 basis points below the current prevailing rates to 400 basis points above current prevailing interest rates. Management makes certain assumptions as to the effect varying levels of interest rates have on certain interest earning assets and interest bearing liabilities, which assumptions consider both historical experience and consensus estimates of outside sources. 47 -------------------------------------------------------------------------------- The following table illustrates the results of our simulation analysis to determine the extent to which market risk would affect net interest income for the next twelve months if prevailing interest rates increased or decreased by the specified amounts from current rates. As noted above, this model uses estimates and assumptions in asset and liability account rate reactions to changes in prevailing interest rates. However, to isolate the market risk inherent in the balance sheet, the model assumes that no growth in the balance sheet occurs during the projection period. This model also assumes an immediate and parallel shift in interest rates, which would result in no change in the shape or slope of the interest rate yield curve. Because of the inherent use of the estimates and assumptions in the simulation model to derive this market risk information, the actual results of the future impact of market risk on our net interest income may differ from that found in the table. Given the current level of prevailing interest rates, management believes prevailing market rates falling 300 basis points and 400 basis points are not reasonable assumptions. All other simulated prevailing interest rates changes modeled indicate a level of sensitivity of the Bank's net interest income to those changes that is acceptable to management and within established Bank policy limits as of both dates shown. Impact on net interest income As of As of March 31, 2021 December 31, 2020
Change in prevailing rates:
+ 400 basis points (8.62 )% (7.80 )%
+ 300 basis points (5.68 )% (5.16 )%
+ 200 basis points (3.47 )% (3.53 )%
+ 100 basis points (1.95 )% (2.19 )%
+ 0 basis points - -
- 100 basis points (1.00 )% 1.57 %
- 200 basis points (1.59 )% 1.44 %
- 300 basis points (1.69 )% 1.35 %
- 400 basis points (1.74 )% 1.30 %
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