TC BANCSHARES, INC. The following discussion provides additional information regarding our results of operations and financial condition for the years endingDecember 31, 2022 and 2021, and should be read in conjunction with our consolidated financial statements and the related notes, which appear beginning in Item 8 of this report. Historical results of operations and the percentage relationships among any amounts included, and any trends that may appear, may not indicate trends in operations or results of operations for any future periods. We have made, and will continue to make, various forward-looking statements with respect to financial and business matters. Comments regarding our business that are not historical facts are considered forward-looking statements that involve inherent risks and uncertainties. Actual results may differ materially from those contained in these forward-looking statements. For additional information regarding our cautionary disclosures, see the "Cautionary Note Regarding Forward-Looking Statements" at the beginning of this annual report.
Recent Mutual-to-Stock Conversion and Reorganization
The Company, aGeorgia corporation, was formed onMarch 5, 2021 to serve as the savings and loan holding company for the Bank. The Bank is a federally chartered savings bank headquartered inThomasville, Georgia that has served the banking needs of our customers since 1934. OnJuly 20, 2021 , the Bank completed a mutual-to-stock conversion in a series of transactions by which it reorganized its corporate structure from a mutual savings bank to a federal stock savings bank, and became a wholly-owned subsidiary of the Company. In connection with the reorganization and conversion, the Company sold 4,898,350 shares of its common stock at a price of$10.00 per share, which we refer to as the "stock offering," and onJuly 21, 2021 , the Company's common stock commenced trading on theNASDAQ Stock Market under the symbol "TCBC." Before the reorganization and conversion, the Company conducted no operations other than organizational activities. In this annual report, unless the context indicates otherwise, all references to "we," "us" and "our" refer to the Company and the Bank, except that if the discussions relate to a period beforeJuly 20, 2021 , these terms refer solely to the Bank.
Recent Banking Events
There were two significant bank failures in the first part ofMarch 2023 , primarily due to the failed banks' lack of liquidity as depositors sought to withdraw their deposits. Due to rising interest rates, the failed banks were unable to sell investment securities held to meet liquidity needs without realizing substantial losses. As a result of theMarch 2023 bank closures and in an effort to strengthen public confidence in the banking system and protect depositors, regulators have announced that any losses to theDeposit Insurance Fund to support uninsured depositors will be recovered by a special assessment on banks, as required by law, which could increase the cost of ourFDIC insurance assessments. Additionally, theFederal Reserve announced the creation of a new Bank Term Funding Program in an effort to minimize the need for banks to sell securities at a loss in times of stress. The future impact of these failures on the economy, financial institutions and their depositors, as well as any governmental regulatory responses or actions resulting from the same, is difficult to predict at this time.
Overview
We are a full service community bank that provides a variety of services to individual and commercial accounts in our market areas. Our business consists primarily of taking deposits from the general public and investing those deposits, together with funds generated from our operations, in one-to-four family residential real estate loans, commercial and multi-family residential real estate loans, commercial and industrial loans, construction and land development loans and consumer loans. AtDecember 31, 2022 , we had total assets of$429.6 million , loans, net of the allowance for loan losses and deferred fees, of$334.1 million , total deposits of$328.8 million and total stockholders' equity of$85.3 million . During 2019, the Bank elected to be treated as a "covered savings association" which allows us to engage in the same activities as a national bank. Our primary deposit products are personal checking accounts, business checking accounts, savings accounts, money market accounts and certificates of deposit. Our lending products include single-family residential loans, construction loans, land development loans and SBA/USDA guaranteed loans. We expect to continue to focus on originating one-to-four family residential real estate loans, commercial and multi-family residential real estate loans, commercial and industrial loans, construction and land development loans and consumer loans. Although in recent years, we have increased our focus, consistent with what we believe to be conservative underwriting standards, on originating higher yielding commercial real estate and commercial and industrial loans. 40 -------------------------------------------------------------------------------- We also invest in securities, which have historically consisted primarily of mortgage-backed securities issued byU.S. government sponsored enterprises but in 2021 and 2022 we also invested inU.S. treasuries and municipal bonds. In recent years, we have originated single-family owner-occupied loans for sale into the secondary market and for our own portfolio. We intend to continue this activity in the future. As a general matter, our interest-bearing liabilities reprice or mature more quickly than our interest-earning assets, which can result in interest expense increasing more rapidly than increases in interest income as interest rates increase. Therefore, increases in interest rates may adversely affect our net interest income and net economic value, which in turn would likely have an adverse effect on our results of operations. To help manage interest rate risk, we promote core deposit products and we are continuing to diversify our loan portfolio by adding more commercial-related loans. We will seek to continue to increase our core checking accounts during 2023.
Business Strategy
Our goal is to provide long-term value to our stockholders, depositors, customers, employees and the communities we serve by executing a safe and sound business strategy that produces increasing earnings. We believe there is a significant opportunity for a community-focused bank to provide a full range of financial services to commercial and retail customers in our market areas, and we believe that the increased capital resulting from the completion of our stock offering enables us to compete more effectively with other financial institutions.
Our current business strategy consists of the following:
•
Leverage the infrastructure of the Bank to create additional value for depositors, employees, customers and the communities in which we operate. We seek to improve our operating efficiency as we optimize a new core processing system that was implemented in 2020 in order to enhance service features for both retail and business customers, and continue the process improvements implemented over the last two years. Our efficiency ratio has gradually improved from 91.2% for the year endedDecember 31, 2020 to 76.7% as ofDecember 31, 2021 , before regressing slightly to 82.7% as ofDecember 31, 2022 . Based on the personnel and systems now in place, we believe we can continue our trend of improving our operational efficiency, particularly as we are able to utilize the capital raised in the stock offering to grow assets and increase top line revenue. The increase in 2022 was related to the expense that accompanied the implementation of the stockholder approved management incentive plans. During 2022, the Bank opened a new commercial lending LPO in theJacksonville market. Currently the Bank is in the process of launching new retail locations inSavannah, Georgia andJacksonville, Florida . Both new branch locations are scheduled to open during the second quarter of 2023. Additionally, management foresees the opportunity to add an additional branch inTallahassee, Florida with possible further expansion in bothSavannah, Georgia andJacksonville, Florida .
Our core processing system conversion was completed in late 2020 which we believe improved our competitive position with constituencies that demand digital access to accounts for the movement of money through expanded capability made available in the new core processing system.
•
Grow our loan portfolio prudently. We intend to continue to maintain a diversified portfolio of loans, with an emphasis on commercial and multi-family real estate loans and residential mortgage loans. We expect to be able to continue to grow our loan portfolio, having grown our outstanding loans$67.8 million , or 25.5%, from year-end 2021, and$3.9 million , or 1.5%, and from year-end 2020 through year-end 2021. We intend to continue to grow our commercial lending activities through government sponsored loan programs, such as the SBA andUSDA loan programs. Through our residential mortgage office inTallahassee , we will continue to seek to originate residential loans for our portfolio as well as for sale in the secondary market, using multiple correspondent relationships for the sale of residential mortgages on a servicing-released basis. Residential lending introduces new customer relationships to the Bank and provides an opportunity for us to offer additional banking services to those clients. For much of the Bank's existence as a federal savings bank, our loan portfolio focused on residential mortgage lending. However, in the first decade of the 2000's, we expanded our loan product mix and now have a diversified mix of one-to- four family residential real estate loans, commercial and multi-family real estate loans, commercial and industrial loans, construction and land development loans and consumer loans. As ofDecember 31, 2022 , 40.2% of our loan portfolio consisted of residential real estate loans, 41.0% were commercial and multi-family real estate loans, 8.2% per construction and land development loans, 7.6% were commercial and industrial loans, 3.7% were home equity loans and 0.3% were consumer loans. Residential loans increased$37.9 million , or 27.8%, to$136.4 million as ofDecember 31, 2022 , from$98.4 million as ofDecember 31, 2021 . Commercial and multi-family real estate loans increased$26.2 million , or 23.9%, to$136.0 million as ofDecember 31, 2022 , from$109.8 million as ofDecember 31, 2021 , commercial and industrial loans increased$9.8 million , or 61.6%, to$25.7million as ofDecember 31, 2022 , from$15.9 million as ofDecember 31 , 41 --------------------------------------------------------------------------------
2021 while construction and land development loans decreased 6.5% to
•
Continue to increase core deposits. We seek to increase the proportion of our deposit base consisting of core deposits in order to provide a stable source of funds to support loan growth, at costs consistent with improving our interest rate spread and margin. Historically, we have relied heavily on certificates of deposit but in recent years we have been building a core deposit base. We have begun reducing deposit costs to market rates and by placing greater emphasis on developing core deposits. As part of our focus on commercial loan growth, our lenders are expected to seek to secure non-interest bearing business checking accounts from our borrowers. We placed greater emphasis on developing core deposits in both 2021 and 2022. As a result of these efforts, core deposits increased by$39.5 million , or 13.7%, to$328.8 million as ofDecember 31, 2022 from$289.3 million as ofDecember 31, 2021 . Management will continue to emphasize the growth of both retail and commercial core deposits. Core deposits also help us maintain loan-to-deposit ratios at levels consistent with regulatory expectations. We consider our core deposits to include checking accounts (both interest-bearing and non-interest bearing), savings accounts and money market deposit accounts. However, we will also explore utilizing non-core funding sources, such as CDARs and brokered deposits, and may use borrowings, as needed, to fund future loan growth and our operations.
•
Maintain Credit Standards while Growing. We believe strong asset quality is a critical key to our long-term financial success. Our strategy for credit risk management focuses on having an experienced team of credit professionals, well-defined policies and procedures, prudent loan underwriting criteria and active credit monitoring. Our non-performing assets to total assets ratio was 0.29% as ofDecember 31, 2022 and 0.40% atDecember 31, 2021 . Leading up to our conversion, we invested in the enhancement of our credit function by hiring additional experienced credit staff, implemented enhanced internal and external credit review processes, and implemented new technology for underwriting processing and credit analysis. We intend to maintain the high value of our credit culture, both in personnel as well as ancillary support systems, in order to be able to evaluate more complex loans and better manage credit risk, which will also support our intended loan growth, especially in the commercial loan market.
•
Supplement organic growth through opportunistic bank or branch acquisitions. Although management has no current definitive plans or commitments to acquire other institutions or financial services businesses, we expect to consider acquisition opportunities that we believe would enhance the value of our franchise and yield potential financial benefits for our stockholders. The capital we raised in our stock offering may provide us the opportunity to acquire other institutions and financial services businesses located within a reasonable proximity of our current market areas. We believe we are well positioned to take advantage of, and execute on, opportunities given the infrastructure improvements we have undertaken, including the upgrade of our core processing system and expanded management expertise.
•
Enhance the sales, marketing and service culture. We believe that loyalty is a key component of the success of community banks. We will continue to develop loyalty with our community and our customers. We will invest in customer and community relationships with the spirit of a servant's heart and servant leadership. We expect to serve customers when and how they wish to be served within the boundaries of safe and sound risk management. Our technology was significantly enhanced during 2020, including an expansion of our digital banking capabilities, as a result of our core conversion upgrade and ancillary services. We plan to continue to optimize the system for greater internal efficiencies and customer interactions. We believe the core system will allow us to materially improve the customer experience and help us facilitate greater cross selling.
•
Expand our employee base to support future growth. We plan to continue to build depth and expertise as needed with increases in our size and complexity.
Lending Operations and Accommodations to Borrowers
•
Starting inMarch 2020 , we modified the terms of loans with customers impacted by the COVID-19 pandemic to permit payment deferral. For the year endedDecember 31, 2020 , these deferrals had affected a total of$46.6 million of loans, including$4.0 million of construction loans,$2.8 million of commercial and industrial loans,$7.9 million of owner-occupied commercial real estate loans and$17.9 million of non-owner-occupied commercial real estate loans. These deferrals were intended to provide customers with temporary relief. At year-end 2020, none of the loans with modification were still on modified terms. We believe these actions provided our customers with the best chance to meet their longer-term obligations and for us to work with those who will not be able to meet their obligations or default on their loans. In 2021 and 2022, there were no COVID-19 related payment deferrals.
•
We did not automatically downgrade borrowers that requested a deferral. However, if the borrower requested a deferral that extended beyond the initial three months granted, we considered downgrades based on the trend in revenues. During 2020, we downgraded to substandard$2.1 million in loans that were placed on deferral, and combined with our other 42 --------------------------------------------------------------------------------
lending activity during the year ended
•
During 2020, as part of the PPP, we originated 307 PPP loans totaling$25.1 million . InJanuary 2021 throughMay 31, 2021 , when the PPP program ended, we originated an additional 141 PPP loans totaling$8.7 million . Payment of principal, interest and fees on PPP loans is deferred until the amount to be forgiven is finalized, in general. We were paid a processing fee by the SBA on PPP loan originations ranging from 1% to 5% of the amount of the loan, based on the size of the loans. We recorded approximately$481,000 in PPP-related SBA fees for the year endedDecember 31, 2021 , compared to$478,000 for the year endedDecember 31, 2020 , and we are accreting these fees into interest income over the estimated life of the applicable loans. If a PPP loan is forgiven or paid off before maturity, the remaining unearned fee is recognized into income at that time. As ofDecember 31, 2021 and 2022, we recognized$678,000 and$62,000 , respectively, in PPP-related SBA fees through accretion. There were no PPP loans outstanding as ofDecember 31, 2022 and all related PPP fees have been recognized into income. Critical Accounting Estimates We have adopted various accounting policies that govern the application of accounting principles generally accepted in theU.S. and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in Note 1 to our Consolidated Financial Statements as ofDecember 31, 2022 . Certain accounting policies inherently involve a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported, which could have a material impact on the carrying values of our assets and liabilities and our results of operations. We consider these accounting policies and estimates to be critical accounting policies. We have identified the determination of the allowance for loan losses and income taxes to be our significant accounting policies that require the most subjective or complex judgments and, as such, could be most subject to revision as new or additional information becomes available or circumstances change, including overall changes in the economic climate and/or market interest rates.
The following represent our significant accounting policies:
Allowance for Loan Losses. The allowance for loan losses is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio. Actual credit losses, net of recoveries, are deducted from the allowance for loan losses. Loans are charged off when the Asset Quality Committee (which consists of Board and management members) believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance for loan losses. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in the Asset Quality Committee's judgment, is adequate to absorb probable losses in the loan portfolio. The Asset Quality Committee's evaluation process used to determine the appropriateness of the allowance for loan losses is subject to the use of estimates, assumptions, and judgment. The evaluation process involves gathering and interpreting many qualitative and quantitative factors which could affect probable credit losses. Because interpretation and analysis involve judgment, current economic or business conditions can change, and future events are inherently difficult to predict, the anticipated amount of estimated loan losses and therefore the appropriateness of the allowance for loan losses could change significantly. The allocation methodology we apply is designed to assess the appropriateness of the allowance for loan losses and includes allocations for specifically identified impaired loans and loss factor allocations for all remaining loans, with a component primarily based on historical loss rates and a component primarily based on other qualitative factors. The methodology includes evaluation and consideration of several factors, such as, but not limited to, an ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and non-accrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. While the Asset Quality Committee uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions or circumstances underlying the collectability of loans. Because each of the criteria used is subject to change, the allocation of the allowance for loan losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the loan portfolio. The Asset Quality Committee believed the allowance for loan losses is appropriate atDecember 31, 2022 . The allowance analysis is reviewed by the Asset Quality Committee on a no less than quarterly basis in compliance with regulatory requirements. In addition, various regulatory agencies and our external auditors, periodically review the allowance for loan losses. As a result of such reviews, we may have to adjust our allowance for loan losses. However, regulatory agencies are not directly involved in the process of establishing the allowance for loan losses as the process is our responsibility and any increase or decrease in the allowance is the responsibility of the Asset Quality Committee. 43 -------------------------------------------------------------------------------- Income Taxes. The assessment of income tax assets and liabilities involves the use of estimates, assumptions, interpretation, and judgment concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management's current assessment, the impact of which could be significant to the results of operations and reported earnings. We file a federal and a state income tax return. Amounts provided for income tax expense are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax law rates applicable to the periods in which the differences are expected to affect taxable income. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income tax expense. Valuation allowances are established when it is more likely than not that a portion of the full amount of the deferred tax asset will not be realized. In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. We may also recognize a liability for unrecognized tax benefits from uncertain tax positions. Unrecognized tax benefits represent the differences between a tax position taken or expected to be taken in a tax return and the benefit recognized and measured in the financial statements. Penalties related to unrecognized tax benefits are classified as income tax expense.
Comparison of Financial Condition at
Total assets. Total assets increased$48.7 million , or 12.8%, to$429.6 million atDecember 31, 2022 from$380.9 million atDecember 31, 2021 . The increase was principally due to increases in net loans of$67.8 million offset by a decrease in cash and cash equivalents of$16.3 million and certificates of deposit with other banks of$1.7 million . In addition, growth in deposits of$39.5 million helped fund the loan growth along with$11.0 million borrowed from FHLB. Cash and cash equivalents. Cash and cash equivalents decreased$16.3 million , or 39.0%, to$25.5 million atDecember 31, 2022 from$41.9 million atDecember 31, 2021 . The decrease resulted primarily from an increase in loans of$67.8 million , partially offset by increases in deposits of$39.5 million and FHLB advances of$11.0 million . Total Loans. Total loans increased$68.2 million , or 25.1%, to$339.6 million atDecember 31, 2022 from to$271.4 million atDecember 31, 2021 . One-to-four family residential loans remained our largest loan category and increased$37.9 million , or 38.6%, to$136.4 million atDecember 31, 2022 from$98.4 million atDecember 31, 2021 . As a percentage of the net loan portfolio, residential real estate loans increased to 40.2% atDecember 31, 2022 from 36.3% atDecember 31, 2021 . Commercial and multi-family real estate loans also increased$26.2 million , or 23.9%, to$136.0 million from$109.8 million atDecember 31, 2021 , and commercial and industrial loans increased$9.8 million , or 61.4%, to$25.7 million atDecember 31, 2022 , from$15.9 million atDecember 31, 2021 . Construction and land development loans decreased$6.5 million to$27.9 million atDecember 31, 2022 from$34.4 million atDecember 31, 2021 . We increased our focus on commercial lending which has benefitted from the opening of our LPO inJacksonville, Florida in 2022 and from the opening of our LPO inSavannah, Georgia in 2017. Allowance for Loan Losses. Management's policy is to maintain the allowance for loan losses at a level sufficient to absorb probable losses inherent in the loan portfolio as of the balance sheet date. The allowance is increased by the provision for loan losses and decreased by charge-offs, net of recoveries. Our allowance for loan losses was$4.4 million , or 1.28% of gross loans atDecember 31, 2022 , compared to$4.2 million , or 1.54% of gross loans, atDecember 31, 2021 . During the year endedDecember 31, 2022 , there were$68,000 in charge-offs; principally the result of overdrawn deposit accounts, which were offset by$135,000 in recoveries, resulting in net recoveries of$67,000 during 2022. Combined with our other lending activities these adjustments resulted in our recording a$111,000 provision for loan losses for the year endedDecember 31, 2022 compared to$123,000 for the year endedDecember 31, 2021 . We had 15 impaired loans, totaling$1.1 million atDecember 31, 2022 , compared to 27 impaired loans, totaling$1.5 million atDecember 31, 2021 . AtDecember 31, 2022 , there were no specific reserves and$10,000 of the allowance for loan losses was unallocated. We had$67,000 in net recoveries for the year endedDecember 31, 2022 , compared to net charge-offs of$25,000 for the year endedDecember 31, 2021 . Investment securities. Investment securities, all of which are available-for-sale, and other investments decreased$1.3 million , or 2.9%, to$44.5 million atDecember 31, 2022 from$45.8 million atDecember 31, 2021 . Investment securities available-for-sale decreased$2.5 million , or 5.63% , to$43.1 million atDecember 31, 2022 from$45.6 million atDecember 31, 2021 . This decrease is due principally from the change in our unrealized loss increasing$4.5 million to$4.7 million atDecember 31, 2022 from$238,000 atDecember 31, 2021 , that was offset by purchases of investment securities available for sale of$5.8 million in 2022. We have invested excess cash in higher-yielding securities instead of lower yielding cash and cash equivalents. 44 -------------------------------------------------------------------------------- Bank Owned Life Insurance. Bank owned life insurance increased$276,000 , or 2.5%, to$11.4 million atDecember 31, 2022 , from$11.2 million atDecember 31, 2021 . We invest in bank owned life insurance to provide us with a funding offset for our benefit plan obligations. Bank owned life insurance also generally provides us noninterest income that is non-taxable. Deposits. Total deposits increased$39.5 million , or 13.7%, to$328.8 million atDecember 31, 2022 , from$289.3 million atDecember 31, 2021 . The increase was primarily due to increase in interest-bearing checking accounts, which increased$21.8 million , or 14.8%, to$168.6 million atDecember 31, 2022 , from$146.8 million atDecember 31, 2021 , and increase in certificates of deposit of$17 million , or 23.4%, to$89.5 million atDecember 31, 2022 , from$72.5 million atDecember 31, 2021 . It should be noted that$13.0 million of the certificate of deposit growth was from brokered deposits placed in the one-way buy CDARs program with IntraFi. In addition, non-interest bearing demand deposits increased$3.2 million , or 8.9%, to$39.2 million atDecember 31, 2022 , from$35.9 million atDecember 31, 2021 . Only our savings accounts decreased$2.4 million , or 7.2%, to$31.6 million atDecember 31, 2022 , from$34.0 million atDecember 31, 2021 . The growth in deposits generally represented continued business growth, including deposits placed remotely fromSavannah andJacksonville from customers interested in the Bank's planned expansion into those markets. Federal Home Loan Bank Advances. We had$11 million outstanding in advances from FHLB atDecember 31, 2022 , and no outstanding advances atDecember 31, 2021 . We began borrowing from FHLB under their daily rate credit program inNovember 2022 to fund our strong long growth of$22.9 million in the fourth quarter of 2022. Stockholders' Equity. Total stockholders' equity decreased$1.5 million , or 1.8%, to$85.3 million atDecember 31, 2022 , from$86.8 million atDecember 31, 2021 . This decrease resulted primarily from the$2.7 million decrease in our accumulated other comprehensive losses, of which$3.4 million was from decrease in unrealized losses on securities available for sale offset by the$675,000 decrease in our post-retirement obligation, net of taxes. The unrealized loss on our securities available for sale are not from credit losses but from the change in interest rates as theFOMC increased the federal funds rate 425 basis points, from 0.25% atJanuary 1, 2022 , to 4.25%, atDecember 31, 2022 . During 2022, the Company purchased 75,172 shares of our common stock for$1.1 million , which is reflected as treasury stock. InDecember 2022 , the Company implemented the Equity Incentive Plan, which resulted in an increase in additional paid in capital of$2.6 million , or 5.6%, to$50.1 million atDecember 31, 2022 , from$47.5 million atDecember 31, 2021 as well as a restricted stock adjustment of ($1.9 million ). Also, net income of$1.1 million increased stockholders' equity which was partially offset by the dividends declared of$0.10 per share, or total of$497,000 of which$252,000 was paid to stockholders inJanuary 2023 .
Comparison of Operating Results for the Years Ended
General. Net income decreased$880,000 , or 33.3%, to$1.8 million for the year endedDecember 31, 2022 , compared to$2.6 million for the year endedDecember 31, 2021 . The decrease was due to a decrease in other income and an increase in other expenses partially offset by an increase in net interest income, as described in more detail below. 45 -------------------------------------------------------------------------------- Interest Income. Interest income increased$2.0 million , or 2.9%, to$15.4 million for the year endedDecember 31, 2022 , from$13.5 million for the year endedDecember 31, 2021 . The increase was due primarily to a$1.2 million , or 9.3%, increase in interest income on loans, which is our primary source of interest income. Interest income on investment securities and interest earning deposits also increased$424,000 and$359,000 , respectively. Our average balance of loans, including loans held for sale, increased$34.0 million , or 12.7%, to$301.6 million for the year endedDecember 31, 2022 , from$267.5 million for the year endedDecember 31, 2021 . Our average yield on loans decreased 14 basis points to 4.65% for the year endedDecember 31, 2022 from 4.79% for the year endedDecember 31, 2021 , as less in deferred fees were recognized in 2022 than in 2021 as the majority of our PPP loans were paid off in 2021. Our average interest-earning deposits decreased$20.9 million , or 35.4%, to$38.2 million for the year endedDecember 31, 2022 , from$59.1 million for the year endedDecember 31, 2021 . The average yield on our interest-earning deposits increased 110 basis points, or 354.9%, to 1.41% for the year endedDecember 31, 2022 from 0.31% for the year endedDecember 31, 2021 . Our securities average balance increased$16.4 million , or 56.0%, to$45.7 million for the year endedDecember 31, 2022 , from$29.3 million for the year endedDecember 31, 2021 . The average yield on our securities increased 39 basis points, or 26.0%, to 1.89% for the year endedDecember 31, 2022 from 1.50% for the year endedDecember 31, 2021 . Interest Expense. Interest expense increased$340,000 , or 33.4%, to$1.4 million for the year endedDecember 31, 2022 compared to$1.0 million for the year endedDecember 31, 2021 , due primarily to an increase in interest expense on deposits due to higher interest rates that were offered after theFOMC raised federal funds rates in 2022. Specifically, interest expense on savings and money market accounts increased$508,000 , or 189.6%, to$776,000 for the year endedDecember 31, 2022 , from$268,000 for the year endedDecember 31, 2021 resulting from primarily an increase in rates. The average rate paid on our savings and money market accounts increased 37 bps to 0.57% for the year endedDecember 31, 2022 from 0.20% for the year endedDecember 31, 2021 . Interest expense on certificates of deposit decreased$211,000 , or 31.2%, to$451,000 for the year endedDecember 31, 2022 , from$662,000 for the year endedDecember 31, 2021 . The average balance outstanding of our certificates of deposit did decrease$4.2 million , or 5.3%, to$74.6 million for the year endedDecember 31, 2022 , from$78.8 million for the year endedDecember 31, 2021 . Net Interest Income. Net interest income increased$1.7 million , or 13.5%, to$14.0 million for the year endedDecember 31, 2022 from$12.4 million for the year endedDecember 31, 2021 , primarily as a result of a higher balance of net interest-earning assets and, to a lesser extent, a higher net interest margin. Our average interest-earning assets increased by$29.9 million , or 8.4%, to$386.3 million for the year endedDecember 31, 2022 , from$356.4 million for the year endedDecember 31, 2021 , due primarily to a$34.1 million increase in the average balances of our loan portfolio and a$16.5 million increase in our average securities. Our net interest rate spread increased by 10 basis points to 3.50% for the year endedDecember 31, 2022 from 3.40% for the year endedDecember 31, 2021 . Our net interest margin increased by 16 basis points to 3.65% for the year endedDecember 31, 2022 from 3.49% for the year endedDecember 31, 2021 , reflecting primarily the increase in the average balance of interest-earning assets combined with the increase in our yield on interest-earning assets.
Average Balances, Interest and Average Yields/Cost
The following tables set forth for the periods indicated, information regarding
average balances of assets and liabilities as well as the total dollar amounts
of interest income from average interest-earning assets and interest expense on
average interest-bearing liabilities, resultant yields, interest rate spread,
net interest margin (otherwise known as net yield on interest-earning assets),
and the ratio of average interest-earning assets to average interest-bearing
liabilities. All average balances are daily average balances. Non-accruing loans
have been included in the table as loans carrying a zero yield. Loan fees are
included in interest income on loans and are not material. No tax-equivalent
yield adjustments have been made, as the effects would be immaterial.
46
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For the
twelve months ended
2022 2022 2021
Yield/rate Average Interest Average Average Interest Average
At 12-31- Balance Earned/ Yield/ Balance Earned/ Yield/
2022 Outstanding Paid Rate Outstanding Paid Rate
(Dollars in thousands)
Interest-earning
assets:
Loans receivable 4.69 % $ 301,553 $ 14,010 4.65 % $ 267,530 $ 12,823 4.79 %
Securities
available-for-sale 2.82 % 45,663 863 1.89 % 29,277 439 1.50 %
Interest-earning
deposits 4.35 % 38,208 540 1.41 % 59,147 181 0.31 %
Other interest-earning
assets 6.00 % 855 44 5.15 % 445 21 4.72 %
Total interest-earning
assets 4.47 % 386,279 15,457 4.00 % 356,399 13,464 3.78 %
Non-interest-earning
assets 21,374 19,697
Total assets $ 407,653 $ 376,096
Interest-bearing
liabilities:
Savings and money
market
accounts 1.61 % $ 136,983 776 0.57 % $ 135,666 268 0.20 %
Interest-bearing
checking
accounts 0.18 % 57,879 75 0.13 % 52,224 47 0.09 %
Certificate accounts 1.55 % 74,639 451 0.60 % 78,843 662 0.84 %
Total interest-bearing
deposits 1.30 % 269,501 1,302 0.48 % 266,733 977 0.37 %
Borrowings 4.57 % 1,299 55 4.23 % 4,736 40 0.84 %
Total interest-bearing
liabilities 1.42 % 270,800 1,357 0.50 % 271,469 1,017 0.37 %
Non-interest-bearing
liabilities 51,030 43,699
Total liabilities 321,830 315,168
Total equity 85,823 60,928
Total liabilities and
equity $ 407,653 $ 376,096
Net interest income $ 14,100 $ 12,447
Net earning assets $ 115,479 $ 84,930
Net interest rate
spread(1) 3.05 % 3.50 % 3.40 %
Net interest margin(2) 3.65 % 3.49 %
Average
interest-earning
assets to average
interest-bearing
liabilities 142.64 % 131.29 %
(1)
Net interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average rate of
interest-bearing liabilities.
(2)
Net interest margin represents net interest income divided by average total
interest-earning assets.
47
--------------------------------------------------------------------------------Rate/Volume Analysis
The following schedule presents the dollar amount of changes in interest income
and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between the changes related to
outstanding balances and that due to the changes in interest rates. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (i.e.,
changes in volume multiplied by old rate) and (ii) changes in rate (i.e.,
changes in rate multiplied by old volume). For purposes of this table, changes
attributable to both rate and volume, which cannot be segregated, have been
allocated proportionately to the change due to volume and the change due to
rate.
Year Ended
December 31,
2022 vs. 2021
Increase/
(decrease) Total
due to increase/
Volume Rate (decrease)
(In thousands)
Interest-earning assets:
Loans receivable $ 1,631 $ (444 ) $ 1,187
Securities available for sale 246 178 424
Interest-earning deposits (64 ) 423 359
Other interest-earning assets 20 3 23
Total interest-earning assets 1,833 160 1,993
Interest-bearing liabilities:
Savings and money market accounts 3 505 508
Interest-bearing checking accounts 5 23 28
Certificate accounts (36 ) (175 ) (211 )
Total interest-bearing deposits (28 ) 353 325
Borrowings (29 ) 44 15
Total interest-bearing liabilities (57 ) 397 340
Change in net interest income
Provision for Loan Losses. Provisions for loan losses are charged to operations to establish an allowance for loan losses at a level necessary to absorb known and inherent losses in our loan portfolio that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management analyzes several qualitative loan portfolio risk factors including, but not limited to, management's ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and non-accrual loans, existing risk characteristics of specific loans or loan pools, the fair value of underlying collateral, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses. See the section entitled "Critical Accounting Estimates" in this Item 7, and the section entitled "Allowance for Loan Losses" in Item 1of this report. Our allowance for loan losses was$4.4 million atDecember 31, 2022 compared to$4.2 million atDecember 31, 2021 . The allowance for loan losses to total net loans decreased to 1.28% atDecember 31, 2022 from 1.54% atDecember 31, 2021 , and the allowance for loan losses to non-performing loans decreased 223.2% to 787.4% atDecember 31, 2022 , from 1010.6% atDecember 31, 2021 . We increased the portion of the allowance for loan losses allocated to the residential loan portfolio due to the$38 million growth in this loan type due to potential for increased loan losses as we apply historical loss ratios to newly originated loans. We modestly decreased the portion of the allowance for loan losses allocated to construction and land development loans as this portfolio decreased$6.5 million , to$27.9 million atDecember 31, 2022 from$34.4 million atDecember 31, 2021 , and we also have a low loss history with respect to construction and land development loans. To the best of our knowledge, we have recorded all loan losses that are both probable and reasonable to estimate atDecember 31, 2022 . However, future changes in the factors described above, including, but not limited to, actual loss experience with respect to our loan portfolio, could result in material increases in our provision for loan losses. In addition, the OCC, as an integral part of its examination process, will periodically review our allowance for loan losses, and as a result of such reviews, we may have to adjust our allowance for loan losses. However, regulatory agencies are not directly involved in establishing the allowance for loan losses as the process is our responsibility and any increase or decrease in the allowance is the responsibility of management. 48 --------------------------------------------------------------------------------
Other Income. Non-interest income information is as follows.
For the twelve
months ended
December 31, Change
2022 2021 Amount Percent
(Dollars in thousands)
Service charges on deposit accounts
(3.6 )% Gain on sale of loans 972 2,064 (1,092 ) (52.9 )% Other 381 313 68 21.7 % Total non-interest income$ 1,908 $ 2,953 $ (1,045 ) (35.4 )% In 2022, other income decreased approximately$1.0 million from 2021, or a 35.4% decrease from the previous year. This decrease is primarily due to the sale of$49.0 million of residential mortgage loans during 2022 that generated$1.0 million in gain on sale of mortgage loans compared to the sale of$99.5 million of residential mortgage loans that generated$2.1 million in gain on sale of mortgage loans during 2021.
Other Expense. Non-interest expense information is as follows.
For the twelve
months ended
December 31, Change
2022 2021 Amount Percent
(Dollars in thousands)
Salaries and employee benefits $ 8,009 $ 7,430 $ 579 7.8 %
Occupancy and equipment 828 819 9 1.1 %
Advertising 240 269 (29 ) (10.8 )%
Audit and examination 597 436 161 36.9 %
Checking account related expenses 634 620 14 2.3 %
Consulting and advisory fees 106 202 (96 ) (47.5 )%
Data system conversion costs - 1 (1 ) (100.0 )%
Data processing fees 509 517 (8 ) (1.5 )%
Director fees 576 296 280 94.6 %
Legal 287 132 155 117.4 %
Other real estate loss/(gain) on sale
and write-downs 132 116 16 13.8 %
Other Insurance Expense 215 169 46 27.2 %
Other 1,328 806 522 64.8 %
Total non-interest expense $ 13,461 $ 11,813 $ 1,648 14.0 %
Overall, our non-interest expenses increased $1.6 million , or 14.0%, in 2022 to
$13.5 million for 2022 from $11.8 million for 2021, primarily due to the
$579,000 increase in salaries and employee benefits due principally to the
implementation of our Equity Incentive Plan of which $497,000 was expensed in
December 2022 as well as a $272,000 in deferred compensation expense. In
addition, director fees increased $280,000 , or 94.6%, due to the implementation
of our Equity Incentive Plan for directors for which $330,000 was expensed.
Legal expenses also increased $155,000 , or 117.4%, as there were additional
legal expense associated with the Equity Incentive Plan and the special
stockholder meeting held in September 2022 to approve the plan.
Income Tax Expense. We incurred income tax expense of $675,472 and $823,000 for
the years ended December 31, 2022 and 2021, respectively, resulting in effective
rates of 27.7% and 23.8%, respectively. The differences in the effective tax
rates in 2022 and 2021 and the statutory federal rate of 21% are mainly due to
fluctuations in pretax earnings, state income taxes and tax exempt income.
49
--------------------------------------------------------------------------------Management of Market Risk
General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our financial condition and results of operations to changes in market interest rates. Our Asset/Liability Management Committee is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the policy and guidelines approved by our board of directors. We currently utilize a third-party modeling program, prepared on a quarterly basis, to evaluate our sensitivity to changing interest rates, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors.
We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk:
•
growing the loan portfolio, with a focus on commercial real estate and commercial and industrial loans, in accordance with our risk appetite, while operating in a safe and sound manner;
•
increasing the diversification of our loan portfolio; and
•
growing our level of core deposits.
By following these strategies, we believe that we are better positioned to react in increased in market interest rates. Beginning in the calendar year 2020, we introduced adjustable-rate, one-to-four family residential real estate loans (in addition to our existing home equity loans and lines of credit, which are originated with adjustable interest rates). In addition, we generally only originate fixed-rate residential mortgage loans for sale into the secondary mortgage market. Net Interest Income. We analyze our sensitivity to changes in interest rates through an interest rate risk model, developed by a third-party provider. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. We estimate what our net interest income would be for a 12-month period. We then calculate what the net interest income would be for the same period under the assumptions that the United States Treasury yield curve increases instantly by up to 400 basis points or decreases instantly by up to 200 basis points, in 100 point increments, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the "Change in Interest Rates" column below.
The table below sets forth, as of
Change in Interest Rates Net Interest Income Year 1 Change
(basis points) (1) Year 1 Forecast from Level
(Dollars in thousands)
+400 $ (3,093 ) (20.10 )
+300 (2,213 ) (14.38 )
+200 (1,599 ) (10.39 )
+100 (866 ) (5.63 )
Level - -
-100 691 4.49
-200 624 4.06
(1)Assumes an immediate uniform change in interest rates at all maturities.
Economic Value of Equity. We also compute amounts by which the net present value
of our assets and liabilities (economic value of equity or "EVE") would change
in the event of a range of assumed changes in market interest rates. This model
uses a discounted cash flow analysis and an option-based pricing approach to
measure the interest rate sensitivity of net portfolio value. The model
estimates the economic value of each type of asset, liability and off-balance
sheet contract under the assumptions that the United States Treasury yield curve
increases or decreases instantaneously by 200 basis point increments, with
changes in interest rates representing immediate and permanent, parallel shifts
in the yield curve.
50
--------------------------------------------------------------------------------
The tables below set forth, as of December 31, 2022 , the estimated changes in
our EVE that would result from the designated instantaneous changes in market
interest rates. Computations of prospective effects of hypothetical interest
rate changes are based on numerous assumptions including relative levels of
market interest rates, loan prepayments and deposit decay, and should not be
relied upon as indicative of actual results.
Estimated Increase (Decrease) EVE as a Percentage of Present
in EVE value of Assets(3)
Increase
Basis Point ("bp") Change Estimated EVE (Decrease)
in Interest Rates(1) EVE(2) Amount Percent Ratio(4) (Basis Points)
(Dollars in thousands)
+400 $ 68,616 $ (19,527 ) (22.15 ) % 18.51 % (296 )
+300 74,204 (13,939 ) (15.81 ) 19.52 (195 )
+200 79,536 (8,607 ) (9.77 ) 20.39 (108 )
+100 84,280 (3,863 ) (4.38 ) 21.06 (41 )
Level 88,143 - - 21.47 -
-100 90,198 2,055 2.33 21.45 (2 )
-200 88,716 572 0.65 20.62 (85 )
(1)
Assumes an instantaneous uniform change in interest rates at all maturities.
(2)
EVE is the discounted present value of expected cash flows from assets,
liabilities and off-balance sheet contracts.
(3)
Present value of assets represents the discounted value of incoming cash flows
on interest-earning assets.
(4)
EVE Ratio represents EVE divided by the present value of assets.
The table above indicates that at December 31, 2022 , in the event of an
instantaneous parallel 200 basis point increase in interest rates, we would
experience a 9.77% decrease in economic value of equity, and in the event of an
instantaneous 200 basis point decrease in interest rates, we would experience a
0.65% increase in economic value of equity.
Certain shortcomings are inherent in the methodologies used in the above
interest rate risk measurements. Modeling changes require making certain
assumptions that may or may not reflect the manner in which actual yields and
costs respond to changes in market interest rates. In this regard, the net
interest income and economic value of equity tables presented assume that the
composition of our interest-sensitive assets and liabilities existing at the
beginning of a period remains constant over the period being measured and
assumes that a particular change in interest rates is reflected uniformly across
the yield curve regardless of the duration or repricing of specific assets and
liabilities. Accordingly, although the net interest income and EVE tables
provide an indication of our interest rate risk exposure at a particular point
in time, such measurements are not intended to and do not provide a precise
forecast of the effect of changes in market interest rates on net interest
income and EVE and will differ from actual results. Furthermore, although
certain assets and liabilities may have similar maturities or periods to
repricing, they may react in different degrees to changes in market interest
rates. Additionally, certain assets have features that restrict changes in
interest rates both on a short-term basis and over the life of the asset.
Interest rate risk calculations also may not reflect the fair values of financial instruments. For example, decreases in market interest rates can increase the fair values of our loans, deposits and borrowings.
Liquidity and Capital Resources. Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from the sale of loans, and proceeds from maturities of securities. We also have the ability to borrow from FHLB. AtDecember 31, 2022 , we had$45.4 million in borrowing capacity with FHLB, and$11 million in outstanding advances as ofDecember 31, 2022 . In addition, we have$28.5 million in unsecured federal funds lines of credit through our correspondent banks and$5.8 million secured borrowing capacity through FHLB. No amounts were outstanding on these lines of credit atDecember 31, 2022 . While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments including interest-bearing demand deposits. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period. Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities was$4.4 million and$3.9 million for the years endedDecember 31, 2022 and 2021, respectively. Net cash used in investing activities, which consists primarily of disbursements for loan originations and the purchase of securities, offset by principal collections on loans, proceeds from the sale of securities and proceeds from maturing securities and pay downs on mortgage-backed securities, was$69.6 million and$33.2 million for the years endedDecember 31, 2022 51 --------------------------------------------------------------------------------
and 2021, respectively. Net cash provided by financing activities was
We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. Based on our deposit retention experience and current pricing strategy, we anticipate that a significant portion of maturing time deposits will be retained.
At
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. AtDecember 31, 2022 , we had outstanding commitments to originate loans of$49.2 million . We anticipate that we will have sufficient funds available to meet our current lending commitments.
The following table is a summary of the total contractual amount of loan
commitments outstanding at
Year Ended December 31,
2022 2021
(Dollars in thousands)
Commitments to extend credit $ 13,057 $ 4,204
Unused lines of credit 14,870 10,348
Construction loans in process 21,262 13,652
Standby financial letters of credit 819 931
Total off-balance sheet instruments
Certificates of deposit that are scheduled to mature in less than one year fromDecember 31, 2022 totaled$76.7 million . As a result of the current interest rate environment, a significant portion of funds have moved from certificate accounts to money market accounts, which provides the customer more flexibility and liquidity. We reduced both certificates of deposit and money market account rates accordingly. Management expects that a substantial portion of the maturing certificates of deposit will be renewed. If a substantial portion of these deposits is not retained, we may utilize FHLB advances or raise interest rates on deposits to attract new deposits, which may result in higher levels of interest expense. Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include data processing services, operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities.
Recent Accounting Pronouncements
Please refer to Note 1 to the Financial Statements for the years endedDecember 31, 2022 and 2021 beginning on page F-1 for a description of recent accounting pronouncements that may affect our financial condition and results of operations. As an "emerging growth company" we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We intend to take advantage of the benefits of this extended transition period. Accordingly, our financial statements may not be comparable to companies that comply with such new or revised accounting standards.
Impact of Inflation and Changing Price
The financial statements and related data presented herein have been prepared in accordance withU.S. GAAP which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates, generally, have a more significant impact on a financial institution's performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. 52 --------------------------------------------------------------------------------
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable to smaller reporting companies.
53--------------------------------------------------------------------------------
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