UWHARRIE CAPITAL CORP A discussion and analysis of the Company's operating results and financial condition are presented in the following narrative and financial tables. The comments are intended to supplement and should be reviewed in conjunction with the consolidated financial statements and notes thereto appearing on pages F-8 through F-52 of this Annual Report. References to changes in assets and liabilities represent end-of-period balances unless otherwise noted. Statements contained in this Annual Report, which are not historical facts, are forward-looking statements, as that term is defined in the Private Securities Litigation Reform Act of 1995. Amounts herein could vary because of market and other factors. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those currently anticipated due to a number of factors, which include, but are not limited to, factors discussed in documents filed by the Company with theSecurities and Exchange Commission periodically. Such forward-looking statements may be identified by the use of such words as "believe," "expect," "anticipate," "should," "might," "planned," "estimated," "potential," and similar words. Examples of forward-looking statements include, but are not limited to, estimates with respect to the financial condition, expected or anticipated revenue, results of operations and business of the Company that are subject to various factors, which could cause actual results to differ materially from these estimates. These factors include, but are not limited to: the impacts of global health crises and pandemics, such as the Coronavirus disease 2019 ("COVID-19") pandemic, on trade (including supply chains and export levels), travel, employee productivity and other economic activities that may have a destabilizing effect on financial markets, economic activity, and customer behavior; declines in general economic conditions, including increased stress in the financial markets due to COVID-19 or other factors; changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company's operations, pricing, products and services. Any use of "we" or "our" in the following discussion refers to the Company on a consolidated basis.
Financial Condition at
The Company's total assets increased$79.8 million from$939.7 million atDecember 31, 2021 to$1.02 billion atDecember 31, 2022 . Cash and cash equivalents increased$20.2 million during the same period. This rise in total assets is related to continued customer deposit growth which served to fund a significant increase in our loans held for investment portfolio during the twelve months endedDecember 31, 2022 . Investment securities consist of securities available for sale and securities held to maturity. Total investment securities decreased$6.1 million , or 1.7%, from$361.1 million atDecember 31, 2021 to$355.0 million atDecember 31, 2022 . AtDecember 31, 2022 , the Company had unrealized losses on securities available for sale of$41.3 million , compared to net unrealized losses of$1.5 million atDecember 31, 2021 . The significant decline in fair value is directly related to the increase in market interest rates atDecember 31, 2022 compared toDecember 31, 2021 , as theU.S. Treasury yield curve reacted to substantial increases in the federal funds rate by theFederal Reserve . During 2022, the unrealized gain on equity securities decreased by$100,000 , resulting in a fair value of$292,000 atDecember 31, 2022 , compared to a fair value of$392,000 atDecember 31, 2021 . Loans held for investment increased$77.1 million , or 18.3%, from$420.8 million atDecember 31, 2021 to$497.9 million atDecember 31, 2022 . The Company experienced net growth in all loans sectors with the exception of real estate 1-4 family construction and SBA PPP loans. SBA PPP loans were issued during 2020 and 2021 as a result of the federal government's response to helping small businesses due to COVID-related issues. These loans are unsecured commercial loans, but are 100% guaranteed by the SBA if the loans comply with PPP requirements. Most of the SBA loans made have been paid off or forgiven by the SBA leaving only$545,000 outstanding. Loans held for sale decreased 87.2%, or$18.9 million , as mortgage loan production slowed drastically during 2022 in response to a rising interest rate environment.
The allowance for loan losses was
Other changes in consolidated assets are primarily related to deferred tax assets, which increased$9.0 million from$1.7 million as ofDecember 31, 2021 to$10.7 million atDecember 31, 2022 as a result of the significant decline in value of the available for sale securities portfolio. Customer deposits, our primary funding source, experienced a$103.1 million increase during the year, increasing from$836.8 million to$939.9 million atDecember 31, 2022 , a 12.3% increase. In addition to receipt of government grant funding by some depositors, a large portion of this increase is related to the overall growth in the number of deposit accounts and relationship sizes. As the Bank operates in a primarily rural market, many competitors have exited the markets where we remain, which has driven deposit growth in our current markets. Demand noninterest-bearing checking accounts increased$22.5 million , interest checking and money market 16
-------------------------------------------------------------------------------- accounts increased by$63.6 million and savings deposits increased$960,000 during the twelve-month period endedDecember 31, 2022 . Time deposits increased$16.1 million during the same period as customers took advantage of higher rates offered on promotional time deposit products. During 2022, the Company's net borrowings increased by$40,000 . Borrowings consist of both short-term and long-term borrowed funds. The Company utilizes both short-term and long-term advances from theFederal Home Loan Bank . AtDecember 31, 2022 and 2021, there were no outstanding advances. Short-term borrowings consisted of$1.0 million in master notes, and long-term borrowings consisted solely of junior subordinated debt securities totaling$29.6 million , net of unamortized debt issuance costs, atDecember 31, 2022 . During the third quarter of 2019, the Company issued$10.0 million in subordinated debt securities with a final maturity date ofSeptember 30, 2029 that may be redeemed on or afterSeptember 30, 2024 . This junior subordinated debt pays interest quarterly at an annual fixed rate of 5.25%. During the third quarter of 2021, the Company issued$12.0 million and$8.0 million of 10-year and 15-year fixed-to-floating rate subordinated debt securities, respectively. The 10-year subordinated notes mature onSeptember 3, 2031 , though redeemable on or afterSeptember 3, 2026 , and initially pay interest quarterly at an annual rate of 3.5%. From and includingSeptember 3, 2026 to but excludingSeptember 3, 2031 , or up to an early redemption date, the interest rate on the 10-year subordinated notes will reset quarterly to an annual rate equal to the then-current three-month Secured Overnight Financing Rate, or SOFR, plus 283 basis points payable quarterly in arrears. The 15-year subordinated notes mature onSeptember 3, 2036 , though redeemable on or afterSeptember 3, 2031 , and initially pay interest quarterly at an annual rate of 4.0%. From and includingSeptember 3, 2031 to but excludingSeptember 3, 2036 , or up to an early redemption date, the interest rate on the 15-year subordinated notes will reset quarterly to an annual rate equal to the then-current three-month SOFR plus 292 basis points payable quarterly in arrears. The subordinated debt has been structured to qualify as and is included in the calculation of the Company's Tier 2 capital. The Company also has a$3.0 million line of credit of which$3.0 million was available to use atDecember 31, 2022 . The valuation of mortgage banking derivatives depreciated$1.4 million , decreasing the asset position by$1.3 million and increasing the liability position by$125,000 during 2022. As rates rise, the value of mandatory mortgage forward sales commitments deteriorate, and the price required to exit out of the commitment decreases. Additionally, the value associated with Interest Rate Lock Commitments ("IRLCs") has depreciated to a liability position as market rates began to exceed interest rates committed to borrowers. AtDecember 31, 2022 , total shareholders' equity was$37.4 million , a decrease of$23.4 million fromDecember 31, 2021 . This decline is a result of unrealized losses on investment securities, net of tax, increasing by$30.6 million as the yield curve continues to steepen. Net income for the period was$8.2 million . The Company repurchased 55,982 outstanding shares of common stock at an aggregate repurchase price of$451,000 . The Company also paid$565,000 in dividends attributed to noncontrolling interest. See Note 1 (Significant Accounting Policies) to the Company's Notes to Consolidated Financial Statements for additional discussion of the noncontrolling interest. AtDecember 31, 2022 , the Company and its subsidiary bank exceeded all applicable regulatory capital requirements.
Results of Operations for the Years Ended
Earnings
Uwharrie Capital Corp reported net income of$8.2 million for the twelve months endedDecember 31, 2022 , as compared to$10.1 million for the twelve months endedDecember 31, 2021 , a decrease of$1.8 million . Net income available to common shareholders was$7.7 million , or$1.08 per common share, for the year endedDecember 31, 2022 , compared to net income available to common shareholders of$9.5 million , or$1.29 per common share, for the year endedDecember 31, 2021 . Net income available to common shareholders is net income less any dividends paid on the aforementioned noncontrolling interest.
Net Interest Income
As with most financial institutions, the primary component of earnings for our subsidiary bank is net interest income. Net interest income is the difference between interest income, principally from the loan and investment securities portfolios, and interest expense, principally on customer deposits and wholesale borrowings. Changes in net interest income result from changes in volume, spread and margin. For this purpose, volume refers to the average dollar level of interest-earning assets and interest-bearing liabilities, spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, and margin refers to net interest income divided by average interest-earning assets. Margin is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities, as well as levels of noninterest bearing liabilities and capital. Net interest income increased$1.7 million to a total of$27.7 million for the twelve months endedDecember 31, 2022 from the$26.1 million earned in the same period of 2021. The average yield on our interest-earning assets decreased 5 basis points to 3.37%, while the average rate paid for interest-bearing liabilities increased 29 basis points. These changes resulted in a net decrease of 34 basis points in our interest rate spread, from 3.14% in 2021 to 2.80% in 2022. Our net interest margin for 2022 was 2.97%, compared to 17 -------------------------------------------------------------------------------- 3.23% in 2021. As a part of the loan agreements, a portion of the Company's loan portfolio has interest rate floors and caps. The interest rate floor feature allows the Company to maintain a more favorable interest margin despite a decline in rates; however, the interest rate cap could hurt the margin in a rising rate environment. Financial Table 1 presents a detailed analysis of the components of the Company's net interest income, while Financial Table 2 summarizes the effects on net interest income from changes in interest rates and in the dollar volume of the components of interest-earning assets and interest-bearing liabilities. Financial Table 1 and Table 2, as well other Financial Tables referenced here appear at the end of this discussion and analysis.
Recovery of Loan Losses
The recovery of loan losses was$1.8 million for the twelve months endedDecember 31, 2022 , compared to a recovery of$917,000 for the same period in 2021. There were net loan recoveries of$23,000 for the twelve months endedDecember 31, 2022 , as compared to net loan recoveries of$541,000 during the same period of 2021. Refer to the Asset Quality section below for further information.
Noninterest Income
The Company generates most of its revenue from net interest income; however, diversification of our earnings base is a key strategic initiative to our long-term success. Noninterest income decreased 46.5%, from$18.9 million in 2021, to$10.1 million in 2022, a decrease of$8.8 million . The primary factor contributing to the overall decline in noninterest income was a decrease of$7.9 million in income from mortgage banking. This decrease is due to the significant reduction in production, primarily mortgage refinancing activity, as interest rates rose steadily during 2022. The gain on sale of securities decreased by$1.1 million to a loss of$91,000 atDecember 31, 2022 , compared to a gain of$991,000 atDecember 31, 2021 as the Company worked during 2021 to reduce duration of the investment portfolio in an attempt to protect capital as long-term interest rates rose. Negative market adjustments of supplemental executive retirement plans contributed$1.2 million to the reduction in total noninterest income. Income from bank owned life insurance increased$1.0 million during the twelve months endedDecember 31, 2022 from insurance proceeds received due to the death of an insured retired executive.
Noninterest Expense
Noninterest expense for the year endedDecember 31, 2022 was$29.7 million compared to$33.1 million for 2021, a decrease of$3.4 million . Salaries and employee benefits, the largest component of noninterest expense, decreased$2.0 million , from$21.6 million for the period endingDecember 31, 2021 to$19.7 million for 2022 due to decreased commissions from reduced production in the mortgage division. Negative market adjustments of supplemental executive retirement plans contributed$1.2 million to the reduction in total noninterest expense. Financial Table 5 reflects the additional breakdown of other noninterest expense.
Income Tax Expense
The Company had income tax expense of$1.7 million for 2022 at an effective tax rate of 17.13% compared to income tax expense of$2.8 million in 2021 with an effective tax rate of 21.51%. Income taxes computed at the statutory rate are affected primarily by the eligible amount of interest earned on state and municipal securities, tax-free municipal loans and income earned on bank owned life insurance. For the twelve months endedDecember 31, 2022 , the effective tax rate decreased due to proceeds received from the payout of a bank owned life insurance policy.
Results of Operations for the Years Ended
Results of operations for the years ended
18
--------------------------------------------------------------------------------Asset Quality
The Company's allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. The allowance is increased by provisions charged to operations and recoveries of amounts previously charged off and is reduced by recovery of provisions and loans charged off. Management continuously evaluates the adequacy of the allowance for loan losses. In evaluating the adequacy of the allowance, management considers the following: the growth, composition and industry diversification of the portfolio; historical loan loss experience; current delinquency levels; adverse situations that may affect a borrower's ability to repay; estimated value of any underlying collateral; prevailing economic conditions; and other relevant factors. The Company's credit administration function, through a review process, periodically validates the accuracy of the initial risk grade assessment. In addition, as a given loan's credit quality improves or deteriorates, the credit administration department has the responsibility to change the borrower's risk grade accordingly. For loans determined to be impaired, the allowance is based on either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the underlying collateral less the selling costs. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, which may be susceptible to significant change. In addition, regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require additions for estimated losses based upon judgments different from those of management. Management uses a risk-grading program designed to evaluate the credit risk in the loan portfolio. In this program, risk grades are initially assigned by loan officers then reviewed and monitored by credit administration. This process includes the maintenance of an internally classified loan list that is designed to help management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower's ability to repay, the borrower's payment history, and the current delinquent status. Because of this process, certain loans are deemed to be impaired and evaluated as an impaired loan. The portion of the Company's allowance for loan loss model related to general reserves captures the mean loss of individual loans within the loan portfolio and adds additional loss based on economic uncertainty and specific indicators of potential issues in the market. Specifically, the Company calculates probable losses on loans by computing a probability of loss and multiplying that by a loss given default derived from historical experience. An additional calculation based on economic uncertainty is added to the probable losses, thus deriving the estimated loss scenario byFDIC call report codes. Together, these expected components, as well as a reserve for qualitative factors based on current economic conditions determined at management's discretion, form the basis of the allowance model. The loans that are impaired and included in the specific reserve are excluded from these calculations. The Company assesses the probability of losses inherent in the loan portfolio using probability of default data derived from the Company's internal historical data, representing a one-year loss horizon for each obligor. Credit scores are used within the model to determine the probability of default. The Company updates the credit scores for individuals that either have a loan, or are financially responsible for the loan, semi-annually, during the first and third quarters. During 2022, the average effective credit score of the portfolio, excluding loans in default, increased slightly from 767 to 771. The probability of default associated with each credit score is a major driver in the allowance for loan losses. The allowance for loan losses represents management's best estimate of an appropriate amount to provide for probable credit risk inherent in the loan portfolio in the normal course of business. While management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ from the assumptions used in making the determinations. Furthermore, while management believes it has established the allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that banking regulators, in reviewing the Company's portfolio, will not require an adjustment to the allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary, should the quality of any loans deteriorate because of the factors discussed herein. Unexpected global events, such as the unprecedented economic disruption due to COVID-19, are the type of future events that often cause material adjustments to the allowance to be necessary. Any material increase in the allowance for loan losses may adversely affect the Company's financial condition, results of operations and the value of its securities. AtDecember 31, 2022 , the levels of our impaired loans, which includes all loans in non-accrual status, TDRs, and other loans deemed by management to be impaired, were$3.1 million , compared to$4.7 million atDecember 31, 2021 , a net decrease of$1.6 million . The decrease is related to two large impaired loans paying off during 2022. Total non-accrual loans decreased from$972,000 atDecember 31, 2021 to$399,000 atDecember 31, 2022 . During 2022, four loans totaling$783,000 were added to impaired loans; however, eleven loans totaling$2.3 million were paid off. We also received net pay downs of$154,000 . 19 -------------------------------------------------------------------------------- The allowance, expressed as a percentage of gross loans held for investment, decreased fifty basis points from 0.96% atDecember 31, 2021 to 0.46% atDecember 31, 2022 . The collectively evaluated allowance as a percentage of collectively evaluated loans was 0.92% atDecember 31, 2021 , compared to 0.43% atDecember 31, 2022 . The decrease is attributable to continued improvement in probability of defaults of the portfolio as impacted by external economic factors. InDecember 2019 , prior to the global COVID-19 pandemic, our collectively evaluated allowance as a percentage of collectively evaluated loans was 0.55%. Due to COVID-19 impacts to the global economy and the uncertainty within our economic markets, our allowance for loan loss model indicated a need for additional reserves due to external factors that are more likely to indicate losses for the loan portfolio. By the end of 2020, the collectively evaluated allowance as a percentage of collectively evaluated loans increased to 0.94%. The model results as ofDecember 31, 2022 reflect the Company's risk in the loan portfolio based on economic indicators of default applicable to our loan portfolio, primarily associated with NC unemployment and the NC-Charlotte region Case Shiller index. Signs of asset quality improvements support reduced reserves as impaired loans fell to an all-time low of$2.9 million and non-accrual loans fell to their all-time low of$201,000 during the third quarter of 2022. The individually evaluated allowance as a percentage of individually evaluated loans increased from 4.54% to 5.64% for the same periods, mainly due to the payoff of one large relationship with small reserves associated due to changes in collateral values.
The ratio of nonperforming loans, which consists of non-accrual loans and loans
past due 90 days and still accruing, to total loans decreased from 0.23% at
Troubled debt restructured loans, included in impaired loans, totaled$2.8 million atDecember 31, 2022 , compared to$3.8 million atDecember 31, 2021 . AtDecember 31, 2021 , there were two troubled debt restructured loan in non-accrual status with balances totaling$52,000 .
Other real estate owned remained at
As of
The following table shows the comparison of nonperforming assets as ofDecember 31, 2022 and 2021: Nonperforming Assets (dollars in thousands) AtDecember 31, 2022 2021
Nonperforming Assets: Accruing loans past due 90 days or more $ - $ - Non-accrual loans
399 972
Other real estate owned - -
Total nonperforming assets $ 399 $ 972
Allowance for loan losses $ 2,290 $ 4,026
Non-accrual loans to total loans 0.08 % 0.23 %
Allowance for loan losses to total loans 0.46 % 0.96 %
Allowance for loan losses to non-accrual loans 573.93 % 414.20 %
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--------------------------------------------------------------------------------Capital Resources
The Company continues to maintain capital ratios intended to support its asset growth. The federal bank regulatory agencies have implemented regulatory capital rules known as "Basel III." The Basel III rules require a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.50%, a minimum ratio of Tier 1 capital to risk-weighted assets of 6.00%, a minimum ratio of total capital to risk-weighted assets of 8.00%, and a minimum Tier 1 leverage ratio of 4.00%. There is also a capital conservation buffer that requires banks to hold common equity Tier 1 capital in excess of minimum risk-based capital ratios by at least 2.5% to avoid limits on capital distributions and certain discretionary bonus payments to executive officers and similar employees. The Company's accumulated other comprehensive income or loss, resulting from unrealized gains and losses, net of income tax, on investment securities available for sale, is excluded from regulatory capital. The phase-in period for the rules became effective for the Company and its subsidiary bank onJanuary 1, 2015 , with full compliance of all the rules' requirements phased in over a multi-year schedule, becoming fully phased-in onJanuary 1, 2019 . Pursuant to theFederal Reserve's Small Bank Holding Company Policy Statement, the Company is exempt from Basel III. As ofDecember 31, 2022 , the Company and its subsidiary bank continue to exceed minimum capital standards and remain well-capitalized under applicable capital adequacy rules. InJanuary 2013 , the Company's subsidiary bank issued$7.9 million of Fixed Rate Noncumulative Perpetual Preferred Stock, Series B. The preferred stock qualifies as Tier 1 capital at the bank and pays dividends at a rate of 5.30%. The offering raised$7.9 million less issuance costs of$113,000 . During the third quarter of 2013, the Company's subsidiary bank raised an additional$2.8 million of Fixed Rate Noncumulative Perpetual Preferred Stock, Series C. The preferred stock qualifies as Tier 1 capital at the bank and pays dividends at an annual rate of 5.30%. The preferred stock has no voting rights. The offering raised net proceeds of$2.8 million less issuance costs of$23,000 . During the third quarter of 2019, the Company conducted a private placement offering of fixed rate junior subordinated debt securities at$1,000 per security with a required minimum investment of$50,000 . The offering raised$10.0 million , of which the entire$10.0 million was outstanding atDecember 31, 2022 . These securities have a final maturity date ofSeptember 30, 2029 and may be redeemed by the Company afterSeptember 30, 2024 . The junior subordinated debt pays interest quarterly at an annual fixed rate of 5.25%. All proceeds of this private placement qualify and are included in the calculation of Tier 2 capital. Once the final maturity drops under five years, the Company must impose a twenty percent annual reduction per year of the amount of the proceeds from the sale of these securities that are eligible to be counted as Tier 2 capital. The Company will have a twenty percent reduction beginning atSeptember 30, 2024 . During the third quarter of 2021, the Company issued$12.0 million and$8.0 million of 10-year and 15-year fixed-to-floating rate subordinated debt securities, respectively. The 10-year subordinated notes mature onSeptember 3, 2031 and are redeemable on or afterSeptember 3, 2026 , and initially pay interest quarterly at an annual rate of 3.5%. From and includingSeptember 3, 2026 to but excludingSeptember 3, 2031 , or up to an early redemption date, the interest rate on the 10-year subordinated notes will reset quarterly to an annual rate equal to the then-current three-month SOFR plus 283 basis points payable quarterly in arrears. The 15-year subordinated notes mature onSeptember 3, 2036 , though redeemable on or afterSeptember 3, 2031 , and initially pay interest quarterly at an annual rate of 4.0%. From and includingSeptember 3, 2031 to but excludingSeptember 3, 2036 , or up to an early redemption date, the interest rate on the 15-year subordinated notes will reset quarterly to an annual rate equal to the then-current three-month SOFR plus 292 basis points payable quarterly in arrears. The subordinated debt has been structured to qualify as and is included in the calculation of the Company's Tier 2 capital. Once the remaining term to maturity drops under five years, the Company must impose a twenty percent annual reduction per year of the amount of the proceeds from the sale of these securities that are eligible to be counted as Tier 2 capital. The Company will have a twenty percent reduction beginning atSeptember 3, 2026 andSeptember 3, 2031 for the 10-year and 15-year subordinated notes, respectively. Proceeds of the Company's aforementioned securities that have been invested in its subsidiary bank qualify for Tier 1 capital treatment for the Bank and are included as such in its year end capital ratios.
The Company expects to continue to exceed required minimum capital ratios without altering current operations or strategy. Note 15 (Shareholders' Equity and Regulatory Matters) to the Notes to Consolidated Financial Statements presents additional information regarding the Company's and its subsidiary bank's capital ratios.
21
--------------------------------------------------------------------------------Dividends
The Board of Directors ofUwharrie Capital Corp declared a 2.5% stock dividend in 2022, a 3% stock dividend in 2021 and a 2% stock dividend in 2020. All references in this Annual Report to net income per share and weighted average common and common equivalent shares outstanding reflect the effects of these stock dividends. Liquidity The objective of the Company's liquidity management policy is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on any opportunities for expansion. Liquidity management addresses the ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature and to fund new loans and investments as opportunities arise. Liquidity is managed primarily by the selection of asset mix and the maturity mix of liabilities. The Company's primary sources of internally generated funds are principal and interest payments on loans, cash flows generated from operations and cash flow generated by investments. Maturities and the marketability of securities provide a source of liquidity to meet deposit fluctuations. Maturities of the securities portfolio are presented in Financial Table 3. Growth in deposits is typically the primary source of funds for loan growth. The Company and its subsidiary bank have multiple funding sources, in addition to deposits, that can be used to increase liquidity and provide additional financial flexibility. AtDecember 31, 2022 , these sources are the subsidiary bank's established federal funds lines with correspondent banks aggregating$38.0 million , with available credit of$38.0 million ; an established borrowing relationship with theFederal Home Loan Bank , with available credit of$129.2 million ; access to borrowings from theFederal Reserve Bank discount window, with available credit of$17.5 million and the issuance of commercial paper. The Company also has a$3.0 million line of credit with TIBThe Independent BankersBank, N.A. The line is secured with 100% of the outstanding common shares of the Company's subsidiary bank. As ofDecember 31, 2022 ,$3.0 million remains available for use on the line of credit. AtDecember 31, 2022 , short-term borrowings amounted to$1.0 million . Long-term debt at that date consisted solely of$29.6 million of junior subordinated debt. Other contractual obligations of the Company exist in the form of operating leases and deposits. Obligations for operating leases and deposits totaled$2.0 million and$939.9 million , respectively, atDecember 31, 2022 . Note 8 (Leases) and Note 9 (Deposits) to the Notes to Consolidated Financial Statements provide additional information, including maturities, regarding these obligations. The Company has various financial instruments (outstanding commitments) with off-balance sheet risk that are issued in the normal course of business to meet the financing needs of its customers. See Note 13 (Commitments and Contingencies) to the Company's Notes to Consolidated Financial Statements for more information regarding these commitments and contingent liabilities.
Management believes that the Company's current sources of funds provide adequate liquidity for its current cash flow needs.
Critical Accounting Policies
A critical accounting policy is one that is both very important to the portrayal of the Company's financial condition and results, and requires management's most difficult, subjective and/or complex judgments. What makes these judgments difficult, subjective and/or complex is the need to make estimates about the effects of matters that are inherently uncertain. Refer to Note 1 (Significant Accounting Policies) in Notes to Consolidated Financial Statements for more information about these and other accounting policies utilized by the Company.
Allowance for Loan Losses
The allowance for loan losses represents management's best estimate of the
losses that are inherent in the loan portfolio but have not yet been
charged-off. The allowance is a critical accounting estimate in the financial
statements as it provides, by reference, an indication of the quality of the
loan portfolio. Estimating credit losses is inherently subjective as it requires
estimates that are susceptible to significant revision as more information
becomes available. Additional measurement uncertainty in the estimate is due, in
part, to the large amount of data evaluated, the long-term nature of the
underlying assets and the analysis of economic indicators. Regulatory examiners
may require the Company to recognize adjustments to the allowance for loan
losses based on their judgement about information available to them at the time
of their assessment.
On a regular basis, the allowance for loan losses is evaluated both individually
and collectively by loan class. Homogeneous loans are collectively evaluated by
loan class for impairment. However, once a loan is deemed impaired, it is
evaluated individually for specific impairment. Appropriately dividing the loan
portfolio into different segments with similar risk characteristics aids in
providing a more accurate estimation of the portfolio's loss. The Company's
methodology for estimating loan losses is well documented and supported by
internal controls, and validation of the process is performed on a recurring
basis.
22
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Loan Servicing Assets
The Company capitalizes mortgage andU.S. Small Business Administration (SBA) loan servicing rights when loans are sold and the loan servicing is retained. Servicing revenue is recognized in the statement of income as a component of other noninterest income. The amortization of servicing rights is realized over the estimated period that net servicing revenues are expected to be received. Essential assumptions used to value the loan servicing rights include prepayment speeds, discount rates and costs to service the loan. Servicing assets are periodically evaluated for impairment based upon their fair value, and any resulting impairment is recognized through a valuation allowance and charged to other expense. An unrelated third party performs a quarterly valuation of the Company's Fannie Mae Mortgage Servicing Rights. Significant judgement is required to estimate the value of servicing rights due to the nature and variety of assumptions used. As such, changes in assumptions could materially affect the estimated value of loan servicing assets.
Interest Rate Sensitivity
Net Interest Income (Margin) is the single largest component of revenue for the
Company. Net Interest Margin is the difference between the yield on earning
assets and interest paid on interest-bearing liabilities. The margin can vary
over time as interest rates change. The variance fluctuates based on both the
timing (repricing) and magnitude of maturing assets and liabilities.
To identify interest rate sensitivity, a common measure is a gap analysis, which
reflects the difference or "gap" between rate sensitive assets and liabilities
over various periods. While management reviews this information, it has
implemented the use of an income simulation model, which calculates expected
future Net Interest Income (Margin) based on projected interest-earning assets,
interest-bearing liabilities and forecasted interest rates along with multiple
other forecasted assumptions. Management believes this provides a more relevant
view of interest rate risk sensitivity than the traditional gap analysis because
the gap analysis ignores optionality embedded in the balance sheet, such as
prepayments or changes based on interest rates. The income simulation model
allows a comparison of flat, rising and falling rate scenarios to determine the
interest rate sensitivity of earnings in varying interest rate environments.
The Company models immediate rising and declining rate shocks of up to 4% (in 1%
intervals) on its subsidiary bank, using a static balance sheet for a two-year
horizon, as preferred by regulators. The most recent consolidated 2% rate shock
projections for a one-year horizon, indicates a negative impact of (0.42%) on
Margin in a rates-down scenario and a positive impact of 1.72% on Margin in a
rates-up scenario. Based on the most recent twelve-month forecast, the
subsidiary bank is asset-sensitive and may experience some negative impact to
earnings should interest rates decline. The subsidiary bank has the potential to
benefit from a rising interest rate environment, but current market deposit
pricing and embedded options in the balance sheet may limit the upside
potential.
The principal goals for asset liability management for the Company are to
maintain adequate levels and sources of liquidity and to manage interest rate
risk. Interest rate risk management attempts to balance the effects of interest
rate changes on both interest-sensitive assets and interest-sensitive
liabilities to protect Margin from wide fluctuations as a result of changes in
market interest rates. To that end, management has recommended and the Board of
Directors has approved policy limits that minimize the downside risk from
interest rate shifts. The aforementioned ratios are within those stated limits
of -18% for the respective modeled scenarios at the subsidiary bank and
combined. Managing interest rate risk is an important factor to the long-term
viability of the Company since Margin is such a large component of earnings. The
Company's Asset Liability Management Committee (ALCO) monitors market changes in
interest rates and assists with the pricing of loans and deposit products while
considering the funding source needs, asset growth projections, and necessary
operating liquidity.
23
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Financial Table 1
Average Balances and Net Interest Income Analysis
2022 2021 2020
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income Yield
(dollars in thousands) Balance Expense Rate (1) Balance Expense Rate (1) Balance Expense Rate (1)
Interest-earning assets
Taxable securities $ 285,020 5,984 2.10 % $ 216,345 3,152 1.46 % $ 130,640 2,570 1.97 %
Non-taxable securities (1) 67,952 1,524 2.71 % 49,207 1,148 2.97 % 26,427 732 3.57 %
Short-term investments 125,766 2,401 1.91 % 97,244 144 0.15 % 103,167 640 0.62 %
Equity Securities 355 20 5.63 % 485 20 4.12 % 950 51 5.37 %
Taxable loans (2) 460,471 21,382 4.64 % 447,904 22,956 5.13 % 424,768 19,812 4.66 %
Non-taxable loans (1) 11,147 251 2.72 % 7,562 211 3.55 % 9,756 270 3.57 %
Total interest-earning assets 950,711 31,562 3.37 % 818,747 27,631 3.42 % 695,708 24,075 3.50 %
Non-earning assets
Cash and due from banks 5,040 3,708 3,718
Premises and equipment, net 15,379 16,506 16,766
Interest receivable and other 30,406 23,970 21,868
Total non-earning assets 50,825 44,184 42,352
Total assets $ 1,001,536 $ 862,931 $ 738,060
Interest-bearing liabilities
Savings deposits $ 107,908 $ 119 0.11 % $ 87,878 $ 65 0.07 % $ 65,671 $ 62 0.09 %
Interest checking & MMDA 458,869 1,892 0.41 % 375,425 401 0.11 % 331,809 716 0.22 %
Time deposits 70,511 452 0.64 % 71,946 272 0.38 % 78,447 897 1.14 %
Total deposits 637,288 2,463 0.39 % 535,249 738 0.14 % 475,927 1,675 0.35 %
Short-term borrowed funds 1,110 10 0.90 % 1,289 4 0.31 % 534 2 0.37 %
Long-term debt 29,560 1,349 4.56 % 16,946 800 4.72 % 10,846 566 5.22 %
Total interest-bearing
liabilities 667,958 3,822 0.57 % 553,484 1,542 0.28 % 487,307 2,243 0.46 %
Noninterest liabilities
Transaction deposits 278,865 236,048 187,261
Interest payable and other 11,197 12,978 10,760
Total liabilities 958,020 802,510 685,328
Shareholders' equity 43,516 60,421 52,732
Total liabilities and
shareholders' equity $ 1,001,536 $ 862,931 $ 738,060
Interest rate spread 2.80 % 3.14 % 3.04 %
Net interest income and net
interest
margin $ 27,740 2.97 % $ 26,089 3.23 % $ 21,832 3.18 %
(1) Yields related to securities and loans exempt from federal and/or state
income taxes are stated on a fully tax-equivalent basis, assuming a 21.00%
tax rate for 2022, 2021 and 2020.
(2) Non-accrual loans are included in loans, net of unearned income.
24
--------------------------------------------------------------------------------Financial Table 2
Volume and Rate Variance Analysis
2022 Versus 2021 2021 Versus 2020
Net Net
(dollars in thousands) Volume Rate Change Volume Rate Change
Interest-earning assets
Taxable securities $ 1,221 $ 1,611 $ 2,832 $ 1,467 $ (885 ) $ 582
Non-taxable securities 429 (53 ) 376 581 (165 ) 416
Short-term investments 293 1,964 2,257 (23 ) (472 ) (495 )
Equity securities (6 ) 6 - (22 ) (9 ) (31 )
Taxable loans 614 (2,188 ) (1,574 ) 1,132 2,012 3,144
Non-taxable loans 90 (50 ) 40 (61 ) 2 (59 )
Total interest-earning assets 2,641 1,290 3,931 3,074 483 3,557
Interest-bearing liabilities
Savings deposits 18 36 54 19 (16 ) 3
Transaction and MMDA deposits 217 1,274 1,491 70 (385 ) (315 )
Other time deposits (7 ) 187 180 (49 ) (576 ) (625 )
Short-term borrowed funds (1 ) 7 6 3 (1 ) 2
Long-term debt 586 (37 ) 549 297 (82 ) 215
Total interest-bearing liabilities 813 1,467 2,280 340 (1,060 ) (720 )
Net interest income $ 1,828 $ (177 ) $ 1,651
The above table analyzes the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities. The table distinguishes between (i) changes
attributable to volume (changes in volume multiplied by the prior period's
rate), (ii) changes attributable to rate (changes in rate multiplied by the
prior period's volume), and (iii) net change (the sum of the previous columns).
The change attributable to both rate and volume (changes in rate multiplied by
changes in volume) has been allocated equally to the change attributable to
volume and the change attributable to rate.
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--------------------------------------------------------------------------------Financial Table 3
Weighted Average Yield on
December 31, 2022 December 31, 2021 Weighted Weighted Average Yield (1) Average Yield (1) Securities available for saleU.S. Treasury Due after one but within five years 3.55 %
-
Due after five but within ten years 1.24 % 1.24 %
2.44 % 1.24 %
U.S. Government agencies
Due within twelve months - 1.80 %
Due after one but within five years 2.61 % 1.93 %
Due after five but within ten years 3.76 % 0.83 %
Due after ten years 4.33 % 0.94 %
3.99 % 1.04 %
Mortgage-backed securities
Due after one but within five years 3.50 % 3.40 %
Due after five but within ten years 1.79 % 1.24 %
Due after ten years 2.19 % 1.16 %
2.19 % 1.29 %
Asset-backed securities
Due after ten years 5.33 % 1.12 %
5.33 % 1.12 %
State and political
Due within twelve months 4.50 % 4.50 %
Due after one but within five years 2.36 % 2.73 %
Due after five but within ten years 2.71 % 1.99 %
Due after ten years 1.98 % 1.82 %
2.07 % 1.85 %
Corporate Bonds
Due within twelve months - 2.98 %
Due after one but within five years 2.10 % 1.68 %
Due after five but within ten years 3.13 % 2.00 %
2.44 % 2.00 %
Total Securities available for sale
Due within twelve months 4.50 % 2.23 %
Due after one but within five years 3.34 % 2.44 %
Due after five but within ten years 2.06 % 1.22 %
Due after ten years 2.81 % 1.39 %
2.69 % 1.41 %
(1) Yields on securities and investments exempt from federal and/or state income
taxes are stated on a fully tax-equivalent basis, assuming a 21.00% tax rate
for 2022 and 2021.
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Financial Table 3
Weighted Average Yield on
December 31, 2022 December 31, 2021
Weighted Weighted
Average Yield (1) Average Yield (1)
Securities held to maturity
U.S. Government agencies
Due after one but within five years 2.87 % 2.75 %
Due after five but within ten years - -
2.87 % 2.75 %
State and political
Due within twelve months 2.18 % 1.70 %
Due after one but within five years 2.41 % 2.23 %
Due after five but within ten years - -
Due after ten years 2.85 % 2.85 %
2.77 % 2.75 %
Corporate Bonds
Due within twelve months - -
Due after one but within five years - -
Due after five but within ten years 4.57 % 4.73 %
Due after ten years - 3.68 %
4.57 % 4.57 %
Total Securities held to maturity
Due within twelve months 2.18 % 1.70 %
Due after one but within five years 2.54 % 2.28 %
Due after five but within ten years 4.57 % 4.73 %
Due after ten years 2.85 % 2.97 %
3.66 % 3.64 %
(1) Yields on securities and investments exempt from federal and/or state income
taxes are stated on a fully tax-equivalent basis, assuming a 21.00% tax rate
for 2022 and 2021.
Financial Table 4
Noninterest Income
Year Ended December 31,
(dollars in thousands) 2022 2021 2020
Service charges on deposit accounts $ 1,041 $ 995 $ 1,027
Other banking fees 815 424 338
Asset management fees 1,940 2,050 1,710
Brokerage commissions 483 587 571
Interchange and card transaction fees, net 1,232 1,181 917
Investment securities gains (losses) (91 ) 991
71
Other gains (losses) from sale of assets 165 48
413
Income from mortgage banking 3,409 11,294
14,714
Supplemental executive retirement plan gain (loss) (244 ) 942
746
Other noninterest income 1,383 420 370
Total noninterest income $ 10,133 $ 18,932 $ 20,877
27
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Financial Table 5
Other Noninterest Expense
Year Ended December 31,
(dollars in thousands) 2022 2021 2020
Postage $ 218 $ 197 $ 187
Telephone and data lines 208 174 182
Office supplies and printing 94 102 108
Shareholder relations expense 154 196 123
Dues and subscriptions 282 373 369
Other 1,424 1,234 990
Total other noninterest expense
Financial Table 6
Loan Portfolio Composition
At December 31,
2022 2021
% of Total % of Total
(dollars in thousands) Amount Loans Amount Loans
Loan type:
Commercial $ 85,917 17.29 % $ 73,035 17.35 %
SBA Paycheck Protection Program (PPP) 545 0.11 % 15,840 3.76 %
Real estate - commercial 183,550 36.93 % 150,382 35.73 %
Real estate - construction 43,690 8.79 % 36,699 8.72 %
Real estate - residential 166,855 33.57 % 129,827 30.85 %
Consumer 9,762 1.97 % 9,579 2.28 %
Other 6,666 1.34 % 5,496 1.31 %
Total loans 496,985 100.00 % 420,858 100.00 %
Less:
Allowance for loan losses (2,290 ) (4,026 )
Unearned net loan (fees) costs 904 (79 )
Net loans $ 495,599 $ 416,753
Financial Table 7
Selected Loan Maturities
December 31, 2022
One Year One to Five to Over Fifteen
(dollars in thousands) or Less Five Years Fifteen Years Years Total
Commercial and agricultural $ 10,673 $ 25,696 $ 24,012 $ 26,081 $ 86,462
Real estate - construction 8,568 2,017 15,758 17,347 43,690
Total selected loans $ 19,241 $ 27,713 $ 39,770 $ 43,428 $ 130,152
Fixed rate loans $ 1,402 $ 30,337 $ 51,061 $ 64,236 $ 147,036
Sensitivity to rate changes:
Variable interest rates $ 23,587 $ 24,040 $ 144,929 $ 158,297 $ 350,853
28
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Financial Table 8
Allocation of Charge-Offs and Recoveries
At December 31,
2022 2021
Net
charge-offs
Net Net charge-offs Net (recoveries)
charge-offs (recoveries) charge-offs to average
(dollars in thousands) (recoveries) Average loans to average loans (recoveries) Average loans loans
Commercial $ (71 ) $ 77,890 (0.09 )% $ 65 $ 67,154 0.10 %
SBA Paycheck Protection
Program (PPP) - 4,960 - - 48,299 -
Real estate - commercial - 167,670 - (359 ) 147,094 (0.24 )%
Other real estate
construction - 38,210 - (185 ) 31,156 (0.59 )%
Real estate 1-4 family
construction - 7,695 - - 5,994 -
Real estate - residential (12 ) 95,040 (0.01 )% (69 ) 79,467 (0.09 )%
Home equity (1 ) 54,867 (0.002 )% (17 ) 51,227 (0.03 )%
Consumer loans 61 9,501 0.64 % 24 10,232 0.23 %
Other loans - 5,603 - - 4,322 -
Total $ (23 ) $ 461,436 (0.005 )% $ (541 ) $ 444,945 (0.12 )%
Financial Table 9
Allocation of the Allowance for Loan Losses
At December 31,
2022 2021
% of Total % of Total
(dollars in thousands) Amount Loans (1) Amount Loans (1)
Commercial $ 435 17.29 % $ 718 17.35 %
SBA Paycheck Protection Program (PPP) - 0.11 % - 3.77 %
Real estate - commercial 760 36.93 % 1,370 35.73 %
Other real estate construction 177 7.46 % 330 6.72 %
Real estate 1-4 family construction - 1.33 % - 2.00 %
Real estate - residential 561 21.87 % 982 18.73 %
Home equity 277 11.71 % 492 12.12 %
Consumer loan 76 1.96 % 123 2.28 %
Other loans 4 1.34 % 11 1.31 %
Total loans $ 2,290 100.00 % $ 4,026 100.00 %
(1) Represents total of all outstanding loans in each category as a percent of
total loans outstanding.
Financial Table 10
Maturities of Time Deposits
December 31, 2022
3 Months Over 3 Months Over 1 Year Over
or Less to 1 Year to 3 Years 3 Years Total
(dollars in thousands)
U.S. time deposits in
amounts in excess of the
FDIC insurance limit $ 22,973 $ 10,141 $ 2,615 $ - $ 35,729
Other time deposits 12,962 18,805 14,873 4,756 51,396
$ 35,935 $ 28,946 $ 17,488 $ 4,756 $ 87,125 © Edgar Online, source
