Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
$ in thousands, except per share data.
The purpose of this discussion and analysis is to provide information about the results of operations, financial condition, liquidity and capital resources of the Company. The discussion should be read in conjunction with the material presented in Item 8, “Financial Statements and Supplementary Data,” of this Form 10-K.
Subsequent events have been considered through the date of this Form 10-K.
Cautionary Statement Regarding Forward-Looking Statements
We make forward-looking statements in this Form 10-K that are subject to significant risks and uncertainties. These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals, and are based upon our management’s views and assumptions as of the date of this report. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements.
These forward-looking statements are based upon or are affected by factors that could cause our actual results to differ materially from historical results or from any results expressed or implied by such forward-looking statements. These factors include, but are not limited to, effects of or changes in:
● interest rates,
● general and local economic conditions,
● the legislative/regulatory climate,
● unanticipated increases in the level of unemployment in the Company’s market,
● the quality or composition of the loan and/or investment portfolios,
● demand for loan products,
● deposit flows,
● competition,
● demand for financial services in the Company’s market,
● the real estate market in the Company’s market,
● laws, regulations and policies impacting financial institutions,
● technological risks and developments, and cyber-threats, attacks or events,
● the Company’s technology initiatives,
● performance by the Company’s counterparties or vendors,
● applicable accounting principles, policies and guidelines, and
These risks and uncertainties should be considered in evaluating the forward-looking statements contained in this report. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report. This discussion and analysis should be read in conjunction with the description of our “Risk Factors” in Item 1A. of this Form 10-K.
Cybersecurity
The Company considers cybersecurity risk to be one of the greatest risks to its business. We have deployed a multi-faceted approach to limit the risk and impact of unauthorized access to customer accounts and to information relevant to customer accounts. We use digital technology safeguards, internal policies and procedures, and employee training to reduce the exposure of our systems to cyber-intrusions. The Company also requires assurances from key vendors regarding their cybersecurity.
We control functionalities of online and mobile banking to reduce risk. We do not offer online account openings or loan originations. We do not permit customers to submit address changes or wire requests through online banking, and we limit the dollar amount of online banking transfers to other banks. We require a special vetting process for commercial customers who wish to originate ACH transfers.
Further, the Company has a program to identify, mitigate and manage its cybersecurity risks. The program includes penetration testing and vulnerability assessment, technological defenses such as antivirus software, patch management, firewall management, email and web protections, an intrusion prevention system, a cybersecurity insurance policy which covers some but not all losses arising from cybersecurity breaches, as well as ongoing employee training. The cost of these measures was $357 for 2021 and $379 for 2020. These costs are included in various categories of noninterest expense.
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However, it is not possible to fully eliminate exposure. The potential for financial and reputational losses due to cyber-breaches is increased by the possibility of human error, unknown system susceptibilities, and the rising sophistication of cyber-criminals to attack systems, disable safeguards and gain access to accounts and related information. We maintain insurance for these risks but insurance policies are subject to exceptions, exclusions and terms whose applications have not been widely interpreted in litigation. Accordingly, insurance can provide less than complete protection against the losses that result from cybersecurity breaches and pursuing recovery from insurers can result in significant expense. In addition, some risks such as reputational damage and loss of customer goodwill, which can result from cybersecurity breaches, cannot be insured against.
Response to COVID-19 Pandemic
The COVID-19 pandemic has affected the global economy since the first quarter of 2020. The Company has complied with national, state and local guidelines to help reduce the spread of the virus, including implementing social distancing measures for employees and customers. The Company’s business relies on positive relationships with customers. At this time, we feel our customer relationships remain strong and our team remains ready to provide banking services. All forms of customer service are now available without restriction.
The Company has a robust business continuity plan, and partners with vendors whom we believe also have robust business continuity plans. In implementing its business continuity plan to address the COVID-19 pandemic, the Company has not incurred material expenditures and does not anticipate material expenditures. Further, all critical functions are cross-trained as part of our business continuity preparedness. Controls over cash and physical assets have remained in place and internal controls over financial reporting and disclosure have been maintained.
Non-GAAP Financial Measures
The Company prepares financial information in accordance with GAAP, with the exception of certain financial measures which are computed under a basis other than GAAP (“non-GAAP”). These measures include the efficiency ratio, the net interest margin and the noninterest margin. Management believes such financial information is meaningful to the reader in understanding operating performance, but cautions that such information not be viewed as a substitute for GAAP.
Net Interest Margin
The Company uses the net interest margin to measure profit on interest generating activities, as a percentage of total interest-earning assets. The net interest margin is calculated by dividing taxable equivalent net interest income by total average interest-earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit is 21%. The reconciliation of tax equivalent net interest income, which is not a measurement under GAAP, to net interest income, is reflected in the table below.
$ in thousands Year ended December 31,
GAAP measures:
Interest on interest-bearing deposits 170 276
Interest and dividends on securities - taxable 7,960 7,383
Interest on securities - nontaxable 1,934 1,826
Non-GAAP measures:
Tax benefit on nontaxable loan income $ 318 $ 444
Tax benefit on nontaxable securities income 643 564
Total tax benefit on nontaxable interest income $ 961 $ 1,008
Total tax-equivalent net interest income $ 42,850 $ 39,179
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Efficiency Ratio
The efficiency ratio is computed by dividing noninterest expense by the sum of net interest income on a tax-equivalent basis and noninterest income, excluding certain items management deems unusual or non-recurring. The tax rate used to calculate the fully taxable equivalent basis is 21%. This is a non-GAAP financial measure that the Company believes provides investors with important information regarding operational efficiency. The components of the efficiency ratio calculation are summarized in the following table.
$ in thousands Year ended December 31,
Taxable-equivalent net interest income $ 42,850 $ 39,179
Less: partnership income (1) (467 ) (332 )
Less: realized securities gains (6 ) (108 )
Total income for ratio calculation $ 50,803 $ 46,683
Critical Accounting Policies
General
The Company’s consolidated financial statements are prepared in accordance with GAAP. The financial information contained within our statements is, to a significant extent, financial information based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. Although the economics of the Company’s transactions may not change, the timing of events that would impact the transactions could change.
Presented below is a discussion of accounting policies that are the most important to the portrayal and understanding of the Company’s financial condition and results of operations. Please refer to Note 1 of Notes to Consolidated Financial Statements for additional information on the Company’s accounting policies. Critical accounting policies require management’s most difficult, subjective, and complex judgments about matters that are inherently uncertain. If conditions occur that differ from our assumptions, depending upon the severity of such differences, the Company’s financial condition or results of operations may be materially impacted. The Company evaluates its critical accounting estimates and assumptions on an ongoing basis and updates them as needed.
Allowance for Loan Losses
The Company evaluates the allowance each quarter through a methodology that estimates losses on individual impaired loans and evaluates the effect of numerous factors on the credit risk of groups of homogeneous loans (collectively-evaluated loans).
Impaired loans
Impaired loans are identified through the Company’s credit risk rating process. Generally, impaired loans have risk ratings that indicate higher risk, such as “classified” or “special mention.” Nonaccrual loan relationships that meet the Company’s balance threshold of $250 are designated impaired. Other loan relationships that meet the Company’s balance threshold of $250 and for which a credit review identified a weakness that indicates principal and interest will not be collected according to the loan terms. All TDRs, regardless of size or past due status are designated impaired.
Troubled debt restructurings
Loan modifications are reviewed to determine whether, at the time of the modification, the borrower is experiencing financial difficulty and whether the Company provided a concession that it would not otherwise consider. With the exception of borrowers affected by COVID-19 in 2020 or 2021 who fell under the provisions of the CARES Act and CAA, modified loans that meet this criteria are designated TDRs.
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Individual evaluation
At the reporting date, the fair value of each impaired loan is estimated using either the cash flow method or the collateral method.
Cash flow method
The cash flow method is applied to loans that are not collateral dependent and for which cash flows may be estimated. The cash flow method measures fair value using assumptions specific to each loan, including expected amount and timing of cash flows and discount rate. For TDR loans, the discount rate is the rate immediately prior to the modification that resulted in a TDR. If an impaired loan evaluated under the cash flow method becomes 90 days or more past due, it is examined to determine whether the late payment indicates collateral dependency or cash flows below those that were used in the fair value measurement.
Collateral method
The collateral method is applied to impaired loans that are collateral-dependent, for which foreclosure is imminent or for which non-collateral repayment sources are determined not to be available or reliable. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. Fair value is based upon the “as-is” value of independent appraisals or evaluations.
Impaired loans secured by residential 1-4 family properties with outstanding principal balances greater than $250 are valued using an appraisal. Appraisals are also used to value impaired loans secured by commercial real estate with outstanding principal balances greater than $500. Impaired loans secured by residential 1-4 family property with outstanding principal balances of $250 or less, or secured by commercial real estate with outstanding principal balances of $500 or less, are valued using a real estate evaluation prepared by a third party.
Appraisals must conform to the Uniform Standards of Professional Appraisal Practice and are prepared by an independent third-party appraiser who is certified and licensed and who is approved by the Company. Appraisals may incorporate market analysis, comparable sales analysis, cash flow analysis and market data pertinent to the property to determine market value.
Evaluations are prepared by third party providers and reviewed by employees of the Company who are independent of the loan origination, operation, management and collection functions. Evaluations provide a property’s market value based on the property’s current physical condition and characteristics and the economic market conditions that affect the collateral’s market value. Multiple sources of data contribute to the estimate of market value, including physical inspection, independent third-party automated tools, comparable sales analysis and local market information.
Updated appraisals or evaluations are ordered when a loan becomes impaired if the appraisal or evaluation on file is more than 24 months old. Appraisals and evaluations are reviewed for propriety and reasonableness and may be discounted if the Company determines that the value exceeds reasonable levels. If an updated appraisal or evaluation has been ordered but has not been received by a reporting date, the fair value may be based on the most recent available appraisal or evaluation, discounted for age. The appraisal or evaluation value is reduced by selling costs if recovery is expected solely from the sale of collateral.
Nonaccrual status of impaired loans
Nonaccrual status is applied to impaired loans that are not TDRs and for which fair value measurement indicates an impairment loss. Nonaccrual status is applied to TDRs that allow the borrower to discontinue payments of principal or interest for more than 90 days, unless the modification provides reasonable assurance of repayment performance and collateral value supports regular underwriting requirements. TDRs that maintain current status for at least a six-month period, including history prior to restructuring, may accrue interest. Impaired loans with partial charge-offs are maintained as impaired until the remaining balance is satisfied.
Collectively evaluated loans
Non-impaired loans are grouped by portfolio segments. Portfolio segments are further divided into smaller loan classes. Loans within a segment or class have similar risk characteristics. Credit loss on collectively-evaluated loans is estimated by applying to current class balances the class historical charge-off rates and percentages for qualitative factors that affect credit risk.
Qualitative factors include changes in national and local economic and business conditions, the nature and volume of classes within the portfolio, loan quality, loan officers’ experience, lending policies and the Company’s loan review system. The qualitative factor allocations are determined for pass-rated loans. To reflect the increased risk of criticized assets, qualitative factor allocations are multiplied by 150% for special mention loans, and multiplied by 200% for classified loans.
Loss rates
Loss rates are calculated for and applied to individual classes by averaging loss rates over the most recent eight quarters. The loss rate calculation for each class includes losses and recoveries on all loans within the class, including TDRs and other impaired loans. The look-back period of eight quarters is applied consistently among all classes.
Two loss rates for each class are calculated: total net charge-offs for the class as a percentage of average class loan balance (“class loss rate”), and total net charge-offs for the class as a percentage of average classified loans in the class (“classified loss rate”). Net charge-offs in both calculations include charge-offs and recoveries for all loans within the class, including classified and non-classified loans, as well as impaired and TDR loans. Class historical loss rates are applied to collectively evaluated pass-rated loan balances and special mention rated loan balances, and classified historical loss rates are applied to collectively evaluated classified loan balances.
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Qualitative factor allocations
The analysis of certain factors results in standard allocations to all classes. These factors include the risk from changes in lending policies, loan officers’ experience, changes in loan review, and economic factors including local unemployment levels, local bankruptcy rates, interest rate environment, and competition/legal/regulatory environments. Standard allocations for residential vacancy rates and housing inventory are applied to the following classes: all classes within the consumer real estate segment, residential construction, investor-owned residential real estate, multifamily loans, other commercial real estate and state and political subdivision loans.
Qualitative factors incorporate economic data targeted to the Company’s market. If market–specific information is not available on a timely basis, regional or national information that historically shows a high degree of correlation to market data may be used.
Also applied to all segments and classes is an economic factor implemented to address COVID-19 uncertainty: national unemployment filings. Due to continuous developments related to the COVID-19 pandemic, current data is valuable in assessing risk. Local unemployment data lags the reporting date but historical analysis determined that local unemployment filings were closely correlated to national unemployment filings.
Factors analyzed for each class, with resultant allocations based upon the level of risk assessed for each class, include levels of past due loans, levels of nonaccrual loans, current class balance as a percentage of total loans, loans that received COVID-related modifications that are still in the modification period, and the percentage of high risk loans within the class. High risk loans include junior liens, interest only and high loan to value loans. High risk loans within each class are analyzed and allocated additional reserves based on current trends.
Nonaccrual status
The Company reviews loans with certain risk indicators to determine whether the loans should be placed on nonaccrual status, including loans that exceed 90 days past due, loans rated classified, and loans with a non-COVID 19 related modification that provides relief from payments of interest or principle for more than 90 days.
Loans in nonaccrual are reviewed on an individual loan basis to determine whether they may return to accrual status. To return to accrual status, the Company’s analysis must determine that future payments are reasonably assured. To satisfy this criteria, the Company’s evaluation must determine that the underlying cause of the original delinquency or weakness that indicated nonaccrual status has been resolved, such as receipt of new guarantees, increased cash flows that cover the debt service or other resolution. Nonaccrual loans that demonstrate reasonable assurance of future payments and that have made at least six consecutive payments in accordance with repayment terms and timeframes may be returned to accrual status.
Sales, purchases and reclassification of loans
The Company finances consumer real estate mortgages under “best efforts” contracts with mortgage purchasers. The mortgages are designated as held for sale upon initiation. There have been no major reclassifications from portfolio loans to held for sale. Mortgages held for sale are not included in the calculation of the allowance for loan losses.
Occasionally, the Company purchases or sells participations in loans. All participation loans purchased met the Company’s normal underwriting standards at the time the participation was entered. Participation loans are included in the appropriate portfolio balances to which the allowance methodology is applied.
Unallocated surplus
In addition to funding the allowance for loan losses based upon data analysis, the Company has the option to fund an unallocated surplus in excess to the calculated requirement, based upon management judgement. The Company’s policy permits an unallocated surplus of between 0% and 5% of the calculated requirement. At December 31, 2021, management provided an unallocated surplus of 4.9% to reflect the uncertainty presented by the ongoing COVID-19 pandemic.
Estimation of the allowance for loan losses
The estimation of the allowance involves analysis of internal and external variables, methodologies, assumptions and management’s judgment and experience. Key judgments used in determining the allowance for loan losses include internal risk rating determinations, market and collateral values, discount rates, loss rates, and management’s assessment of current economic conditions. These judgments are inherently subjective and actual losses could be greater or less than the estimate. Future estimates of the allowance could increase or decrease based on changes in the financial condition of individual borrowers, concentrations of various types of loans, economic conditions or the markets in which collateral may be sold. The estimate of the allowance accrual determines the amount of provision expense and directly affects our financial results.
The estimate of the allowance for December 31, 2021 considered market conditions as of December 31, 2021 where possible, and the most recent available information when data was not available as of December 31, 2021, portfolio conditions and levels of delinquencies at December 31, 2021, and net charge-offs in the eight quarters prior to the quarter ended December 31, 2021. For additional discussion of the allowance, see Note 5 of the Notes to Consolidated Financial Statements and the subsections “Asset Quality,” and “Provision and Allowance for Loan Losses” below.
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Goodwill
Goodwill is subject to at least an annual assessment for impairment by applying a fair value based test. The Company contracts with a third party valuation expert to perform impairment testing in the fourth quarter of each year. The Company’s most recent impairment test was performed using data from September 30, 2021. Accounting guidance provides the option of performing preliminary assessment of qualitative factors to determine whether impairment testing is necessary. The Company opted not to perform the preliminary assessment. The Company’s goodwill impairment analysis considered three valuation techniques appropriate to the measurement. The first technique uses the Company’s market capitalization as an estimate of fair value; the second technique estimates fair value using current market pricing multiples for companies comparable to the Company; while the third technique uses current market pricing multiples for change-of-control transactions involving companies comparable to the Company. The analysis did not result in an impairment assessment.
Certain key judgments were used in the valuation measurement. Goodwill is held by the Company’s bank subsidiary. The bank subsidiary is 100% owned by the Company, and no market capitalization is available. Because most of the Company’s assets are comprised of the bank subsidiary’s equity, the Company’s market capitalization was used to estimate the Bank’s market capitalization. Other judgments include the assumption that the companies and transactions used as comparables for the second and third technique were appropriate to the estimate of the Company’s fair value, and that the comparable multiples are appropriate indicators of fair value, and compliant with accounting guidance.
Pension Plan
The Company’s actuary determines plan obligations and annual pension expense using a number of key assumptions. Key assumptions may include the discount rate, the estimated return on plan assets and the anticipated rate of compensation increases. Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may impact pension assets, liabilities or expense.
Performance Summary
The COVID-19 pandemic continued to impact the Company in 2021, although in somewhat different respects than the impact in 2020. During 2020, the Company worked with borrowers impacted by the COVID-19 pandemic to provide payment relief, which reduced interest income on certain loans within the portfolio. Adverse economic indicators escalated credit risk, increasing provision for loan loss expense. Positive effects of the COVID-19 pandemic resulted from the low interest rate environment, which fueled refinance activity and gains from the sale of mortgages. The Company also participated in the SBA’s PPP loan program and recognized increased fee income.
During 2021, the Company recognized additional fee income from PPP loans. Pandemic-related modifications slowed significantly and there are currently no loans under modified terms related to the COVID-19 pandemic. Economic indicators improved markedly and the Company was able to recover some of the provision expense recognized in 2020.
Key performance ratios provide a summary of the Company’s results and allow comparison with results from prior years. The following table presents NBI’s key performance ratios for the years indicated:
Year Ended December 31,
Return on average assets 1.26 % 1.15 %
Return on average equity(1) 10.59 % 8.21 %
Basic net earnings per common share $ 3.28 $ 2.48
Fully diluted net earnings per common share $ 3.28 $ 2.48
Net interest margin (2) 2.81 % 2.98 %
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Growth
NBI’s key growth indicators are shown in the following table:
Securities and restricted stock, loans and total assets increased when amounts at December 31, 2021 are compared with amounts at December 31, 2020. Customer deposits increased $197,444 or 15.22% from December 31, 2020, with the most substantial increase in interest-bearing deposits, as well as increases in noninterest-bearing deposits and savings deposits. Time deposits declined. The liquidity provided by the increase of deposits supported growth in loans of $35,256 or 4.64% and growth in securities and restricted stock of $138,904 or 25.35%.
Asset Quality
Key indicators of NBI’s asset quality are presented in the following table:
Loans past due 90 days or more and accruing 90 17
Allowance for loan losses to loans(2) 0.96 % 1.10 %
Net charge-off ratio 0.05 % 0.05 %
(2) Loans are net of unearned income and deferred fees and costs.
The Company monitors asset quality indicators in managing credit risk and in determining the allowance and provision for loan losses. As of December 31, 2021, nonperforming loans and other real estate improved when compared with levels at December 31, 2020, while accruing loans past due 90 days or more increased slightly. The net charge-off ratio remained steady from 2020 to 2021.
The Company’s risk analysis determined an allowance for loan losses of $7,674 at December 31, 2021, resulting in a recovery of previous provision expense of $398. This compares with an allowance for loan losses of $8,481 as of December 31, 2020, and a provision of $1,991 for the year ended December 31, 2020. The ratio of the allowance for loan losses to loans decreased to 0.96% at December 31, 2021, from 1.10% at December 31, 2020. The methodology for determining the allowance for loan losses relies on historical charge-off trends, modified by loan portfolio trends and economic indicators.
More information about the level and calculation methodology of the allowance for loan losses is provided in the sections “Provision and Allowance for Loan Losses”, “Balance Sheet – Loans – Risk Elements” and “Balance Sheet – Loans – Modifications and Troubled Debt Restructurings” below as well as Notes 1 and 5 of the Notes to Consolidated Financial Statements.
Sufficient resources have been dedicated to working out problem assets, and exposure to loss is somewhat mitigated because most of the nonperforming loans are collateralized. More information about nonaccrual and past due loans is provided in the section “Balance Sheet – Loans – Risk Elements” below and Note 5 of the Notes to Consolidated Financial Statements. The Company continues to carefully monitor risk levels within the loan portfolio and the evolving impact of the COVID-19 pandemic.
Net Interest Income
The Company’s primary source of revenue is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and other interest-bearing liabilities. Net interest income is affected by various factors, including the Federal Reserve’s monetary policy, U.S. fiscal policy, competitive pressure, the level and composition of the interest-earning assets and the composition of interest-bearing liabilities. Changes in the Federal Reserve’s target interest rate immediately affect the yield on the Company’s interest-bearing deposits in other banks, and affect other interest-earning assets within a short time. The primary source of funds used to support the Company’s interest-earning assets is deposits. When the interest rate environment changes, the Company can immediately change rates on interest-bearing deposits and change offering rates on new time deposits. Existing time deposits commit the Company to the contractual rate for the length of the term. Time deposits provide a measure of stability in the cost of funds, but partially delay the Company’s ability to respond to downward rate movements.
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The net interest margin for the year ended December 31, 2021 declined when compared with the year ended December 31, 2020. The Federal Reserve cut rates in March 2020 in an effort to counter the COVID-19 pandemic’s economic impact and maintained low interest rates throughout 2021. The low rates spurred high levels of loan refinance activity. Calls on securities surged and reinvestment opportunities for matured and called securities as well as investing excess liquidity from customer deposits resulted in lower yields for taxable and nontaxable securities. Further, uncertainty surrounding the length of time that customer deposits, bolstered by federal stimulus aid, will remain with the Bank resulted in a higher balance in interest-bearing deposits, which provides the lowest yielding investment opportunity. In response, the Company reduced offering rates on deposits in 2020 and 2021.
Fees and interest income from PPP loans helped increase the net interest margin in 2021 and 2020. During 2020 and 2021, the Company generated 1,259 PPP loans with original principal balances totaling $83,023. The loans bear a contractual interest rate of 1%, supplemented by an origination fee which is accreted over the life of the loan. When loans are forgiven or paid off prior to maturity, the Company recognizes the outstanding origination fee at the date of forgiveness or payoff. PPP loans contributed interest and fee income of $2,711 for the year ended December 31, 2021 and $1,753 for the year ended December 31, 2020. As of December 31, 2021, gross PPP loans totaling $1,094 with net deferred fees of $42 remain on the balance sheet.
The frequency and/or magnitude of future changes in market interest rates and legislative changes are difficult to predict and may have a greater short-term impact on net interest income than adjustments by management. Please refer to the section titled “Analysis of Changes In Interest Income and Interest Expense” for further information related to rate and volume changes.
Analysis of Net Interest Earnings
The following table shows the major categories of interest‐earning assets and interest‐bearing liabilities, the interest earned or paid, the average yield or rate on the daily average balance outstanding, net interest income and net yield on average interest‐earning assets for the years indicated.
Interest-earning assets:
Interest-bearing liabilities:
Net yield on average interest‐earning assets 2.81 % 2.98 %
(4) Nonaccrual loans are included in average balances for yield computations.
(5) Daily averages are shown at amortized cost.
(6) Includes restricted stock.
The following table reconciles net interest income on a fully-taxable equivalent basis to net interest income on a GAAP basis for the years indicated.
$ in thousands December 31,
Taxable equivalent adjustment 961 1,008
Net interest income, fully taxable equivalent $ 42,850 $ 39,179
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Analysis of Changes in Interest Income and Interest Expense
The following table sets forth, for the years indicated, a summary of the changes in interest income and interest expense resulting from changes in average asset and liability balances (volume) and changes in average interest rates (rate).
Changes Due To
Rates(2) Volume(2) Net Dollar Change
Interest income: (1)
Interest expense:
Interest-bearing demand deposits $ (1,789 ) $ 687 $ (1,102 )
(1) Taxable equivalent basis using a Federal income tax rate of 21%.
The low interest rate environment reduced interest income when the year ended December 31, 2021 is compared with the year ended December 31, 2020. However, greater volume more than offset the impact of rates, resulting in a net increase in interest income.
The Company’s reduced deposit offering rates saved $3,178 in interest expense, slightly offset by increased expense for higher volume when the year ended December 31, 2021 is compared with the year ended December 31, 2020.
Interest Rate Sensitivity
Interest rate risk is the risk to earnings or capital arising from movements in market interest rates. When interest-earning assets and interest-bearing liabilities reprice at different times or in different degrees or when call options are exercised, in response to change in market interest rates, future net interest income is impacted. When interest-earning assets mature or re-price more quickly than interest-bearing liabilities, the balance sheet is considered “asset sensitive”. An asset sensitive position will produce relatively more net interest income when interest rates rise and less net interest income when rates decline. Conversely, when interest-bearing liabilities mature or re-price more quickly than interest-earning assets in a given period, the balance sheet is considered “liability sensitive”. A liability sensitive position will produce relatively more net interest income when interest rates fall and less net interest income when rates increase.
The Company considers interest rate risk to be a significant risk and manages its exposure through policies approved by its Asset Liability Committee ("ALCO") and Board of Directors. ALCO reviews periodic reports of the Company's interest rate risk position, including results of simulation analysis. Simulation analysis applies interest rate shocks, hypothetical immediate shifts in interest rates, to the Company’s financial instruments and determines the impact to projected one-year net interest income and other key measures.
The following table shows the results of rate shocks on the one-year projected net interest income as of December 31, 2021 and 2020. For purposes of this analysis, noninterest income and expenses are assumed to be flat.
Rate Shift (bp) Change in Projected Net Interest Income
Results of the simulation for net interest income at December 31, 2021 and December 31, 2020 indicate the Company is in an asset sensitive position. As a part of the simulation process, certain estimates and assumptions must be made. These include, but are not limited to, asset growth, the mix of assets and liabilities, the interest rate environment and local and national economic conditions. Asset growth and the mix of assets can, to a degree, be influenced by management. Other areas, such as the interest rate environment and economic factors, cannot be controlled. In addition, competitive pressures can make it difficult to price deposits and loans in a manner that optimally minimizes interest rate risk. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes; changes in market conditions and customer behavior; and changes in management strategies.
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While the asset/liability management program is designed to protect the Company over the long term, it does not provide near-term protection from interest rate shocks, as interest rate sensitive assets and liabilities do not by their nature move up or down in tandem in response to changes in the overall rate environment. The Company’s profitability in the near term may be temporarily negatively affected in a period of rapidly rising or rapidly falling rates, because it takes some time for the Company’s portfolio to reflect changes to offering rates in response to a new interest rate environment.
Noninterest Income
The following table presents the Company’s noninterest income for the years indicated.
$ in thousands Year Ended December 31, Change
An enhanced fee schedule implemented in the latter half of 2020 benefitted income from service charges on deposits in 2021. Service charges on deposit accounts include account maintenance fees, fees for nonsufficient funds, ATM and wire transfer fees. Other service charges and fees include charges for official checks, income from the sale of checks to customers, safe deposit box rent, fees from letters of credit and income from commissions on the sale of credit life, accident and health insurance.
Increased transactions improved credit card fees when the year ended December 31, 2021 is compared with the year ended December 31, 2020. Credit card fees are presented net of certain processing expenses and are dependent on the volume of transactions.
Trust fees increased when the year ended December 31, 2021 is compared with the year ended December 31, 2020. Trust fees are generated from a number of different types of accounts, including estates, personal trusts, employee benefit trusts, investment management accounts, attorney-in-fact accounts and guardianships. Trust income varies depending on the number and type of accounts under management and financial market conditions.
The Company purchased an additional $5,000 in bank-owned life insurance (“BOLI”) during 2021, contributing to increased income compared with 2020.
A robust housing market during 2020 and the Federal Reserve’s rate cuts in March 2020 spurred a high level of consumer real estate purchase activity and refinance activity, increasing the sale of mortgage loans. During the year ended December 31, 2021, activity returned to more conventional levels, decreasing the gain on sale of mortgage loans when the year ended December 31, 2021 is compared with the year ended December 31, 2020.
Other income benefitted in 2021 from increased commissions on sales of securities and insurance, compared with the year ended December 31, 2020. Other income includes dividends and increases in the Company’s equity-method investments, net gains from the sale of fixed assets, and revenue from investment and insurance sales.
During 2021, securities gains resulted solely from the call of securities. During 2020, the Company realized net securities gains of $43 on the sale of securities and $65 on calls of securities. The sale of securities was pursuant to a restructuring plan to manage interest rate risk.
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Noninterest Expense
The following table presents the Company’s noninterest expense for the years indicated.
$ in thousands Year Ended December 31, Change
Net costs of other real estate owned 51 39 12 30.77 %
Salaries and employee benefits expense, which includes salaries, payroll taxes, health insurance, contributions to the employee stock ownership plan and employee 401(k), pension expense, incentives and salary continuation increased when 2021 is compared with 2020, due to normal compensation and staffing decisions as well as increased pension cost.
When the year ended December 31, 2021 is compared with the year ended December 31, 2020, occupancy, furniture and fixtures expense increased slightly, while data processing and ATM expense decreased slightly.
FDIC assessment expense increased from 2020 to 2021. The FDIC assessment is accrued based on a method provided by the FDIC. During the third quarter of 2019, the FDIC notified the Bank that it was eligible to use small bank assessment credits. The credits reduced expense for the first half of 2020, after which FDIC assessment expense returned to normal levels.
Net costs of other real estate owned ("OREO") increased slightly when the years ended December 31, 2021 and 2020 are compared. This expense category varies with the number of foreclosed properties owned by NBB and with the costs associated with each. It includes write-downs on OREO plus other costs associated with carrying these properties, as well as net gains or losses on the sale of other real estate. There were no write downs during 2021 and one write-down in 2020 totaling $9. Other costs for these properties in 2021 were $25, compared with $51 in 2020. The Company recorded a loss of $26 on the sale of OREO in 2021 and a gain of $21 on the sale of OREO in 2020. The Company currently has loans of $62 in process of foreclosure.
Franchise tax expense increased when the years ended December 31, 2021 and 2020 are compared. Franchise taxes are levied by the states in which NBB operates and are based upon NBB’s total equity at the prior year-end, adjusted for real estate taxes and certain other items.
The category of other operating expenses includes noninterest expense items such as professional services, stationery and supplies, telephone costs and charitable donations. Other operating expenses decreased when the years ended December 31, 2021 and 2020 are compared, primarily due to decreased non-service pension cost.
Income Taxes
Income tax expense for 2021 was $4,251 compared to $3,077 in 2020. The Company’s statutory tax rate was 21% for such years. The Company’s effective tax rates for 2021 and 2020 were 17.26% and 16.06%, respectively. The expected income tax expense based on the Company’s statutory tax rate differs from the actual income tax expense due to tax exempt income on municipal securities and loans. See Note 9 of the Notes to Consolidated Financial Statements for information relating to income taxes.
Effects of Inflation
The Company’s consolidated statements of income generally reflect the effects of inflation. Since interest rates, loan demand and deposit levels are related to inflation, the resulting changes are included in net income. The most significant item which does not reflect the effects of inflation is depreciation expense. Historical dollar values used to determine depreciation expense do not reflect the effects of inflation on the market value of depreciable assets after their acquisition.
Provision and Allowance for Loan Losses
The Company’s risk analysis at December 31, 2021 determined an allowance for loan losses of $7,674 or 0.96% of loans net of unearned income and deferred fees and costs. The allowance at December 31, 2020 was $8,481 or 1.10% of loans net of unearned income and deferred fees and costs. The determination of the appropriate level for the allowance for loan losses resulted in a recovery of $398 for the twelve months ended December 31, 2021, compared with a provision of $1,991 for the twelve month period ended December 31, 2020. To determine the appropriate level of the allowance for loan losses, the Company considers credit risk for certain loans designated as impaired and for non-impaired (“collectively evaluated”) loans.
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Individually Evaluated Impaired Loans
Individually evaluated impaired loans at December 30, 2021 were $5,878 gross and $5,880 net of unearned income and deferred fees and costs. There were no specific allocations to the allowance for loan losses as of December 31, 2021. At December 31, 2020, individually evaluated impaired loans totaled $4,903 gross and $4,905 net of unearned income and deferred fees and costs, with specific allocations to the allowance for loan losses totaling $75. The specific allocation is determined based on criteria particular to each impaired loan.
Collectively Evaluated Loans
Collectively evaluated loans totaled $797,851 gross and $797,368 net of unearned income and deferred fees and costs, with an allowance of $7,674 or 0.96% of collectively-evaluated loans net of unearned income and deferred fees and costs at December 31, 2021. At December 31, 2020, collectively evaluated loans totaled $765,124 gross and $763,894 net of unearned income and deferred fees and costs, with an allowance of $8,406 or 1.10%.
Collectively evaluated loans are divided into classes based upon risk characteristics. In order to calculate the allowance for collectively evaluated loans, the Company applies to each loan class a historical net charge-off rate for the class, adjusted for qualitative factors that influence credit risk. Qualitative factors evaluated for impact to credit risk include economic measures, asset quality indicators, loan characteristics, and changes to internal Company policies and changes in management.
Net Charge-Offs
Increases in the net charge-off rate increase the required allowance for collectively-evaluated loans, while decreases in the net charge-off rate decrease the required allowance for collectively-evaluated loans. On a portfolio level, net charge-offs were $409 for the twelve months ended December 31, 2021, or 0.05% of average loans. Net charge-offs for the twelve months ended December 31, 2020 were $373 or 0.05% of average loans. The 8-quarter average historical loss rate was 0.05% as of December 31, 2021 and 0.07% as of December 31, 2020.
Economic Factors
Economic factors influence credit risk and impact the allowance for loan loss. The Company considers economic indicators within its market area, including: unemployment, business and personal bankruptcy filings, the residential vacancy rate and the inventory of new and existing homes.
The Company sources economic data pertinent to its market from the most recently available publications. Most economic indicators lag the report date by one to three months. In periods of low volatility, lagging indicators are accepted as reasonably representative of current conditions. The COVID-19 pandemic introduced significant uncertainty and beginning in 2020, the Company implemented a qualitative factor for national unemployment filings to capture current economic data. Unemployment filings for the Company’s market area are not available on a timely basis, however national data is available on a timely basis and historical analysis shows a strong correlation between national and local unemployment filings.
National unemployment claims escalated sharply beginning in the latter half of March 2020 and the Company reacted by substantially increasing the allowance for loan losses. During 2021, national unemployment claims decreased considerably and average weekly claims over the last six weeks of the year were similar to pre-pandemic levels, allowing the Company to reduce the allocation for this factor.
The Company continues to monitor the most recently available economic indicators for its market and their effect on credit risk. As of December 30, 2021, the unemployment rate for the Company’s market area was measured as of November 30, 2021 and decreased from the measurement available at December 31, 2020, decreasing the allocation to the allowance for loan losses.
Business and personal bankruptcy filing data was available as of September 2021. Higher bankruptcy filings indicate heightened credit risk and increase the allowance for loan losses, while lower bankruptcy filings have a beneficial impact on credit risk. Compared with data available at December 31, 2020, business bankruptcies were at a similar level and received the same allocation and personal bankruptcies were slightly lower and resulted in a slightly lower allocation.
Residential vacancy rates and housing inventory impact the Company’s residential construction customers and the consumer real estate market. Higher levels increase credit risk. The residential vacancy rate at December 31, 2021 was measured as of the third quarter of 2021 and while still lower than normal levels, worsened slightly from the data incorporated into the December 31, 2020 calculation, resulting in a higher allocation. Housing inventory data was available as of December 31, 2021. Levels are historically low and are lower than those at December 31, 2020.
Asset Quality Indicators
Asset quality indicators, including past due levels, nonaccrual levels and internal risk ratings, are evaluated at the class level. Loans past due and loans designated nonaccrual indicate heightened credit risk. Increases in past due and nonaccrual loans increase the required level of the allowance for loan losses and decreases in past due and nonaccrual loans reduce the required level of the allowance for loan losses.
Accruing loans past due 30-89 days were 0.12% of total loans net of unearned income and deferred fees and costs at December 31, 2021, a decrease from 0.19% at December 31, 2020. Accruing loans past due 90 days or more were 0.01% of total loans, net of unearned income and deferred fees and costs at December 31, 2021 compared to 0.00% at December 31, 2020. Nonaccrual loans at December 30, 2021 were 0.36% of total loans net of unearned income and deferred fees and costs, lower than 0.48% at December 31, 2020.
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Loans rated special mention and classified (together, “criticized assets”) indicate heightened credit risk. Higher levels of criticized assets increase the required level of the allowance for collectively-evaluated loans, while lower levels of criticized assets reduce the required level of the allowance for collectively-evaluated loans. Collectively evaluated loans rated special mention were $3,728 at December 31, 2021, lower than $8,035 at December 31, 2020. Collectively evaluated loans rated classified were $1,064 at December 31, 2021 and $473 at December 31, 2020.
Other Factors
The Company considers other factors that impact credit risk, including the interest rate environment, the competitive, legal and regulatory environments, changes in lending policies and loan review, changes in management, high risk loans, as well as a factor to measure the risk from loans that received a COVID-19 modification and then received a subsequent COVID-19 modification.
The interest rate environment impacts variable rate loans. If interest rates increase, the payment on variable rate loans increases, which may increase credit risk. The interest rate environment is at a low level as of December 31, 2021, unchanged from the level at December 31, 2020. The low level of interest rates indicates no additional credit risk.
The competitive, legal and regulatory environments were evaluated for changes that would impact credit risk. Higher competition for loans increases credit risk, while lower competition decreases credit risk. Competition remained at similar levels to those at December 31, 2020. The legal and regulatory environments remain in a similar posture to that at December 31, 2020.
Lending policies, loan review procedures and management’s experience influence credit risk. Since December 31, 2020, there have been no changes that affect credit risk to the Company’s lending policies or loan review procedures. During the fourth quarter, the Company’s Chief Credit Officer resigned. The Company allocated to the allowance for loan losses to reflect the increased risk that results from a change in management.
Levels of high risk loans are considered in the determination of the level of the allowance for loan loss. A decrease in the level of high risk loans within a class decreases the required allocation for the loan class, and an increase in the level of high risk loans within a class increases the required allocation for the loan class. Total high risk loans decreased $23,101 or 20.41% from the level at December 31, 2020, resulting in a decreased allocation.
At December 31, 2020, the Company allocated to the allowance for loan losses for certain COVID-19 related modifications. As of December 31, 2021, there were no loans with COVID-19 related modifications still in the modification period, and no allocation was taken.
Unallocated Surplus
The unallocated surplus at December 30, 2021 is $361 or 4.94% in excess of the calculated requirement. The unallocated surplus at December 31, 2020 was $396 or 4.89% in excess of the calculated requirement. The surplus provides some mitigation of the uncertainty surrounding the impact of COVID-19.
Conclusion
The calculation of the appropriate level for the allowance for loan losses incorporates analysis of multiple factors and requires management’s prudent and informed judgment. The most recently available data showed improvements that decreased the required level of the allowance for loan losses at December 31, 2021 from December 31, 2020 including loans considered high risk, business and personal bankruptcy filings, the unemployment rate, criticized loans and certain loans with COVID-19 related modifications. Other indicators, including accruing loans past due 90 days or more and residential vacancy, showed worsening from levels at December 31, 2020 and increased the required level of the allowance for loan losses.
To reflect the impact of the COVID-19 pandemic, the Company added a qualitative factor for national unemployment filings beginning with the first quarter of 2020. During 2020, national unemployment filings increased dramatically from pre-pandemic levels and was the source of most of the provision taken for 2020. During 2021, unemployment filings declined substantially, which was a key factor in reducing the required level of the allowance for loan losses and resulted in a recovery for the year ended December 31, 2021.
The Company augmented the calculated requirement with an unallocated surplus of 4.94% to mitigate some of the uncertainty caused by the lingering pandemic. Based on analysis of historical indicators, asset quality and economic factors, management believes the level of allowance for loan losses is reasonable for the credit risk in the loan portfolio as of December 31, 2021.
Please refer to Note 5of Notes to Consolidated Financial Statements for further information on collectively evaluated loans, individually evaluated impaired loans and the unallocated portion of the allowance for loan losses.
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Balance Sheet
Total assets at December 31, 2021 were $1,702,175, an increase of $182,502 or 12.01%, from $1,519,673 at December 31, 2020. Growth in assets was fueled by growth in customer deposits, which increased $197,444 or 15.22% from $1,297,143 at December 31, 2020 to $1,494,587 at December 31, 2021.
Loans
The Company’s loan categorization reflects its approach to loan portfolio management and includes six groups. Real estate construction loans include construction loans for residential and commercial properties, as well as land. Consumer real estate loans include conventional and junior lien mortgages, equity lines and investor-owned residential real estate. Commercial real estate loans are comprised of owner-occupied and leased nonfarm, nonresidential properties, multi-family residence loans and farmland. Commercial non-real estate loans include agricultural loans, operating capital lines and loans secured by capital assets, as well as PPP loans. At December 31, 2021, PPP loans were $1,094 with deferred fees of $42. At December 31, 2020, PPP loans were $36,903 with net deferred fees of $911. Public sector and industrial development authority (“IDA”) loans are extended to municipalities. Consumer non-real estate loans include automobile loans, personal loans, credit cards and consumer overdrafts.
A. Maturities and Interest Rate Sensitivities
The following table presents maturities and interest rate sensitivities for loans. Loans are presented on a gross basis.
$ in thousands December 31, 2021
< 1 Year 1 – 5 Years 6-15 Years >15 Years Total
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B. Modifications and Troubled Debt Restructurings
Modifications
In the ordinary course of business the Company modifies loan terms on a case-by-case basis, including consumer and commercial loans, for a variety of reasons. Modifications may include rate reductions, payment extensions of varying lengths of time, a change in amortization term or method or other arrangements. Payment extensions allow borrowers temporary payment relief and result in extending the original contractual maturity by the number of months for which the extension was granted. The Company may grant payment extensions to borrowers who have demonstrated a willingness and ability to repay their loan but who are experiencing consequences of a specific unforeseen temporary hardship. If the temporary event is not expected to impact a borrower’s ability to repay the debt, and if the Company expects to collect all amounts due including interest accrued at the contractual interest rate for the extension period at contractual maturity, the modification is not designated a TDR.
Modifications to consumer loans generally involve short-term payment extensions to accommodate specific, temporary circumstances. Modifications to commercial loans may include, but are not limited to, changes in interest rate, maturity, amortization and financial covenants. If the modified terms are consistent with competitive market conditions and representative of terms the borrower could otherwise obtain in the open market, the modified loan is not categorized as a TDR.
The Company codes modifications to assist in identifying TDRs. When the COVID-19 pandemic began, the Company added coding to identify modifications to borrowers experiencing COVID-19 related hardship.
Modifications Made for Competitive Purposes
During the year ended December 31, 2021, the Company provided 875 modifications for competitive reasons to loans totaling $112,718. The modifications were not TDRs and were not related to COVID-19. For the twelve months ended December 31, 2020, the Company provided non-TDR modifications for competitive reasons to 1,047 loans totaling $152,681.
Modifications Related to COVID-19
The COVID-19 pandemic negatively impacted a significant number of the Company’s borrowers, and may adversely impact some borrowers in the future. Since the COVID-19 pandemic began in March 2020, the Company provided modifications related to COVID-19 financial difficulty, including payment extensions and interest only periods. The CARES Act, the CAA and regulatory guidance specify criteria that, if met, permit an election not to designate the loans as TDRs. The TDRs designated during the year ended December 31, 2021 resulted from COVID-19 related modifications that did not meet the legal and regulatory criteria to avoid designation as TDR. All of the Company’s other COVID-19 related modifications met the criteria and were not designated TDR. The Company followed its normal risk rating and nonaccrual designation procedures and did not automatically downgrade or designate as nonaccrual if the loan was modified for COVID-19 related difficulty.
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The following tables provide information regarding COVID-19 related modifications for the years ended December 31, 2021 and December 31, 2020.
Twelve Months Ended December 31,
Maturity date extension - - 2 729
Rate reductions(1) - - 5 442
A loan that received multiple modifications as part of one request, for instance, a rate reduction and a payment extension, is presented only under one modification category. A loan that was modified pursuant to a first request and then was modified subsequently pursuant to a separate request is included for each of the requests. For example, a loan that received a payment extension under a first request and a rate reduction under a second request is counted in the rate reduction category and again in the payment extension category.
All COVID-19 related modifications for payment extensions and interest-only periods have returned to contractual terms as of December 31, 2021.
TDRs
The Company’s TDRs, by delinquency status, are presented below:
$ in thousands TDR Delinquency Status as of December 31, 2021
Accruing
Total TDR Loans Current 30-89 Days Past Due 90+ Days Past Due Nonaccrual
Consumer real estate $ 191 $ 191 $ - $ - $ -
Commercial non-real estate 301 - - - 301
$ in thousands TDR Delinquency Status as of December 31, 2020
Accruing
Total TDR Loans Current 30-89 Days Past Due 90+ Days Past Due Nonaccrual
Consumer real estate $ 194 $ 194 $ - $ - $ -
Consumer non-real estate 2 1 - 1 -
Please refer to Note 5 of Notes to Consolidated Financial Statements for information on the effect of default on the allowance for loan losses.
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Summary of Loan Loss Experience
A. Loan Loss Data
The following table provides information about the allowance for loan losses, nonperforming assets and accruing loans past due 90 days or more:
December 31,
Allowance for loan losses $ 7,674 $ 8,481
Total loans, net of unearned income and deferred fees 803,248 768,799
Nonaccrual loans $ - $ 846
TDR loans in nonaccrual status 2,873 2,839
Total nonperforming loans $ 2,873 $ 3,685
Other real estate owned, net 957 1,553
Total nonperforming assets $ 3,830 $ 5,238
Allowance for loan losses to nonperforming loans 267.11 % 230.15 %
Allowance for loan losses to nonperforming assets 200.37 % 161.91 %
Accruing loans past due 90 days or more $ 90 $ 17
Management analyzes many factors to determine the appropriate level for the allowance for loan losses and resultant provision expense, including the historical loss rate, the quality of the loan portfolio as determined by management, diversification as to type of loans in the portfolio, internal policies and economic factors. The allowance for loan losses at December 31, 2020 reflected stressed economic data and a high level of uncertainty associated with the COVID-19 pandemic. The percentage of the allowance for loan losses to total loans decreased from December 31, 2020 to December 31, 2021. Improved economic conditions at December 31, 2021, as well as lower loss rates, decreases in the amount of loans considered high risk, criticized loans and certain loans with COVID-19 related modifications, led to the reduction of the percentage of the allowance for loan losses to loans. Nonperforming loans and other real estate owned (“OREO”), together nonperforming assets, improved from December 31, 2020 to December 31, 2021, while accruing loans past due 90 days or more worsened slightly. More information about the level and calculation methodology of the allowance for loan losses is provided in the sections “Provision and Allowance for Loan Losses” as well as Notes 1 and 5 of Notes to Consolidated Financial Statements.
B. Analysis of Net Charge-Offs
The following tables show net charge-offs, average loan balance and the percentage of charge-offs to average loan balance for each of the Company’s loan segments at the end of each period. Average loans are presented net of unearned income and net deferred fees.
$ in thousands December 31, 2021
Real estate construction $ - $ 45,463 - %
Consumer real estate (7 ) 193,159 - %
Public Sector and IDA - 45,829 - %
$ in thousands December 31, 2020
Real estate construction $ - $ 37,258 - %
Public Sector and IDA - 57,760 - %
The Company charges off commercial real estate loans at the time that a loss is confirmed. When delinquency status or other information indicates that the borrower will not repay the loan, the Company considers collateral value based upon a current appraisal or internal evaluation. Any loan amount in excess of collateral value is charged off and the collateral is taken into OREO.
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C.Allocation of the Allowance for Loan Losses
The allowance for loan losses has been allocated according to the amount deemed necessary to provide for anticipated losses within the categories of loans for the years indicated. Loans are presented net of unearned income and net deferred fees.
An analysis of the allowance for loan losses by impairment basis follows. Loans are presented on a gross basis.
$ in thousands December 31,
Allowance related to impaired loans - 75
Allowance to impaired loans - 1.53 %
Allowance related to non-impaired loans 7,674 8,406
Allowance to non-impaired loans 0.95 % 1.10 %
Less: unearned income and deferred fees and costs (481 ) (1,228 )
Loans, net of unearned income and deferred fees and costs 803,248 768,799
Allowance for loan losses, total 7,674 8,481
Please refer to the discussion under “Provision and Allowance for Loan Losses” for additional information on the determination of the allowance for loan loss.
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Securities
The fair value of securities available for sale was $686,080, an increase of $139,338 or 25.49% from December 31, 2020. The securities portfolio is subject to the volatility and risk in the financial markets. The risk in financial markets affects the Company in the same way that it affects other institutional and individual investors. The Company’s investment portfolio includes corporate bonds. If the corporate issuers were to default, there could be a delay in the payment of interest, or there could be a loss of principal and accrued interest. To date, there have been no defaults in any of the corporate bonds held in the portfolio. The Company’s investment portfolio also contains a large percentage of municipal bonds. If economic forces reduce the ability of states and municipalities to make scheduled principal and interest payments on their outstanding indebtedness, or if their income from taxes and other sources declines significantly, states and municipalities could default on their bond obligations. There have been no defaults among the municipal bonds in the Company’s investment portfolio. The fair value of available for sale securities is reflected on the Company's balance sheet.
In making investment decisions, management follows internal policy guidelines that help to limit risk by specifying parameters for both security quality and industry and geographic concentrations. Management regularly monitors the quality of the investment portfolio and tracks changes in financial markets. The value of individual securities will be written down if a decline in fair value is considered to be other than temporary, given the totality of the circumstances.
Additional information about securities available for sale and securities held to maturity can be found in Note 3 of the Notes to Consolidated Financial Statements.
Maturities and Associated Yields
The following table presents the maturities for debt securities available for sale at their carrying values as of December 31, 2021 and weighted average yield for each range of maturities. Weights are based upon the value of each security.
$ in thousands Maturities and Yields
< 1 Year 1-5 Years 5-10 Years > 10 Years None Total
Available for Sale:
Weighted average yield - - 1.61 % 4.00 % - 3.20 %
(1) Rates shown represent weighted average yield on a fully taxable basis.
The majority of mortgage-backed securities and collateralized mortgage obligations held at December 31, 2021 were backed by U.S. government agencies. Certain holdings are required to be periodically subjected to the Federal Financial Institution Examination Council’s (FFIEC) high risk mortgage security test. These tests address possible fluctuations in the average life and variances caused by the change in rate times the change in volume that have been allocated to rate and volume changes proportional to the relationship of the absolute dollar amounts of the change in each. Except for U.S. government agency securities, the Company has no securities with any issuer that exceeds 10% of stockholders’ equity.
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Deposits
The following table presents deposit categories:
Deposits, including noninterest-bearing demand deposits, interest-bearing deposits and interest-bearing time deposits are obtained in the Company’s markets through traditional marketing techniques. The Company’s deposits do not include any brokered deposits. Time deposits decreased due to decreased offering rates. All other categories of deposits increased, due in large part to government stimulus funds received by municipal depositors and other depositors.
A. Average Amounts of Deposits and Average Rates Paid
Average amounts and average rates paid on deposit categories are presented below:
$ in thousands Year Ended December 31,
Average Amounts Average Rates Paid Average Amounts Average Rates Paid
B.Uninsured Deposits
FDIC insurance covers deposits of up to $250 per depositor. As of December 31, 2021, $599,948 of the Bank's deposits were uninsured. The following table sets forth time deposit that exceed $250.
$ in thousands December 31, 2021
Derivatives and Market Risk Exposures
The Company engages in derivative financial instruments associated with its secondary market operation. The derivatives are valued within other assets and other liabilities. Please refer to Note 1 of Notes to Consolidated Financial Statements for information on derivative valuation. The Company is not a party to derivatives with off-balance sheet risks such as futures, forwards, swaps, and options.
The Company is a party to financial instruments with off-balance sheet risks such as commitments to extend credit, standby letters of credit, and recourse obligations in the normal course of business to meet the financing needs of its customers. See Note 13 of Notes to Consolidated Financial Statements for additional information relating to financial instruments with off-balance sheet risk. Management does not plan any future involvement in high risk derivative products.
The Company has investments in mortgage-backed securities, principally through the Government National Mortgage Association and Federal National Mortgage Association, with a fair value of approximately $206,174. See Note 3 of Notes to Consolidated Financial Statements for additional information relating to securities.
The Company’s securities and loans are subject to credit and interest rate risk, and its deposits are subject to interest rate risk. Management considers credit risk when a loan is granted and monitors credit risk after the loan is granted. The Company maintains an allowance for loan losses to absorb losses in the collection of its loans. See Note 5 of Notes to Consolidated Financial Statements for information relating to the allowance for loan losses. See Note 14 of Notes to Consolidated Financial Statements for information relating to concentrations of credit risk.
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The effects of changing interest rates are primarily managed through adjustments to the loan portfolio and deposit base, to the extent competitive factors allow. Adjustments for asset and liability management are made when securities are called or mature and funds are subsequently reinvested. Securities may be sold for reasons related to credit quality, to maintain compliance with regulatory limitations or for interest rate risk management. No trading activity is planned in the foreseeable future.
See Interest Rate Sensitivity for further details on asset liability management and Note 15 of Notes to Consolidated Financial Statements for information relating to fair value of financial instruments.
Liquidity
Liquidity measures the Company’s ability to meet its financial commitments at a reasonable cost. Demands on the Company’s liquidity include funding additional loan demand and accepting withdrawals of existing deposits. The Company has diverse liquidity sources, including customer and purchased deposits, customer repayments of loan principal and interest, sales, calls and maturities of securities, Federal Reserve discount window borrowing, short-term borrowing, and FHLB advances. At December 31, 2021, the Bank did not have purchased deposits, discount window borrowings, short-term borrowings, or FHLB advances. To assure that short-term borrowing is readily available, the Company tests accessibility annually.
The Company considers its security portfolio for typical liquidity needs, within accounting, legal and strategic parameters. Portions of the securities portfolio are pledged to meet state requirements for public funds deposits. Discount window borrowings also require pledged securities. Increased/decreased liquidity from public funds deposits or discount window borrowings results in increased/decreased liquidity from pledging requirements. The Company monitors public funds pledging requirements and unpledged available for sale securities accessible for liquidity needs.
Regulatory capital levels determine the Company’s ability to use purchased deposits and the Federal Reserve discount window. At December 31, 2021, the Company is considered well capitalized and does not have any restrictions on purchased deposits or borrowing ability at the Federal Reserve discount window.
The Company monitors factors that may increase its liquidity needs. Some of these factors include deposit trends, large depositor activity, maturing deposit promotions, interest rate sensitivity, maturity and repricing timing gaps between assets and liabilities, the level of unfunded loan commitments and loan growth. At December 31, 2021, the Company’s liquidity is sufficient to meet projected trends in these areas.
To monitor and estimate liquidity levels, the Company performs stress testing under varying assumptions on credit sensitive liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows. The Company’s Contingency Funding Plan sets forth avenues for rectifying liquidity shortfalls. At December 31, 2021, the analysis indicated adequate liquidity under the tested scenarios.
The Company utilizes several other strategies to maintain sufficient liquidity. Loan and deposit growth are managed to keep the loan to deposit ratio within the Company’s own policy range of 65% to 75%. At December 31, 2021, the loan to deposit ratio was 53.74%. The investment strategy takes into consideration the term of the investment, and securities in the available for sale portfolio are laddered based upon projected funding needs.
In the normal course of business, we enter into certain contractual obligations, including obligations to make future payments on lease arrangements, contractual commitments with depositors, and service contracts. The table below presents our significant contractual obligations as of December 31, 2021, except for pension and other postretirement benefit plans, which are included in Note 8 of Notes to Consolidated Financial Statements in this Form 10-K.
$ in thousands Payments Due by Period
Total Less Than 1 Year 1-3 Years 4-5 Years More Than 5 Years
(1) Includes contracts with a minimum annual payment of $100.
As of December 31, 2021, the Company was not aware of any other known trends, events or uncertainties that have or are reasonably likely to have a material impact on our liquidity. As of December 31, 2021, the Company has no material commitments for long term debt or for capital expenditures.
Recent Accounting Pronouncements
See Note 1 of Notes to Consolidated Financial Statements for information relating to recent accounting pronouncements.
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Capital Resources
Total stockholders’ equity at December 31, 2021 was $191,751, a decrease of $8,856, or 4.41%, from the $200,607 at December 31, 2020. The largest component of stockholders’ equity, retained earnings, decreased from $189,547 at December 31, 2020 to $188,229 at December 31, 2020, due to dividends of $8,806 and repurchase of shares of $12,894, offset by net income of $20,382.
The Company qualifies as a small bank holding company under the Federal Reserve’s Small Bank Holding Company Policy Statement, which exempts bank holding companies with less than $3 billion in assets from reporting consolidated regulatory capital ratios and from minimum regulatory capital requirements. NBB is subject to various capital requirements administered by banking agencies, including an additional capital conservation buffer in order to make capital distributions or discretionary bonus payments. Risk-based capital ratios are calculated in compliance with OCC rules based on the Basel III Capital Rules. The Bank’s ratios are well above the required minimums at December 31, 2021 and December 31, 2020. Risk based capital ratios for the Bank are shown in the following tables.
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements at December 31, 2021 are detailed in the table below.
$ in thousands Payments Due by Period
Total Less Than 1 Year 1-3 Years 4-5 Years More Than 5 Years
Mortgage loans with potential recourse 18,287 18,287 - - -
In the normal course of business the Company’s banking affiliate extends lines of credit to its customers. Amounts drawn upon these lines vary at any given time depending on the business needs of the customers.
Standby letters of credit are also issued to the Bank’s customers. There are two types of standby letters of credit. The first is a guarantee of payment to facilitate customer purchases. The second type is a performance letter of credit that guarantees a payment if the customer fails to perform a specific obligation. Revenue from these letters was approximately $42 in 2021.
While it would be possible for customers to fully draw on approved lines of credit and for beneficiaries to call all letters of credit, historically this has not occurred. In the event of a sudden and substantial draw on these lines, the Company has its own lines of credit from which it can draw funds. A sale of loans or investments would also be an option to meet liquidity demands.
The Company sells mortgages on the secondary market subject to recourse agreements. The mortgages originated must meet strict underwriting and documentation requirements for the sale to be completed. The Company estimates a potential loss reserve for recourse provisions. The amount is not material as of December 31, 2021. To date, no recourse provisions have been invoked.
Operating leases are for buildings used in the Company’s day-to-day operations.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Information about market risk is set forth above in the “Interest Rate Sensitivity” and “Derivatives and Market Risk Exposure” sections, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of this Form 10-K.
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Item 8. Financial Statements and Supplementary Data
Consolidated Balance Sheets
December 31,
$ in thousands, except per share data 2021 2020
Assets
Mortgage loans held for sale 615 866
Loans:
Less unearned income and deferred fees and costs (481 ) (1,228 )
Loans, net of unearned income and deferred fees and costs 803,248 768,799
Less allowance for loan losses (7,674 ) (8,481 )
Other real estate owned, net 957 1,553
Liabilities and Stockholders’ Equity
Accrued interest payable 48 56
Commitments and contingencies
Stockholders’ equity:
Accumulated other comprehensive (loss) income, net (4,058 ) 3,020
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Income
Years ended December 31,
$ in thousands, except per share data 2021 2020
Interest Income
Interest on interest-bearing deposits 170 276
Interest and dividends on securities – taxable 7,960 7,383
Interest on securities – nontaxable 1,934 1,826
Interest Expense
Provision for (recovery of) loan losses (398 ) 1,991
Net interest income after provision for (recovery of) loan losses 42,287 36,180
Noninterest Income
Service charges on deposit accounts 2,045 1,966
Other service charges and fees 179 162
Credit and debit card fees, net 1,869 1,400
Gain on sale of mortgage loans 364 676
Realized securities gains, net 6 108
Noninterest Expense
Occupancy, furniture and fixtures 1,842 1,795
Net costs of other real estate owned 51 39
Basic and fully diluted net income per common share $ 3.28 $ 2.48
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Comprehensive Income
Years ended December 31,
Other Comprehensive (Loss) Income, Net of Tax
The accompanying notes are an integral part of these consolidated financial statements.
Consolidated Statements of Changes in Stockholders’ Equity
Other comprehensive loss, net of tax of ($1,881) - - (7,078 ) (7,078 )
The accompanying notes are an integral part of these consolidated financial statements.
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Consolidated Statements of Cash Flows
Years ended December 31,
Cash Flows from Operating Activities
Adjustment to reconcile net income to net cash provided by operating activities:
(Recovery of) provision for loan losses (398 ) 1,991
Deferred income tax expense 152 282
Depreciation of premises and equipment 636 708
Amortization of premiums and accretion of discounts, net 1,688 1,455
Gain on disposal of fixed assets - (2 )
Gain on calls and sales of securities available for sale, net (6 ) (108 )
Loss (gain) and write-down on other real estate owned 25 (13 )
Loss on sale of repossessed assets - 1
Income on investment in BOLI (910 ) (877 )
Gain on sale of mortgage loans held for sale (364 ) (676 )
Origination of mortgage loans held for sale (17,672 ) (39,647 )
Contribution to defined benefit plan - (5,000 )
Net change in:
Accrued interest receivable (76 ) (743 )
Accrued interest payable (8 ) (88 )
Net cash provided by operating activities 22,882 13,793
Cash Flows from Investing Activities
Net change in interest-bearing deposits (9,296 ) (43,844 )
Proceeds from repayments of mortgage-backed securities 44,881 18,068
Purchases of securities available for sale (219,331 ) (241,164 )
Net change in restricted stock 434 (59 )
Purchases of loan participations (25,167 ) (11,404 )
Collections of loan participations 15,191 207
Loan originations and principal collections, net (25,289 ) (24,875 )
Proceeds from disposal of other real estate owned 621 72
Proceeds from disposal of repossessed assets 11 30
Recoveries on loans charged off 346 347
Purchase of BOLI (5,000 ) -
Additions to premises and equipment (323 ) (1,824 )
Proceeds from sale of premises and equipment - 2
(continued)
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Cash Flows from Financing Activities
Net change in cash and due from banks (4,379 ) 2,857
Cash and due from banks at beginning of year 13,147 10,290
Cash and due from banks at end of year $ 8,768 $ 13,147
Supplemental Disclosures of Cash Flow Information
Interest paid on deposits and borrowed funds $ 3,106 $ 5,925
Supplemental Disclosures of Noncash Activities
Loans charged against the allowance for loan losses $ 755 $ 720
Loans transferred to other real estate owned 50 -
Loans transferred to repossessed assets 11 4
Unrealized (loss) gain on securities available for sale (13,054 ) 16,570
Minimum pension liability adjustment 4,095 (1,981 )
The accompanying notes are an integral part of these consolidated financial statements.
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Notes to Consolidated Financial Statements
$ in thousands, except per share data.
Note 1: Summary of Significant Accounting Policies
The consolidated financial statements include the accounts of National Bankshares, Inc. and its wholly-owned subsidiaries, the National Bank of Blacksburg, and National Bankshares Financial Services, Inc. All intercompany balances and transactions have been eliminated in consolidation.
The accounting and reporting policies of the Company conform to GAAP and to general practices within the banking industry. Subsequent events have been considered through the date of this Form 10-K. The following summarizes significant accounting policies.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and amounts due from banks.
Interest-Bearing Deposits
The Company invests over-night funds in interest-bearing deposits at other banks, including the FHLB, the Federal Reserve and other entities. Interest-bearing deposits are carried at cost.
Securities
Certain debt securities that management has the positive intent and ability to hold to maturity may be classified as “held to maturity” and recorded at amortized cost. Trading securities are recorded at fair value with changes in fair value included in earnings. Securities not classified as held to maturity or trading, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive (loss) income. The Company uses the interest method to recognize purchase premiums and discounts in interest income over the term of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
The Company follows the accounting guidance related to recognition and presentation of other–than-temporary impairment (“OTTI”). The guidance specifies that if (a) an entity does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that the entity will not have to sell the debt security prior to recovery, the security would not be considered OTTI, unless there is a credit loss. When criteria (a) and (b) are met, the entity will recognize the credit component of an OTTI of a debt security in earnings and the remaining portion in other comprehensive (loss) income.
Equity securities with readily-determinable fair values are measured at fair value using the “exit price notion”. Changes in fair value are recognized in net income. Equity securities without readily-determinable fair values are recorded as other assets at cost less impairment, if any, and adjusted for changes resulting from observable price changes in orderly transactions for identical or similar investment of the same issuer.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value on an individual loan basis. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. The Company releases mortgage servicing rights when loans are sold on the secondary market.
Loans
The Company, through its banking subsidiary, provides mortgage, commercial, and consumer loans to customers. Loans that management has the intent and ability to hold for the foreseeable future, or until maturity or payoff, are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses, any purchase premium or discount, unearned income and deferred fees or costs. Interest income is accrued on the unpaid principal balance. Unearned income on dealer-originated loans and loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. Purchase premium or discount is recognized as an adjustment of the related loan yield using the interest method.
The Bank’s loan policy is updated and approved by the Board of Directors annually and disseminated to lending and loan portfolio management personnel to ensure consistent lending practices. The policy communicates the Company’s risk tolerance by prescribing underwriting guidelines and procedures, including approval limits and hierarchy, documentation standards, requirements for collateral and loan-to-value limits, debt coverage, overall creditworthiness and guarantor support. Of primary consideration is the repayment ability of the borrowers and (if secured) the collateral value in relation to the principal balance. Collateral lowers risk and may be used as a secondary source of repayment. The credit decision must be supported by documentation appropriate to the type of loan, including current financial information, income verification or cash flow analysis, tax returns, credit reports, collateral information, guarantor verification, title reports, appraisals (where appropriate) and other documents.
The Company’s loans are grouped into six segments: real estate construction, consumer real estate, commercial real estate, commercial non-real estate, public sector and IDA, and consumer non-real estate. Each segment is subject to certain risks that influence pricing, loan structures, approval requirements, reserves, and ongoing credit management.
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Real Estate Construction Loans. Real estate construction loans are subject to general risks from changing commercial building and housing market trends and economic conditions that may impact demand for completed properties and the costs of completion. Completed properties that do not sell or become leased within originally expected timeframes may impact the borrower’s ability to service the debt. Construction loans are underwritten against projected cash flows from rental income, business and/or personal income from an owner-occupant or the sale of the property to an end-user. Associated risks may be mitigated by requiring fixed-price construction contracts, performance and payment bonding, controlled disbursements, and pre-sale contracts or pre-lease agreements. Risks specific to the borrower are also evaluated, including previous repayment history, debt service ability, and current and projected loan-to value ratios for the collateral.
Consumer Real Estate Loans. The Bank offers a variety of first mortgage and junior lien loans secured by primary residences within our markets. The credit quality of consumer real estate is subject to risks associated with the borrower’s repayment ability and collateral value. Credit decisions are primarily based on loan-to-value (“LTV”) ratios, debt-to-income (“DTI”) ratios, liquidity and net worth. Income and financial information is obtained from personal tax returns, personal financial statements and employment documentation. A maximum LTV ratio of 80% is generally required. The DTI ratio is limited to 43% of gross income.
Consumer real estate mortgages may have fixed interest rates for the entire term of the loan or variable interest rates subject to change after the first, third, or fifth year. Variable rates are based on the weekly average yield of United States Treasury Securities and are underwritten at fully-indexed rates.
Home equity loans are secured primarily by second mortgages on residential property. The underwriting policy for home equity loans generally permits aggregate (the total of all liens secured by the collateral property) borrowing availability up to 80% of the appraised value of the collateral. We offer both fixed rate and variable rate home equity loans, with variable rate loans underwritten at fully-indexed rates. Decisions are primarily based on LTV ratios, DTI ratios, liquidity and credit history. We do not offer home equity loan products with reduced documentation.
We do not offer certain high risk loan products such as interest-only consumer mortgage loans, hybrid loans, payment option adjustable rate mortgages (“ARMs”), reverse mortgage loans, loans with initial teaser rates or any product with negative amortization. Hybrid loans are loans that start out as a fixed rate mortgage, but after a set number of years they automatically adjust to an ARM. Payment option ARMs usually have adjustable rates, for which borrowers choose their monthly payment of either a full payment, interest only, or a minimum payment which may be lower than the payment required to reduce the balance of the loan in accordance with the originally underwritten amortization.
Commercial Real Estate Loans. Commercial real estate loans generally are secured by first mortgages on real estate, including multifamily residential real estate, commercial real estate occupied by the owner/borrower, and commercial real estate leased to non-owners. Properties financed include retail centers, office space, hotels and motels, apartments, and industrial properties. Loans in the commercial real estate segment are impacted by economic risks from changing commercial real estate markets, rental markets for multi-family housing and commercial buildings, and economic factors that would impact the businesses housed by the commercial real estate. Underwriting decisions are based upon an analysis of the economic viability of the collateral and creditworthiness of the borrower. The Bank obtains appraisals from qualified certified independent appraisers to establish the value of collateral properties. The loan amount is generally limited to 80% of the lower of cost or appraised value and is individually determined based on the property type, quality, location and financial strength of any guarantors. The property’s projected net cash flows compared to the debt service (often referred to as the “debt service coverage ratio”) is required to be 115% or greater and is computed after deduction for a vacancy factor and property expenses, as appropriate. Borrower cash flow may be supplemented by a personal guarantee from the principal(s) of the borrower and guarantees from other parties. The Bank may employ stress testing techniques on higher balance loans to determine repayment ability in a changing rate environment before granting loan approval. The Bank requires title insurance, fire, extended coverage casualty insurance and flood insurance, if appropriate, in order to protect the security interest in the underlying property.
Commercial Non-Real Estate Loans. Commercial non-real estate loans are secured by collateral other than real estate, or are unsecured. Credit risk for commercial non-real estate loans is subject to economic conditions, borrower repayment ability and collateral value (if secured). Commercial and agricultural loans primarily finance equipment acquisition, expansion, working capital, and other general business purposes. Because these loans have a higher degree of risk, the Bank generally obtains collateral such as inventory, accounts receivables or equipment and personal guarantees from the borrowing entity’s principal owners. The Bank’s policy limits lending up to 60% of the appraised value for inventory, up to 90% of the lower of cost of market value of equipment and up to 70% for accounts receivables less than 90 days old. Credit decisions are based upon an assessment of the financial capacity of the applicant, including the primary borrower’s ability to repay within proposed terms, a risk assessment, financial strength of guarantors and adequacy of collateral. Credit agency reports of individual owners’ credit history supplement the analysis.
Included within this category are SBA PPP loans. The Bank provided qualifying customers with small business loans to pay payroll and other qualifying expenses. The vast majority of the Bank’s PPP loans have been repaid.
Public Sector and IDA Loans. Public sector and IDA loans are extended to municipalities and related entities within the Bank’s geographical footprint. Borrowers include general taxing authorities such as a city or county, industrial/economic development authorities or utility authorities. Credit risk stems from the entity’s ability to repay through either a direct obligation or assignment of specific revenues from an enterprise or other economic activity. Repayment sources are derived from taxation, such as property taxes and sales taxes, or revenue from the project financed with the loan. The Company’s underwriting considers economic and population trends of the municipality and the municipality’s reserves, pension liabilities and other liabilities.
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Consumer Non-Real Estate Loans. Consumer non-real estate includes credit cards, automobile and other consumer loans. Credit cards and certain other consumer loans are unsecured, while collateral is obtained for automobile loans and other consumer loans. Credit risk stems primarily from the borrower’s ability to repay. Our procedures for underwriting consumer loans include an assessment of an applicant’s overall financial capacity, including credit history and the ability to meet existing obligations and payments on the proposed loan. If the loan is secured by an automobile or other collateral, the underwriting process also includes a comparison of the value of the collateral security to the proposed loan amount. We require borrowers to maintain collision insurance on automobiles securing consumer loans.
Past Due Status and Nonaccrual Designation
A loan is considered past due when a payment of principal and/or interest is due but not paid. Credit card payments not received within 30 days after the statement date, real estate loan payments not received within the payment cycle and all other non-real estate secured loans for which payment is not made within the required payment cycle are considered 30 days past due. Management closely monitors past due loans in timeframes of 30-89 days past due and 90 or more days past due.
The Company considers multiple factors when determining whether to discontinue accrual of interest on individual loans. Generally loans are placed in nonaccrual status when collection of interest and/or full principal is considered doubtful. Interest accrual is discontinued at the time a commercial real estate loan or commercial non-real estate loan is 90 days delinquent unless the credit is well secured and in the process of collection. Accrued interest is reversed against income when a loan is placed in nonaccrual status. Any interest payments received during a loan’s nonaccrual period are credited to the principal balance of the loan.
Nonaccrual loans that are not TDR are returned to accrual status when all the principal and interest amounts contractually due are current and future payments are reasonably assured. Nonaccrual TDR loans may return to accrual status after six months of timely repayment performance. The Company reviews nonaccrual loans on an individual loan basis to determine whether future payments are reasonably assured. In order for this criteria to be satisfied, the Company’s evaluation must determine that the underlying cause of the original delinquency or weakness that indicated nonaccrual status has been resolved, such as receipt of new guarantees, increased cash flows that cover the debt service or other resolution.
Allowance for Loan Losses
The allowance for loan losses is an estimate of probable losses inherent in the loan portfolio. The allowance is funded by the provision for loan losses, reduced by charge-offs of loans and increased by recoveries of previously charged-off loans. The determination of the allowance is based on two accounting principles, Accounting Standards Codification ("ASC") Topic 450-20 (Contingencies) which requires that losses be accrued when occurrence is probable and the amount of the loss is reasonably estimable, and ASC Topic 310-10 (Receivables) which requires accrual of losses on impaired loans if the recorded investment exceeds fair value.
Impaired loans
Impaired loans are larger non-homogeneous loans for which there is a probability that collection of principal or interest will not occur according to the contractual terms of the loan agreement, as well as loans whose terms have been modified in a TDR. Impaired loans are individually evaluated to determine appropriate reserves and are measured at the lower of the invested amount or the fair value. Fair value of impaired loans is estimated in one of three ways: (1) the estimated fair value (less selling costs) of the underlying collateral, (2) the present value of the loan’s expected future cash flows, or (3) the loan’s observable market value.
The estimated fair value is compared with the loan’s recorded investment (unpaid principal net of any interest payments made by the borrower during the nonaccrual period and net of any partial charge-offs, accrued interest and deferred fees and costs). Any amount of recorded investment that exceeds estimated fair value on collateral-dependent loans, as well as any other impairment loss considered uncollectible, is charged against the allowance for loan losses. Fair value shortfalls that are not considered uncollectible for loans that are not collateral-dependent are accrued in the allowance as specific reserves. Impaired loans for which collection of interest or principal is in doubt are placed in nonaccrual status. If fair value of an impaired loan is higher than the book value, no specific reserve is recorded, and the loan remains impaired as long as analysis indicates that collection of the loan will not occur according to the contractual terms of the loan agreement.
Collectively-evaluated loans
General allowances are established for collectively evaluated loans. Collectively evaluated loans are grouped into classes based on similar characteristics. Factors considered in determining general allowances include historical loss rates, internal risk ratings, delinquency and nonperforming rates, product mix, changes in loan policies and procedures, changes in loan review systems, changes in economic conditions, changes in management experience, industry trends, interest rate trends and changes in the competitive, legal and regulatory environment.
Charge-off policy
The Company’s charge-off policy meets or is more stringent than the minimum standards required by regulators. When available information confirms that a specific loan or a portion thereof, within any loan class, is uncollectible the amount is charged off against the allowance for loan losses. Additionally, losses on consumer real estate and consumer non-real estate loans are typically charged off no later than when the loans are 120-180 days past due, and losses on loans secured by residential real estate or by commercial real estate are charged off by the time the loans reach 180 days past due, in compliance with regulatory guidelines. Accordingly, secured loans may be charged down to the estimated value of the collateral, with previously accrued unpaid interest reversed. Subsequent charge-offs may be required as a result of changes in the market value of collateral or other repayment prospects.
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Credit quality indicators
Credit quality indicators, which the Company terms risk grades, are assigned through the Company’s credit review function for larger loans and selective review of loans that fall below credit review thresholds. Credit quality is rated based on the loan’s payment history, the borrower’s current financial situation and value of the underlying collateral.
Loans that do not indicate heightened risk are graded as “pass.” Loans that appear to have elevated credit risk because of frequent or persistent past due status, which is less than 75 days, or that show weakness in the borrower’s financial condition are risk graded “special mention.” Loans with frequent or persistent delinquency exceeding 75 days or that have a higher level of weakness in the borrower’s financial condition are graded “classified.” Classified loans have regulatory risk ratings of “substandard” and “doubtful.”
TDRs
When the Company grants a concession to a borrower for economic or legal reasons related to a borrower’s financial condition, the loan is classified a TDR. When the Company grants a subsequent modification to a loan that had previously been modified but not designated TDR, it considers whether the totality of the accommodations amount to a concession that, along with the evaluation of borrower financial difficulty, indicate TDR status. Concessions may include reduction of the interest rate, extension of the maturity date at an interest rate lower than the current market rate for a new loan with similar risk, forgiveness of principal or accrued interest or other actions intended to minimize the economic loss. TDR loans are individually measured for impairment. TDRs may be removed from TDR status, and therefore from individual evaluation, if the restructuring agreement specifies a contractual interest rate that is a market interest rate at the time of restructuring and the loan is in compliance with its modified terms one year after the restructure was completed.
Rate Lock Commitments
The Company enters into commitments to originate mortgage loans in which the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 30 to 60 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, by committing to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result, the Company is not exposed to losses nor will it realize significant gains related to its rate lock commitments due to changes in interest rates. The correlation between the rate lock commitments and the best efforts contracts is very high due to their similarity.
The market value of rate lock commitments and best efforts contracts is not readily ascertainable because rate lock commitments and best effort contracts are not actively traded in stand-alone markets. The Company determines the fair value of rate lock commitments and best efforts contracts by measuring the changes in the value of the underlying assets while taking into consideration the probability that the rate lock commitments will close. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss occurs on the rate lock commitments.
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is charged to expense over the estimated useful lives of the assets on the straight-line basis. Depreciable lives include 40 years for premises, 3-10 years for furniture and equipment, and 3 years for computer software. Costs of maintenance and repairs are charged to expense as incurred and improvements are capitalized.
Other Real Estate Owned
Real estate acquired through or in lieu of foreclosure is held for sale and is initially recorded at fair value less estimated costs to sell at the date of foreclosure, establishing the cost basis of the asset. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other operating expenses.
Goodwill
The Company records as goodwill the excess of purchase price over the fair value of the identifiable net assets acquired. Goodwill is subject to at least an annual assessment for impairment by applying a fair value based test. The Company performs its annual analysis as of September 30 of each fiscal year. The impairment test for 2021 incorporated data as of September 30, 2021.
The Company’s goodwill impairment analysis considered three valuation techniques appropriate to the measurement. The first technique uses the Company’s market capitalization as an estimate of fair value, the second technique estimates fair value using current market pricing multiples for companies comparable to NBI, while the third technique uses current market pricing multiples for change-of-control transactions involving companies comparable to NBI. Certain key judgments were used in the valuation measurement. Goodwill is held by the Company’s bank subsidiary. The bank subsidiary is 100% owned by the Company, and no market capitalization is available. Because most of the Company’s assets are comprised of the bank subsidiary’s equity, the Company’s market capitalization was used to estimate the Bank’s market capitalization. Other judgments include the assumption that the companies and transactions used as comparables for the second and third techniques were appropriate to the estimate of the Company’s fair value, and that the comparable multiples are appropriate indicators of fair value, and compliant with accounting guidance. Based upon data at September 30, 2021, each measure indicated that the Company’s fair value exceeded its book value and no impairment was indicated.
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Pension Plan
The Company recognizes the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its statement of financial position and recognizes changes in that funded status in the year in which the changes occur through other comprehensive (loss) income. The funded status of a benefit plan is measured as the difference between plan assets at fair value and the projected benefit obligation.
Income Taxes
Income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the asset and liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The Company recognizes interest and penalties on income taxes as a component of income tax expense.
Trust Assets and Income
Assets (other than cash deposits) held by NBB’s Trust Department in a fiduciary or agency capacity for customers are not included in the consolidated financial statements since such items are not assets of the Company. Trust income is recognized on the accrual basis.
Earnings Per Common Share
Basic earnings per common share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. During 2021 and 2020, there were no potential common shares outstanding.
The following shows the weighted average number of shares used in computing earnings per common share for the years indicated.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business are recorded as liabilities when the likelihood of loss is probable and reasonably estimated. Management does not believe there are such matters that will have a material effect on the consolidated financial statements.
Advertising
The Company charges advertising costs to expenses as incurred. Advertising expenses were $112 for the year ended December 31, 2021 and $99 for the year ended December 31, 2020.
Revenue Recognition
The Company accounts for revenue associated with financial instruments, including loans and securities via the accrual method. The Company recognizes noninterest income when it satisfies commitments to customers. Please refer to Note 18: Revenue Recognition.
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Use of Estimates
In preparing consolidated financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, evaluation of impairment of goodwill, and pension obligations.
Reclassifications
Certain amounts reported in prior years have been reclassified to conform to the current year’s presentation. These reclassifications had no effect on the Company’s net income of stockholders' equity.
Recent Accounting Pronouncements
In June 2016, the FASB issued Accounting Standards Update (“ASU”) No.2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASUs 2019-04,2019-05,2019-10,2019-11,2020-02, and 2020-03. These ASUs have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the SEC and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. The Company is working to ensure readiness and compliance with the standard. The Company has engaged with a vendor, validated data, analyzed correlations for forecasting, selected methodologies and begun running parallel models. Management will continue to refine assumptions that impact the calculation prior to the effective date.
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (SAB) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.
In March 2020, the FASB issued ASU No.2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the FASB issued ASU No.2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU No.2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU No.2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company has a small number of participation loans that reference LIBOR. The Company is working with the primary banks to determine appropriate actions.
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Recently Adopted Accounting Developments
In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. ASU 2019-12 was effective for the Company on January 1, 2021. The adoption of ASU 2019-12 did not have a material impact on the Company’s consolidated financial statements.
In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2020-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. ASU 2020-01 was effective for the Company on January 1, 2021. The adoption of ASU 2020-01 did not have a material impact on the Company’s consolidated financial statements.
In October 2020, the FASB issued ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable fees and Other Costs.” This ASU clarifies that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. ASU 2020-08 was effective for the Company on January 1, 2021. The adoption of ASU 2020-08 did not have a material impact on the Company’s consolidated financial statements.
In December 2020, the CAA was passed. Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the CARES Act, including the PPP loan program and treatment of certain loan modifications related to the COVID-19 pandemic. The Company modified loans in accordance with the CAA and the CARES Act. The Company modified loans in accordance with the CAA and the CARES Act.
In August 2021, the FASB issued ASU 2021-06, “'Presentation of Financial Statements (Topic 205), Financial Services—Depository and Lending (Topic 942), and Financial Services—Investment Companies (Topic 946): Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No.33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No.33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU incorporates recent SEC rule changes into the FASB Codification, including SEC Final Rule Releases No.33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No.33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants”. The ASU was effective upon addition to the FASB Codification. The adoption of ASU 2021-06 did not have a material impact on the Company’s consolidated financial statements.
Risks and Uncertainties
Since the beginning of 2020, the COVID-19 pandemic and efforts to reduce its spread have caused significant disruptions in the U.S. economy and negatively impacted financial activity in the Company’s market. The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions. Some measures appear to indicate a positive trajectory, however if the pandemic escalates, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows. While it is not possible to know the full extent of the impact COVID-19 will have on the Company’s operations, the Company is disclosing potentially material items of which it is aware.
Financial position and results of operations
During 2020, the COVID-19 pandemic led to declines in two key income categories: interest income and overdraft fee income. Interest income was impacted by certain modification requests that reversed accrued interest when granted, and by a decreased interest rate environment. During 2021, the number of modification requests that reduce interest income vastly decreased, though loan refinance and securities call activity spurred by the low interest rates continue to impact interest income, with reinvestment opportunities at lower rates. If the COVID-19 pandemic’s evolution brings new or worsened economic impacts, these income categories and others may be negatively affected.
Low interest rates since the beginning of the pandemic, financial aid to consumers provided by the CARES Act and the CAA, increased demand and supply chain bottlenecks have resulted in historically high levels of inflation. Potential future increases in interest rates to address inflation may adversely affect net interest income if liabilities reprice more quickly than assets. If future interest rate movements reduce economic activity more substantially than desired, the Company’s market area could experience a decline that would reduce lending activity and fee income. At this time, the Company is unable to project the materiality of such an impact.
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