Item 1A. Risk Factors
Ownership of our common stock involves a high degree of risk. You should carefully consider the risks described below, together with all other information included in this Annual Report on Form 10-K, including the disclosures in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements and the related notes included in "Item 8. Financial Statements and Supplementary Data." We believe the risks described below are the risks that are material to us as of the date of this Annual Report on Form 10-K. Any of the following risks, as well as risks of which we are not now aware or currently deem immaterial, could materially and adversely affect our business, financial condition, and results of operations. Further, to the extent that any of the information in this report constitutes forward-looking statements, the risk factors below also are cautionary statements identifying important factors that could cause actual results to differ materially from those expressed in any forward-looking statements made by us or on our behalf.
Risks Related to the Ongoing COVID-19 Pandemic
The COVID-19 pandemic is adversely affecting our business, financial condition, and results of operations, and the ultimate impact will depend on future developments which are uncertain and cannot be predicted.
The COVID-19 pandemic is creating extensive disruptions to the global economy and to the lives of individuals throughout the world. Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus, and legislation designed to deliver monetary aid and other relief. The pandemic and related efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, prompted decreases in interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. If these implications continue for a prolonged period or result in sustained economic stress, many of the risk factors identified in this Annual Report on Form 10-K could be exacerbated and such effects could have a material adverse effect on us related to credit, collateral, interest rate risk, profitability, and operations as described in the following sections.
•Credit and Collateral Risk. The spread of COVID-19 has caused, and may continue to cause, business shutdowns, limitations on commercial activity and financial transactions, labor shortages, supply chain interruptions, increased unemployment and commercial property vacancy rates, reduced profitability and ability for property owners to make mortgage payments, and overall economic and financial market instability. All of these factors could cause our customers to be unable to make scheduled loan payments. If the effects of COVID-19 result in widespread and sustained repayment shortfalls on loans in our portfolio, we could incur significant delinquencies, foreclosures, and credit losses, particularly if the available collateral is insufficient to cover our exposure.
The effects of COVID-19 on economic activity could negatively affect collateral values and our ability to liquidate such collateral. Further, in the event of delinquencies, regulatory changes and policies designed to protect borrowers may slow or prevent us from making business decisions or may result in a delay in our taking certain remedial actions, such as foreclosure. All of these factors could cause the level of our nonperforming loans, charge-offs, and delinquencies to increase, potentially requiring significant future provisions for credit losses.
•Interest Rate Risk. Our net interest income, lending activities, deposits, and profitability could be negatively affected by volatility in interest rates and other factors resulting from uncertainties stemming from COVID-19. In March 2020, the Federal Reserve lowered the target federal funds rate to 0.25%, citing concerns about the impact of COVID-19 on markets and stress in the energy sector. This low interest rate environment has and could continue to negatively impact our net interest income and net income. Higher income volatility from changes in interest rates and spreads to benchmark indices could also cause decreases in current fair market values of our assets. Fluctuations in interest rates may impact both the level of income and expense recorded on some of our assets and liabilities and the market value of applicable interest-earning assets and interest-bearing liabilities, which could, in turn, negatively affect our net income.
•Profitability Risk. Our profitability has and could continue to be negatively affected by changes in interest rates as well as other aspects of the COVID-19 pandemic. In the second quarter of 2020, we temporarily reduced or eliminated (and could reduce or eliminate again) several of our normal customer service fees, which decreased our noninterest income, and in turn, our net income. We have also experienced (and could continue to experience) lower than normal demand for our non-PPP loans due to the economic downturn related to the COVID-19 pandemic.
•Operational Risk. While we continue to take precautions related to COVID-19 in terms of physical separation of employees from each other and from customers, resuming all precautions implemented earlier in the pandemic could limit our ability to meet customer servicing expectations and have a material adverse effect on our operations. We rely on business processes and banking center activity that largely depend on people and technology, including access to information technology systems, as well as information, applications, payment
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systems, and other services provided by third parties. Technology in employees’ homes may not be as robust as in our offices and could cause the networks, information systems, applications, and other tools available to employees to be more limited or less reliable than in our offices. Work-from-home measures and increased electronic interaction with our customers also introduces additional operational risk, including increased cybersecurity risk. These cyber risks include greater phishing, malware, and other cybersecurity attacks, vulnerability to disruptions of our information technology infrastructure and telecommunications systems for remote operations, increased risk of unauthorized dissemination of confidential information, limited ability to restore the systems in the event of a systems failure or interruption, greater risk of a security breach resulting in destruction or misuse of valuable information, and potential impairment of our ability to perform critical functions, including wiring funds, all of which could expose us to risks of data or financial loss, litigation, and liability, and could seriously disrupt our operations and the operations of any affected customers.
Moreover, we rely on many third parties in our business operations, including appraisers of real property collateral; title companies; vendors that supply essential services such as loan servicers, providers of financial information, systems, analytical tools, and electronic payment and settlement systems; and local, state, and federal government agencies, offices, and courthouses. In light of the measures in responding to the pandemic, many of these entities have limited and may continue to limit the availability of and access to their services. Loan closings could be delayed related to reductions in available staff in recording offices or the closing of courthouses in certain parishes, which slows the process for title work, mortgage, and Uniform Commercial Code filings in those parishes. If the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may materially and adversely affect our operations.
Because there have been no recent global pandemics of comparable global impact, we do not yet know the full extent of COVID-19’s effects on our business, operations, or the global economy as a whole. Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our social-distancing accommodation arrangements, third party providers’ ability to support our operations, and any actions taken by governmental authorities and other third parties in response to the pandemic. The uncertain future development of this crisis and the pandemic’s enhancement of the various risks described above could have a material adverse effect on our business, financial condition, and results of operations.
As a participating lender in the PPP, we are subject to risks related to the SBA program and related PPP loans.
The CARES Act in March of 2020 and the Economic Aid Act in December of 2020 include a significant loan program administered through the SBA referred to as the PPP which includes the PPP Second Draw program. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. We are participating as a lender in the PPP. The PPP became available on April 3, 2020. Due to how quickly each act was passed, there was and continues to be a significant amount of ambiguity and changes in the laws, rules, and guidance regarding requirements for eligibility, underwriting, origination, funding, and forgiveness of PPP loans. This ambiguity and changes and the speed which was necessary to implement the program expose us to regulatory and legal risks relating to noncompliance with the PPP.
PPP loans are also subject to regulatory requirements that require forbearance of loan payments for a specified time and limit our ability to pursue all available remedies in the event of a loan default. If a borrower under a PPP loan fails to qualify for loan forgiveness, our risk is heightened because we hold these loans at unfavorable interest rates.
We also have credit risk on PPP loans if the SBA determines that there is a deficiency in the manner in which the loan was originated, funded, or serviced by us, such as an issue with the eligibility of a borrower to receive a PPP loan. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or seek recovery from us of any loss related to the deficiency. In addition, we have credit risk related to how forgiveness of PPP loans is handled and how the forgiveness amounts are determined. Governmental agencies have, and may continue to change the rules, create new rules, have a very detailed review process, or require additional forms or paperwork that the borrower may not complete appropriately. All of these items could negatively impact us.
Since the commencement of the PPP, numerous other banks have been subject to litigation regarding the process and procedures that those banks used in processing applications for the PPP. We may be exposed to similar litigation from customers, non‐customers, and agents that approach us regarding PPP loans and regarding our procedures for processing applications, funding PPP loans, and coordinating the forgiveness of the loans. If any such litigation is initiated against us, it may result in significant financial liability, significant litigation costs, or adversely affect our reputation. Any of these legal, regulatory, and credit risks related to our participation in the PPP could have a material adverse effect on our business, financial condition, and results of operations.
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Risks Related to Our Credit Activities
We may not be able to adequately measure and limit our credit risk, which could lead to unexpected losses.
Our business depends on our ability to successfully measure and manage credit risk. As a lender, we are exposed to the risk that our borrowers will be unable to repay their loans according to their terms, and the collateral securing repayment of their loans, if any, may not be sufficient to ensure repayment. In addition, there are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual borrowers. The creditworthiness of a borrower is affected by many factors including local market conditions and general economic conditions. If the overall economic climate in the U.S., generally, or in Louisiana, specifically, experiences material disruption, our borrowers may experience difficulties in repaying their loans, the collateral we hold may decrease in value or become illiquid, and the level of nonperforming loans, charge-offs, and delinquencies could rise and require significant additional provisions for credit losses.
Our risk management practices, such as monitoring the concentration of our loans within specific industries and our credit approval, review, and administrative practices may not adequately reduce credit risk. Further, our credit administration personnel, policies, and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of our loan portfolio. A failure to effectively measure and limit our credit risk could result in loan defaults, foreclosures, and additional charge-offs. As a result, we may need to significantly increase our allowance for loan losses, which could adversely affect our net income. All of these consequences could, in turn, have a material adverse effect on our business, financial condition, and results of operations.
A significant portion of our loan portfolio consists of real estate loans which subjects us to potential impairment of the collateral securing the loan if the real estate economy experiences negative changes as well as costs and potential risks associated with the ownership of the real property if we are forced to foreclose.
The market value of real estate can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. Real estate values in many Louisiana markets have experienced periods of fluctuation over the last several years. As of December 31, 2020, $1.13 billion, or 70.9%, of loans HFI were secured by real estate as the primary component of collateral. We also make loans secured by real estate as a supplemental source of collateral. Real estate values and real estate markets are affected by many factors, such as changes in national, regional, or local economic conditions; the rate of unemployment; fluctuations in interest rates and the availability of loans to potential purchasers; changes in tax laws and other governmental statutes; regulations and policies; and acts of nature, such as hurricanes and other natural disasters. Adverse changes affecting real estate values and the liquidity of real estate in one or more of our markets could increase the credit risk associated with our loan portfolio, significantly impair the value of property pledged as collateral on loans, and affect our ability to sell the collateral upon foreclosure without a loss or additional losses. Consequently, we could be required to increase our allowance for loan losses, adversely affecting profitability. Additionally, we may have to foreclose on the collateral property to protect our investment. We may thereafter own and operate such property, in which case we would be exposed to the risks inherent in the ownership of real estate, including potential environmental liability due to contamination of a property either during ownership or after divesting of it. As of December 31, 2020, we held approximately $896,000 in OREO. This amount could increase in the future, depending upon the level of our real estate foreclosures and our ability to efficiently divest of the foreclosed OREO. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to, general or local economic conditions, environmental cleanup liability, assessments, interest rates, real estate tax rates, operating expenses of the mortgaged properties, ability to obtain and maintain adequate occupancy of the properties, zoning laws, governmental and regulatory rules, and natural disasters. Any of these events could have a material adverse effect on our business, financial condition, and results of operations.
Our commercial real estate loan portfolio exposes us to risks that may be greater than the risks related to other types of loans.
Our loan portfolio includes non-owner occupied commercial real estate loans for individuals and businesses for various purposes, which are secured by commercial properties, as well as real estate construction and development loans. As of December 31, 2020, our construction and development loans, non-owner occupied commercial real estate loans, and non-real estate secured loans financing commercial real estate activities totaled $365.5 million, or 23.0%, of loans HFI. These loans typically involve repayment dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service. This projected income may be adversely affected by changes in the economy or local market conditions. Commercial real estate loans expose us to greater credit risk than loans secured by residential real estate because there are fewer potential purchasers for the commercial real estate collateral, which can make liquidation more difficult. Additionally, non-owner occupied commercial real estate loans generally involve relatively large balances to single borrowers or related groups of borrowers. Accordingly, charge-offs on non-owner occupied commercial real estate loans may be larger on an individual loan basis than those incurred with our residential or consumer loan portfolios. Unexpected deterioration in the credit quality of our
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commercial real estate loan portfolio would require us to increase our provision for loan losses, which would reduce our profitability. Any of these potential consequences could have a material adverse effect on our business, financial condition, and results of operations.
Our business may be adversely affected by credit risk associated with residential property.
As of December 31, 2020, $442.9 million, or 27.9%, of our total loan portfolio was secured by first liens on one-to-four family residential loans. One-to-four family residential loans are generally sensitive to regional and local economic conditions that significantly impact the borrowers’ ability to meet their loan payment obligations. A decline in residential real estate values resulting from a downturn in the housing market in our market areas may reduce the value of the real estate collateral securing these types of loans and increase our risk of losses due to default. A downturn in the housing market coupled with elevated unemployment rates may also result in a decline in demand for our products and services.
In addition, interest rate increases often result in larger payment requirements for our borrowers, which increases the potential for default and could result in a decrease in the demand for residential loans. At the same time, the marketability of the property securing a residential loan may be adversely affected by any reduced demand resulting from higher interest rates. In a declining interest rate environment, there may be an increase in prepayments on residential loans as borrowers refinance their loans at lower rates. Losses or declines in profitability as a result of these potential negative events could have a material adverse effect on our business, financial condition, and results of operations.
A significant portion of our loan portfolio is comprised of commercial and industrial loans secured by receivables, inventory, equipment, or other commercial collateral, the deterioration in value of which could expose us to credit losses.
As of December 31, 2020, approximately $250.4 million, or 15.8%, of loans HFI were commercial and industrial loans collateralized, in general, by general business assets including, among other things, accounts receivable, inventory, equipment, and available real estate and most are backed by a personal guaranty of the borrower or principal. These commercial and industrial loans are typically larger in amount than loans to individuals and, therefore, have the potential for larger losses on an individual loan basis. Additionally, the repayment of commercial and industrial loans is subject to the ongoing business operations of the borrower. The collateral securing such loans generally includes movable property, such as equipment and inventory. These types of collateral may decline in value more rapidly than we anticipate, exposing us to increased credit risk. In addition, a portion of our customer base, including customers in the energy and real estate business, may be exposed to volatile businesses or industries which are sensitive to commodity prices or market fluctuations, such as energy prices. Accordingly, negative changes in commodity prices, real estate values, or liquidity could impair the value of the collateral securing these loans. Significant adverse changes in the economy or local market conditions in which our commercial lending customers operate could cause rapid declines in loan collectability and the values associated with general business assets resulting in inadequate collateral coverage. These events, in turn, may expose us to credit losses that could adversely affect our business, financial condition, and results of operations.
Our allowance for loan losses may prove to be insufficient to absorb losses inherent in our loan portfolio.
We establish our allowance for loan losses and maintain it at a level considered adequate by management to absorb probable loan losses based on our analysis of our loan portfolio, our historical loss experience, and conditions within our markets. As of December 31, 2020, our allowance for loan losses totaled $18.0 million, which represents approximately 1.13% of loans HFI. The allowance for loan losses represents our estimate of probable losses in our loan portfolio at each balance sheet date and is based upon relevant information available to us. The allowance contains provisions for probable losses that have been identified relating to specific borrowing relationships, as well as probable losses inherent in the loan portfolio and credit undertakings that are not specifically identified. Additions to the allowance for loan losses, which are charged to earnings through the provision for loan losses, are determined based on a variety of factors, including an analysis of our loan portfolio, historical loss experience, and an evaluation of current economic conditions in our market areas. The actual amount of loan losses is affected by changes in economic, operating, and other conditions within our markets, as well as changes in the financial condition, cash flows, and operations of our borrowers. All of these factors are beyond our control, and such losses may exceed our current estimates.
Additional loan losses will likely occur in the future and may occur at a rate greater than we have previously experienced or than we anticipate. We may be required to make additional provisions for loan losses to further supplement our allowance for loan losses, due either to our management’s decision or as a regulatory requirement. In addition, bank regulatory agencies will periodically review our allowance for loan losses and the value attributed to nonaccrual loans or to real estate acquired through foreclosure. Such regulatory agencies may require us to recognize future charge-offs, which could have a material adverse effect on our business, financial condition, and results of operations.
Finally, the measure of our allowance for loan losses will be subject to new accounting standards. FASB has adopted a new accounting standard that will be effective for us on January 1, 2023, due to our classification as an SEC registrant with smaller reporting company filing status. This new standard, referred to as CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans and recognize the expected credit losses as
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allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which could require us to increase our allowance for loan losses. CECL will also greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses. The CECL model could create more volatility in the level of our allowance for loan losses after it becomes applicable to us. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses could adversely affect our business, financial condition, and results of operations.
Appraisals and other valuation techniques we use in evaluating and monitoring loans secured by real property, OREO, and repossessed personal property may not accurately describe the net value of the asset.
In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made. Because real estate values may change significantly in relatively short periods of time (especially in periods of heightened economic uncertainty), this estimate may not accurately describe the net value of the real property collateral after the loan is made. As a result, we may not be able to realize the full amount of any remaining indebtedness when we foreclose on and sell the relevant property. In addition, we rely on appraisals and other valuation techniques to establish the value of our OREO and personal property that we acquire through foreclosure and to determine certain loan impairments. If any of these valuations are inaccurate, our combined and consolidated financial statements may not reflect the correct value of our OREO or personal property, and our allowance for loan losses may not reflect accurate loan impairments. These consequences could have a material adverse effect on our business, financial condition, and results of operations.
The amount of our nonperforming and classified assets may increase significantly, resulting in additional losses, costs, and expenses.
As of December 31, 2020, we had nonperforming assets of $4.2 million, or 0.16% of total assets. Nonperforming assets adversely affect our net income in various ways. We do not record interest income on OREO or on nonperforming loans, which adversely affects our income. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to market value of the collateral, which may ultimately result in a loss. An increase in the level of nonperforming assets also increases our risk profile, which may cause our regulators to require additional amounts of capital. Finally, nonperforming assets can take significant time and resources to resolve, causing the related costs of maintaining those assets to increase. These effects may be particularly pronounced in a market of reduced real estate values and excess inventory. Such losses and expenses due to any increase in nonperforming assets could have a material adverse effect on our business, financial condition, and results of operations.
The small to medium-sized businesses that we lend to may have fewer resources to weather adverse business developments, which may impair our borrowers’ ability to repay loans.
A significant portion of our business development and marketing strategy is focused on small to medium-sized businesses. Small to medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete, and may experience substantial volatility in operating results. Any of these factors may impair a borrower’s ability to repay a loan. In addition, the success of a small or medium-sized business often depends on the management skills, talents, and efforts of one individual or a small group of individuals. The death, disability, or resignation of one or more of these people could have an adverse impact on the business and its ability to repay loans. If our small to medium-sized business customers are negatively impacted by general economic conditions or other adverse business developments, this, in turn, could have a material adverse effect on our business, financial condition, and results of operations.
We could be subject to losses, regulatory action, or reputational harm due to fraudulent and negligent acts on the part of loan applicants, our employees, and other parties.
In deciding whether and upon what terms to extend credit or enter into other transactions with customers and counterparties, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, property appraisals, title information, employment and income documentation, account information, and other financial information. We may also rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Any misrepresentation or incorrect or incomplete information, whether fraudulent or inadvertent, may not be detected prior to entering into the transaction. In addition, one or more of our employees could cause a significant breakdown or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates our loan documentation, operations, or systems. Whether a misrepresentation is made by the applicant or another third party, we generally bear the risk of loss associated with the misrepresentation. We are often contractually required to indemnify counterparties for losses caused by a material misrepresentation, and a loan subject to a material misrepresentation is typically not marketable or, if sold, is subject to repurchase. The sources of the misrepresentations may also be difficult to locate, and we may be unable to recover any of the monetary losses we may suffer as a result. Any of these developments could have a material adverse effect on our business, financial condition, and results of operations.
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Risks Related to Interest Rates and Economic Conditions
Interest rate shifts could reduce net interest income.
The majority of our banking assets are monetary in nature and subject to risk from changes in interest rates. Like most financial institutions, our earnings and cash flows depend to a great extent upon the level of our net interest income. Net interest income represents the difference between the interest income we earn on loans, investments, and other interest-earning assets, and the interest we pay on interest-bearing liabilities, such as deposits and borrowings. When interest-earning assets mature or reprice more quickly, or to a greater degree than interest-bearing liabilities, falling interest rates could reduce net interest income. Similarly, when interest-bearing liabilities mature or reprice more quickly, or to a greater degree than interest-earning assets in a period, an increase in interest rates could reduce net interest income. Our interest sensitivity profile was asset sensitive as of December 31, 2020, meaning that our assets have the opportunity to reprice at a faster pace than our liabilities. Consequently, we estimate our net interest income would decrease in a falling interest rate environment and increase in a rising interest rate environment.
Interest rates are affected by many factors outside of our control, including governmental monetary policies, inflation, deflation, recession, changes in unemployment, the money supply, international disorder, and instability in domestic and foreign financial markets. Changes in the level of market interest rates affect our net yield on interest-earning assets, our cost of funds, and our loan origination volume. A decrease in the general level of interest rates may, among other things, increase prepayments within the loan portfolio and on mortgage-backed securities within the securities portfolio, and increase competition for deposits. An increase in the general level of interest rates may, among other things, reduce the demand for loans and decrease loan repayment rates. In light of these considerations, a failure to effectively manage our interest rate risk could have a material adverse effect on our business, financial condition, or results of operations.
The geographic concentration of our markets in Louisiana makes us sensitive to adverse changes in the local economy.
We are a community banking franchise concentrated in Louisiana. As of December 31, 2020, 93.6% of loans HFI were made to borrowers who reside or conduct business in Louisiana, and substantially all of our real estate loans are secured by properties located in Louisiana. A deterioration in local economic conditions or in the residential or commercial real estate markets could have an adverse effect on the quality of our loan portfolio, the demand for our products and services, the ability of borrowers to timely repay loans, and the value of the collateral securing loans. If the population, employment, or income growth in any of our markets is negative or slower than projected, income levels, deposits, and real estate development could be adversely impacted. Any of these consequences could have a material adverse effect on our business, financial condition, and results of operations.
Volatility in oil prices and downturns in the energy industry, particularly in Louisiana, could lead to increased credit losses in our loan portfolio.
As of December 31, 2020, we had non-PPP energy loans of $20.4 million, or 1.4%, of non-PPP loans HFI (non-GAAP). For further information on non-GAAP financial measures, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures." We also may have indirect exposure to energy prices, as some of our non-energy customers’ businesses may be affected by volatility with the oil and gas industry and energy prices. Prolonged or further pricing pressure on oil and gas could lead to increased credit stress with respect to those borrowers. Such a decline or general uncertainty resulting from continued volatility could have other adverse impacts such as job losses in industries tied to energy, lower borrowing needs, higher transaction deposit balances, or a number of other effects that are difficult to isolate or quantify, particularly in states with significant dependence on the energy industry like Louisiana. All of these potential consequences could have a material adverse effect on our business, financial condition, and results of operations.
Natural disasters, acts of war or terrorism, the impact of pandemics, civil unrest, and other external events could result in a disruption of our operations and increases in loan losses.
A significant portion of our business is generated from Louisiana markets that have been, and may continue to be, damaged by major hurricanes, floods, tropical storms, tornadoes, and other natural disasters. Natural disasters can disrupt our operations, cause widespread property damage, and severely depress the local economies in which we operate. Moreover, the value of real estate or other collateral that secures our loans could be materially and adversely affected by a natural disaster. Additionally, our business could be adversely affected by the effects of civil unrest or a widespread outbreak of disease pandemics, including the ongoing pandemic caused by COVID-19.
If the economies in our primary markets experience an overall decline as a result of these types of external events, demand for loans and our other products and services could be reduced. In addition, the rate of delinquencies, foreclosures, bankruptcies, and losses on loan portfolios may increase substantially, as uninsured property losses or sustained job interruption or loss may materially impair borrowers’ ability to repay their loans. Such external events could,
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therefore, result in decreased revenue and increased loan losses. All of these consequences could have a material adverse effect on our business, financial condition, and results of operations.
As a business operating in the financial services industry, our business and operations may be adversely affected in numerous and complex ways by weak economic conditions.
Our business and operations, which primarily consist of lending money to customers in the form of loans, borrowing money from customers in the form of deposits, and investing in securities, are sensitive to general business and economic conditions in the U.S. The business environment in which we operate can be impacted by uncertainty about the federal fiscal and monetary policymaking process. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. The medium and long-term fiscal outlook of the federal government and U.S. economy are concerns for businesses, consumers, and investors in the U.S. In addition, economic conditions in foreign countries, including global political hostilities, could affect the stability of global financial markets, which could hinder domestic economic growth. Uncertainty regarding both short and long-term interest rates impacts our ability to attract deposits and manage net interest margin. Adverse economic conditions and government policy responses to such conditions could have a material adverse effect on our business, financial condition, and results of operations.
The borrowing needs of our customers may increase, especially during a challenging economic environment, which could result in increased borrowing against our contractual obligations to extend credit.
A commitment to extend credit is a formal agreement to lend funds to a customer as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our customers under these credit commitments have historically been lower than the contractual amount of the commitments. Because of the credit profile of our customers, we typically have a substantial amount of total unfunded credit commitments, which is not reflected on our balance sheet. As of December 31, 2020, we had $293.8 million in unfunded credit commitments to our customers. Actual borrowing needs of our customers may exceed our expectations, especially during a challenging economic environment when our customers may be more dependent on our credit commitments due to the lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from alternative sources. This could adversely affect our liquidity, which could impair our ability to fund operations and meet obligations as they become due. Such an inability to satisfy our obligations could have a material adverse effect on our business, financial condition, and results of operations.
Risks Related to Our Operations
We rely heavily on our executive management team and other key employees, and we could be adversely affected by an unexpected loss of their service.
Our success depends in large part on the performance of our key personnel, as well as on our ability to attract, motivate, and retain highly qualified management and employees. Competition for employees is intense, and the process of locating key personnel with the combination of skills and attributes required to execute our business plan may be lengthy. We may not be successful in retaining our key employees. If we unexpectedly lose the services of one or more of our key personnel, we would also lose the benefit of their skills, knowledge of our primary markets, and years of industry experience. We may not be able to identify and hire qualified replacement personnel on terms acceptable to us, or at all, which could have a material adverse effect on our business, financial condition, and results of operations.
Unauthorized access, cyber-crime, and other threats to data security may require significant resources, harm our reputation, and otherwise cause harm to our business.
In the ordinary course of our business, we necessarily collect, use, and hold personal and financial information concerning individuals and businesses with which we have a banking relationship. Threats to data security such as unauthorized access and cyber-attacks emerge and change rapidly. These threats may increase our costs for protection or remediation. They may also result in competing time constraints between applicable privacy and other requirements and our ability to secure data in accordance with customer expectations.
It is difficult or impossible to defend against every risk posed by changing technologies and criminals intent on committing cyber-crime. Increasing sophistication of cyber-criminals and terrorists makes it increasingly difficult to prevent a security breach. Controls employed by our information technology department, our other employees, and our vendors could prove inadequate. We could also experience a breach due to circumstances such as intentional or negligent conduct on the part of employees or other internal sources, software bugs, or other technical malfunctions. Any of these threats may cause our customer accounts to become vulnerable to account takeover schemes or cyber-fraud. A breach of our security that results in unauthorized access to our data could expose us to disruption or challenges relating to our daily operations as well as to data loss, litigation, damages, fines, significant increases in compliance costs, and reputational damage. Any of these consequences could have a material adverse effect on our business, results of operations, and financial condition.
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We rely on third parties to provide key components of our business infrastructure, and a failure of these parties to perform for any reason could disrupt our operations.
Third parties provide key components of our business infrastructure such as data processing, internet connections, network access, core application processing, statement production, and account analysis. Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity. Additionally, our operations could be interrupted if any of our third-party service providers experience financial difficulty, are inadvertently or intentionally negligent, are subject to cybersecurity breaches, terminate their services, or fail to comply with applicable banking regulations. Any of these consequences could have a material adverse effect on our business, financial condition, and results of operations.
We have a continuing need for technological change, and we may not have the resources to effectively implement new technology, or we may experience operational challenges when implementing new technology.
The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. As we continue to grow, our success will be partially dependent upon our ability to address the needs of our customers and enhance operational efficiencies through the use of technology. We may experience operational challenges as we implement these new technology products or enhancements. As a result, we may not fully realize the anticipated benefits from our new technology, or we may incur significant costs to overcome related challenges in a timely manner.
Many of our larger competitors have substantially greater resources to invest in technological improvements. As a result, they may be able to offer additional or superior products, which would put us at a competitive disadvantage. Accordingly, we may lose customers seeking technology-driven products and services that we are not able to provide. Our inability to overcome any of these technological challenges could, in turn, have a material adverse effect on our business, financial condition, and results of operations.
Our financial results depend on management’s selection of accounting methods and certain assumptions and estimates.
The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amounts of certain assets and liabilities, disclosure of contingent assets and liabilities, and the reported amount of related revenues and expenses. Certain accounting policies are inherently based to a greater extent on estimates, assumptions, and judgments of management and, as such, have a greater possibility of producing results that could be materially different than originally estimated. These critical accounting policies include the allowance for loan losses, accounting for income taxes, the determination of fair value for financial instruments, and accounting for stock-based compensation. Management’s judgment and the data relied upon by management may be based on assumptions that prove to be inaccurate, particularly in times of market stress or other unforeseen circumstances. Even if the relevant, factual assumptions are accurate, our decisions may prove to be inadequate or inaccurate because of other flaws in the design or use of analytical tools used by management. Any such failure in our process for producing accounting estimates and managing risks could have a material adverse effect on our business, financial condition, and results of operations.
We are dependent on the use of data and modeling in our management’s decision-making, and faulty data or modeling approaches could negatively impact our decision-making ability or subject us to regulatory scrutiny.
The use of statistical and quantitative models and other quantitative analysis is intrinsic to bank decision-making and is becoming increasingly widespread in our operations. It is also becoming more prevalent in regulatory compliance. While we are not currently subject to annual stress testing under the Dodd-Frank Act and the Federal Reserve's Comprehensive Capital Analysis and Review submissions, we currently utilize stress testing for monitoring and managing interest rate risk and liquidity. While we believe the quantitative techniques and approaches of these models improve our decision-making, they also create the possibility that faulty data, flawed quantitative approaches, or misunderstanding or misuse of their outputs could negatively impact our decision-making ability or, if we become subject to regulatory stress-testing in the future, cause adverse regulatory scrutiny. Any of these items could have a material adverse effect on our business, financial condition, and results of operations.
We are subject to claims, litigation, and other proceedings that could result in legal liability.
From time to time, we, including our subsidiaries, are or may be involved in various legal matters arising in the ordinary course of business. One or more unfavorable outcomes of these ordinary course claims or litigation against us or our subsidiaries could have a material adverse effect for the period in which they are resolved. In addition, regardless of their merits or ultimate outcomes, such matters are costly, divert management’s attention, and may materially and adversely
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affect our reputation or that of our subsidiaries, even if resolved favorably. Regardless of the scope or validity of such matters, or the merits of any claims by potential or actual litigants, we may have to engage in protracted litigation. Such litigation is often expensive, time-consuming, disruptive to our operations, and distracting to management. If legal claims were resolved against us or settled, we could be required to make payments in amounts that could have a material adverse effect on our business, financial condition, and results of operations.
We may be adversely affected by the condition or performance of our third-party brokerage partners.
We are not registered with the SEC as an investment advisor or broker-dealer. To provide a broader range of financial and investment services to our customers, we partner with third-parties who are licensed and registered to serve in those capacities. The investment products and services provided to our customers by virtue of these third-party channels generally are not insured by the FDIC. To the extent our customers use those products and services, we may have exposure for illegal, negligent, fraudulent, or other acts of these investment advisors and brokers. Although we seek to limit this exposure through clear disclosure, ongoing oversight, and contractual provisions requiring indemnification, limitations of liability, insurance coverage, and other similar protections, those obligations may not always be enforceable, or our third-party service providers ultimately may not have sufficient financial strength to fully comply. Losses due to this exposure or our inability to effectively manage the related third-party risks may have a material adverse effect on our business, financial condition, and results of operations.
Risks Related to Our Competition and Services
Our ability to attract and retain customers and maintain our reputation is critical to our growth, profitability, and market share.
We operate in the highly competitive banking industry and face significant competition for customers from bank and non-bank competitors. Our business plan emphasizes relationship banking in order to originate loans, attract deposits, and provide other financial services. As a result, our reputation is one of the most valuable components of our business. Our competitors are generally larger and may have significantly more resources, greater name recognition, and more extensive and established branch networks or geographic footprints. Because of their scale, many of these competitors can be more aggressive on loan and deposit pricing. Also, many of our non-bank competitors have fewer regulatory constraints and may have lower cost structures. We expect competition to continue to intensify due to financial institution consolidation; legislative, regulatory, and technological changes; and the emergence of alternative sources for financial services, including fintech companies, which could cause us to lose some of our existing customers, and we may not be successful attracting new customers. Our failure to compete effectively in our primary markets could cause us to lose market share and could have a material adverse effect on our business, financial condition, and results of operations.
We may not be able to implement our expansion strategy, which may adversely affect our ability to maintain our historical earnings trends.
Our expansion strategy focuses on organic growth, supplemented by strategic acquisitions and expansion of the Bank’s banking center network, or de novo expansion. De novo expansion carries with it certain potential risks, including possibly significant startup costs and anticipated initial operating losses; an inability to gain regulatory approval; an inability to secure the services of qualified senior management to operate the de novo banking center and successfully integrate and promote our corporate culture; poor market reception for de novo banking centers established in markets where we do not have a preexisting reputation; challenges posed by local economic conditions; challenges associated with securing attractive locations at a reasonable cost; and additional strain on management resources and internal systems and controls. Failure to adequately manage these risks could have a material adverse effect on our business, financial condition, and results of operations.
Further, we may not be able to execute on more general aspects of our expansion strategy, which may impair our ability to sustain our historical rate of growth or prevent us from growing at all. We may not be able to generate sufficient new loans and deposits within acceptable risk and expense tolerances, obtain the personnel or funding necessary for additional growth, or find suitable acquisition candidates. Various factors, such as economic conditions and competition with other financial institutions, may impede or prohibit the growth of our operations, the opening of new banking centers, and the consummation of acquisitions. The success of our strategy also depends on our ability to effectively manage growth, which is dependent upon a number of factors, including our ability to adapt our credit, operational, technology, and governance infrastructure to accommodate expanded operations. Acquisitions typically involve the payment of a premium over book and market values; therefore, some dilution of our tangible book value and earnings per common share may occur in connection with any future acquisition. Further, the carrying amount of any goodwill that we currently maintain or may acquire may be subject to impairment in future periods. If we fail to implement one or more aspects of our expansion strategy, we may be unable to maintain our historical growth and earnings trends, which could have a material adverse effect on our business, financial condition, and results of operations.
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New lines of business, products, product enhancements, or services may subject us to additional risks.
From time to time, we implement new lines of business or offer new products and product enhancements as well as new services within our existing lines of business. In doing so, we may invest significant time and resources. At the same time, we may not allocate the appropriate level of resources or expertise necessary to make these new efforts successful or to realize their expected benefits. Further, initial timetables for the introduction and development of new lines of business, products, product enhancements, or services may not be achieved, and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the ultimate implementation. Any new line of business, product, product enhancement, or service could also have a significant impact on the effectiveness of our system of internal controls. Consequently, our failure to successfully manage these types of development and implementation risks could have a material adverse effect on our business, financial condition, or results of operations.
We may be adversely affected by the soundness of other financial institutions.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, and other relationships. We have exposure to different industries and counterparties, and through transactions with counterparties in the financial services industry, including broker-dealers, commercial banks, investment banks, and other financial intermediaries. In addition, we participate in loans originated by other institutions, and we participate in syndicated transactions (including shared national credits) in which other lenders serve as the lead bank. As a result, defaults by, declines in the financial condition of, or even rumors or questions about one or more financial institutions, financial service companies, or the financial services industry generally, may lead to market-wide liquidity, asset quality, or other problems and could lead to losses or defaults by us or by other institutions. These problems, losses, or defaults could have a material adverse effect on our business, financial condition, and results of operations.
Risks Related to Our Financial Stability
We may need to raise additional capital in the future, and if we fail to maintain sufficient capital, we may not be able to satisfy regulatory requirements or maintain adequate protection against financial stress.
We must satisfy ongoing regulatory capital requirements, and regulatory capital requirements could increase from current levels. We may then need to raise additional capital to comply with these requirements or to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, which could include the possibility of financing acquisitions. Our ability to raise additional capital depends on a number of factors, including without limitation our financial condition and performance, conditions in the capital markets, economic conditions, investor perceptions regarding the banking industry, and governmental activities. Many of these factors are beyond our control, and as such, there is no assurance we will be able to raise additional capital if needed or on terms acceptable to us. If we fail to maintain capital sufficient to meet regulatory requirements, we may not be able to withstand periods of financial stress and we could be subject to enforcement actions or other regulatory consequences. Any of these events could have a material adverse effect on our business, financial condition, and results of operations.
A lack of liquidity could impair our ability to fund operations.
Liquidity is essential to our business. We rely on our ability to generate deposits and effectively manage the repayment and maturity schedules of our loans and investment securities, respectively, to ensure that we have adequate liquidity to fund our operations. Our most important source of funds is deposits. Historically, our deposits have provided a stable source of funds. However, deposit balances can decrease when customers perceive alternative investments as providing a better risk/return tradeoff. Even though a majority of our certificates of deposit renew upon maturity with what we believe are competitive rates, some of our more rate-sensitive customers may move those funds to higher-yielding alternatives. If our customers move money out of bank deposits and into other investments such as money market funds, we would lose a relatively low-cost source of funds, increasing our funding costs, and reducing our net interest income and net income.
Our other primary sources of liquidity consist of cash flows from operations, maturities and sales of investment securities, and proceeds from the issuance and sale of our equity to investors. As a secondary source of liquidity, we have the ability to borrow overnight funds from other financial institutions with whom we have a correspondent relationship. We also have the ability to borrow from the FHLB. Historically, we have not utilized brokered or internet deposits to meet liquidity needs.
Our access to funding sources in amounts adequate to finance or capitalize our activities or on terms that are acceptable to us, could be impaired by factors that affect us, the financial services industry, or the economy in general. These factors may include disruptions in the financial markets or negative expectations about the industry’s prospects. Our access to funding sources could also be affected by regulatory actions against us or by a decrease in the level of our business activity due to a downturn in the Louisiana economy or in economic conditions generally. A decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or fulfill obligations such as
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meeting deposit withdrawal demands or repaying our borrowings. Any of these consequences could, in turn, have a material adverse effect on our business, financial condition, and results of operations.
The fair value of our investment securities can fluctuate due to factors outside of our control.
Factors beyond our control can significantly influence the fair value of securities in our investment portfolio, potentially resulting in adverse changes to the portfolio’s fair value. These factors include, but are not limited to, rating agency actions related to the securities, defaults by the issuer or with respect to the underlying collateral, and changes in market interest rates and instability in the capital markets. Any of these factors, among others, could cause OTTI and realized or unrealized losses in future periods and declines in other comprehensive income, which could have a material adverse effect on our business, financial condition, and results of operations. In addition, the process for determining whether impairment of a security is other-than-temporary often requires complex, subjective judgments about whether there has been a significant deterioration in the financial condition of the issuer, whether management has the intent or ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value, the future financial performance and liquidity of the issuer and any underlying collateral, and other relevant factors. Our failure to correctly and timely assess any impairments or losses with respect to our securities could have a material adverse effect on our business, financial condition, and results of operations.
We may be adversely affected by the transition from LIBOR.
In July 2017, the United Kingdom Financial Conduct Authority (the authority that regulates LIBOR) announced it intends to stop compelling banks to submit rates for the calculation of LIBOR after 2021. The Alternative Reference Rates Committee (“ARRC”) has proposed that the Secured Overnight Financing Rate (“SOFR”) is the rate that represents best practice as the alternative to USD-LIBOR for use in derivatives and other financial contracts that are currently indexed to USD-LIBOR.
As of December 31, 2020, 3.6% of loans HFI were indexed to LIBOR. While many of these loans contain either provisions for the designation of an alternate benchmark rate or “fallback” provisions providing for alternative rate calculations in the event LIBOR is unavailable, not all of our loans, derivatives, or financial instruments contain such provisions, and the existing provisions and/or recent modifications to our documents to address transition may not adequately address the actual changes to LIBOR or the financial impact of successor benchmark rates. We may not be able to successfully amend these loans, derivatives, and financial instruments to provide for alternative benchmarks or alternative rate calculations. Even with provisions allowing for designation of alternative benchmarks or “fallback” provisions, changes to or the discontinuance of LIBOR could result in customer uncertainty and disputes arising as a consequence of the transition from LIBOR. All of this could have a material adverse effect on our business, financial condition, and results of operations.
Risks Related to the Regulation of Our Industry
We operate in a highly regulated environment and the laws and regulations that govern our operations, corporate governance, executive compensation, and accounting principles, or changes in them, or our failure to comply with them, could subject us to regulatory action or penalties.
We are subject to extensive regulation, supervision, and legal requirements that govern almost all aspects of our operations. These laws and regulations are not intended to protect our shareholders. Rather, these laws and regulations are intended to protect consumers, customers, depositors, the FDIC Deposit Insurance Fund, and the overall financial stability of the U.S. These laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on the business activities in which we can engage, limit the dividends or distributions that Red River Bank can pay to us and that we can pay to our shareholders, impose certain specific accounting requirements on us that may be more restrictive and may result in greater or earlier charges to earnings or reductions in our capital than GAAP would require, require us to have an effective anti-money laundering program, and prohibit discriminatory lending practices and unfair, deceptive, or abusive acts. Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional compliance costs. Our failure to comply with these laws and regulations, even if the failure follows good faith efforts or reflects a difference in interpretation, could subject us to restrictions on our business activities, fines, and other penalties, any of which could adversely affect our results of operations, capital base, and the price of our securities. Further, any new laws, rules, and regulations could make compliance more difficult or expensive. All of these laws and regulations, and the supervisory framework applicable to our industry, could have a material adverse effect on our business, financial condition, and results of operations.
Legislative and regulatory actions taken now or in the future, may increase our costs.
Current and past economic conditions, particularly in the financial markets, have resulted in government regulatory agencies and political bodies placing increased focus and scrutiny on the financial services industry. New proposals for legislation continue to be introduced in the U.S. Congress that could substantially increase regulation of the financial services industry; impose restrictions on the operations and general ability of firms within the industry to conduct business
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consistent with historical practices, including in the areas of compensation, interest rates, financial product offerings, and disclosures; and have an effect on collection and bankruptcy proceedings with respect to consumer residential real estate mortgages, among other things.
Certain aspects of current or proposed regulatory or legislative changes, if enacted or adopted, may impact the profitability of our business activities by requiring more oversight or changing certain of our business practices, including our ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads. They also may require us to invest significant management attention and resources to make necessary operational changes to comply. All of these events could have a material adverse effect on our business, financial condition, and results of operations.
Federal and state banking agencies periodically conduct examinations of our business, and our failure to comply with any supervisory actions as a result of such examinations could result in regulatory action or penalties.
As part of the bank regulatory process, the FDIC, the Louisiana OFI, and the Federal Reserve periodically conduct examinations of our business, including our compliance with laws and regulations. If, as a result of an examination, a federal or state banking agency were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of any of our operations had become unsatisfactory, or that we or Red River Bank were in violation of any law or regulation, such agency may take a number of different remedial actions as it deems appropriate. These actions include the power to stop any practices such agency found to be unsafe or unsound; to require affirmative action to correct any conditions resulting from any violation or practice; to issue an administrative order that can be judicially enforced; to direct an increase in our capital; to restrict our ability to pay dividends; to restrict our growth; to assess civil money penalties against us, Red River Bank, or our respective officers or directors; to remove officers and directors; and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate Red River Bank’s deposit insurance and place it into receivership or conservatorship. Any such regulatory action could have a material adverse effect on our business, results of operations, and financial condition.
We are subject to stringent capital requirements, which may result in lower returns on equity, require us to raise additional capital, limit growth opportunities, result in regulatory restrictions, or require us to commit capital resources to support Red River Bank.
Because Red River Bank does not intend to utilize the simplified CBLR framework, it remains subject to rules designed to implement the recommendations with respect to regulatory capital standards, commonly known as Basel III. The rules establish a regulatory capital standard based on common equity Tier I, require the Bank to satisfy a minimum capital adequacy requirement, and impose a capital conservation buffer. Failure to meet the capital conservation buffer will result in certain limitations on dividends, capital repurchases, and discretionary bonus payments to executive officers.
Our subsidiary, Red River Bank, is also subject to separate regulatory capital requirements imposed by the FDIC. If Red River Bank does not meet minimum capital requirements, it will be subject to prompt corrective action by the FDIC. Prompt corrective action can include progressively more restrictive constraints on operations, management, and capital distributions. Even if we satisfy the objectives of our capital plan and meet minimum capital requirements, it is possible that our regulators may ask us to raise additional capital. For example, banking organizations experiencing significant internal growth or making acquisitions are often expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
In addition, the Federal Reserve may require us to commit capital resources to support Red River Bank. The Federal Reserve requires a bank holding company to act as a source of financial and managerial strength to its subsidiary banks and to commit resources to support its subsidiary banks. Under this “source of strength” doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank at times when the bank holding company may not be inclined to do so and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. Accordingly, we could be required to make a capital injection to Red River Bank if it experiences financial distress. Such a capital injection may be required at a time when our resources are limited, and we may be required to borrow the funds or to raise additional equity capital to make the required capital injection. Any of these scenarios could have a material adverse effect on our business, financial condition, results of operations, and the value of our common stock.
New activities and expansion require regulatory approvals, and failure to obtain them may restrict our growth.
We may complement and expand our business by pursuing strategic acquisitions of financial institutions and other complementary businesses. Generally, we must receive state and federal regulatory approval before we can acquire an FDIC-insured depository institution or related business. Such regulatory approvals may not be granted on terms that are acceptable to us, or at all. We may also be required to open or sell banking centers as a condition to receiving regulatory approval, which condition may not be acceptable to us or, if acceptable to us, may reduce the benefit of any acquisition.
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In addition to the acquisition of existing financial institutions, as opportunities arise, we plan to continue establishing de novo banking centers as a part of our organic growth strategy. De novo expansion and any acquisitions carry with them numerous risks, including the inability to obtain all required regulatory approvals. The failure to obtain these regulatory approvals for potential future strategic acquisitions and de novo banking centers could have a material adverse effect on our business, financial condition, and results of operations.
Federal, state, and local consumer lending laws may restrict our ability to originate certain mortgage loans, increase our risk of liability with respect to such loans, increase the time and expense associated with the foreclosure process, or prevent us from foreclosing at all.
Certain federal, state, and local laws are intended to eliminate lending practices which are considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans, and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. It is our policy not to make predatory loans, but these laws create the potential for liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans. They also may cause us to reduce the average percentage rate or the points and fees on loans that we do make. Additionally, consumer protection initiatives or changes in state or federal law may substantially increase the time and expense associated with the foreclosure process or prevent us from foreclosing at all. If new state or federal laws or regulations are ultimately enacted that significantly raise the cost of foreclosure or raise outright barriers, such laws or regulations could have a material adverse effect on our business, financial condition, and results of operations.
We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance.
Deposits are insured by the FDIC up to legal limits and subject to the payment of FDIC deposit insurance assessments. The Bank’s regular assessments are determined by the level of its assessment base and its risk classification, which is based on its regulatory capital levels and the level of supervisory concern that it poses. The FDIC has the power to change deposit insurance assessment rates, the manner in which deposit insurance is calculated, and also to charge special assessments to FDIC-insured institutions. Any future additional assessments, increases, or required prepayments in FDIC insurance premiums could adversely impact our earnings. This, in turn, could have a material adverse effect on our business, financial condition, and results of operations.
We are subject to laws regarding the privacy, information security, and protection of personal information and any violation of these laws or another incident involving personal, confidential, or proprietary information of individuals could damage our reputation and otherwise adversely affect our operations and financial condition.
Our business requires the collection and retention of large volumes of customer data, including personally identifiable information in various information systems that we maintain and in those maintained by third party data service providers. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. We are subject to complex and evolving laws and regulations governing the privacy and protection of personal information of individuals (including customers, employees, suppliers, and other third parties). Ensuring that our collection, use, transfer, and storage of personal information complies with all applicable laws and regulations can increase our costs. Furthermore, we may not be able to ensure that all of our clients, suppliers, counterparties, and other third parties have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidential, or proprietary information of customers or others were to be mishandled or misused, we could be exposed to litigation or regulatory sanctions under personal information laws and regulations. Concerns regarding the effectiveness of our measures to safeguard personal information, or even the perception that such measures are inadequate, could cause us to lose customers or potential customers for our products and services and thereby reduce our revenues. Accordingly, any failure or perceived failure to comply with applicable privacy or data protection laws and regulations may subject us to inquiries, examinations, and investigations that could result in requirements to modify or cease certain operations or practices or incur significant liabilities, fines, or penalties, and could damage our reputation and otherwise have a material adverse effect on our business, financial condition, and results of operations.
We may be adversely affected by changes in U.S. tax laws and regulations.
Future changes in tax laws may have an adverse effect on our income tax expense, deferred tax balances, and the amount of taxes payable. This, in turn, could reduce our profitability, and could have a material adverse effect on our business, financial condition, and results of operations.
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Risks Related to an Investment in Our Common Stock
The market price of our common stock may be subject to substantial fluctuations, which may make it difficult to sell shares at the volumes, prices, or times desired.
There are many factors that may impact the market price and trading volume of our common stock. In particular, the realization of any of the risks described in this "Item 1A. Risk Factors” of this Annual Report on Form 10-K could have a material adverse effect on the market price of our common stock, causing the value of any investment to decline. The stock market and, in particular, the market for financial institution stocks has experienced substantial fluctuations in recent years, which in many cases has been unrelated to the operating performance and prospects of particular companies. In addition, significant fluctuations in the trading volume in our common stock may cause significant price variations to occur. Increased market volatility could have an adverse effect on the market price of our common stock, which could make it difficult for investors to sell shares at volumes, prices, or times desired.
Future sales or the availability for sale of substantial amounts of our equity securities in the public market could adversely affect the prevailing market price of our common stock and could impair our ability to raise capital through future sales of equity securities.
We may issue shares of equity securities as consideration for future acquisitions and investments and under compensation and incentive plans. We may also grant registration rights covering those shares of our equity securities in connection with any such acquisition or investment. Sales of substantial amounts of our equity securities, or the perception that such sales could occur, may adversely affect prevailing market prices for our common stock and could impair our ability to raise capital through future sales of our securities.
Our directors and executive officers have significant control over our business.
As of December 31, 2020, our directors and executive officers beneficially owned approximately 23.9% of our issued and outstanding shares of common stock. Consequently, our management and board of directors may be able to significantly affect the outcome of the election of directors and the potential outcome of other matters submitted to a vote of our shareholders, such as mergers, the sale of substantially all of our assets, and other extraordinary corporate matters. The interests of these insiders could conflict with the interests of our other shareholders.
The rights of our common shareholders may be subordinate to the holders of any debt securities or preferred stock that we may issue in the future.
As of December 31, 2020, we do not have any outstanding long-term debt. However, any future indebtedness that we may incur may be senior to our common stock. As a result, we would make payments on our potential future indebtedness before any dividends could be paid on our common stock, and, in the event of our bankruptcy, dissolution, or liquidation, the holders of our potential future indebtedness would be satisfied in full before any distributions could be made to the holders of our common stock.
Although we have not historically issued shares of preferred stock, our board of directors has the authority to issue in the aggregate up to 1,000,000 such shares, and to determine the terms of each issuance of preferred stock and any indebtedness, without shareholder approval. Accordingly, you should assume that any shares of preferred stock and any indebtedness that we may issue in the future will also be senior to our common stock. As a result, holders of our common stock bear the risk that our future issuances of debt or equity securities or our incurrence of other borrowings may negatively affect the market price of our common stock.
We are an emerging growth company, and the reduced reporting requirements applicable to emerging growth companies may make our common stock less attractive to investors.
We are an emerging growth company, as defined in the JOBS Act. For as long as we continue to be an emerging growth company we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. These include, without limitation, an exemption from the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002, reduced financial reporting requirements, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a non-binding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved.
We will remain an emerging growth company until the earliest of (1) the end of the fiscal year during which we have total annual gross revenues of $1.07 billion or more, (2) the last day of the fiscal year following the fifth anniversary of the completion of our IPO on May 7, 2019, (3) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities, or (4) the date on which we are deemed to be a large accelerated filer under the Exchange Act. Investors may find our common stock less attractive if we rely on these exemptions, which may result in a less active trading market and increased volatility in our stock price.
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Our dividend policy may change without notice, and our future ability to pay dividends is subject to restrictions.
Holders of our common stock are entitled to receive only such cash dividends as our board of directors may declare out of funds legally available for the payment of dividends. Although we anticipate paying quarterly dividends going forward, we have no obligation to continue paying dividends, and we may change our dividend policy at any time without notice to our shareholders. Our ability to pay dividends may also be limited on account of any potential future outstanding indebtedness, as we generally would make payments on outstanding indebtedness before any dividends could be paid on our common stock. Also, because our primary earning asset is our investment in the capital stock of Red River Bank, we may become dependent upon dividends from the Bank to pay our operating expenses, satisfy our obligations, and pay dividends on our common stock. Red River Bank’s ability to pay dividends on its common stock will substantially depend upon its earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate, and other factors deemed relevant by its board of directors. There are numerous laws and banking regulations and guidance that limit our and Red River Bank’s ability to pay dividends. For more information on dividend regulations, see “Item 1. Business - Supervision and Regulation.”
Our corporate governance documents, and certain corporate and banking laws applicable to us, could make a takeover more difficult.
Certain provisions of our articles of incorporation and bylaws, each as amended and restated, and corporate and federal banking laws, could make it more difficult for a third party to acquire control of our organization or conduct a proxy contest, even if those events were perceived by many of our shareholders as beneficial to their interests. These provisions, and the corporate and banking laws and regulations applicable to us, enable our board of directors to issue additional shares of authorized, but unissued capital stock; do not provide preemptive rights to our shareholders; enable our board of directors to issue “blank check” preferred stock with such designations, rights, and preferences as may be determined from time to time by the board; enable our board of directors to increase the size of the board and fill the vacancies created by the increase; do not provide for cumulative voting in the election of directors; enable our board of directors to amend our bylaws without shareholder approval; require the request of holders of at least 25.0% of the outstanding shares of our capital stock entitled to vote at a meeting to call a special shareholders’ meeting; establish an advance notice procedure for director nominations and other shareholder proposals; and require prior regulatory application and approval of any transaction involving control of our organization.
These provisions may discourage potential acquisition proposals and could delay or prevent a change in control, including under circumstances in which our shareholders might otherwise receive a premium over the market price of our shares.
An investment in our common stock is not an insured deposit and is subject to risk of loss.
An investment in our common stock is not a bank deposit and is not insured or guaranteed by the FDIC or any other government agency. An investment in our common stock is subject to investment risk, and the entire investment may be lost.
Securities analysts may not continue coverage on us.
The trading market for our common stock depends, in part, on the research and reports that securities analysts publish about us and our business. We do not have any control over these securities analysts, and they may not cover us. If one or more of these analysts cease to cover us or fail to publish regular reports on us, we could lose visibility in the financial markets, which could cause the price or trading volume of our common stock to decline. If we are covered by securities analysts and are the subject of an unfavorable report, the price of our common stock may decline.
Our stock repurchase program may not enhance long-term stockholder value and stock repurchases, if any, could increase the volatility of the price of our common stock and will diminish our cash reserves.
On August 27, 2020, our board of directors approved a stock repurchase program. The repurchase program authorizes us to purchase up to $3.0 million of our outstanding shares of common stock through August 27, 2021. Repurchases may be made from time to time in the open market at prevailing prices and based on market conditions, or in privately negotiated transactions. Repurchases pursuant to our stock repurchase program could affect our stock price and increase its volatility. The existence of a stock repurchase program could also cause our stock price to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for our stock. Additionally, repurchases under our stock repurchase program will diminish our cash reserves, which impacts our ability to pursue possible future strategic opportunities and acquisitions, support our operations, invest in securities, and pay dividends and could result in lower overall returns on our cash balances. Stock repurchases may not enhance shareholder value because the market price of our common stock may decline below the levels at which we repurchased shares of stock, and short-term stock price fluctuations could reduce the program’s effectiveness.
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Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Red River Bank operates from a network of 25 banking centers throughout Louisiana and one combined loan and deposit production office in Lafayette, Louisiana. The Bank's principal executive office is located at 1412 Centre Court Drive, Alexandria, Louisiana. Banking centers are located in the following Louisiana markets: Central, which includes the Alexandria MSA; Northwest, which includes the Shreveport-Bossier City MSA; Capital, which includes the Baton Rouge MSA; Southwest, which includes the Lake Charles MSA; and the Northshore, which includes Covington.
As of December 31, 2020, Red River Bank owned its main office building and 18 of its banking centers. The remaining banking office facilities were subject to lease agreements. Our facilities are in good condition and are adequate to meet our operating needs for the foreseeable future.
Item 3. Legal Proceedings
The Company is named as a defendant in a purported class action lawsuit, Aeron Averette v. Red River Bancshares, filed on August 28, 2020, in the 19th Judicial District Court of the State of Louisiana. The lawsuit alleges the Bank wrongfully imposed multiple non-sufficient funds fees on what the plaintiff describes as a single item presented for payment, thereby resulting in the Bank breaching its customer account agreement, abusing its rights, and being unjustly enriched. The plaintiff purports to represent a class consisting of all account holders in Louisiana who incurred similar charges by the Bank within the applicable statute of limitations. The plaintiff seeks unspecified damages, costs, fees, attorney’s fees, and general and equitable relief for herself and the purported class. The Company and Bank deny the allegations and intend to vigorously defend the matter. At this early stage of the lawsuit, we cannot determine the probability of a materially adverse result or reasonably estimate the potential exposure, if any.
From time to time, the Company, including its subsidiaries, are or may be involved in various legal matters arising in the ordinary course of business. In the opinion of management, neither the Company, nor any of its subsidiaries, are involved in such legal proceedings that the resolution is expected to have a material adverse effect on the Company’s consolidated results of operations, financial condition, or cash flows. However, one or more unfavorable outcomes in these ordinary claims or litigation against the Company or its subsidiaries could have a material adverse effect for the period in which they are resolved. In addition, regardless of their merits or ultimate outcomes, such matters are costly, divert management’s attention, and may materially and adversely affect the reputation of the Company or its subsidiaries, even if resolved favorably.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Market Information for Common Stock
Shares of our common stock are traded on the Nasdaq Global Select Market under the symbol “RRBI.” Our shares have been traded on the Nasdaq Global Select Market since May 3, 2019. Prior to that date, there was no public trading market for our common stock.
Holders of Record
As of March 5, 2021, there were approximately 300 holders of record of our common stock.
Dividends and Dividend Policy
Taking into consideration our performance and capital levels, we began paying quarterly cash dividends of $0.06 per share in 2020, resulting in $0.24 per share in cash dividends for the year ended December 31, 2020. Although we anticipate paying quarterly dividends going forward, we have no obligation to continue paying dividends, and we may change our dividend policy at any time without notice to our shareholders. Any future determination relating to dividends will be made at the discretion of our board of directors and will depend on a number of factors, including our historical and projected financial condition, liquidity, and results of operations; our capital levels and needs; any acquisitions or potential acquisitions that we are considering; contractual, statutory, and regulatory prohibitions and other limitations; general economic conditions; and other factors deemed relevant by our board of directors.
For information on regulatory restrictions on our and the Bank's present and future ability to pay dividends, see "Item 1. Business - Supervision and Regulation - Bank Holding Company Regulation - Regulatory Restrictions on Dividends; Source of Strength" and " - Bank Regulation - Regulatory Restrictions on Dividends."
Use of Proceeds from Registered Sales of Equity Securities
On May 7, 2019, we sold 663,320 new shares of our common stock at a public offering price of $45.00 per share in our IPO, including 90,000 shares sold pursuant to the exercise of the underwriters’ option to purchase additional shares in the offering. The offer and sale of shares in the IPO were registered under the Securities Act pursuant to a registration statement on Form S-1 (File No. 333-230798), which the SEC declared effective on May 2, 2019. FIG Partners, LLC and Stephens Inc. acted as underwriters. The offering commenced on May 3, 2019, and did not terminate until the sale of all of the shares offered. There has been no material change in the planned use of proceeds from our IPO as described in our Prospectus that was filed with the SEC on May 3, 2019, pursuant to Rule 424(b)(4) under the Securities Act.
Issuer Purchases of Equity Securities
On August 27, 2020, our board of directors approved a stock repurchase program. The repurchase program authorizes us to purchase up to $3.0 million of our outstanding shares of common stock through August 27, 2021. Repurchases may be made from time to time in the open market at prevailing prices and based on market conditions, or in privately negotiated transactions. We did not repurchase any of our shares of common stock under a share repurchase plan during the three months ended December 31, 2020. As of December 31, 2020, approximately $2.9 million remains available to repurchase shares under the stock repurchase program.
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Item 6. Selected Financial Data
The following tables set forth selected historical consolidated financial information for each of the periods indicated. The historical financial information as of and for the years ended December 31, 2020 and 2019, except for the selected ratios, is derived from our audited consolidated financial statements included elsewhere in this document. The historical financial information as of and for the years ended December 31, 2018, 2017, and 2016, except for the selected ratios, is derived from our audited consolidated financial statements that are not included in this document. Our historical results may not be indicative of our future performance.
You should read the selected historical consolidated financial and operating data set forth below in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as our consolidated financial statements and the related notes included in "Item 8. Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. The selected historical consolidated financial information presented below contains financial measures that are not presented in accordance with GAAP and have not been audited. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures” for a reconciliation of non-GAAP financial measures.
As of and for the Years Ended December 31,
Selected Period End Balance Sheet Data:
Securities held-to-maturity — — — 8,991 10,193
Selected Income Statement Data:
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As of and for the Years Ended December 31,
Per Common Share Data: (1)
Cash dividends per share $ 0.24 $ 0.20 $ 0.15 $ — $ —
Summary Performance Ratios:
Summary Credit Quality Ratios:
Capital Ratios:
(1)2017 and 2016 amounts adjusted to give effect to the 2018 2-for-1 stock split.
(2)Non-GAAP financial measure. For calculations and reconciliations to GAAP of non-GAAP financial measures, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Non-GAAP Financial Measures" in this Annual Report on Form 10-K.
(3)We calculate tangible book value per common share as total stockholders’ equity, less intangible assets, divided by the outstanding number of shares of our common stock at the end of the relevant period.
(4)Net interest margin FTE includes an FTE adjustment using a 21% federal income tax rate for 2020, 2019, and 2018, and a 35% tax rate for 2017 and 2016 on tax-exempt securities and tax-exempt loans.
(5)Efficiency ratio represents operating expenses divided by the sum of net interest income and noninterest income.
(6)We calculate tangible common equity as total stockholders’ equity, less intangible assets, net of accumulated amortization, and we calculate tangible assets as total assets, less intangible assets, net of accumulated amortization.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this discussion and analysis is to focus on significant changes in financial condition and results of operations of Red River Bancshares, Inc. on a consolidated basis during the year ended December 31, 2020 and selected prior periods. This discussion and analysis should be read in conjunction with information presented elsewhere in this report, including "Item 6. Selected Financial Data" and our audited consolidated financial statements and notes thereto included in "Item 8. Financial Statements and Supplementary Data."
The following discussion contains forward-looking statements that reflect our current views with respect to, among other things, future events and our financial performance. We caution that assumptions, expectations, projections, intentions, or beliefs about future events may, and often do, vary from actual results and the differences can be material. See “Cautionary Note Regarding Forward-Looking Statements.” Also, see risk factors and other cautionary statements described in "Item 1A. Risk Factors” in this Annual Report on Form 10-K. We do not undertake any obligation to publicly update any forward-looking statements except as otherwise required by applicable law.
CORPORATE SUMMARY
Red River Bancshares, Inc. is the bank holding company for Red River Bank, a Louisiana state-chartered bank established in 1999 that provides a fully integrated suite of banking products and services tailored to the needs of our commercial and retail customers. Red River Bank operates from a network of 25 banking centers throughout Louisiana and one combined loan and deposit production office in Lafayette, Louisiana. Banking centers are located in the following Louisiana markets: Central, which includes the Alexandria MSA; Northwest, which includes the Shreveport-Bossier City MSA; Capital, which includes the Baton Rouge MSA; Southwest, which includes the Lake Charles MSA; and the Northshore, which includes Covington.
Our priority is to drive shareholder value through the establishment of a market-leading commercial banking franchise in Louisiana. We provide services through relationship-oriented bankers who are committed to their customers and the communities in which we offer our products and services. Our strategy is to expand geographically through the establishment of de novo banking centers in new markets and, to a lesser extent, through the acquisition of financial institutions with customer-oriented, compatible philosophies and in desirable geographic areas.
OVERVIEW
The year ended December 31, 2020, had many challenges and successes. We were impacted by the global outbreak of the COVID-19 pandemic, the passage of the CARES Act, changing government orders, economic shutdowns, a low interest rate environment, and two hurricanes that impacted our markets. Despite these challenges, we participated in the SBA PPP program, welcomed many new customers, implemented a stock buyback program, opened a new banking center, purchased two banking center locations, and had record high levels of mortgage activity, balance sheet growth, and earnings.
2020 Financial and Operational Highlights
•Net income for the year ended December 31, 2020, was $28.1 million, or $3.83 diluted EPS, an increase of $3.3 million, or 13.4%, compared to $24.8 million, or $3.49 diluted EPS, for the year ended December 31, 2019.
•The return on average assets was 1.22% for 2020 and 1.30% for 2019.
•The return on average equity was 10.39% for 2020 and 10.86% for 2019.
•Assets increased $654.4 million, or 32.9%, to $2.64 billion as of December 31, 2020, compared to $1.99 billion as of December 31, 2019. This increase was driven by a $619.2 million, or 36.0%, increase in deposits for the same period. The deposit growth in 2020 was due to customers receiving funds from various government stimulus programs, customers depositing the proceeds from their PPP loans, strong deposit account opening activity, and customers maintaining larger deposit balances.
•Loans HFI increased $149.5 million, or 10.4%, to $1.59 billion as of December 31, 2020, compared to $1.44 billion as of December 31, 2019. The increase in loans was mainly due to PPP loans originated during the year.
•Red River Bank participated in the SBA PPP, supporting Louisiana businesses with PPP loans. In the second quarter of 2020, Red River Bank originated 1,384 PPP loans totaling $199.0 million, with an average loan size of $144,000. In the fourth quarter of 2020, the SBA began approving our initial PPP loan forgiveness applications. As of December 31, 2020, PPP loans, net of deferred income, were $118.4 million.
•Mortgage loan production and income in 2020 were at record high levels for the Company.
•During 2020, our investment group successfully converted our registered broker-dealer relationship to LPL Financial LLC. This conversion allows us to support future brokerage services growth, as well as provide better technology and benefits to our customers and investment group.
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•We expanded organically throughout Louisiana with the following:
◦Late in 2019, we purchased a banking center building in Sulphur, Louisiana, located in our Southwest Louisiana market. This property was remodeled and opened as a Red River Bank banking center late in the first quarter of 2020.
◦In the third quarter of 2020, we began operations in our newest market, Acadiana, which includes the Lafayette, Louisiana MSA. We hired an Acadiana market president and opened a combined loan and deposit production office in Lafayette.
◦In the fourth quarter of 2020, we purchased a banking center building in Lake Charles, Louisiana. This location allows us to continue to expand banking services in our Southwest Louisiana market. This property is being remodeled and is expected to open as a full-service banking center in the second quarter of 2021, pending all necessary regulatory approvals.
◦In the fourth quarter of 2020, we purchased a banking center building in Lafayette, Louisiana. This property is being remodeled and is expected to open as our Acadiana market's first, full-service banking center in the summer of 2021, pending all necessary regulatory approvals.
•Beginning in the first quarter of 2020, we began paying cash dividends on a quarterly basis. Quarterly cash dividends of $0.06 per common share were paid in 2020, resulting in cash dividends of $0.24 per common share for 2020, compared to $0.20 per common share for 2019.
•In August 2020, our board approved a stock repurchase program that authorizes us to purchase up to $3.0 million of our outstanding shares through August 27, 2021. In 2020, we repurchased 2,824 shares.
•Our Southwest and Central Louisiana markets were impacted by Hurricane Laura in August 2020 and Hurricane Delta in October 2020. Banking center locations in the impacted areas were temporarily closed prior to and after the hurricane; however, banking services quickly resumed. Red River Bank did not sustain any significant damage to its locations from these hurricanes.
RESULTS OF OPERATIONS
Net income for the year ended December 31, 2020, was $28.1 million, or $3.83 diluted EPS, an increase of $3.3 million, or 13.4%, compared to $24.8 million, or $3.49 diluted EPS, for the year ended December 31, 2019. The increase in net income was primarily due to a $7.2 million increase in noninterest income and a $5.4 million increase in net interest income, partially offset by a $4.5 million increase in provision for loan losses and a $4.1 million increase in operating expenses. The return on average assets for the year ended December 31, 2020, was 1.22%, compared to 1.30% for the prior year. The return on average equity was 10.39% for the year ended December 31, 2020, compared to 10.86% for the prior year. Our efficiency ratio for the year ended December 31, 2020, was 55.77%, compared to 59.46% for the year ended December 31, 2019.
Net Interest Income and Net Interest Margin
Our operating results depend primarily on our net interest income. Fluctuations in market interest rates impact the yield on interest-earning assets and the rate paid on interest-bearing liabilities. Changes in the amount and type of interest-earning assets and interest-bearing liabilities also impact our net interest income. To evaluate net interest income, we measure and monitor: (1) yields on loans and other interest-earning assets; (2) the costs of deposits and other funding sources; (3) net interest spread; and (4) net interest margin. Since noninterest-bearing sources of funds, such as noninterest-bearing deposits and stockholders’ equity, also fund interest-earning assets, net interest margin includes the benefit of these noninterest-bearing funding sources.
The Federal Reserve sets the target federal funds rate, which is the cost of immediately available overnight funds, and influences other market rates, such as the prime rate. These market rates impact pricing of certain assets and liabilities used by financial institutions. Our net interest income and net interest margin are directly affected by these rates and their changes. During 2019, the target federal funds rate remained consistent between January and July, decreased 75 bps in the second half of the year, and was 1.75% as of December 31, 2019. During 2020, the target federal funds rate decreased 150 bps in March, remained consistent the rest of the year, and was 0.25% as of December 31, 2020. Due to these fluctuations, the average effective federal funds rate was 2.16% for 2019 and 0.38% for 2020. In 2020, the lower interest rate environment impacted yields on new, renewing, and floating rate loans, short-term liquid assets, and taxable securities. For the year ended December 31, 2020, net interest income and net interest margin FTE were impacted by the lower interest rate environment.
Net interest income for the year ended December 31, 2020, totaled $69.0 million, a $5.4 million, or 8.4%, increase from the year ended December 31, 2019. Net interest income increased due to a $3.7 million, or 5.0%, increase in interest and dividend income, combined with a $1.7 million, or 16.9%, decrease in interest expense. The increase in interest and dividend income was due to $5.6 million of PPP loan income recorded during 2020 and a $360,000 increase in interest
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income for total securities, partially offset by a $1.4 million decrease in interest income on short-term liquid assets and a $904,000 decrease in non-PPP loan income. In 2020, deposit growth exceeded loan growth which created excess liquidity. During 2020, this excess liquidity was deployed into interest-bearing deposits in other banks, as well as securities. For the year ended December 31, 2020, compared to the year ended December 31, 2019, average short-term liquid assets increased $110.1 million, while the interest income for these liquid assets decreased $1.4 million because of the lower interest rate environment. For the same period, average total securities increased $83.5 million resulting in an increase in interest income for total securities that was partially offset by a decrease in yield. For the year ended December 31, 2020, average non-interest bearing deposits increased $229.8 million, or 39.8%, and average interest-bearing transaction deposits increased $138.3 million, or 18.7%, compared to the prior year. Interest expense decreased as a result of our decision to reduce interest rates on deposits during the year ended December 31, 2020, combined with redeeming the junior subordinated debentures mid-2019 and eliminating the related interest expense.
Net interest margin FTE decreased 38 bps to 3.14% for the year ended December 31, 2020, from 3.52% for the year ended December 31, 2019, mainly due to the Federal Reserve lowering interest rates 225 bps since August 2019. The yield on loans decreased 29 bps to 4.30% for the year ended December 31, 2020, compared to 4.59% for the prior year, due to the impact of the low interest rate environment on new, renewed, and floating rate loans. As of December 31, 2020, floating rate loans were 14.6% of loans HFI. For the year ended December 31, 2020, the yield on taxable securities decreased 53 bps to 1.60%, compared to 2.13% for the prior year. The yield decreased as securities purchased throughout 2020 were at lower yields than the portfolio yield for taxable securities as of December 31, 2019, combined with an increase in amortization expense on mortage-backed securities. For the year ended December 31, 2020, compared to the prior year, the yield on federal funds sold decreased 184 bps, and the yield on interest-bearing balances due from banks decreased 190 bps, due to the lower interest rate environment. The resulting yield on interest-earning assets was 3.47% for the year ended December 31, 2020, a 56 bp decrease, compared to 4.03% for the prior year. The cost of deposits was 0.41% for the year ended December 31, 2020, an 18 bp decrease, compared to 0.59% for the prior year. The cost of deposits was lower for the year ended December 31, 2020, due to average noninterest-bearing deposits increasing $229.8 million, or 39.8%, combined with a 21 bp decrease in the rate on interest-bearing deposits for the same period as a result of our adjustments to deposit rates.
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The following table presents average balance sheet information, interest income, interest expense, and the corresponding average yields earned and rates paid for the years presented:
For the Years Ended December 31,
Assets
Interest-earning assets:
Liabilities and Stockholders’ Equity
Interest-bearing liabilities:
Noninterest-bearing liabilities:
(1)Includes average outstanding balances of loans HFS of $14.2 million, $4.1 million, and $2.9 million for the years ended December 31, 2020, 2019, and 2018, respectively.
(2)Nonaccrual loans are included as loans carrying a zero yield.
(3)Net interest margin FTE includes an FTE adjustment using a 21% federal income tax rate on tax-exempt securities and tax-exempt loans.
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In 2020, Red River Bank participated in the SBA PPP and originated 1,384 PPP loans totaling $199.0 million. For the year ended December 31, 2020, average PPP loans, net of deferred income, totaled $127.4 million at an interest rate of 1.0%. Under the terms of the PPP, we received loan origination fees from the SBA ranging from 1.0% to 5.0% of the initial principal amount of the loans. PPP origination fees were $7.0 million, or 3.52%, of originated PPP loans and are being recorded to interest income over the 24-month loan term or until the loans are forgiven by the SBA. As PPP loan forgiveness payments are received, the remaining portion of origination fees are recorded to income. In the fourth quarter of 2020, 39.4% of our PPP loans originated were forgiven by the SBA, and $77.7 million of PPP loan payments were received from the SBA and our borrowers. For the year ended December 31, 2020, PPP loan income totaled $5.6 million, resulting in a 4.35% yield.
Excluding PPP loan income, net interest income (non-GAAP) for the year ended December 31, 2020, was $63.4 million, which was $201,000, or 0.30%, lower than the prior year. Also, with PPP loans excluded for the year ended December 31, 2020, the yield on non-PPP loans (non-GAAP) was 4.29%, and the net interest margin FTE (non-GAAP) was 3.07%. For the year ended December 31, 2020, PPP loans had a one bp accretive impact to the yield on loans and a seven bp accretive impact to the net interest margin FTE. For further information on non-GAAP financial measures, see " - Non-GAAP Financial Measures" in this Annual Report on Form 10-K.
The following table presents interest income for total loans, PPP loans, total non-PPP loans (non-GAAP), and net interest ratios excluding PPP loans (non-GAAP) for the years ended December 31, 2020, 2019 and 2018.
For the Years Ended December 31,
Less: PPP loans, net
Ratios excluding PPP loans, net (non-GAAP)(4)
(1)Includes average outstanding balances of loans HFS of $14.2 million, $4.1 million, and $2.9 million for the years ended December 31, 2020, 2019, and 2018, respectively.
(2)Nonaccrual loans are included as loans carrying a zero yield.
(3)Net interest margin FTE includes an FTE adjustment using a 21% federal income tax rate on tax-exempt securities and tax-exempt loans.
(4)Non-GAAP financial measure. See also " - Non-GAAP Financial Measures" in this Annual Report on Form 10-K.
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Rate/Volume Analysis
Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning assets and interest-bearing liabilities, as well as changes in average interest rates. The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and those due to changes in interest rates. The change in interest attributable to rate has been determined by applying the change in rate between periods to average balances outstanding in the earlier period. The change in interest due to volume has been determined by applying the rate from the earlier period to the change in average balances outstanding between periods. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to rate.
(in thousands) Volume Rate (Decrease) Volume Rate (Decrease)
Interest-earning assets:
Nonmarketable equity securities 26 (29) (3) 1 4 5
Investment in trusts (11) — (11) (8) 3 (5)
Interest-bearing liabilities:
Other borrowings 16 — 16 (7) — (7)
Provision for Loan Losses
The provision for loan losses is a charge to income necessary to maintain the allowance for loan losses at a level considered appropriate by management. Factors impacting the provision include loan portfolio growth, changes in the quality and composition of the loan portfolio, the level of nonperforming loans, delinquency and charge-off trends, and current economic conditions.
The provision expense for the year ended December 31, 2020, was $6.3 million, an increase of $4.5 million from $1.8 million for the year ended December 31, 2019. The increase in provision for loan losses was due to expected economic pressures relating to the COVID-19 pandemic.
Due to economic uncertainties related to the pandemic shutdowns and future risks associated with the continuing COVID-19 pandemic, we are closely monitoring asset quality and will adjust provision for loan losses as needed in 2021.
Noninterest Income
Our primary sources of noninterest income are fees related to the sale of mortgage loans, service charges on deposit accounts, debit card fees, brokerage income from advisory services, and other loan and deposit fees. Noninterest income increased $7.2 million to $23.2 million for the year ended December 31, 2020, compared to the prior year. The increase in noninterest income was mainly due to higher mortgage loan income, a larger gain on the sale of securities, higher debit card income, and higher brokerage income. These increases were partially offset by a decrease in service charges on deposits accounts.
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The table below presents, for the periods indicated, the major categories of noninterest income:
For the Years Ended December 31,
(dollars in thousands) 2020 2019 Increase/(Decrease)
Noninterest income:
Gain (Loss) on equity securities 85 115 (30) (26.1) %
Due to the lower mortgage interest rate environment in 2020, mortgage loan production and income have been at record high levels. For 2020, mortgage loan production increased 140.2% from 2019, resulting in $8.4 million of mortgage loan income, an increase of $5.4 million from $3.0 million for the prior year.
The gain on the sale of securities was $1.4 million for 2020, compared to $18,000 for 2019. The 2020 gain was primarily a result of proactive portfolio restructuring transactions that occurred in the first and second quarters of 2020 in response to the lower interest rate environment. We obtained favorable pricing on the securities sold, which resulted in the gain.
Debit card income, net, increased $546,000 to $3.6 million for 2020, compared to $3.1 million for 2019. The increase was due to increases in the number of deposit accounts, debit cards issued, and debit card transactions.
Brokerage income increased $199,000 to $2.3 million for 2020, compared to $2.1 million for 2019. This increase is primarily due to the addition of new brokerage clients and accounts in 2020, as well as additional funds invested by existing clients. These increases were partially offset by a temporary reduction in revenue in the second quarter of 2020 resulting from an investment group broker-dealer partner conversion. Assets under management were $647.8 million and $633.1 million as of December 31, 2020 and 2019, respectively.
Service charges on deposit accounts decreased $465,000 to $4.1 million for 2020, compared to $4.6 million for 2019. This decrease was partially due to fewer customer deposit non-sufficient fund transactions. In addition, 2020 was impacted by approximately $168,000 in reduced deposit fees due to temporary fee reductions in the second quarter of 2020 in response to the COVID-19 pandemic.
Operating Expenses
Operating expenses are composed of all employee expenses and costs associated with operating our facilities, obtaining and retaining customer relationships, and providing services. For the year ended December 31, 2020, operating expenses totaled $51.4 million, an increase of $4.1 million, compared to $47.3 million for the year ended December 31, 2019. The increase in operating expenses was mainly due to higher personnel expenses, legal and professional expenses, technology expenses, regulatory assessment expense, other taxes, and occupancy and equipment expenses, partially offset by lower other operating expenses.
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The following table presents, for the periods indicated, the major categories of operating expenses:
For the Years Ended December 31,
(dollars in thousands) 2020 2019 Increase (Decrease)
Operating expenses:
Non-staff expenses:
Personnel expenses are the largest component of operating expenses and include payroll expenses, incentive compensation, benefit plans, health insurance, and payroll taxes. Personnel expenses were $31.2 million for 2020, an increase of $3.4 million compared to 2019. As of December 31, 2020 and 2019, we had 336 and 325 full-time equivalent employees, respectively. The increase in personnel expenses was related to additional staff resulting from our expansion in the Northshore, Southwest, and Acadiana markets, as well as an increase in staff to support operational growth. In addition, commission compensation increased for 2020, primarily due to significantly higher mortgage loan activity.
Legal and professional expenses increased $600,000 to $2.1 million for 2020 compared to 2019. This increase was a result of higher attorney, audit, and compliance expenses, combined with having a full year of expenses related to operating as a public company.
Technology expenses increased $249,000 to $2.5 million for 2020 compared to the prior year. This increase was a result of higher mortgage software expense due to increased mortgage loan activity; additional software to enhance operational efficiency, cybersecurity, and information security infrastructure; and COVID-19 pandemic preparation and response efforts.
Regulatory assessment expense increased $187,000 in 2020 compared to 2019. This increase was primarily due to an increase of $159,000 in FDIC insurance assessment expense. The Bank was notified by the FDIC that it did not have an FDIC insurance assessment for the second half of 2019 and first quarter of 2020. Therefore, no FDIC insurance assessment expense was incurred for these periods. The FDIC insurance assessment expense for 2020 was $409,000 compared to $250,000 in 2019.
Other taxes increased $154,000 to $1.7 million for 2020 compared to 2019. The increase was due to a $157,000 increase in State of Louisiana bank stock tax resulting from higher deposit account balances and higher net income for the applicable tax years.
Occupancy and equipment expenses increased $130,000 to $5.1 million for 2020 compared to 2019. This increase was mainly due to the recent expansion in our Northshore, Southwest, and Acadiana markets, as well as increased supplies and services needed in all banking centers as a result of the COVID-19 pandemic.
Other operating expenses decreased $357,000 to $3.3 million for 2020 compared to 2019. This decrease was primarily a result of a $311,000 nonrecurring expense reduction related to the dissolution of an acquired subsidiary in the first quarter of 2020, combined with reduced travel and event expenses due to the COVID-19 pandemic.
Income Tax Expense
The amount of income tax expense is influenced by the amounts of our pre-tax income, tax-exempt income, and other nondeductible expenses. Deferred tax assets and liabilities are reflected at currently enacted income tax rates in effect for
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the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.
Our effective income tax rates have differed from the U.S. statutory rate due to the effect of tax-exempt income from loans, securities, life insurance policies, and the income tax effects associated with stock-based compensation. The CARES Act and Families First Coronavirus Response Act passed in March of 2020 did not have a material impact on our income tax expense or our effective tax rate for the year ended December 31, 2020.
For the years ended December 31, 2020 and 2019, income tax expense totaled $6.3 million and $5.6 million, respectively. The increase in income tax expense was primarily due to the increase in pre-tax income. The effective income tax rate for 2020 was 18.3%, compared to 18.5% for 2019.
FINANCIAL CONDITION
General
As of December 31, 2020, total assets were $2.64 billion which was $654.4 million, or 32.9%, higher than total assets of $1.99 billion as of December 31, 2019. Within total assets, compared to December 31, 2019, interest-bearing deposits in other banks increased by $310.3 million, securities AFS increased by $162.6 million, and loans HFI increased by $149.5 million. For liabilities, compared to December 31, 2019, noninterest-bearing deposits increased $358.7 million, and interest-bearing deposits increased $260.5. As of December 31, 2020, the loans HFI to deposits ratio was 67.87%, compared to 83.60% as of December 31, 2019, and the noninterest-bearing deposits to total deposits ratio was 40.32%, compared to 33.98% as of December 31, 2019. Stockholders' equity increased $33.6 million from $251.9 million as of December 31, 2019, to $285.5 million as of December 31, 2020.
Securities
Our securities portfolio is the second largest component of earning assets and provides a significant source of revenue. As of December 31, 2020, our securities portfolio was 19.0% of total assets. It is designed primarily to provide and maintain liquidity, generate a favorable return on investments without incurring unnecessary interest rate and credit risk, and to complement our lending activities. We may invest in various types of liquid assets that are permissible under governing regulations and approved by our investment policy, which include U.S. Treasury obligations, U.S. government agency obligations, certificates of deposit of insured domestic banks, mortgage-backed and mortgage-related securities, corporate notes having an investment rating of "A" or better, municipal bonds, and certain equity securities.
Securities AFS were $498.2 million as of December 31, 2020, an increase of $162.6 million, or 48.5%, from $335.6 million as of December 31, 2019. Investment activity for the twelve months ended December 31, 2020, included $419.4 million of securities purchased, partially offset by $151.3 million in sales and $112.6 million in maturities, principal repayments, and calls. The net unrealized gain of the securities AFS portfolio increased $8.8 million for the year ended December 31, 2020.
Equity securities were $4.0 million and $3.9 million as of December 31, 2020 and 2019, respectively. There were no purchases or sales of equity securities for the twelve months ended December 31, 2020.
In 2020, we sold $151.3 million of securities, consisting of a mix across various sectors that had lower yields and short average lives, along with a strategic group of higher yielding municipal securities which also had short average lives. A large portion of the securities sold were mortgage-backed securities which had faster prepayment speeds or were owned at higher book prices, and due to higher amortization expense from accelerated prepayment speeds, the yields had declined. We were able to obtain a gain of $1.4 million on these transactions due to timing and favorable pricing within the market. We reinvested the proceeds into securities with improved structure for the current rate environment. These transactions reduced the amount of securities repricing in the short-term, rebalanced cash flows for the portfolio, partially mitigated higher amortization expense for the mortgage-backed sector, and are expected to partially offset our exposure to a lower net interest margin and the low rate environment.
During the twelve months ended December 31, 2020, due to the low interest rate environment, we reallocated $259.9 million from federal funds sold yielding 0.30% to securities AFS yielding 1.55%. Although this reallocation has negatively impacted the overall securities portfolio yield, we expect it to improve future interest income by moving these funds from federal funds sold to a higher yielding investment.
The securities portfolio tax-equivalent yield was 2.02% for the year ended December 31, 2020, compared to 2.32% for the year ended December 31, 2019. This decrease was due to accelerated prepayment speeds which increased amortization expense on our mortgage-backed securities, combined with the $259.9 million in funds reallocated from federal funds sold to securities with lower yields than the portfolio yield as of December 31, 2019.
The contractual maturity of mortgage-backed securities and collateralized mortgage obligations is not a reliable indicator of their expected lives because borrowers have the right to prepay their obligations at any time. Mortgage-backed
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securities and collateralized mortgage obligations are typically issued with stated principal amounts and are backed by pools of mortgage loans and other loans with varying maturities. The term of the underlying mortgages and loans may vary significantly due to the ability of a borrower to prepay. Monthly pay downs on mortgage-backed securities may cause the average lives of the securities to be much different than the stated contractual maturity. During a period of rising interest rates, fixed rate mortgage-backed securities are not likely to experience heavy prepayments of principal, and, consequently, the average lives of these securities are typically lengthened. If interest rates begin to fall, prepayments may increase, thereby shortening the estimated average lives of these securities. As of December 31, 2020, the average life of our securities portfolio was 3.9 years with an estimated modified duration of 3.6 years.
The carrying values of our securities AFS are adjusted for unrealized gain or loss, and any unrealized gain or loss is reported on an after-tax basis as a component of accumulated other comprehensive income (loss) in stockholders’ equity. As of December 31, 2020, the unrealized gain of the securities AFS portfolio was $8.8 million, compared to an unrealized loss of $30,000 as of December 31, 2019.
The $4.0 million in equity securities as of December 31, 2020, is an investment in the CRA Qualified Investment Fund which is managed by Community Capital Management, Inc. We invested in the CRA Qualified Investment Fund as part of our strategy to meet our obligations described within the Community Reinvestment Act, which encourages financial institutions to help meet the credit needs of their entire market area, including low and moderate income neighborhoods, consistent with safe and sound banking principles. Through this fund, mortgage-backed securities are purchased according to our allocations, with their underlying collateral located in our market areas, which strengthens our efforts to meet our CRA obligations.
Equity securities, consisting of a mutual fund, are carried at fair value on the consolidated balance sheets with periodic changes in value recorded through the consolidated statements of income. The fair value of our equity securities was $4.0 million as of December 31, 2020, with a recognized gain of $85,000 for the year ended December 31, 2020, compared to a fair value of $3.9 million as of December 31, 2019, with a recognized gain of $115,000 for the year ended December 31, 2019.
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The following tables summarize the amortized cost and estimated fair value of our securities by type as of the dates indicated. As of December 31, 2020, other than securities issued by U.S. government agencies or government sponsored enterprises, our securities portfolio did not contain securities of any one issuer with an aggregate book value in excess of 10.0% of our stockholders’ equity.
Securities AFS:
Securities AFS:
Securities AFS:
The following table shows the fair value of securities AFS which mature during each of the periods indicated. The contractual maturity of a mortgage-backed security is the date at which the last underlying mortgage matures.
Contractual Maturity as of December 31, 2020
Securities AFS:
(1)Tax equivalent projected book yield as of December 31, 2020.
Loan Portfolio
Our loan portfolio is our largest category of earning assets, and interest income earned on our loan portfolio is our primary source of income. We maintain a diversified loan portfolio with a focus on commercial real estate, one-to-four family residential, and commercial and industrial loans. As of December 31, 2020, loans HFI were $1.59 billion, an increase of $149.5 million, or 10.4%, compared to $1.44 billion as of December 31, 2019. The increase in loans HFI was primarily due to the issuance of SBA PPP loans in 2020.
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In the second quarter of 2020, Red River Bank originated 1,384 PPP loans totaling $199.0 million, with an average PPP loan size of $144,000. We began accepting PPP loan forgiveness applications on September 14, 2020, and in the fourth quarter of 2020, the SBA began approving PPP loan forgiveness applications. As of December 31, 2020, 48.0% of the 1,384 PPP loans and 39.4% of the $199.0 million originated were forgiven by the SBA, and we received SBA forgiveness and borrower payments of $77.8 million. As of December 31, 2020, PPP loans were $118.4 million, net of $2.8 million of deferred income, or 7.5% of loans HFI. Through February 28, 2021, 70.1% of the 1,384 PPP loans and 59.8% of the $199.0 million originated were forgiven by the SBA, and we received $118.9 million in SBA forgiveness and borrower payments.
On December 27, 2020, the SBA and U.S. Treasury, through the Economic Aid Act, authorized a streamlined PPP loan forgiveness application process for PPP loans of $150,000 or less. As of February 28, 2021, approximately 76.9% of the 414 remaining PPP loans and 17.5% of the $80.1 million remaining PPP loan balance may be eligible for the streamlined process. Additionally, the Economic Aid Act allows for certain businesses, who previously received a PPP loan, to apply for a PPP Second Draw loan. Red River Bank is participating in the PPP Second Draw program, and as of February 28, 2021, 339 borrower applications totaling $40.3 million have been approved by the SBA.
As of December 31, 2020, loans HFI excluding $118.4 million of PPP loans (non-GAAP), net of deferred income, were $1.47 billion, an increase of $31.1 million, or 2.2%, from December 31, 2019. The increase in non-PPP loans was attributable to new loan activity in our newer markets. For calculations and reconciliations to GAAP of non-GAAP financial measures, see " - Non-GAAP Financial Measures" in this Annual Report on Form 10-K.
Loans HFI by Category
Loans HFI by category, non-PPP loans HFI (non-GAAP), and loans HFS are summarized below as of the dates indicated:
December 31,
Real estate:
SBA PPP, net of deferred income 118,447 7.5 % — — % — — % — — % — — %
(1)Non-GAAP financial measure. For calculations and reconciliations to GAAP of non-GAAP financial measures, see " - Non-GAAP Financial Measures" in this Annual Report on Form 10-K.
Commercial Real Estate Loans. Commercial real estate loans are primarily made for commercial property that is owner occupied as well as commercial property owned by real estate investors. Real estate securing these loans includes many property types, such as retail centers, nursing homes, offices and office buildings, medical facilities, warehouses, churches and related facilities, production facilities, and multifamily properties. Commercial real estate loans increased $24.8 million, or 4.7%, to $556.8 million as of December 31, 2020, from $532.0 million as of December 31, 2019.
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Non-owner occupied commercial real estate loans were $237.0 million, or 14.9%, of loans HFI, and represented 87.4% of the Bank’s total risk-based capital as of December 31, 2020. The owner occupied and non-owner occupied components of the commercial real estate portfolio are summarized below.
Commercial Real Estate
(dollars in thousands) Owner Occupied Non-Owner Occupied Total
One-to-Four Family Residential Loans. One-to-four family residential loans are predominantly first lien mortgage loans secured by owner occupied one-to-four family residential properties. One-to-four family residential loans increased $22.9 million, or 5.4%, to $442.9 million as of December 31, 2020, compared to $420.0 million as of December 31, 2019.
Construction and Development Loans. The construction and development portfolio includes loans to small and medium-sized businesses to construct owner occupied facilities, loans to developers of commercial real estate investment properties and residential developments and, to a lesser extent, loans to individual clients for construction of single-family homes. Construction and development loans decreased $5.1 million, or 3.9%, to $127.3 million as of December 31, 2020, compared to $132.5 million as of December 31, 2019.
Commercial and Industrial Loans. Commercial and industrial loans are made for a variety of business purposes, including, but not limited to, inventory, equipment, capital expansion, and working capital enhancement. Collateral typically includes a lien on general business assets including, among other things, accounts receivable, inventory, equipment, and available real estate. A personal guaranty is generally obtained from the borrower or principal. Commercial and industrial loans decreased $17.5 million, or 6.5%, to $250.4 million as of December 31, 2020, from $267.9 million as of December 31, 2019.
SBA PPP, Net of Deferred Income. SBA PPP loans are made to small businesses and other entities and individuals according to the criteria set forth by the CARES Act in March 2020. These loans are guaranteed by the SBA, have a 24 month term at an interest rate of 1.0%, and are subject to forgiveness by the SBA dependent upon meeting eligibility requirements.
Tax-Exempt Loans. Tax-exempt loans are made to political subdivisions of the State of Louisiana including parishes, municipalities, utility districts, school districts, and development authorities. These loans are typically secured by and paid for by ad valorem taxes. Tax-exempt loans increased $12.2 million, or 21.5%, to $68.7 million as of December 31, 2020, compared to $56.5 million as of December 31, 2019.
Consumer Loans. Consumer loans are made to individuals for personal, family, and household purposes and include secured and unsecured installment and term loans. Consumer loans are offered as an accommodation to existing customers and are not marketed to persons without a pre-existing relationship with us.
Loan Payment Deferments
During 2020, we granted loan payment deferments for requesting borrowers impacted by pandemic-related economic shutdowns. As of December 31, 2020, $12.5 million, or 0.8% of non-PPP loans HFI (non-GAAP), remained on active deferral and were deferrals of principal payments only. For calculations and reconciliations to GAAP of non-GAAP financial measures, see " - Non-GAAP Financial Measures" in this Annual Report on Form 10-K.
In accordance with interagency regulatory guidance issued in March 2020 and revised in April 2020, these short-term deferrals are not deemed to be TDRs to the extent they meet the terms of such guidance.
Industry Concentrations
As of December 31, 2020, the health care sector was the only concentration of loans within any single industry in excess of 10.0% of non-PPP loans HFI (non-GAAP) as segregated by the North American Industry Classification System
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(“NAICS”). NAICS is an industry classification system used to categorize loans by the borrower’s type of business. Industry concentrations stated as a percentage of non-PPP loans HFI (non-GAAP) are presented below:
Health care 10.2 %
Construction 4.6 %
Retail trade 3.8 %
Investor one-to-four family and multifamily 4.0 %
Hospitality services 4.0 %
Religious and other nonprofit 2.4 %
Public administration 3.3 %
Energy 1.4 %
Finance and insurance 1.6 %
Manufacturing 1.7 %
All other 63.0 %
Total non-PPP loans HFI (non-GAAP) by industry concentration 100.0 %
Our health care loans are made up of a diversified portfolio of health care providers. As of December 31, 2020, health care credits were $149.4 million, or 10.2% of non-PPP loans HFI (non-GAAP), compared to $133.4 million, or 9.3% of non-PPP loans HFI as of December 31, 2019. The average health care loan size was $305,000 as of December 31, 2020, and $274,000 as of December 31, 2019. Within the health care sector, nursing and residential care loans were 4.4% of non-PPP loans HFI (non-GAAP) as of December 31, 2020, and 5.3% as of December 31, 2019. Loans to physician and dental practices were 5.7% of non-PPP loans HFI (non-GAAP) as of December 31, 2020, and 3.9% as of December 31, 2019. As of December 31, 2020, the health care sector had no active deferrals.
We have identified certain sectors within our loan portfolio that we believe have a heightened overall level of risk due to pandemic-related macro-economic conditions. The following table shows non-PPP loans HFI (non-GAAP) in these sectors as of the date indicated:
Hospitality services:
Retail trade:
Loan payment deferments in the hospitality services sector represents 65.0% of our active deferrals. As of December 31, 2020, active deferrals in the hospitality services were $8.1 million, or 0.6% of non-PPP loans HFI (non-GAAP). As of December 31, 2020, there were no active deferrals in the retail trade or energy sectors. For calculations and reconciliations to GAAP of non-GAAP financial measures, see " - Non-GAAP Financial Measures" in this Annual Report on Form 10-K.
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Other Portfolio Sectors
The following table shows non-PPP loans HFI (non-GAAP) in other non-industry specific areas that we believe may be affected by the pandemic:
(dollars in thousands) Amount Percent of Non-PPP Loans HFI (non-GAAP)
Credit card loans:
Total credit card loans $ 2,457 0.2 %
None of the markets in which we directly operate are characterized by a high degree of tourism-driven hospitality services. Likewise, our geographic footprint is not closely aligned with the bulk of Louisiana’s energy-concentrated local economies. We believe this provides our portfolio with some degree of insulation against the current stress in both of those segments.
The following table summarizes non-PPP loans HFI (non-GAAP) by market of origin:
(dollars in thousands) Amount Percent of Non-PPP Loans HFI (non-GAAP)
For further information on non-GAAP financial measures, see " - Non-GAAP Financial Measures" in this Annual Report on Form 10-K.
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Loan Portfolio Maturity Analysis
The maturity distribution for non-PPP loans HFI (non-GAAP) and the amount of such loans with fixed and floating interest rates are summarized below:
Real estate:
Variable rate percent 9.2 % 4.0 % 2.6 % 15.8 %
Nonperforming Assets
NPAs consist of nonperforming loans and property acquired through foreclosures or repossession. Nonperforming loans include loans that are contractually past due 90 days or more and loans that are on nonaccrual status. Loans are considered past due when principal and interest payments have not been received as of the date such payments are due.
Asset quality is managed through disciplined underwriting policies, continual monitoring of loan performance, and focused management of NPAs. There can be no assurance, however, that the loan portfolio will not become subject to losses due to declines in economic conditions, deterioration in the financial condition of our borrowers, or a decline in the value of collateral.
NPAs totaled $4.2 million as of December 31, 2020, down $2.3 million, or 34.9%, from $6.5 million as of December 31, 2019. Our ratio of NPAs to total assets was 0.16% as of December 31, 2020, compared to 0.33% as of December 31, 2019. The change was largely due to the charge-off of nonaccrual loans and the sale of foreclosed assets.
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Nonperforming loan and asset information is summarized below:
December 31,
Nonperforming loans:
Foreclosed assets:
Other — 18 — — —
Troubled debt restructurings:(1,2)
Accruing loans 90 or more days past due — — — 792 —
(1)Troubled debt restructurings – nonaccrual and accruing loans 90 or more days past due are included in the respective components of nonperforming loans.
(2)In accordance with interagency regulatory guidance issued in March 2020 and revised in April 2020, COVID-19 pandemic-related short-term deferrals are not deemed to be TDRs to the extent they meet the terms of such guidance.
(3)Non-GAAP financial measure. For calculations and reconciliations to GAAP of non-GAAP financial measures, see " - Non-GAAP Financial Measures" in this Annual Report on Form 10-K.
Nonaccrual loans are summarized below by category:
December 31,
Real estate:
SBA PPP — — — — —
Tax-exempt — — — — —
Potential Problem Loans
From a credit risk standpoint, we classify loans in one of five categories: pass, special mention, substandard, doubtful, or loss. Loan classifications reflect a judgment about the risk of default and loss associated with the loans. Classifications are reviewed periodically and adjusted to reflect the degree of risk and loss believed to be inherent in each loan. The methodology is structured so that specific reserve allocations are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).
Loans classified as pass are of satisfactory quality and do not require a more severe classification.
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Loans classified as special mention have potential weaknesses that deserve management’s close attention. If these weaknesses are not corrected, repayment possibilities for the loan may deteriorate. However, the loss potential does not warrant substandard classification.
Loans classified as substandard have well defined weaknesses which jeopardize normal repayment of principal and interest. Prompt corrective action is required to reduce exposure and to assure adequate remedial actions are taken by the borrower. If these weaknesses do not improve, loss is possible. Loans classified as doubtful have well defined weaknesses that make full collection improbable. Loans classified as loss are considered uncollectible and charged-off to the allowance for loan losses.
Loans HFI are summarized below by risk category:
(dollars in thousands) Pass SpecialMention Substandard Doubtful Loss Total
Real estate:
Allowance for Loan Losses
The allowance for loan losses is established for known and inherent losses in the loan portfolio based upon management’s best assessment of the loan portfolio at each balance sheet date. It is maintained at a level estimated to be adequate to absorb potential losses through periodic changes to loan losses.
In connection with the review of the loan portfolio, risk elements attributable to particular loan types or categories are considered in assessing the quality of individual loans. Some of the risk elements considered include:
• for commercial real estate loans, the debt service coverage ratio (income from the business in excess of operating expenses compared to loan repayment requirements); operating results of the owner in the case of owner occupied properties; the loan to value ratio; the age and condition of the collateral; and the volatility of income, property value, and future operating results typical of properties of that type;
• for one-to-four family residential mortgage loans, the borrower’s ability to repay the loan, including a consideration of the debt to income ratio and employment and income stability; the loan-to-value ratio; and the age, condition, and marketability of the collateral;
• for construction and development loans, the perceived feasibility of the project including the ability to sell developed lots or improvements constructed for resale or the ability to lease property constructed for lease; the quality and nature of contracts for presale or prelease, if any; experience and ability of the developer; and the loan to value ratio; and
• for commercial and industrial loans, the debt service coverage ratio; the operating results of the commercial, industrial, or professional enterprise; the borrower’s business, professional, and financial ability and expertise; the specific risks and volatility of income and operating results typical for businesses in that category; the value, nature, and marketability of collateral; and the financial resources of the guarantor(s), if any.