NOTE 5 – FAIR VALUE (Continued)
Quantitative information about Level 3 fair value measurements measured on a non-recurring basis was as follows at period end (dollars in thousands):
| | | Asset Fair Value | | Valuation Technique | | Unobservable Inputs | | Range (%) |
March 31, 2021 | | | | | | | | |
| Impaired Loans | | $ | 5,800 | | Sales comparison approach | | Adjustment for differences between comparable sales | | 1.0 to 20.0 |
| | | | | | Income approach | | Capitalization rate | | 9.5 to 11.0 |
| Other real estate owned | | | 28 | | Sales comparison approach | | Adjustment for differences between comparable sales | | 3.0 to 20.0 |
| | | | | | Income approach | | Capitalization rate | | 9.5 to 11.0 |
| | | Asset Fair Value | | Valuation Technique | | Unobservable Inputs | | Range (%) |
December 31, 2020 | | | | | | | | |
| Impaired Loans | | $ | 4,686 | | Sales comparison approach | | Adjustment for differences between comparable sales | | 1.5 to 20.0 |
| | | | | | Income approach | | Capitalization rate | | 9.5 to 11.0 |
| Other real estate owned | | | 194 | | Sales comparison approach | | Adjustment for differences between comparable sales | | 3.0 to 20.0 |
| | | | | | Income approach | | Capitalization rate | | 9.5 to 11.0 |
NOTE 5 – FAIR VALUE (Continued)
The carrying amounts and estimated fair values of financial instruments, not previously presented, were as follows at March 31, 2021 and December 31, 2020 (dollars in thousands):
| Level in
| | March 31, 2021 | | | December 31, 2020 | |
| Fair Value Hierarchy | | Carrying Amount | | | Fair Value | | | Carrying Amount | | | Fair Value | |
| Financial assets | | | | | | | | | | | | | |
| Cash and due from banks | Level 1 | | $ | 26,900 | | | $ | 26,900 | | | $ | 31,480 | | | $ | 31,480 | |
| Cash equivalents | Level 2 | | | 884,985 | | | | 884,985 | | | | 752,256 | | | | 752,256 | |
| Securities held to maturity | Level 3 | | | 89,170 | | | | 92,139 | | | | 79,468 | | | | 83,246 | |
| FHLB stock | | | | 11,558 | | | NA | | | | 11,558 | | | NA | |
| Loans, net | Level 2 | | | 1,377,151 | | | | 1,402,744 | | | | 1,407,236 | | | | 1,448,874 | |
| Bank owned life insurance | Level 3 | | | 42,244 | | | | 42,244 | | | | 42,516 | | | | 42,516 | |
| Accrued interest receivable | Level 2 | | | 5,994 | | | | 5,994 | | | | 5,625 | | | | 5,625 | |
| Financial liabilities | | | | | | | | | | | | | | | | | |
| Deposits | Level 2 | | | (2,387,945 | ) | | | (2,388,095 | ) | | | (2,298,587 | ) | | | (2,298,867 | ) |
| Other borrowed funds | Level 2 | | | (70,000 | ) | | | (72,438 | ) | | | (70,000 | ) | | | (73,010 | ) |
| Long-term debt | Level 2 | | | (20,619 | ) | | | (18,073 | ) | | | (20,619 | ) | | | (18,011 | ) |
| Accrued interest payable | Level 2 | | | (240 | ) | | | (240 | ) | | | (242 | ) | | | (242 | ) |
| Off-balance sheet credit-related items | | | | | | | | | | | | | | | | | |
| Loan commitments | | | | — | | | | — | | | | — | | | | — | |
The methods and assumptions used to estimate fair value are described as follows.
Carrying amount is the estimated fair value for cash and cash equivalents, bank owned life insurance, accrued interest receivable and payable, demand deposits, short-term borrowings and variable rate loans or deposits that reprice frequently and fully. Security fair values are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities as discussed above. For fixed rate loans, interest-bearing time deposits in other financial institutions, or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk (including consideration of widening credit spreads). Fair value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. The fair value of off-balance sheet credit-related items is not significant.
The estimated fair values of financial instruments disclosed above as follow the guidance in ASU 2016-01 which prescribes an “exit price” approach in estimating and disclosing fair value of financial instruments incorporating discounts for credit, liquidity and marketability factors.
NOTE 6 – DEPOSITS
Deposits are summarized as follows (dollars in thousands):
| | | March 31, 2021 | | | December 31, 2020 | |
| Noninterest-bearing demand | | $ | 848,798 | | | $ | 809,437 | |
| Interest bearing demand | | | 614,316 | | | | 642,918 | |
| Savings and money market accounts | | | 822,493 | | | | 742,685 | |
| Certificates of deposit | | | 102,338 | | | | 103,547 | |
| | | $ | 2,387,945 | | | $ | 2,298,587 | |
Time deposits that exceed the FDIC insurance limit of $250,000 were approximately $29.9 million at March 31, 2021 and $28.8 million at December 31, 2020.
NOTE 7 - OTHER BORROWED FUNDS
Other borrowed funds include advances from the Federal Home Loan Bank and borrowings from the Federal Reserve Bank.
Federal Home Loan Bank Advances
At period-end, advances from the Federal Home Loan Bank were as follows (dollars in thousands):
Principal Terms | | Advance Amount | | Range of Maturities | | Weighted Average Interest Rate | |
March 31, 2021 | | | | | | | |
| Single maturity fixed rate advances | | $ | 40,000 | | April 2021 to July 2024 | | | 2.50 | % |
| Putable advances | | | 30,000 | | November 2024 to February 2030 | | | 1.36 | % |
| | | $ | 70,000 | | | | | | |
Principal Terms | | Advance Amount | | Range of Maturities | | Weighted Average Interest Rate | |
December 31, 2020 | | | | | | | |
| Single maturity fixed rate advances | | $ | 40,000 | | April 2021 to July 2024 | | | 2.50 | % |
| Putable advances | | | 30,000 | | November 2024 to February 2030 | | | 1.36 | % |
| | | $ | 70,000 | | | | | | |
NOTE 7 - OTHER BORROWED FUNDS (Continued)
Each advance is subject to a prepayment fee if paid prior to its maturity date. Fixed rate advances are payable at maturity. These advances were collateralized by residential and commercial real estate loans totaling $402.7 million and $427.9 million under a blanket lien arrangement at March 31, 2021 and December 31, 2020, respectively.
Scheduled repayments of FHLB advances as of March 31, 2021 were as follows (in thousands):
| 2021 | | $ | 10,000 | |
| 2022 | | | — | |
| 2023 | | | 10,000 | |
| 2024 | | | 40,000 | |
| 2025 | | | — | |
| Thereafter | | | 10,000 | |
| | | $ | 70,000 | |
Federal Reserve Bank borrowings
The Company has a financing arrangement with the Federal Reserve Bank. There were no borrowings outstanding at March 31, 2021 and December 31, 2020, and the Company had approximately $2.6 million and $12.9 million in unused borrowing capacity based on commercial and mortgage loans pledged to the Federal Reserve Bank totaling $2.9 million and $13.8 million at March 31, 2021 and December 31, 2020, respectively.
NOTE 8 - EARNINGS PER COMMON SHARE
A reconciliation of the numerators and denominators of basic and diluted earnings per common share for the three month periods ended March 31, 2021 and 2020 are as follows (dollars in thousands, except per share data):
| | | Three Months Ended March 31, 2021 | | | Three Months Ended March 31, 2020 | |
| Net income available to common shares | | $ | 7,778 | | | $ | 6,411 | |
| Weighted average shares outstanding, including participating stock awards - Basic | | | 34,195,526 | | | | 34,106,719 | |
| Dilutive potential common shares: | | | | | | | | |
| Stock options | | | — | | | | — | |
| Weighted average shares outstanding - Diluted | | | 34,195,526 | | | | 34,106,719 | |
| Basic earnings per common share | | $ | 0.23 | | | $ | 0.19 | |
| Diluted earnings per common share | | $ | 0.23 | | | $ | 0.19 | |
There were no antidilutive shares of common stock in the three month periods ended March 31, 2021 and 2020.
NOTE 9 - FEDERAL INCOME TAXES
Income tax expense was as follows (dollars in thousands):
| | | Three Months Ended March 31, 2021 | | | Three Months Ended March 31, 2020 | |
| Current | | $ | 2,294 | | | $ | 1,700 | |
| Deferred | | | (528 | ) | | | (271 | ) |
| | | $ | 1,766 | | | $ | 1,429 | |
The difference between the financial statement tax expense and amount computed by applying the statutory federal tax rate to pretax income was reconciled as follows (dollars in thousands):
| | | Three Months Ended March 31, 2021 | | | Three Months Ended March 31, 2020 | |
| Statutory rate | | | 21 | % | | | 21 | % |
| Statutory rate applied to income before taxes | | $ | 2,004 | | | $ | 1,646 | |
| Deduct | | | | | | | | |
| Tax-exempt interest income | | | (159 | ) | | | (178 | ) |
| Bank-owned life insurance | | | (58 | ) | | | (51 | ) |
| Other, net | | | (21 | ) | | | 12 | |
| | | $ | 1,766 | | | $ | 1,429 | |
The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, the Company considers positive and negative evidence, including taxable income in carry-back years, scheduled reversals of deferred tax liabilities, expected future taxable income and tax planning strategies. Management believes it is more likely than not that all of the deferred tax assets at March 31, 2021 and December 31, 2020 will be realized against deferred tax liabilities and projected future taxable income.
The net deferred tax asset recorded included the following amounts of deferred tax assets and liabilities (dollars in thousands):
| | | March 31, 2021 | | | December 31, 2020 | |
| Deferred tax assets | | | | | | |
| Allowance for loan losses | | $ | 3,665 | | | $ | 3,656 | |
| Net deferred loan fees | | | 1,309 | | | $ | 822 | |
| Nonaccrual loan interest | | | 96 | | | | 120 | |
| Valuation allowance on other real estate owned | | | 22 | | | | 41 | |
| Unrealized loss on securities available for sale | | | — | | | | — | |
| Other | | | 525 | | | | 499 | |
| Gross deferred tax assets | | | 5,617 | | | | 5,138 | |
| Valuation allowance | | | — | | | | — | |
| Total net deferred tax assets | | | 5,617 | | | | 5,138 | |
| Deferred tax liabilities | | | | | | | | |
| Depreciation | | | (1,238 | ) | | | (1,285 | ) |
| Prepaid expenses | | | (170 | ) | | | (170 | ) |
| Unrealized gain on securities available for sale | | | (409 | ) | | | (1,120 | ) |
| Other | | | (502 | ) | | | (504 | ) |
| Gross deferred tax liabilities | | | (2,319 | ) | | | (3,079 | ) |
| Net deferred tax asset | | $ | 3,298 | | | $ | 2,059 | |
There were no unrecognized tax benefits at March 31, 2021 or December 31, 2020 and the Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. The Company is no longer subject to examination by the Internal Revenue Service for years before 2016.
NOTE 10 – COMMITMENTS AND OFF BALANCE-SHEET RISK
Some financial instruments are used to meet customer financing needs and to reduce exposure to interest rate changes. These financial instruments include commitments to extend credit and standby letters of credit. These involve, to varying degrees, credit and interest rate risk in excess of the amount reported in the financial statements.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment, and generally have fixed expiration dates. Collateral or other security is normally not obtained for these financial instruments prior to their use and many of the commitments are expected to expire without being used. Standby letters of credit are conditional commitments to guarantee a customer’s performance to a third party. Exposure to credit loss if the other party does not perform is represented by the contractual amount for commitments to extend credit and standby letters of credit.
A summary of the contractual amounts of financial instruments with off‑balance‑sheet risk was as follows at period-end (dollars in thousands):
| | | March 31, 2021 | | | December 31, 2020 | |
| Commitments to make loans | | $ | 77,460 | | | $ | 88,022 | |
| Letters of credit | | | 12,374 | | | | 11,751 | |
| Unused lines of credit | | | 644,440 | | | | 596,298 | |
The notional amount of commitments to fund mortgage loans to be sold into the secondary market was approximately $6.3 million and $0 at March 31, 2021 and December 31, 2020, respectively.
The Bank enters into commitments to sell mortgage backed securities, which it later buys back in order to hedge its exposure to interest rate risk in its mortgage pipeline. These commitments were approximately $33.8 million and $21.0 million at March 31, 2021 and December 31, 2020, respectively.
At March 31, 2021, approximately 53.3% of the Bank’s commitments to make loans were at fixed rates, offered at current market rates. The remainder of the commitments to make loans were at variable rates tied to prime or one month LIBOR and generally expire within 30 days. The majority of the unused lines of credit were at variable rates tied to prime.
NOTE 11 – CONTINGENCIES
The Company and its subsidiaries periodically become defendants in certain claims and legal actions arising in the ordinary course of business. As of March 31, 2021, there were no material pending legal proceedings to which the Company or any of its subsidiaries are a party or which any of its properties are the subject.
NOTE 12 – SHAREHOLDERS' EQUITY
Regulatory Capital
The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.
The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits. If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.
In July 2013, the Board of Governors of the Federal Reserve Board and the FDIC approved the rules implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks (commonly known as Basel III). The rules include a common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which effectively results in a minimum CET1 ratio of 7.0%. The minimum ratio of Tier 1 capital to risk-weighted assets is 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5%), which effectively results in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer), and requires a minimum leverage ratio of 4.0%.
NOTE 12 – SHAREHOLDERS' EQUITY (Continued)
At March 31, 2021 and December 31, 2020, actual capital levels and minimum required levels were (dollars in thousands):
| | | | | | | | | Minimum Capital | | | Minimum Capital Adequacy With | | | To Be Well Capitalized Under Prompt Corrective | |
| | | Actual | | | Adequacy | | | Capital Buffer | | | Action Regulations | |
| | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
March 31, 2021 | | | | | | | | | | | | | | | | | | | | | | | | |
| CET1 capital (to risk weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 240,843 | | | | 16.7 | % | | $ | 64,791 | | | | 4.5 | % | | $ | 100,786 | | | | 7.0 | % | | | N/A | | | | N/A | |
| Bank | | | 253,330 | | | | 17.6 | | | | 64,785 | | | | 4.5 | | | | 100,776 | | | | 7.0 | | | $ | 93,578 | | | | 6.5 | % |
| Tier 1 capital (to risk weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 260,843 | | | | 18.1 | | | | 86,388 | | | | 6.0 | | | | 122,383 | | | | 8.5 | | | | N/A | | | | N/A | |
| Bank | | | 253,330 | | | | 17.6 | | | | 86,380 | | | | 6.0 | | | | 122,371 | | | | 8.5 | | | | 115,173 | | | | 8.0 | |
| Total capital (to risk weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 278,295 | | | | 19.3 | | | | 115,184 | | | | 8.0 | | | | 151,180 | | | | 10.5 | | | | N/A | | | | N/A | |
| Bank | | | 270,782 | | | | 18.8 | | | | 115,173 | | | | 8.0 | | | | 151,165 | | | | 10.5 | | | | 143,966 | | | | 10.0 | |
| Tier 1 capital (to average assets) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 260,843 | | | | 9.8 | | | | 106,493 | | | | 4.0 | | | | N/A | | | | N/A | | | | N/A | | | | N/A | |
| Bank | | | 253,330 | | | | 9.5 | | | | 106,459 | | | | 4.0 | | | | N/A | | | | N/A | | | | 133,073 | | | | 5.0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2020 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| CET1 capital (to risk weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | $ | 235,629 | | | | 15.8 | % | | $ | 67,170 | | | | 4.5 | % | | $ | 104,487 | | | | 7.0 | % | | | N/A | | | | N/A | |
| Bank | | | 248,829 | | | | 16.7 | | | | 67,161 | | | | 4.5 | | | | 104,473 | | | | 7.0 | | | $ | 97,010 | | | | 6.5 | % |
| Tier 1 capital (to risk weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 255,629 | | | | 17.1 | | | | 89,561 | | | | 6.0 | | | | 126,877 | | | | 8.5 | | | | N/A | | | | N/A | |
| Bank | | | 248,829 | | | | 16.7 | | | | 89,548 | | | | 6.0 | | | | 126,860 | | | | 8.5 | | | | 119,397 | | | | 8.0 | |
| Total capital (to risk weighted assets) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 273,037 | | | | 18.3 | | | | 119,414 | | | | 8.0 | | | | 156,731 | | | | 10.5 | | | | N/A | | | | N/A | |
| Bank | | | 266,237 | | | | 17.8 | | | | 119,397 | | | | 8.0 | | | | 156,709 | | | | 10.5 | | | | 149,247 | | | | 10.0 | |
| Tier 1 capital (to average assets) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Consolidated | | | 255,629 | | | | 9.9 | | | | 103,420 | | | | 4.0 | | | | N/A | | | | N/A | | | | N/A | | | | N/A | |
| Bank | | | 248,829 | | | | 9.6 | | | | 103,391 | | | | 4.0 | | | | N/A | | | | N/A | | | | 129,238 | | | | 5.0 | |
All $20.0 million of trust preferred securities outstanding at March 31, 2021 and December 31, 2020, respectively, qualified as Tier 1 capital. Refer to our 2020 Form 10-K for more information on the trust preferred securities.
The Bank was categorized as "well capitalized" at March 31, 2021 and December 31, 2020.
| Item 2. | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Macatawa Bank Corporation is a Michigan corporation and a registered bank holding company. It wholly-owns Macatawa Bank and Macatawa Statutory Trust II. Macatawa Bank is a Michigan chartered bank with depository accounts insured by the FDIC. The Bank operates twenty-six branch offices and a lending and operational service facility, providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan. Macatawa Statutory Trust II is a grantor trust and issued $20.0 million of pooled trust preferred securities. This trust is not consolidated in our Consolidated Financial Statements. For further information regarding consolidation, see the Notes to Consolidated Financial Statements.
At March 31, 2021, we had total assets of $2.73 billion, total loans of $1.38 billion, total deposits of $2.39 billion and shareholders' equity of $242.4 million. For the three months ended March 31, 2021, we recognized net income of $7.8 million compared to $6.4 million for the same period in 2020. The Bank was categorized as “well capitalized” under regulatory capital standards at March 31, 2021.
We paid a dividend of $0.08 per share in each quarter of 2020 and in the first quarter of 2021.
In response to the COVID-19 pandemic, federal, state and local governments have taken and continue to take actions designed to mitigate the effect of the virus on public health and to address the economic impact from the virus. The Federal Reserve reduced the overnight federal funds rate by 50 basis points on March 3, 2020 and by another 100 basis points on March 15, 2020 and announced the resumption of quantitative easing. Congress passed a number of measures in late March 2020, designed to infuse cash into the economy to offset the negative impacts of business closings and restrictions. Individual states, including Michigan, implemented restrictions including closure of schools, restrictions on public gatherings, restrictions on businesses, including closures and mandatory work at home orders, implementation of “social distancing” practices, and other measures.
The Company quickly responded to the changing environment by successfully executing its business continuity plan, including implementing work from home arrangements and limiting branch activities. As of March 31, 2021, branches were fully open with additional health and safety requirements to comply with U.S. federal and state of Michigan health mandates, including, among other things, daily deep cleaning, nonsurgical face mask requirements and strict social distancing measures.
On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus.” This guidance encourages financial institutions to work prudently with borrowers that are or that may be unable to meet their contractual obligations because of the effects of COVID-19. The guidance goes on to explain that in consultation with the FASB staff the federal banking agencies concluded that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a modification are not Troubled Debt Restructurings (“TDRs”). The Coronavirus Aid, Relief and Economic Security (“CARES”) Act was passed by Congress on March 27, 2020. Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were not more than 30 days past due as of December 31, 2019 are not TDRs. On December 27, 2020, President Trump signed another COVID-19 relief bill that extended this guidance until the earlier of January 1, 2022 or 60 days after the date on which the national emergency declared as a result of COVID-19 is terminated. Through March 31, 2021, the Bank had applied this guidance and modified 726 individual loans with aggregate principal balances totaling $337.2 million. The majority of these modifications involved three-month extensions. By March 31, 2021, most of these modifications had expired, other than those receiving a third short-term modification as allowed under the guidance. At March 31, 2021, there were 5 such loans under COVID-19 modification, totaling $21.9 million. This is down from a quarter end peak of $297.3 million at June 30, 2020.
The CARES Act, as amended, included an allocation of $659 billion for loans to be issued by financial institutions through the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”). PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5, 2020), if not forgiven, in whole or in part. Payments are deferred until either the date on which the SBA remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10 month period. Through December 31, 2020, the Bank had originated 1,738 PPP loans totaling $346.7 million in principal, with an average loan size of $200,000. Fees totaling $10.0 million were generated from the SBA for these loans in the year ended December 31, 2020. These fees are deferred and amortized into interest income over the contractual period of 24 months or 60 months, as applicable. Upon SBA forgiveness, unamortized fees are then recognized into interest income. Participation in the PPP had a significant impact on the Bank’s asset mix and net interest income in 2020 and will continue to impact both asset mix and net interest income until these loans are forgiven or paid off. The initial PPP expired on August 8, 2020. Through December 31, 2020, 747 PPP loans totaling $96.9 million had been forgiven by the SBA and a total of $4.4 million in PPP fees had been recognized by the Bank. Of the 5 remaining loans, 3 were modified during the three months ended March 31, 2021.
On December 27, 2020, President Trump signed another COVID-19 relief bill that extended and modified several provisions of the PPP. This included an additional allocation of $284 billion. The SBA reactivated the PPP on January 11, 2021. The Bank is originating additional PPP loans, which will currently extend through May 31, 2021. In the three months ended March 31, 2021, the Bank had generated and received SBA approval on 898 PPP loans totaling $112.7 million with $5.1 million in related deferred fees under the 2021 PPP authorization. In the three months ended March 31, 2021, 523 PPP loans totaling $71.7 million had been forgiven by the SBA and a total of $2.0 million in PPP fees had been recognized by the Bank including fees recognized upon forgiveness and continuing amortization of fees from the 2020 and 2021 PPP originations.
RESULTS OF OPERATIONS
Summary: Net income for the three months ended March 31, 2021 was $7.8 million, compared to $6.4 million for the same period in 2020. Net income per share on a diluted basis for the three months ended March 31, 2021 was $0.23 compared to $0.19 for the same period in 2020.
The increase in earnings in the three months ended March 31, 2021 compared to the same period in 2020 was due primarily to a higher level of net gains on mortgage loans and, to a lesser extent, a lower provision for loan losses. The provision for loan losses was $0 for the three months ended March 31, 2021 compared to $700,000 for the same period in 2020. The provision for loan losses in the three months ended March 31, 2020 was impacted by the establishment of a specific reserve on a large commercial loan relationship. Provisions in both periods were impacted by qualitative factors applied to address the increased risk of loss from the negative effects of the COVID-19 pandemic. We were in a net loan recovery position for the three months ended March 31, 2021, with $44,000 in net loan recoveries, compared to $989,000 in net loan recoveries in the same period in 2020. Partially offsetting the favorable impact on earnings of higher mortgage gains and a lower provision for loan losses, net interest income decreased to $14.5 million in the three months ended March 31, 2021 compared to $15.3 million in the same period in 2020.
Net Interest Income: Net interest income totaled $14.5 million for the three months ended March 31, 2021 compared to $15.3 million for the same period in 2020.
Net interest income was positively impacted in the three months ended March 31, 2021 by an increase in average earning assets of $640.0 million compared to the same period in 2020. However, our average yield on earning assets for the three months ended March 31, 2021 decreased 126 basis points compared to the same period in 2020 from 3.71% to 2.45%, offsetting the effect of the growth in earning assets.
Net interest income for the first quarter of 2021 decreased $813,000 compared to the same period in 2020. Of this decrease, $3.0 million was due to decreases in rates earned or paid, partially offset by $2.1 million from increases in the volume of average interest earning assets and interest bearing liabilities. The largest changes came in commercial loan interest income which decreased by $489,000 in the first quarter of 2021. Of the $489,000 decrease in interest income on commercial loans, $1.5 million was due to decreases in rates earned, partially offset by the increase of $1.0 million in average balances between periods. Net interest income in the first quarter of 2021 benefitted from $2.0 million in fee amortization related to PPP loans. Net interest income in the first quarter of 2020 benefitted from prepayment fees and interest recovery of $65,000 collected on two commercial loans.
Average interest earning assets totaled $2.54 billion for three months ended March 31, 2021 compared to $1.90 billion for the same period in 2020. An increase of $624.0 million in average federal funds sold and other short-term investments were the primary components of the increase. The net interest margin was 2.33% for the three months ended March 31, 2021 compared to 3.25% for the same period in 2020. Yield on commercial loans (excluding PPP loans) decreased from 4.32% for three months ended March 31, 2020 to 3.76%, for the same period in 2021. The yield on PPP loans was 4.24% for the three months ended March 31, 2021. The rate on these loans is 1.0%, but the yield is also impacted by amortization of PPP fees. The yield on residential mortgage loans decreased from 3.71% for the three months ended March 31, 2020 to 3.51% for the same period in 2021, while yields on consumer loans decreased from 4.79% for the first quarter of 2020 to 4.09% for the first quarter of 2021. The decreases in yields on commercial loans and consumer loans were the result of the predominance of loans in these categories with variable rates of interest tied to prime and LIBOR, each of which decreased significantly in 2020 and remained low in the first quarter of 2021.
In response to the news and government action related to COVID-19, the Federal Reserve Board decreased the target federal funds rate by 150 basis points in March 2020. As the Company is in an asset-sensitive position, reductions in market interest rates have a negative impact on margin as the Company’s interest earning assets reprice faster than its interest-bearing liabilities. Much of our asset-sensitivity is due to commercial and consumer loans that have variable interest rates. For both loan types we established floor rates several years ago. These floors provide protection to net interest income when short-term interest rates decline.
The cost of funds decreased to 0.19% in the first quarter of 2021 compared to 0.66% in the first quarter of 2020. Decreases in the rates paid on our interest-bearing checking, savings and money market accounts in response to the federal funds rate decreases over the past year caused the decrease in our cost of funds.
The following table shows an analysis of net interest margin for the three month periods ended March 31, 2021 and 2020 (dollars in thousands):
| | | For the three months ended March 31, | |
| | | 2021 | | | 2020 | |
| | | Average Balance | | | Interest Earned or Paid | | | Average Yield or Cost | | | Average Balance | | | Interest Earned or Paid | | | Average Yield or Cost | |
Assets | | | | | | | | | | | | | | | | | | |
| Taxable securities | | $ | 190,019 | | | $ | 787 | | | | 1.66 | % | | $ | 191,531 | | | $ | 1,061 | | | | 2.22 | % |
| Tax-exempt securities (1) | | | 124,039 | | | | 758 | | | | 3.15 | | | | 127,972 | | | | 882 | | | | 3.54 | |
| Commercial loans, excluding PPP loans (2) | | | 956,396 | | | | 8,995 | | | | 3.76 | | | | 1,103,320 | | | | 12,036 | | | | 4.32 | |
| PPP loans (3) | | | 240,545 | | | | 2,552 | | | | 4.24 | | | | — | | | | — | | | | — | |
| Residential mortgage loans | | | 150,701 | | | | 1,323 | | | | 3.51 | | | | 205,782 | | | | 1,908 | | | | 3.71 | |
| Consumer loans | | | 59,129 | | | | 597 | | | | 4.09 | | | | 76,195 | | | | 907 | | | | 4.79 | |
| Federal Home Loan Bank stock | | | 11,558 | | | | 61 | | | | 2.10 | | | | 11,558 | | | | 124 | | | | 4.24 | |
| Federal funds sold and other short-term investments | | | 804,913 | | | | 201 | | | | 0.10 | | | | 180,878 | | | | 576 | | | | 1.26 | |
| Total interest earning assets (1) | | | 2,537,300 | | | | 15,274 | | | | 2.45 | | | | 1,897,236 | | | | 17,494 | | | | 3.71 | |
| Noninterest earning assets: | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and due from banks | | | 31,156 | | | | | | | | | | | | 29,142 | | | | | | | | | |
| Other | | | 98,346 | | | | | | | | | | | | 91,445 | | | | | | | | | |
| Total assets | | $ | 2,666,802 | | | | | | | | | | | $ | 2,017,823 | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits: | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest bearing demand | | $ | 626,664 | | | $ | 35 | | | | 0.02 | % | | $ | 434,910 | | | $ | 190 | | | | 0.18 | % |
| Savings and money market accounts | | | 797,590 | | | | 60 | | | | 0.03 | | | | 651,035 | | | | 714 | | | | 0.44 | |
| Time deposits | | | 107,625 | | | | 184 | | | | 0.69 | | | | 153,561 | | | | 699 | | | | 1.83 | |
| Borrowings: | | | | | | | | | | | | | | | | | | | | | | | | |
| Other borrowed funds | | | 70,000 | | | | 352 | | | | 2.01 | | | | 63,736 | | | | 349 | | | | 2.17 | |
| Long-term debt | | | 20,619 | | | | 153 | | | | 2.96 | | | | 20,619 | | | | 239 | | | | 4.59 | |
| Total interest bearing liabilities | | | 1,622,498 | | | | 784 | | | | 0.19 | | | | 1,323,861 | | | | 2,191 | | | | 0.66 | |
| Noninterest bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest bearing demand accounts | | | 789,133 | | | | | | | | | | | | 462,489 | | | | | | | | | |
| Other noninterest bearing liabilities | | | 14,148 | | | | | | | | | | | | 10,935 | | | | | | | | | |
| Shareholders' equity | | | 241,023 | | | | | | | | | | | | 220,538 | | | | | | | | | |
| Total liabilities and shareholders' equity | | $ | 2,666,802 | | | | | | | | | | | $ | 2,017,823 | | | | | | | | | |
| Net interest income | | | | | | $ | 14,490 | | | | | | | | | | | $ | 15,303 | | | | | |
| Net interest spread (1) | | | | | | | | | | | 2.26 | % | | | | | | | | | | | 3.05 | % |
| Net interest margin (1) | | | | | | | | | | | 2.33 | % | | | | | | | | | | | 3.25 | % |
| Ratio of average interest earning assets to average interest bearing liabilities | | | 156.38 | % | | | | | | | | | | | 143.31 | % | | | | | | | | |
| (1) | Yields are presented on a tax equivalent basis using a 21% assumed tax rate at March 31, 2021 and 2020. |
| (2) | Includes loan fees of $169,000 and $178,000 for the three months ended March 31, 2021 and 2020, respectively. Includes average nonaccrual loans of approximately $528,000 and $2,546,000 for the three months ended March 31, 2021 and 2020, respectively. |
| (3) | Includes loan fees of $2.0 million for the three months ended March 31, 2021. |
The following table presents the dollar amount of changes in net interest income due to changes in volume and rate:
| | | For the three months ended March 31, 2021 vs 2020 Increase (Decrease) Due to | |
| | | Volume | | | Rate | | | Total | |
| (Dollars in thousands) | | | | | | | | | |
| Interest income | | | | | | | | | |
| Taxable securities | | $ | (8 | ) | | $ | (266 | ) | | $ | (274 | ) |
| Tax-exempt securities | | | (26 | ) | | | (98 | ) | | | (124 | ) |
| Commercial loans, excluding PPP loans | | | (1,494 | ) | | | (1,547 | ) | | | (3,041 | ) |
| PPP loans | | | 2,552 | | | | — | | | | 2,552 | |
| Residential mortgage loans | | | (488 | ) | | | (97 | ) | | | (585 | ) |
| Consumer loans | | | (185 | ) | | | (125 | ) | | | (310 | ) |
| Federal Home Loan Bank stock | | | — | | | | (63 | ) | | | (63 | ) |
| Federal funds sold and other short-term investments | | | 3,055 | | | | (3,430 | ) | | | (375 | ) |
| Total interest income | | | 3,406 | | | | (5,626 | ) | | | (2,220 | ) |
| Interest expense | | | | | | | | | | | | |
| Interest bearing demand | | $ | 393 | | | $ | (548 | ) | | $ | (155 | ) |
| Savings and money market accounts | | | 908 | | | | (1,562 | ) | | | (654 | ) |
| Time deposits | | | (167 | ) | | | (348 | ) | | | (515 | ) |
| Other borrowed funds | | | 126 | | | | (123 | ) | | | 3 | |
| Long-term debt | | | — | | | | (86 | ) | | | (86 | ) |
| Total interest expense | | | 1,260 | | | | (2,667 | ) | | | (1,407 | ) |
| Net interest income | | $ | 2,146 | | | $ | (2,959 | ) | | $ | (813 | ) |
Provision for Loan Losses: The provision for loan losses for the three months ended March 31, 2021 was $0 compared to $700,000 for the same period in 2020. Positively impacting the provision for loan losses for each period were the continued stabilization of asset quality metrics and net loan recoveries of $44,000 in the three months ended March 31, 2021 and $989,000 in the same period in 2020. Positively impacting the provision for loan losses for the three months ended March 31, 2021 was the reduction in loan portfolio balances, excluding PPP loans. Negatively impacting the provision for loan losses for the first quarter of 2020 was the establishment of a specific reserve on a large commercial loan. Provisions in both periods were impacted by the estimated impact of COVID-19.
Gross loan recoveries were $94,000 for the three months ended March 31, 2021 and $1.0 million for the same period in 2020. In the three months ended March 31, 2021, we had $50,000 in charge-offs, compared to $39,000 in the same period in 2020. We continue to experience positive results from our collection efforts as evidenced by our net loan recoveries. While we expect our collection efforts to produce further recoveries, they may not continue at the same level we have experienced the past several quarters.
The amounts of loan loss provision in both the most recent quarter and comparable prior year period were the result of establishing our allowance for loan losses at levels believed necessary based upon our methodology for determining the adequacy of the allowance. More information about our allowance for loan losses and our methodology for establishing its level may be found under the heading "Allowance for Loan Losses" below.
Noninterest Income: Noninterest income for the three month period ended March 31, 2021 was $6.5 million compared to $5.0 million for the same period in 2020. The components of noninterest income are shown in the table below (in thousands):
| | | Three Months Ended March 31, 2021 | | | Three Months Ended March 31, 2020 | |
| Service charges and fees on deposit accounts | | $ | 992 | | | $ | 1,110 | |
| Net gains on mortgage loans | | | 2,015 | | | | 650 | |
| Trust fees | | | 1,005 | | | | 935 | |
| ATM and debit card fees | | | 1,485 | | | | 1,337 | |
| Bank owned life insurance (“BOLI”) income | | | 276 | | | | 242 | |
| Investment services fees | | | 477 | | | | 424 | |
| Other income | | | 289 | | | | 261 | |
| Total noninterest income | | $ | 6,539 | | | $ | 4,959 | |
Net gains on mortgage loans were up $1.4 million in the three months ended March 31, 2021 compared to same period in 2020 as a result of an increase in the volume of loans originated for sale and a continued period of historically low market interest rates. Mortgage loans originated for sale in the three months ended March 31, 2021 were $47.3 million, compared to $29.4 million in the same period in 2020. Mortgage loans originated for portfolio in the three months ended March 31, 2021 were $9.8 million, compared to $4.6 million in the same period in 2020. Investment services fees were up in the first three months of 2021 due to success in growing the number of investment services customer relationships we have and favorable investment market value changes. ATM and debit card fees were up in the three months ended March 31, 2021 due to higher volume of usage by our customers.
Noninterest Expense: Noninterest expense decreased to $11.5 million for the three month period ended March 31, 2021, from $11.7 million for the same period in 2020. The components of noninterest expense are shown in the table below (in thousands):
| | | Three Months Ended March 31, 2021 | | | Three Months Ended March 31, 2020 | |
| Salaries and benefits | | $ | 6,412 | | | $ | 6,691 | |
| Occupancy of premises | | | 1,037 | | | | 1,009 | |
| Furniture and equipment | | | 937 | | | | 855 | |
| Legal and professional | | | 222 | | | | 291 | |
| Marketing and promotion | | | 175 | | | | 238 | |
| Data processing | | | 908 | | | | 760 | |
| FDIC assessment | | | 170 | | | | — | |
| Interchange and other card expense | | | 358 | | | | 347 | |
| Bond and D&O insurance | | | 111 | | | | 105 | |
| Net (gains) losses on repossessed and foreclosed properties | | | 18 | | | | 31 | |
| Administration and disposition of problem assets | | | 14 | | | | 30 | |
| Outside services | | | 434 | | | | 453 | |
| Other noninterest expense | | | 689 | | | | 912 | |
| Total noninterest expense | | $ | 11,485 | | | $ | 11,722 | |
Most categories of noninterest expense were relatively unchanged compared to the three months ended March 31, 2020 due to our ongoing efforts to manage expenses and scale our operations. Our largest component of noninterest expense, salaries and benefits, decreased by $279,000 in the three months ended March 31, 2021 from same period in 2020. This decrease was partially due to higher salary cost deferrals (driven by PPP loan originations) and lower medical insurance claims experience, offset by a higher level of variable based compensation which was up $150,000 for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 due in part to higher mortgage production.
Occupancy expenses were up $28,000 in the three months ended March 31, 2021 compared to the same period in 2020 due to higher maintenance costs associated with our branch facilities. These maintenance costs were up $32,000 primarily due to higher costs incurred for snow removal.
Our FDIC assessment costs increased by $170,000 in the first quarter of 2021 compared to the same period in 2020 due primarily to no assessment being due in the first quarter of 2020. In January 2019, the FDIC notified us that the Bank would receive an assessment credit of approximately $438,000 to offset future assessment as the FDIC Deposit Insurance Fund had exceeded its target ratio of 1.35%. Assessment credits totaling $266,000 were applied in the third and fourth quarters of 2019 and the remaining $172,000 credits were applied in 2020.
Costs associated with administration and disposition of problem assets have decreased significantly over the past several years and are now at negligible levels. These expenses include legal costs and repossessed and foreclosed property administration expense. Repossessed and foreclosed property administration expense includes survey and appraisal, property maintenance and management and other disposition and carrying costs. Net (gains) losses on repossessed and foreclosed properties include both net gains and losses on the sale of properties and unrealized losses from value declines for outstanding properties. The net of these two line items decreased from the first quarter of 2020 to the first quarter of 2021, primarily due to higher losses on sale of properties and higher related legal costs in the first three months of 2020.
These costs are itemized in the following table (in thousands):
| | | Three Months Ended March 31, 2021 | | | Three Months Ended March 31, 2020 | |
| Legal and professional – nonperforming assets | | $ | 11 | | | $ | 15 | |
| Repossessed and foreclosed property administration | | | 3 | | | | 15 | |
| Net (gains) losses on repossessed and foreclosed properties | | | 18 | | | | 31 | |
| Total | | $ | 32 | | | $ | 61 | |
As the level of problem loans and assets has declined over the past several years, the costs associated with these nonperforming assets have decreased significantly. Other real estate owned decreased from $3.3 million at March 31, 2020 to $2.4 million at March 31, 2021.
Net (gains) losses on repossessed assets and foreclosed properties for the three month period ended March 31, 2021 decreased by $13,000 compared to the same period in 2020. In the three month period ended March 31, 2021, valuation writedowns totaled $4,000 compared to valuation writedowns of $31,000 for the same period in 2020. In the three month period ended March 31, 2021, net realized losses totaled $14,000, compared to net realized losses of $0 for the same period in 2020.
Other noninterest expense decreased by $223,000 in the first three months of 2021 compared to the same period in 2020. The first three months of 2020 included an expense of $156,000 related to a correction to one of our trust accounts.
Federal Income Tax Expense: We recorded $1.8 million in federal income tax expense for the three month period ended March 31, 2021 compared to $1.4 million in the same period in 2020. Our effective tax rate for the three period ended March 31, 2021 was 18.50% compared to 18.23% for the same period in 2020.
FINANCIAL CONDITION
Total assets were $2.73 billion at March 31, 2021, an increase of $92.3 million from $2.64 billion at December 31, 2020. This change reflected increases of $128.1 million in cash and cash equivalents, $3.9 million in loans held for sale, and $9.7 million in securities held to maturity, partially offset by a decrease of $46.4 million in our loan portfolio and $3.2 million in securities available for sale. Total deposits increased by $89.4 million at March 31, 2021 compared to December 31, 2020. Throughout the COVID-19 pandemic, our deposit customers have held significantly higher balances, which has resulted in a substantial increase in our cash and cash equivalent balances and total assets.
Cash and Cash Equivalents: Our cash and cash equivalents, which include federal funds sold and short-term investments, were $911.9 million at March 31, 2021 compared to $783.7 million at December 31, 2020. The increase in these balances related primarily to the increase in total deposits.
Securities: Debt securities available for sale were $233.7 million at March 31, 2021 compared to $236.8 million at December 31, 2020. The balance at March 31, 2021 primarily consisted of U.S. agency securities, agency mortgage backed securities and various municipal investments. Our held to maturity portfolio was $79.5 million at December 31, 2020 and $89.2 million at March 31, 2021. Our held to maturity portfolio is comprised of state, municipal and privately placed commercial bonds.
Portfolio Loans and Asset Quality: Total portfolio loans decreased by $46.4 million in the first three months of 2021 and were $1.38 billion at March 31, 2021 compared to $1.43 billion at December 31, 2020. During the first three months of 2020, our commercial portfolio decreased by $31.0 million, while our consumer portfolio decreased by $5.6 million and our residential mortgage portfolio decreased by $9.8 million.
Mortgage loans originated for portfolio are typically loans that conform to secondary market requirements and have a term of fifteen years or less. Mortgage loans originated for portfolio in the first three months of 2021 increased $5.2 million compared to the same period in 2020, from $4.6 million in the first three months of 2020 to $9.8 million in the same period in 2021.
Due primarily to re-financings associated with a lower rate environment, the volume of residential mortgage loans originated for sale in the first three months of 2021 increased $17.9 million compared to the same period in 2020. Residential mortgage loans originated for sale were $47.3 million in the first three months of 2021 compared to $29.4 million in the first three months of 2020.
The following table shows our loan origination activity for loans to be held in portfolio during the first three months of 2021 and 2020, broken out by loan type and also shows average originated loan size (dollars in thousands):
| | | Three months ended March 31, 2021 | | | Three months ended March 31, 2020 | |
| | | Portfolio Originations | | | Percent of Total Originations | | | Average Loan Size | | | Portfolio Originations | | | Percent of Total Originations | | | Average Loan Size | |
| Commercial real estate: | | | | | | | | | | | | | | | | | | |
| Residential developed | | $ | 5,086 | | | | 2.7 | % | | $ | 636 | | | $ | 126 | | | | 0.0 | % | | $ | 42 | |
| Unsecured to residential developers | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Vacant and unimproved | | | 433 | | | | 0.2 | | | | 217 | | | | 2,978 | | | | 3.0 | | | | 1,489 | |
| Commercial development | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Residential improved | | | 36,580 | | | | 19.4 | | | | 778 | | | | 16,942 | | | | 16.6 | | | | 385 | |
| Commercial improved | | | 3,656 | | | | 1.9 | | | | 609 | | | | 8,476 | | | | 8.3 | | | | 848 | |
| Manufacturing and industrial | | | 8,553 | | | | 4.5 | | | | 1,222 | | | | 4,544 | | | | 4.5 | | | | 303 | |
| Total commercial real estate | | | 54,308 | | | | 28.7 | | | | 776 | | | | 33,066 | | | | 32.4 | | | | 517 | |
| Commercial and industrial, excluding PPP | | | 15,652 | | | | 8.3 | | | | 423 | | | | 54,144 | | | | 53.1 | | | | 918 | |
| PPP loans | | | 96,958 | | | | 51.2 | | | | 129 | | | | — | | | | — | | | | — | |
| Total commercial and commercial real estate | | | 166,918 | | | | 88.2 | | | | 1,560 | | | | 87,210 | | | | 85.5 | | | | 709 | |
| Consumer | | | | | | | | | | | | | | | | | | | | | | | | |
| Residential mortgage | | | 9,803 | | | | 5.2 | | | | 338 | | | | 4,577 | | | | 4.5 | | | | 254 | |
| Unsecured | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Home equity | | | 12,105 | | | | 6.4 | | | | 114 | | | | 9,890 | | | | 9.7 | | | | 103 | |
| Other secured | | | 375 | | | | 0.2 | | | | 20 | | | | 299 | | | | 0.3 | | | | 15 | |
| Total consumer | | | 22,283 | | | | 11.8 | | | | 145 | | | | 14,766 | | | | 14.5 | | | | 110 | |
| Total loans | | $ | 189,201 | | | | 100.0 | % | | | 725 | | | $ | 101,976 | | | | 100.0 | % | | | 397 | |
The following table shows a breakout of our commercial loan activity during the first three months of 2021 and 2020 (dollars in thousands):
| | | Three Months Ended March 31, 2021 | | | Three Months Ended March 31, 2020 | |
| Commercial loans originated | | $ | 166,918 | | | $ | 87,210 | |
| Repayments of commercial loans | | | (154,807 | ) | | | (74,069 | ) |
| Change in undistributed - available credit | | | (43,073 | ) | | | 9,070 | |
| Net decrease in total commercial loans | | $ | (30,962 | ) | | $ | 22,211 | |
Overall, the commercial loan portfolio decreased $46.4 million in the first three months of 2021 compared to the same period in 2020. Our commercial and industrial portfolio decreased by $19.4 million while our commercial real estate loans decreased by $11.6 million in the first three months of 2021 compared to the same period in 2020. Our production of commercial loans increased by $79.7 million from $87.2 million in the first three months of 2020 to $166.9 million in the same period of 2021.
Commercial and commercial real estate loans remained our largest loan segment and accounted for approximately 85.8% and 85.2% of the total loan portfolio at March 31, 2021 and December 31, 2020, respectively. Residential mortgage and consumer loans comprised approximately 14.2% of total loans at March 31, 2021 and 14.8% at December 31, 2020.
A further breakdown of the composition of the loan portfolio is shown in the table below (in thousands):
| | | March 31, 2021 | | | December 31, 2020 | |
| | | Balance | | | Percent of Total Loans | | | Balance | | | Percent of Total Loans | |
| Commercial real estate: (1) | | | | | | | | | | | | |
| Residential developed | | $ | 8,651 | | | | 0.6 | % | | $ | 8,549 | | | | 0.6 | % |
| Unsecured to residential developers | | | — | | | | — | | | | — | | | | — | |
| Vacant and unimproved | | | 41,375 | | | | 3.0 | | | | 47,122 | | | | 3.3 | |
| Commercial development | | | 841 | | | | 0.1 | | | | 857 | | | | — | |
| Residential improved | | | 112,618 | | | | 8.1 | | | | 114,392 | | | | 8.0 | |
| Commercial improved | | | 264,122 | | | | 19.1 | | | | 266,006 | | | | 18.6 | |
| Manufacturing and industrial | | | 112,995 | | | | 8.2 | | | | 115,247 | | | | 8.1 | |
| Total commercial real estate | | | 540,602 | | | | 39.1 | | | | 552,173 | | | | 38.6 | |
| Commercial and industrial, excluding PPP | | | 392,208 | | | | 28.4 | | | | 436,331 | | | | 30.6 | |
| PPP loans | | | 253,811 | | | | 18.3 | | | | 229,079 | | | | 16.0 | |
| Total commercial and commercial real estate | | | 1,186,621 | | | | 85.8 | | | | 1,217,583 | | | | 85.2 | |
| Consumer | | | | | | | | | | | | | | | | |
| Residential mortgage | | | 139,727 | | | | 10.1 | | | | 149,556 | | | | 10.5 | |
| Unsecured | | | 134 | | | | — | | | | 161 | | | | — | |
| Home equity | | | 52,709 | | | | 3.8 | | | | 57,975 | | | | 4.0 | |
| Other secured | | | 3,760 | | | | 0.3 | | | | 4,056 | | | | 0.3 | |
| Total consumer | | | 196,330 | | | | 14.2 | | | | 211,748 | | | | 14.8 | |
| Total loans | | $ | 1,382,951 | | | | 100.0 | % | | $ | 1,429,331 | | | | 100.0 | % |
| (1) | Includes both owner occupied and non-owner occupied commercial real estate. |
Commercial real estate loans accounted for 39.1% and 38.6% of the total loan portfolio at March 31, 2021 and December 31, 2020, respectively, and consisted primarily of loans to business owners and developers of owner and non-owner occupied commercial properties and loans to developers of single and multi-family residential properties. In the table above, we show our commercial real estate portfolio by loans secured by residential and commercial real estate, and by stage of development. Improved loans are generally secured by properties that are under construction or completed and placed in use. Development loans are secured by properties that are in the process of development or fully developed. Vacant and unimproved loans are secured by raw land for which development has not yet begun and agricultural land.
Our consumer residential mortgage loan portfolio, which also includes residential construction loans made to individual homeowners, comprised 10.1% of portfolio loans at March 31, 2021 and 10.5% at December 31, 2020. We expect to continue to retain in our loan portfolio certain types of residential mortgage loans (primarily high quality, low loan-to-value loans) in an effort to continue to diversify our credit risk and deploy our excess liquidity.
The volume of residential mortgage loans originated for sale during the first three months of 2021 increased from the first three months of 2020 as a result of interest rate conditions. The continued historically low interest rate environment in 2020 and so far in 2021 has caused an increase in refinancing of long-term fixed rate mortgages which we sell into the secondary market.
Our portfolio of other consumer loans includes loans secured by personal property and home equity fixed term and line of credit loans. Consumer loans were $56.6 million at March 31, 2021 and $62.2 million at December 31, 2020. Consumer loans comprised 4.1% of our portfolio loans at March 31, 2021 and 4.3% at December 31, 2020.
Our loan portfolio is reviewed regularly by our senior management, our loan officers, and an internal loan review team that is independent of our loan originators and credit administration. An administrative loan committee consisting of senior management and seasoned lending and collections personnel meets quarterly to manage our internal watch list and proactively manage high risk loans.
When reasonable doubt exists concerning collectability of interest or principal of one of our loans, the loan is placed in nonaccrual status. Any interest previously accrued but not collected is reversed and charged against current earnings.
Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. At March 31, 2021, nonperforming assets totaled $2.9 million compared to $3.1 million at December 31, 2020. There were no additions to other real estate owned in the first three months of 2021 or in the first three months of 2020. At March 31, 2021, there were no loans in redemption following foreclosure, so we expect there to be few additions to other real estate owned in 2021. Proceeds from sales of foreclosed properties were $148,000 in the first three months of 2021, resulting in net realized loss on sales of $14,000. Proceeds from sales of foreclosed properties were $91,000 in the first three months of 2020 resulting in net realized loss on sales of $0.
Nonperforming loans include loans on nonaccrual status and loans delinquent more than 90 days but still accruing. As of March 31, 2021, nonperforming loans totaled $525,000, or 0.04% of total portfolio loans, compared to $533,000, or 0.04% of total portfolio loans, at December 31, 2020.
Nonperforming loans at March 31, 2021 consisted of $432,000 of commercial real estate loans and $93,000 of consumer and residential mortgage loans.
Foreclosed and repossessed assets include assets acquired in settlement of loans. Foreclosed assets totaled $2.4 million at March 31, 2021 and $2.5 million at December 31, 2020. The entire balance at March 31, 2021 was comprised of three commercial real estate properties. All properties acquired through or in lieu of foreclosure are initially transferred at their fair value less estimated costs to sell and then evaluated monthly for impairment after transfer using a lower of cost or market approach. Updated property valuations are obtained at least annually on all foreclosed assets.
At March 31, 2021, our foreclosed asset portfolio had a weighted average age held in portfolio of 9.03 years. Below is a breakout of our foreclosed asset portfolio at March 31, 2021 and December 31, 2020 by property type and the percentages the property has been written down since taken into our possession and the combined writedown percentage, including losses taken when the property was loan collateral (dollars in thousands):
| | | March 31, 2021 | | | December 31, 2020 | |
| Foreclosed Asset Property Type | | Carrying Value | | | Foreclosed Asset Writedown | | | Combined Writedown (Loan and Foreclosed Asset) | | | Carrying Value | | | Foreclosed Asset Writedown | | | Combined Writedown (Loan and Foreclosed Asset) | |
| Single Family | | | — | | | | — | % | | | — | % | | | — | | | | — | % | | | — | % |
| Residential Lot | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Multi-Family | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Vacant Land | | | 28 | | | | 73.2 | | | | 83.7 | | | | 67 | | | | 72.0 | | | | 78.2 | |
| Residential Development | | | — | | | | — | | | | — | | | | 127 | | | | 15.3 | | | | 49.4 | |
| Commercial Office | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Commercial Industrial | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
| Commercial Improved | | | 2,343 | | | | — | | | | — | | | | 2,343 | | | | — | | | | — | |
| | | $ | 2,371 | | | | 4.2 | | | | 10.3 | | | $ | 2,537 | | | | 7.1 | | | | 12.5 | |
The following table shows the composition and amount of our nonperforming assets (dollars in thousands):
| | | March 31, 2021 | | | December 31, 2020 | |
| Nonaccrual loans | | $ | 525 | | | $ | 533 | |
| Loans 90 days or more delinquent and still accruing | | | — | | | | — | |
| Total nonperforming loans (NPLs) | | | 525 | | | | 533 | |
| Foreclosed assets | | | 2,371 | | | | 2,537 | |
| Repossessed assets | | | — | | | | — | |
| Total nonperforming assets (NPAs) | | $ | 2,896 | | | $ | 3,070 | |
| NPLs to total loans | | | 0.04 | % | | | 0.04 | % |
| NPAs to total assets | | | 0.11 | % | | | 0.12 | % |
The following table shows the composition and amount of our troubled debt restructurings (TDRs) at March 31, 2021 and December 31, 2020 (dollars in thousands):
| | | March 31, 2021 | | | December 31, 2020 | |
| | | Commercial | | | Consumer | | | Total | | | Commercial | | | Consumer | | | Total | |
| Performing TDRs | | $ | 5,875 | | | $ | 3,817 | | | $ | 9,692 | | | $ | 4,959 | | | $ | 4,049 | | | $ | 9,008 | |
| Nonperforming TDRs (1) | | | 432 | | | | — | | | | 432 | | | | 437 | | | | — | | | | 437 | |
| Total TDRs | | $ | 6,307 | | | $ | 3,817 | | | $ | 10,124 | | | $ | 5,396 | | | $ | 4,049 | | | $ | 9,445 | |
| (1) | Included in nonperforming asset table above |
We had a total of $10.1 million and $9.4 million of loans whose terms have been modified in TDRs as of March 31, 2021 and December 31, 2020, respectively. These loans may have involved the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow. These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit. For each restructuring, a comprehensive credit underwriting analysis of the borrower’s financial condition and prospects of repayment under the revised terms is performed to assess whether the structure can be successful and whether cash flows will be sufficient to support the restructured debt. An analysis is also performed to determine whether the restructured loan should be on accrual status. Generally, if the loan is on accrual at the time of restructure, it will remain on accrual after the restructuring. In some cases, a nonaccrual loan may be placed on accrual at restructuring if the loan’s actual payment history demonstrates it would have cash flowed under the restructured terms. After six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accruing status. In situations where there is a subsequent modification or renewal and the loan is brought to market terms, including a contractual interest rate not less than a market interest rate for new debt with similar credit risk characteristics, the TDR and impaired designations may be removed. Total TDRs increased by $679,000 from December 31, 2020 to March 31, 2021 due to an increase in the balances of existing TDRs. There were no new TDRs added during the quarter. There were 70 loans identified as TDRs at March 31, 2021 compared to 76 loans at December 31, 2020.
As with other impaired loans, an allowance for loan loss is estimated for each TDR based on the most likely source of repayment for each loan. For impaired commercial real estate loans that are collateral dependent, the allowance is computed based on the fair value of the underlying collateral, less estimated costs to sell. For impaired commercial loans where repayment is expected from cash flows from business operations, the allowance is computed based on a discounted cash flow computation. Certain groups of TDRs, such as residential mortgages, have common characteristics and for them the allowance is computed based on a discounted cash flow computation on the change in weighted rate for the pool. The allowance allocations for commercial TDRs where we have reduced the contractual interest rate are computed by measuring cash flows using the new payment terms discounted at the original contractual rate.
On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus.” This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19. The guidance goes on to explain that, in consultation with the FASB staff, the federal banking agencies concluded that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a modification are not TDRs. The CARES Act was passed by Congress on March 27, 2020. Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were not more than 30 days past due as of December 31, 2019 are not TDRs. The Economic Aid Act passed by Congress on December 27, 2020 extended the date for such modifications to not be treated as TDRs to the earlier of 60 days after date on which the national emergency declared as a result of COVID-19 is terminated or January 1, 2022. Through March 31, 2021, the Bank had applied this guidance and modified 726 individual loans with aggregate principal balances totaling $337.2 million. The majority of these modifications involved three-month extensions.
Allowance for loan losses: The allowance for loan losses at March 31, 2021 was $17.5 million, an increase of $44,000 from December 31, 2020. The allowance for loan losses represented 1.26% of total portfolio loans at March 31, 2021 and 1.22% at December 31, 2020. The ratios at March 31, 2021 and December 31, 2020 were impacted by $253.8 million and $229.1 million of remaining PPP loans which are fully guaranteed and receive no allowance allocation. The ratios excluding these loans were 1.55% at March 31, 2021 and 1.45% at December 31, 2020. The allowance for loan losses to nonperforming loan coverage ratio increased from 3266% at December 31, 2020 to 3324% at March 31, 2021.
The table below shows the changes in certain credit metrics over the past five quarters:
| (Dollars in millions) | | Quarter Ended March 31, 2021 | | | Quarter Ended December 31, 2020 | | | Quarter Ended September 30, 2020 | | | Quarter Ended June 30, 2020 | | | Quarter Ended March 31, 2020 | |
| Commercial loans | | $ | 1,186.6 | | | $ | 1,217.6 | | | $ | 1,311.9 | | | $ | 1,310.7 | | | $ | 1,120.2 | |
| Nonperforming loans | | | 0.5 | | | | 0.5 | | | | 0.2 | | | | 3.0 | | | | 7.2 | |
| Other real estate owned and repo assets | | | 2.4 | | | | 2.5 | | | | 2.6 | | | | 2.6 | | | | 2.6 | |
| Total nonperforming assets | | | 2.9 | | | | 3.0 | | | | 2.8 | | | | 5.6 | | | | 9.9 | |
| Net charge-offs (recoveries) | | | (0.4 | ) | | | (0.5 | ) | | | (0.2 | ) | | | 4.0 | | | | (1.0 | ) |
| Total delinquencies | | | 0.2 | | | | 0.6 | | | | 0.5 | | | | 3.3 | | | | 0.5 | |
At March 31, 2021, we have had net loan recoveries in twenty-three of the past twenty-five quarters. Our total delinquencies have continued to be negligible and were $217,000 at March 31, 2021 and $581,000 at December 31, 2020. Our delinquency percentage at March 31, 2021 was only 0.02%.
These factors all impact our necessary level of allowance for loan losses and our provision for loan losses. The allowance for loan losses increased $44,000 in the first three months of 2020. We recorded a provision for loan losses of $0 for the three months ended March 31, 2021 compared to $700,000 for the same period of 2020. Net loan recoveries were $44,000 for the three months ended March 31, 2021, compared to net recoveries of $989,000 for the same period in 2020. The ratio of net recoveries to average loans was -0.01% on an annualized basis for the first three months of 2021, compared to -0.29% for the first three months of 2020.
We are pleased with the low level of gross charge-offs over recent quarters. We do, however, recognize that future charge-offs and resulting provisions for loan losses are expected to be impacted by the timing and extent of changes in the overall economy and the real estate markets.
Our allowance for loan losses is maintained at a level believed appropriate based upon our assessment of the probable estimated losses inherent in the loan portfolio. Our methodology for measuring the appropriate level of allowance and related provision for loan losses relies on several key elements, which include specific allowances for loans considered impaired, general allowance for commercial loans not considered impaired based upon applying our loan rating system, and general allocations based on historical trends for homogeneous loan groups with similar risk characteristics.
Overall, impaired loans increased by $666,000 to $11.3 million at March 31, 2021 compared to $10.6 million at December 31, 2020. The specific allowance for impaired loans decreased $224,000 to $1.0 million at March 31, 2021, compared to $1.2 million at December 31, 2020. The specific allowance for impaired loans represented 8.7% of total impaired loans at March 31, 2021 and 11.4% at December 31, 2020.
The general allowance allocated to commercial loans that were not considered to be impaired was based upon the internal risk grade of such loans. We use a loan rating method based upon an eight point system. Loans are stratified between real estate secured and non-real estate secured. The real estate secured portfolio is further stratified by the type of real estate. Each stratified portfolio is assigned a loss allocation factor. A higher numerical grade assigned to a loan category generally results in a greater allocation percentage. Changes in risk grade of loans affect the amount of the allowance allocation.
The determination of our loss factors is based upon our actual loss history by loan grade and adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the analysis date. We use a rolling 18 month actual net chargeoff history as the base for our computation. Over the past few years, the 18 month period computations have reflected sizeable decreases in net chargeoff experience. We addressed this volatility in the qualitative factor considerations applied in our allowance for loan losses computation. We also considered the extended period of strong asset quality in assessing the overall qualitative component.
At March 31, 2020, we also considered the effect that the global economic shutdown to combat COVID-19 was having on our loan borrowers and our local economy. While significant stimulus and mitigation efforts were expected to soften the impact, we believed a downgrade to our economic qualitative factor was appropriate and we added 7 basis points to this qualitative factor at March 31, 2020. Additional allocations were provided in the second, third and fourth quarters of 2020. In the first quarter of 2021, this factor was decreased by 2 basis points in recognition of improved economic conditions but additional allocations were made to other factors for a net increase of 8 basis points in the quarter.
Certain industry sectors will be more negatively impacted by the economic effects of COVID-19 and governmental action than others. For example, businesses that thrive on large masses of people assembling in close proximity, such as hospitality, restaurants and sporting events will likely incur longer negative effects than other industries. We believe our commercial portfolio is adequately diversified, with our largest commercial concentrations in Real Estate, Rental and Leasing (25%), followed by Retail Trade (16%). The table below breaks down our commercial loan portfolio by industry type at March 31, 2021 (dollars in thousands):
| | | March 31, 2021 | |
| | | Excluding PPP | | | PPP Loans | | | Total | | | Percent of Total Loans | | | Percent Grade 4 or Better | | | Percent Grade 5 or Worse | |
| Industry: | | | | | | | | | | | | | | | | | | |
| Agricultural Products | | $ | 59,073 | | | $ | 8,518 | | | $ | 67,591 | | | | 5.70 | % | | | 93.32 | % | | | 6.68 | % |
| Mining and Oil Extraction | | | 864 | | | | 62 | | | | 926 | | | | 0.08 | % | | | 100.00 | % | | | 0.00 | % |
| Utilities | | | — | | | | — | | | | — | | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % |
| Construction | | | 59,875 | | | | 36,343 | | | | 96,218 | | | | 8.11 | % | | | 99.06 | % | | | 0.94 | % |
| Manufacturing | | | 129,233 | | | | 64,173 | | | | 193,406 | | | | 16.30 | % | | | 97.64 | % | | | 2.36 | % |
| Wholesale Trade | | | 42,943 | | | | 8,319 | | | | 51,262 | | | | 4.32 | % | | | 99.84 | % | | | 0.16 | % |
| Retail Trade | | | 105,559 | | | | 9,903 | | | | 115,462 | | | | 9.73 | % | | | 99.91 | % | | | 0.09 | % |
| Transportation and Warehousing | | | 46,452 | | | | 17,229 | | | | 63,681 | | | | 5.37 | % | | | 98.19 | % | | | 1.81 | % |
| Information | | | 720 | | | | 526 | | | | 1,246 | | | | 0.11 | % | | | 46.79 | % | | | 53.21 | % |
| Finance and Insurance | | | 41,036 | | | | 4,168 | | | | 45,204 | | | | 3.81 | % | | | 100.00 | % | | | 0.00 | % |
| Real Estate and Rental and Leasing | | | 295,016 | | | | 2,497 | | | | 297,513 | | | | 25.07 | % | | | 99.77 | % | | | 0.23 | % |
| Professional, Scientific and Technical Services | | | 7,430 | | | | 16,583 | | | | 24,013 | | | | 2.02 | % | | | 99.01 | % | | | 0.99 | % |
| Management of Companies and Enterprises | | | 3,842 | | | | — | | | | 3,842 | | | | 0.32 | % | | | 100.00 | % | | | 0.00 | % |
| Administrative and Support Services | | | 18,029 | | | | 28,195 | | | | 46,224 | | | | 3.90 | % | | | 99.76 | % | | | 0.24 | % |
| Education Services | | | 2,654 | | | | 8,477 | | | | 11,131 | | | | 0.94 | % | | | 99.18 | % | | | 0.82 | % |
| Health Care and Social Assistance | | | 51,904 | | | | 20,498 | | | | 72,402 | | | | 6.10 | % | | | 100.00 | % | | | 0.00 | % |
| Arts, Entertainment and Recreation | | | 7,113 | | | | 3,033 | | | | 10,146 | | | | 0.86 | % | | | 96.60 | % | | | 3.40 | % |
| Accommodations and Food Services | | | 37,573 | | | | 14,350 | | | | 51,923 | | | | 4.38 | % | | | 84.86 | % | | | 15.14 | % |
| Other Services | | | 23,494 | | | | 10,902 | | | | 34,396 | | | | 2.90 | % | | | 99.03 | % | | | 0.97 | % |
| Public Administration | | | — | | | | — | | | | — | | | | 0.00 | % | | | 0.00 | % | | | 0.00 | % |
| Private Households | | | — | | | | 35 | | | | 35 | | | | 0.00 | % | | | 100.00 | % | | | 0.00 | % |
| Total commercial loans | | $ | 932,810 | | | $ | 253,811 | | | $ | 1,186,621 | | | | 100.00 | % | | | 98.18 | % | | | 1.82 | % |
Considering the change in our qualitative factors and our commercial loan portfolio balances, the general allowance allocated to commercial loans was $14.0 million at March 31, 2021 and $13.7 million at December 31, 2020. The qualitative component of our allowance allocated to commercial loans was $14.0 million at March 31, 2021, up $281,000 from $13.7 million at December 31, 2020.
Groups of homogeneous loans, such as residential real estate and open- and closed-end consumer loans, receive allowance allocations based on loan type. A rolling 12 month (four quarter) historical loss experience period was applied to residential mortgage and consumer loan portfolios. As with commercial loans that are not considered impaired, the determination of the allowance allocation percentage is based principally on our historical loss experience. These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent loss experience for these similar pools of loans. The homogeneous loan allowance was $2.4 million at March 31, 2021 and $2.4 million at December 31, 2020.
The allowance allocations are not intended to imply limitations on usage of the allowance for loan losses. The entire allowance for loan losses is available for any loan losses without regard to loan type.
Premises and Equipment: Premises and equipment totaled $43.1 million at March 31, 2021, down $141,000 from $43.3 million at December 31, 2020.
Bank Owned Life Insurance (BOLI): The Bank has purchased life insurance on certain officers. BOLI is recorded at its currently realizable cash surrender value and totaled $42.2 million at March 31, 2021 compared to $42.5 million at December 31, 2020. The net decrease of $272,000 from December 31, 2020 was due to BOLI earnings during the quarter, offset by the payout of $560,000 on a death claim received during the quarter. In early April 2021, the Bank purchased an additional $10.0 million of BOLI policies.
Deposits and Other Borrowings: Total deposits increased $89.4 million to $2.39 billion at March 31, 2021, as compared to $2.30 billion at December 31, 2020. Non-interest checking account balances increased $39.4 million during the first three months of 2021. Interest bearing demand account balances decreased $28.6 million and savings and money market account balances increased $79.8 million in the first three months of 2021 as municipal and business customers have held higher balances during the COVID-19 pandemic. Certificates of deposits decreased by $1.2 million in the first three months of 2021 reflecting the continued low market interest rates. We believe our success in maintaining the balances of personal and business checking and savings accounts was primarily attributable to our focus on quality customer service, the desire of customers to deal with a local bank, the convenience of our branch network and the breadth and depth of our sophisticated product line.
Noninterest bearing demand accounts comprised 36% of total deposits at March 31, 2021 and 35% of total deposits at December 31, 2020. These balances typically increase at year end for many of our commercial customers, then decline in the first quarter. This didn’t happen in the first quarter 2021 due to customers of all types holding higher balances during the COVID-19 pandemic. In addition, because of the generally low rates paid on interest bearing account alternatives, many of our business customers chose to keep their balances in these more liquid noninterest bearing demand account types. Interest bearing demand, including money market and savings accounts, comprised 60% of total deposits at March 31, 2021 and 60% at December 31, 2020. Time accounts as a percentage of total deposits were 4% at March 31, 2021 and 5% December 31, 2020.
Borrowed funds totaled $90.6 million at March 31, 2021, including $70.0 million of Federal Home Loan Bank (“FHLB”) advances and $20.6 million in long-term debt associated with trust preferred securities. Borrowed funds totaled $90.6 million at December 31, 2020, including $70.0 million of FHLB advances and $20.6 million in long-term debt associated with trust preferred securities.
CAPITAL RESOURCES
Total shareholders' equity of $242.4 million at March 31, 2021 increased $2.5 million from $239.8 million at December 31, 2020. The increase was primarily a result of net income of $7.8 million earned in the first three months of 2021, partially offset by a decrease of $2.7 million in accumulated other comprehensive income and a payment of $2.7 million in cash dividends to shareholders. The Bank was categorized as “well capitalized” at March 31, 2021.
Capital guidelines for U.S. banks are commonly known as Basel III guidelines. The rules include a common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, effectively resulting in a minimum CET1 ratio of 7.0%. The Basel III minimum ratio of Tier 1 capital to risk-weighted assets is 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5%), and the minimum total capital to risk-weighted assets ratio is 10.5% (with the capital conservation buffer), and Basel III requires a minimum leverage ratio of 4.0%. The capital ratios for the Company and the Bank under Basel III have continued to exceed the well capitalized minimum capital requirements.
The following table shows our regulatory capital ratios (on a consolidated basis) for the past several quarters:
Macatawa Bank Corporation | | March 31, 2021 | | | Dec 31, 2020 | | | Sept 30, 2020 | | | June 30, 2020 | | | March 31, 2020 | |
| Total capital to risk weighted assets | | | 19.3 | % | | | 18.3 | % | | | 17.7 | % | | | 17.3 | % | | | 15.8 | % |
| Common Equity Tier 1 to risk weighted assets | | | 16.7 | | | | 15.8 | | | | 15.3 | | | | 14.9 | | | | 13.4 | |
| Tier 1 capital to risk weighted assets | | | 18.1 | | | | 17.1 | | | | 16.6 | | | | 16.3 | | | | 14.7 | |
| Tier 1 capital to average assets | | | 9.8 | | | | 9.9 | | | | 9.8 | | | | 10.5 | | | | 11.9 | |
All of the $20.0 million of trust preferred securities outstanding at March 31, 2021 qualified as Tier 1 capital.
LIQUIDITY
Liquidity of Macatawa Bank: The liquidity of a financial institution reflects its ability to manage a variety of sources and uses of funds. Our Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus on developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for our investment and loan portfolios. Our sources of liquidity include our borrowing capacity with the FRB's discount window, the Federal Home Loan Bank, federal funds purchased lines of credit and other secured borrowing sources with our correspondent banks, loan payments by our borrowers, maturity and sales of our securities available for sale, growth of our deposits, federal funds sold and other short-term investments, and the various capital resources discussed above.
Liquidity management involves the ability to meet the cash flow requirements of our customers. Our customers may be either borrowers with credit needs or depositors wanting to withdraw funds. Our liquidity management involves periodic monitoring of our assets considered to be liquid and illiquid, and our funding sources considered to be core and non-core and short-term (less than 12 months) and long-term. We have established parameters that monitor, among other items, our level of liquid assets to short-term liabilities, our level of non-core funding reliance and our level of available borrowing capacity. We maintain a diversified wholesale funding structure and actively manage our maturing wholesale sources to reduce the risk to liquidity shortages. We have also developed a contingency funding plan to stress test our liquidity requirements arising from certain events that may trigger liquidity shortages, such as rapid loan growth in excess of normal growth levels or the loss of deposits and other funding sources under extreme circumstances.
We have actively pursued initiatives to maintain a strong liquidity position. The Bank has reduced its reliance on non-core funding sources, including brokered deposits, and focused on achieving a non-core funding dependency ratio below its peer group average. We have had no brokered deposits on our balance sheet since December 2011. We continue to maintain significant on-balance sheet liquidity. At March 31, 2021, the Bank held $885.0 million of federal funds sold and other short-term investments. In addition, the Bank had available borrowing capacity from correspondent banks of approximately $269.3 million as of March 31, 2021.
In the normal course of business, we enter into certain contractual obligations, including obligations which are considered in our overall liquidity management. The table below summarizes our significant contractual obligations at March 31, 2021 (dollars in thousands):
| | | Less than 1 year | | | 1-3 years | | | 3-5 years | | | More than 5 years | |
| Long term debt | | $ | — | | | $ | — | | | $ | — | | | $ | 20,619 | |
| Time deposit maturities | | | 86,297 | | | | 14,912 | | | | 1,072 | | | | 57 | |
| Other borrowed funds | | $ | 10,000 | | | | 20,000 | | | | 30,000 | | | | 10,000 | |
| Operating lease obligations | | | 385 | | | | 404 | | | | 262 | | | | — | |
| Total | | $ | 96,682 | | | $ | 35,316 | | | $ | 31,334 | | | $ | 30,676 | |
In addition to normal loan funding, we also maintain liquidity to meet customer financing needs through unused lines of credit, unfunded loan commitments and standby letters of credit. The level and fluctuation of these commitments is also considered in our overall liquidity management. At March 31, 2021, we had a total of $644.4 million in unused lines of credit, $77.5 million in unfunded loan commitments and $12.4 million in standby letters of credit.
Liquidity of Holding Company: The primary sources of liquidity for the Company are dividends from the Bank, existing cash resources and the capital markets if the need to raise additional capital arises. Banking regulations and the laws of the State of Michigan in which our Bank is chartered limit the amount of dividends the Bank may declare and pay to the Company in any calendar year. Under the state law limitations, the Bank is restricted from paying dividends to the Company in excess of retained earnings. In 2020, the Bank paid dividends to the Company totaling $11.7 million. In the same period, the Company paid $10.9 million in dividends to its shareholders. On February 24, 2021, the Bank paid a dividend totaling $3.7 million to the Company in anticipation of the common share cash dividend of $0.08 per share paid on February 25, 2021 to shareholders of record on February 10, 2021. The cash distributed for this cash dividend payment totaled $2.7 million. The Company retained the remaining balance in each period for general corporate purposes. At March 31, 2021, the Bank had a retained earnings balance of $90.7 million.
During 2020 and 2019, the Company received payments from the Bank totaling $7.7 million and $8.0 million, respectively, representing the Bank’s intercompany tax liability for the 2020 and 2019 tax years, respectively, in accordance with the Company’s tax allocation agreement.
The Company has the right to defer interest payments for 20 consecutive quarters on its trust preferred securities if necessary for liquidity purposes. During the deferral period, the Company may not declare or pay any dividends on its common stock or make any payment on any outstanding debt obligations that rank equally with or junior to the trust preferred securities.
The Company’s cash balance at March 31, 2021 was $7.3 million. The Company believes that it has sufficient liquidity to meet its cash flow obligations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES:
To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and future results could differ. The allowance for loan losses, other real estate owned valuation, loss contingencies, revenue recognition and income taxes are deemed critical due to the required level of management judgment and the use of estimates, making them particularly subject to change.
Our methodology for determining the allowance for loan losses and the related provision for loan losses is described above in the "Allowance for Loan Losses" discussion. This area of accounting requires significant judgment due to the number of factors which can influence the collectability of a loan. Unanticipated changes in these factors, including judgments made related to the effect of the COVID-19 pandemic, could significantly change the level of the allowance for loan losses and the related provision for loan losses. Although, based upon our internal analysis, and in our judgment, we believe that we have provided an adequate allowance for loan losses, there can be no assurance that our analysis has properly identified all of the probable losses in our loan portfolio. As a result, we could record future provisions for loan losses that may be significantly different than the levels that we recorded in the first three months of 2021.
Assets acquired through or instead of foreclosure, primarily other real estate owned, are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. New real estate appraisals are generally obtained at the time of foreclosure and are used to establish fair value. If fair value declines, a valuation allowance is recorded through expense. Estimating the initial and ongoing fair value of these properties involves a number of factors and judgments including holding time, costs to complete, holding costs, discount rate, absorption and other factors.
Loss contingencies are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. This, too, is an accounting area that involves significant judgment. Although, based upon our judgment, internal analysis, and consultations with legal counsel we believe that we have properly accounted for loss contingencies, future changes in the status of such contingencies could result in a significant change in the level of contingent liabilities and a related impact to operating earnings.
Noninterest revenue is recognized in accordance with contractual requirements and as we fulfill our obligations under contractual terms. Most of our noninterest revenue comes from services that are transaction based and such revenue is recognized as the related service is provided.
Our accounting for income taxes involves the valuation of deferred tax assets and liabilities primarily associated with differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes. At March 31, 2021, we had gross deferred tax assets of $5.6 million and gross deferred tax liabilities of $2.3 million resulting in a net deferred tax asset of $3.3 million. Accounting standards require that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard. We concluded at March 31, 2021 that no valuation allowance on our net deferred tax asset was required. Changes in tax laws, changes in tax rates, changes in ownership and our future level of earnings can impact the ultimate realization of our net deferred tax asset.
| Item 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. Macatawa Bank has only limited agricultural-related loan assets, and therefore has no significant exposure to changes in commodity prices.
Our balance sheet has sensitivity, in various categories of assets and liabilities, to changes in prevailing rates in the U.S. for prime rate, mortgage rates, U.S. Treasury rates and various money market indexes. Our asset/liability management process aids us in providing liquidity while maintaining a balance between interest earning assets and interest bearing liabilities.
We utilize a simulation model as our primary tool to assess the direction and magnitude of variations in net interest income and the economic value of equity (“EVE”) resulting from potential changes in market interest rates. Key assumptions in the model include contractual cash flows and maturities of interest-sensitive assets and interest-sensitive liabilities, prepayment speeds on certain assets, and changes in market conditions impacting loan and deposit pricing. We also include pricing floors on discretionary priced liability products which limit how low various checking and savings products could go under declining interest rates. These floors reflect our pricing philosophy in response to changing interest rates.
We forecast the next twelve months of net interest income under an assumed environment of gradual changes in market interest rates under various scenarios. The resulting change in net interest income is an indication of the sensitivity of our earnings to directional changes in market interest rates. The simulation also measures the change in EVE, or the net present value of our assets and liabilities, under an immediate shift, or shock, in interest rates under various scenarios, as calculated by discounting the estimated future cash flows using market-based discount rates.
The following table shows the impact of changes in interest rates on net interest income over the next twelve months and EVE based on our balance sheet as of March 31, 2021 (dollars in thousands):
Interest Rate Scenario | | Economic Value of Equity | | | Percent Change | | | Net Interest Income | | | Percent Change | |
| Interest rates up 200 basis points | | $ | 320,464 | | | | 4.99 | % | | $ | 57,877 | | | | 12.43 | % |
| Interest rates up 100 basis points | | | 311,660 | | | | 2.11 | | | | 54,536 | | | | 5.94 | |
| No change | | | 305,221 | | | | — | | | | 51,476 | | | | — | |
| Interest rates down 100 basis points | | | 292,305 | | | | (4.23 | ) | | | 51,344 | | | | (0.28 | ) |
| Interest rates down 200 basis points | | | 292,695 | | | | (4.10 | ) | | | 51,340 | | | | (0.27 | ) |
If interest rates were to increase, this analysis suggests that we are positioned for an improvement in net interest income over the next twelve months. If interest rates were to decrease, this analysis suggests we would experience a reduction in net interest income over the next twelve months.
We also forecast the impact of immediate and parallel interest rate shocks on net interest income under various scenarios to measure the sensitivity of our earnings under these differing conditions.
The quarterly simulation analysis is monitored against acceptable interest rate risk parameters by the Asset/Liability Committee and reported to the Board of Directors.
In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other variables, including: the growth, composition and absolute levels of loans, deposits, and other earning assets and interest-bearing liabilities; economic and competitive conditions; potential changes in lending, investing and deposit gathering strategies; and client preferences.
| Item 4: | CONTROLS AND PROCEDURES |
| (a) | Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e) as of March 31, 2021, the end of the period covered by this report. |
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as the Company's are designed to do, and management necessarily was required to apply its judgment in evaluating whether the benefits of the controls and procedures that the Company adopts outweigh their costs.
Our CEO and CFO, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this report, have concluded that the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms.
| (b) | Changes in Internal Controls. During the period covered by this report, there have been no changes in the Company’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting. |
PART II – OTHER INFORMATION
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
The following table provides information regarding the Company’s purchase of its own common stock during the first quarter of 2021. All employee transactions are under stock compensation plans. These include shares of Macatawa Bank Corporation common stock surrendered for cancellation to satisfy tax withholding obligations that occur upon the vesting of restricted shares. The value of the shares withheld is determined based on the closing price of Macatawa Bank Corporation common stock at the date of vesting. The Company has no publicly announced repurchase plans or programs.
| | | Total Number of Shares Purchased | | | Average Price Paid Per Share | |
Period | | | | | | |
| January 1 - January 31, 2021 | | | | | | |
| Employee Transactions | | | — | | | | — | |
| February 1 - February 28, 2021 | | | | | | | | |
| Employee Transactions | | | 526 | | | $ | 8.72 | |
| March 1 - March 31, 2021 | | | | | | | | |
| Employee Transactions | | | — | | | | — | |
| Total for First Quarter ended March 31, 2021 | | | | | | | | |
| Employee Transactions | | | 526 | | | $ | 8.72 | |
| | Restated Articles of Incorporation. Previously filed with the Commission on October 27, 2016 in Macatawa Bank Corporation’s Quarterly Report on Form 10-Q, Exhibit 3.1. Here incorporated by reference. |
| | Bylaws. Previously filed with the Commission on February 19, 2015 in Macatawa Bank Corporation's Annual Report on Form 10-K for the year ended December 31, 2014, Exhibit 3.2. Here incorporated by reference. |
| | Restated Articles of Incorporation. Exhibit 3.1 is here incorporated by reference. |
| | Bylaws. Exhibit 3.2 is here incorporated by reference. |
| 4.3 | | Long-Term Debt. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the SEC upon request. |
| | Certification of Chief Executive Officer. |
| | Certification of Chief Financial Officer. |
| | Certification pursuant to 18 U.S.C. Section 1350. |
| 101.INS | | XBRL Instance Document |
| 101.SCH | | XBRL Taxonomy Extension Schema Document |
| 101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document |
| 101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document |
| 101.LAB | | XBRL Taxonomy Extension Label Linkbase Document |
| 101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document |
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | MACATAWA BANK CORPORATION |
| | |
| | /s/ Ronald L. Haan |
| | Ronald L. Haan |
| | Chief Executive Officer |
| | (Principal Executive Officer) |
| | |
| | /s/ Jon W. Swets |
| | Jon W. Swets |
| | Senior Vice President and |
| | Chief Financial Officer |
| | (Principal Financial and Accounting Officer) |
| | |
| Dated: April 22, 2021 |
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