MACKINAC FINANCIAL CORPORATION Forward Looking Statements/Risk Factors
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Corporation intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of these safe harbor provisions. Forward-looking statements which are based on certain assumptions and describe future plans, strategies, or expectations of the Corporation, are generally identifiable by use of the words "believe", "expect", "intend", "anticipate", "estimate", "project", or similar expressions. The Corporation's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors that could cause actual results to differ from the results in forward-looking statements include, but are not limited to: RISK FACTORS
Risks Related to our Lending and Credit Activities
The outbreak of the COVID-19 pandemic, including the severity, magnitude,
? duration and businesses' and governments' responses thereto, may have a
negative impact on the Corportion's operations and personnel, as well as on
activity and demand across the customers it serves.
Our business may be adversely affected by conditions in the financial markets
? and economic conditions generally, as our borrowers' ability to repay loans and
the value of the collateral securing our loans decline.
Weakness in the markets for residential or commercial real estate, including
? the secondary residential mortgage loan markets, could reduce our net income
and profitability.
As a community banking organization, the Corporation's success depends upon
? local and regional economic conditions and the Corporation has different
lending risks than larger banks.
We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries and through loan approval and review procedures. We have established an evaluation process designed to determine the adequacy of our allowance for loan losses. While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses is estimated based on experience, judgment and expectations regarding borrowers and economic conditions, as well as regulator judgments. We can make no assurance that our loan loss reserves will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, profitability or financial condition.
? Our allowance for loan losses may be insufficient.
Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in our allowance for loan losses.
Risks Related to Our Operations
? We are subject to interest rate risk.
Our earnings and cash flows are largely dependent upon our net interest income, which is the difference between interest income on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. There are many factors which influence interest rates that are beyond our control, including but not limited to general economic conditions and governmental policy, in particular, the
policies of the FRB.
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? Changes in our accounting policies or in accounting standards could materially
affect how we report our financial results and condition.
? We may not realize the expected benefits of our acquisitions of First Federal
of
? Our controls and procedures may fail or be circumvented.
? Impairment of deferred income tax assets could require charges to earnings,
which could result in an adverse impact on our results of operations. In assessing the realizability of deferred income tax assets, management considers whether it is more likely than not that some allowance requires management to evaluate all available evidence, both negative and positive. Positive evidence necessary to overcome the negative evidence includes whether future taxable income in sufficient amounts and character within the carry back and carry forward periods is available under the tax law, including the use of tax planning strategies. When negative evidence (e.g. cumulative losses, history of operating loss or tax credit carry forwards expiring unused) exists, more positive evidence than negative evidence will be necessary. AtJune 30, 2021 , net deferred tax assets were approximately$2.496 million . If a valuation allowance becomes necessary with respect to such balance, it could have a material adverse effect on our business, results of operations and financial condition.
? Our information systems may experience an interruption or breach in security.
Risks Related to Legal and Regulatory Compliance
? We operate in a highly regulated environment, which could increase our cost
structure or have other negative impacts on our operations. Strategic Risks
? Maintaining or increasing our market share may depend on lowering prices and
market acceptance of new products and services.
? Future growth or operating results may require us to raise additional capital
but that capital may not be available. Reputation Risks
Unauthorized disclosure of sensitive or confidential client or customer
? information, whether through a breach of our computer system or otherwise,
could severely harm our business. Liquidity Risks
? We could experience an unexpected inability to obtain needed liquidity.
The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. We seek to ensure our funding needs are met by maintaining an appropriate level of liquidity through asset/liability management.
Risks Related to an Investment in Our Common Stock
? Limited trading activity for shares of our common stock may contribute to price
volatility.
? Our securities are not an insured deposit.
? You may not receive dividends on your investment in common stock.
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Our ability to pay dividends is dependent upon our receipt of dividends from the
Bank, which is subject to regulatory restrictions. Such restrictions, which
govern state-chartered banks, generally limit the payment of dividends on bank
stock to the bank's undivided profits after all payments of all necessary
expenses, provided that the bank's surplus equals or exceeds its capital.
These risks and uncertainties should be considered in evaluating forward-looking
statements. Further information concerning the Corporation and its business,
including additional factors that could materially affect the Corporation's
financial results, is included in the Corporation's filings with the Securities
and Exchange Commission . All forward-looking statements contained in this report
are based upon information presently available and the Corporation assumes no
obligation to update any forward-looking statements.
The following discussion covers results of operations, asset quality, financial
position, liquidity, interest rate sensitivity, and capital resources for the
periods indicated. The information included in this discussion is intended to
assist readers in their analysis of, and should be read in conjunction with, the
consolidated financial statements, the related notes, and other supplemental
information presented elsewhere in this report. It should be noted that there
may be non-GAAP disclosures presented within this discussion to further assist
readers in their analysis of the financial condition of the Corporation. This
discussion should also be read in conjunction with the consolidated financial
statements and footnotes contained in the Corporation's Annual Report and
Form 10-K for the year-ended December 31, 2020 . Throughout this discussion and
elsewhere in this report, the term "Bank" refers to mBank, the principal banking
subsidiary of the Corporation.
FINANCIAL OVERVIEW
The Corporation recorded second quarter 2021 net income of$2.945 million , or$.28 per share, compared to net income of$3.454 million , or$.33 per share, for the second quarter of 2020.
Weighted average shares outstanding for the six month period in 2021 totaled 10,536,722, compared to 10,625,778 shares in the same period of 2020.
The net interest income and net interest margin for the second quarter of 2021 was$13.266 million , or 4.56%, compared to$14.458 million , or 4.51%, for the second quarter of 2020. Net interest income in the second quarter of 2021 was positively impacted by the recognition of$1.167 million of fees generated by participation in the PPP loan program. Total assets of the Corporation atJune 30, 2021 were$1.519 billion , up by$17.222 million , or 1.15%, from the$1.502 billion in total assets reported at year-end 2020. A large portion of this increase is a result of participation in the Paycheck Protection Program, of which we have current loan balances of$55.384 million . As of the end of the second quarter of 2021, the Corporation had experienced no material adverse systemic issues or material deterioration in its loan portfolio due to the COVID-19 pandemic. At the onset of COVID-19, the Corporation began to actively work to identify potential heightened industry and consumer exposure within the portfolio based on its footprint. The Corporation does expect that COVID-19 will unavoidably impact many of its customer's businesses and will be prepared to assist these customers with appropriate relief using the regulatory guidance provided, particularly for industries experiencing negative environmental factors and risk trends. The Corporation will continue to refine these measures and continually assess its financial reporting and loan loss reserves as the Corporation and its customers work through the pandemic crisis in the upcoming quarters. FINANCIAL CONDITION Cash and Cash Equivalents Cash and cash equivalents increased$132.500 million during the first six months of 2021, compared to 2020 year end. See further discussion of the change in cash and cash equivalents in the Liquidity section of this Quarterly Report on Form 10-Q. 32 Table of ContentsInvestment Securities Securities available for sale decreased$9.881 million fromDecember 31, 2020 toJune 30, 2021 , with the balance onJune 30, 2021 totaling$101.955 million . Investment securities are increased or decreased as appropriate as a result of managing interest rate risk and liquidity. As ofJune 30, 2021 , investment securities with an estimated fair value of$19.162 million were pledged against borrowings at the FHLB and certain customer relationships. Loans Through the first six months of 2021, loan balances decreased by$99.537 million fromDecember 31, 2020 balances of$1.078 billion . During the first six months of 2021, the Bank had total loan production of$161.225 million , exclusive of PPP loans, which included$67.986 million of secondary market loan production. This loan production, however, was offset by loan amortization and payoffs. When including the PPP loans, total production was$218.897 million , which includes$57.672 million of PPP loans. Management believes a properly positioned loan portfolio provides the most attractive earning asset yield available to the Corporation and, with a diligent loan approval process and exception reporting, management can effectively manage the risk in the loan portfolio. Management intends to continue to pursue loan growth within its markets for mortgage, consumer, and commercial loan products while concentrating on loan quality, industry concentration issues, and competitive pricing. The Corporation is highly competitive in structuring loans to meet borrowing needs, while maintaining strong underwriting requirements.
Following is a summary of the loan portfolio at
June 30 , Percent of
2021 Total 2020 Total
Commercial real estate $ 480,477 49.12% $ 498,450 46.25%
Commercial, financial, and agricultural 209,747 21.45 273,759 25.40
Commercial construction 48,205 4.93 47,698 4.43
One to four family residential real estate 210,364 21.51
227,044 21.07
Consumer 18,238 1.86 18,980 1.76
Consumer construction 11,024 1.13 11,661 1.08
Total loans $ 978,055 100.00% $ 1,077,592 100.00%
Following is a table showing the significant industry types in the commercial
loan portfolio as of June 30, 2021 and December 31, 2020 (dollars in thousands).
June 30, 2021 December 31, 2020
Outstanding Percent of Percent of Outstanding Percent of Percent of
Balance Loans Capital Balance Loans Capital
Real estate - operators of nonresidential buildings 130,222 17.64% 75.75% 138,992 16.95% 82.80% Hospitality and tourism
100,162 13.56 58.26 100,237 12.23 59.71 Lessors of residential buildings
53,016 7.18 30.84 52,035 6.35 31.00
Gasoline stations and convenience stores 26,583 3.60 15.46 29,046 3.54 17.30 Logging 17,408 2.36 10.13 18,651 2.27 11.11 Commercial construction 48,205 6.53 28.04 47,698 5.82 28.41 Other 362,833 49.13 211.05 433,248 52.84 258.09 Total Commercial Loans$ 738,429 100.00%$ 819,907 100.00% Management recognizes that additional risks presented by concentration in certain segments of the portfolio. Management does not believe that its current portfolio composition has increased such risk related to any specific industry concentration as ofJune 30, 2021 . The current concentration of commercial real estate-related loans represents a broad customer base composed of a high percentage of owner-occupied developments. The company will slow, and has slowed, growth and origination of certain industry concentrations where internal limits have been reached. Our residential real estate portfolio predominantly includes one to four family adjustable rate mortgages that have repricing terms generally from one to three years, construction loans to individuals and bridge financing loans for qualifying customers. As ofJune 30, 2021 , our residential loan portfolio totaled$221.388 million , or 22.64%, of our total outstanding loans. 33 Table of Contents Due to the seasonal nature of many of the Corporation's commercial loan customers, our loan payment terms provide flexibility by structuring payments to coincide with our customers' business cycles. The lending staff evaluates the collectability of past due loans based on documented collateral values and payment history. The Corporation discontinues the accrual of interest on loans when, in the opinion of management, there is an indication that the borrower may be unable to meet the payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Credit Quality The table below shows period end balances of nonperforming assets (dollars in thousands): June 30, December 31, 2021 2020 Nonperforming Assets: Nonaccrual loans$ 4,927 $ 5,458 Loans past due 90 days or more 6 - Restructured loans on nonaccrual - - Total nonperforming loans 4,933 5,458 Other real estate owned 1,343 1,752 Total nonperforming assets$ 6,276 $ 7,210 Nonperforming loans as a % of loans .50% .51% Nonperforming assets as a % of assets .41% .48% Reserve for Loan Losses: At period end$ 5,651 $ 5,816 As a % of outstanding loans .58% .54% As a % of nonperforming loans 114.56% 106.56% As a % of nonaccrual loans 114.69% 106.56% Texas Ratio 4.07% 4.82%
The following ratios provide additional information relative to the Corporation's credit quality (dollars in thousands):
At Period End
June 30, 2021 December 31,
2020
Total loans, at period end $ 978,055 1,077,592
Average loans for the period $ 1,051,518 $ 1,117,132
For the Period Ended
Six Months Ended Twelve Months
Ended
June 30, 2021 December 31,
2020
Net charge-offs during the period $ 265 492 Net charge-offs to average loans, annualized .05%
.04%
Management seeks to address market issues, if any, impacting its loan customer
base. In conjunction with the Corporation's senior lending staff and bank
regulatory examinations, management reviews the Corporation's loans, related
collateral evaluations, and the overall lending process. The Corporation also
utilizes an outside loan consultant to perform a review of the loan portfolio.
The opinion of this consultant upon completion of the 2020 independent review
provided findings similar to management's findings with respect to credit
quality.
During the first six months of 2021, the Corporation recorded a provision for
loan losses of $100,000 . The Corporation is not yet subject to the requirements
of CECL and management will actively refine the provision and loan reserves as
client impact and broader economic data from the pandemic become more clear.
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COVID-19 loan modifications resided at approximately$2.1 million , or .22% of total loans with no commercial loans remaining in total payment deferral atJune 30, 2021 . This is compared to peak levels of$201 million in the second quarter of 2020. As ofJune 30, 2021 , the allowance for loan losses represented .58% of total loans. AtJune 30, 2021 , the allowance included specific reserves in the amount of$.560 million , as compared to specific reserves of$1.155 million atDecember 31, 2020 . In management's opinion, the allowance for loan losses is adequate to cover probable losses related to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio. Purchased impaired credits do not have an effect on the allowance for loan losses, unless they experience further deterioration subsequent to acquisition, in accordance with ASC 310-30. As part of the process of resolving problem credits, the Corporation may acquire ownership of collateral which secured such credits. The Corporation carries this collateral in other real estate on the balance sheet.
The following table represents the activity in other real estate for the periods indicated (dollars in thousands):
Six Months Ended Year Ended
June 30, 2021 December 31, 2020 Balance at beginning of period $ 1,752 $ 2,194 Other real estate transferred from loans due to foreclosure 600 874 Proceeds from sale of other real estate (977) (1,338) Writedowns on other real estate held for sale (83) (65) Gain on other real estate held for sale
51 87 Balance at end of period $ 1,343 $ 1,752 During the first six months of 2021, the Corporation received real estate in lieu of loan payments of$.600 million . In determining the carrying value of other real estate held for sale, the Corporation generally starts with a third party appraisal of the underlying collateral and then deducts estimated selling costs to arrive at a net asset value. After the initial receipt, management periodically re-evaluates the recorded balances and records any additional reductions in the fair value as a write-down of other real estate held for
sale. Deposits The Corporation had an increase in deposits in the first six months of 2021. Total deposits increased by$48.378 million , or 3.84%, in the first six months of 2021. The increase in deposits for the first six months of 2021 is composed of a increase in core deposits of$83.038 million and a decrease in noncore deposits of$34.660 million . Management utilizes brokered deposits as a funding source, which provides flexibility in managing interest rate risk for fixed
rate longer term loan fundings.
Management continues to monitor existing deposit products in order to stay
competitive, both as to terms and pricing, which will remain important as we
move through the current rate cycle to protect our margin. This focus on
deposits has become especially important with changing client banking habits and
demographics, as well as customer desire for more electronic and mobile based
banking products and services, particularly in light of the pandemic. It is the
intent of management to focus on growing core deposit levels, as the
comparatively inexpensive core deposits, in relation to wholesale deposit
sources, will continue to prove valuable as rates continue to increase.
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The following table represents detail of deposits at the end of the periods indicated (dollars in thousands):
June 30, December 31,
2021 % of Total 2020 % of Total
Noninterest bearing $ 459,716 35.17% $ 414,804 32.94%
NOW, money market, checking 501,251 38.35 450,556 35.79
Savings 141,729 10.84 130,755 10.39Certificates of Deposit <$250,000 178,723 13.67 202,266 16.07 Total core deposits 1,281,419 98.03
1,198,381 95.20
Certificates of Deposit >$250,000 12,384 .95
15,224 1.21
Brokered CDs 13,351 1.02 45,171 3.59
Total non-core deposits 25,735 1.97 60,395 4.80
Total deposits $ 1,307,154 100.00% $ 1,258,776 100.00%
Borrowings
The Corporation also utilizes FHLB borrowings as a source of funding. At June
30, 2021 , this source of funding totaled $28 million and the Corporation secured
this funding by pledging loans and investments. The $28 million of FHLB
borrowings have a weighted average maturity of 3.33 years and a weighted average
interest rate of 1.47% at June 30, 2021 . The Corporation also has a USDA Rural
Development loan held by its wholly owned subsidiary, First Rural Relending,
that has an outstanding balance of $.324 million , with a fixed interest rate of
1% that matures in August 2024 .
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), created the
Paycheck Protection Program to support lending to small businesses that have
been affected by the disruption caused by COVID-19. The Federal Reserve created
the Paycheck Protection Program Lending Facility (PPPLF) to offer a source of
liquidity to the financial institution lenders who lend to small businesses
through the Small Business Administration's (SBA) Paycheck Protection Program.
The PPPLF bears an interest rate of 0.35% and is collateralized by the PPP loans
pledged. There were no PPP loans pledged as of June 30, 2021 as the balance was
repaid in the third quarter of 2020.
The Corporation currently has one correspondent banking borrowing relationship.
As of June 30, 2021 the relationship consisted of a $15.0 million revolving line
of credit, which had no balance. The line of credit bears an interest rate of
LIBOR plus 2.00%, with a floor rate of 3.00% and a ceiling of 22%. The line of
credit expires April 30, 2022 . LIBOR at June 30, 2021 was 0.15%. This
relationship is secured by all of the outstanding mBank stock.
Shareholders' Equity
Total shareholders' equity increased$4.055 million fromDecember 31, 2020 toJune 30, 2021 . Contributing to the change in shareholders' equity was net income of$6.825 million , offset by a reduction for cash dividends on common stock of$2.954 million , an increase due to stock compensation of$.460 million , and an decrease in the market value of securities of$.276 million . RESULTS OF OPERATIONS Summary The Corporation recorded first six months of 2021 net income of$6.825 million , or$.65 per share, compared to net income of$6.505 million , or$.61 per share, for the first six months of 2020. Net Interest Income Net interest income is the Corporation's primary source of core earnings. Net interest income represents the difference between the average yield earned on interest earning assets and the average rate paid on interest bearing obligations. Net 36 Table of Contents
interest income is impacted by economic and competitive factors that influence rates, loan demand, and the availability of funding.
Net interest income and net interest margin on a fully taxable equivalent basis amounted to$27.206 million and 4.57% of average earning assets, respectively, in the first six months of 2021, compared to$28.112 million and 4.59% of average earning assets, respectively, in the first six months of 2020. Included in the net interest income for the first six months of 2021 is$3.319 million of fee recognition on the PPP loans. The$3.319 million of fee recognition included$.749 million to offset direct origination costs involved in the program, as well as$2.570 million of accretion of the remaining deferred fees. The following table presents the amount of interest income from average interest-earning assets and the yields earned on those assets, as well as the interest expense on average interest-bearing obligations and the rates paid on those obligations. All average balances are daily average balances. Six Months Ended 2021-2020 Average Balances Average Rates Interest Income/ Rate/ June 30, Increase/
June 30, June 30, Expense Volume
Rate Volume (dollars in thousands) 2021 2020 (Decrease) 2021 2020 2021 2020 Variance Variance Variance Variance Loans (1,2,3)$ 1,051,518 $ 1,097,382 $ (45,864)
5.31% 5.59%$ 27,664 $ 30,484 $ (2,820) $ (1,271) (1,529) (20) Taxable securities 85,524 89,996 (4,472) 2.42 2.50 1,028 1,181 (153) (55) (32) (66) Nontaxable securities (2) 21,632 19,522 2,110 3.24 3.12 348 303 45 33 12 - Federal funds sold 35,552 9,835 25,717 .10 .18 18 9 9 23 (4) (10) Other interest-earning assets 7,208 14,061 (6,853) 5.18 5.52 185 386 (201) (188) (24) 11 Total earning assets 1,201,434 1,230,796 (29,362) 4.91 5.28 29,243 32,363 (3,120) (1,458) (1,577) (85) Reserve for loan losses (5,750) (5,287) (463) Cash and due from banks 236,573 96,700 139,873 Fixed Assets 25,069 24,719 350 Other Real Estate 1,654 2,221 (567) Other assets 58,205 61,932 (3,727) Total assets$ 1,517,185 $ 1,411,081 $ 106,104 NOW and money market deposits$ 370,775 $ 284,440 $ 86,335 .21 .30$ 379 $ 426 $ (47) $ 129 (134) (42) Interest checking 109,969 95,965 14,004 .02 .05 12 25 (13) 4 (14) (3) Savings deposits 136,135 114,299 21,836 .18 .62 123 352 (229) 67 (248) (48) Certificates of deposit 202,145 241,298 (39,153) .92 1.76 924 2,116 (1,192) (342) (1,007) 157 Brokered deposits 28,734 92,287 (63,553) 1.22 1.56 174 715 (541) (491) (154) 104 Borrowings 51,771 95,308 (43,537) 1.66 1.30 425 617 (192) (281) 167 (78) Total interest-bearing liabilities 899,529 923,597 (24,068) .46 .93 2,037 4,251 (2,214) (914) (1,390) 90 Demand deposits 439,089 315,863 123,226 Other liabilities 8,350 9,065 (715) Shareholders' equity 170,217 162,556 7,661 Total liabilities and shareholders' equity$ 1,517,185 $ 1,411,081 $ 106,104 Rate spread 4.45% 4.35% Net interest margin/revenue 4.57% 4.59%$ 27,206 $ 28,112 $ (906) $ (544)$ (187) $ (175) 37 Table of Contents Three Months Ended 2021-2020 Average Balances Average Rates Interest Income/ Rate/ June 30, Increase/ June 30, June 30, Expense Volume Rate
Volume
(dollars in thousands) 2021 2020 (Decrease) 2021
2020 2021 2020 Variance Variance Variance Variance
Loans (1,2,3) $ 1,025,306 $ 1,147,620 $ (122,314) 5.27% 5.48% $ 13,477 $ 15,635 $ (2,158) $ (1,672) $ (602) $ 116
Taxable securities 84,558 90,991 (6,433) 2.39 2.62 504 560 (56) (42) (51) 37
Nontaxable securities 3.26
(2) 20,571 19,521 1,050 3.96 167 192 (25) 10 (34) (1)
Federal funds sold 30,601 18,627 11,974 .10 0.10 8 5 3 3 - -
Other interest-earning 6.39
assets 6,970 13,253 (6,283) 3.67 111 121 (10) (58) 90 (42)
Total earning assets 1,168,006 1,290,012 (122,006) 4.90 5.16 14,267 16,513 (2,246) (1,759) (597) 110
Reserve for loan
losses (5,839) (5,306) (533)
Cash and due from
banks 276,469 126,860 149,609
Fixed Assets 24,791 26,268 (1,477)
Other Real Estate 1,643 2,262 (619)
Other assets 57,478 61,327 (3,849)
Total assets $ 1,522,548 $ 1,501,423 $ 21,125
NOW and money market
deposits $ 380,622 $ 285,020 $ 95,602 .21 .18 $ 200 $ 131 $ 69 $ 44 $ 18 $ 7
Interest checking 112,586 98,008 14,578 .02 .03 6 8 (2) 1 (3) -
Savings deposits 139,826 118,257 21,569 .18 .39 62 114 (52) 21 (62) (11)
Certificates of
deposit 196,716 239,714 (42,998) .85 1.75 416 1,043 (627) (188) (539) 100
Brokered deposits 13,351 124,514 (111,163) 1.17 1.33 39 411 (372) (368) (48) 44
Borrowings 48,777 116,750 (67,973) 1.64 .95 200 276 (76) (161) 202 (117)
Total interest-bearing
liabilities 891,878 982,263 (90,385) .42 .81 923 1,983 (1,060) (651) (432) 23
Demand deposits 452,881 346,180 106,701
Other liabilities 6,378 11,169 (4,791)
Shareholders' equity 171,411 161,811 9,600
Total liabilities and
shareholders' equity $ 1,522,548 $ 1,501,423 $ 21,125
Rate spread 4.48% 4.35%
Net interest
margin/revenue 4.58%4.54%$ 13,344 $ 14,530 $ (1,186) $ (1,108) $ (165) $ 87
(1) For purposes of these computations, nonaccruing loans are included in the
daily average loan amounts outstanding.
(2) The amount of interest income on loans and nontaxable securities has been
adjusted to a tax equivalent basis, using a 21% tax rate.
(3) Interest income on loans includes fees.
The Corporation continues to reprice a significant portion of its loan portfolio. Management has been diligent when repricing maturing or new loans in establishing interest rate floors in order to maintain our interest rate spread. The Corporation is anticipating some margin pressure in future periods as we continue to see extremely competitive pricing on new and renewable loans. Provision for Loan Losses
The Corporation records a provision for loan losses when it believes it is necessary to adjust the allowance for loan losses to maintain an adequate level after considering factors such as loan charge-offs and recoveries, changes in identified levels of risk in the loan portfolio, changes in the mix of loans in the portfolio, loan growth, and other economic factors. During the first half of 2021, the Corporation recorded a loan loss provision of$100,000 compared to$200,000 in the first half of 2020. There were net charge-offs of$265,000 in the first six months of 2021, compared to net charge-offs of$153,000 for the same period in 2020. There was no provision for loan losses for acquired loans as a result of acquisition fair value adjustments. 38 Table of Contents Other Income Other income was$4.822 million in the first six months of 2021, compared to$4.304 million in the same period in 2020. The increase year over year was largely a result of increased income from loans sold in the secondary market and loans sold to the SBA. Management continues to evaluate deposit products and services for ways to better serve its customer base and also enhance service fee income through a broad array of products that price services based on income contribution and cost attributes.
The following table details other income for the three and six months ended
Three Months Ended Six Months Ended
June 30, June 30,
Increase/(Decrease) Increase/(Decrease)
2021 2020 Dollars Percent 2021 2020 Dollars Percent
Deposit service fees $ 265 $ 237 $ 28 11.81% $ 522 $ 640 $ (118) (18.44)%
Income from loans sold in
the secondary market 982 1,512 (530) (35.05) 2,284 2,050 234 11.41
SBA/USDA loan sale gains 869 274 595 217.15 1,302 984 318 32.32
Net mortgage servicing
(amortization) income 154 204 (50) (24.51) 395 393 2 0.51
Net realized security gains - - - NM 36 - 36 N/A
Other noninterest income 154 140 14 10.00 283 237 46 19.41
Total other income $ 2,424 $ 2,367 $ 57 2.41% $ 4,822 $ 4,304 $ 518 12.04%
Other Expense
For the first six months of 2021, the Corporation recorded other expenses of
$23.760 million , compared to $23.724 million in 2020, an increase of $.036
million . The increase is the result of transaction related costs associated with
the merger of the Corporation with and into Nicolet Bankshares, Inc. of $.495
million .
The following table details other expense for the three and six months ended
Three Months Ended Six Months Ended
June 30, June 30,
Increase/(Decrease) Increase/(Decrease)
2021 2020 Dollars Percentage 2021 2020 Dollars Percentage
Salaries and
employee benefits $ 6,306 $ 7,009 $ (703) (10.03)% $ 13,130 $ 13,060 $ 70 0.54%
Occupancy 1,092 1,008 84 8.33 2,275 2,132 143 6.71
Furniture and equipment 818 804 14 1.74 1,660 1,606 54 3.36
Data processing 707 852 (145) (17.02) 1,477 1,677 (200) (11.93)
Advertising 176 312 (136) (43.59) 289 524 (235) (44.85)
Professional service fees 515 574 (59) (10.28) 1,013 1,072 (59) (5.50)
Loan origination expenses
and deposit and card
related fees 419 406 13 3.20 869 787 82 10.42
Writedowns and losses on
other real estate held for
sale 84 31 53 NM 32 34 (2) (5.88)
FDIC insurance assessment 150 165 (15) (9.09) 290 315 (25) (7.94)
Communications 259 224 35 15.63 500 437 63 14.42
Transaction related
expenses 495 - 495 N/A 495 - 495 N/A
Other 891 967 (76) (7.86) 1,730 2,080 (350) (16.83)
Total other expense $ 11,912 $ 12,352 $ (440) (3.56)% $ 23,760 $ 23,724 $ 36 0.15%
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Federal Income Taxes
The Corporation recognized a federal income tax expense for the six months ended
The Corporation has reported deferred tax assets of$2.496 million atJune 30, 2021 . A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred tax asset will not be realized. As ofJune 30, 2021 , the Corporation had a net operating loss carryforwards for tax purposes of approximately$8.0 million . The carryforwards, if not utilized, will begin to expire in the year 2023. A portion of the NOL and credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code. The annual limitation is$2.0 million for the NOL and the equivalent value of tax credits, which is approximately$.420 million . These limitations for use were established in conjunction with the recapitalization of the Corporation inDecember 2004 . The Corporation will continue to evaluate the future benefits from these carryforwards in order to determine if any adjustment to the deferred tax asset is warranted. LIQUIDITY
We define liquidity as the ability to generate cash at a reasonable cost to fulfill lending commitments and support asset growth, while satisfying the withdrawal demands of customers and making payments on any existing borrowing commitments. The Bank's principal sources of liquidity are core deposits and loan and investment payments and prepayments. Providing a secondary source of liquidity is the available for sale investment portfolio, FHLB borrowings and brokered deposits. As a final source of liquidity, the Bank can exercise existing credit arrangements. Current balance sheet liquidity consists of$351.477 million in cash and cash equivalents and$80.887 million of unpledged investment securities. Although current liquidity is deemed adequate, management has the ability to increase on hand liquidity by acquiring brokered CDs in order to fund any anticipated loan growth. During the first six months of 2021, the Corporation increased cash and cash equivalents by$132.500 million . The management of bank liquidity for funding of loans and deposit maturities and withdrawals includes monitoring projected loan fundings and scheduled prepayments and deposit maturities within a 30 day period, a 30- to 90- day period and from 90 days until the end of the year. This funding forecast model is completed weekly. The Corporation's primary source of liquidity on a stand-alone basis is dividends from the Bank. During the first six months of 2021, the Bank paid dividends of$3.5 million to theCorporation. Bank capital remains strong and above the "well-capitalized" level for regulatory purposes as ofJune 30, 2021 . The Corporation also has a line of credit with a correspondent bank that had borrowing availability atJune 30, 2021 of$15 million . The Corporation's current plan for dividends from the Bank are dependent upon the profitability of the Bank, growth of assets at the Bank and the level of capital needed to stay "adequately capitalized." The Corporation will continue to explore opportunities for longer term sources of liquidity and permanent equity to support projected asset growth. Liquidity is managed by the Corporation through itsAsset and Liability Committee ("ALCO"). The ALCO Committee meets regularly to discuss asset and liability management in order to address liquidity and funding needs to provide a process to seek the best alternatives for investments of assets, funding costs, and risk management. The liquidity position of the Bank is managed daily, thus enabling the Bank to adapt its position according to market fluctuations. Core deposits are important in maintaining a strong liquidity position as they represent a stable and relatively low cost source of funds. The Bank's liquidity is best illustrated by the mix in the Bank's core and noncore funding dependence ratio, which explains the degree of reliance on noncore liabilities to fund long-term assets. Core deposits are herein defined as demand deposits, NOW (negotiable order withdrawals), money markets, savings and certificates of deposit under$250,000 . Noncore funding consists of certificates of deposit greater than$250,000 , brokered deposits, and FHLB,Farmers' Home Administration and other borrowings. AtJune 30, 2021 , the Bank's core deposits in relation to total funding were 97.83% compared to 90.63% atDecember 31, 2020 . These ratios indicate that atJune 30, 2021 , that the Bank had slightly decreased its reliance on noncore deposits and borrowings to fund the Bank's long-term assets, namely loans and investments. This decrease is the result of the Bank having taken precautionary measures to augment its cash position at the onset of the COVID-19 pandemic in the first quarter of 2020. The Bank believes that by maintaining adequate volumes of short-term investments and implementing competitive pricing strategies on deposits, it can ensure adequate liquidity to support future growth. The Bank also has correspondent lines 40
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of credit available to meet unanticipated short-term liquidity needs. As ofJune 30, 2021 , the Bank had$106 million of unsecured lines available and additional funding sources available if secured. The Bank believes that its liquidity position remains sufficient to meet both present and future financial obligations and commitments, events or uncertainties that have resulted or are reasonably likely to result in material changes with respect to the Bank's liquidity, including any additional liquidity pressure that may stem from the effects of the COVID-19 pandemic. From a long-term perspective, the Corporation's strategy is to increase core deposits in the Corporation's local markets. Management continually evaluates deposit products it offers in order to remain competitive in its goal of increasing core deposits. The Corporation also has the ability to augment local deposit growth efforts with wholesale CD funding. REGULATORY CAPITAL The Corporation is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory-and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Corporation's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios (set forth in the table below) of total, Tier 1 capital and Common Equity Tier 1 Capital to risk-weighted assets and of Tier 1 capital to average assets. Management has determined that, as ofJune 30, 2021 , the Corporation is well-capitalized. In order to be "well-capitalized" under the current guidelines, a depository institution must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more; an Additional Tier 1 Capital ratio of 8% or more; a Total Capital ratio of 10% or more; and a leverage ratio of 5% or more. The Corporation's and the Bank's actual capital and ratios compared to generally applicable regulatory requirements as ofJune 30, 2021 are as follows (dollars in thousands): Actual Adequacy Purposes Well-Capitalized Amount Ratio Amount Ratio Amount Ratio
Total capital to risk weighted assets: Consolidated$ 150,363 16.2% >$ 74,034 > 8.0% > $ N/A > N/A mBank$ 145,739 15.8% >$ 73,992
> 8.0% >
Tier 1 capital to risk weighted assets: Consolidated$ 144,712 15.6% >$ 55,526 > 6.0% > $ N/A > N/A mBank$ 140,129 15.2% >$ 55,494 > 6.0% >$ 73,992 > 8.0% Common equity Tier 1 capital to risk weighted assets Consolidated$ 144,712 15.6% >$ 41,644 > 4.5% > $ N/A > N/A mBank$ 140,129 15.2% >$ 41,621
> 4.5% >
Tier 1 capital to average assets: Consolidated$ 144,712 9.7% >$ 59,773 > 4.0% > $ N/A > N/A mBank$ 140,129 9.4% >$ 59,751
> 4.0% >$ 74,689 > 5.0%
Regulatory capital is not the same as shareholders' equity reported in the
accompanying condensed consolidated financial statements. Certain assets cannot
be considered assets for regulatory purposes, such as acquisition intangibles
and noncurrent deferred tax benefits.
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