MACKINAC FINANCIAL CORPORATION Forward Looking Statements
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:
? changes in business, economic or political conditions;
? changes in interest rates or interest rate volatility;
? the effects global pandemics and local and national governmental responses
thereto;
? our ability to manage our balance sheet size and capital levels;
? disruptions or failures of our information technology systems or those of our
third party service providers;
? cyber security threats, system disruptions and other potential security
breaches or incidents;
? customer demand for financial products and services;
? our ability to continue to compete effectively and respond to aggressive
competition within our industry;
our ability to participate in consolidation opportunities in our industry, to
? complete consolidation transactions and to realize synergies or implement
integration plans;
? our ability to manage our significant risk exposures effectively;
? our ability to manage credit risk with customers and counterparties;
changes in government regulation, including interpretations, or actions by our
? regulators, including those that may result from the implementation and
enforcement of regulatory reform legislation;
? adverse developments in any investigations, disciplinary actions or litigation;
and
? other factors detailed from time to time in our filings with the
Overview
The following discussion and analysis presents the more significant factors affecting the Corporation's financial condition as ofDecember 31, 2020 and 2019 and the results of operations for 2019 and 2020. This discussion also covers asset quality, liquidity, interest rate sensitivity, and capital resources for the years 2019 and 2020. 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 and related notes and other supplemental information presented elsewhere in this report. Throughout this discussion, the term "Bank" refers to mBank, the principal banking subsidiary of the Corporation.
Dollar amounts in tables are stated in thousands, except for per share data.
EXECUTIVE SUMMARY The purpose of this section is to provide a brief summary of the 2020 results of operations and financial condition. A more detailed analysis of the results of operations and financial condition follows this summary. The Corporation reported net income of$13.473 million , or$1.27 per share, for the year endedDecember 31, 2020 , compared to$13.850 million , or$1.29 per share, in 2019. Net income was positively impacted by the recognition of$4.030 million as a result of participation in the Payment Protection Program ("PPP") Total assets of the Corporation atDecember 31, 2020 , were$1.502 billion , an increase of$181.661 million , or 13.76%, from total assets of$1.320 billion reported atDecember 31, 2019 . 27 Table of Contents AtDecember 31, 2020 , the Corporation's total loans stood at$1.078 billion , an increase of$18.816 million , or 1.78%, from 2019 year-end balances of$1.059 billion . Total loan production in 2020 exluding PPP loans amounted to$393.059 million , which included$208.398 million of secondary market mortgage loans sold. When including the PPP loans, total production was$545.565 million , which includes$152.506 million of PPP loans. The Corporation also sold$14.057 million of SBA/USDA guaranteed loans. Loan balances were also impacted by normal amortization and paydowns, some of which related to payoffs on participation loans. As ofDecember 31, 2020 , the Corporation had experienced no material adverse systemic issues or material deterioration in its loan portfolio prior 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 inavoidably 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 the 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. COVID-19 loan modifications resided at a nominal$2.4 million , or .25% of total loans with no commervial loans remaining in total payment deferral atDecember 31, 2020 . This is compared to peak levels of$201 million in the second quarter of 2020. Nonperforming loans totaled$5.458 million , or .51%, of total loans atDecember 31, 2020 compared to$5.183 million , or .49% of total loans atDecember 31, 2019 . Nonperforming assets atDecember 31, 2020 , were$7.210 million , .48% of total assets, compared to$7.377 million , or .56% of total assets, atDecember 31, 2019 . Total deposits increased from$1.076 billion atDecember 31, 2019 to$1.259 billion atDecember 31, 2020 , an increase of 17.02%. The increase in deposits in 2020 was comprised of a decrease in noncore deposits of$11.002 million and an increase in core deposits of$194.101 million . Shareholders' equity totaled$167.864 million atDecember 31, 2020 , compared to$161.919 million at the end of 2019, an increase of$5.945 million . This change reflects the net income available to common shareholders of$13.473 million , other comprehensive income of$.767 million , an increase related to stock compensation expense of$.878 million , dividends declared on common stock of$5.895 million , and a decrease due to share repurchases of$3.278 million . The book value per common share atDecember 31, 2020 , amounted to$15.99 compared to$15.06 at the end of 2019.
For a description of our significant accounting policies, see Note 1 to the financial statements included herein.
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RESULTS OF OPERATIONS
(dollars in thousands, except per share data) 2020 2019
Taxable-equivalent net interest income$ 55,185 $ 54,179 Taxable-equivalent adjustment (379) (272)
Net interest income, per income statement 54,806 53,907 Provision for loan losses
1,000 385
Other income 10,199 5,953
Other expense 46,949 41,765
Income before provision for income taxes 17,056 17,710
Provision for income taxes 3,583 3,860
Net income $ 13,473 $ 13,850
Earnings per common share
Basic $ 1.27 $ 1.29
Diluted $ 1.27 $ 1.29
Return on average assets .92% 1.04%
Return on average equity 8.19 8.78
Summary
The Corporation reported net income available to common shareholders of
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 funding sources. Net interest revenue is the Corporation's principal source of revenue, representing 84.31% of total revenue in 2020. The Corporation's net interest income is impacted by economic and competitive factors that influence rates, loan demand, and the availability of funding. Net interest income on a taxable equivalent basis increased$1.006 million from$54.179 million in 2019 to$55.185 million in 2020. In 2020, there was one 100 basis point rate decrease and one 50 basis point rate decrease to the federal funds rate. There were three 25 basis point rate increases to the federal funds rate in 2019. The Corporation experienced a decrease of 51 basis points in the overall rates on earning assets from 5.49% in 2019 to 4.98% in 2020. Interest bearing funding sources decreased by 38 basis points, from 1.17% in 2019 to 0.79% in 2020. The combination of these effective rate changes resulted in a decrease in the taxable equivalent net interest margin from 4.60% in 2019 to 4.40% in 2020. 29 Table of Contents
The following table details sources of net interest income for the two years
ended
2020 Mix 2019 Mix
Interest Income
Loans, taxable $ 58,412 94.17% $ 59,673 92.68%
Loans, tax-exempt 201 0.32 187 0.29
Taxable securities 2,255 3.64 2,708 4.21
Nontaxable securities 535 0.86 343 0.53Other interest-earning assets 626 1.01 1,473 2.29 Total earning assets
62,029 100.00% 64,384 100.00%
Interest Expense NOW, money markets, checking 781 10.81 1,473 14.06% Savings
497 6.88 599 5.72
Certificates of deposit 3,669 50.80 4,869 46.47
Brokered deposits 1,105 15.30 2,495 23.81
Borrowings 1,171 16.21 1,041 9.94
Total interest-bearing funds 7,223 100.00% 10,477 100.00%Net interest income$ 54,806 $ 53,907 Average Rates Earning assets 4.95% 5.46% Interest-bearing funds 0.79 1.17 Interest rate spread 4.16 4.29
For purposes of this presentation, non-taxable interest income has not been restated on a tax-equivalent basis.
As shown in the table above, income on loans provides more than 94% of the Corporation's interest revenue. The Corporation's loan portfolio has approximately$386.198 million of variable rate loans that predominantly reprice with changes in the prime rate and$691.394 million of fixed rate loans. A portion of the variable rate loans, 22%, or$86.255 million , have interest
rate
floors.
The majority of interest bearing liabilities do not reprice automatically with
changes in interest rates, which provides flexibility to manage interest income.
Management monitors the interest rate sensitivity of earning assets and interest
bearing liabilities to minimize the risk of movements in interest rates.
The following table presents the amount of taxable equivalent 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.
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Taxable equivalent adjustments are the result of increasing income from tax-free
loans and investments by an amount equal to the taxes that would be paid if the
income were fully taxable based on a 21% federal tax rate, thus making
tax-exempt yields comparable to taxable asset yields.
Year Ended December 31,
2020 2019
Average Average Average Average
(dollars in thousands) Balance Interest Rate Balance Interest Rate
ASSETS:
Loans (1,2,3) $ 1,117,132 $ 58,850 5.27% $ 1,047,439 $ 60,055 5.73%
Taxable securities 86,767 2,255 2.60 94,768 2,709 2.86
Nontaxable securities (2) 21,503 677 3.15 14,988 419 2.80Other interest-earning assets 28,909 626 2.17
21,544 1,473 6.84
Total earning assets 1,254,311 62,408 4.98 1,178,739 64,656 5.49
Reserve for loan losses (5,436) (5,254)
Cash and due from banks 126,731 72,711
Fixed assets 25,233 23,364
Other real estate owned 2,067 2,448
Other assets 61,768 60,874
210,363 154,143
TOTAL AVERAGE ASSETS $ 1,464,674 $ 1,332,882
LIABILITIES AND SHAREHOLDERS'
EQUITY:
NOW and Money Markets $ 298,508 $ 742 0.25% $ 256,974 $ 1,315 0.51%
Interest checking 99,788 39 0.04 106,978 159 0.15
Savings deposits 121,485 497 0.41 110,559 599 0.54
Certificates of deposit 236,606 3,669 1.55 259,381 4,869 1.88
Brokered deposits 77,861 1,105 1.42 102,317 2,494 2.44
Borrowings 85,651 1,171 1.37 58,300 1,041 1.79Total interest-bearing liabilities 919,899 7,223 0.79
894,509 10,477 1.17
Demand deposits 369,056 266,007
Other liabilities 11,214 14,535
Shareholders' equity 164,505 157,831
544,775 438,373
TOTAL AVERAGE LIABILITIES AND
SHAREHOLDERS' EQUITY $ 1,464,674 $ 1,332,882
Rate spread 4.19 4.32
Net interest margin/revenue, tax
equivalent basis $ 55,185 4.40% $ 54,179 4.60%
(1) For purposes of these computations, non-accruing loans are included in the
daily average loan amounts outstanding.
(2) The amount of interest income on nontaxable securities and loans has been
adjusted to a tax equivalent basis, using a 21% tax rate for 2020 and 2019.
(3) Interest income on loans includes loan fees.
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The following table presents the dollar amount, in thousands, of changes in
taxable equivalent interest income and interest expense for major components of
interest-earning assets and interest-bearing obligations. It distinguishes
between changes related to higher or lower outstanding balances and changes due
to the levels and fluctuations in interest rates. For each category of
interest-earning assets and interest-bearing obligations, information is
provided for changes attributable to (i) changes in volume (i.e. changes in
volume multiplied by prior period rate) and (ii) changes in rate (i.e. changes
in rate multiplied by prior period volume). For purposes of this table, changes
attributable to both rate and volume are shown as a separate variance.
Year ended December 31,
2020 vs. 2019
Increase (Decrease)
Due to Total
Volume Increase
Volume Rate and Rate (Decrease)
Interest earning assets:
Loans $ 3,996 $ (4,877) $ (324) $ (1,205)
Taxable securities (229) (246) 21 (454)
Nontaxable securities 182 53 23 258Other interest earning assets (130) (631) (86) (847) Total interest earning assets$ 3,819 $ (5,701)
Interest bearing obligations: NOW and money market deposits$ 213 $ (676)
$ (110) $ (573) Interest checking (11) (117) 8 (120) Savings deposits 59 (147) (14) (102) Certificates of deposit (427) (847) 74 (1,200) Brokered deposits (596) (1,042) 249 (1,389) Borrowings 488 (244) (114) 130
Total interest bearing obligations$ (274) $ (3,073)
Net interest income, tax equivalent basis
$ 1,006 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 2020, the Corporation recorded a provision for loan loss of$1.00 million , compared to a provision of$.385 million in 2019. There was no provision for loan losses for acquired loans as there was no further deterioration of acquired loans since acquisition. Noninterest Income
Noninterest income was$10.199 million and$5.953 million in 2020 and 2019, respectively. The principal recurring sources of noninterest income are the gains and fees on the sale of SBA/USDA guaranteed loans and secondary market mortgage loans. In 2020, revenues from these two business lines totaled$7.664 million compared to$2.797 million in 2019. Deposit related income totaled$1.133 million in 2020 compared to$1.586 million in 2019. 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. 32 Table of Contents
The following table details noninterest income for the two years ended
2020 2019 2020-2019%
Deposit service charges $ 555 $ 548 1.28%
NSF Fees 578 1,038 (44.32)Gain on sale of secondary market loans 5,205 1,544
237.11
Secondary market fees generated 730 345
111.59
SBA Fees 1,729 908
90.42
Mortgage servicing rights (amortization) income 838 693
20.92 Other 562 669 (15.99) Subtotal 10,197 5,745 77.49 Net security gains 2 208 - Total noninterest income$ 10,199 $ 5,953 71.33% Noninterest Expense
Noninterest expense was$46.949 million in 2020 compared to$41.765 million in 2019. Salaries and benefits, at$26.081 million , increased by$3.338 million , or 14.68%, from the 2019 expenses of$22.743 million . The increased salaries and benefits expense was a result of customary annual increases to legacy employees and COVID related expenses.
Management will continue to review all areas of noninterest expense in order to evaluate where opportunities may exist which could reduce expenses without compromising service to customers.
The following table details noninterest expense for the two years ended
% Increase
(Decrease)
2020 2019 2020-2019
Salaries and benefits $ 26,081 $ 22,743 14.68%
Occupancy 4,370 4,069 7.40
Furniture and equipment 3,347 3,000 11.57
Data processing 3,093 2,717 13.84
Professional service fees:
Accounting 765 914 (16.30)
Legal 245 222 10.36
Consulting and other 832 964 (13.69)Total professional service fees 1,842 2,100 (12.29) Loan origination expenses and deposit and card related fees 1,965 1,546 27.10 Writedowns and (gains) losses on OREO held for sale (22)
212 (110.38)
FDIC insurance assessment 578 70 725.71
Communications 935 885 5.65
Advertising 912 889 2.59
Other operating expenses 3,848 3,534 8.89
Total noninterest expense $ 46,949 $ 41,765 12.41%
Federal Income Taxes
Current Federal Tax Provision
The Corporation recognized a federal income tax expense of approximately$3.583 million for the year endedDecember 31, 2020 and$3.860 million for the year endedDecember 31, 2019 . The 2019 tax expense included the effect of a$.140 million one-time non-cash amortization related to an acquired tax credit. The Corporation has reported deferred tax assets of$3.303 million atDecember 31, 2020 . 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. The Corporation, as ofDecember 31, 2020 , had a net operating loss carryforwards for tax purposes of 33
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approximately$8.0 million . The net operating loss carryforwards expire twenty years from the date they originated. These 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.
The table below details the major components of the Corporation's net deferred tax assets (dollars in thousands):
2020 2019
Deferred tax assets:
NOL carryforward $ 1,671 $ 2,147
Allowance for loan losses 1,277 1,144
OREO 157 177
Deferred compensation 198 253
Pension liability 139 147
Stock compensation 159 75
Purchase accounting adjustments 832 1,507
Lease liability 928 980
Other 785 442
Total deferred tax assets 6,146 6,872
Deferred tax liabilities:
Core deposit premium (959) (1,108)
FHLB stock dividend (73) (73)
Right of use asset (928) (980)Unrealized gain on securities (522) (273) Other
(361) (706)
Total deferred tax liabilities (2,843) (3,140)
Net deferred tax asset$ 3,303 $ 3,732 34 Table of Contents FINANCIAL POSITION
The table below illustrates the relative composition of various liability funding sources and asset make-up.
December 31,
2020 2019
(dollars in thousands) Balance Mix Balance Mix
Sources of funds:
Deposits:Non-interest bearing transactional deposits$ 414,804 27.62%$ 287,611 21.79% Interest-bearing transactional deposits 581,311 38.71
482,713 36.57 CD's <$250,000 202,266 13.47 233,956 17.72 Total core deposit funding 1,198,381 79.80 1,004,280 76.08 CD's >$250,000 15,224 1.01 12,775 0.97 Brokered deposits 45,171 3.01 58,622 4.44
Total noncore deposit funding 60,395 4.02
71,397 5.41 FHLB and other borrowings 63,479 4.23 70,776 5.36 Other liabilities 11,611 0.77 11,697 0.89 Shareholders' equity 167,864 11.18 161,919 12.26 Total$ 1,501,730 100.00%$ 1,320,069 100.00% Uses of Funds: Net Loans$ 1,071,776 71.37%$ 1,053,468 79.82%
Securities available for sale 111,836 7.45 107,972 8.18 Federal funds sold 76 0.01 32 - Federal Home Loan Bank Stock 4,924 0.33
4,924 0.37
Interest-bearing deposits 2,917 0.19 10,295 0.78
Cash and due from banks 218,901 14.58 49,794 3.77
Other assets 91,300 6.07 93,584 7.08
Total $ 1,501,730 100.00% $ 1,320,069 100.00%
Securities
The securities portfolio is an important component of the Corporation's asset
composition to provide diversity in its asset base and provide liquidity.
Securities increased
The carrying value of the Corporation's securities atDecember 31 (dollars in thousands) is as follows: 2020 2019 US Agencies$ 6,589 $ 14,496 US Agencies - MBS 34,280 34,526 Corporate 28,043 20,938
Obligations of states and political subdivisions 42,924 38,012
Total securities$ 111,836 $ 107,972
The Corporation's policy is to purchase securities of high credit quality, consistent with its asset/liability management strategies. The Corporation classifies all securities as available for sale, in order to maintain adequate liquidity and to maximize its ability to react to changing market conditions. AtDecember 31, 2020 , investment securities with an estimated fair market value of$26.190 million were pledged as collateral for FHLB borrowings and certain
customer relationships.
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Loans
The Bank is a full service lender and offers a variety of loan products in all
of its markets. The majority of its loans are commercial, which represents
approximately 76% of total loans outstanding at
The Corporation continued to experience strong loan demand in 2020, total loan production excluding PPP loans was$393.059 million of new organic loan production, which included$208.398 million of mortgage loans sold in the secondary market. When including the PPP loans, total production was$545.565 million , which includes$152.506 million of PPP loans. At 2020 year-end, the Corporation's loans stood at$1.078 billion , an increase from the 2019 year-end balances of$1.059 billion . The production of loans, exclusive of PPP loans, was distributed among our regions, with theUpper Peninsula at$171.251 million ,$143.559 million in theNorthern Lower Peninsula ,$21.839 million inSoutheast Michigan and$56.410 million inWisconsin .
Management believes a properly positioned loan portfolio provides the most attractive earning asset yield available to the Corporation and, with the current loan approval process and exception reporting, management can effectively manage the risk in the loan portfolio. Management intends to continue 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 and satisfy strong underwriting requirements.
The following table details the loan activity for 2020 and 2019 (dollars in thousands):
Loan balances as of
Total production 385,548 Secondary market sales (89,546) SBA loan sales (12,334) Loans transferred to OREO (1,629)
Normal amortization/paydowns and payoffs (262,127)
Loan balances as of
Total production 545,565 Secondary market sales (208,398) SBA loan sales 14,057 Loans transferred to OREO (874)
Normal amortization/paydowns and payoffs (331,534)
Loan balances as of
Following is a table that illustrates the balance changes in the loan portfolio for 2020 and 2019 year-end (dollars in thousands):
Percent Change
2020 2019 2020-2019
Commercial real estate $ 498,450 $ 514,394 (3.15)%Commercial, financial, and agricultural 273,759 211,023
29.73
One-to-four family residential real estate 227,044 253,918
(10.58)
Construction:
Consumer 11,661 18,096 (35.56)
Commercial 47,698 40,107 18.93
Consumer 18,980 21,238 (10.63)
Total $ 1,077,592 $ 1,058,776 1.75%
Our commercial real estate loan portfolio predominantly relates to owner occupied real estate, and our loans are generally secured by a first mortgage lien. We make commercial loans for many purposes, including working capital
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lines, which are generally renewable annually and supported by business assets, personal guarantees and additional collateral. Commercial business lending is generally considered to involve a higher degree of risk than traditional consumer bank lending. Following is a table showing the composition of loans by significant industry types in the commercial loan portfolio as ofDecember 31 (dollars in thousands): 2020 2019 % of % of % of % of Balance Loans Capital Balance Loans Capital Real estate - operators of nonresidential buildings$ 138,992 16.95% 82.80$ 141,965 18.54% 87.68 Hospitality and tourism 100,237 12.23 59.71 97,721 12.77 60.35 Lessors of
residential buildings 52,035 6.35 31.00 51,085 6.67 31.55 Gasoline stations and convenience stores 29,046 3.54 17.30 27,176 3.55 16.78 Logging 18,651 2.27 11.11 22,136 2.89 13.67 Commercial construction 47,698 5.82 28.41 40,107 5.24 24.77 Other 433,248 52.84 258.09 385,334 50.34 237.98 Total commercial loans$ 819,907 100.00%$ 765,524 100.00%
Management recognizes the additional risk presented by the concentration in certain segments of the portfolio. Management does not believe that its current portfolio composition has increased exposure related to any specific industry concentration as of 2020 year-end. 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 ofDecember 31, 2020 , our residential loan portfolio totaled$238.705 million , or 22.15%, of our total outstanding loans. Due to the seasonal nature of many of the Corporation's commercial loan customers, loan payment terms provide flexibility by structuring payments to coincide with the customer's business cycle. The lending staff evaluates the collectability of the 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. Troubled debt restructurings ("TDR") are determined on a loan-by-loan basis. Generally restructurings are related to interest rate reductions, loan term extensions and short term payment forbearance as means to maximize collectability of troubled credits. If a portion of the TDR loan is uncollectible (including forgiveness of principal), the uncollectible amount will be charged off against the allowance at the time of the restructuring. In general, a borrower must make at least six consecutive timely payments before the Corporation would consider a return of a restructured loan to accruing status in accordance withFDIC guidelines regarding restoration of credits to accrual status. More recent regulatory guidelines and accounting standards indicate that loan modifications or forbearances elated to the COVID-19 pandemic will generally not be considered TDRs. COVID-19 loan modifications resided at a nominal$2.4 million , or .25% of total loans with no commervial loans remaining in total payment deferral atDecember 31, 2020 . This is compared to peak levels of$201 million in the second quarter of 2020. The Corporation has, in accordance with generally accepted accounting principles standard updates, evaluated all loan modifications to determine the fair value impact of the underlying asset. The carrying amount of the loan is compared to the expected payments to be received, discounted at the loan's original rate, or for collateral dependent loans, to the fair value of the collateral. 37 Table of Contents The Corporation, atDecember 31, 2020 , had performing loans of$5.910 million and$.900 million of nonperforming loans for which repayment terms were modified to the extent that they were deemed to be "restructured" loans. The total performing restructured loans of$5.910 million is comprised of 23 performing loans, the largest of which had aDecember 31, 2020 balance of$1.502 million . The nonperforming restructured portfolio consists of six loan relationships, the largest balance of which is$.784 million . These TDRs are not COVID-19 related. Credit Quality
The table below shows balances of nonperforming assets for the years ended
December 31, December 31,
2020 2019
Nonperforming Assets:
Nonaccrual loans $ 5,458 $ 5,172
Loans past due 90 days or more - 11
Restructured loans on nonaccrual - -
Total nonperforming loans 5,458 5,183
Other real estate owned 1,752 2,194
Total nonperforming assets $ 7,210 $ 7,377
Nonperforming loans as a % of loans 0.51% 0.49%
Nonperforming assets as a % of assets 0.48% 0.56%
Reserve for Loan Losses:
At period end $ 5,816 $ 5,308
As a % of outstanding loans .54% .51%
As a % of nonperforming loans 106.56% 102.41%
As a % of nonaccrual loans 106.56% 102.63%
Texas Ratio 4.82% 4.41%
Management continues to address market issues impacting its loan customer base.
In conjunction with the Corporation's senior lending staff and the bank
regulatory examinations, management reviews the Corporation's loans, related
collateral evaluations, and the overall lending process. The Corporation also
utilizes a loan review 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 with respect to credit quality. The
Corporation will again utilize a consultant for loan review in 2021.
The following table details the impact of nonperforming loans on interest income
for the two years ended
2020 2019
Interest income that would have been recorded at original rate
- -
Net interest lost $ 272 $ 211
Allowance for Loan Losses
Management analyzes the allowance for loan losses on a quarterly basis to
determine whether the losses inherent in the portfolio are properly reserved
for. Net charge-offs in 2020 amounted to $.492 million , or .04% of average loans
outstanding, compared to $.260 million , or .02% of loans outstanding in 2019.
The current reserve balance is representative of the relevant risk inherent
within the Corporation's loan portfolio. The balance of the allowance for loan
losses does not contemplate acquisition fair value adjustments, as detailed in
Note 4 - "Loans". Additions or reductions to the reserve in future periods will
be dependent upon a combination of future loan growth, nonperforming loan
balances and charge-off activity. Management continues to actively refine the
provision and allowance for loan losses as client impact and broader economic
data from the pandemic becomes more clear. As of December 31, 2020 , there have
been no indications of systemic adverse trends and COVID-19 related
modifications are at modest levels.
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A two year history of relevant information on the Corporation's credit quality is displayed in the following table (dollars in thousands):
Allowance for Loan Losses 2020 2019 Balance at beginning of period$ 5,308 $
5,183
Loans charged off: Commercial 525
130
One-to-four family residential real estate 117
152 Consumer 117 228 Total loans charged off 759 510 Recoveries of loans previously charged off: Commercial 187
165
One-to-four family residential real estate 19
49
Consumer 61
36
Total recoveries of loans previously charged off 267
250 Net loans charged off 492 260 Provision for loan losses 1,000 385 Balance at end of period$ 5,816 $ 5,308 Total loans, period end$ 1,077,592 $ 1,058,776 Average loans for the year 1,117,132 1,047,439 Allowance to total loans at end of year 0.54%
0.50%
Net charge-offs to average loans 0.04
0.02
Net charge-offs to beginning allowance balance 9.27 5.02 The computation of the required allowance for loan losses as of any point in time is one of the critical accounting estimates made by management in the financial statements. As such, factors used to establish the allowance could change significantly from the assumptions made and impact future earnings positively or negatively. The future of the national and local economies and the resulting impact on borrowers' ability to repay their loans and the value of collateral are examples of areas where assumptions must be made for individual loans, as well as the overall portfolio. The allowance for loan losses consists of specific and general components. Our internal risk system is used to identify loans that meet the criteria for being "impaired" as defined in the accounting guidance. The specific component relates to loans that are individually classified as impaired and where expected cash flows are less than carrying value. The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors include: (1) changes in the nature, volume and terms of loans, (2) changes in lending personnel, (3) changes in the quality of the loan review function, (4) changes in nature and volume of past-due, nonaccrual and/or classified loans, (5) changes in concentration of credit risk, (6) changes in economic and industry conditions, (7) changes in legal and regulatory requirements, (8) unemployment and inflation statistics, and (9) underlying collateral values. As ofDecember 31, 2020 , the allowance for loan losses represented .54% of total loans. The total coverage ratio (equivalent to ALLL plus remaining purchase accounting credit marks to total loans less PPP balances) is .95%. 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. This position is further illustrated by the ratio of the allowance as a percent of nonperforming loans, which stood at 106.56% atDecember 31, 2020 . The Corporation maintains balances in nonperforming loans garnered in various acquisitions. In 2020, the Corporation had positive resolution of a portion of this portfolio, which resulted in accretable interest of approximately$1.006 million compared to$.404 million in 2019. As part of the process of resolving problem credits, the Corporation may acquire ownership of real estate collateral which secured such credits. The Corporation carries this collateral in other real estate held for sale on the balance sheet. 39 Table of Contents
The following table represents the activity in other real estate held for sale (dollars in thousands):
Balance at December 31, 2018$ 3,119
Other real estate transferred from loans due to foreclosure 1,629 Proceeds from sale of other real estate
(1,329)
Transfer to premise and equipment (1,013)
Writedowns on other real estate held for sale (347)
Loss on other real estate held for sale 135
Balance at December 31, 2019 $ 2,194 Other real estate transferred from loans due to foreclosure 874 Proceeds from sale of other real estate
(1,338)
Transfer to premise and equipment -
Writedowns on other real estate held for sale (65)
Gain on other real estate held for sale 87
Balance at December 31, 2020 $ 1,752
During 2020, the Corporation received real estate in lieu of loan payments of
$.874 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 balance and records any additional reductions in the fair value as
a write-down of other real estate held for sale.
Deposits
Total deposits at December 31, 2020 were $1.259 billion , an increase of $183.099
million , or 17.02%, from December 31, 2019 deposits of $1.076 billion . The table
below shows the deposit mix for the periods indicated (dollars in thousands):
2020 Mix 2019 Mix
CORE:
Noninterest bearing $ 414,804 32.95% $ 287,611 26.74%
NOW, money market, checking 450,556 35.79 373,165 34.69
Savings 130,755 10.39 109,548 10.18
Certificates of Deposit <
21.75
Total core deposits 1,198,381 95.20 1,004,280 93.36
NONCORE:
Certificates of Deposit >
1.19
Brokered CDs 45,171 3.59 58,622 5.45
Total non-core deposits 60,395 4.80 71,397 6.64
Total deposits $ 1,258,776 100.00% $ 1,075,677 100.00%
The increase in deposits is composed of a decrease in noncore deposits of
$11.002 million and an increase in core deposits of $194.101 million . As shown
in the table above, core deposits represent approximately 95% of total deposits.
The majority of the growth in core deposits has centered on transactional
deposits through our branch network outreach and treasury management line of
business.
Management continues to monitor existing deposit products in order to stay
competitive, both as to terms and pricing. 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. It is the intent of management to be aggressive in its markets to
grow core deposits with an emphasis placed on transactional accounts.
40
Table of Contents
Borrowings
The Corporation also utilizes FHLB borrowings as a source of funding. At 2020
year end, this source of funding totaled $63.1 million and the Corporation
secured this funding by pledging loans and investments. The $63.1 million of
FHLB borrowings had a weighted average maturity of 1.89 years, with a weighted
average rate of 1.67% at December 31, 2020 .
The Corporation currently has one correspondent banking borrowing relationship.
The relationship consists of a $15.0 million revolving line of credit, which had
no outstanding balance at December 31, 2020 . The line of credit bears interest
at a rate of LIBOR plus 2.00%, with a floor rate of 3.00% and a ceiling of 22%.
The line of credit expires on April 30, 2022 . LIBOR was 0.24% at December 31,
2020 . The relationship is secured by all of the outstanding mBank stock.
Shareholders' Equity
Changes in shareholders' equity are discussed in detail in the "Capital and Regulatory" section of this report.
LIQUIDITY Liquidity is defined 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 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. As a final source of liquidity, the Bank can exercise existing credit arrangements. During 2020, the Corporation increased cash and cash equivalents by$169.151 million . As shown on the Corporation's consolidated statement of cash flows, liquidity was primarily impacted by cash provided by investing activities and cash used in financing activities. The net change in investing activities included a net increase in loans of$16.508 million and a net increase in securities available for sale of$2.789 million . The Corporation also had a net increase in cash through financing activities partially due to a increase in deposit liabilities of$183.099 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 Bank's investment portfolio provides added liquidity during periods of market turmoil and overall liquidity concerns in the financial markets. As ofDecember 31, 2020 ,$85.646 million of the Bank's investment portfolio was unpledged, which makes them readily available for sale to address any short
term liquidity needs. It is anticipated that during 2021, the Corporation will fund anticipated loan production with a combination of core-deposit growth and noncore funding, primarily brokered CDs to the extent the level of brokered CDs remains within our conservative policy limitations. The Corporation's primary source of liquidity on a stand-alone basis is dividends from the Bank. In 2020, the Bank paid$11.5 million in dividends to theCorporation. Bank capital, after payment of this dividend, remained strong and above the "well capitalized" level for regulatory purposes. The Corporation has a$15.0 million line of credit with a correspondent bank, which also serves as a source of liquidity. As ofDecember 31, 2020 ,$15.0 million was available to the Corporation under this line. 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 alternative 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 (the "ALCO" Committee). 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 non-core funding dependency ratio, which explains the degree of reliance on non-core liabilities to fund long-term assets. 41 Table of Contents
Core deposits are herein defined as demand deposits, NOW (negotiable order withdrawals), money markets, savings and certificates of deposit under$250,000 . Non-core funding consists of certificates of deposit greater than$250,000 , brokered deposits, and FHLB and other borrowings. AtDecember 31, 2020 , the Bank's core deposits in relation to total funding were 90.63% compared to 87.60% in 2019. These ratios indicated atDecember 31, 2020 , that the Bank had decreased its reliance on non-core deposits and borrowings to fund the Bank's long-term assets, namely loans and investments. 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 of credit available to meet unanticipated short-term liquidity needs. As ofDecember 31, 2020 , the Bank had$106 million of unsecured overnight borrowing lines available and additional amounts available if secured. Management believes that its liquidity position remains strong 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.
From a long-term perspective, the Corporation's strategy is to increase core deposits in the Corporation's local markets. The Corporation also has the ability to augment local deposit growth with wholesale CD funding.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
As disclosed in the Notes to the Consolidated Financial Statements, the
Corporation has certain obligations and commitments to make future payments
under contracts. At
Payments Due by Period
After 5
Less than 1 Year 1 to 3 Years 4 to 5 Years Years Total
Contractual Obligations
Total deposits $ 1,169,402 $ 83,423 $ 5,251 $ 700 $ 1,258,776 Federal Home Loan Bank borrowings 35,003 25,152 - 3,000 63,155 Other borrowings 82 242 - - 324 Directors' deferred compensation 302 673 270 317 1,562 Annual rental / purchase commitments under noncancelable leases / contracts 836 1,690 1,042 1,038 4,606 TOTAL$ 1,205,625 $ 111,180 $ 6,563 $ 5,055 $ 1,328,423 Other Commitments Letters of credit $ 8,781 $ - $ - $ -$ 8,781
Commitments to extend credit 172,633 -
- - 172,633
Credit card commitments 7,136 - - - 7,136
TOTAL $ 188,550 $ - $ - $ - $ 188,550
CAPITAL AND REGULATORY
As a bank holding company, the Corporation is required to maintain certain levels of capital under government regulation. There are several measurements of regulatory capital, and the Corporation is required to meet minimum requirements under each measurement. The federal banking regulators have also established capital classifications beyond the minimum requirements in order to risk-rate deposit insurance premiums and to provide trigger points for prompt corrective action in the event an institution becomes financially troubled.The Corporation and Bank capital is also impacted by the disallowed portion of the Corporation's deferred tax asset. The portion of the deferred tax asset which is allowed to be included in regulatory capital is based on the amount of the asset, net of any valuation allowance and deferred tax liabilities. The amount included is phased in through 2018. See "Business - Supervision and Regulation" and "Regulatory Capital Requirements" for additional information regarding regulatory capital, as well as Note 16 to the Corporation's Consolidated Financial Statements in Item 8 of this Form 10-K below. 42 Table of Contents
Impact of Inflation and Changing Prices
The accompanying financial statements have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and results of operations in historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Corporation's operations. Nearly all the assets and liabilities of the Corporation are financial, unlike industrial or commercial companies. As a result, the Corporation's performance is directly impacted by changes in interest rates, which are indirectly influenced by inflationary expectations. The Corporation's ability to match the interest sensitivity of its financial assets to the interest sensitivity of its financial liabilities tends to minimize the effect of changes in interest rates on the Corporation's performance. Changes in interest rates do not necessarily move to the same extent as changes in the prices of goods and services.
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