RIVERVIEW BANCORP INC Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
This report contains certain financial information determined by methods other than in accordance with accounting principles generally accepted in
the United States of America("GAAP"). These measures include net interest income on a fully tax equivalent basis and net interest margin on a fully tax equivalent basis. Management uses these non-GAAP measures in its analysis of the Company's performance. The tax equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets. Management believes that it is a standard practice in the banking industry to present net interest income and net interest margin on a fully tax equivalent basis, and accordingly believes that providing these measures may be useful for peer comparison purposes. These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other
companies. Critical Accounting Policies Critical accounting policies and estimates are discussed in our 2021 Form 10-K under Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies." That discussion highlights estimates that the Company makes that involve uncertainty or potential for substantial change. There have not been any material changes in the Company's critical accounting policies and estimates as compared to the disclosures contained in the Company's 2021 Form 10-K.
As a progressive, community-oriented financial services business, the Company emphasizes local, personal service to residents of its primary market area. The Company considers
Clark, Klickitatand Skamaniacounties of Washington, and Multnomah, Washingtonand Marioncounties of Oregonas its primary market area. The Company is engaged predominantly in the business of attracting deposits from the general public and using such funds in its primary market area to originate commercial business, commercial real estate, multi-family real estate, land, real estate construction, residential real estate and other consumer loans. The Company's loans receivable, net, totaled $947.1 millionat December 31, 2021compared to $924.1 millionat March 31, 2021. The Bank's subsidiary, Riverview Trust Company(the " Trust Company"), is a trust and financial services company with one office located in downtown Vancouver, Washingtonand one office in Lake Oswego, Oregon. The Trust Companyprovides full-service brokerage activities, trust and asset management services. The Bank's Business and Professional Banking Division, with two lending offices in Vancouverand one in Portland, offers commercial and business banking services. The Company's strategic plan includes targeting the commercial banking customer base in its primary market area for loan originations and deposit growth, specifically small and medium size businesses, professionals and wealth building individuals. In pursuit of these goals, the Company will seek to increase the loan portfolio consistent with its strategic plan and asset/liability and regulatory capital objectives, which includes maintaining a significant amount of commercial business and commercial real estate loans in its loan portfolio. Significant portions of recent loan originations, other than SBA PPP loans, are mainly concentrated in commercial business and commercial real estate loans which carry adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate consumer real estate one-to-four family mortgages. The strategic plan also stresses increased emphasis on non-interest income, including increased fees for asset management services through the Trust Companyand deposit service charges. The strategic plan is designed to enhance earnings, reduce interest rate risk and provide a more complete range of financial services to customers and the local communities the Company serves. We believe we are well positioned to attract new customers and to increase our market share through our 16 branches, including, among others, nine in Clark County, three in the Portlandmetropolitan area and three lending centers. 32 Table of Contents Vancouveris located in Clark County, Washington, which is just north of Portland, Oregon. Many businesses are located in the Vancouverarea because of the favorable tax structure and lower energy costs in Washingtonas compared to Oregon. Companies located in the Vancouverarea include: Sharp Microelectronics, Hewlett Packard, Georgia Pacific, Underwriters Laboratory, WaferTech, Nautilus, Barrett Business Services, PeaceHealthand Banfield Pet Hospitals, as well as several support industries. In addition to this industry base, the ColumbiaRiver Gorge Scenic Area and the Portlandmetropolitan area are sources of tourism, which has helped to transform the area from its past dependence on
the timber industry. Operating Strategy
Fiscal year 2022 marks the 99th anniversary since the Bank began operations in 1923. The primary business strategy of the Company is to provide comprehensive banking and related financial services within its primary market area. The historical emphasis had been on residential real estate lending. Since 1998, however, the Company has been diversifying its loan portfolio through the expansion of its commercial and real estate construction loan portfolios. At
December 31, 2021, commercial and real estate construction loans represented 90.7% of total loans compared to 93.8% at March 31, 2021. Commercial lending, including commercial real estate loans, typically has higher credit risk, greater interest margins and shorter terms than residential lending which can increase the loan portfolio's profitability. The Company's goal is to deliver returns to shareholders by increasing higher-yielding assets (in particular, commercial real estate and commercial business loans), increasing core deposit balances, managing problem assets, reducing expenses, hiring experienced employees with a commercial lending focus and exploring expansion opportunities. The Company seeks to achieve these results by focusing on the following objectives: Execution of our Business Plan. The Company is focused on increasing its loan portfolio, especially higher yielding commercial and real estate construction loans, and its core deposits by expanding its customer base throughout its primary market areas. By emphasizing total relationship banking, the Company intends to deepen the relationships with its customers and increase individual customer profitability through cross-marketing programs, which allows the Company to better identify lending opportunities and services for customers. To build its core deposit base, the Company will continue to utilize additional product offerings, technology and a focus on customer service in working toward this goal. The Company will also continue to seek to expand its franchise through de novo branches, the selective acquisition of individual branches, loan purchases and whole bank transactions that meet its investment and market objectives. In this regard, the Company previously announced plans for three new branches located in Clark County, Washington, to complement its existing branch network. New branches in both downtown Camasand in the Cascade Parkneighborhood of Vancouveropened in fiscal 2021. The third new branch location in Ridgefieldis expected to open in the fourth quarter of fiscal 2022. Maintaining Strong Asset Quality. The Company believes that strong asset quality is a key to long-term financial success. The Company has actively managed delinquent loans and nonperforming assets by aggressively pursuing the collection of consumer debts, marketing saleable properties upon foreclosure or repossession, and through work-outs of classified assets and loan charge-offs. The Company's approach to credit management uses well defined policies and procedures and disciplined underwriting criteria resulting in our strong asset quality and credit metrics. Although the Company intends to prudently increase the percentage of its assets consisting of higher-yielding commercial real estate, real estate construction and commercial business loans, which offer higher risk-adjusted returns, shorter maturities and more sensitivity to interest rate fluctuations, the Company intends to manage credit exposure through the use of experienced bankers in these areas and a conservative approach to its lending. 33 Table of Contents Introduction of New Products and Services. The Company continuously reviews new products and services to provide its customers more financial options. All new technology and services are generally reviewed for business development and cost saving purposes. The Company continues to experience growth in customer use of its online banking services, where the Bank provides a full array of traditional cash management products as well as online banking products including mobile banking, mobile deposit, bill pay, e-statements, and text banking. The products are tailored to meet the needs of small to medium size businesses and households in the markets we serve. The Company launched MobiMoney™ in January 2021, which allows account holders the ability to control their respective Riverview debit card from a smartphone or tablet. The Company intends to selectively add other products to further diversify revenue sources and to capture more of each customer's banking relationship by cross selling loan and deposit products and additional services, including services provided through the Trust Companyto increase its fee income. Assets under management by the Trust Companytotaled $1.4 billionand $1.3 billionat December 31, 2021and March 31, 2021, respectively. The Company also offers a third-party identity theft product to its customers. The identity theft product assists our customers in monitoring their credit and includes an identity theft restoration service. Attracting Core Deposits and Other Deposit Products. The Company offers personal checking, savings and money-market accounts, which generally are lower-cost sources of funds than certificates of deposit and are less likely to be withdrawn when interest rates fluctuate. To build its core deposit base, the Company has sought to reduce its dependence on traditional higher cost deposits in favor of stable lower cost core deposits to fund loan growth and decrease its reliance on other wholesale funding sources, including FHLB and FRB advances. The Company believes that its continued focus on building customer relationships will help to increase the level of core deposits and locally-based retail certificates of deposit. In addition, the Company intends to increase demand deposits by growing business banking relationships through expanded product lines tailored to meet its target business customers' needs. The Company maintains technology-based products to encourage the growth of lower cost deposits, such as personal financial management, business cash management, and business remote deposit products, that enable it to meet its customers' cash management needs and compete effectively with banks of all sizes. Core branch deposits increased $117.5 millionat December 31, 2021compared to March 31, 2021. Recruiting and Retaining Highly Competent Personnel with a Focus on Commercial Lending. The Company's ability to continue to attract and retain banking professionals with strong community relationships and significant knowledge of its markets will be a key to its success. The Company believes that it enhances its market position and adds profitable growth opportunities by focusing on hiring and retaining experienced bankers focused on owner occupied commercial real estate and commercial lending, and the deposit balances that accompany these relationships. The Company emphasizes to its employees the importance of delivering exemplary customer service and seeking opportunities to build further relationships with its customers. The goal is to compete with other financial service providers by relying on the strength of the Company's customer service and relationship banking approach. The Company believes that one of its strengths is that its employees are also shareholders through the Company's employee stock ownership ("ESOP") and 401(k) plans. 34 Table of Contents
Composition of commercial and construction loans
The following tables set forth the composition of the Company's commercial and construction loan portfolios based on loan purpose at the dates indicated (in thousands): Other Commercial &
Commercial Real Estate
Business Mortgage Construction Total
December 31, 2021Commercial business $ 208,213$ - $ - $ 208,213SBA PPP 14,322 - - 14,322 Commercial construction - - 7,887 7,887 Office buildings - 125,139 - 125,139 Warehouse/industrial - 97,414 - 97,414
Retail/shopping centers/strip malls - 79,860
- 79,860 Assisted living facilities - 712 - 712 Single purpose facilities - 263,531 - 263,531 Land - 11,351 - 11,351 Multi-family - 53,865 - 53,865
One-to-four family construction - -
10,478 10,478 Total
$ 222,535 $ 631,872 $ 18,365 $ 872,772March 31, 2021 Commercial business $ 171,701$ - $ - $ 171,701SBA PPP 93,444 - - 93,444 Commercial construction - - 9,810 9,810 Office buildings - 135,526 - 135,526 Warehouse/industrial - 87,880 - 87,880
Retail/shopping centers/strip malls - 85,414 -
85,414 Assisted living facilities - 854 - 854 Single purpose facilities - 233,793 - 233,793 Land - 14,040 - 14,040 Multi-family - 45,014 - 45,014
One-to-four family construction - - 7,180
$ 265,145 $ 602,521 $ 16,990 $ 884,656
Comparison of the financial situation at
Cash and cash equivalents, including interest-earning accounts, totaled
$239.9 millionat December 31, 2021compared to $265.4 millionat March 31, 2021. The Company's cash balances fluctuate based upon funding needs and the Company's utilization of its excess cash to purchase higher yielding investment securities based on its asset/liability management program and liquidity objectives in order to maximize earnings. As a part of this strategy, the Company also invests a portion of its excess cash in short-term certificates of deposit held for investment. All of the certificates of deposit held for investment are fully insured by the FDIC. Certificates of deposits held for investment totaled $249,000at both December 31, 2021and March 31, 2021. Investment securities totaled $395.0 millionand $255.9 millionat December 31, 2021and March 31, 2021, respectively. The increase is due to investment purchases partially offset by normal pay downs, calls and maturities. During the nine months ended December 31, 2021and 2020, purchases of investment securities totaled $178.7 millionand $72.9 million, respectively. The Company primarily purchases a combination of securities backed by government agencies (FHLMC, FNMA, SBA or GNMA). At December 31, 2021, the Company determined that none of its investment securities required an other than temporary impairment ("OTTI") charge. For additional information on the Company's investment securities, see Note 5 of the Notes to the Consolidated Financial Statements contained in Item 1 of this Form 10-Q. 35
Loans receivable, net, totaled
$947.1 millionat December 31, 2021compared to $924.1 millionat March 31, 2021, an increase of $23.0 million. The increase is attributed to originations of commercial real estate loans and other commercial business loans and purchases of other commercial business loans and real estate one-to-four family loans. The increases were offset by a decrease in SBA PPP loans related to forgiveness repayments. At December 31, 2021, SBA PPP loans, net of deferred fees which are included in the commercial business loan category, totaled $14.3 millionas compared to $93.4 millionat March 31, 2021. Commercial business loans, excluding SBA PPP loans, and commercial real estate loans increased $36.5 millionand $23.2 million, respectively, since March 31, 2021. Consumer loans increased $30.9 millionfor the nine months ended December 31, 2021due to the purchase of one-to-four family loans totaling $43.4 million. The Company no longer originates one-to-four family mortgage loans and used this purchase as a way to supplement loan originations in this category. Additionally, the Company began purchasing commercial business loans as a way to supplement loan originations and diversity in the commercial loan portfolio. These loans were originated by a third-party located outside the Company's primary market area and totaled $15.0 millionat December 31, 2021. The Company also purchases the guaranteed portion of SBA loans as a way to supplement loan originations, further diversifying its loan portfolio and earn a higher yield than earned on its cash or short-term investments. These SBA loans are originated through another financial institution located outside the Company's primary market area and are purchased with servicing retained by the seller. At December 31, 2021, the Company's purchased SBA loan portfolio was $46.2 millioncompared to $47.4 millionat March 31, 2021. Deposits increased $127.4 millionto $1.5 billionat December 31, 2021compared to $1.3 billionat March 31, 2021. The increase was due to proceeds from SBA PPP loans deposited directly into customer accounts and also due to a change in savings and spending habits as a result of COVID-19. The Company had no wholesale-brokered deposits at December 31, 2021and March 31, 2021. Core branch deposits accounted for 97.0% of total deposits at December 31, 2021compared to 97.4% at March 31, 2021. The Company plans to continue its focus on core deposits and on building customer relationships as opposed to obtaining deposits through the wholesale markets. Shareholders' equity increased $11.5 millionto $163.1 millionat December 31, 2021from $151.6 millionat March 31, 2021. The increase is mainly attributable to net income of $17.7 million. The increase is partially offset by payments of cash dividends totaling $3.6 millionand the repurchase of 249,908 shares of common stock totaling $1.7 millionduring the nine months ended December 31, 2021. Capital Resources The Bank is a state-chartered, federally insured institution subject to various regulatory capital requirements administered by the FDICand WDFI. Failure to meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank'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 Bank to maintain minimum amounts and ratios of total and tier I capital to risk-weighted assets, core capital to total assets and tangible capital to tangible assets (set forth in the table below). Management believes the Bank met all capital adequacy requirements to which it was subject as of December 31, 2021. 36 Table of Contents As of December 31, 2021, the Bank was categorized as "well capitalized" under the FDIC'sregulatory framework for prompt corrective action. The Bank's actual and required minimum capital amounts and ratios were as follows at the dates indicated (dollars in thousands): "Well Capitalized" For Capital Under Prompt Actual Adequacy Purposes Corrective Action Amount Ratio Amount Ratio Amount Ratio December 31, 2021 Total Capital: (To Risk-Weighted Assets) $ 165,70016.72 % $ 79,2858.0 % $ 99,10610.0 % Tier 1 Capital: (To Risk-Weighted Assets) 153,273 15.47 59,463 6.0 79,285 8.0 Common equity tier 1 Capital: (To Risk-Weighted Assets) 153,273 15.47 44,598 4.5 64,419 6.5 Tier 1 Capital (Leverage): (To Average Tangible Assets) 153,273 9.10 67,408
4.0 84,260 5.0 March 31, 2021 Total Capital: (To Risk-Weighted Assets)
$ 151,55517.35 % $ 69,8798.0 % $ 87,34910.0 % Tier 1 Capital: (To Risk-Weighted Assets) 140,529 16.09 52,409 6.0 69,879 8.0 Common equity tier 1 Capital: (To Risk-Weighted Assets) 140,529 16.09 39,307 4.5 56,777 6.5 Tier 1 Capital (Leverage): (To Average Tangible Assets) 140,529 9.63 58,344
4.0 72,930 5.0
In addition to the minimum common equity tier 1 ("CET1"), Tier 1 and total capital ratios, the Bank is required to maintain a capital conservation buffer consisting of additional CET1 capital in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. The capital conservation buffer is required to be an amount greater than 2.5% of risk-weighted assets. As of
December 31, 2021, the Bank's CET1 capital exceeded the required capital conservation buffer at an amount greater than 2.5%. For a bank holding company, such as the Company, the capital guidelines apply on a bank only basis. The Federal Reserveexpects the holding company's subsidiary banks to be well capitalized under the prompt corrective action regulations. If the Company was subject to regulatory guidelines for bank holding companies at December 31, 2021, the Company would have exceeded all regulatory capital requirements. At periodic intervals, the Company's banking regulators routinely examine the Company's financial condition and risk management processes as part of their legally prescribed oversight. Based on their examinations, these regulators can direct that the Company's consolidated financial statements be adjusted in accordance with their findings. A future examination could include a review of certain transactions or other amounts reported in the Company's 2022 consolidated financial statements.
Liquidity is essential to our business. The objective of the Bank's liquidity management is to maintain ample cash flows to meet obligations for depositor withdrawals, to fund the borrowing needs of loan customers, and to fund ongoing operations. Core relationship deposits are the primary source of the Bank's liquidity. As such, the Bank focuses on deposit relationships with local consumer and business clients who maintain multiple accounts and services at the Bank. 37 Table of Contents Liquidity management is both a short and long-term responsibility of the Company's management. The Company adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits and (v) its asset/liability management program objectives. Excess liquidity is generally invested in interest-bearing overnight deposits and other short-term government and agency obligations. If the Company requires funds beyond its ability to generate them internally, it has additional diversified and reliable sources of funds with the FHLB, the FRB and other wholesale facilities. These sources of funds may be used on a long or short-term basis to compensate for a reduction in other sources of funds or on a long-term basis to support lending activities. The Company's primary sources of funds are customer deposits, proceeds from principal and interest payments on loans, proceeds from the sale of loans, maturing securities, FHLB advances and FRB borrowings. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and prepayment of mortgage loans and mortgage-backed securities are greatly influenced by general interest rates, economic conditions and competition. Management believes that its focus on core relationship deposits coupled with access to borrowing through reliable counterparties provides reasonable and prudent assurance that ample liquidity is available. However, depositor or counterparty behavior could change in response to competition, economic or market situations or other unforeseen circumstances, which could have liquidity implications that may require different strategic or operational actions. The Company must maintain an adequate level of liquidity to ensure the availability of sufficient funds for loan originations, deposit withdrawals and continuing operations, satisfy other financial commitments and take advantage of investment opportunities. During the nine months ended
December 31, 2021, the Bank used excess liquidity to fund loan commitments and to purchase investment securities. At December 31, 2021, cash and cash equivalents, certificates of deposit held for investment and available for sale investment securities totaled $422.4 million, or 25.1% of total assets. The Bank generally maintains sufficient cash and short-term investments to meet short-term liquidity needs; however, its primary liquidity management practice is to manage short-term borrowings, including FRB borrowings and FHLB advances consistent with its asset/liability objectives. At December 31, 2021, the Bank, which maintains a credit facility with the FRB with an available borrowing capacity of $42.8 million, subject to sufficient collateral, had no outstanding advances with the FRB. At December 31, 2021, the Bank had an available borrowing capacity of $285.5 millionwith the FHLB, subject to sufficient collateral and stock investment, and had no outstanding advances. At December 31, 2021, the Bank had sufficient unpledged collateral to allow it to utilize its available borrowing capacity from the FRB and the FHLB. Borrowing capacity may, however, fluctuate based on acceptability and risk rating of loan collateral and counterparties could adjust discount rates applied to such collateral at their discretion. An additional source of wholesale funding includes brokered certificates of deposit. While the Company has utilized brokered deposits from time to time, the Company historically has not extensively relied on brokered deposits to fund its operations. At December 31, 2021and March 31, 2021, the Bank had no wholesale brokered deposits. The Bank also participates in the CDARS and ICS deposit products, which allow the Company to accept deposits in excess of the FDICinsurance limit for depositors while obtaining "pass-through" insurance for total deposits. The Bank's CDARS and ICS balances were $50.8 million, or 3.4% of total deposits, and $37.9 million, or 2.8% of total deposits, at December 31, 2021and March 31, 2021, respectively. In addition, the Bank is enrolled in an internet deposit listing service. Under this listing service, the Bank may post time deposit rates on an internet site where institutional investors have the ability to deposit funds with the Bank. At December 31, 2021and March 31, 2021, the Company had no deposits through this listing service. Although the Company did not originate any internet-based deposits during the nine months ended December 31, 2021, the Company may do so in the future consistent with its asset/liability objectives. The combination of all the Bank's funding sources gives the Bank available liquidity of $981.9 million, or 58.3% of total assets at December 31, 2021. At December 31, 2021, the Company had total commitments of $155.7 million, which includes commitments to extend credit of $29.7 million, unused lines of credit totaling $96.8 million, undisbursed real estate construction loans totaling $27.4 million, and standby letters of credit totaling $1.8 million. The Company anticipates that it will have sufficient funds available to meet current loan commitments. Certificates of deposit that are scheduled to mature in less than one year from December 31, 2021totaled $79.0 million. Historically, the Bank has been able to retain a significant amount of its deposits as they mature. Offsetting these cash outflows are scheduled loan maturities of less than one year totaling $43.6 millionat December 31, 2021. 38
Riverview Bancorp, Inc., as a separate legal entity from the Bank, must provide for its own liquidity. Sources of capital and liquidity for Riverview Bancorp, Inc.include distributions from the Bank and the issuance of debt or equity securities. Dividends and other capital distributions from the Bank are subject to regulatory notice. At December 31, 2021, Riverview Bancorp, Inc.had $10.4 millionin cash to meet its liquidity needs.
Nonperforming assets, consisting of nonperforming loans were
$1.8 millionor 0.11% of total assets at December 31, 2021compared with $571,000or 0.04% of total assets at March 31, 2021.
The following table presents information regarding the Company’s non-performing loans as of the dates indicated (in thousands of dollars):
December 31, 2021 March 31, 2021 Number of Number of Loans Balance Loans Balance Commercial business 6
$ 1,6573 $ 357Commercial real estate 1 127 1 144 Consumer 3 56 5 70 Total 10 $ 1,8409 $ 571The increase of $1.2 millionin commercial business nonperforming loans relates to purchased SBA government guaranteed loans which payments due to the Company were delayed due to the servicing rights transfer between two outside third-parties. The Company expects these loans to be removed from the nonperforming loan totals once the servicing transfer is complete. The allowance for loan losses was $15.2 millionor 1.58% of total loans at December 31, 2021compared to $19.2 millionor 2.03% of total loans at March 31, 2021. The Company recorded a recapture of loan losses of $4.0 millionfor the nine months ended December 31, 2021compared to a provision for loan losses of $6.3 millionfor the nine months ended December 31, 2020. The decrease in the allowance for loan losses was primarily due to the continued improvement since March 31, 2021in the national and local economies associated with the recovery from the COVID-19 pandemic. Our SBA PPP loans were omitted from the calculation of the required allowance for loan losses at December 31, 2021and 2020 as these loans are fully guaranteed by the SBA and management expects that a majority of SBA PPP borrowers will seek full or partial forgiveness of their loan obligations from the SBA, which in turn, the SBA will reimburse the Bank for the amount forgiven. The coverage ratio of allowance for loan losses to nonperforming loans was 824.62% at December 31, 2021compared to 3358.67% at March 31, 2021. At December 31, 2021, the Company identified $233,000or 12.64% of its nonperforming loans as impaired and performed a specific valuation analysis on each loan resulting in no specific reserves being required for these impaired loans. Management considers the allowance for loan losses to be adequate at December 31, 2021to cover probable losses inherent in the loan portfolio based on the assessment of various factors affecting the loan portfolio, and the Company believes it has established its existing allowance for loan losses in accordance with GAAP. However, a decline in national and local economic conditions (including declines as a result of the COVID-19 pandemic), results of examinations by the Company's banking regulators, or other factors could result in a material increase in the allowance for loan losses and may adversely affect the Company's future financial condition and results of operations. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses will be adequate or that substantial increases will not be necessary should the quality of any loans deteriorate or should collateral values decline as a result of the factors discussed elsewhere in this document. For further information regarding the Company's impaired loans and allowance for loan losses, see Note 7 of the Notes to Consolidated Financial Statements contained in Item 1 of this Form 10-Q. 39 Table of Contents
Troubled debt restructurings ("TDRs") are loans for which the Company, for economic or legal reasons related to the borrower's financial condition, has granted a concession to the borrower that it would otherwise not consider. A TDR typically involves a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, and/or an extension of the maturity date(s) at a stated interest rate lower than the current market rate for a new loan with similar risk. TDRs are considered impaired loans and as such, when a loan is deemed to be impaired, the amount of the impairment is measured using discounted cash flows and the original note rate, except when the loan is collateral dependent. In these cases, the estimated fair value of the collateral (less any selling costs, if applicable) is used. Impairment is recognized as a specific component within the allowance for loan losses if the estimated value of the impaired loan is less than the recorded investment in the loan. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. All of the Company's TDRs were paying as agreed at
December 31, 2021. The Company has determined that, in certain circumstances, it is appropriate to split a loan into multiple notes. This typically includes a nonperforming charged-off loan that is not supported by the cash flow of the relationship and a performing loan that is supported by the cash flow. These may also be split into multiple notes to align portions of the loan balance with the various sources of repayment when more than one exists. Generally, the new loans are restructured based on customary underwriting standards. In situations where they are not, the policy exception qualifies as a concession, and if the borrower is experiencing financial difficulties, the loans are accounted for as TDRs. The accrual status of a loan may change after it has been classified as a TDR. The Company'sgeneral policy related to TDRs is to perform a credit evaluation of the borrower's financial condition and prospects for repayment under the revised terms. This evaluation includes consideration of the borrower's sustained historical repayment performance for a reasonable period of time. A sustained period of repayment performance generally would be a minimum of six months and may include repayments made prior to the restructuring date. If repayment of principal and interest appears doubtful, it is placed on non-accrual status.
The following table presents information regarding the Company’s non-performing assets as of the dates indicated (in thousands of dollars):
December 31, 2021 March 31, 2021 Loans accounted for on a non-accrual basis: Commercial business $ 123 $ 182 Other real estate mortgage 127 144 Consumer 56 69 Total 306 395 Accruing loans which are contractually past due 90 days or more 1,534 176 Total nonperforming assets $ 1,840 $ 571
Foregone interest on non-accrual loans (1) $ 21 $
Total nonperforming loans to total loans 0.19 % 0.06 % Total nonperforming loans to total assets 0.11 % 0.04 % Total nonperforming assets to total assets 0.11 %
(1) Nine months ended
40 Table of Contents The following tables set forth information regarding the Company's nonperforming assets by loan type and geographical area at the dates indicated (in thousands): Southwest Washington Other Total December 31, 2021 Commercial business
$ 105 $ 1,552 $ 1,657Commercial real estate 127 - 127 Consumer 56 - 56 Total nonperforming assets $ 288 $ 1,552 $ 1,840March 31, 2021 Commercial business $ 182 $ 175 $ 357Commercial real estate 144 - 144 Consumer 63 7 70 Total nonperforming assets $ 389 $ 182 $ 571
The composition of speculative and custom/pre-sold land acquisition and development and construction loans by geographic area is as follows at the dates indicated (in thousands):
Northwest Other Southwest Other Oregon Oregon Washington Washington Total
December 31, 2021Land acquisition and development $ 2,139$ - $ 9,212$ - $ 11,351Speculative and custom/presold construction - - 10,085 393 10,478 Total $ 2,139$ - $ 19,297 $ 393 $ 21,829March 31, 2021 Land acquisition and development $ 2,221 $ 1,765 $ 10,054$ - $ 14,040Speculative and
custom/presold construction - 450 5,382
- 5,832 Total
$ 2,221 $ 2,215 $ 15,436$ - $ 19,872Other loans of concern, which are classified as substandard loans and are not presently included in the non-accrual category, consist of loans where the borrowers have cash flow problems, or the collateral securing the respective loans may be inadequate. In either or both of these situations, the borrowers may be unable to comply with the present loan repayment terms, and the loans may subsequently be included in the non-accrual category. Management considers the allowance for loan losses to be adequate to cover the probable losses inherent in these and other loans.
The following table provides information regarding the Company’s Other Loans of Concern as of the dates indicated (in thousands of dollars):
December 31, 2021 March 31, 2021 Number of Number of Loans Balance Loans Balance Commercial business 2
$ 132- $ - Commercial real estate 3 6,120 2 7,268 Multi-family 1 8 2 24 Total 6 $ 6,2604 $ 7,29241 Table of Contents At December 31, 2021, loans delinquent 30 - 89 days were 0.37% of total loans compared to 0.03% at March 31, 2021and were comprised mainly of commercial business, real estate construction, and consumer loans. There were no loans 30 - 89 days delinquent in the commercial real estate ("CRE") portfolio. At December 31, 2021, CRE loans represented the largest portion of the loan portfolio at 58.89% of total loans and commercial business represented 23.12% of total loans.
Off-balance sheet arrangements and other contractual obligations
In the normal course of operations, the Company enters into certain contractual obligations and other commitments. Obligations generally relate to funding of operations through deposits and borrowings as well as leases for premises. Commitments generally relate to lending operations.
The Company has obligations under long-term operating and capital leases, primarily for building premises and land. Lease terms generally cover periods of five years, with extension options, and are not subject to cancellation.
The Company has commitments to originate fixed and variable rate mortgage loans to customers. Because some commitments expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Undisbursed loan funds and unused lines of credit include funds not disbursed but committed to construction projects and home equity and commercial lines of credit. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.
For more information regarding the Company’s off-balance sheet arrangements and other contractual obligations, see Notes 13 and 14 of the Notes to the Consolidated Financial Statements contained in Item 1 of this Form 10-Q.
Valuation of goodwill
Goodwillis initially recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. Goodwillis presumed to have an indefinite useful life and is tested, at least annually, for impairment at the reporting unit level. The Company has two reporting units, the Bank and the Trust Company, for purposes of evaluating goodwill for impairment. All of the Company's goodwill has been allocated to the Bank reporting unit. The Company performs an annual review in the third quarter of each fiscal year, or more frequently if indications of potential impairment exist, to determine if the recorded goodwill is impaired. If the fair value exceeds the carrying value, goodwill at the reporting unit level is not considered impaired and no additional analysis is necessary. If the carrying value of the reporting unit is greater than its fair value, there is an indication that impairment may exist and additional analysis must be performed to measure the amount of impairment loss, if any. The amount of impairment is determined by comparing the implied fair value of the reporting unit's goodwill to the carrying value of the goodwill in the same manner as if the reporting unit was being acquired in a business combination. Specifically, the Company would allocate the fair value to all of the assets and liabilities of the reporting unit, including unrecognized intangible assets, in a hypothetical analysis that would calculate the implied fair value of goodwill. If the implied fair value of goodwill is less than the recorded goodwill, the Company would record an impairment charge for the difference. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, among others: a significant decline in our expected future cash flows; a sustained, significant decline in our stock price and market capitalization; a significant adverse change in legal factors or in the business climate; adverse action or assessment by a regulator; and unanticipated competition. Any adverse change in these factors could have a significant impact on the recoverability of these assets and could have a material impact on the Company's consolidated financial statements. 42 Table of Contents
The Company performed its annual goodwill impairment test as of
October 31, 2021. The goodwill impairment test involves a two-step process. Step one of the goodwill impairment test estimates the fair value of the reporting unit utilizing the allocation of corporate value approach, the income approach, the whole bank transaction approach and the market approach in order to derive an enterprise value of the Company. The allocation of corporate value approach applies the aggregate market value of the Company and divides it among the reporting units. A key assumption in this approach is the control premium applied to the aggregate market value. A control premium is utilized as the value of a company from the perspective of a controlling interest is generally higher than the widely quoted market price per share. The Company used an expected control premium of 30%, which was based on comparable transactional history. The income approach uses a reporting unit's projection of estimated operating results and cash flows that are discounted using a rate that reflects current market conditions. The projection uses management's best estimates of economic and market conditions over the projected period including growth rates in loans and deposits, estimates of future expected changes in net interest margins and cash expenditures. Assumptions used by the Company in its discounted cash flow model (income approach) included an annual revenue growth rate that approximated 8.1%, a net interest margin that approximated 3.0% and a return on assets that ranged from 1.06% to 1.37% (average of 1.20%). In addition to utilizing the above projections of estimated operating results, key assumptions used to determine the fair value estimate under the income approach were the discount rate of 15.71% utilized for our cash flow estimates and a terminal value estimated at 1.43 times the ending book value of the reporting unit. The Company used a build-up approach in developing the discount rate that included: an assessment of the risk-free interest rate, the rate of return expected from publicly traded stocks, the industry the Company operates in and the size of the Company. The whole bank transaction approach estimates fair value by applying key financial variables in transactions involving acquisitions of similar institutions. In applying the whole bank transaction approach method, the Company identified transactions that occurred during the first 10 months of calendar 2021 utilizing a multiple of 1.4 times price to book value. The market approach estimates fair value by applying tangible book value multiples to the reporting unit's operating performance. The multiples are derived from comparable publicly traded companies with similar operating and investment characteristics of the reporting unit. In applying the market approach method, the Company selected four publicly traded comparable institutions. After selecting comparable institutions, the Company derived the fair value of the reporting unit by completing a comparative analysis of the relationship between their financial metrics listed above and their market values utilizing a market multiple of 1.0 times book value, a market multiple of 1.1 times tangible book value and an earnings multiple of 10 times. The Company calculated a fair value of its reporting unit of $213.0 millionusing the corporate value approach, $204.0 millionusing the income approach, $249.0 millionusing the whole bank transaction approach and $230.0 millionusing the market approach, with a final concluded value of $224.0 million, with equal weight given to the income approach, the whole bank approach, the market approach and the corporate value approach. The results of the Company's step one test indicated that the reporting unit's fair value was greater than its carrying value and therefore no impairment of goodwill exists. The Company also completed a qualitative assessment of goodwill as of December 31, 2021and concluded that it is more likely than not that the fair value of the Bank (the reporting unit), exceeds its carrying value at December 31, 2021. Even though the Company determined that there was no goodwill impairment, a sustained decline in the value of its stock price as well as values of other financial institutions, declines in revenue for the Company beyond our current forecasts, significant adverse changes in the operating environment for the financial industry or an increase in the value of our assets without an increase in the value of the reporting unit may result in a future impairment charge. It is also possible that changes in circumstances existing at the measurement date or at other times in the future, or in the numerous estimates associated with management's judgments, assumptions and estimates made in assessing the fair value of our goodwill, could result in an impairment charge of a portion or all of our goodwill. If the Company recorded an impairment charge, its financial position and results of operations would be adversely affected; however, such an impairment charge would have no impact on our liquidity, operations or regulatory capital. 43 Table of Contents
Comparison of operating results for the three and nine months ended
Net Income. Net income was
$5.5 million, or $0.25per diluted share for the three months ended December 31, 2021, compared to $4.0 million, or $0.18per diluted share for same prior year period. Net income for the nine months ended December 31, 2021and 2020 was $17.7 million, or $0.80per diluted share, and $7.1 million, or $0.32per diluted share, respectively. The Company's net income increased primarily as a result of increased net interest income and the recapture of loan losses of $1.3 millionand $4.0 millionfor the three and nine months ended December 31, 2021, respectively, compared to no provision for loan losses and a provision for loan losses of $6.3 millionfor the three and nine months ended December 31, 2020, respectively. The Company recognized in other non-interest expense a $1.0 milliongain on sale of premises and equipment during the nine months ended December 31, 2021that was not present during the nine months ended December 31, 2020. In addition, the Company recognized in other non-interest income a $500,000BOLI death benefit during the nine months ended December 31, 2021that was not present during the nine months ended December 31, 2020. Net Interest Income. The Company's profitability depends primarily on its net interest income, which is the difference between the income it receives on interest-earning assets and the interest paid on deposits and borrowings. When the rate earned on interest-earning assets equals or exceeds the rate paid on interest-bearing liabilities, this positive interest rate spread will generate net interest income. The Company's results of operations are also significantly affected by general economic and competitive conditions, particularly changes in market interest rates, government legislation and regulation, and monetary and fiscal policies. Net interest income for the three and nine months ended December 31, 2021was $12.1 millionand $35.7 million, representing an increase of $530,000 millionand $2.0 million, respectively, compared to the three and nine months ended December 31, 2020. The net interest margin for the three and nine months ended December 31, 2021was 2.96% and 3.05%, respectively, compared to 3.40% and 3.46% for the three and nine months ended December 31, 2020. The decrease in the net interest margin was primarily the result of the continued low interest rate environment putting downward pressure on adjustable rate instruments and lower yields on new loan originations and investment purchases as compared to the yields on the legacy loan and investment securities portfolios. The increase in low yielding overnight cash balances and the impact of low yielding SBA PPP loans also caused a decrease in the average yield on interest-earning assets partially offset by the decrease in the average yield on interest-bearing liabilities. Finally, the decrease in net interest margin was due to yields earned on interest-earning assets declining at a faster rate than interest rates paid on interest-bearing liabilities as changes in the average rate paid on interest-bearing deposits tend to lag changes in market interest rate changes. Interest and Dividend Income. Interest and dividend income for the three and nine months ended December 31, 2021was $12.6 millionand $37.4 million, respectively, compared to $12.3 millionand $36.5 million, respectively, for the same periods in the prior year. The increase for the three months ended December 31, 2021was primarily due to the increase in interest on investment securities of $776,000when compared to the three months ended December 31, 2020due to the overall increase in average balance of investment securities. Partially offsetting this increase was a decrease in interest income on loans receivable of $555,000due to the 36 basis point decrease in the average yield on mortgage loans to 4.60% for the three months ended December 31, 2021compared to 4.96% for the three months ended December 31, 2020. Interest and dividend income for the nine months ended December 31, 2021increased primarily due to a $1.8 millionincrease in interest income on investment securities which offset a $1.0 milliondecrease in interest income on loans receivable due to the 14 basis point decrease in the average yield on mortgage loans to 4.89% for the nine months ended December 31, 2021compared to 5.03% for the nine months ended December 31, 2020. The average yield on non-mortgage related loans increased 40 basis points to 4.89% and 73 basis points to 4.61% for the three and nine months ended December 31, 2021, respectively, predominantly from higher deferred SBA PPP loan fees recognized from SBA PPP loans that are forgiven. SBA PPP loans have a favorable impact on our non-mortgage loan yields when SBA PPP loans are forgiven and the remaining deferred fees are recognized. Loan interest income was also impacted by the decline in the average balance of net loans between period, as discussed below. The substantial increase in the average balance of overnight cash balances as a result of the increase in deposit balances, is also negatively impacting the average yield on interest earning assets which decreased 55 basis points for both the three and nine months ended December 31, 2021, to 3.08% and 3.19%, respectively, for the three and nine months ended December 31, 2021, compared to 3.63% and 3.74%, respectively, for the three and nine months ended December 31, 2020. Interest and dividend income for the
three and nine months ended 44 Table of Contents
December 31, 2021included $781,000and $2.6 million, respectively, of interest income and fees earned related to SBA PPP loans, compared to $1.5 millionand $3.0 million, respectively, for the same periods in the prior year. The average balance of net loans decreased $17.1 millionand $53.1 millionto $938.1 millionand $922.1 millionfor the three and nine months ended December 31, 2021, respectively, from $955.2 millionand $975.2 millionfor the same periods in the prior year. The average yield on net loans decreased to 4.67% for the three months ended December 31, 2021compared to 4.82% for the same period in the prior year due primarily to lower rates on loan originations. The average yield on net loans increased to 4.81% for the nine months ended December 31, 2021compared to 4.69% for the same period in the prior year due primarily to loan prepayment fees and remaining deferred fees being recognized upon SBA PPP loan forgiveness. For the three and nine months ended December 31, 2021, the average balance of SBA PPP loans was $23.8 millionand $50.0 million, respectively, and the average yield on SBA PPP loans was 13.04% and 6.91%, respectively, which included the recognition of the net deferred fees. The impact of SBA PPP loans on loan yields will change during any period based on the volume of prepayments or amounts forgiven by the SBA as certain criteria are met. Interest Expense. Interest expense totaled $492,000and $1.7 millionfor the three and nine months ended December 31, 2021, respectively, compared to $763,000and $2.8 millionfor the three and nine months ended December 31, 2020, respectively. Interest expense on deposits decreased $256,000and $930,000for the three and nine months ended December 31, 2021, respectively, compared to the same periods in the prior year due to the overall decrease in the weighted average interest rate on interest-bearing deposits. The weighted average interest rate on interest-bearing deposits decreased to 0.12% and 0.16% for the three and nine months ended December 31, 2021, respectively, compared to 0.26% and 0.34% for the same periods in the prior year. The decrease in the weighted average interest rate on regular savings accounts and certificates of deposits contributed primarily to the overall decrease in the expense on deposits which reflects the market's response to the 150 basis point reduction in the targeted federal funds rate in March 2020due to the COVID-19 pandemic. The average balance of interest-bearing deposits increased $162.3 millionand $177.6 millionfor the three and nine months ended December 31, 2021, respectively, compared to the same periods in the prior year. The increase in the average balance of interest-bearing deposits is due primarily to proceeds from SBA PPP loans deposited directly into customer accounts, government stimulus checks and an increase in savings trends and a change in spending habits as a result of COVID-19. Interest expense on borrowings decreased $15,000and $111,000for the three and nine months ended December 31, 2021, respectively, compared to the same periods in the prior year. The average balance of other interest-bearing liabilities decreased $8.8 millionand $19.9 millionfor the three and nine months ended December 31, 2021, respectively, compared to the same periods in the prior year. The weighted average interest rate on other interest-bearing liabilities increased to 2.62% and 2.63% for the three and nine months ended December 31, 2021, respectively, compared to 2.17% and 1.86% for the same periods in the prior year due to the higher rate paid on the outstanding junior subordinated debentures as compared to the outstanding FHLB borrowings. Overall, total interest expense is lower due to the decrease in the weighted average interest rate on total interest-bearing liabilities for the three and nine months ended December 31, 2021compared to the same periods in the prior year. 45
The following tables set forth, for the periods indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income earned on average interest-earning assets and interest expense paid on average interest-bearing liabilities, resultant yields, interest rate spread, ratio of interest-earning assets to interest-bearing liabilities and net interest margin (dollars in thousands): Three
2021 2020 Interest Interest Average and Average and Balance Dividends Yield/Cost Balance Dividends Yield/Cost Interest-earning assets: Mortgage loans
$ 708,329 $ 8,2124.60 % $ 669,531 $ 8,3714.96 % Non-mortgage loans 229,784 2,834 4.89 285,652 3,230 4.49 Total net loans (1) 938,113 11,046 4.67 955,183 11,601 4.82 Investment securities (2) 368,628 1,390 1.50 154,265 607 1.56 Daily interest-earning assets 2,602 - - 1,545 - - Other earning assets 310,432 136 0.17 235,331 98 0.17 Total interest-earning assets 1,619,775 12,572
3.08 1,346 324 12,306 3.63
Non-interest-earning assets: Office properties and equipment, net 18,305 18,970 Other non-interest-earning assets 74,727
78,332 Total assets
$ 1,712,807 $ 1,443,626Interest-bearing liabilities: Regular savings accounts $ 327,22864 0.08 $ 258,13257 0.09 Interest checking accounts 282,916 22 0.03 235,363 19 0.03 Money market accounts 279,958 37 0.05 218,490 34 0.06 Certificates of deposit 112,885 177 0.62 128,677 446 1.38
Total interest-bearing deposits 1,002,987 300 0.12 840,662 556 0.26 Other interest-bearing liabilities 29,102 192 2.62 37,864 207 2.17 Total interest-bearing liabilities 1,032,089 492 0.19 878,526 763 0.34
Non-interest bearing debts:
Non-interest-bearing deposits 500,749
395,939 Other liabilities 17,687 17,525 Total liabilities 1,550,525 1,291,990 Shareholders' equity 162,282 151,636 Total liabilities and shareholders' equity
$ 1,712,807 $ 1,443,626Net interest income $ 12,080 $ 11,543Interest rate spread 2.89 % 3.29 % Net interest margin 2.96 % 3.40 % Ratio of average interest-earning assets to average interest-bearing liabilities 156.94 % 153.25 % Tax equivalent adjustment (3) $ 21 $ 14
(1) Includes outstanding loans.
(2) For the purposes of calculating the average return on investment securities
available for sale, historical cost balances were used; Therefore, the
performance information does not take into account changes in fair value
reflected as a component of equity.
(3) The tax equivalent adjustment relates to non-taxable investment interest income
and preferred equity securities dividend income. 46 Table of Contents Nine Months Ended December 31, 2021 2020 Interest Interest Average and Average and Balance Dividend Yield/Cost Balance Dividends Yield/Cost Interest-earning assets: Mortgage loans
$ 683,719 $ 25,1744.89 % $ 688,044 $ 26,0785.03 % Non-mortgage loans 238,352 8,274 4.61 287,159 8,397 3.88 Total net loans (1) 922,071 33,448 4.81 975,203 34,475 4.69 Investment securities (2) 324,755 3,663 1.50 140,985 1,813 1.71
Daily interest-earning assets 2,690 - - 575 - - Other earning assets 309,649 379 0.16 179,440 216 0.16 Total interest-earning assets 1,559,165 37,490
3.19 1,296,203 36,504 3.74
Non-interest-earning assets: Office properties and equipment, net 19,005 18,183 Other non-interest-earning assets 77,385 77,881 Total assets
Interest-bearing liabilities: Regular savings accounts
$ 314,338184 0.08 $ 250,043364 0.19 Interest checking accounts 276,699 66 0.03 219,210 66 0.04 Money market accounts 265,850 108 0.05 196,929 121 0.08 Certificates of deposit 119,017 783 0.87 132,128 1,520 1.53
Total interest-bearing deposits 975,904 1,141
0.16 798 310 2071 0.34
Other interest-bearing liabilities 29,099 576 2.63 49,011 687 1.86
Total interest-bearing debt 1,005,003 1,717 0.23 847,321 2,758 0.43
Non-interest bearing debts:
Non-interest-bearing deposits 473,082
379,516 Other liabilities 18,436 14,515 Total liabilities 1,496,521 1,241,352 Shareholders' equity 159,034 150,915 Total liabilities and shareholders' equity
$ 1,655,555 $ 1,392,267Net interest income $ 35,773 $ 33,746Interest rate spread 2.96 % 3.31 % Net interest margin 3.05 % 3.46 % Ratio of average interest-earning assets to average interest-bearing liabilities 155.14 % 152.98 % Tax equivalent adjustment (3) $ 54 $ 25
(1) Includes outstanding loans.
(2) For the purposes of calculating the average return on investment securities
available for sale, historical cost balances were used; Therefore, the
performance information does not take into account changes in fair value
reflected as a component of equity.
(3) The tax equivalent adjustment relates to non-taxable investment interest income
and preferred equity securities dividend income. 47 Table of Contents
The following table sets forth the effects of changing rates and volumes on net interest income of the Company for the periods ended
December 31, 2021compared to the periods ended December 31, 2020. Variances that were insignificant have been allocated based upon the percentage relationship of changes in volume and changes in rate to the total net change (in thousands). Three Months Ended December 31, Nine Months Ended December 31, 2021 vs 2020 2021 vs 2020 Increase (Decrease) Due to Increase (Decrease) Due to Total Total Increase Increase Volume Rate (Decrease) Volume Rate (Decrease) Interest Income: Mortgage loans $ 469 $ (628) $ (159)$ (167) $ (737) $ (904)Non-mortgage loans (668) 272 (396) (1,558) 1,435 (123) Investment securities (1) 807 (24) 783 2,098 (248) 1,850 Daily interest-earning - - - - - - Other earning assets 38 - 38 163 - 163 Total interest income 646 (380) 266 536 450 986 Interest Expense: Regular savings accounts 15 (8) 7 72 (252) (180) Interest checking accounts 3 - 3 17 (17) - Money market accounts 9 (6) 3 37 (50) (13) Certificates of deposit (49) (220) (269) (138) (599) (737)
Other interest-bearing liabilities (53) 38 (15) (336) 225 (111) Total interest expense (75) (196)
(271) (348) (693) (1,041) Net interest income $ 721
$ (184) $ 537$ 884 $ 1,143 $ 2,027
(1) Interest is presented on a fully equivalent tax basis.
Provision for Loan Losses. The Company maintains an allowance for loan losses to provide for probable losses inherent in the loan portfolio consistent with GAAP guidelines. The adequacy of the allowance is evaluated monthly to maintain the allowance at levels sufficient to provide for inherent losses existing at the balance sheet date. The key components to the evaluation are the Company's internal loan review function by its credit administration, which reviews and monitors the risk and quality of the loan portfolio; as well as the Company's external loan reviews and its loan classification systems. Credit officers are expected to monitor their portfolios and make recommendations to change loan grades whenever changes are warranted. Credit administration approves any changes to loan grades and monitors loan grades. In accordance with GAAP, loans acquired from MBank during the fiscal year ended
March 31, 2017were recorded at their estimated fair value, which resulted in a net discount to the loans' contractual amounts, of which a portion reflects a discount for possible credit losses. Credit discounts are included in the determination of fair value, and, as a result, no allowance for loan losses is recorded for acquired loans at the acquisition date. The discount recorded on the acquired loans is not reflected in the allowance for loan losses or related allowance coverage ratios. However, we believe it should be considered when comparing certain financial ratios of the Company calculated in periods after the MBank transaction, compared to the same financial ratios of the Company in periods prior to the MBank transaction. The net discount on these acquired loans was $497,000and $722,000at December 31, 2021and March 31, 2021, respectively. 48 Table of Contents The Company recorded a recapture of loan losses of $1.3 millionand $4.0 millionfor the three and nine months ended December 31, 2021, respectively. There was no provision for loan losses for the three months ended December 31, 2020. The provision for loan losses was $6.3 millionfor the nine months ended December 31, 2020. The recapture of loan losses for the three and nine months ended December 31, 2021is based primarily upon the improving local and national economic conditions associated with the COVID-19 pandemic since March 31, 2021. The provision for loan losses for the nine months ended December 31, 2020was primarily due to the uncertain economic conditions resulting from the COVID-19 pandemic and its expected adverse economic effect on the respective industry exposures within our loan portfolio at that time. Any future decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company's financial condition and results of operations. Net charge-offs totaled $52,000and $30,000for the three and nine months ended December 31, 2021, respectively, compared to net recoveries of $326,000and $268,000for the three and nine months ended December 31, 2020, respectively. Annualized net charge-offs were 0.02% for the three months ended December 31, 2021. For the nine months ended December 31, 2021, annualized net charge-offs were insignificant. For the three and nine months ended December 31, 2020, annualized net recoveries were (0.14)% and (0.03)%, respectively. Nonperforming loans were $1.8 millionat December 31, 2021, compared to $393,000at December 31, 2020. The ratio of allowance for loan losses to nonperforming loans was 824.62% at December 31, 2021compared to 4883.46% at December 31, 2020. See "Asset Quality" above for additional information related to asset quality that management considers in determining the provision for loan losses. Impaired loans are subjected to an impairment analysis to determine an appropriate reserve amount to be held against each loan. As of December 31, 2021, the Company had identified $738,000of impaired loans. Because the significant majority of the impaired loans are collateral dependent, nearly all of the specific allowances are calculated based on the estimated fair value of the collateral. Of those impaired loans, $496,000have no specific valuation allowance as their estimated collateral value is equal to or exceeds the carrying costs, which in some cases is the result of previous loan charge-offs. At December 31, 2021, charge-offs on these impaired loans totaled $85,000from their original loan balances. The remaining $242,000of impaired loans has specific valuation allowances totaling $11,000at December 31, 2021. Non-Interest Income. Non-interest income increased $304,000and $1.5 millionto $3.1 millionand $9.8 millionfor the three and nine months ended December 31, 2021, respectively, compared to $2.8 millionand $8.3 millionin the same periods in the prior year primarily due to increases in fees and service charges, asset management fees and proceeds received from a BOLI death benefit. Fees and service charges increased to $1.8 millionand $5.4 million, respectively, for the three and nine months ended December 31, 2021compared to $1.7 millionand $4.7 million, respectively, in the same period in the prior year primarily from an increase in customer transactions and continued improvements in the economies and business activity in our market areas. Asset management fees grew due to an increase in irrevocable trust fees of $206,000during the three months ended December 31, 2021compared to the same prior year period. Non-interest income also included a BOLI death benefit on a former employee of $500,000during the nine months ended December 31, 2021that was not present during the nine months ended December 31, 2020. 49 Table of Contents Non-Interest Expense. Non-interest expense increased $172,000to $9.3 millionfor the three months ended December 31, 2021, compared to $9.1 millionin the same period in the prior year. Non-interest expense remained constant at $26.6 millionfor both the nine months ended December 31, 2021and 2020. For the three months ended December 31, 2021, non-interest expenses increased due to an increase in salaries and employee benefits related to employee retention and hiring due to increased wages in our markets. For the nine months ended December 31, 2021, non-interest expense remained constant, however, salaries and employee benefits increased $1.0 millionmainly due to capitalized loan origination costs related to SBA PPP loans incurred during the nine months ended December 31, 2020, which are deferred and amortized over the life of the loan. These increases were offset by a decrease in occupancy and depreciation of $67,000and $256,000for the three and nine months ended December 31, 2021, respectively, compared to the same periods in the prior year mainly due to the cost savings as a result of several branch consolidations. For the nine months ended December 31, 2021, non-interest expense included the recognition of a $1.0 milliongain on sale of premises and equipment related to the sale of a building related to a former branch location. Data processing expense increased $60,000and $191,000for the three and nine months ended December 31, 2021, respectively, due to the increased cost associated with the increase in the volume of customer transactions being processed related to our core banking platform and continued investments into enhancing our information technology infrastructure and other technology expenditures compared to the same prior year period. Income Taxes. The provision for income taxes was $1.7 millionand $5.2 millionfor the three and nine months ended December 31, 2021, respectively, compared to $1.2 millionand $2.0 millionfor the same periods in the prior year. The increase in the provision for income taxes was due to higher pre-tax income for the three and nine months ended December 31, 2021compared to the same periods in the prior year. Income before income taxes was $7.2 millionand $22.9 millionfor the three and nine months ended December 31, 2021, respectively, compared to $5.2 millionand $9.0 millionfor the same periods in the prior year. The increase was mainly due to the recapture of loan losses for the three and nine months ended December 31, 2021compared to the provision for loan losses for the nine months ended December 31, 2020. The Company's effective tax rate for the three and nine months ended December 31, 2021was 23.2% and 22.6%, respectively, compared to 22.9% and 22.0% for the three and nine months ended December 31, 2020. The lower effective tax rate for the three and nine months ended December 31, 2020is due to lower pretax income being offset by investments in tax-exempt bank owned life insurance. At December 31, 2021, management deemed that a valuation allowance related to the Company's deferred tax asset was not necessary. At December 31, 2021, the Company had a net deferred tax asset of $5.8 millioncompared to $5.4 millionat March 31, 2021. 50 Table of Contents
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