Item 2. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
Macatawa Bank Corporation is a Michigan corporation and a registered bank holding company. It wholly-owns Macatawa Bank. Macatawa Bank is a Michigan chartered bank with depository accounts insured
by the FDIC. The Bank operates twenty-six branch offices and a lending and operational service facility, providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County,
Michigan. For further information regarding consolidation, see the Notes to Consolidated Financial Statements.
At March 31, 2023, we had total assets of $2.64 billion, total loans of $1.22 billion, total deposits of $2.33 billion and shareholders’ equity of $260.6 million. For the three months ended March
31, 2023, we recognized net income of $12.0 million compared to $6.0 million for the same period in 2022. The Bank was categorized as “well capitalized” under regulatory capital standards at March 31, 2023.
We paid a dividend of $0.08 per share in each quarter in 2022 and in the first quarter of 2023.
In early March 2023, over the course of five days, three large financial institutions in the United States failed. Silvergate Bank self liquidated and Silicon Valley Bank and Signature Bank were
both closed by the FDIC. These bank failures were driven by rapid withdrawals by depositors with large uninsured balances held at these institutions and losses incurred by these banks in liquidating their bond portfolios to provide liquidity to
fund these deposit outflows. Silvergate Bank’s failure was also caused by its exposure to FTX and Alameda cryptocurrency firm failures. The FDIC determined that Silicon Valley Bank and Signature Bank were systematically important and fully
guaranteed their depositor balances above the $250,000 FDIC insurance limit. Given the sharp increase in market interest rates during 2022 and into 2023, most financial institutions’ bond portfolios have significant unrealized loss positions.
In response to this, the FRB created a new borrowing facility called the Bank Term Funding Program. This program allows a bank to borrow against its investment portfolio, at par value, with no reduction for unrealized losses. The term is for
one year and interest rate is fixed at the time the advance is taken and there is no prepayment penalty. Allowable investments for pledge are those the FRB can own. This would include all of the Company’s investments except municipal securities
and corporate bonds. At March 31, 2023, the Company had no advances under this program and had $642.2 million in unused borrowing capacity under this program. The program expires on March 11, 2024.
At March 31, 2023, the Company had $391.3 million in federal funds sold and overnight balances and had total additional borrowing capacity of $951 million, including $242.3 million in unused
availability with the FHLB, $65.0 million in available fed funds facilities with correspondent banks, $1.5 million in availability at the FRB’s Discount Window and the $642.2 million availability in the FRB Bank Term Funding Program discussed
above. Given the flexibility of borrowing structure options with the FHLB, if the Company needed to borrow, we would likely utilize our FHLB capacity first. At March 31, 2023, our uninsured deposits totaled approximately $962.7 million, or 41%
of total deposits, and our liquidity sources exceeded the amount of uninsured deposit balances by over $300 million.
While the Bank experienced a decline in deposit balances during the three months ended March 31, 2023, most of the decline took place prior to the early March 2023 bank failures noted. Our deposit
base is primarily made up of many small accounts, and balances at March 31, 2023 were comprised of 48% personal customers and 52% business customers. Our core deposits - which we define as deposits we have sourced within our local markets -
represented 100% of our total deposits at March 31, 2023. Our total deposit balances of $2.33 billion at March 31, 2023 remain elevated, reflecting a $625.5 million increase, or 37%, over pre-pandemic totals of $1.71 billion as of March 31,
2020.
RESULTS OF OPERATIONS
Summary: Net income for the three months ended March 31, 2023 was $12.0 million, compared to $6.0 million for the same period in 2022. Net income per share
on a diluted basis for the three months ended March 31, 2023 was $0.35 compared to $0.18 for the same period in 2022.
The increase in earnings in the three months ended March 31, 2023 compared to the same period in 2022 was due primarily to higher levels of net interest income partially offset by lower mortgage
banking income and a provision for credit losses benefit recorded in the first quarter of 2022. Throughout 2022, beginning in March, the Federal Reserve Bank increased the federal funds rate several times, bringing the high end of their rate
range rate from 0.25% at the beginning of 2022 to 4.50% at the end of 2022. The Federal Reserve Bank raised this rate an additional 50 basis points to 5.00% during the three months ended March 31, 2023. Given our asset sensitive balance sheet
posture, this had a significant positive impact on our net interest income. Net interest income increased to $22.6 million in the three months ended March 31, 2023 compared to $12.7 million in the same period in 2022. Gains on sales of
mortgage loans decreased to $11,000 in the three months ended March 31, 2023 compared to $308,000 in the same period in 2022.
The provision for credit losses was $0 for the three months ended March 31, 2023, compared to a benefit (income) of $1.5 million for the same period in 2022. We were in a net loan recovery position
for the three months ended March 31, 2023, with $33,000 in net loan recoveries, compared to $227,000 in net loan recoveries in the same period in 2022. Several of the previous qualitative environmental factors related to the COVID-19 pandemic
were reduced in the first quarter of 2022, reflecting improvement in economic conditions and success at mitigating the effects of the COVID-19 pandemic, resulting in the net provision benefit recorded in the first quarter of 2022. Also impacting
comparability between periods is our adoption of ASU 2016-13, commonly referred to as CECL, effective January 1, 2023. At adoption, we increased the allowance for credit losses by $1.5 million. Provision for the first quarter 2023 was
determined under CECL while the first quarter 2022 was determined under the probable incurred loss model.
Net Interest Income: Net interest income totaled $22.6 million for the three months ended March 31, 2023 compared to $12.7 million for the same period in
2022.
Net interest income for the first quarter of 2023 increased $10.0 million compared to the same period in 2022. Of this increase, $1.4 million was from changes in the volume of average interest
earning assets and interest bearing liabilities and $8.6 million was from increases from changes in rates earned or paid. The largest changes occurred in interest income on commercial loans and in overnight funds. The net change in interest
income for commercial loans was an increase of $5.4 million with an increase of $4.6 million due to rate and an increase of $782,000 due to portfolio growth. Overnight funds contributed an increase of $6.2 million due to changes in rate,
partially offset by a reduction of $394,000 due to lower average balances compared to the first quarter of 2022 as excess funds were deployed into loans and investment securities. The average balance of our investment portfolio grew by $326.0
million from $572.7 million in the first quarter of 2022 to $898.7 million in the first quarter of 2023. This growth resulted in an additional $1.6 million of interest income in the first quarter of 2023.
The cost of funds increased to 1.07% in the first quarter of 2023 compared to 0.11% in the first quarter of 2022. Increases in the rates paid on our interest-bearing checking, savings, money market
and certificate of deposit accounts in response to the federal funds rate increases over the past year and market conditions caused the increase in our cost of funds.
The asset yield improvement to 4.15% in the first quarter of 2023 from 1.92% in the first quarter of 2022, far outweighed the increase in cost of funds. As a result, net interest margin improved to
3.44% for the first quarter 2023 compared to 1.85% for the first quarter of 2022.
The following table shows an analysis of net interest margin for the three month periods ended March 31, 2023 and 2022 (dollars in thousands):
|
|
For the three months ended March 31,
|
|
|
|
2023
|
|
|
2022
|
|
|
|
Average
Balance
|
|
|
Interest
Earned
or Paid
|
|
|
Average
Yield
or Cost
|
|
|
Average
Balance
|
|
|
Interest
Earned
or Paid
|
|
|
Average
Yield
or Cost
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Taxable securities
|
|
$
|
765,999
|
|
|
$
|
4,481
|
|
|
|
2.35
|
%
|
|
$
|
402,863
|
|
|
$
|
1,434
|
|
|
|
1.43
|
%
|
Tax-exempt securities (1)
|
|
|
132,692
|
|
|
|
698
|
|
|
|
2.71
|
|
|
|
169,845
|
|
|
|
731
|
|
|
|
2.22
|
|
Commercial loans (2)
|
|
|
985,258
|
|
|
|
13,300
|
|
|
|
5.40
|
|
|
|
902,347
|
|
|
|
7,888
|
|
|
|
3.50
|
|
PPP loans (3)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
20,364
|
|
|
|
1,052
|
|
|
|
20.66
|
|
Residential mortgage loans
|
|
|
143,839
|
|
|
|
1,343
|
|
|
|
3.73
|
|
|
|
116,504
|
|
|
|
939
|
|
|
|
3.22
|
|
Consumer loans
|
|
|
57,303
|
|
|
|
1,017
|
|
|
|
7.20
|
|
|
|
54,096
|
|
|
|
519
|
|
|
|
3.89
|
|
Federal Home Loan Bank stock
|
|
|
10,211
|
|
|
|
65
|
|
|
|
2.55
|
|
|
|
11,019
|
|
|
|
51
|
|
|
|
1.84
|
|
Federal funds sold and other short-term investments
|
|
|
555,670
|
|
|
|
6,362
|
|
|
|
4.58
|
|
|
|
1,111,216
|
|
|
|
529
|
|
|
|
0.19
|
|
Total interest earning assets (1)
|
|
|
2,650,972
|
|
|
|
27,266
|
|
|
|
4.15
|
|
|
|
2,788,254
|
|
|
|
13,143
|
|
|
|
1.92
|
|
Noninterest earning assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and due from banks
|
|
|
34,615
|
|
|
|
|
|
|
|
|
|
|
|
32,505
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
72,007
|
|
|
|
|
|
|
|
|
|
|
|
96,703
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
2,757,594
|
|
|
|
|
|
|
|
|
|
|
$
|
2,917,462
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand
|
|
$
|
690,246
|
|
|
$
|
742
|
|
|
|
0.43
|
%
|
|
$
|
706,872
|
|
|
$
|
40
|
|
|
|
0.02
|
%
|
Savings and money market accounts
|
|
|
903,236
|
|
|
|
3,017
|
|
|
|
1.35
|
|
|
|
894,976
|
|
|
|
65
|
|
|
|
0.03
|
|
Time deposits
|
|
|
134,401
|
|
|
|
735
|
|
|
|
2.22
|
|
|
|
92,244
|
|
|
|
53
|
|
|
|
0.23
|
|
Borrowings:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other borrowed funds
|
|
|
30,000
|
|
|
|
156
|
|
|
|
2.08
|
|
|
|
85,002
|
|
|
|
320
|
|
|
|
1.51
|
|
Total interest bearing liabilities
|
|
|
1,757,883
|
|
|
|
4,650
|
|
|
|
1.07
|
|
|
|
1,779,094
|
|
|
|
478
|
|
|
|
0.11
|
|
Noninterest bearing liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Noninterest bearing demand accounts
|
|
|
732,434
|
|
|
|
|
|
|
|
|
|
|
|
875,223
|
|
|
|
|
|
|
|
|
|
Other noninterest bearing liabilities
|
|
|
17,117
|
|
|
|
|
|
|
|
|
|
|
|
11,545
|
|
|
|
|
|
|
|
|
|
Shareholders’ equity
|
|
|
250,160
|
|
|
|
|
|
|
|
|
|
|
|
251,600
|
|
|
|
|
|
|
|
|
|
Total liabilities and shareholders’ equity
|
|
$
|
2,757,594
|
|
|
|
|
|
|
|
|
|
|
$
|
2,917,462
|
|
|
|
|
|
|
|
|
|
Net interest income
|
|
|
|
|
|
$
|
22,616
|
|
|
|
|
|
|
|
|
|
|
$
|
12,665
|
|
|
|
|
|
Net interest spread (1)
|
|
|
|
|
|
|
|
|
|
|
3.08
|
%
|
|
|
|
|
|
|
|
|
|
|
1.81
|
%
|
Net interest margin (1)
|
|
|
|
|
|
|
|
|
|
|
3.44
|
%
|
|
|
|
|
|
|
|
|
|
|
1.85
|
%
|
Ratio of average interest earning assets to average interest bearing liabilities
|
|
|
150.80
|
%
|
|
|
|
|
|
|
|
|
|
|
156.72
|
%
|
|
|
|
|
|
|
|
|
(1) |
Yields are presented on a tax equivalent basis using an assumed tax rate of 21% at March 31, 2023 and 2022.
|
(2) |
Includes loan fees of $148,000 and $99,000 for the three months ended March 31, 2023 and 2022, respectively. Includes average nonaccrual loans of approximately $75,000 and $90,000 for the three months
ended March 31, 2023 and 2022, respectively. Excludes PPP loans.
|
(3) |
Includes loan fees of $0 and $1.0 million for the three months ended March 31, 2023 and 2022, respectively.
|
The following table presents the dollar amount of changes in net interest income due to changes in volume and rate (dollars in thousands):
|
|
For the three months ended March 31,
2023 vs 2022
Increase (Decrease) Due to
|
|
|
|
Volume
|
|
|
Rate
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
|
|
|
|
|
|
|
|
Taxable securities
|
|
$
|
1,778
|
|
|
$
|
1,269
|
|
|
$
|
3,047
|
|
Tax-exempt securities
|
|
|
(223
|
)
|
|
|
190
|
|
|
|
(33
|
)
|
Commercial loans, excluding PPP loans
|
|
|
782
|
|
|
|
4,630
|
|
|
|
5,412
|
|
PPP loans
|
|
|
(1,052
|
)
|
|
|
—
|
|
|
|
(1,052
|
)
|
Residential mortgage loans
|
|
|
241
|
|
|
|
163
|
|
|
|
404
|
|
Consumer loans
|
|
|
32
|
|
|
|
466
|
|
|
|
498
|
|
Federal Home Loan Bank stock
|
|
|
(4
|
)
|
|
|
18
|
|
|
|
14
|
|
Federal funds sold and other short-term investments
|
|
|
(394
|
)
|
|
|
6,227
|
|
|
|
5,833
|
|
Total interest income
|
|
|
1,160
|
|
|
|
12,963
|
|
|
|
14,123
|
|
Interest expense
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest bearing demand
|
|
$
|
(1
|
)
|
|
$
|
703
|
|
|
$
|
702
|
|
Savings and money market accounts
|
|
|
1
|
|
|
|
2,951
|
|
|
|
2,952
|
|
Time deposits
|
|
|
35
|
|
|
|
647
|
|
|
|
682
|
|
Other borrowed funds
|
|
|
(257
|
)
|
|
|
93
|
|
|
|
(164
|
)
|
Long-term debt
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total interest expense
|
|
|
(222
|
)
|
|
|
4,394
|
|
|
|
4,172
|
|
Net interest income
|
|
$
|
1,382
|
|
|
$
|
8,569
|
|
|
$
|
9,951
|
|
Provision for Credit Losses: The provision for credit losses for the three months ended March 31, 2023 was $0 compared to a benefit of $1.5 million for the
same period in 2022. Total loans increased by $43.2 million in the three months ended March 31, 2023 which, on its own, creates a need for provision expense; however, the economic forecast used in our calculation improved slightly from January
1, 2023 to March 31, 2023, thereby offsetting the need to record provision expense due to loan portfolio growth. Net loan recoveries were $33,000 in the three months ended March 31, 2023 compared to net loan recoveries of $227,000 in the same
period in 2022.
Gross loan recoveries were $54,000 for the three months ended March 31, 2023 and $262,000 for the same period in 2022. In the three months ended March 31, 2023, we had $21,000 in gross loan
charge-offs, compared to $35,000 in the same period in 2022.
We adopted CECL effective January 1, 2023 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting
periods beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with the probable incurred loss accounting standards. The transition adjustment of the CECL adoption included an
increase in the allowance for credit losses of $1.5 million, $62,000 to establish a reserve for unfunded commitments and a $1.2 million decrease to retained earnings to reflect the cumulative effect of adoption of CECL, with the $323,000 tax
impact portion being recorded as part of the deferred tax asset on our Consolidated Balance Sheet. The amounts of provision for credit losses in both the most recent quarter and comparable prior year period were the result of establishing our
allowance for credit losses at levels believed necessary based upon our methodology for determining the adequacy of the allowance. The provision for credit losses for the three months ended March 31, 2022 was impacted by net reductions to
certain qualitative factors that had been elevated in response to the COVID-19 pandemic. More information about our allowance for loan losses and our methodology for establishing its level may be found under the heading “Allowance for Credit
Losses” below.
Noninterest Income: Noninterest income for the three month period ended March 31, 2023 was $4.5 million compared to $5.0 million for the same period in
2022. The components of noninterest income are shown in the table below (in thousands):
|
|
Three Months
Ended
March 31,
2023
|
|
|
Three Months
Ended
March 31,
2022
|
|
Service charges and fees on deposit accounts
|
|
$
|
994
|
|
|
$
|
1,211
|
|
Net gains on mortgage loans
|
|
|
11
|
|
|
|
308
|
|
Trust fees
|
|
|
1,033
|
|
|
|
1,088
|
|
ATM and debit card fees
|
|
|
1,662
|
|
|
|
1,599
|
|
Bank owned life insurance (“BOLI”) income
|
|
|
199
|
|
|
|
240
|
|
Investment services fees
|
|
|
411
|
|
|
|
313
|
|
Other income
|
|
|
218
|
|
|
|
206
|
|
Total noninterest income
|
|
$
|
4,528
|
|
|
$
|
4,965
|
|
Net gains on mortgage loans were down $297,000 in the three months ended March 31, 2023 compared to the same period in 2022 as a result of changes in the volume of loans originated for sale.
Mortgage rates increased sharply throughout 2022 and into the first quarter of 2023, causing a reduction in mortgage volume compared to the first quarter of 2022. In addition, more of our origination volume in the first three months of 2023 was
in variable rate products, which we hold in portfolio. Mortgage loans originated for sale in the three months ended March 31, 2023 were $179,000, compared to $10.1 million in the same period in 2022.
Service charges on deposit accounts decreased by $217,000 in the three months ended March 31, 2023 as compared to the same period in 2022 largely due to higher earnings credit offsets for treasury
management accounts. Trust fees were down $55,000 in the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The decrease for the three months ended March 31, 2023 was largely due to lower market valuations of
underlying trust investments. ATM and debit card fees were up $63,000 in the three months ended March 31, 2023 as compared to the three months ended March 31, 2022 due to higher volume of usage by our customers.
Noninterest Expense: Noninterest expense increased by $426,000 to $12.2 million for the three month period ended March 31, 2023 as compared to the same period
in 2022. The components of noninterest expense are shown in the table below (in thousands):
|
|
Three Months
Ended
March 31,
2023
|
|
|
Three Months
Ended
March 31,
2022
|
|
Salaries and benefits
|
|
$
|
6,698
|
|
|
$
|
6,289
|
|
Occupancy of premises
|
|
|
1,137
|
|
|
|
1,172
|
|
Furniture and equipment
|
|
|
1,031
|
|
|
|
1,016
|
|
Legal and professional
|
|
|
348
|
|
|
|
194
|
|
Marketing and promotion
|
|
|
219
|
|
|
|
195
|
|
Data processing
|
|
|
955
|
|
|
|
884
|
|
FDIC assessment
|
|
|
330
|
|
|
|
180
|
|
Interchange and other card expense
|
|
|
384
|
|
|
|
373
|
|
Bond and D&O insurance
|
|
|
122
|
|
|
|
130
|
|
Outside services
|
|
|
469
|
|
|
|
494
|
|
Other noninterest expense
|
|
|
472
|
|
|
|
812
|
|
Total noninterest expense
|
|
$
|
12,165
|
|
|
$
|
11,739
|
|
Most categories of noninterest expense were relatively unchanged compared to the three months ended March 31, 2022 due to our ongoing efforts to manage expenses and scale our operations. Our largest
component of noninterest expense, salaries and benefits, increased by $409,000 in the three months ended March 31, 2023 from the same period in 2022. This increase is primarily due to higher base compensation, higher variable compensation, higher
medical costs and lower salary deferral from commercial loan originations partially offset by lower variable compensation tied to lower mortgage production. The table below identifies the primary components of salaries and benefits (in
thousands):
|
|
Three Months
Ended
March 31,
2023
|
|
|
Three Months
Ended
March 31,
2022
|
|
Salaries and other compensation
|
|
$
|
5,912
|
|
|
$
|
5,627
|
|
Salary deferral from commercial loan originations
|
|
|
(145
|
)
|
|
|
(215
|
)
|
Bonus accrual
|
|
|
287
|
|
|
|
221
|
|
Mortgage production - variable comp
|
|
|
58
|
|
|
|
144
|
|
401k matching contributions
|
|
|
211
|
|
|
|
212
|
|
Medical insurance costs
|
|
|
375
|
|
|
|
300
|
|
Total salaries and benefits
|
|
$
|
6,698
|
|
|
$
|
6,289
|
|
Legal and professional fees were up $154,000 in the three months ended March 31, 2023 compared to the same period in 2022 due to costs associated with new accounting and proxy disclosures as well as
regulatory compliance matters related to loan and deposit accounts referred to legal counsel during the quarter. FDIC assessment costs were up $150,000 in the three months ended March 31, 2023 compared to the same period in 2022 due to higher
assessment rates imposed by the FDIC on all banks. Other noninterest expense was down $340,000 in the three months ended March 31, 2023 compared to the same period in 2022 due to $356,000 net gain recognized on the sale of our last remaining
other real estate owned property during the first quarter of 2023.
Federal Income Tax Expense: We recorded $3.0 million in federal income tax expense for the three month period ended March 31, 2023 compared to $1.4 million
for the same period in 2022. Our effective tax rate for the three month period ended March 31, 2023 was 19.86% compared to 18.82% for the same period in 2022.
FINANCIAL CONDITION
Total assets were $2.64 billion at March 31, 2023, a decrease of $269.8 million from December 31, 2022. This decrease was caused primarily by a decrease in total deposits of $284.2 million at March
31, 2023 compared to December 31, 2022.
Cash and Cash Equivalents: Our cash and cash equivalents, which include federal funds sold and short-term investments, were $420.7 million at March 31, 2023
compared to $755.2 million at December 31, 2022. The decrease in these balances primarily related to an increase in our loan and investment portfolios as well as a reduction in deposit balances.
Securities: Debt securities available for sale were $526.0 million at March 31, 2023 compared to $499.3 million at December 31, 2022. The balance at March 31,
2023 primarily consisted of U.S. agency securities, agency mortgage backed securities and various municipal investments. Our held to maturity portfolio was $348.4 million at March 31, 2023 compared to $348.8 million at December 31, 2022. Our
held to maturity portfolio is comprised of U.S. Treasury securities and state, municipal and privately placed commercial bonds.
We classify privately placed municipal and commercial bonds as held to maturity as they are typically non-transferable in the bond market. In addition, we generally classify short-term U.S.
Treasury securities as held to maturity. Typically the final maturity on these short-term Treasury securities is three years or less. Longer-term Treasury securities and all other marketable debt securities are generally classified as available
for sale.
At March 31, 2023, the overall duration of our debt security available for sale portfolio was 3.11 years and the overall duration of our debt security held to maturity portfolio was 2.18 years and
were similar to durations for these portfolios before the pandemic. Net unrealized losses on debt securities available for sale decreased by $6.7 million from $40.1 million at December 31, 2022 to $33.7 million at March 31, 2023. Net unrealized
losses on debt securities held to maturity decreased by $3.3 million from $16.1 million at December 31, 2022 to $12.8 million at March 31, 2023. Our overall bond portfolio will provide nearly $400 million in liquidity through maturities and
scheduled paydowns over the next 24 months ending March 31, 2025.
Per U.S. generally accepted accounting principles, unrealized gains or losses on debt securities available for sale are reflected on the balance sheet in accumulated other comprehensive income
(loss), while unrealized gains or losses on debt securities held to maturity are not reflected on the balance sheet in accumulated other comprehensive income (loss).
Portfolio Loans and Asset Quality: Total portfolio loans increased by $43.2 million in the first three months of 2023 and were $1.22 billion at March 31, 2023
compared to $1.18 billion at December 31, 2022. During the first three months of 2023, our commercial portfolio increased by $37.4 million. During the same period, our consumer portfolio decreased by $3.7 million and our residential mortgage
portfolio increased by $9.5 million.
Mortgage loans originated for portfolio are typically adjustable rate loans as well as fixed rate loans that conform to secondary market requirements and have a term of fifteen years or less.
However, given the significant increase in residential mortgage rates, we have increased the percentage of our longer term fixed rate mortgage production that we hold in portfolio as they will typically have lower duration due to refinancings
that occur when interest rates decline. Mortgage loans originated for portfolio in the first three months of 2023 decreased $1.7 million compared to the same period in 2022, from $14.8 million in the first three months of 2022 to $13.1 million
in the same period in 2023.
The volume of residential mortgage loans originated for sale in the first three months of 2023 decreased $10.0 million compared to the same period in 2022. Residential mortgage loans originated for
sale were $179,000 in the first three months of 2023 compared to $10.1 million in the first three months of 2022.
The following table shows our loan origination activity for loans to be held in portfolio during the first three months of 2023 and 2022, broken out by loan type and also shows average originated
loan size (dollars in thousands):
|
|
Three months ended March 31, 2023
|
|
|
Three months ended March 31, 2022
|
|
|
|
Portfolio
Originations
|
|
|
Percent of
Total
Originations
|
|
|
Average
Loan Size
|
|
|
Portfolio
Originations
|
|
|
Percent of
Total
Originations
|
|
|
Average
Loan Size
|
|
Commercial real estate:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential developed
|
|
$
|
125
|
|
|
|
0.1
|
%
|
|
$
|
63
|
|
|
$
|
4,322
|
|
|
|
2.7
|
%
|
|
$
|
1,080
|
|
Unsecured to residential
developers
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Vacant and unimproved
|
|
|
2,779
|
|
|
|
3.1
|
|
|
|
463
|
|
|
|
1,570
|
|
|
|
1.0
|
|
|
|
523
|
|
Commercial development
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Residential improved
|
|
|
11,852
|
|
|
|
13.1
|
|
|
|
539
|
|
|
|
23,944
|
|
|
|
15.1
|
|
|
|
684
|
|
Commercial improved
|
|
|
3,161
|
|
|
|
3.5
|
|
|
|
316
|
|
|
|
22,907
|
|
|
|
14.5
|
|
|
|
1,909
|
|
Manufacturing and
industrial
|
|
|
5,364
|
|
|
|
5.9
|
|
|
|
894
|
|
|
|
44,128
|
|
|
|
27.8
|
|
|
|
4,413
|
|
Total commercial real estate
|
|
|
23,281
|
|
|
|
25.7
|
|
|
|
506
|
|
|
|
96,871
|
|
|
|
61.1
|
|
|
|
1,514
|
|
Commercial and industrial
|
|
|
47,097
|
|
|
|
52.0
|
|
|
|
1,002
|
|
|
|
32,371
|
|
|
|
20.4
|
|
|
|
549
|
|
Total commercial and commercial real estate
|
|
|
70,378
|
|
|
|
77.7
|
|
|
|
757
|
|
|
|
129,242
|
|
|
|
81.5
|
|
|
|
1,051
|
|
Consumer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage
|
|
|
13,084
|
|
|
|
14.4
|
|
|
|
262
|
|
|
|
14,829
|
|
|
|
9.4
|
|
|
|
362
|
|
Unsecured
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Home equity
|
|
|
6,818
|
|
|
|
7.5
|
|
|
|
114
|
|
|
|
13,372
|
|
|
|
8.4
|
|
|
|
131
|
|
Other secured
|
|
|
348
|
|
|
|
0.4
|
|
|
|
29
|
|
|
|
1,080
|
|
|
|
0.7
|
|
|
|
154
|
|
Total consumer
|
|
|
20,250
|
|
|
|
22.3
|
|
|
|
166
|
|
|
|
29,281
|
|
|
|
18.5
|
|
|
|
195
|
|
Total loans
|
|
$
|
90,628
|
|
|
|
100.0
|
%
|
|
$
|
422
|
|
|
$
|
158,523
|
|
|
|
100.0
|
%
|
|
$
|
581
|
|
Overall, the commercial loan portfolio increased $37.4 million in the first three months of 2023. Our commercial and industrial portfolio increased by $31.7 million while our commercial real estate
loans increased by $5.7 million. While overall originations as shown in the table above were down compared to the first three months of 2022, our on-balance-sheet commercial loan balances grew since year end 2022. This largely resulted from the
funding of various construction projects originating in 2022 and higher usage of approved commercial lines by our commercial borrowers. This utilization was up $22.2 million from December 31, 2022 to March 31, 2023.
We also have a significant amount of unfunded commercial lines of credit, that can be drawn on by our commercial loan customers. The table below shows the total commitment, the unused portion and
the percentage of unused to total commitment at March 31, 2023 and December 31, 2022 (dollars in thousands):
|
|
March 31,
2023
|
|
|
December 31,
2022
|
|
Commercial - Lines of credit commitments
|
|
$
|
1,011,846
|
|
|
$
|
1,021,795
|
|
Commercial - Unused portion of lines of credit
|
|
|
580,120
|
|
|
|
612,317
|
|
Commercial - Unused lines of credit to total commitment
|
|
|
57.33
|
%
|
|
|
60.07
|
%
|
Total commercial lines of credit commitments decreased by $9.9 million from December 31, 2022 to March 31, 2023.
Commercial and commercial real estate loans remained our largest loan segment and accounted for approximately 83.3% and 83.2% of the total loan portfolio at March 31, 2023 and December 31, 2022,
respectively. Residential mortgage and consumer loans comprised approximately 16.7% and 16.8% of total loans at March 31, 2023 and December 31, 2022, respectively.
A further breakdown of the composition of the loan portfolio is shown in the table below (in thousands):
|
|
March 31, 2023
|
|
|
December 31, 2022
|
|
|
|
Balance
|
|
|
Percent of
Total Loans
|
|
|
Balance
|
|
|
Percent of
Total Loans
|
|
Commercial real estate: (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential developed
|
|
$
|
7,001
|
|
|
|
0.6
|
%
|
|
$
|
7,234
|
|
|
|
0.6
|
%
|
Unsecured to residential developers
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Vacant and unimproved
|
|
|
38,700
|
|
|
|
3.2
|
|
|
|
36,270
|
|
|
|
3.1
|
|
Commercial development
|
|
|
99
|
|
|
|
—
|
|
|
|
103
|
|
|
|
—
|
|
Residential improved
|
|
|
116,177
|
|
|
|
9.5
|
|
|
|
112,791
|
|
|
|
9.6
|
|
Commercial improved
|
|
|
255,894
|
|
|
|
20.9
|
|
|
|
259,281
|
|
|
|
22.0
|
|
Manufacturing and industrial
|
|
|
125,477
|
|
|
|
10.3
|
|
|
|
121,924
|
|
|
|
10.4
|
|
Total commercial real estate
|
|
|
543,348
|
|
|
|
44.5
|
|
|
|
537,603
|
|
|
|
45.7
|
|
Commercial and industrial
|
|
|
473,354
|
|
|
|
38.8
|
|
|
|
441,716
|
|
|
|
37.5
|
|
Total commercial and commercial real estate
|
|
|
1,016,702
|
|
|
|
83.3
|
|
|
|
979,319
|
|
|
|
83.2
|
|
Consumer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential mortgage
|
|
|
148,676
|
|
|
|
12.2
|
|
|
|
139,148
|
|
|
|
11.8
|
|
Unsecured
|
|
|
106
|
|
|
|
—
|
|
|
|
121
|
|
|
|
—
|
|
Home equity
|
|
|
52,647
|
|
|
|
4.3
|
|
|
|
56,321
|
|
|
|
4.8
|
|
Other secured
|
|
|
2,808
|
|
|
|
0.2
|
|
|
|
2,839
|
|
|
|
0.2
|
|
Total consumer
|
|
|
204,237
|
|
|
|
16.7
|
|
|
|
198,429
|
|
|
|
16.8
|
|
Total loans
|
|
$
|
1,220,939
|
|
|
|
100.0
|
%
|
|
$
|
1,177,748
|
|
|
|
100.0
|
%
|
|
(1) |
Includes both owner occupied and non-owner occupied commercial real estate.
|
Commercial real estate loans accounted for 44.5% and 45.7% of the total loan portfolio at March 31, 2023 and December 31, 2022, respectively, and consisted primarily of loans to business owners and
developers of owner and non-owner occupied commercial properties and loans to developers of single and multi-family residential properties. In the table above, we show our commercial real estate portfolio by loans secured by residential and
commercial real estate, and by stage of development. Improved loans are generally secured by properties that are under construction or completed and placed in use. Development loans are secured by properties that are in the process of development
or fully developed. Vacant and unimproved loans are secured by raw land for which development has not yet begun and agricultural land.
Our consumer residential mortgage loan portfolio, which also includes residential construction loans made to individual homeowners, comprised 12.2% of portfolio loans at March 31, 2023 and 11.8% at
December 31, 2022. We expect to continue to retain in our loan portfolio certain types of residential mortgage loans (primarily high quality, low loan-to-value loans) in an effort to continue to diversify our credit risk and deploy our excess
liquidity.
Our portfolio of other consumer loans includes loans secured by personal property and home equity fixed term and line of credit loans. This portfolio decreased by $3.7 million to $55.6 million at
March 31, 2023 from $59.3 million at December 31, 2022. These other consumer loans comprised 4.5% of our portfolio loans at March 31, 2023 and 5.0% at December 31, 2022.
Given that current industry credit conditions are tightening, we expect industry pricing will increase in response to cost of funds increases and we will respond accordingly.
Our loan portfolio is reviewed regularly by our senior management, our loan officers, and an internal loan review team that is independent of our loan originators and credit administration. An
administrative loan committee consisting of senior management and seasoned lending and collections personnel meets quarterly to manage our internal watch list and proactively manage high risk loans.
When reasonable doubt exists concerning collectability of interest or principal of one of our loans, the loan is placed in nonaccrual status. Any interest previously accrued but not collected is
reversed and charged against current earnings.
Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. At March 31, 2023, nonperforming assets totaled just $75,000, down $2.3 million from $2.4 million
at December 31, 2022. There were no additions to other real estate owned in the first three months of 2023 or in the first three months of 2022. At March 31, 2023, there were no loans in foreclosure, so we expect there to be few, if any,
additions to other real estate owned in the remainder of 2023. Proceeds from sales of foreclosed properties were $2.7 million in the first three months of 2023, resulting in net realized gains on sales of $356,000. Proceeds from sales of
foreclosed properties were $0 in the first three months of 2022, resulting in net realized loss on sales of $0. With the sale of foreclosed properties in the first quarter of 2023, we have no remaining other real estate owned at March 31, 2023.
Nonperforming loans include loans on nonaccrual status and loans delinquent more than 90 days but still accruing. Nonperforming loans at March 31, 2023 consisted of $75,000 of residential mortgage
loans. As of March 31, 2023, nonperforming loans totaled $75,000, or 0.01% of total portfolio loans, compared to $78,000, or 0.01% of total portfolio loans, at December 31, 2022.
Foreclosed and repossessed assets include assets acquired in settlement of loans. Foreclosed assets totaled $0 at March 31, 2023 and $2.3 million at December 31, 2022. All properties acquired
through or in lieu of foreclosure are initially transferred at their fair value less estimated costs to sell and then evaluated monthly for impairment after transfer using a lower of cost or market approach. Updated property valuations are
obtained at least annually on all foreclosed assets.
The following table shows the composition and amount of our nonperforming assets (dollars in thousands):
|
|
March 31,
2023
|
|
|
December 31,
2022
|
|
Nonaccrual loans
|
|
$
|
75
|
|
|
$
|
78
|
|
Loans 90 days or more delinquent and still accruing
|
|
|
—
|
|
|
|
—
|
|
Total nonperforming loans (NPLs)
|
|
|
75
|
|
|
|
78
|
|
Foreclosed assets
|
|
|
—
|
|
|
|
2,343
|
|
Repossessed assets
|
|
|
—
|
|
|
|
—
|
|
Total nonperforming assets (NPAs)
|
|
$
|
75
|
|
|
$
|
2,421
|
|
NPLs to total loans
|
|
|
0.01
|
%
|
|
|
0.01
|
%
|
NPAs to total assets
|
|
|
0.00
|
%
|
|
|
0.08
|
%
|
We adopted ASU 2022-02 effective January 1, 2023. This standard eliminated the previous troubled debt restructuring (“TDR”) accounting model and replaced it with guidance and disclosure
requirements for identifying modifications to loans to borrowers experiencing financial difficulty. The following table shows the balance of loans modified to borrowers experiencing financial difficulty as of March 31, 2023 (dollars in
thousands):
|
|
March 31, 2023
|
|
|
|
Number of
Loans
|
|
|
Outstanding
Recorded
Balance
|
|
|
Percentage to
Total
Loans
|
|
Commercial and industrial
|
|
|
3
|
|
|
$
|
309
|
|
|
|
0.07
|
%
|
Commercial real estate
|
|
|
3
|
|
|
|
509
|
|
|
|
0.09
|
%
|
Consumer
|
|
|
32
|
|
|
|
2,847
|
|
|
|
1.39
|
%
|
|
|
|
38
|
|
|
$
|
3,665
|
|
|
|
0.30
|
%
|
Allowance for credit losses: The allowance for credit losses at March 31, 2023 was $16.8 million, an increase of $1.5 million from December 31, 2022. The
allowance for credit losses represented 1.38% of total portfolio loans at March 31, 2023 and 1.30% at December 31, 2022. The allowance for credit losses to nonperforming loan coverage ratio increased from 19596.2% at December 31, 2022 to
22392.0% at March 31, 2023.
We adopted the Current Expected Credit Loss (“CECL”) standard effective January 1, 2023 using the modified retrospective method for all financial assets measured at amortized cost and off-balance
sheet credit exposures. Results for reporting periods after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with the probable incurred loss accounting standards. The transition
adjustment of the CECL adoption included an increase in the allowance for credit losses of $1.5 million, $62,000 to establish a reserve for unfunded commitments and a $1.2 million decrease to retained earnings to reflect the cumulative effect of
adoption of CECL, with the $323,000 tax impact portion being recorded as part of the deferred tax asset on our Consolidated Balance Sheet.
The table below shows the changes in certain credit metrics over the past five quarters (dollars in thousands):
|
|
Quarter Ended
March 31,
2023
|
|
|
Quarter Ended
December 31,
2022
|
|
|
Quarter Ended
September 30,
2022
|
|
|
Quarter Ended
June 30,
2022
|
|
|
Quarter Ended
March 31,
2022
|
|
Nonperforming loans
|
|
$
|
75
|
|
|
$
|
78
|
|
|
$
|
85
|
|
|
$
|
90
|
|
|
$
|
90
|
|
Other real estate owned and repo assets
|
|
|
—
|
|
|
|
2,343
|
|
|
|
2,343
|
|
|
|
2,343
|
|
|
|
2,343
|
|
Total nonperforming assets
|
|
|
75
|
|
|
|
2,421
|
|
|
|
2,428
|
|
|
|
2,433
|
|
|
|
2,433
|
|
Net charge-offs (recoveries)
|
|
|
(33
|
)
|
|
|
(89
|
)
|
|
|
(190
|
)
|
|
|
(15
|
)
|
|
|
(227
|
)
|
Total delinquencies
|
|
|
277
|
|
|
|
172
|
|
|
|
84
|
|
|
|
197
|
|
|
|
171
|
|
At March 31, 2023, we had net loan recoveries in thirty-one of the past thirty-three quarters. Our total delinquencies were $277,000 at March 31, 2023 and $172,000 at December 31, 2022. Our
delinquency percentage at March 31, 2023 was 0.02%.
The allowance for credit losses increased $1.5 million in the first three months of 2023. As discussed above, the increase in the first three months of 2023 was due to the effect of adopting CECL
on January 1, 2023. We recorded a provision for credit losses expense of $0 for the three months ended March 31, 2023 compared to a provision benefit of $1.5 million for the same period of 2022. Net loan recoveries were $33,000 for the three
months ended March 31, 2023, compared to net loan recoveries of $227,000 for the same period in 2022. The ratio of net charge-offs (recoveries) to average loans was -0.01% on an annualized basis for the first three months of 2023 and -0.03% for
the first three months of 2022.
While we have experienced low levels of gross charge-offs over recent quarters, we recognize that future charge-offs and resulting provisions for credit losses are expected to be impacted by the
timing and extent of changes in the overall economy and the real estate markets.
The allowance for credit loss accounting in effect at December 31, 2022 and all prior periods was based on our estimate of probable incurred loan losses as of the reporting date (“incurred loss”
methodology). Under the CECL methodology, our allowance is based on the total amount of credit losses that are expected over the remaining life of the loan portfolio. Our estimate of credit losses under CECL is determined using a complex model
that relies on historical loss information including our own history as well as peer loss history, reasonable and supportable economic forecasts, and various qualitative factors.
The primary risk elements with respect to our commercial loans are the financial condition of the borrower, sufficiency of collateral and timeliness of scheduled payments. We have a policy of
reviewing periodic financial statements from commercial loan customers and have a disciplined and formalized review of the existence of collateral and its value. The primary risk element with respect to residential and consumer loans is the
timeliness of scheduled payments. We have a reporting process that monitors past due loans and have adopted policies to pursue creditors’ rights in order to preserve our collateral position. Over the past several years, consumer delinquency has
been nominal.
Under CECL, for commercial loans not identified as collateral dependent, we estimate the CECL reserve based on the internal risk grade of such loans. We use a loan rating method based upon an eight
point system. Loans are stratified between real estate secured and non-real estate secured. The real estate secured portfolio is further stratified by the type of real estate. Each stratified portfolio is assigned a loss allocation factor. A
higher numerical grade assigned to a loan category generally results in a greater allocation percentage. Changes in risk grade of loans affect the amount of the allowance allocation.
We believe our commercial portfolio is adequately diversified, with our largest commercial concentrations in Real Estate, Rental and Leasing (27.5%), followed by Manufacturing (13.3%) and Retail
Trade (11.7%).
The table below breaks down our commercial loan portfolio by industry type at March 31, 2023 and identifies the percentage of loans in each type that have a pass rating within our grading system (4 or better) and
criticized rating (5 or worse) (dollars in thousands):
|
|
Total
|
|
|
Percent of
Total Loans
|
|
|
Percent Grade 4 or
Better
|
|
|
Percent Grade 5 or
Worse
|
|
Industry:
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural Products
|
|
$
|
47,478
|
|
|
|
4.67
|
%
|
|
|
85.04
|
%
|
|
|
14.96
|
%
|
Mining and Oil Extraction
|
|
|
397
|
|
|
|
0.04
|
%
|
|
|
89.17
|
%
|
|
|
10.83
|
%
|
Construction
|
|
|
86,876
|
|
|
|
8.54
|
%
|
|
|
97.56
|
%
|
|
|
2.44
|
%
|
Manufacturing
|
|
|
134,851
|
|
|
|
13.26
|
%
|
|
|
96.34
|
%
|
|
|
3.66
|
%
|
Wholesale Trade
|
|
|
68,215
|
|
|
|
6.71
|
%
|
|
|
100.00
|
%
|
|
|
0.00
|
%
|
Retail Trade
|
|
|
119,262
|
|
|
|
11.73
|
%
|
|
|
99.95
|
%
|
|
|
0.05
|
%
|
Transportation and Warehousing
|
|
|
68,983
|
|
|
|
6.78
|
%
|
|
|
99.94
|
%
|
|
|
0.06
|
%
|
Information
|
|
|
567
|
|
|
|
0.06
|
%
|
|
|
5.47
|
%
|
|
|
94.53
|
%
|
Finance and Insurance
|
|
|
44,467
|
|
|
|
4.37
|
%
|
|
|
100.00
|
%
|
|
|
0.00
|
%
|
Real Estate and Rental and Leasing
|
|
|
279,131
|
|
|
|
27.45
|
%
|
|
|
99.98
|
%
|
|
|
0.02
|
%
|
Professional, Scientific and Technical Services
|
|
|
5,807
|
|
|
|
0.57
|
%
|
|
|
96.68
|
%
|
|
|
3.32
|
%
|
Management of Companies and Enterprises
|
|
|
756
|
|
|
|
0.07
|
%
|
|
|
100.00
|
%
|
|
|
0.00
|
%
|
Administrative and Support Services
|
|
|
24,246
|
|
|
|
2.38
|
%
|
|
|
98.41
|
%
|
|
|
1.59
|
%
|
Education Services
|
|
|
4,639
|
|
|
|
0.46
|
%
|
|
|
100.00
|
%
|
|
|
0.00
|
%
|
Health Care and Social Assistance
|
|
|
37,907
|
|
|
|
3.73
|
%
|
|
|
100.00
|
%
|
|
|
0.00
|
%
|
Arts, Entertainment and Recreation
|
|
|
3,588
|
|
|
|
0.35
|
%
|
|
|
91.56
|
%
|
|
|
8.44
|
%
|
Accommodations and Food Services
|
|
|
51,198
|
|
|
|
5.04
|
%
|
|
|
86.78
|
%
|
|
|
13.22
|
%
|
Other Services
|
|
|
38,334
|
|
|
|
3.77
|
%
|
|
|
100.00
|
%
|
|
|
0.00
|
%
|
Total commercial loans
|
|
$
|
1,016,702
|
|
|
|
100.00
|
%
|
|
|
97.78
|
%
|
|
|
2.22
|
%
|
Considering our qualitative factors and our commercial loan portfolio balances, the general allowance allocated to commercial loans was $13.8 million at March 31, 2023 (under CECL) and $12.8 million
at December 31, 2022 (under incurred loss). The qualitative component of our allowance allocated to commercial loans was $11.2 million at March 31, 2023 (under CECL) compared to $12.7 million at December 31, 2022 (under incurred loss). Under
CECL, we use historical peer loss history so the quantitative component receives a higher allocation and, with the addition of reasonable and supportable forecast assumption under CECL in choosing the historical loss period, less qualitative
allocations related to economic conditions are necessary.
Groups of homogeneous loans, such as residential real estate and open- and closed-end consumer loans, receive allowance allocations based on loan type. The determination of the allowance allocation
percentage is based principally on peer historical loss experience under CECL. These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent
loss experience for these similar pools of loans. The homogeneous allowance for credit losses for consumer loans was $2.8 million at March 31, 2023 (under CECL) and $2.2 million at December 31, 2022 (under incurred loss).
Allowance for credit losses allocated to loans identified as collateral dependent were $6,000 at March 31, 2023 (under CECL). Allowance allocations for loans identified as impaired at December 31,
2022 (under incurred loss) were $295,000.
The allowance allocations are not intended to imply limitations on usage of the allowance for loan losses. The entire allowance for credit losses is available for any loan loss without regard to
loan type.
See Note 1 - Significant Accounting Policies in this Form 10-Q for further descriptions of our allowance for credit loss estimation process. See also Note 3 - Loans in this Form 10-Q for further
information regarding our loan portfolio and allowance.
Bank-Owned Life Insurance: Bank-owned life insurance increased $212,000 from December 31, 2022 to March 31, 2023 due to earnings on the underlying policies.
Premises and Equipment: Premises and equipment totaled $40.2 million at March 31, 2023, down $57,000 from $40.3 million at December 31, 2022.
Deposits and Other Borrowings: Total deposits decreased $284.2 million to $2.33 billion at March 31, 2023, as compared to $2.62 billion at December 31,
2022. While the Bank experienced a decline in deposit balances during the three months ended March 31, 2023, most of the decline took place prior to the early March 2023 bank failures noted earlier. We experienced a seasonal run up in business
deposits of about $90 million in December 2022, which came back out in January 2023. In addition, a couple of large business customers removed deposits totaling nearly $90 million in early March 2023 for specific designated purposes. We saw
very little change in our deposit balances overall following the news of the bank failures and banking system disruption.
Our deposit base is primarily made up of many small accounts, and balances at March 31, 2023 were comprised of 48% personal customers and 52% business customers. Our core deposits - which we define
as deposits we have sourced within our local markets - represented 100% of our total deposits at March 31, 2023. Our total balances of $2.33 billion at March 31, 2023 remain elevated, reflecting a $625.5 million increase, or 37%, over
pre-pandemic totals of $1.71 billion as of March 31, 2020.
Non-interest checking account balances decreased $144.4 million during the first three months of 2023. Interest bearing demand account balances decreased $151.9 million and savings and money market
account balances decreased $63.5 million in the first three months of 2023 as municipal and business customers have begun deploying their excess balances they carried during the pandemic, including stimulus funding. Certificates of deposits
increased by $75.6 million in the first three months of 2023 reflecting our increases in offered interest rates, particularly in the 12-18 month term. We believe our success in maintaining the balances of personal and business checking and
savings accounts was primarily attributable to our focus on quality customer service, the desire of customers to deal with a local bank, the convenience of our branch network and the breadth and depth of our sophisticated product line.
Noninterest bearing demand accounts comprised 30% of total deposits at March 31, 2023 and 31% of total deposits at December 31, 2022. In recent years, because of the generally low rates paid on
interest bearing account alternatives, many of our business customers chose to keep their balances in these more liquid noninterest bearing demand account types. We have begun to see some of these balances move to higher earning deposit types.
Interest bearing demand, including money market and savings accounts, comprised 63% of total deposits at March 31, 2023 and 64% at December 31, 2022. Time accounts as a percentage of total deposits were 7% at March 31, 2023 and 4% at December 31,
2022.
Deposit balances in excess of the $250,000 FDIC insured limit totaled approximately $962.7 million, or 41% of total deposits, at March 31, 2023 and approximately $1.21 billion, or 45% of total
deposits, at December 31, 2022. As discussed previously, we have sufficient liquid resources to cover all of the uninsured balances at March 31, 2023.
Borrowed funds at March 31, 2023 consisted of $30.0 million of Federal Home Loan Bank (“FHLB”) advances. Borrowed funds at December 31, 2022 consisted of $30.0 million of FHLB advances. At March
31, 2023, we had $242.3 million in available borrowing capacity at the FHLB.
CAPITAL RESOURCES
Total shareholders’ equity of $260.6 million at March 31, 2023 reflected an increase of $13.5 million from $247.0 million at December 31, 2022. The increase was primarily a result of net income of
$12.0 million earned in the first three months of 2023 and a positive swing of $5.3 million in accumulated other comprehensive income (“AOCI”), partially offset by a payment of $2.7 million in cash dividends to shareholders and $1.2 million
reduction from adoption of the ASU 2016-13 CECL standard on January 1, 2023. The positive swing in AOCI was attributable to a decrease in market interest rates on bonds during the first quarter 2023 causing an increase in market value on our
investment securities available for sale. The Bank was categorized as “well capitalized” at March 31, 2023. The amount of capital retained by the Bank in excess of well capitalized minimums was $127.2 million at March 31, 2023.
Capital guidelines for U.S. banks are commonly known as Basel III guidelines. The rules include a common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital
conservation buffer of 2.5% of risk-weighted assets, effectively resulting in a minimum CET1 ratio of 7.0%. The Basel III minimum ratio of Tier 1 capital to risk-weighted assets is 6.0% (which, with the capital conservation buffer, effectively
results in a minimum Tier 1 capital ratio of 8.5%), and the minimum total capital to risk-weighted assets ratio is 10.5% (with the capital conservation buffer), and Basel III requires a minimum leverage ratio of 4.0%. The capital ratios for the
Company and the Bank under Basel III have continued to exceed the well capitalized minimum capital requirements.
The following table shows our regulatory capital ratios (on a consolidated basis) for the past several quarters:
Macatawa Bank Corporation
|
|
March 31,
2023
|
|
|
Dec 31,
2022
|
|
|
Sept 30,
2022
|
|
|
June 30,
2022
|
|
|
March 31,
2022
|
|
Total capital to risk weighted assets
|
|
|
18.1
|
%
|
|
|
17.9
|
%
|
|
|
17.6
|
%
|
|
|
17.5
|
%
|
|
|
17.9
|
%
|
Common Equity Tier 1 to risk weighted assets
|
|
|
17.1
|
|
|
|
16.9
|
|
|
|
16.7
|
|
|
|
16.5
|
|
|
|
16.9
|
|
Tier 1 capital to risk weighted assets
|
|
|
17.1
|
|
|
|
16.9
|
|
|
|
16.7
|
|
|
|
16.5
|
|
|
|
16.9
|
|
Tier 1 capital to average assets
|
|
|
10.3
|
|
|
|
9.7
|
|
|
|
9.3
|
|
|
|
9.1
|
|
|
|
8.8
|
|
LIQUIDITY
Liquidity of Macatawa Bank: The liquidity of a financial institution reflects its ability to manage a variety of sources and uses of funds. Our Consolidated
Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus on developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide
funds for our investment and loan portfolios. Our sources of liquidity include our borrowing capacity with the FRB’s discount window, the Federal Home Loan Bank, federal funds purchased lines of credit and other secured borrowing sources with our
correspondent banks, loan payments by our borrowers, maturity and sales of our securities available for sale, maturities of our securities held to maturity, growth of our deposits, federal funds sold and other short-term investments, and the
various capital resources discussed above. In March 2023, the Federal Reserve Bank introduced a new borrowing facility named the Bank Term Funding Program. This program allows an institution to borrow against its investment portfolio at a fixed
rate for up to one year and to use their investment portfolio for liquidity without incurring losses by liquidating those investments. At March 31, 2023, we would qualify for approximately $642.2 million in such borrowing capacity.
Liquidity management involves the ability to meet the cash flow requirements of our customers. Our customers may be either borrowers with credit needs or depositors wanting to withdraw funds. Our
liquidity management involves periodic monitoring of our assets considered to be liquid and illiquid, and our funding sources considered to be core and non-core and short-term (less than 12 months) and long-term. We have established parameters
that monitor, among other items, our level of liquid assets to short-term liabilities, our level of non-core funding reliance and our level of available borrowing capacity. We maintain a diversified wholesale funding structure and actively manage
our maturing wholesale sources to reduce the risk to liquidity shortages. We have also developed a contingency funding plan to stress test our liquidity requirements arising from certain events that may trigger liquidity shortages, such as rapid
loan growth in excess of normal growth levels or the loss of deposits and other funding sources under extreme circumstances.
We have actively pursued initiatives to maintain a strong liquidity position. The Bank has reduced its reliance on non-core funding sources, including brokered deposits, and focused on achieving a
non-core funding dependency ratio below its peer group average. We have had no brokered deposits on our balance sheet since December 2011. We continue to maintain significant on-balance sheet liquidity. At March 31, 2023, the Bank held $391.3
million of federal funds sold and other short-term investments. In addition, the Bank had available borrowing capacity from correspondent banks, including the Bank Term Funding Program discussed above, of approximately $951.0 million as of March
31, 2023. Finally, because we have maintained the discipline of buying shorter-term bond durations in our investment securities portfolio, we have $393.0 million in bond maturities and paydowns coming into the Bank in the next 24 months ending
March 31, 2025.
In addition to normal loan funding, we also maintain liquidity to meet customer financing needs through unused lines of credit, unfunded loan commitments and standby letters of credit. The level
and fluctuation of these commitments is also considered in our overall liquidity management. At March 31, 2023, we had a total of $719.0 million in unused lines of credit, $115.1 million in unfunded loan commitments and $11.9 million in standby
letters of credit.
Liquidity of Holding Company: The primary sources of liquidity for the Company are dividends from the Bank, existing cash resources and the capital markets if
the need to raise additional capital arises. Banking regulations and the laws of the State of Michigan in which our Bank is chartered limit the amount of dividends the Bank may declare and pay to the Company in any calendar year. Under the
state law limitations, the Bank is restricted from paying dividends to the Company in excess of retained earnings. In 2022, the Bank paid dividends to the Company totaling $11.9 million. In the same period, the Company paid $10.9 million in
dividends to its shareholders. On February 27, 2023, the Bank paid a dividend totaling $3.1 million to the Company in anticipation of the common share cash dividend of $0.08 per share paid on February 28, 2023 to shareholders of record on
February 13, 2023. The cash distributed for this cash dividend payment totaled $2.7 million. The Company retained the remaining balance in each period for general corporate purposes. At March 31, 2023, the Bank had a retained earnings balance
of $114.5 million.
The Company’s cash balance at March 31, 2023 was $8.1 million. The Company believes that it has sufficient liquidity to meet its cash flow obligations.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES:
To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available
information. These estimates and assumptions affect the amounts reported in the financial statements and future results could differ. The allowance for credit losses, other real estate owned valuation, loss contingencies, revenue recognition
and income taxes are deemed critical due to the required level of management judgment and the use of estimates, making them particularly subject to change.
Our methodology for determining the allowance for credit losses and the related provision for credit losses is described above in the “Allowance for Credit Losses” discussion. This area of
accounting requires significant judgment due to the number of factors which can influence the collectability of a loan. Unanticipated changes in these factors could significantly change the level of the allowance for credit losses and the
related provision for credit losses. Although, based upon our internal analysis, and in our judgment, we believe that we have provided an adequate allowance for credit losses, there can be no assurance that our analysis has properly identified
all of the probable losses in our loan portfolio. As a result, we could record future provisions for credit losses that may be significantly different than the levels that we recorded in the first three months of 2023.
Assets acquired through or instead of foreclosure, primarily other real estate owned, are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis.
New real estate appraisals are generally obtained at the time of foreclosure and are used to establish fair value. If fair value declines, a valuation allowance is recorded through expense. Estimating the initial and ongoing fair value of these
properties involves a number of factors and judgments including holding time, costs to complete, holding costs, discount rate, absorption and other factors.
Loss contingencies are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. This, too, is an accounting area that involves
significant judgment. Although, based upon our judgment, internal analysis, and consultations with legal counsel we believe that we have properly accounted for loss contingencies, future changes in the status of such contingencies could result
in a significant change in the level of contingent liabilities and a related impact to operating earnings.
Noninterest revenue is recognized in accordance with contractual requirements and as we fulfill our obligations under contractual terms. Most of our noninterest revenue comes from services that are
transaction based and such revenue is recognized as the related service is provided.
Our accounting for income taxes involves the valuation of deferred tax assets and liabilities primarily associated with differences in the timing of the recognition of revenues and expenses for
financial reporting and tax purposes. At March 31, 2023, we had gross deferred tax assets of $10.8 million and gross deferred tax liabilities of $2.3 million resulting in a net deferred tax asset of $8.5 million. Accounting standards require
that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. We concluded at March 31, 2023 that no
valuation allowance on our net deferred tax asset was required. Changes in tax laws, changes in tax rates, changes in ownership and our future level of earnings can impact the ultimate realization of our net deferred tax asset.