Caution Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q may contain certain forward-looking statements consisting of estimates with respect to the financial condition, results of operations and business of the Company that are subject to various factors that could cause actual results to differ materially from these estimates. These factors include, but are not limited to: the impact of the novel Coronavirus disease, or COVID-19, and its variants on our borrowers' ability to meet their financial obligations to us; increases in our past due loans and provisions for loan losses that may result from COVID-19 and its broader economic effects, including labor shortages, supply chain issues, and inflation that may impact our borrowers; declines in general economic conditions, including increased stress in the financial markets due to COVID-19; changes in interest rates, deposit flows, loan demand, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory, and technological factors affecting the Company's operations, pricing, products and services. Any use of "we" or "our" in the following discussion refers to the Company on a consolidated basis.
Comparison of the financial situation at
In the three months ended
Cash and cash equivalents increased
Investment securities consist of securities available for sale and securities held to maturity. Investment securities decreased
$8.1 millionto $353.0 millionfor the three-month period ended March 31, 2022. At March 31, 2022, the Company had unrealized losses on securities available for sale of $19.7 million, compared to unrealized losses of $1.5 millionat December 31, 2021. The significant decline in fair value is directly related to the increase in market interest rates at March 31, 2022compared to December 31, 2021, as the market prepares for the anticipated increase in overnight rates by the Federal Reserve. At March 31, 2022, equity securities declined slightly in value from $392,000at December 31, 2021to $383,000as a result of the decline in value in the equity market. Loans held for sale decreased 45.1%, or $9.8 million, as many of the loans produced near the December 31, 2021quarter-end date were not sold on the secondary market until 2022. Loans held for investment increased from $420.8 millionto $445.9 million, an increase of $25.1 millionfor the three-month period ended March 31, 2022. The Company experienced a net increase in all loan sectors with the exception of consumer loans, other loans and SBA PPP loans. SBA PPP loans were issued during 2020 and 2021 as a result of the Federal Government's response to helping small businesses due to COVID-related issues. These loans are unsecured commercial loans, but are 100% guaranteed by the SBA if the loans comply with PPP requirements. The allowance for loan losses was $4.2 millionat March 31, 2022, which represented 0.93% of the total loans held for investment, compared to $4.0 millionor 0.96% of the total loans held for investment at December 31, 2021. Additional discussion regarding the allowance is included in the Asset Quality section below. Other changes in our consolidated assets are primarily related to other assets, which increased $4.6 millionfrom $9.5 millionas of December 31, 2021to $14.1 millionat March 31, 2022as a result of the increase in deferred tax assets from the significant decline in value of the available for sale security portfolio. Additionally, restricted stock increased $507,000for the same period mainly due to the increase in FRB stock required to be held from increased common equity. Customer deposits, our primary funding source, experienced a $46.7 millionincrease during the three-month period ended March 31, 2022, increasing from $836.8 millionto $883.5 million, a 5.6% increase. In addition to receipt of government grant funding by some depositors, a large portion of this increase is related to the overall growth in the number of deposit accounts and relationship sizes. As the banking subsidiary of the Company operates in a primarily rural market, many competitors have exited the markets where we remain, which has driven deposit growth in our current markets. Demand noninterest-bearing checking accounts increased $29.2 million, interest checking and money market accounts increased $13.5 millionand savings deposits increased $6.2 millionduring the three months ended March 31, 2022. Time deposits decreased by $2.1 millionduring the same period as customers transitioned to liquid accounts. Total short-term borrowings increased $263,000for the three-month period. At March 31, 2022, the Company had $29.5 millionin long-term debt outstanding, which consists solely of its junior subordinated debt securities. During the third quarter of 2019, the Company issued $10.0 millionin subordinated debt securities with a final maturity date of September 30, 2029that may be redeemed on or after September 30, 2024. This junior subordinated debt pays interest quarterly at an annual fixed rate of 5.25%. During the third -28- -------------------------------------------------------------------------------- quarter of 2021, the Company issued $12.0 millionand $8.0 millionof 10-year and 15-year fixed-to-floating rate subordinated debt securities, respectively. The 10-year subordinated notes mature on September 3, 2031, though redeemable on or after September 3, 2026, and initially pay interest quarterly at an annual rate of 3.5%. From and including September 3, 2026to but excluding September 3, 2031, or up to an early redemption date, the interest rate on the 10-year subordinated notes will reset quarterly to an annual rate equal to the then-current three-month secured overnight financing rate ("SOFR"), plus 283 basis points payable quarterly in arrears. The 15-year subordinated notes mature on September 3, 2036, though redeemable on or after September 3, 2031, and initially pay interest quarterly at an annual rate of 4.0%. From and including September 3, 2031to but excluding September 3, 2036, or up to an early redemption date, the interest rate on the 15-year subordinated notes will reset quarterly to an annual rate equal to the then-current three-month SOFR plus 292 basis points payable quarterly in arrears. The subordinated debt has been structured to qualify as and is included in the calculation of the Company's Tier 2 capital. The Company also has a $3.0 millionline of credit of which $3.0 millionwas available to use at March 31, 2022. Other changes in consolidated liabilities are primarily related to increases in accruals for bonuses, donations and income taxes totaling $711,000. These increases are offset by a decline in the mortgage forward sales commitments liability. Mortgage forward sales commitments decreased $50,000from $50,000at December 31, 2021to $0at March 31, 2022, because of the rise in interest rates since year-end. As rates rise, the value of the mandatory commitment deteriorates, and the price required to exit out of the commitment decreases. At March 31, 2022, total shareholders' equity was $47.2 million, a decrease of $13.6 millionfrom December 31, 2021. Net income for the three-month period ended March 31, 2022was $801,000. Unrealized losses on investment securities, net of tax, increased by $14.0 millionas the yield curve continues to steepen. The Company repurchased 28,839 shares of common stock at a total cost of $254,000during the first three months of 2022. The Company paid $139,000in dividends attributable to noncontrolling interest during the first three months of 2022. See Note 3 (Noncontrolling Interest) to the Company's Notes to Consolidated Financial Statements for additional discussion of the noncontrolling interest.
Results of operations for the three months ended
Net profit and net profit available to ordinary shareholders
Uwharrie Capital Corpreported net income of $801,000for the three months ended March 31, 2022, as compared to $4.6 millionfor the three months ended March 31, 2021, a decrease of $3.8 million. Net income available to common shareholders was $662,000, or $0.10per common share, for the three months ended March 31, 2022, compared to $4.4 million, or $0.61per common share, at March 31, 2021. Net income available to common shareholders is net income less dividends on the aforementioned noncontrolling interest.
Net interest income
Net interest income for the three months ended
March 31, 2022was $6.0 million, compared to $6.8 millionfor the three months ended March 31, 2021, a decrease of $777,000. During the first quarter of 2022, the average yield on our interest-earning assets decreased eighty-four basis points to 2.96% from the same period in 2021, and the average rate we paid for our interest-bearing liabilities increased five basis points to 0.32%. These changes resulted in a lower interest rate spread of 2.65% as of March 31, 2022, compared to 3.53% as of March 31, 2021. Our net interest margin was 2.74% and 3.62% for the comparable periods in 2022 and 2021, respectively. -29- --------------------------------------------------------------------------------
The following table presents the average balance sheet and an analysis of net interest income for the three months ended
Average Balance Sheet and Net Interest Income Analysis For the Three Months Ended
(dollars in thousands) Average Balance Income/Expenses Rate/Yield 2022 2021 2022 2021 2022 2021 Interest-earning assets: Taxable securities
$ 296,892 $ 193,755 $ 1,015 $ 8261.39 % 1.73 % Nontaxable securities (1) 65,181 39,490 358 253 2.80 % 3.26 % Short-term investments 88,426 58,384 40 16 0.18 % 0.11 % Equity Securities 392 721 5 - 5.17 % 0.00 % Taxable loans 449,205 471,456 5,057 6,004 4.57 % 5.16 % Non-taxable loans (1) 7,604 8,197 50
58 3.36% 3.60% Total interest-earning assets 907,700 772,003 6,525 7,157 2.96% 3.80%
Interest-bearing liabilities: Interest-bearing deposits 597,942 510,486 177 211 0.12 % 0.17 % Short-term borrowed funds 1,092 1,621 1 1 0.37 % 0.25 % Long-term debt 29,541 12,004 315 136 4.32 % 4.56 % Total interest-bearing liabilities 628,575 524,111 493 348 0.32 % 0.27 % Net interest spread
$ 279,125 $ 247,892 $ 6,032 $ 6,8092.65 % 3.53 % Net interest margin (1) (% of earning assets) 2.74 % 3.62 %
(1) Returns related to securities and loans exempt from income tax are
on a fully equivalent to tax basis, assuming an effective tax rate of 21%.
Allowance (recovery) and allowance for loan losses
The provision for loan losses was
$118,000for the three months ended March 31, 2022, compared to a recovery of $34,000for the same period in 2021. There were net loan recoveries of $12,000for the three months ended March 31, 2022, as compared to net loan charge-offs of $116,000during the same period of 2021. Refer to the Asset Quality section below for further information.
The Company generates most of its revenue from net interest income; however, diversification of our revenue sources is important as well. Total noninterest income decreased by
$4.5 millionfor the three-month period ended March 31, 2022, as compared to the same period in 2021. The gain on sale of securities decreased $1.0 millionto a loss of $91,000at March 31, 2022compared to a gain of $940,000at March 31, 2021as the Company worked to reduce the duration of the investment portfolio in an attempt to protect capital as long-term interest rates rise. The primary factor contributing to the overall decline in noninterest income was a decrease of $3.8 millionin income from mortgage loan sales. This decrease is due to the significant reduction in production, particularly mortgage refinancing activity, as interest rates have risen quickly during the first three months of 2022. Interchange fees, or "swipe" fees, are charges that merchants pay to us and other card-issuing banks for processing electronic payment transactions. Interchange and card transaction fees consist of income from check card usage, point-of-sale income from PIN-based debit card transactions, ATM service fees, and credit card usage. A comparison of gross interchange and card transaction fees and interchange and card transaction fees net of associated network costs for the reported periods is presented in the table below: Three Months Ended March 31, 2022 2021 (in thousands) Income from debit card transactions $ 505 $
Income from credit card transactions 145
Gross interchange and transaction fee income 650 606 Network costs - debit card 254 251 Network costs - credit card 158 136 Total $ 238 $ 219 -30-
Noninterest expense for the three months ended
March 31, 2022decreased by $571,000from the same period in 2021, to $7.6 million. Salaries and benefits, the largest component of noninterest expense, decreased $373,000due to decreased commissions from reduced production in the mortgage division. As a result of production declines in the mortgage division, loan costs decreased by $137,000to $169,000for the three months ended March 31, 2022and marketing and donations decreased $287,000to $334,000for the same time period. Total other noninterest expense increased $115,000for the three months ended March 31, 2022, compared to the same period in 2021. This change was due to market valuation adjustments that increased the expense associated with supplemental executive retirement plans by $135,000, included in "Other" line item below. The table below reflects the composition of other noninterest expense. Three Months Ended March 31, 2022 2021 (in thousands) Postage $ 64 $ 46 Telephone and data lines 57 49 Office supplies and printing 24 26 Shareholder relations expense 37 33 Dues and subscriptions 76 109 Other 324 204 Total $ 582 $ 467 Income Tax Expense The Company had income tax expense of $168,000for the three months ended March 31, 2022at an effective tax rate of 17.3% compared to income tax expense of $1.2 millionwith an effective tax rate of 21.1% in the comparable 2021 period. Income taxes computed at the statutory rate are primarily affected by the state income tax expense offset by the eligible amount of interest earned on state and municipal securities, tax free municipal loans and income earned on bank-owned life insurance. For the three months ended March 31, 2022, the effective tax rate decreased due to the increase in tax-exempt security holdings.
The Company's allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. The allowance is increased by provisions charged to operations and recoveries of amounts previously charged off and is reduced by recovery of provisions and loans charged off. Management continuously evaluates the adequacy of the allowance for loan losses. In evaluating the adequacy of the allowance, management considers the following: the growth, composition and industry diversification of the portfolio; historical loan loss experience; current delinquency levels; adverse situations that may affect a borrower's ability to repay; estimated value of any underlying collateral; prevailing economic conditions; and other relevant factors. The Company's credit administration function, through a review process, periodically validates the accuracy of the initial risk grade assessment. In addition, as a given loan's credit quality improves or deteriorates, the credit administration department has the responsibility to change the borrower's risk grade accordingly. For loans determined to be impaired, the allowance is based on either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price, or the estimated fair value of the underlying collateral less the selling costs. This evaluation is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans, which may be susceptible to significant change. In addition, regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses and may require additions for estimated losses based upon judgments different from those of management. Management uses a risk-grading program designed to evaluate the credit risk in the loan portfolio. In this program, risk grades are initially assigned by loan officers and then reviewed and monitored by credit administration. This process includes the maintenance of an internally classified loan list that is designed to help management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. In establishing the appropriate classification for specific assets, management considers, among other factors, the estimated value of the underlying collateral, the borrower's ability to repay, the borrower's payment history, and the current delinquent status. Because of this process, certain loans are deemed to be impaired and evaluated as an impaired loan. The portion of the Company's allowance for loan loss model related to general reserves captures the mean loss of individual loans within the loan portfolio and adds additional loss based on economic uncertainty and specific indicators of potential issues in the market. Specifically, the Company calculates probable losses on loans by computing a probability of loss and multiplying that by a loss given default derived from historical experience. An additional calculation based on economic uncertainty is added to the probable losses, thus deriving the estimated loss scenario by
FDICcall report codes. Together, these expected components, as well as -31- -------------------------------------------------------------------------------- a reserve for qualitative factors based on economic conditions determined at management's discretion, form the basis of the allowance model. The loans that are impaired and included in the specific reserve are excluded from these calculations. The Company assesses the probability of losses inherent in the loan portfolio using probability of default data derived from the Company's internal historical data, representing a one-year loss horizon for each obligor. Credit scores are used within the model to determine the probability of default. The Company updates the credit scores for individuals that either have a loan, or are financially responsible for the loan, semi-annually, during the first and third quarters. During the first three months of 2022, the average effective credit score of the portfolio, excluding loans in default, increased slightly from 767 to 771. The probability of default associated with each credit score is a major driver in the allowance for loan losses. The allowance for loan losses represents management's best estimate of an appropriate amount to provide for probable credit risk inherent in the loan portfolio in the normal course of business. While management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary and results of operations could be adversely affected if circumstances differ from the assumptions used in making the determinations. Furthermore, while management believes it has established the allowance for loan losses in conformity with generally accepted accounting principles, there can be no assurance that banking regulators, in reviewing the Company's portfolio, will not require an adjustment to the allowance for loan losses. 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 is adequate or that increases will not be necessary, should the quality of any loans deteriorate because of the factors discussed herein. Unexpected global events, such as the unprecedented economic disruption due to COVID-19, are the type of future events that often cause material adjustments to the allowance to be necessary. Any material increase in the allowance for loan losses may adversely affect the Company's financial condition, results of operations and the value of its securities. At March 31, 2022, the level of our impaired loans, which includes all loans in non-accrual status, TDRs, and other loans deemed by management to be impaired, was $4.1 million, compared to $4.7 millionat December 31, 2021, a net decrease of $617,000. The decrease is related to one large relationship paying off in the first quarter of 2022 and another relationship with a large pay down due to collateral sale. Total non-accrual loans, which are a component of impaired loans, decreased from $972,000at December 31, 2021to $861,000at March 31, 2022. During the first three months of 2022, one additional loan totaling $18,000was added to impaired loans; however, one loan totaling $169,000was paid off. We also had net pay downs of $466,000. The allowance, expressed as a percentage of gross loans held for investment, decreased three basis points from 0.96% at December 31, 2021to 0.93% at March 31, 2022. The collectively evaluated allowance as a percentage of collectively evaluated loans was 0.92% at December 31, 2021and 0.89% at March 31, 2022. The decrease is attributable to continued improvement in probability of defaults of the portfolio. The individually evaluated allowance as a percentage of individually evaluated loans increased from 4.54% to 5.93% for the same periods, mainly due to one relationship with a large pay down and little reserves associated due to collateral values. The ratio of nonperforming loans, which consists of non-accrual loans and loans past due 90 days and still accruing, to total loans decreased from 0.23% at December 31, 2021to 0.19% at March 31, 2022, and was related to the nonaccrual relationship that was paid off in the first quarter. Troubled debt restructured loans, included in impaired loans, totaled $3.3 millionat March 31, 2022and $3.8 millionat December 31, 2021. At March 31, 2022, there was one troubled debt restructured loan in non-accrual status, which had a balance of $38,000.
The other properties held remained at
-32- -------------------------------------------------------------------------------- The following table shows the comparison of nonperforming assets at
March 31, 2022and December 31, 2021: Nonperforming Assets (dollars in thousands) March 31, 2022 December 31, 2021 Nonperforming assets: Accruing loans past due 90 days or more $ - $ - Non-accrual loans 861 972 Other real estate owned - - Total nonperforming assets $ 861 $ 972 Allowance for loans losses $ 4,156 $ 4,026 Nonaccrual loans to total loans 0.19 % 0.23 % Allowance for loan losses to total loans 0.93 % 0.96 % Allowance for loan losses to nonaccrual loans 482.69 % 414.20 %
Cash and capital resources
The objective of the Company's liquidity management policy is to ensure the availability of sufficient cash flows to meet all financial commitments and to capitalize on any opportunities for expansion. Liquidity management addresses the ability to meet deposit withdrawals on demand or at contractual maturity, to repay borrowings as they mature and to fund new loans and investments as opportunities arise. The Company's primary sources of internally generated funds are principal and interest payments on loans, cash flows generated from operations and cash flow generated by investments. Growth in deposits is typically the primary source of funds for loan growth. The Company and its subsidiary bank have multiple funding sources, in addition to deposits, that can be used to increase liquidity and provide additional financial flexibility. At
March 31, 2022, these sources are the subsidiary bank's established federal funds lines with correspondent banks aggregating $43.0 million, with available credit of $43.0 million; an established borrowing relationship with the Federal Home Loan Bank, with available credit of $95.1 million; access to borrowings from the Federal Reserve Bankdiscount window, with available credit of $16.4 millionand the issuance of commercial paper. The Company also has a $3.0 millionline of credit with TIB The Independent BankersBank, N.A.The line is secured with 100% of the outstanding common shares of the Company's subsidiary bank. As of March 31, 2022, $3.0 millionremained available for use on the line of credit. The Company has also secured long-term debt from other sources consisting of $29.5 millionof junior subordinated debt at both March 31, 2022and December 31, 2021. Banks and bank holding companies, as regulated institutions, must meet required levels of capital. The Federal Reserve, the primary federal regulator of the Company and its subsidiary bank, has adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. The Company continues to maintain capital ratios that support its asset growth. The federal bank regulatory agencies have implemented regulatory capital rules known as "Basel III." The Basel III rules require a common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.50%, a minimum ratio of Tier 1 capital to risk-weighted assets of 6.00%, a minimum ratio of total capital to risk-weighted assets of 8.00%, and a minimum Tier 1 leverage ratio of 4.00%. There is also a capital conservation buffer that requires banks to hold common equity Tier 1 capital in excess of minimum risk-based capital ratios by at least 2.5% to avoid limits on capital distributions and certain discretionary bonus payments to executive officers and similar employees.
The Company's subsidiary bank has a net total of
$10.6 millionin outstanding Fixed Rate Noncumulative Perpetual Preferred Stock. The preferred stock qualifies as Tier 1 capital at the Bank and pays dividends at an annual rate of 5.30%. The net total of $10.6 millionis presented as noncontrolling interest at the Company level and qualifies as Tier 1 capital at the Company. At March 31, 2022, the Company had $29.5 millionin subordinated debt outstanding, which qualifies as Tier 2 capital at the Company level. The Company has made all interest and dividend payments in a timely manner. -33- --------------------------------------------------------------------------------
Off-balance sheet arrangements
Off-balance sheet arrangements include transactions, agreements or other contractual arrangements to which an unconsolidated entity of the Company is a party and pursuant to which the Company has obligations, including an obligation to provide guarantees on behalf of an unconsolidated entity, or retains an interest in assets transferred to an unconsolidated entity. We currently have no off-balance sheet arrangements of this kind. Derivative financial instruments include futures contracts, forward contracts, interest rate swaps, options contracts, and other financial instruments with similar characteristics. We have not engaged in significant derivative activities through
March 31, 2022, with the exception of mortgage banking derivatives. See Note 14 (Mortgage Banking Derivatives) to the Company's Notes to Consolidated Financial Statements for additional discussion of mortgage banking derivatives.
The timing and amount of our contractual obligations has not changed materially since our 2021 Annual Report on Form 10-K, which was filed with the
Securities and Exchange Commissionon March 9, 2022. Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Disclosure under this heading is not required for small reporting companies.
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