# First Community Bankshares Inc: Form 10-Q for the period ended Mar 31, 2020

- Company: [First Community Bankshares Inc](/companies/fcbc.md) (CIK 859070)
- Form: 10-Q
- Filed: 2020-05-11
- Accepted by EDGAR: May 11, 2020, 17:31 ET
- Period: 2020-03-31
- Accession: 0001437749-20-010337
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/859070/000143774920010337/fcbc20200331_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/859070/000143774920010337/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2020-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2020-01-01 to 2020-03-31 | $1.8m | us-gaap:InterestExpense |
| Income tax | 3 months, 2020-01-01 to 2020-03-31 | $2.2m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2020-01-01 to 2020-03-31 | $7.9m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2020-01-01 to 2020-03-31 | $0.44 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2020-01-01 to 2020-03-31 | $0.44 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2020-01-01 to 2020-03-31 | 18,050,071 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2020-01-01 to 2020-03-31 | $11.4m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2020-01-01 to 2020-03-31 | $1.6m | us-gaap:PaymentsToAcquireProductiveAssets |
| Dividends paid | 3 months, 2020-01-01 to 2020-03-31 | $4.6m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 3 months, 2020-01-01 to 2020-03-31 | $21.9m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2020-03-31 | $241.6m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2020-03-31 | $2.74bn | us-gaap:Assets |
| Total liabilities | at 2020-03-31 | $2.33bn | us-gaap:Liabilities |
| Long-term debt | at 2020-03-31 | $0 | us-gaap:LongTermDebt |
| Short-term borrowings | at 2020-03-31 | $2.3m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2020-03-31 | $411.6m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 58,159 characters.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help the reader understand our financial condition, changes in financial condition, and results of operations. MD&A contains forward-looking statements and should be read in conjunction with our consolidated financial statements, accompanying notes, and other financial information included in this report and our Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”). Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bankshares, Inc. and its subsidiaries as a consolidated entity.

### Executive Overview

First Community Bankshares, Inc. (the “Company”) is a financial holding company, headquartered in Bluefield, Virginia, that provides banking products and services through its wholly owned subsidiary First Community Bank (the “Bank”), a Virginia chartered bank institution. As of March 31, 2020, the Bank operated 58 branches as First Community Bank in Virginia, West Virginia, and North Carolina and as People’s Community Bank, a Division of First Community Bank, in Tennessee. As of March 31, 2020, full-time equivalent employees, calculated using the number of hours worked, totaled 654. Our primary source of earnings is net interest income, the difference between interest earned on assets and interest paid on liabilities, which is supplemented by fees for services, commissions on sales, and various deposit service charges. We fund our lending and investing activities primarily through the retail deposit operations of our branch banking network and, to a lesser extent, retail and wholesale repurchase agreements and Federal Home Loan Bank (“FHLB”) borrowings. We invest our funds primarily in loans to retail and commercial customers and various investment securities. Our common stock is traded on the NASDAQ Global Select Market under the symbol, FCBC.

The Bank offers trust management, estate administration, and investment advisory services through its Trust Division and wholly owned subsidiary First Community Wealth Management (“FCWM”). The Trust Division manages inter vivos trusts and trusts under will, develops and administers employee benefit and individual retirement plans, and manages and settles estates. Fiduciary fees for these services are charged on a schedule related to the size, nature, and complexity of the account. Revenues consist primarily of investment advisory fees and commissions on assets under management and administration. As of March 31, 2020, the Trust Division and FCWM managed and administered $1.02 billion in combined assets under various fee-based arrangements as fiduciary or agent.

Recent Events

In December 2019, a novel strain of coronavirus (“COVID-19”) surfaced in China, and quickly spread across most of the earth, including the United States. In March 2020, President Trump declared a National Public Health Emergency. Government responses to the COVID-19 pandemic have severely restricted the level of economic activity in the Company’s markets. While the financial services industry has been designated an essential business in each of the states in which the Company operates, many or the Company’s customers are non-essential businesses, or are employed by non-essential businesses, and have been adversely affected by government shutdowns.

To date, the COVID-19 pandemic has impacted trade, travel, employee productivity, unemployment, consumer spending, and other economic activities, resulting in less economic activity, lower equity market valuations, significant volatility and disruption in financial markets, adversely affecting the Company’s business volume, financial condition and results of operations. However, the impact of the COVID-19 pandemic is fluid and continues to evolve. The ultimate extent to which the COVID-19 pandemic will impact the Company’s business, financial condition, and results of operations is currently uncertain and will depend on various developments, including the duration and scope of the pandemic, governmental, regulatory and private sector responses to the pandemic, the pandemic’s depth of impact on national and local economies, financial market reactions, responses of the Company’s customers, employees and vendors, and other factors.

The Company’s business, financial condition, and results of operations generally rely upon the ability of borrowers to repay their loans, the value of collateral underlying secured loans, and demand for loans and other financial products and services. Each of these conditions depends highly on the business environment in the primary markets where the Company operates and in the United States as a whole. To this point, the COVID-19 pandemic has begun to have a significant impact on the Company’s business and operations.

In order to implement and exercise social distancing, on March 20, 2020, the Company began limiting access to branch lobbies and conducting most business through drive-through tellers and through electronic and online means. To support the health and well-being of employees, a majority of the Company’s back office workforce is currently working remotely, and the Company has temporarily implemented pay differential for employees not working remotely. To support and assist loan customers and/or comply with guidance from regulatory bodies, the Company has deferred loan payments for many consumer and commercial customers, suspended residential property foreclosures, evictions, and involuntary automobile repossessions, and is offering fee waivers, payment deferrals, and other extra-ordinary assistance for automobile, mortgage, small business and personal lending customers. Future regulatory or governmental actions may require these and other types of customer-assistance measures.

Through May 1, 2020, the Company has modified or deferred payments on a total of 2,176 loans totaling $327.52 million in principal (887 commercial loans totaling $254.72 million in principal, 698 consumer installment loans totaling $9.22 million in principal, 484 consumer mortgages totaling $57.47 million in principal, and 107 home equity loans totaling $6.10 million in principal). Deferred interest and fees for these loans will continue to accrue. However, should eventual credit losses on deferred payments occur, accrued interest income and fees would be reversed, which would negatively impact interest income in future periods. At this time, the Company is unable to project the materiality of any such impact. The Company proactively reached out to customers to provide guidance and assistance on loan deferrals. To date, the company has not experienced an increase in borrowers drawing on lines of credit. Management currently believes the hotel/motel and retail loan portfolios to be at the greatest risk.

The Company is also participating in the Paycheck Protection Program (“PPP”), administered by the Small Business Administration (“SBA”), in an attempt to assist both existing customers and non-customers. Through May 1, 2020, the Company closed or secured SBA approval for 641 loans totaling $58.26 million through the PPP.

Management and the Board of Directors are closely monitoring the impact of the COVID-19 pandemic on results of operations and financial condition. The Company recorded a provision for loan losses of $3.50 million in the first quarter of 2020, which was significantly higher than in recent previous quarters. Management expects the provisions for loan losses for periods ending after March 31, 2020, to be materially impacted by the COVID-19 pandemic.

### Acquisitions and Divestitures

On September 11, 2019, the Company entered into an Agreement and Plan of Merger with Highlands Bankshares, Inc. (“Highlands” ) of Abingdon, Virginia. Under the terms of the agreement and plan of merger, each share of Highlands’ common and preferred stock outstanding immediately converted into the right to receive 0.2703 shares of the Company’s stock. The transaction was consummated the close of business December 31, 2019. The transaction combined two traditional Southwestern Virginia community banks who serve the Highlands region in Virginia, North Carolina, and Tennessee. The total purchase price for the transaction was $86.65 million.

The Highlands transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the acquisition date. Fair values are preliminary and subject to refinement for up to a year after the closing date of the acquisition.

### Critical Accounting Estimates

We prepare our consolidated financial statements in accordance with generally accepted accounting principles (“GAAP”) in the U.S. and conform to general practices within the banking industry. Our financial position and results of operations may require management to make significant estimates and assumptions that have a material impact on our financial condition or operating performance. Due to the level of subjectivity and the susceptibility of such matters to change, actual results could differ significantly from management’s assumptions and estimates. Estimates, assumptions, and judgments, which are periodically evaluated, are based on historical experience and other factors, including expectations of future events believed reasonable under the circumstances. These estimates are generally necessary when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve, or when an asset or liability needs recorded based on the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices, when available, or third-party sources. When quoted prices or third-party information is not available, management estimates valuation adjustments primarily through the use of financial modeling techniques and appraisal estimates.

Our accounting policies are fundamental in understanding MD&A and the disclosures presented in Item 1, “Financial Statements,” of this report. Our accounting policies are described in detail in Note 1, “Basis of Presentation,” of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2020, and in Note 1, “Basis of Presentation and Significant Accounting Policies,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of our 2019 Form 10-K. Our critical accounting estimates are detailed in the “Critical Accounting Estimates” section in Part II, Item 7 of our 2019 Form 10-K.

### Performance Overview

Highlights of our results of operations for the three months ended March 31, 2020, and financial condition as of March 31, 2020, include the following:

- Diluted earnings per share was $0.44.
- Current year quarter earnings includes a loan loss provision of $3.50 million, an increase of $2.28 million over first quarter of 2019. The provision had the effect of building loan loss reserves $2.71 million during the first quarter to recognize the impact of the coronavirus slowdown.
- Despite the significant increase in loan loss provision, return on average assets was 1.16% for the quarter.
- Net interest margin increased 11 basis points to 4.71% compared to the same quarter of 2019, reflective of the addition of Highlands Bankshares, Inc.
- The Company incurred $1.89 million in residual merger expenses related to the Highlands acquisition that occurred December 31, 2019.
- Prior to the pandemic responses, the Company completed its stock repurchase authorization with the repurchase of 734,653 shares for approximately $21.87 million. Based on the current outlook for economic conditions, the Company decided to temporarily suspend any further share repurchases. As of March 31, 2020, the Company continues to significantly exceed regulatory “well capitalized” targets, as well as all capital targets of its capital management plan.

### Results of Operations

#### Net Income

The following table presents the changes in net income and related information for the periods indicated:

*(Amounts in thousands, except per share data)*

|  | Three Months Ended March 31, 2020 | 2019 | Increase (Decrease) | % Change |
| --- | ---: | ---: | ---: | ---: |
| Net income | $7,872 | $9,631 | $(1,759) | -18.26% |
| Basic earnings per common share | 0.44 | 0.61 | (0.17) | -27.87% |
| Diluted earnings per common share | 0.44 | 0.60 | (0.16) | -26.67% |
| Return on average assets | 1.16% | 1.75% | -0.59% | -33.71% |
| Return on average common equity | 7.49% | 11.77% | -4.28% | -36.36% |

*Three-Month Comparison.* Net income decreased $1.76 million in the first quarter of 2020 due to a $2.28 million increase in the provision for loan losses as a result of building the reserve to recognize the impact of the coronavirus slowdown. Additional decreases resulted from increases in salaries and employee benefits of $2.22 million reflective of the addition of Highlands; and $1.89 million in residual merger expenses related to the Highlands acquisition that occurred December 31, 2019. Results for first quarter 2019 also included one-time litigation settlements of $1.68 million. These decreases were offset by an increase of $5.50 million in net interest income that is reflective of the addition of Highlands.

#### Net Interest Income

Net interest income, our largest contributor to earnings, is analyzed on a fully taxable equivalent (“FTE”) basis, a non-GAAP financial measure. For additional information, see “Non-GAAP Financial Measures” below. The following tables present the consolidated average balance sheets and net interest analysis on a FTE basis for the dates indicated:

### AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS (Unaudited)

*(Amounts in thousands)*

| Assets Earning assets | Three Months Ended March 31, 2020 Average Balance | Interest(1) | Average Yield/ Rate(1) | 2019 Average Balance | Interest(1) | Average Yield/ Rate(1) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans(2)(3) | $2,081,132 | $28,105 | 5.43% | $1,765,132 | $22,236 | 5.11% |
| Securities available for sale | 136,109 | 1,060 | 3.13% | 145,783 | 1,231 | 3.43% |
| Securities held to maturity | - | - | - | 12,348 | 45 | 1.48% |
| Interest-bearing deposits | 163,483 | 535 | 1.31% | 54,694 | 338 | 2.50% |
| Total earning assets | 2,380,724 | 29,700 | 5.02% | 1,977,957 | 23,850 | 4.89% |
| Other assets | 353,647 |  |  | 247,965 |  |  |
| Total assets | $2,734,371 |  |  | $2,225,922 |  |  |
| **Liabilities and stockholders' equity** |  |  |  |  |  |  |
| Interest-bearing deposits |  |  |  |  |  |  |
| Demand deposits | $502,603 | $90 | 0.07% | $447,023 | $37 | 0.03% |
| Savings deposits | 679,656 | 414 | 0.24% | 501,276 | 175 | 0.14% |
| Time deposits | 485,085 | 1,322 | 1.10% | 438,454 | 1,093 | 1.01% |
| Total interest-bearing deposits | 1,667,344 | 1,826 | 0.44% | 1,386,753 | 1,305 | 0.38% |
| Borrowings |  |  |  |  |  |  |
| Retail repurchase agreements | 1,459 | 2 | 0.59% | 3,259 | 1 | 0.13% |
| Wholesale repurchase agreements | - | - | - | 15,278 | 119 | 3.17% |
| FHLB advances and other borrowings | 134 | 1 | 1.70% | - | - | - |
| Total borrowings | 1,593 | 3 | - | 18,537 | 120 | 2.63% |
| Total interest-bearing liabilities | 1,668,937 | 1,829 | 0.44% | 1,405,290 | 1,425 | 0.41% |
| Noninterest-bearing demand deposits | 600,636 |  |  | 459,766 |  |  |
| Other liabilities | 42,174 |  |  | 28,894 |  |  |
| Total liabilities | 2,311,747 |  |  | 1,893,950 |  |  |
| Stockholders' equity | 422,624 |  |  | 331,972 |  |  |
| Total liabilities and stockholders' equity | $2,734,371 |  |  | $2,225,922 |  |  |
| Net interest income, FTE(1) |  | $27,871 |  |  | $22,425 |  |
| Net interest rate spread |  |  | 4.58% |  |  | 4.48% |
| Net interest margin, FTE(1) |  |  | 4.71% |  |  | 4.60% |

(1) Interest income and average yield/rate are presented on a FTE, non-GAAP, basis using the federal statutory income tax rate of 21%.

(2) Nonaccrual loans are included in the average balance; however, no related interest income is recorded during the period of nonaccrual.

(3) Interest on loans includes non-cash and accelerated purchase accounting accretion of $1.95 million and $764 thousand for the three months ended March 31, 2020 and 2019, respectively.

41

The following table presents the impact to net interest income on a FTE basis due to changes in volume (average volume times the prior year’s average rate), rate (average rate times the prior year’s average volume), and rate/volume (average volume times the change in average rate), for the periods indicated:

*(Amounts in thousands)*

| Interest earned on(1) | Three Months Ended March 31, 2020 Dollar Increase (Decrease) due to Volume | Rate | Rate/ Volume | Total |
| --- | ---: | ---: | ---: | ---: |
| Loans | $3,937 | $1,602 | $330 | $5,869 |
| Securities available-for-sale | (81) | (92) | 2 | (171) |
| Securities held-to-maturity | (45) | (45) | 45 | (45) |
| Interest-bearing deposits with other banks | 665 | (159) | (309) | 197 |
| Total interest earning assets | 4,476 | 1,306 | 68 | 5,850 |
| Interest paid on(1) |  |  |  |  |
| Demand deposits | 5 | 43 | 5 | 53 |
| Savings deposits | 62 | 130 | 47 | 239 |
| Time deposits | 115 | 113 | 1 | 229 |
| Retail repurchase agreements | (1) | 4 | (2) | 1 |
| Wholesale repurchase agreements | (118) | (119) | 118 | (119) |
| FHLB advances and other borrowings | - | - | 1 | 1 |
| Total interest-bearing liabilities | 63 | 171 | 170 | 404 |
| Change in net interest income(1) | $4,413 | $1,135 | $(102) | $5,446 |

(1) FTE basis based on the federal statutory rate of 21%.

*Three-Month Comparison*. Net interest income comprised 78.57% of total net interest and noninterest income in the first quarter of 2020 compared to 73.30% in the same quarter of 2019. Net interest income on a GAAP basis increased $5.50 million, or 24.77%, compared to an increase of $5.45 million, or 24.29%, on a FTE basis. The net interest margin on a FTE basis increased 11 basis points and the net interest spread on a FTE basis increased 10 basis points. The increase in the net interest margin and the net interest spread are primarily attributable to the acquisition of Highlands Bankshares, Inc.

Average earning assets increased $402.77 million, or 20.36%, primarily due to a increase in average loans as well as an increase in interest-bearing deposits. Average loans increased $316.00 million which was primarily due to the addition of Highlands. The yield on earning assets increased 13 basis points or 2.66%, due to a 32 basis point increase in yield on loans. The average loan to deposit ratio decreased to 91.76% from 95.59% in the same quarter of 2019. Non-cash accretion income increased $1.19 million, or 155.76%, due to the addition of loans from the Highlands acquisition.

Average interest-bearing liabilities, which consist of interest-bearing deposits and borrowings, increased $263.65 million, or 18.76%, primarily due to an increase in interest-bearing deposits. The yield on interest-bearing liabilities increased 3 basis points. Average borrowings decreased $16.94 million, largely due to a $25 million payoff of a wholesale repurchase agreement in the first quarter of 2019. Average interest-bearing deposits increased $280.59 million, or 20.23%, which was driven by the December 31, 2019 Highlands acquisition with increases in average savings deposits of $178.38 million, or 35.59%, interest-bearing demand of $55.58 million, or 12.43%, and time deposits of $46.63 million, or 10.64%

#### Provision for Loan Losses

*Three-Month Comparison*. The provision charged to operations increased $2.28 million, or 186.89%, to $3.50 million in the first quarter of 2020 compared to the same quarter of 2019. The provision had the effect of increasing loan loss reserves $2.71 million during the first quarter to recognize the impact of the coronavirus slowdown. For additional information, see “Allowance for Loan Losses” in the “Financial Condition” section below.

#### Noninterest Income

The following table presents the components of, and changes in, noninterest income for the periods indicated:

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2020 | 2019 | Increase% (Decrease) | Change |
| --- | ---: | ---: | ---: | ---: |
| Wealth management | $844 | $745 | $99 | 13.29% |
| Service charges on deposits | 3,731 | 3,408 | 323 | 9.48% |
| Other service charges and fees | 2,231 | 2,049 | 182 | 8.88% |
| Net gain on sale of securities | 385 | - | 385 | - |
| Net FDIC indemnification asset amortization | (486) | (552) | 66 | -11.96% |
| Other income/litigation settlements | - | 1,675 | (1,675) | - |
| Other operating income | 844 | 755 | 89 | 11.79% |
| Total noninterest income | $7,549 | $8,080 | $(531) | -6.57% |

*Three-Month Comparison*. Noninterest income comprised 21.43% of total net interest and noninterest income in the first quarter of 2020 compared to 26.70% in the same quarter of 2019. Noninterest income decreased $531 thousand, or 6.57%. The decrease was primarily due to $1.68 million received from litigation settlements in the first quarter of 2019, offset by net gains on the sale of securities of $385 thousand, an increase in service charges on deposits of $323 thousand, and an increase of $182 thousand in other service charges and fees.

#### Noninterest Expense

The following table presents the components of, and changes in, noninterest expense for the periods indicated:

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2020 | 2019 | Increase% (Decrease) | Change |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | $11,386 | $9,166 | $2,220 | 24.22% |
| Occupancy expense | 1,315 | 1,153 | 162 | 14.05% |
| Furniture and equipment expense | 1,384 | 1,033 | 351 | 33.98% |
| Service fees | 1,523 | 1,030 | 493 | 47.86% |
| Advertising and public relations | 512 | 524 | (12) | -2.29% |
| Professional fees | 233 | 414 | (181) | -43.72% |
| Amortization of intangibles | 361 | 246 | 115 | 46.75% |
| FDIC premiums and assessments | - | 168 | (168) | -100.00% |
| Merger expense | 1,893 | - | 1,893 | - |
| Other operating expense | 3,057 | 3,051 | 6 | 0.20% |
| Total noninterest expense | $21,664 | $16,785 | $4,879 | 29.07% |

*Three-Month Comparison*. Noninterest expense increased $4.88 million, or 29.07%, in the first quarter of 2020 compared to the same quarter of 2019. The increase was largely due to an increase in salaries and benefits of $2.22 million primarily attributable to the addition of Highlands employees. In addition, the Company incurred $1.89 million in residual merger expenses related to the Highlands acquisition. The decrease in FDIC premiums and assessments of $168 thousand was attributable to the receipt of Small Bank Assessment credits from the FDIC.

#### Income Tax Expense

The Company’s effective tax rate, income tax as a percent of pre-tax income, may vary significantly from the statutory rate due to permanent differences and available tax credits. Permanent differences are income and expense items excluded by law in the calculation of taxable income. The Company’s most significant permanent differences generally include interest income on municipal securities and increases in the cash surrender value of life insurance policies.

*Three-Month Comparison*. Income tax expense decreased $435 thousand, or 16.54%, primarily due to the decrease in pre-tax earnings. The effective tax rate increased to 21.80% in the first quarter of 2020 from 21.45% in the same quarter of 2019.

### Non-GAAP Financial Measures

In addition to financial statements prepared in accordance with GAAP, we use certain non-GAAP financial measures that management believes provide investors with important information useful in understanding our operational performance and comparing our financial measures with other financial institutions. The non-GAAP financial measure presented in this report includes net interest income on a FTE basis. We believe FTE basis is the preferred industry measurement of net interest income and provides better comparability between taxable and tax exempt amounts. We use this non-GAAP financial measure to monitor net interest income performance and to manage the composition of our balance sheet. The FTE basis adjusts for the tax benefits of income from certain tax exempt loans and investments using the federal statutory rate of 21%. While we believe certain non-GAAP financial measures enhance understanding of our business and performance, they are supplemental and not a substitute for, or more important than, financial measures prepared on a GAAP basis. Our non-GAAP financial measures may not be comparable to those reported by other financial institutions. The reconciliations of non-GAAP to GAAP measures are presented below.

The following table reconciles net interest income and margin, as presented in our consolidated statements of income, to net interest income on a FTE basis for the periods indicated:

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2020 | 2019 |
| --- | ---: | ---: |
| Net interest income, GAAP | $27,682 | $22,186 |
| FTE adjustment(1) | 189 | 239 |
| Net interest income, FTE | 27,871 | 22,425 |
| Net interest margin, GAAP | 4.68% | 4.55% |
| FTE adjustment(1) | 0.03% | 0.05% |
| Net interest margin, FTE | 4.71% | 4.60% |

### Financial Condition

Total assets as of March 31, 2020, decreased $59.89 million, or 2.14% from December 31, 2019. The decrease in assets was primarily driven by a decrease in investment securities of $61.82 million, or 36.46%. In addition, total liabilities as of March 31, 2020, decreased $42.67 million, or 1.80% from December 31, 2019. The decrease in liabilities was primarily the result of a decrease in total deposits of $41.50 million, or 1.78%.

#### Investment Securities

Our investment securities are used to generate interest income through the employment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral where required. The composition of our investment portfolio changes from time to time as we consider our liquidity needs, interest rate expectations, asset/liability management strategies, and capital requirements.

Available-for-sale debt securities as of March 31, 2020, decreased $61.82 million, or 36.46%, compared to December 31, 2019. The decrease was primarily due to the sale of $51.03 million in securities. The market value of debt securities available for sale as a percentage of amortized cost was 101.81% as of March 31, 2020, compared to 100.65% as of December 31, 2019.

Investment securities are reviewed quarterly for possible other-than-temporary impairment (“OTTI”) charges. We recognized no OTTI charges in earnings associated with debt securities for the three months ended March 31, 2020 or 2019. For additional information, see Note 2, “Debt Securities,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

#### Loans Held for Investment

Loans held for investment, our largest component of interest income, are grouped into commercial, consumer real estate, and consumer and other loan segments. Each segment is divided into various loan classes based on collateral or purpose. Certain loans acquired in FDIC-assisted transactions are covered under loss share agreements (“covered loans”). Total loans held for investment, net of unearned income, as of March 31, 2020, decreased $17.74 million, or 0.84%, compared to December 31, 2019. Covered loans decreased $746 thousand, or 5.80%, as the covered Waccamaw portfolio continues to pay down. For additional information, see Note 3, “Loans,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The following table presents loans, net of unearned income, with non-covered loans by loan class as of the dates indicated:

*(Amounts in thousands)*

| Non-covered loans held for investment Commercial loans | March 31, 2020 Amount | Percent | December 31, 2019 Amount | Percent | March 31, 2019 Amount | Percent |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Construction, development, and other land | $53,321 | 2.54% | $48,659 | 2.30% | $63,975 | 3.68% |
| Commercial and industrial | 129,728 | 6.19% | 142,962 | 6.76% | 94,039 | 5.41% |
| Multi-family residential | 110,202 | 5.26% | 121,840 | 5.76% | 102,071 | 5.87% |
| Single family non-owner occupied | 187,771 | 8.96% | 163,181 | 7.72% | 140,037 | 8.06% |
| Non-farm, non-residential | 726,664 | 34.65% | 727,261 | 34.39% | 602,207 | 34.67% |
| Agricultural | 11,303 | 0.54% | 11,756 | 0.56% | 8,975 | 0.52% |
| Farmland | 26,045 | 1.24% | 23,155 | 1.10% | 18,569 | 1.07% |
| Total commercial loans | 1,245,034 | 59.38% | 1,238,814 | 58.59% | 1,029,873 | 59.28% |
| Consumer real estate loans |  |  |  |  |  |  |
| Home equity lines | 105,384 | 5.03% | 110,078 | 5.21% | 90,000 | 5.18% |
| Single family owner occupied | 603,546 | 28.79% | 620,697 | 29.35% | 502,059 | 28.89% |
| Owner occupied construction | 13,946 | 0.66% | 17,241 | 0.82% | 13,867 | 0.80% |
| Total consumer real estate loans | 722,876 | 34.48% | 748,016 | 35.38% | 605,926 | 34.87% |
| Consumer and other loans |  |  |  |  |  |  |
| Consumer loans | 112,127 | 5.35% | 110,027 | 5.20% | 79,185 | 4.56% |
| Other | 4,573 | 0.22% | 4,742 | 0.22% | 4,921 | 0.28% |
| Total consumer and other loans | 116,700 | 5.57% | 114,769 | 5.42% | 84,106 | 4.84% |
| Total non-covered loans | 2,084,610 | 99.43% | 2,101,599 | 99.39% | 1,719,905 | 98.99% |
| Total covered loans | 12,115 | 0.57% | 12,861 | 0.61% | 17,475 | 1.01% |
| Total loans held for investment, net of unearned income | 2,096,725 | 100.00% | 2,114,460 | 100.00% | 1,737,380 | 100.00% |
| Less: allowance for loan losses | 21,137 |  | 18,425 |  | 18,243 |  |
| Total loans held for investment, net of unearned income and allowance | $2,075,588 |  | $2,096,035 |  | $1,719,137 |  |
| Loans held for sale | $- |  | $263 |  | $- |  |

The following table presents covered loans, by loan class, as of the dates indicated:

*(Amounts in thousands)*

| Commercial loans | March 31, 2020 Amount | Percent | December 31, 2019 Amount | Percent | March 31, 2019 Amount | Percent |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Construction, development, and other land | $27 | 0.22% | $28 | 0.22% | $33 | 0.19% |
| Single family non-owner occupied | 194 | 1.60% | 199 | 1.55% | 231 | 1.32% |
| Non-farm, non-residential | 2 | 0.02% | 3 | 0.02% | 6 | 0.03% |
| Total commercial loans | 223 | 1.84% | 230 | 1.79% | 270 | 1.54% |
| Consumer real estate loans |  |  |  |  |  |  |
| Home equity lines | 9,306 | 76.81% | 9,853 | 76.61% | 14,076 | 80.55% |
| Single family owner occupied | 2,586 | 21.35% | 2,778 | 21.60% | 3,129 | 17.91% |
| Total consumer real estate loans | 11,892 | 98.16% | 12,631 | 98.21% | 17,205 | 98.46% |
| Total covered loans | $12,115 | 100.00% | $12,861 | 100.00% | $17,475 | 100.00% |

#### Risk Elements

We seek to mitigate credit risk by following specific underwriting practices and by ongoing monitoring of our loan portfolio. Our underwriting practices include the analysis of borrowers’ prior credit histories, financial statements, tax returns, and cash flow projections; valuation of collateral based on independent appraisers’ reports; and verification of liquid assets. We believe our underwriting criteria are appropriate for the various loan types we offer; however, losses may occur that exceed the reserves established in our allowance for loan losses. We track certain credit quality indicators that include: trends related to the risk rating of commercial loans, the level of classified commercial loans, net charge-offs, nonperforming loans, and general economic conditions. The Company’s loan review function generally analyzes all commercial loan relationships greater than $4.00 million annually and at various times during the year. Smaller commercial and retail loans are sampled for review during the year.

Nonperforming assets consist of nonaccrual loans, accrual loans contractually past due 90 days or more, unseasoned troubled debt restructurings (“TDRs”), and OREO. Ongoing activity in the classification and categories of nonperforming loans include collections on delinquencies, foreclosures, loan restructurings, and movements into or out of the nonperforming classification due to changing economic conditions, borrower financial capacity, or resolution efforts. Loans acquired with credit deterioration, with a discount, continue to accrue interest based on expected cash flows; therefore, PCI loans are not generally considered nonaccrual. For additional information, see Note 4, “Credit Quality,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The following table presents the components of nonperforming assets and related information as of the periods indicated:

*(Amounts in thousands)*

| Non-covered nonperforming | March 31, 2020 | December 31, 2019 | March 31, 2019 |
| --- | ---: | ---: | ---: |
| Nonaccrual loans | $20,263 | $16,113 | $18,544 |
| Accruing loans past due 90 days or more | 329 | 144 | 156 |
| TDRs(1) | 623 | 720 | 835 |
| Total nonperforming loans | 21,215 | 16,977 | 19,535 |
| Non-covered OREO | 2,502 | 3,969 | 3,903 |
| Total non-covered nonperforming assets | $23,717 | $20,946 | $23,438 |
| **Covered nonperforming** |  |  |  |
| Nonaccrual loans | $145 | $244 | $237 |
| Total nonperforming loans | 145 | 244 | 237 |
| Covered OREO | - | - | 152 |
| Total covered nonperforming assets | $145 | $244 | $389 |
| **Total nonperforming** |  |  |  |
| Nonaccrual loans | $20,408 | $16,357 | $18,781 |
| Accruing loans past due 90 days or more | 329 | 144 | 156 |
| TDRs(1) | 623 | 720 | 835 |
| Total nonperforming loans | 21,360 | 17,221 | 19,772 |
| OREO | 2,502 | 3,969 | 4,055 |
| Total nonperforming assets | $23,862 | $21,190 | $23,827 |
| **Additional Information** |  |  |  |
| Performing TDRs(2) | $8,429 | $5,855 | $5,654 |
| Total Accruing TDRs(3) | 9,052 | 6,575 | 6,489 |
| **Non-covered ratios** |  |  |  |
| Nonperforming loans to total loans | 1.02% | 0.81% | 1.14% |
| Nonperforming assets to total assets | 0.87% | 0.75% | 1.05% |
| Non-PCI allowance to nonperforming loans | 99.63% | 108.53% | 93.39% |
| Non-PCI allowance to total loans | 1.01% | 0.88% | 1.06% |
| **Total ratios** |  |  |  |
| Nonperforming loans to total loans | 1.02% | 0.81% | 1.14% |
| Nonperforming assets to total assets | 0.87% | 0.76% | 1.06% |
| Allowance for loan losses to nonperforming loans | 98.96% | 106.99% | 92.27% |
| Allowance for loan losses to total loans | 1.01% | 0.87% | 1.05% |

(1) TDRs restructured within the past six months and nonperforming TDRs exclude nonaccrual TDRs of $2.31 million, $95 thousand, and $800 thousand for the periods ended March 31, 2020, December 31, 2019, and March 31, 2019, respectively.

(2) TDRs with six months or more of satisfactory payment performance exclude nonaccrual TDRs of $318 thousand, $2.25 million, and $2.06 million for the periods ended March 31, 2020, December 31, 2019, and March 31, 2019, respectively.

(3) Total accruing TDRs exclude nonaccrual TDRs of $2.62 million, $2.34 million, and $2.86 million for the periods ended March 31, 2020, December 31, 2019, and March 31, 2019, respectively.

Non-covered nonperforming assets as of March 31, 2020, increased $2.77 million, or 13.23%, from December 31, 2019, primarily due to a increase in non-covered nonaccrual loans acquired from Highlands Union Bank offset by a decrease in OREO of $1.47 million. Non-covered nonaccrual loans as of March 31, 2020, increased $4.15 million, or 25.76%, from December 31, 2019. As of March 31, 2020, non-covered nonaccrual loans were largely attributed to single family owner occupied (40.54%), non-farm, non-residential (18.38%), and single family non-owner occupied loans (10.03%). As of March 31, 2020, approximately $3.32 million or 16.39%, of non-covered nonaccrual loans were attributed to performing loans acquired through the Highlands acquisition. Certain loans included in the nonaccrual category have been written down to estimated realizable value or assigned specific reserves in the allowance for loan losses based on management’s estimate of loss at ultimate resolution.

Non-covered delinquent loans, comprised of loans 30 days or more past due and nonaccrual loans, totaled $45.23 million as of March 31, 2020, a increase of $9.61 million, or 26.97%, compared to $35.62 million as of December 31, 2019. Non-covered delinquent loans as a percent of total non-covered loans totaled 2.15% as of March 31, 2020, which includes past due loans (1.19%) and nonaccrual loans (0.96%).

When restructuring loans for borrowers experiencing financial difficulty, we generally make concessions in interest rates, loan terms, or amortization terms. Certain TDRs are classified as nonperforming when modified and are returned to performing status after six months of satisfactory payment performance; however, these loans remain identified as impaired until full payment or other satisfaction of the obligation occurs. Accruing TDRs as of March 31, 2020, increased $2.48 million, or 37.67%, to $9.05 million from December 31, 2019. Unseasoned, or loans restructured within the last six months, and nonperforming accruing TDRs as of March 31, 2020, increased $1.86 million to $2.76 million compared to December 31, 2019. Unseasoned and nonperforming accruing TDRs as a percent of total accruing TDRs totaled 30.45% as of March 31, 2020, compared to 13.69% as of December 31, 2019. Specific reserves on TDRs totaled $351 thousand as of March 31, 2020, compared to $353 thousand as of December 31, 2019.

The provisions of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act included an election to not apply the guidance on accounting for troubled debt restructurings to loan modifications, such as extensions or deferrals, related to COVID-19 made between March 1, 2020 and the earlier of (i) December 31, 2020 or (ii) 60 days after the end of the COVID-19 national emergency. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. The Company elected to adopt these provisions of the CARES Act.

Through March 31, 2020, the Company had modified 154 loans with principal balances totaling $6.61 million related to COVID-19 relief. Those modifications were generally short-term payment deferrals and are not considered TDR’s based on the CARES Act; however, the Company’s policy is to downgrade commercial loans modified for COVID-19 to special mention.

Non-covered OREO, which is carried at the lesser of estimated net realizable value or cost, decreased $1.47 million, or 36.96%, as of March 31, 2020, compared to December 31, 2019, and consisted of 27 properties with an average holding period of 6 months. The net loss on the sale of OREO totaled $300 thousand for the three months ended March 31, 2020, compared to $364 thousand for the same period of the prior year. The following table presents the changes in OREO during the periods indicated:

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2020 Non-covered | Covered | Total | 2019 Non-covered | Covered | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Beginning balance | $3,969 | $- | $3,969 | $3,806 | $32 | $3,838 |
| Additions | 377 | - | 377 | 1,778 | 130 | 1,908 |
| Disposals | (1,453) | - | (1,453) | (1,392) | - | (1,392) |
| Valuation adjustments | (391) | - | (391) | (289) | (10) | (299) |
| Ending balance | $2,502 | $- | $2,502 | $3,903 | $152 | $4,055 |

#### Allowance for Loan Losses

The allowance for loan losses is maintained at a level management deems sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by the provision for loan losses and recoveries of prior loan charge-offs and decreased by loans charged off. The provision for loan losses is calculated and charged to expense to bring the allowance to an appropriate level using a systematic process of measurement that requires significant judgments and estimates. As of March 31, 2020, our allowance reflects a higher risk of loan losses due to uncertainty around the impact that the COVID-19 pandemic will have on business and economic conditions in our primary market areas. The loan portfolio is continually monitored for deterioration in credit, which may result in the need to increase the allowance for loan losses in future periods. Management considered the allowance adequate as of March 31, 2020; however, no assurance can be made that additions to the allowance will not be required in future periods. For additional information, see Note 5, “Allowance for Loan Losses,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The allowance for loan losses as of March 31, 2020, increased $2.71 million, or 14.71%, from December 31, 2019 due primarily to the increased potential for loan defaults and losses related to the COVID-19 pandemic. The non-PCI allowance as a percent of non-covered loans totaled 1.01% as of March 31, 2020, compared to 0.88% as of December 31, 2019. Effective January 1, 2020, the Company collapsed the PCI loans and discounts for Peoples and Waccamaw acquired loans into the core loan portfolio. The Highlands transaction added the following pools: 1-4 Family, Senior-Consumer, 1-4 Family Senior-Commercial, 1-4 Family, Junior and Home Equity Lines, Commercial Land and Development, Farmland and Agricultural, Multi-family, Commercial Real Estate – Owner Occupied, Commercial Real Estate – Non-owner Occupied, Commercial and Industrial, and Consumer. Net charge-offs decreased $789 thousand for the three months ended March 31, 2020, compared to the same period of the prior year. The decrease in net charge-offs was driven by reduced losses in the single-family owner occupied loan pool.

The following table presents the changes in the allowance for loan losses during the periods indicated:

*(Amounts in thousands)*

|  | Three Months Ended March 31 2020 Non-PCI Portfolio | PCI Portfolio | Total | 2019 Non-PCI Portfolio | PCI Portfolio | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Beginning balance | $18,425 | $- | $18,425 | $18,267 | $- | $18,267 |
| Provision for loan losses charged to operations | 3,500 | - | 3,500 | 1,220 | - | 1,220 |
| Charge-offs | (1,194) | - | (1,194) | (1,622) | - | (1,622) |
| Recoveries | 406 | - | 406 | 378 | - | 378 |
| Net charge-offs | (788) | - | (788) | (1,244) | - | (1,244) |
| Ending balance | $21,137 | $- | $21,137 | $18,243 | $- | $18,243 |

#### Deposits

Total deposits as of March 31, 2020, decreased $41.50 million, or 1.78%, compared to December 31, 2019. The decrease was largely attributable to time deposits which decreased $42.38 million, or 8.22%, with decreases in noninterest-bearing demand deposits of $7.58 million, and savings deposits of $7.44 million. These decreases were offset by an increase in interest-bearing demand accounts of $15.90 million, or 3.20%.

#### Borrowings

Total borrowings as of March 31, 2020, increased $747 thousand, compared to December 31, 2019. The increase was primarily driven by a $1.00 million draw on a correspondent line of credit that was tested at quarter-end. The borrowing was paid back early April 2020.

### Liquidity and Capital Resources

#### Liquidity

Liquidity is a measure of our ability to convert assets to cash or raise cash to meet financial obligations. We believe that liquidity management should encompass an overall balance sheet approach that draws together all sources and uses of liquidity. Poor or inadequate liquidity risk management may result in a funding deficit that could have a material impact on our operations. We maintain a liquidity risk management policy and contingency funding policy (“Liquidity Plan”) to detect potential liquidity issues and protect our depositors, creditors, and shareholders. The Liquidity Plan includes various internal and external indicators that are reviewed on a recurring basis by our Asset/Liability Management Committee (“ALCO”) of the Board of Directors. ALCO reviews liquidity risk exposure and policies related to liquidity management; ensures that systems and internal controls are consistent with liquidity policies; and provides accurate reports about liquidity needs, sources, and compliance. The Liquidity Plan involves ongoing monitoring and estimation of potentially credit sensitive liabilities and the sources and amounts of balance sheet and external liquidity available to replace outflows during a funding crisis. The liquidity model incorporates various funding crisis scenarios and a specific action plan is formulated, and activated, when a financial shock that affects our normal funding activities is identified. Generally, the plan will reflect a strategy of replacing liability outflows with alternative liabilities, rather than balance sheet asset liquidity, to the extent that significant premiums can be avoided. If alternative liabilities are not available, outflows will be met through liquidation of balance sheet assets, including unpledged securities.

As a financial holding company, the Company’s primary source of liquidity is dividends received from the Bank, which are subject to certain regulatory limitations. Other sources of liquidity include cash, investment securities, and borrowings. As of March 31, 2020, the Company’s cash reserves totaled $8.33 million and availability on an unsecured, committed line of credit with an unrelated financial institution totaled $15.00 million. There was an outstanding balance on the line of credit of $1.00 million as of March 31, 2020. The Company’s cash reserves and investments provide adequate working capital to meet obligations and anticipated debt repayments for the next twelve months.

In addition to cash on hand and deposits with other financial institutions, we rely on customer deposits, cash flows from loans and investment securities, and lines of credit from the FHLB and the Federal Reserve Bank (“FRB”) Discount Window to meet potential liquidity demands. These sources of liquidity are immediately available to satisfy deposit withdrawals, customer credit needs, and our operations. Secondary sources of liquidity include approved lines of credit with correspondent banks and unpledged available-for-sale securities. As of March 31, 2020, our unencumbered cash totaled $241.69 million, unused borrowing capacity from the FHLB totaled $241.61 million, available credit from the FRB Discount Window totaled $6.08 million, available lines from correspondent banks totaled $85.00 million, and unpledged available-for-sale securities totaled $80.42 million.

#### Cash Flows

The following table summarizes the components of cash flow for the periods indicated:

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2020 | 2019 |
| --- | ---: | ---: |
| Net cash provided by operating activities | $11,373 | $14,093 |
| Net cash provided by investing activities | 80,487 | 71,642 |
| Net cash used in financing activities | (67,256) | (14,062) |
| Net increase (decrease) in cash and cash equivalents | 24,604 | 71,673 |
| Cash and cash equivalents, beginning balance | 217,009 | 76,873 |
| Cash and cash equivalents, ending balance | $241,613 | $148,546 |

Cash and cash equivalents increased $24.60 million for the three months ended March 31, 2020, compared to an increase of $71.67 million for the same period of the prior year. The increase in cash and cash equivalents was driven by an increase in net cash used in financing activities. The increase in net cash used in financing activities was driven by a decrease in deposits of $64.19 million and the increase in repurchases of common stock totaling $14.09 million offset by the 2019 repayment of the wholesale repurchase agreement of $25.00 million.

#### Capital Resources

We are committed to effectively managing our capital to protect our depositors, creditors, and shareholders. Failure to meet certain capital requirements may result in actions by regulatory agencies that could have a material impact on our operations. Total stockholders’ equity as of March 31, 2020, decreased $17.21 million, or 4.01%, to $411.61 million from $428.82 million as of December 31, 2019. The change in stockholders’ equity was largely due to net income of $7.87 million offset by the repurchase of 734,653 shares of our common stock totaling $21.87 million and dividends declared on our common stock of $4.59 million. Accumulated other comprehensive loss decreased $367 thousand to $1.14 million as of March 31, 2020, compared to December 31, 2019, primarily due to net unrealized gains on securities. In accordance with current regulatory guidelines, accumulated other comprehensive income/(loss) is largely excluded from stockholders’ equity in the calculation of our capital ratios. Our book value per common share decreased $0.08 or 0.34% to $23.25 as of March 31, 2020, from $23.33 as of December 31, 2019.

#### Capital Adequacy Requirements

Risk-based capital guidelines, issued by state and federal banking agencies, include balance sheet assets and off-balance sheet arrangements weighted by the risks inherent in the specific asset type. Our current risk-based capital requirements, based on the international capital standards known as Basel III, became effective on January 1, 2015, subject to a four-year phase-in period. Basel III’s capital conservation buffer became effective on January 1, 2016, at 0.625%, and was phased in over a four-year period (increasing by an additional 0.625% each year, reaching 2.5% on January 1, 2019). A description of the Basel III capital rules is included in Part I, Item 1 of the 2018 Form 10-K. Our current required capital ratios are as follows:

- 4.5% Common Equity Tier 1 capital to risk-weighted assets (effectively 7.00% including the capital conservation buffer)
- 6.0% Tier 1 capital to risk-weighted assets (effectively 8.50% including the capital conservation buffer)
- 8.0% Total capital to risk-weighted assets (effectively 10.50% including the capital conservation buffer)
- 4.0% Tier 1 capital to average consolidated assets (“Tier 1 leverage ratio”)

49

The following table presents our capital ratios as of the dates indicated:

|  | March 31, 2020 Company | Bank | December 31, 2019 Company | Bank |
| --- | ---: | ---: | ---: | ---: |
| Common equity Tier 1 ratio | 13.54% | 13.05% | 14.31% | 12.87% |
| Tier 1 risk-based capital ratio | 13.54% | 13.05% | 14.31% | 12.87% |
| Total risk-based capital ratio | 14.58% | 14.10% | 15.21% | 13.78% |
| Tier 1 leverage ratio | 10.59% | 10.11% | 14.01% | 12.61% |

Our risk-based capital ratios as of March 31, 2020, decreased from December 31, 2019, due to a decrease in total capital. The decrease in total capital was primarily attributable to the repurchase of 734,653 shares of our common stock totaling $21.87 million offset by net income of $7.87 million. As of March 31, 2020, we continued to meet all capital adequacy requirements and were classified as well-capitalized under the regulatory framework for prompt corrective action. Management believes there have been no conditions or events since those notifications that would change the Bank’s classification. Additionally, our capital ratios were in excess of the minimum standards under the Basel III capital rules as of March 31, 2020.

### Off-Balance Sheet Arrangements

We extend contractual commitments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. Our exposure to credit loss in the event of nonperformance by other parties to financial instruments is the same as the contractual amount of the instrument. The following table presents our off-balance sheet arrangements as of the dates indicated:

*(Amounts in thousands)*

|  | March 31, 2020 | December 31, 2019 |
| --- | ---: | ---: |
| Commitments to extend credit | $217,022 | $228,716 |
| Standby letters of credit and financial guarantees (1) | 174,029 | 167,612 |
| Total off-balance sheet risk | $391,051 | $396,328 |
| Reserve for unfunded commitments | $66 | $66 |

(1) Includes FHLB letters of credit

### Market Risk and Interest Rate Sensitivity

Market risk represents the risk of loss due to adverse changes in current and future cash flows, fair values, earnings, or capital due to movements in interest rates and other factors. Our profitability is largely dependent upon net interest income, which is subject to variation due to changes in the interest rate environment and unbalanced repricing opportunities. We are subject to interest rate risk when interest-earning assets and interest-bearing liabilities reprice at differing times, when underlying rates change at different levels or in varying degrees, when there is an unequal change in the spread between two or more rates for different maturities, and when embedded options, if any, are exercised. ALCO reviews our mix of assets and liabilities with the goal of limiting exposure to interest rate risk, ensuring adequate liquidity, and coordinating sources and uses of funds while maintaining an acceptable level of net interest income given the current interest rate environment. ALCO is also responsible for overseeing the formulation and implementation of policies and strategies to improve balance sheet positioning and mitigate the effect of interest rate changes.

In order to manage our exposure to interest rate risk, we periodically review internal simulation and third-party models that project net interest income at risk, which measures the impact of different interest rate scenarios on net interest income, and the economic value of equity at risk, which measures potential long-term risk in the balance sheet by valuing our assets and liabilities at fair value under different interest rate scenarios. Simulation results show the existence and severity of interest rate risk in each scenario based on our current balance sheet position, assumptions about changes in the volume and mix of interest-earning assets and interest-bearing liabilities, and estimated yields earned on assets and rates paid on liabilities. The simulation model provides the best tool available to us and the industry for managing interest rate risk; however, the model cannot precisely predict the impact of fluctuations in interest rates on net interest income due to the use of significant estimates and assumptions. Actual results will differ from simulated results due to the timing, magnitude, and frequency of interest rate changes; changes in market conditions and customer behavior; and changes in our strategies that management might undertake in response to a sudden and sustained rate shock.

As of March 31, 2020, the Federal Open Market Committee had set the benchmark federal funds rate to a range of 0 to 25 basis points. Given the current range, a complete downward shock of 200 basis points is rendered meaningless; accordingly, downward rate scenarios are limited to minus 100 basis points. In the downward rate shocks presented, benchmark interest rates are assumed at levels with floors near 0%. The following table presents the sensitivity of net interest income from immediate and sustained rate shocks in various interest rate scenarios over a twelve-month period for the periods indicated.

*(Dollars in thousands)*

| Increase (Decrease) in Basis Points | March 31, 2020 Change in Net Interest Income | Percent Change | December 31, 2019 Change in Net Interest Income | Percent Change |
| ---: | ---: | ---: | ---: | ---: |
| 300 | $1,868 | 1.9% | $171 | 0.2% |
| 200 | 1,330 | 1.3% | 428 | 0.4% |
| 100 | 731 | 0.7% | 426 | 0.4% |
| (100) | (1,978) | -2.0% | (4,631) | -4.3% |

### Inflation and Changing Prices

Our consolidated financial statements and related notes are presented in accordance with GAAP, which requires the measurement of results of operations and financial position in historical dollars. Inflation may cause a rise in price levels and changes in the relative purchasing power of money. These inflationary effects are not reflected in historical dollar measurements. The primary effect of inflation on our operations is increased operating costs. In management’s opinion, interest rates have a greater impact on our financial performance than inflation. Interest rates do not necessarily fluctuate in the same direction, or to the same extent, as the price of goods and services; therefore, the effect of inflation on businesses with large investments in property, plant, and inventory is generally more significant than the effect on financial institutions. The U.S. inflation rate continues to be relatively stable, and management believes that any changes in inflation will not be material to our financial performance.

In anticipation of the potential discontinuance of the London Interbank Offered Rate (LIBOR) at the end of 2021, the Company has broken the transition efforts into two phases. The first phase is adding additional language to new loans that allows the Company to replace LIBOR with an equivalent rate index and adjust the margin to ensure the resulting interest rate is the same as it previously was using LIBOR. Also included in the first phase the Company will be transitioning from the LIBOR swap curve to treasury rates when repricing certain loans. The second phase is transitioning current variable loans tied to LIBOR or on a LIBOR swap curve. The Company is currently quantifying the dollar amount and number of loans that extend beyond 2021.

## Market risk

As filed, 139 characters.

The information required in this item is incorporated by reference to “Market Risk and Interest Rate Sensitivity” in Item 2 of this report.

## Controls and procedures

As filed, 2,522 characters.

### Evaluation of Disclosure Controls and Procedures

In connection with this report, we conducted an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures under the Exchange Act Rule 13a-15(b). Based upon that evaluation, the CEO and CFO concluded that, as of March 31, 2020, our disclosure controls and procedures were effective.

Disclosure controls and procedures are our Company’s controls and other procedures that are designed to ensure that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions about required disclosure.

Management, including the CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, collusion of two or more people, or management’s override of the controls.

### Changes in Internal Control over Financial Reporting

We assess the adequacy of our internal control over financial reporting quarterly and enhance our controls in response to internal control assessments and internal and external audit and regulatory recommendations. There were no changes in our internal control over financial reporting during the quarter ended March 31, 2020, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 9,848 characters.

The risk factors set forth in our annual report on Form 10-K for the year ended December 31, 2019 discuss potential events, trends, or other circumstances that could adversely affect our business, financial condition, results of operations, cash flows, liquidity, access to capital resources, and, consequently, cause the market value of our common stock to decline. These risks could cause our future results to differ materially from historical results and expectations of future financial performance. If any of the risks occur and the market price of our common stock declines significantly, individuals may lose all, or part, of their investment in our Company. Individuals should carefully consider our risk factors and information included in our annual report on Form 10-K for the year ended December 31, 2019 before making an investment decision. There may be risks and uncertainties that we have not identified or that we have deemed immaterial that could adversely affect our business; therefore, such risk factors are not intended to be an exhaustive list of all risks we face. There have been no material changes to the risk factors included in Part I, Item 1A, “Risk Factors,” of our annual report on Form 10-K for the year ended December 31, 2019.

The Company is providing these additional risk factors to supplement the risk factors contained in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2019.

***The COVID-19 pandemic has adversely affected the Company’s business, financial condition and results of operations. The ultimate impacts of the pandemic on the Company will depend on future developments and other factors that are highly uncertain, the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.***

The ongoing COVID-19 global and national health emergency has caused significant disruption in the international and United States economies and financial markets and has had an adverse effect on the Company’s business, financial condition and results of operations. The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in business activity and financial transactions, supply chain interruptions and overall economic and financial market instability. In response to the COVID-19 pandemic, the governments of the states in which the Company operates, and of most other states have taken preventative or protective actions, such as imposing restrictions on travel and business operations, advising or requiring individuals to limit or forego their time outside of their homes, and ordering temporary closures of businesses that have been deemed to be non-essential. These restrictions and other consequences of the pandemic have resulted in significant adverse effects for many different types of businesses, including, among others, those in the travel, hospitality and food and beverage industries, and have resulted in a significant number of layoffs and furloughs of employees nationwide and in the regions in which we operate.

The ultimate effects of the COVID-19 pandemic on the broader economy and the markets that we serve are not known nor is the ultimate length of the restrictions described above and any accompanying effects. Moreover, the Federal Reserve has taken action to lower the Federal Funds rate, which may negatively affect our interest income and, therefore, earnings, financial condition and results of operation. e may include, or exacerbate, among other consequences, the following:

- employees contracting COVID-19;
- reductions in our operating effectiveness as our employees work from home;
- a work stoppage, forced quarantine, or other interruption of our business;
- unavailability of key personnel necessary to conduct our business activities;
- effects on key employees, including operational management personnel and those charged with preparing, monitoring and evaluating our financial reporting and internal controls;
- sustained closures of our branch lobbies or the offices of our customers;
- declines in demand for loans and other banking services and products;
- reduced consumer spending due to both job losses and other effects attributable to the COVID-19 pandemic;
- unprecedented volatility in United States financial markets;
- volatile performance of our investment securities portfolio;
- decline in the credit quality of our loan portfolio, owing to the effects of the COVID-19 pandemic in the markets we serve, leading to a need to increase our allowance for loan losses;
- declines in value of collateral for loans, including real estate collateral;
- declines in the net worth and liquidity of borrowers and loan guarantors, impairing their ability to honor commitments to us; and
- declines in demand resulting from businesses being deemed to be “non-essential” by governments in the markets we serve, and from “non-essential” and “essential” businesses suffering adverse effects from reduced levels of economic activity in our markets.

These factors, together or in combination with other events or occurrences that may not yet be known or anticipated, may materially and adversely affect our business, financial condition and results of operations.

The ongoing COVID-19 pandemic has resulted in meaningfully lower stock prices for many companies, as well as the trading prices for many other securities. The further spread of the COVID-19 outbreak, as well as ongoing or new governmental, regulatory and private sector responses to the pandemic, may materially disrupt banking and other economic activity generally and in the areas in which we operate. This could result in further decline in demand for our banking products and services, and could negatively impact, among other things, our liquidity, regulatory capital and our growth strategy. Any one or more of these developments could have a material adverse effect on our business, financial condition and results of operations.

We are taking precautions to protect the safety and well-being of our employees and customers. However, no assurance can be given that the steps being taken will be adequate or deemed to be appropriate, nor can we predict the level of disruption which will occur to our employee’s ability to provide customer support and service. If we are unable to recover from a business disruption on a timely basis, our business, financial condition and results of operations could be materially and adversely affected. We may also incur additional costs to remedy damages caused by such disruptions, which could further adversely affect our business, financial condition and results of operations.

***As a participating lender in the Small Business Administration Paycheck Protection Program (“PPP”), the Company and the Bank are subject to additional risks of litigation from the Bank’s customers or other parties regarding the Bank’s processing of loans for the PPP and risks that the SBA may not fund some or all PPP loan guaranties.***

On March 27, 2020, President Trump signed the CARES Act, which included a $349 billion loan program administered through the SBA referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. The Bank is participating as a lender in the PPP. The PPP opened on April 3, 2020; however, because of the short timeframe between the passing of the CARES Act and the opening of the PPP, there is some ambiguity in the laws, rules and guidance regarding the operation of the PPP, which exposes the Company to risks relating to noncompliance with the PPP. On or about April 16, 2020, the SBA notified lenders that the $349 billion earmarked for the PPP was exhausted. Congress approved additional funding for the PPP of approximately $320 billion on April 24, 2020. As of May 1, 2020, we have funded approximately 234 loans totaling approximately $37.68 million through the PPP program.

Since the opening of the PPP, several other larger banks have been subject to litigation regarding the process and procedures that such banks used in processing applications for the PPP. The Company and the Bank may be exposed to the risk of litigation, from both customers and non-customers that approached the Bank regarding PPP loans, regarding its process and procedures used in processing applications for the PPP. If any such litigation is filed against the Company or the Bank and is not resolved in a manner favorable to the Company or the Bank, it may result in significant financial liability or adversely affect the Company’s reputation. In addition, litigation can be costly, regardless of outcome. Any financial liability, litigation costs or reputational damage caused by PPP related litigation could have a material adverse impact on our business, financial condition and results of operations.

The Bank also has credit risk on PPP loans if a determination is made by the SBA that there is a deficiency in the manner in which the loan was originated, funded, or serviced by the Bank, such as an issue with the eligibility of a borrower to receive a PPP loan, which may or may not be related to the ambiguity in the laws, rules and guidance regarding the operation of the PPP. In the event of a loss resulting from a default on a PPP loan and a determination by the SBA that there was a deficiency in the manner in which the PPP loan was originated, funded, or serviced by the Company, the SBA may deny its liability under the guaranty, reduce the amount of the guaranty, or, if it has already paid under the guaranty, seek recovery of any loss related to the deficiency from the Company.

Filed May 11, 2020.
Source: SEC EDGAR, the filing index for accession 0001437749-20-010337. Last ingested by Listed: Nov 6, 2026, 14:30 ET. No prices; not investment advice.