California Banp(CALB) - 2020 Q2 - Quarterly Report

PART I – FINANCIAL INFORMATION This part details the Company's financial statements, management's discussion and analysis, market risk disclosures, and controls and procedures Item 1. Financial Statements Unaudited consolidated financial statements detail asset and liability growth, decreased net income from credit loss provisions, and the impact of COVID-19 on operations Consolidated Statements of Financial Condition (Balance Sheet) This table provides a snapshot of the Company's assets, liabilities, and shareholders' equity, showing significant growth in total assets and liabilities Consolidated Statements of Financial Condition (Unaudited) (Dollar amounts in thousands) | Metric | June 30, 2020 | December 31, 2019 | Change (Absolute) | Change (%) | | :----- | :------------ | :---------------- | :---------------- | :--------- | | Total Assets | $1,910,426 | $1,152,034 | $758,392 | 65.83% | | Total Cash and Cash Equivalents | $508,069 | $114,342 | $393,727 | 344.35% | | Loans, net | $1,285,388 | $941,132 | $344,256 | 36.58% | | Total Liabilities | $1,776,761 | $1,021,778 | $754,983 | 73.89% | | Total Deposits | $1,385,702 | $988,236 | $397,466 | 40.22% | | Other Borrowings | $364,703 | $10,000 | $354,703 | 3547.03% | | Total Shareholders' Equity | $133,665 | $130,256 | $3,409 | 2.62% | Consolidated Statements of Income This section details the Company's revenues, expenses, and net income, highlighting a decrease in net income due to higher credit loss provisions Consolidated Statements of Income (Unaudited) (Dollar amounts in thousands, except per share data) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Net Interest Income | $10,785 | $10,084 | $701 | 6.95% | | Provision for Credit Losses | $2,930 | $246 | $2,684 | 1091.06% | | Net Income | $1,550 | $2,550 | $(1,000) | -39.22% | | Basic EPS | $0.19 | $0.32 | $(0.13) | -40.63% | | Diluted EPS | $0.19 | $0.31 | $(0.12) | -38.71% | Consolidated Statements of Income (Unaudited) (Dollar amounts in thousands, except per share data) | Metric | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Net Interest Income | $20,966 | $19,921 | $1,045 | 5.25% | | Provision for Credit Losses | $3,330 | $826 | $2,504 | 303.15% | | Net Income | $2,023 | $4,418 | $(2,395) | -54.21% | | Basic EPS | $0.25 | $0.55 | $(0.30) | -54.55% | | Diluted EPS | $0.25 | $0.54 | $(0.29) | -53.70% | Consolidated Statements of Comprehensive Income This statement presents the Company's net income and other comprehensive income components, such as unrealized gains on available-for-sale securities Consolidated Statements of Comprehensive Income (Unaudited) (Dollar amounts in thousands) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Net Income | $1,550 | $2,550 | $(1,000) | -39.22% | | Unrealized gains on securities available for sale | $669 | $261 | $408 | 156.32% | | Total comprehensive income | $2,021 | $2,734 | $(713) | -26.08% | Consolidated Statements of Changes in Shareholders' Equity This statement outlines changes in common stock, retained earnings, and accumulated other comprehensive income from December 31, 2019, to June 30, 2020 Consolidated Statements of Changes in Shareholders' Equity (Unaudited) (Dollars in thousands) | Metric | June 30, 2020 | December 31, 2019 | Change (Absolute) | Change (%) | | :----- | :------------ | :---------------- | :---------------- | :--------- | | Common Stock Amount | $107,241 | $106,427 | $814 | 0.76% | | Retained Earnings | $25,541 | $23,518 | $2,023 | 8.60% | | Accumulated Other Comprehensive Income (Loss) | $883 | $311 | $572 | 183.92% | | Total Shareholders' Equity | $133,665 | $130,256 | $3,409 | 2.62% | Consolidated Statements of Cash Flows This statement details cash flows from operating, investing, and financing activities, showing a significant increase in cash and cash equivalents Consolidated Statements of Cash Flows (Unaudited) (Dollar amounts in thousands) | Metric | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Net cash from operating activities | $6,539 | $2,376 | $4,163 | 175.21% | | Net cash used in investing activities | $(365,201) | $(64,045) | $(301,156) | 470.22% | | Net cash provided by financing activities | $752,389 | $38,359 | $714,030 | 1861.46% | | Increase (decrease) in cash and cash equivalents | $393,727 | $(23,310) | $417,037 | -1790.81% | | Cash and cash equivalents, end of period | $508,069 | $55,395 | $452,674 | 817.10% | Notes to Unaudited Consolidated Financial Statements This section provides detailed explanatory notes to the unaudited consolidated financial statements, covering accounting policies, investments, loans, borrowings, commitments, fair value, and COVID-19 impact Note 1. Nature of Operations California BanCorp operates as a bank holding company for California Bank of Commerce, with financial statements reflecting management's estimates, particularly for loan loss allowances, impacted by COVID-19 - The Company is a bank holding company for California Bank of Commerce, operating 2 full-service branches and 3 loan production offices in California[24][121] - Unaudited consolidated financial statements are prepared in accordance with GAAP, with estimates and assumptions, particularly for the allowance for loan losses, which may be materially different due to the COVID-19 pandemic[25][29] - Certain prior balances have been reclassified to conform to current year presentation, including a modification in loan segment disclosure from collateral-based to purpose-based for transparency of SBA loan portfolio (e.g., Paycheck Protection Program loans)[31][32] - These reclassifications had no effect on net income, stockholders' equity, total gross loan balances, or the overall allowance for credit losses[32] Earnings Per Share (EPS) (Dollars in thousands, except per share data) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Net income available to common shareholders | $1,550 | $2,550 | $2,023 | $4,418 | | Weighted average basic common shares outstanding | 8,127,911 | 8,046,635 | 8,115,575 | 8,033,613 | | Weighted average diluted common shares outstanding | 8,165,938 | 8,124,165 | 8,160,152 | 8,113,184 | | Basic earnings per share | $0.19 | $0.32 | $0.25 | $0.55 | | Diluted earnings per share | $0.19 | $0.31 | $0.25 | $0.54 | - The Company has elected to defer the adoption of the CECL model (ASU 2016-13) until January 1, 2023, but has initiated steps for implementation, including forming a CECL Committee, engaging a third-party vendor, and establishing a framework for portfolio segmentation[36] Note 2. Investment Securities The Company's available-for-sale investment securities increased to $39.72 million at June 30, 2020, from $28.56 million at December 31, 2019, with net unrealized gains rising significantly Investment Securities, Available for Sale (Dollars in thousands) | Metric | June 30, 2020 | December 31, 2019 | Change (Absolute) | Change (%) | | :----- | :------------ | :---------------- | :---------------- | :--------- | | Total available for sale securities (Estimated Fair Value) | $39,723 | $28,555 | $11,168 | 39.11% | | Net unrealized gains on available for sale investment securities | $1,255 (net of tax) | $440 (net of tax) | $815 | 185.23% | - The Company purchased $21.7 million in securities and sold $7.7 million during the six months ended June 30, 2020, compared to no purchases or sales in the prior year period[39] - At June 30, 2020, one government agency security was in an unrealized loss position, but management does not consider it other-than-temporarily impaired due to interest rate changes and illiquidity, with no intent to sell before fair value recovery[40][41] Note 3. Loans and Allowance for Loan Losses Gross loans increased significantly by 37% to $1.299 billion at June 30, 2020, primarily driven by a substantial increase in SBA loans, largely due to the Paycheck Protection Program Outstanding Loans (Dollars in thousands) | Loan Type | June 30, 2020 | December 31, 2019 | Change (Absolute) | Change (%) | | :-------- | :------------ | :---------------- | :---------------- | :--------- | | Commercial and industrial | $365,881 | $389,746 | $(23,865) | -6.12% | | Real estate - other | $508,916 | $502,929 | $5,987 | 1.19% | | Real estate - construction and land | $49,524 | $42,519 | $7,005 | 16.47% | | SBA | $373,429 | $12,830 | $360,599 | 2810.59% | | Other | $1,731 | $1,628 | $103 | 6.33% | | Total loans, gross | $1,299,481 | $949,652 | $349,829 | 36.84% | | Allowance for loan losses | $(12,524) | $(11,075) | $(1,449) | 13.08% | | Total loans, net | $1,285,388 | $941,132 | $344,256 | 36.58% | Loan Portfolio by Internal Risk Ratings (Dollars in thousands) | Risk Grade | June 30, 2020 | December 31, 2019 | Change (Absolute) | Change (%) | | :--------- | :------------ | :---------------- | :---------------- | :--------- | | Pass | $1,270,620 | $925,736 | $344,884 | 37.26% | | Special Mention | $13,598 | $18,265 | $(4,667) | -25.55% | | Substandard | $15,263 | $5,651 | $9,612 | 170.09% | | Total | $1,299,481 | $949,652 | $349,829 | 36.84% | Aging Analysis of Loan Portfolio (Dollars in thousands) | Status | June 30, 2020 | December 31, 2019 | Change (Absolute) | Change (%) | | :----- | :------------ | :---------------- | :---------------- | :--------- | | Current | $1,297,048 | $945,459 | $351,589 | 37.19% | | 30 Days Past Due | $1,190 | $0 | $1,190 | N/A | | 60 Days Past Due | $0 | $1,440 | $(1,440) | -100.00% | | Non-Accrual | $1,243 | $2,753 | $(1,510) | -54.85% | | Total loans, gross | $1,299,481 | $949,652 | $349,829 | 36.84% | Allowance for Loan Losses by Impairment Methodology (Dollars in thousands) | Metric | June 30, 2020 | December 31, 2019 | Change (Absolute) | Change (%) | | :----- | :------------ | :---------------- | :---------------- | :--------- | | Loans individually evaluated for impairment (Gross) | $3,489 | $5,603 | $(2,114) | -37.73% | | Loans collectively evaluated for impairment (Gross) | $1,295,992 | $944,049 | $351,943 | 37.28% | | Allowance for loans individually evaluated | $69 | $650 | $(581) | -89.38% | | Allowance for loans collectively evaluated | $12,455 | $10,425 | $2,030 | 19.47% | | Total allowance for loan losses | $12,524 | $11,075 | $1,449 | 13.08% | Changes in Allowance for Loan Losses (Dollars in thousands) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Beginning balance | $11,565 | $11,250 | $11,075 | $10,800 | | Provision for loan losses | $2,930 | $246 | $3,330 | $826 | | Charge-offs | $(1,976) | $0 | $(1,976) | $(137) | | Recoveries | $5 | $5 | $95 | $12 | | Ending balance | $12,524 | $11,501 | $12,524 | $11,501 | - The Company had no recorded investments or allocated specific reserves related to troubled debt restructurings (TDRs) at June 30, 2020, down from $722,000 at December 31, 2019[60][61] - No new TDRs occurred in the six months ended June 30, 2020 or 2019[61] Note 4. Borrowing Arrangements The Company significantly increased its borrowing capacity and outstanding borrowings at June 30, 2020, primarily through a new $332.7 million Paycheck Protection Liquidity Facility (PPPLF) term borrowing from the Federal Reserve Bank of San Francisco, secured in April 2020 - Available borrowing capacity with the Federal Reserve Bank of San Francisco increased to approximately $450.1 million at June 30, 2020, from $127.3 million at December 31, 2019[63] - In April 2020, the Company secured a $332.7 million Paycheck Protection Liquidity Facility (PPPLF) term borrowing, maturing in April 2022 at a fixed rate of 0.35%[63] - The Company entered into a new three-year borrowing arrangement for $12.0 million with a correspondent bank on March 20, 2020, at a fixed rate of 3.95%, secured by its investment in the Bank[67] Note 5. Commitments and Contingent Liabilities The Company's outstanding commitments for loans increased to $422.5 million at June 30, 2020, from $390.0 million at December 31, 2019, and uninsured deposits significantly increased to $487.1 million - Outstanding commitments for loans increased to approximately $422.5 million at June 30, 2020, from $390.0 million at December 31, 2019[72] - Uninsured deposits at financial institutions were approximately $487.1 million at June 30, 2020, a significant increase from $4.0 million at December 31, 2019[78] Operating Lease Information (Dollars in thousands) | Metric | June 30, 2020 | | :----- | :------------ | | Operating lease cost | $1,241 | | Operating lease - operating cash flows | $1,129 | | Operating lease - ROU assets | $9,326 | | Operating lease - liabilities | $11,556 | | Weighted average lease term | 3.7 years | | Weighted average discount rate | 2.58% | Note 6. Fair Value Measurements The Company categorizes its financial instruments into a three-level fair value hierarchy, with total financial assets measured at fair value at $1.84 billion at June 30, 2020, and a significant portion of loans and other borrowings classified as Level 3 - The Company classifies financial instruments into Level 1 (quoted market prices), Level 2 (observable market data for similar instruments), and Level 3 (unobservable assumptions)[79][80][81] Carrying Amounts and Estimated Fair Values of Financial Instruments (Dollars in thousands) | Metric | Carrying Amount (June 30, 2020) | Fair Value (June 30, 2020) | Level 1 | Level 2 | Level 3 | | :----- | :------------------------------ | :------------------------- | :------ | :------ | :------ | | Cash and due from banks | $508,069 | $508,069 | $508,069 | $0 | $0 | | Securities available for sale | $39,723 | $39,723 | $0 | $39,723 | $0 | | Loans, net | $1,285,388 | $1,288,088 | $0 | $0 | $1,288,088 | | Deposits | $1,385,702 | $1,385,982 | $1,221,207 | $164,775 | $0 | | Other borrowings | $364,703 | $364,703 | $0 | $0 | $364,703 | | Subordinated debt | $4,986 | $5,063 | $0 | $0 | $5,063 | Assets Measured at Fair Value on a Recurring Basis (Dollars in thousands) | Metric | Fair Value (June 30, 2020) | Level 1 | Level 2 | Level 3 | | :----- | :------------------------- | :------ | :------ | :------ | | Investments available for sale | $39,723 | $0 | $39,723 | $0 | Impaired Loans Measured at Fair Value on a Non-Recurring Basis (Dollars in thousands) | Metric | Carrying Amount (March 31, 2020) | Fair Value (March 31, 2020) | Level 1 | Level 2 | Level 3 | | :----- | :------------------------------- | :-------------------------- | :------ | :------ | :------ | | Impaired loans - Commercial | $1,489 | $1,489 | $0 | $0 | $1,489 | Note 7. Business Impact of COVID-19 The COVID-19 pandemic has caused significant economic disruption, leading the Company to implement a broad-based risk management strategy, including a proactive loan deferral program and participation in the Paycheck Protection Program (PPP) - The COVID-19 pandemic has caused significant economic disruption, leading to a broad-based risk management strategy and continuous evaluation of potential other-than-temporary impairment (OTTI) for investments[103][105][106] - The Company granted payment deferments on approximately 385 loans totaling $323.9 million, with 255 loans ($216.6 million) having resumed payments as of the filing date[108] - The Company processed 720 eligible PPP loan applications, funding $361.6 million by June 30, 2020[109] - These loans have a 24-month term, 1% interest rate, and deferred payments for the first 6 months, with potential for full forgiveness[110] Concentration of PPP Loans by Industry (Dollars in millions) (June 30, 2020) | Industry | Number of Loans | Principal Balance | PPP Loans as % of Gross Loans (Number) | PPP Loans as % of Gross Loans (Principal Balance) | | :------- | :-------------- | :---------------- | :------------------------------------- | :------------------------------------------------ | | Dental services | 282 | $42.8 | 39% | 12% | | Contractors | 113 | $136.8 | 16% | 38% | | Other | 325 | $182.0 | 45% | 50% | | Total | 720 | $361.6 | 100% | 100% | - PPP loans and related PPPLF borrowing provided a net benefit of $1.3 million to net interest income in Q2 2020[113] - The Company received $9.1 million in deferred fees from PPP loan originations[113] - Operating expenses were reduced by $4.2 million in deferred loan origination costs, with $2.5 million related to PPP loans[113] - The provision for loan losses increased by approximately $1.9 million in Q2 2020 due to the continued uncertainty of the pandemic's economic effects[113] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's discussion analyzes financial condition and results, highlighting COVID-19's impact on performance, increased loan loss provisions, and Paycheck Protection Program effects Forward Looking Statements Forward-looking statements on future operations and financial performance are subject to risks, including economic conditions, credit quality, and regulatory changes, exacerbated by COVID-19 - Forward-looking statements are based on current information and assumptions about future economic and market conditions, subject to risks and uncertainties[118] - Key risks include deteriorating economic conditions, credit quality decline, potential recession, interest rate changes, and changes in government regulation, all exacerbated by the COVID-19 pandemic[119] Overview California BanCorp operates through its subsidiary, California Bank of Commerce, with 2 branches and 3 loan production offices in California - California BanCorp is a bank holding company for California Bank of Commerce, operating 2 full-service branches and 3 loan production offices in California[121] Selected Financial Data Selected financial data shows decreased net income and EPS due to higher credit loss provisions, with asset quality metrics reflecting changes in allowance for loan losses relative to nonperforming and gross loans Selected Income Statement Data (Dollars in thousands, except per share data) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Net Interest Income | $10,785 | $10,084 | $20,966 | $19,921 | | Provision for Credit Losses | $2,930 | $246 | $3,330 | $826 | | Net Income | $1,550 | $2,550 | $2,023 | $4,418 | | Basic EPS | $0.19 | $0.32 | $0.25 | $0.55 | | Diluted EPS | $0.19 | $0.31 | $0.25 | $0.54 | Selected Performance Measures | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | | :----- | :--------------------------- | :--------------------------- | :--------------------------- | :--------------------------- | | Return on average assets | 0.35% | 0.98% | 0.55% | 0.88% | | Return on average tangible equity | 4.95% | 8.67% | 6.50% | 7.65% | | Net interest margin | 2.59% | 4.18% | 3.06% | 4.22% | | Efficiency ratio | 55.70% | 66.75% | 73.14% | 68.92% | Selected Balance Sheet and Asset Quality Data (Dollars in thousands) | Metric | June 30, 2020 | December 31, 2019 | | :----- | :------------ | :---------------- | | Total Assets | $1,910,426 | $1,152,034 | | Loans, net | $1,285,388 | $941,132 | | Deposits | $1,385,702 | $988,236 | | Shareholders' equity | $133,665 | $130,256 | | Allowance for loan losses / gross loans | 0.96% | 1.17% | | Allowance for loan losses / nonperforming loans | 1007.56% | 402.29% | | Nonperforming assets / total assets | 0.07% | 0.24% | | Nonperforming loans / gross loans | 0.10% | 0.29% | Capital Adequacy Measures (Bank) | Metric | June 30, 2020 | December 31, 2019 | | :----- | :------------ | :---------------- | | Tier I leverage ratio | 8.68% | 10.44% | | Tier I risk-based capital ratio | 12.03% | 10.38% | | Total risk-based capital ratio | 13.63% | 11.79% | Critical Accounting Policies Financial statements rely on significant management estimates and assumptions, especially for loan loss allowances, subject to judgment and potential differences - Financial statements require complex and subjective estimates and assumptions, especially for the allowance for loan losses, which are subject to management judgment and potential differences from actual results[127] COVID-19 The Company addresses COVID-19 with a multi-pronged approach, focusing on employee safety, community support, and new programs for loan and deposit customers - The Company has implemented a multi-pronged approach to address the COVID-19 pandemic, focusing on employee safety, community support, and new programs for loan and deposit customers[129] Results of Operations – Three Months Ended June 30, 2020 and 2019 This section analyzes the Company's financial performance for the three months ended June 30, 2020, and 2019, detailing changes in net interest income, credit loss provisions, noninterest income, and expenses Overview Net income decreased by 39% to $1.6 million in Q2 2020, primarily due to a 1091% increase in credit loss provisions, partially offset by increased net interest income and decreased other expenses Net Income (Dollars in thousands) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Net Income | $1,550 | $2,550 | $(1,000) | -39% | | Provision for credit losses | $2,930 | $246 | $2,684 | 1091% | | Net interest income | $10,785 | $10,084 | $701 | 7% | | Other expenses | $6,440 | $7,382 | $(942) | -13% | Net Interest Income and Margin Net interest income increased 7% to $10.8 million in Q2 2020, driven by earning asset growth and PPP loan fee amortization, despite a net interest margin decrease to 2.59% from 4.18% - Net interest income increased by $701,000 (7%) to $10.8 million, primarily due to amortization of fees collected on PPP loans and growth in average earning assets[133] - Average total interest-earning assets increased by $707.6 million (73%) to $1.68 billion[134] - Average deposit balances grew $479.0 million (57%), while average loans grew $333.3 million (37%)[134] - Net interest margin decreased by 159 basis points to 2.59% from 4.18%, mainly due to a 199 basis point decrease in the yield on average earning assets to 3.07%[134][137] - The cost of interest-bearing deposits decreased by 42 basis points to 0.86%, and the overall cost of average total deposit balances decreased by 33 basis points to 0.46%[136] Interest Income Interest income increased by $560,000 in Q2 2020, driven by PPP loan fee amortization and a $333.3 million increase in average loans, partially offset by lower loan yield - Interest income increased by $560,000, driven by PPP loan fee amortization and a $333.3 million increase in average loans outstanding[144] - The increase in interest earned on the loan portfolio was $723,000, comprising $1.2 million from volume growth and a $439,000 decrease from lower yields (4.06% from 5.23%)[144] Interest Expense Interest expense decreased by $141,000 in Q2 2020, primarily due to lower rates on interest-bearing deposits and reduced PPPLF borrowing rates - Interest expense decreased by $141,000, primarily due to decreased rates on interest-bearing deposits and lower borrowing rates from the PPPLF[145] - The average rate paid on interest-bearing liabilities decreased by 69 basis points to 0.80% from 1.49%[145] Provision for Credit Losses Provision for loan losses significantly increased to $2.9 million in Q2 2020, with net loan charge-offs of $2.0 million, and the allowance for loan loss decreased to 0.96% (or 1.35% excluding PPP loans) Provision for Credit Losses (Dollars in thousands) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Provision for loan losses | $2,930 | $246 | $2,684 | 1091% | | Net loan charge-offs | $1,976 | $(5) | $1,981 | -39620% | - The allowance for loan loss as a percentage of outstanding loans was 0.96% at June 30, 2020, down from 1.26% at June 30, 2019, but would be 1.35% excluding SBA-guaranteed PPP loans[146] Noninterest Income Noninterest income decreased 20% to $777,000 in Q2 2020, mainly due to lower loan-related fees, despite increased BOLI earnings and other income Noninterest Income (Dollars in thousands) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Total noninterest income | $777 | $976 | $(199) | -20% | | Service charges and other fees | $537 | $820 | $(283) | -35% | | Earnings on BOLI | $143 | $103 | $40 | 39% | | Other | $97 | $53 | $44 | 83% | Noninterest Expense Noninterest expenses decreased 13% to $6.4 million in Q2 2020, primarily from a $2.7 million decrease in salaries and benefits due to deferred loan origination costs, partially offset by higher professional fees Noninterest Expense (Dollars in thousands) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Total noninterest expense | $6,440 | $7,382 | $(942) | -13% | | Salaries and benefits | $2,121 | $4,823 | $(2,702) | -56% | | Premises and equipment | $1,132 | $771 | $361 | 47% | | Professional fees | $1,267 | $290 | $977 | 337% | - The decrease in salaries and benefits was primarily due to $4.2 million in deferred loan origination costs, with $2.5 million related to PPP loans and $1.7 million to loan modifications[151] Provision for Income Taxes Income tax expense decreased to $642,000 in Q2 2020 from $882,000 in Q2 2019, with the effective tax rate increasing to 29.3% from 25.7% Provision for Income Taxes (Dollars in thousands) | Metric | 3 Months Ended June 30, 2020 | 3 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Income tax expense | $642 | $882 | $(240) | -27.21% | | Effective tax rate | 29.3% | 25.7% | 3.6% | 14.01% | Results of Operations – Six Months Ended June 30, 2020 and 2019 This section analyzes the Company's financial performance for the six months ended June 30, 2020, and 2019, detailing changes in net interest income, credit loss provisions, noninterest income, and expenses Overview Net income decreased 54% to $2.0 million for the six months ended June 30, 2020, primarily due to a 303% increase in credit loss provisions Net Income (Dollars in thousands) | Metric | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Net Income | $2,023 | $4,418 | $(2,395) | -54% | | Provision for credit losses | $3,330 | $826 | $2,504 | 303% | Net Interest Income and Margin Net interest income increased 5% to $21.0 million for the six months ended June 30, 2020, driven by PPP loan fee amortization and earning asset growth, but net interest margin decreased to 3.06% - Net interest income increased by $1.0 million (5%) to $21.0 million, primarily due to PPP loan fee amortization and growth in average earning assets[156] - Average total interest-earning assets increased by $427.3 million (45%) to $1.38 billion[157] - Average deposit balances grew $311.1 million (37%), while average loans grew $213.0 million (24%)[157] - Net interest margin decreased by 116 basis points to 3.06% from 4.22%, mainly due to a 136 basis point decrease in the yield on average earning assets to 3.66%[157][160] - The cost of interest-bearing deposits decreased by 18 basis points to 1.06%, and the overall cost of average total deposit balances decreased by 15 basis points to 0.61%[159] Interest Income Interest income increased by $1.4 million in H1 2020, driven by PPP loan fee amortization and a $212.3 million increase in average loans, partially offset by lower loan yield - Interest income increased by $1.4 million, driven by PPP loan fee amortization and a $212.3 million increase in average loans outstanding[166] - The increase in interest earned on the loan portfolio was $1.6 million, comprising $2.2 million from volume growth and a $678,000 decrease from lower yields (4.46% from 5.20%)[166] Interest Expense Interest expense increased by $323,000 in H1 2020, primarily due to decreased rates on interest-bearing deposits and lower PPPLF borrowing rates - Interest expense increased by $323,000, primarily due to decreased rates on interest-bearing deposits and lower borrowing rates from the PPPLF[167] - The average rate paid on interest-bearing liabilities decreased by 36 basis points to 1.01% from 1.37%[167] Provision for Credit Losses Provision for loan losses significantly increased to $3.3 million in H1 2020, with net loan charge-offs of $1.9 million, and the allowance for loan loss decreased to 0.96% (or 1.35% excluding PPP loans) Provision for Credit Losses (Dollars in thousands) | Metric | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Provision for loan losses | $3,330 | $826 | $2,504 | 303% | | Net loan charge-offs | $1,976 | $137 | $1,839 | 1342% | - The allowance for loan loss as a percentage of outstanding loans was 0.96% at June 30, 2020, down from 1.26% at June 30, 2019, but would be 1.35% excluding SBA-guaranteed PPP loans[168] Noninterest Income Noninterest income increased 12% to $2.07 million in H1 2020, primarily due to increased loan-related and ancillary fees, despite a decrease in SBA loan sale gains Noninterest Income (Dollars in thousands) | Metric | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Total noninterest income | $2,068 | $1,839 | $229 | 12% | | Service charges and other fees | $1,508 | $1,489 | $19 | 1% | | Gain on sale of SBA loans | $0 | $23 | $(23) | -100% | | Earnings on BOLI | $296 | $208 | $88 | 42% | | Other | $264 | $119 | $145 | 122% | Noninterest Expense Noninterest expenses increased 12% to $16.8 million in H1 2020, driven by higher professional fees and premises/equipment expenses, partially offset by decreased salaries and benefits Noninterest Expense (Dollars in thousands) | Metric | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Total noninterest expense | $16,847 | $14,998 | $1,849 | 12% | | Salaries and benefits | $8,598 | $9,338 | $(740) | -8% | | Premises and equipment | $2,271 | $1,517 | $754 | 50% | | Professional fees | $2,222 | $648 | $1,574 | 243% | - Operating expenses included increases in professional and legal fees related to FDICIA and SEC compliance, as well as occupancy and equipment from facility expansion[173] Provision for Income Taxes Income tax expense decreased to $834,000 in H1 2020 from $1.5 million in the prior year, with the effective tax rate increasing to 29.2% from 25.6% Provision for Income Taxes (Dollars in thousands) | Metric | 6 Months Ended June 30, 2020 | 6 Months Ended June 30, 2019 | Change (Absolute) | Change (%) | | :----- | :--------------------------- | :--------------------------- | :---------------- | :--------- | | Income tax expense | $834 | $1,518 | $(684) | -45.06% | | Effective tax rate | 29.2% | 25.6% | 3.6% | 14.06% | Financial Condition This section discusses the Company's financial position, including changes in its loan portfolio, nonperforming assets, allowance for loan losses, investment portfolio, deposits, liquidity, and capital resources Overview Total assets increased significantly to $1.91 billion at June 30, 2020, from $1.15 billion at December 31, 2019, driven by loan portfolio growth and federal funds sold - Total assets increased to $1.91 billion at June 30, 2020, from $1.15 billion at December 31, 2019, driven by growth in loans and federal funds sold, funded by deposits and other borrowings[175] Loan Portfolio Gross loan portfolio increased 37% to $1.299 billion at June 30, 2020, primarily due to a substantial increase in SBA loans from the Paycheck Protection Program, shifting portfolio composition - Gross loan balances increased by $349.8 million (37%) to $1.299 billion, primarily due to PPP loans classified as SBA loans[176] Loan Portfolio Composition (Percentage Distribution) | Loan Type | June 30, 2020 | December 31, 2019 | Change (Percentage Points) | | :-------- | :------------ | :---------------- | :------------------------- | | Commercial and industrial | 28% | 41% | -13% | | Real estate - other | 39% | 53% | -14% | | Real estate - construction and land | 4% | 4% | 0% | | SBA | 29% | 1% | 28% | | Other | 0% | 0% | 0% | Loan Maturity Distribution (Dollars in thousands) (June 30, 2020) | Loan Type | Due in One Year Or Less | Over One Year But Less Than Five Years | Over Five Years | Total Loans, Gross | Fixed Rates | Variable Rates | | :-------- | :---------------------- | :------------------------------------- | :-------------- | :----------------- | :---------- | :------------- | | Commercial and industrial | $110,017 | $95,735 | $160,129 | $365,881 | $220,746 | $145,135 | | Real estate - construction and land | $32,264 | $7,544 | $9,716 | $49,524 | $9,705 | $39,819 | | Real estate - other | $22,996 | $106,129 | $379,791 | $508,916 | $210,138 | $298,778 | | SBA | $103 | $362,906 | $10,420 | $373,429 | $361,845 | $11,584 | | Other | $162 | $1,170 | $399 | $1,731 | $0 | $1,731 | | Total loans, gross | $165,542 | $573,484 | $560,455 | $1,299,481 | $802,434 | $497,047 | Nonperforming Assets Total nonperforming assets decreased to $1.24 million at June 30, 2020, from $2.75 million at December 31, 2019, primarily due to reduced nonaccrual loans, with no 90-day past due or foreclosed assets Nonperforming and Restructured Loans (Dollars in thousands) | Metric | June 30, 2020 | December 31, 2019 | Change (Absolute) | Change (%) | | :----- | :------------ | :---------------- | :---------------- | :--------- | | Nonaccrual loans | $1,243 | $2,753 | $(1,510) | -54.85% | | Total nonperforming loans | $1,243 | $2,753 | $(1,510) | -54.85% | | Total nonperforming assets | $1,243 | $2,753 | $(1,510) | -54.85% | | Performing TDR's | $0 | $646 | $(646) | -100.00% | - The Company had no loans 90 days or more past due and still accruing interest, and no other real estate owned at June 30, 2020[182][184] Allowance for Loan Losses Allowance for loan losses increased to $12.52 million at June 30, 2020, reflecting increased provision due to COVID-19's potential impact and modest loan growth, with heavy allocation to commercial and installment loans - The allowance for loan losses increased to $12.52 million, reflecting an increased provision due to the potential impact of the COVID-19 pandemic and modest loan growth[192] - The provision reflects a heavier allocation toward commercial and installment loans due to COVID-19 and less toward real estate segments[192] Investment Portfolio The investment portfolio consists entirely of available-for-sale debt securities, primarily mortgage-backed securities from U.S. government agencies, used for liquidity and interest rate risk management - The investment portfolio consists entirely of available-for-sale debt securities, with no held-to-maturity investments[193] - The majority of the available-for-sale portfolio comprises mortgage-backed securities issued or guaranteed by U.S. government agencies or GSEs, providing liquidity and managing interest rate risk[194] Investment Securities, Available for Sale (Dollars in thousands) | Metric | June 30, 2020 (Amortized Cost) | June 30, 2020 (Estimated Fair Value) | December 31, 2019 (Amortized Cost) | December 31, 2019 (Estimated Fair Value) | | :----- | :----------------------------- | :----------------------------------- | :--------------------------------- | :--------------------------------------- | | Mortgage backed securities | $28,977 | $29,986 | $20,291 | $20,722 | | Government agencies | $2,470 | $2,466 | $7,824 | $7,833 | | Corporate bonds | $7,021 | $7,271 | $0 | $0 | | Total available for sale securities | $38,468 | $39,723 | $28,115 | $28,555 | Deposits Deposits, primarily from core business customers, with 46% in noninterest-bearing demand deposits, increased to $1.39 billion at June 30, 2020, from $988.24 million at December 31, 2019 - Deposits are primarily from core business customer relationships, with 46% in noninterest-bearing demand deposits at June 30, 2020[195][196] Deposit Distribution (Dollars in thousands) | Deposit Type | June 30, 2020 (Balance) | June 30, 2020 (% of Total) | December 31, 2019 (Balance) | December 31, 2019 (% of Total) | | :----------- | :---------------------- | :------------------------- | :-------------------------- | :----------------------------- | | Demand noninterest-bearing | $643,354 | 46% | $387,267 | 39% | | Demand interest-bearing | $28,769 | 2% | $25,178 | 3% | | Money market and savings | $549,084 | 40% | $455,436 | 46% | | Time | $164,495 | 12% | $120,355 | 12% | | Total deposits | $1,385,702 | 100% | $988,236 | 100% | Liquidity The Company manages liquidity through marketable securities and borrowing capacity, with approximately 20% of deposits from the 10 largest depositors at June 30, 2020 - The Company manages liquidity through marketable securities and borrowing capacity to meet expected and unexpected needs[201] - Approximately 20% of deposits were represented by the 10 largest depositors as of June 30, 2020[201] Capital Resources The Company complied with regulatory capital requirements, with the Bank "well-capitalized"; Tier 1 risk-based capital ratio increased to 12.03%, while Tier I leverage ratio decreased to 8.68% - The Company was in compliance with all regulatory capital requirements, and the Bank qualified as "well-capitalized" at June 30, 2020[202] Capital Adequacy Measures (Bank) | Metric | June 30, 2020 | December 31, 2019 | Change (Percentage Points) | | :----- | :------------ | :---------------- | :------------------------- | | Tier I leverage ratio | 8.68% | 10.44% | -1.76% | | Tier I risk-based capital ratio | 12.03% | 10.38% | 1.65% | | Total risk-based capital ratio | 13.63% | 11.79% | 1.84% | - During Q1 2020, the Company infused $12.0 million into the Bank from a new borrowing arrangement to support Tier I capital[203] Item 3. Quantitative and Qualitative Disclosures About Market Risk As a smaller reporting company, the registrant is not required to provide detailed quantitative and qualitative disclosures about market risk - As a smaller reporting company, the registrant is not required to provide quantitative and qualitative disclosures about market risk[204] Item 4. Controls and Procedures Disclosure controls and procedures were ineffective at June 30, 2020, due to a material weakness in review precision for SEC filings and financial reporting, involving documentation, checklists, and related party listings Effectiveness of Disclosure Controls and Procedures Disclosure controls and procedures were ineffective at June 30, 2020, due to a material weakness in review precision for SEC filings and financial reporting, involving documentation, checklists, and related party listings - Disclosure controls and procedures were not effective as of June 30, 2020, due to a material weakness in the precision of review in SEC filings and financial reporting[205] - The material weakness includes insufficient documentation of management's review, inconsistent use of GAAP/SEC disclosure checklists, failure to identify subsequent events, and lack of a regularly reviewed related party listing[206] - Remediation efforts are ongoing and primarily involve developing and implementing formalized procedures and controls[206] Changes in Internal Control over Financial Reporting No material changes in internal control over financial reporting occurred during the last fiscal quarter - No material changes in internal control over financial reporting occurred during the last fiscal quarter[207] PART II – OTHER INFORMATION This part covers legal proceedings, risk factors, unregistered sales of equity securities, defaults upon senior securities, mine safety disclosures, other information, and exhibits Item 1. Legal Proceedings The Company faces routine legal actions, but management does not expect a material adverse effect on its financial position or results of operations - The Company is party to routine legal actions, but management does not expect them to have a material adverse effect on its financial position or results of operations[209] Item 1A. Risk Factors No material changes to risk factors from the Annual Report on Form 10-K for the year ended December 31, 2019 - No material changes in risk factors from the Annual Report on Form 10-K for the year ended December 31, 2019[210] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds No unregistered sales of equity securities or use of proceeds to report - None[211] Item 3. Defaults Upon Senior Securities No defaults upon senior securities to report - None[211] Item 4. Mine Safety Disclosures Not applicable - Not Applicable[211] Item 5. Other Information No other information to report - None[211] Item 6. Exhibits This section lists exhibits filed with Form 10-Q, including organizational documents, compensation agreements, certifications, and XBRL-related documents - Exhibits include Articles of Incorporation, Bylaws, Executive Supplemental Compensation Agreement, Certifications (Sarbanes-Oxley Act, Public Company Accounting Reform and Investor Protections Act), and XBRL documents[212] Signatures The report was signed by Steven E. Shelton (President and CEO) and Thomas A. Sa (EVP and CFO) on August 14, 2020 - The report was signed by Steven E. Shelton (President and CEO) and Thomas A. Sa (EVP and CFO) on August 14, 2020[213][214][215]