UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
For
the quarterly period ended
OR
For the transition period from __________________ to __________________
Commission
File Number
(Exact name of Registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
| (Address of principal executive office) | (Zip Code) | ||||
Registrant’s
telephone number, including area code:
Not Applicable
(Former name, former address and formal fiscal year, if changed since last report)
| Securities registered pursuant to 12(b) of the Act: | ||
| Title of each class | Trading symbol | Name of each exchange on which registered |
| The | ||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | o | Accelerated filer | o | |
| x | Smaller reporting company | |||
| Emerging growth company |
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying
with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes
o
As of August 9, 2021, there were shares of the registrant’s common stock, no par value, outstanding.
1
TABLE OF CONTENTS
2
Cautionary Note Regarding Forward-Looking Statements
This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent plans, estimates, objectives, goals, guidelines, expectations, intentions, projections, and statements of our beliefs concerning future events, business plans, objectives, expected operating results, and the assumptions upon which those statements are based. Forward-looking statements include without limitation, any statement that may predict, forecast, indicate, or imply future results, performance, or achievements, and are typically identified with words such as “may,” “could,” “should,” “will,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “aim,” “intend,” “plan,” or words or phases of similar meaning. We caution that the forward-looking statements are based largely on our expectations and are subject to a number of known and unknown risks and uncertainties that are subject to change based on factors which are, in many instances, beyond our control. Such forward-looking statements are based on various assumptions (some of which may be beyond our control) and are subject to risks and uncertainties, which change over time, and other factors which could cause actual results to differ materially from those currently anticipated. Such risks and uncertainties include, but are not limited to:
| ● | uncertain market conditions and economic trends nationally, regionally, and particularly in Northern California and California, including as a result of the coronavirus, and variants thereof, including the Delta variant (“COVID-19”), pandemic; |
| ● | risks related to the concentration of our business in California, and specifically within Northern California, including risks associated with any downturn in the real estate sector; |
| ● | the occurrence of significant natural disasters, including fires and earthquakes; |
| ● | risks related to the impact of the COVID-19 pandemic on our business and operations; |
| ● | changes in market interest rates that affect the pricing of our loans and deposits and our net interest income; |
| ● | risks related to our strategic focus on lending to small to medium-sized businesses; |
| ● | the sufficiency of the assumptions and estimates we make in establishing reserves for potential loan losses and the value of loan collateral and securities; |
| ● | our ability to attract and retain executive officers and key employees and their customer and community relationships; |
| ● | the risks associated with our loan portfolios, and specifically with our commercial real estate loans; |
| ● | our level of nonperforming assets and the costs associated with resolving problem loans, if any, and complying with government-imposed foreclosure moratoriums; |
| ● | our ability to maintain adequate liquidity and to maintain capital necessary to fund our growth strategy and operations and satisfy minimum regulatory capital levels; |
| ● | the effects of increased competition from a wide variety of local, regional, national, and other providers of financial and investment services; |
| ● | risks associated with unauthorized access, cyber-crime, and other threats to data security; |
| ● | our ability to comply with various governmental and regulatory requirements applicable to financial institutions, including supervisory actions by federal and state banking agencies; |
| ● | the impact of recent and future legislative and regulatory changes, including changes in banking, securities, and tax laws and regulations and their application by our regulators, and economic stimulus programs; |
| ● | governmental monetary and fiscal policies, including the policies of the Board of Governors of the Federal Reserve System; |
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| ● | our ability to implement, maintain, and improve effective internal controls; and |
| ● | other factors that are discussed in the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors.” |
The foregoing factors should not be considered exhaustive and should be read together with other cautionary statements that are included in this report, including those discussed in the section entitled “Risk Factors.” Additional factors that could cause results or performance to materially differ from those expressed in our forward-looking statements are detailed in the section entitled “Risk Factors” of our Registration Statement on Form S-1, which was declared effective by the U.S. Securities and Exchange Commission (“SEC”) on May 4, 2021, and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2021, and other filings we may make with the SEC, copies of which are available from us at no charge. New risks and uncertainties may emerge from time to time, and it is not possible for us to predict their occurrence or how they will affect us. If one or more of the factors affecting our forward-looking information and statements proves incorrect, then our actual results, performance, or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements contained in this Quarterly Report on Form 10-Q. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We disclaim any duty to revise or update the forward-looking statements, whether written or oral, to reflect actual results or changes in the factors affecting the forward-looking statements, except as specifically required by law.
4
PART I FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIVE STAR BANCORP AND SUBSIDIARY CONSOLIDATED
BALANCE SHEETS (In thousands, except share and per share data) |
| June 30, 2021 | December 31, | |||||||
(Unaudited) |
2020 | |||||||
| ASSETS | ||||||||
| Cash and due from financial institutions | $ | $ | ||||||
| Interest-bearing deposits in banks | ||||||||
| Cash and cash equivalents | ||||||||
| Time deposits in banks | ||||||||
| Securities – available-for-sale, at fair value | ||||||||
| Securities – held-to-maturity, at amortized cost (fair value
of $ |
||||||||
| Loans held for sale | ||||||||
| Loans,
net of allowance for loan losses of $ |
||||||||
| Federal Home Loan Bank of San Francisco (“FHLB”) stock | ||||||||
| Premises
and equipment, net of accumulated depreciation of $ |
||||||||
| Bank owned life insurance | ||||||||
| Interest receivable and other assets | ||||||||
| $ | $ | |||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
| Deposits | ||||||||
| Non-interest-bearing | $ | $ | ||||||
| Interest-bearing | ||||||||
| Total deposits | ||||||||
| Subordinated notes, net | ||||||||
| Interest payable and other liabilities | ||||||||
| Total liabilities | ||||||||
| Commitments and contingencies (Note 10) | ||||||||
| Shareholders’ equity | ||||||||
| Common stock, par value; shares authorized; shares issued and outstanding as of June 30, 2021; shares issued and outstanding as of December 31, 2020 | ||||||||
| Retained earnings | ||||||||
| Accumulated other comprehensive income, net | ||||||||
| Total shareholders’ equity | ||||||||
| $ | $ | |||||||
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
5
FIVE STAR BANCORP AND SUBSIDIARY CONSOLIDATED
STATEMENTS OF INCOME |
| For the three months ended June 30, | For the six months ended June 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Interest and dividend income | ||||||||||||||||
| Loans, including fees | $ | $ | $ | $ | ||||||||||||
| Taxable securities | ||||||||||||||||
| Nontaxable securities | ||||||||||||||||
| Interest-bearing deposits in other banks | ||||||||||||||||
| Interest expense | ||||||||||||||||
| Deposits | ||||||||||||||||
| Subordinated notes | ||||||||||||||||
| Net interest income | ||||||||||||||||
| Provision for loan losses | ||||||||||||||||
| Net interest income after provision for loan losses | ||||||||||||||||
| Non-interest income | ||||||||||||||||
| Service charges on deposit accounts | ||||||||||||||||
| Net gains on sales of securities available-for-sale | ||||||||||||||||
| Gain on sale of loans | ||||||||||||||||
| Loan-related fees | ||||||||||||||||
| FHLB stock dividends | ||||||||||||||||
| Earnings on bank-owned life insurance | ||||||||||||||||
| Other | ||||||||||||||||
| Non-interest expense | ||||||||||||||||
| Salaries and employee benefits | ||||||||||||||||
| Occupancy and equipment | ||||||||||||||||
| Data processing and software | ||||||||||||||||
| Federal deposit insurance | ||||||||||||||||
| Professional services | ||||||||||||||||
| Advertising and promotional | ||||||||||||||||
| Loan-related expenses | ||||||||||||||||
| Other operating expenses | ||||||||||||||||
| Income before provision for income taxes | ||||||||||||||||
| Provision for income taxes | ||||||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||
| Basic earnings per share | $ | $ | $ | $ | ||||||||||||
| Diluted earnings per share | $ | $ | $ | $ | ||||||||||||
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
6
FIVE STAR BANCORP AND SUBSIDIARY CONSOLIDATED
STATEMENTS OF COMPREHENSIVE INCOME |
| For the three months ended June 30, | For the six months ended June 30, | |||||||||||||||
| 2021 | 2020 | 2021 | 2020 | |||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||
| Net unrealized holding gains (losses) on securities available-for-sale during the period | ( | ) | ||||||||||||||
| Reclassification adjustment for net realized gains included in net income | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Income tax expense related to other comprehensive income | ||||||||||||||||
| Other comprehensive income (loss) | ( | ) | ||||||||||||||
| Total comprehensive income | $ | $ | $ | $ | ||||||||||||
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
7
FIVE STAR BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY |
| For
the three months ended June 30, 2021 and 2020 (Unaudited) (In thousands, except share and per share data) |
| Accumulated | ||||||||||||||||||||
| Common Stock | Other | |||||||||||||||||||
| Comprehensive | ||||||||||||||||||||
| Retained | (Loss) Income, | |||||||||||||||||||
| (in thousands, except share data; unaudited) | Shares | Amount | Earnings | Net of Taxes | Total | |||||||||||||||
| For the three months ended June 30, 2021 | ||||||||||||||||||||
| Balance at March 31, 2021 | $ | $ | $ | ( |
) | $ | ||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive income | — | |||||||||||||||||||
| Stock offering | ||||||||||||||||||||
| Stock issued under stock award plans | ||||||||||||||||||||
| Stock compensation expense | — | |||||||||||||||||||
| Stock issued to directors | ||||||||||||||||||||
| Reclassification of retained deficit | — | ( |
||||||||||||||||||
| Cash dividends paid ($3.25 per share) | — | ( |
) | ( |
) | |||||||||||||||
| Balance at June 30, 2021 | $ | $ | $ | $ | ||||||||||||||||
| For the three months ended June 30, 2020 | ||||||||||||||||||||
| Balance at March 31, 2020 | $ | $ | $ | $ | ||||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive income | — | |||||||||||||||||||
| Stock compensation expense | — | |||||||||||||||||||
| Cash dividends paid ($0.50 per share) | — | ( |
) | ( |
) | |||||||||||||||
| Balance at June 30, 2020 | $ | $ | $ | $ | ||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
8
FIVE
STAR BANCORP AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
For the six months ended June 30, 2021 and 2020
(Unaudited)
(In thousands, except share and per share data)
| Accumulated | ||||||||||||||||||||
| Common Stock | Other | |||||||||||||||||||
| Comprehensive | ||||||||||||||||||||
| Retained | Income (Loss), | |||||||||||||||||||
| (in thousands, except share data; unaudited) | Shares | Amount | Earnings | Net of Taxes | Total | |||||||||||||||
| For the six months ended June 30, 2021 | ||||||||||||||||||||
| Balance at December 31, 2020 | $ | $ | $ | $ | ||||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive loss | — | ( |
) | ( |
) | |||||||||||||||
| Stock offering | ||||||||||||||||||||
| Stock issued under stock award plans | ||||||||||||||||||||
| Stock compensation expense | — | |||||||||||||||||||
| Stock issued to directors | ||||||||||||||||||||
| Stock forfeitures | ( |
) | ||||||||||||||||||
| Reclassification of retained deficit | — | ( |
||||||||||||||||||
| Cash dividends paid ($4.25 per share) | — | ( |
) | ( |
) | |||||||||||||||
| Balance at June 30, 2021 | $ | $ | $ | $ | ||||||||||||||||
| For the six months ended June 30, 2020 | ||||||||||||||||||||
| Balance at December 31, 2019 | $ | $ | $ | ( |
) | $ | ||||||||||||||
| Net income | — | |||||||||||||||||||
| Other comprehensive income | — | |||||||||||||||||||
| Stock compensation expense | — | |||||||||||||||||||
| Stock issued under stock award plans | ||||||||||||||||||||
| Cash dividends paid ($1.20 per share) | — | ( |
) | ( |
) | |||||||||||||||
| Balance at June 30, 2020 | $ | $ | $ | $ | ||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
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|
FIVE STAR BANCORP AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS |
| For
the six months ended June 30, 2021 and 2020 (Unaudited) (In thousands, except share and per share data) |
| June 30, 2021 | June 30, 2020 | |||||||
| Cash Flows from Operating Activities: | ||||||||
| Net income | $ | $ | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
| Provision for loan losses | ||||||||
| Loans originated for sale | ( |
) | ( |
) | ||||
| Gain on sale of loans | ( |
) | ( |
) | ||||
| Proceeds from sales of loans | ||||||||
| Net gains on sales of securities available-for-sale | ( |
) | ( |
) | ||||
| Earnings on bank owned life insurance | ( |
) | ( |
) | ||||
| Stock compensation expense | ||||||||
| Director stock compensation expense | ||||||||
| Change in deferred loan fees | ||||||||
| Amortization and accretion of security premiums and discounts | ||||||||
| Amortization of subordinated notes issuance costs | ||||||||
| Depreciation and amortization | ||||||||
| Net changes in: | ||||||||
| Interest receivable and other assets | ( |
) | ( |
) | ||||
| Interest payable and other liabilities | ( |
) | ||||||
| Net cash provided by operating activities | ||||||||
| Cash Flows from Investing Activities: | ||||||||
| Proceeds on sale of available-for-sale securities | ||||||||
| Maturities, prepayments, and calls of securities available-for-sale | ||||||||
| Purchases of securities available-for-sale | ( |
) | ( |
) | ||||
| Increase in time deposits in banks | ||||||||
| Loan originations, net of repayments | ( |
) | ( |
) | ||||
| Purchase of premises and equipment | ( |
) | ( |
) | ||||
| Purchase of FHLB stock | ( |
) | ( |
) | ||||
| Purchase of bank owned life insurance | ( |
) | ||||||
| Net cash used in investing activities | ( |
) | ( |
) | ||||
| Cash Flows from Financing Activities: | ||||||||
| Net change in deposits | ||||||||
| Proceeds from issuance of stock | ||||||||
| FHLB repayment | ( |
) | ||||||
| Cash dividends paid | ( |
) | ( |
) | ||||
| Net cash provided by financing activities | ||||||||
| Net change in cash and cash equivalents | ||||||||
| Cash and cash equivalents at beginning of period | ||||||||
| Cash and cash equivalents at end of period | $ | $ | ||||||
| Supplemental disclosure of cash flow information: | ||||||||
| Interest paid | $ | $ | ||||||
| Income taxes paid | $ | $ | ||||||
| Supplemental disclosure of noncash investing and financing activities: | ||||||||
| Transfer from loans held for investment to loans held for sale | $ | $ | ||||||
| Unrealized (loss) gains on securities | $ | ( |
) | $ | ||||
The accompanying notes are an integral part of these consolidated financial statements (unaudited).
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note 1: Basis of Presentation
Nature of Operations and Principles of Consolidation
Five Star Bank (the “Bank”) was chartered on October 26, 1999 and began operations on December 20, 1999. Five Star Bancorp (“Bancorp” or the “Company”) was incorporated on September 16, 2002, and subsequently obtained approval from the Board of Governors of the Federal Reserve System (“Federal Reserve”) to be a bank holding company in connection with its acquisition of the Bank. The Company became the sole shareholder of the Bank on June 2, 2003 in a statutory merger, pursuant to which each outstanding share of the Bank’s common stock was exchanged for one share of common stock of the Company.
The Company, through the Bank, provides financial services to customers who are predominately small and middle-market businesses, professionals, and individuals residing in the northern California region. Its primary loan products are commercial real estate loans, land development loans, construction loans, and operating lines of credit; and its primary deposit products are checking accounts, savings accounts, money market accounts, and term certificate accounts. The Bank currently has seven branch offices in Roseville, Natomas, Rancho Cordova, Redding, Elk Grove, Chico, and Yuba City, and two loan production offices in Santa Rosa and Sacramento.
The Company terminated its status as a Subchapter S corporation as of May 5, 2021, in connection with the Company’s Initial Public Offering (“IPO”) and became a taxable C Corporation. Prior to that date, as an S Corporation, the Company had no U.S. federal income tax expense.
On April 9, 2021, the Company publicly filed a Registration Statement on Form S-1 with the U.S. Securities and Exchange Commission (“SEC”) in connection with its IPO (the “Registration Statement”), which was subsequently amended on April 26, 2021 and May 3, 2021. The Registration Statement was declared effective by the SEC on May 4, 2021. In connection with the IPO, the Company issued 6,054,750 shares of common stock, no par value, which included 789,750 shares sold pursuant to the underwriters’ exercise of their option to purchase additional shares. The securities were sold to the public at a price of $20.00 per share and began trading on the Nasdaq Stock Market LLC on May 5, 2021. On May 7, 2021, the closing date of the IPO, the Company received total net proceeds of $111.2 million. The net proceeds less other related expenses, including audit fees, legal fees, listing fees, and other expenses totaled $109.1 million.
Basis of financial statement presentation and consolidation
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as contained within the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) and rules and regulations of the SEC, including the instructions to Regulation S-X. These interim unaudited consolidated financial statements reflect all adjustments (consisting solely of normal recurring adjustments and accruals) which, in the opinion of management, are necessary for a fair presentation of financial position, results of operations and comprehensive income, changes in shareholders’ equity, and cash flows for the interim periods presented. These unaudited consolidated financial statements have been prepared on a basis consistent with, and should be read in conjunction with, the audited consolidated financial statements as of and for the year ended December 31, 2020, and the notes thereto, as filed in the Company’s Form S-1, which was declared effective by the SEC on May 4, 2021.
The unaudited consolidated financial statements include Five Star Bancorp and its wholly owned subsidiary, Five Star Bank. All significant intercompany transactions and balances are eliminated in consolidation.
The results of operations for the three and six months ended June 30, 2021 are not necessarily indicative of the results of operations that may be expected for any other interim period or for the year ending December 31, 2021.
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While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed, and financial performance is evaluated, on a Company-wide basis. Discrete financial information is not available other than on a Company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.
The Company’s accounting and reporting policies conform to GAAP and to general practices within the banking industry.
The Company qualifies as an emerging growth company as defined in the Jumpstart Our Business Startups Act of 2012, and, as such, may take advantage of specified reduced reporting requirements and is relieved of other significant requirements that are otherwise generally applicable to other public companies.
Use of Estimates
Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions affect the amounts reported in the unaudited consolidated financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses is the most significant accounting estimate reflected in the Company’s consolidated financial statements.
Basic EPS is net income divided by the weighted average number of common shares outstanding during the period less average unvested restricted stock awards. Diluted EPS includes the dilutive effect of additional potential common shares related to unvested restricted stock awards using the treasury stock method. The Company has two forms of outstanding common stock: common stock and unvested restricted stock awards. Holders of unvested restricted stock awards receive non-forfeitable dividends at the same rate as common shareholders and they both share equally in undistributed earnings, and therefore are considered participating securities. However, under the two-class method, the difference in EPS is not significant for these participating securities.
| For the three months ended | For the six months ended | |||||||||||||||
| (in thousands, except per share data) | June 30, 2021 | June 30, 2020 | June 30, 2021 | June 30, 2020 | ||||||||||||
| Net income | $ | $ | $ | $ | ||||||||||||
| Weighted average basic common shares outstanding | ||||||||||||||||
| Add: Dilutive effects of assumed vesting of restricted stock | ||||||||||||||||
| Weighted average diluted common shares outstanding | ||||||||||||||||
| Income per common share: | ||||||||||||||||
| Basic EPS | $ | $ | $ | $ | ||||||||||||
| Diluted EPS | $ | $ | $ | $ | ||||||||||||
During the three and six months ended June 30, 2021 and 2020, there were no outstanding stock options. Anti-dilutive shares, which are excluded from the dilutive EPS calculation, were deemed to be immaterial.
| For the three months ended | For the six months ended | |||||||||||||||
| (in thousands, except per share data) | June 30, 2021 | June 30, 2020 | June 30, 2021 | June 30, 2020 | ||||||||||||
| Net income before provision for income taxes - GAAP | $ | $ | $ | $ | ||||||||||||
| Pro forma provision for income taxes | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
| Pro forma net income | ||||||||||||||||
| Weighted average basic common shares outstanding | ||||||||||||||||
| Add: Dilutive effects of assumed vesting of restricted stock | ||||||||||||||||
| Weighted average diluted common shares outstanding | ||||||||||||||||
| Income per common share: | ||||||||||||||||
| Basic EPS | $ | $ | $ | $ | ||||||||||||
| Diluted EPS | $ | $ | $ | $ | ||||||||||||
Note 2: Recently Issued Accounting Standards
The following reflect recent accounting standards that are pending adoption by the Company. As discussed in Note 1, Basis of Presentation, the Company qualifies as an emerging growth company, and as such, has elected to use the extended transition period for complying with new or revised accounting standards and is not subject to the new or revised accounting standards applicable to public companies during the extended transition period. The accounting standards discussed below reflect effective dates for the Company as an emerging growth company with the extended transition period.
12
Accounting Standards Not Yet Adopted
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). The amendments in this ASU intend to increase transparency and comparability among organizations by recognizing an asset, which represents the right to use the asset for the lease term, and a lease liability, which is a lessee’s obligation to make lease payments measured on a discounted basis. This ASU generally applies to leasing arrangements exceeding a twelve-month term. As amended by ASU 2020-05, ASU 2016-02 is effective for annual periods, including interim periods within those annual periods beginning after December 15, 2021 and requires a modified retrospective method of adoption. In July 2018, the FASB issued two amendments to ASU 2016-02: ASU No. 2018-10, Codification Improvements to Topic 842, Leases, which provides various corrections and clarifications to ASU 2016-02; and ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which provides a new optional transition method and provides a lessor with practical expedients for separating lease and non-lease components of a lease. Entities will apply a modified retrospective approach at either the beginning of the earliest period presented or at the beginning of the period of adoption through a cumulative-effect adjustment to retained earnings. The Company is currently evaluating the effect that the ASU will have on its financial condition or results of operations.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The standard will replace the “incurred loss” model with a “current expected credit loss” (“CECL”) model. The CECL model will apply to estimated credit losses on loans receivable, held-to-maturity debt securities, unfunded loan commitments, and certain other financial assets measured at amortized cost. The CECL model is based on lifetime expected losses, rather than incurred losses, and requires the recognition of credit loss expense in the consolidated statement of income and a related allowance for credit losses on the consolidated statement of condition at the time of origination or purchase of a loan receivable or held-to-maturity debt security. Likewise, subsequent changes in this estimate are recorded through credit loss expense and related allowance. The CECL model requires the use of not only relevant historical experience and current conditions, but reasonable and supportable forecasts of future events and circumstances, incorporating a broad range of information in developing credit loss estimates, which could result in significant changes to both the timing and amount of credit loss expense and allowance. Under ASU 2016-13, available-for-sale debt securities are evaluated for impairment if fair value is less than amortized cost. Estimated credit losses are recorded through a credit loss expense and an allowance, rather than a write-down of the investment. Changes in fair value that are not credit-related will continue to be recorded in other comprehensive income. The ASU also expands the disclosure requirements regarding assumptions, models, and methods for estimating the allowance for loan losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU 2016-13 is effective for the Company for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Entities will apply a modified retrospective approach through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. While the Company believes the change from an incurred loss model to a CECL model has the potential to increase the allowance for loan losses at the adoption date, the Company cannot reasonably quantify the impact of the adoption of the amendments to its financial condition or results of operations at this time due to the complexity and extensive changes from these amendments. The Company is working with its third-party vendor to identify data gaps and determine the appropriate methodologies and resources to utilize in preparation for transition to the new accounting standard, including but not limited to the use of certain tools to forecast future economic conditions that affect the cash flows of loans over their lifetime.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The primary objective of the amendments in this update is to simplify the application of hedge accounting. More specifically, the amendments in this update better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. Furthermore, the amendments expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. Additionally, amendments in this update require an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. Hedge ineffectiveness is no longer separately measured and reported. The amendments in this update will be effective for fiscal years beginning after December 15, 2020 and interim periods within fiscal years beginning after December 15, 2021. Early adoption is permitted in any interim period. The impact of adopting this ASU is expected to be immaterial to the Company’s consolidated financial statements.
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In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848). The amendments in this ASU are elective and provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform. The amendments in this ASU provide optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions that reference the London Inter-Bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued because of reference rate reform. Additionally, in January 2021, the FASB issued ASU No. 2021-01, Reference Rate Reform (Topic 848), which refines the scope of ASC 848 and clarifies its guidance, permitting entities to elect certain optional expedients and exceptions when accounting for derivative contracts and certain hedging relationships affected by changes in the interest rates used for discounting cash flows, for computing variation margin settlements, and for calculating price alignment interest in connection with reference rate reform activities under way in global financial markets. The amendments in these ASUs may be elected as of March 12, 2020 through December 31, 2022. An entity may choose to elect the amendments in these updates at an interim period subsequent to March 12, 2020, with adoption methods varying based on transaction type. The Company has not elected to apply these amendments; however, the Company is assessing the applicability of the ASUs and continues to monitor guidance for reference rate reform from FASB and its impact on the Company’s financial condition and results of operations.
Note 3: Fair Value of Assets and Liabilities
Fair Value Hierarchy and Fair Value Measurement
Accounting standards require the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect the Company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The fair values of securities are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).
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The following table summarizes the Company’s assets and liabilities that were required to be recorded at fair value on a recurring basis.
| (in thousands) | Carrying Value |
Quoted
Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
Measurement Categories: Changes in Fair Value Recorded In1 | |||||||||||||
| June 30, 2021 | ||||||||||||||||||
| Assets: | ||||||||||||||||||
| Securities available-for-sale: | ||||||||||||||||||
| U.S. government treasuries, U.S. government agencies, mortgage-backed securities, obligations of states and political subdivisions, and collateralized mortgage obligations | $ | $ | $ | $ | OCI | |||||||||||||
| Derivatives – interest rate swap | NI | |||||||||||||||||
| Liabilities: | ||||||||||||||||||
| Derivatives – interest rate swap | NI | |||||||||||||||||
| December 31, 2020 | ||||||||||||||||||
| Assets: | ||||||||||||||||||
| Securities available-for-sale: | ||||||||||||||||||
| U.S. government agencies, mortgage-backed securities, obligations of states and political subdivisions, and collateralized mortgage obligations | $ | $ | $ | $ | OCI | |||||||||||||
| Derivatives – interest rate swap | NI | |||||||||||||||||
| Liabilities: | ||||||||||||||||||
| Derivatives – interest rate swap | $ | NI | ||||||||||||||||
| 1 | Other comprehensive income (“OCI”) or net income (“NI”). |
Available-for-sale securities are recorded at fair value on a recurring basis. When available, quoted market prices (Level 1) are used to determine the fair value of available-for-sale securities. If quoted market prices are not available, management obtains pricing information from a reputable third-party service provider, who may utilize valuation techniques that use current market-based or independently sourced parameters, such as bid/ask prices, dealer-quoted prices, interest rates, benchmark yield curves, prepayment speeds, probability of default, loss severity, and credit spreads (Level 2). Level 2 securities include U.S. agencies or government-sponsored agencies’ debt securities, mortgage-backed securities, government agency issued bonds, privately issued collateralized mortgage obligations, and corporate bonds. As of June 30, 2021 and December 31, 2020, there were no Level 1 or Level 3 securities.
On a recurring basis, derivative financial instruments are recorded at fair value, which is based on the income approach using observable Level 2 market inputs, reflecting market expectations of future interest rates as of the measurement date. Standard valuation techniques are used to calculate the present value of the future expected cash flows assuming an orderly transaction. Valuation adjustments may be made to reflect both the Company’s credit risk and the counterparties’ credit risk in determining the fair value of the derivatives. A similar credit risk adjustment, correlated to the credit standing of the counterparty, is made when collateral posted by the counterparty does not fully cover their liability to the Company. For further discussion on the Company’s methodology in valuing its derivative financial instruments, refer to Note 11, Derivative Financial Instruments and Hedging Activities.
Certain financial assets may be measured at fair value on a non-recurring basis. These assets are subject to fair value adjustments that result from the application of the lower of cost or fair value accounting or write-downs of individual assets, such as impaired loans that are collateral dependent and other real estate owned (“OREO”). As of June 30, 2021 and December 31, 2020, the Company did not carry any assets measured at fair value on a non-recurring basis.
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Disclosures about Fair Value of Financial Instruments
The table below is a summary of fair value estimates for financial instruments as of June 30, 2021 and December 31, 2020. The carrying amounts in the following table are recorded in the consolidated balance sheets under the indicated captions. Further, management has not disclosed the fair value of financial instruments specifically excluded from disclosure requirements such as bank-owned life insurance policies (“BOLI”).
| June 30, 2021 | December 31, 2020 | |||||||||||||||||||
| (in thousands) | Carrying Amounts |
Fair Value |
Fair
Value Hierarchy |
Carrying Amounts |
Fair Value |
Fair
Value Hierarchy | ||||||||||||||
| Financial assets (recorded at amortized cost) | ||||||||||||||||||||
| Cash and cash equivalents | $ | $ | Level 1 | $ | $ | Level 1 | ||||||||||||||
| Time deposits in banks | Level 1 | Level 1 | ||||||||||||||||||
| Securities – available-for-sale | Level 2 | Level 2 | ||||||||||||||||||
| Securities – held-to-maturity | Level 3 | Level 3 | ||||||||||||||||||
| Loans – held for sale | Level 2 | Level 2 | ||||||||||||||||||
| Loans – held for investment | Level 3 | Level 3 | ||||||||||||||||||
| Interest receivable | Level 3 | Level 3 | ||||||||||||||||||
| Financial liabilities (recorded at amortized cost) | ||||||||||||||||||||
| Deposits | Level 2 | |||||||||||||||||||