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Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. 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Exhibit 13

 

img01.jpg

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Shareholders and the Board of Directors of Middlefield Banc Corp.

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheets of Middlefield Banc Corp. and subsidiaries (the “Company”) as of December 31, 2021 and 2020; the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for the years then ended; and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent, with respect to the Company, in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

 

1
 

 

a01.jpg

 

Basis for Opinion (Continued)

 

Critical Audit Matters

 

The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements; and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter, in any way, our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

 

Allowance for Loan Losses (ALL) – Qualitative Factors

 

Description of the Matter

 

The Company’s loan portfolio totaled $981.7 million as of December 31, 2021, and the associated ALL was $14.3 million. As discussed in Notes 1 and 5 to the consolidated financial statements, determining the amount of the ALL requires significant judgment about the collectability of loans, which includes an assessment of quantitative factors such as historical loss experience within each risk category of loans and testing of certain commercial loans for impairment. Management applies additional qualitative adjustments to reflect the inherent losses that exist in the loan portfolio at the balance sheet date that are not reflected in the historical loss experience. Qualitative adjustments are made based upon changes in lending policies and practices, economic conditions, changes in the loan portfolio mix, trends in loan delinquencies and classified loans, collateral values, and concentrations of credit risk for the commercial loan portfolios.

 

We identified these qualitative adjustments within the ALL as critical audit matters because they involve a high degree of subjectivity. In turn, auditing management’s judgments regarding the qualitative factors applied in the ALL calculation involved a high degree of subjectivity.

 

How We Addressed the Matter in Our Audit

 

We gained an understanding of the Company’s process for establishing the ALL, including the qualitative adjustments made to the ALL. We evaluated the design and tested the operating effectiveness of controls over the Company’s ALL process, which included, among others, management’s review and approval controls designed to assess the need and level of qualitative adjustments to the ALL, as well as the reliability of the data utilized to support management’s assessment.

 

To test the qualitative adjustments, we evaluated the appropriateness of management’s methodology and assessed whether all relevant risks were reflected in the ALL and the need to consider qualitative adjustments, including the potential effect of COVID-19 on the adjustments.

 

2
 

 

a01.jpg

 

Allowance for Loan Losses (ALL) – Qualitative Factors (Continued)

 

How We Addressed the Matter in Our Audit (Continued)

 

Regarding the measurement of the qualitative adjustments, we evaluated the completeness, accuracy, and relevance of the data and inputs utilized in management’s estimate. For example, we compared the inputs and data to the Company’s historical loan performance data, third-party macroeconomic data, and peer bank data and considered the existence of new or contrary information. We also compared the ALL to a range of historical losses to evaluate the ALL, including the reasonableness of qualitative adjustments. Furthermore, we analyzed the changes in the components of the qualitative reserves relative to changes in external market factors, the Company’s loan portfolio, and asset quality trends, which included the evaluation of management’s ability to capture and assess relevant data from both external sources and internal reports on loan customers affected by the COVID-19 pandemic and the supporting documentation for substantiating revisions to qualitative factors.

 

We also utilized internal credit review specialists with knowledge to evaluate the appropriateness of management’s risk-rating processes, to ensure that the risk ratings applied to the commercial loan portfolio were reasonable.

 

We have served as the Company’s auditor since 1986.

 

 

/s/S. R. Snodgrass, P.C.

 

 

Cranberry Township, Pennsylvania

March 15, 2022

 

3
 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED BALANCE SHEET

(Dollar amounts in thousands)

 

  

December 31,

 
  

2021

  

2020

 
         

ASSETS

        

Cash and due from banks

 $97,172  $92,874 

Federal funds sold

  22,322   19,543 

Cash and cash equivalents

  119,494   112,417 

Equity securities, at fair value

  818   609 

Investment securities available for sale, at fair value

  170,199   114,360 

Loans held for sale

  1,051   878 

Loans:

        

Commercial real estate:

        

Owner occupied

  111,470   103,121 

Non-owner occupied

  283,618   309,424 

Multifamily

  31,189   39,562 

Residential real estate

  240,089   233,995 

Commercial and industrial

  148,812   232,044 

Home equity lines of credit

  104,355   112,543 

Construction and other

  54,148   63,573 

Consumer installment

  8,010   9,823 

Total loans

  981,691   1,104,085 

Less: allowance for loan and lease losses

  14,342   13,459 

Net loans

  967,349   1,090,626 

Premises and equipment, net

  17,272   18,333 

Goodwill

  15,071   15,071 

Core deposit intangibles

  1,403   1,724 

Bank-owned life insurance

  17,060   16,938 

Other real estate owned

  6,992   7,387 

Accrued interest receivable and other assets

  14,297   13,636 
         

TOTAL ASSETS

 $1,331,006  $1,391,979 
         

LIABILITIES

        

Deposits:

        

Noninterest-bearing demand

 $334,171  $291,347 

Interest-bearing demand

  196,308   195,722 

Money market

  177,281   198,493 

Savings

  260,125   243,888 

Time

  198,725   295,750 

Total deposits

  1,166,610   1,225,200 

Other borrowings

  12,901   17,038 

Accrued interest payable and other liabilities

  6,160   5,931 

TOTAL LIABILITIES

  1,185,671   1,248,169 

STOCKHOLDERS' EQUITY

        

Common stock, no par value; 10,000,000 shares authorized, 7,330,548 and 7,308,685 shares issued; 5,888,737 and 6,379,323 shares outstanding

  87,131   86,886 

Retained earnings

  83,971   69,578 

Accumulated other comprehensive income

  3,462   4,284 

Treasury stock, at cost; 1,441,811 and 929,362 shares

  (29,229)  (16,938)

TOTAL STOCKHOLDERS' EQUITY

  145,335   143,810 
         

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

 $1,331,006  $1,391,979 

 

See accompanying notes to the consolidated financial statements.

 

4
 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF INCOME

(Dollar amounts in thousands, except per share data)

 

  

Year Ended December 31,

 
  

2021

  

2020

 

INTEREST AND DIVIDEND INCOME

        

Interest and fees on loans

 $47,896  $49,003 

Interest-earning deposits in other institutions

  90   118 

Federal funds sold

  3   22 

Investment securities:

        

Taxable interest

  1,679   909 

Tax-exempt interest

  2,565   2,472 

Dividends on stock

  102   114 

Total interest and dividend income

  52,335   52,638 
         

INTEREST EXPENSE

        

Deposits

  3,913   8,962 

Short-term borrowings

  -   79 

Other borrowings

  152   209 

Total interest expense

  4,065   9,250 
         

NET INTEREST INCOME

  48,270   43,388 
         

Provision for loan losses

  700   9,840 
         

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES

  47,570   33,548 
         

NONINTEREST INCOME

        

Service charges on deposit accounts

  3,425   2,539 

Gains (losses) on equity securities

  209   (101)

Earnings on bank-owned life insurance

  546   427 

Gain on sale of loans

  1,240   1,487 

Revenue from investment services

  727   526 

Other income

  1,059   1,112 

Total noninterest income

  7,206   5,990 
         

NONINTEREST EXPENSE

        

Salaries and employee benefits

  17,151   15,835 

Occupancy expense

  2,178   2,158 

Equipment expense

  1,361   1,308 

Data processing costs

  2,880   2,650 

Ohio state franchise tax

  1,144   1,082 

Federal deposit insurance expense

  494   423 

Professional fees

  1,313   1,359 

Net gain (loss) on other real estate owned

  11   (172)

Advertising expense

  885   698 

Software amortization expense

  361   351 

Core deposit intangible amortization

  321   332 

Other expense

  3,979   3,764 

Total noninterest expense

  32,078   29,788 
         

Income before income taxes

  22,698   9,750 

Income taxes

  4,065   1,401 
         

NET INCOME

 $18,633  $8,349 
         

EARNINGS PER SHARE

        

Basic

 $3.01  $1.31 

Diluted

  3.00   1.30 

 

See accompanying notes to the consolidated financial statements.

 

5
 

 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(Dollar amounts in thousands)

 

  

Year Ended December 31,

 
  

2021

  

2020

 
         

Net income

 $18,633  $8,349 
         

Other comprehensive income (loss):

        

Net unrealized holding gain on available- for-sale investment securities

  (1,041)  3,091 

Tax effect

  219   (649)
         

Reclassification adjustment for investment securities gains included in net income

  -   - 

Tax effect

  -   - 
         

Total other comprehensive income (loss)

  (822)  2,442 
         

Comprehensive income

 $17,811  $10,791 

 

See accompanying notes to the consolidated financial statements.

 

6
 

 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

(Dollar amounts in thousands, except dividend per share amount)

 

              

Accumulated

         
              

Other

      

Total

 
  

Common Stock

  

Retained

  

Comprehensive

  

Treasury

  

Stockholders'

 
  

Shares

  

Amount

  

Earnings

  

Income (Loss)

  

Stock

  

Equity

 

Balance, December 31, 2019

  7,294,792  $86,617  $65,063  $1,842  $(15,747) $137,775 
                         

Net income

          8,349           8,349 

Other comprehensive income

              2,442       2,442 

Stock options exercised

  1,350   12               12 

Stock-based compensation, net

  12,543   257               257 

Treasury shares acquired (58,200 shares)

                  (1,191)  (1,191)

Cash dividends ($0.60 per share)

          (3,834)          (3,834)
                         

Balance, December 31, 2020

  7,308,685  $86,886  $69,578  $4,284  $(16,938) $143,810 
                         

Net income

          18,633           18,633 

Other comprehensive income (loss)

              (822)      (822)

Stock options exercised

  10,650   94               94 

Stock-based compensation, net

  11,213   151               151 

Treasury shares acquired (512,449 shares)

                  (12,291)  (12,291)

Cash dividends ($0.69 per share)

          (4,240)          (4,240)
                         

Balance, December 31, 2021

  7,330,548  $87,131  $83,971  $3,462  $(29,229) $145,335 

 

See accompanying notes to the consolidated financial statements.

 

7
 

 

 

MIDDLEFIELD BANC CORP.

CONSOLIDATED STATEMENT OF CASH FLOWS 

(Dollar amounts in thousands) 

 

  

Year Ended December 31,

 
  

2021

  

2020

 

OPERATING ACTIVITIES

        

Net income

 $18,633  $8,349 

Adjustments to reconcile net income to net cash provided by operating activities:

        

Provision for loan losses

  700   9,840 

(Gain) loss on equity securities

  (209)  101 

Depreciation and amortization of premises and equipment, net

  1,420   1,342 

Software amortization expense

  361   351 

Financing lease amortization expense

  313   286 

Gain on sale of premises and equipment

  -   (27)

Amortization of premium and discount on investment securities, net

  506   365 

Accretion of deferred loan fees, net

  (4,780)  (2,790)

Amortization of core deposit intangibles

  321   332 

Stock-based compensation (income) expense, net

  478   144 

Origination of loans held for sale

  (34,081)  (42,487)

Proceeds from sale of loans

  35,148   44,316 

Gain on sale of loans

  (1,240)  (1,487)

Earnings on bank-owned life insurance

  (546)  (427)

Deferred income tax

  (401)  (1,348)

Gain on other real estate owned

  (43)  (253)

Increase in accrued interest receivable

  1,078   (1,739)

Decrease in accrued interest payable

  (343)  (337)

Other, net

  (1,893)  551 

Net cash provided by operating activities

  15,422   15,082 
         

INVESTING ACTIVITIES

        

Investment securities available for sale:

        

Proceeds from repayments and maturities

  11,521   18,170 

Purchases

  (68,907)  (24,071)

Decrease (increase) in loans, net

  127,294   (127,874)

Proceeds from the sale of other real estate owned

  501   709 

Net purchase of premises and equipment

  (605)  (1,077)

Proceeds from the disposal of premises and equipment

  -   27 

Purchase of restricted stock

  -   (1,600)

Redemption of restricted stock

  658   391 

Proceeds from bank-owned life insurance

  424   - 

Net cash (used in) provided by investing activities

  70,886   (135,325)
         

FINANCING ACTIVITIES

        

Net (decrease) increase in deposits

  (58,590)  204,357 

Decrease in short-term borrowings, net

  -   (5,075)

Proceeds from other borrowings

  -   3,952 

Repayment of other borrowings

  (4,204)  (674)

Stock options exercised

  94   12 

Repurchase of treasury shares

  (12,291)  (1,191)

Cash dividends

  (4,240)  (3,834)

Net cash (used in) provided by financing activities

  (79,231)  197,547 
         

Increase (decrease) in cash and cash equivalents

  7,077   77,304 
         

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

  112,417   35,113 
         

CASH AND CASH EQUIVALENTS AT END OF YEAR

 $119,494  $112,417 

 

See accompanying notes to the consolidated financial statements.

 

8
 

 

   

Year Ended December 31,

  
   

2021

    

2020

  

SUPPLEMENTAL INFORMATION

                

Cash paid during the year for:

                

Interest on deposits and borrowings

   $ 4,408     $ 9,587  

Income taxes

     5,526       2,177  
                 

Noncash investing transactions:

                

Transfers from loans to other real estate owned

   $ 63     $ 7,688  

Finance lease assets added to premises and equipment

     (67 )     (1,010 )
                 

Noncash financing transactions:

                

Finance lease liabilities added to borrowed funds

   $ 67     $ 1,010  

 

See accompanying notes to the consolidated financial statements.

 

9
 

 

MIDDLEFIELD BANC CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

A summary of the significant accounting and reporting policies applied in the presentation of the accompanying financial statements follows:

 

Nature of Operations and Basis of Presentation

 

Middlefield Banc Corp. (the “Company”) is an Ohio corporation organized to become the holding company of The Middlefield Banking Company (“MBC”). MBC is a state-chartered bank located in Ohio, whose consolidated financial statements also include the accounts of MBC’s subsidiary, Middlefield Investments, Inc. (“MI”), established March 13, 2019. Significant intercompany items have been eliminated in preparing MBC’s consolidated financial statements. On October 23, 2009, the Company established an asset resolution subsidiary named EMORECO, Inc. The Company and its subsidiaries derive substantially all of their income from banking and bank-related services, including interest earnings on residential real estate, commercial mortgage, commercial and consumer financings, and interest earnings on investment securities and deposit services to its customers through sixteen full-service locations. The Company is supervised by the Board of Governors of the Federal Reserve System. At the same time, MBC is subject to regulation and supervision by the Federal Deposit Insurance Corporation and the Ohio Division of Financial Institutions.

 

The consolidated financial statements of the Company include its wholly-owned subsidiaries, MBC and EMORECO, Inc. Significant intercompany items have been eliminated in preparing the consolidated financial statements.

 

The financial statements have been prepared according to U.S. Generally Accepted Accounting Principles. In preparing the financial statements, management must make estimates and assumptions that affect the reported amounts of assets and liabilities as of the balance sheet date and revenues and expenses for the period. Actual results could differ from those estimates.

 

Investment and Equity Securities

 

Investment securities are classified at the time of purchase, based on management’s intention and ability, as securities held to maturity or securities available for sale. Debt securities acquired with the intent and ability to hold to maturity are stated at cost, adjusted for amortization of premium and accretion of discount, computed using a level yield method, and recognized as interest income adjustments. Certain other debt securities have been classified as available for sale to serve principally as a source of liquidity. Unrealized holding gains and losses for available-for-sale securities are reported as a separate component of stockholders’ equity, net of tax, until realized. Realized security gains and losses are computed using the specific identification method. Interest and dividends on investment securities are recognized as income when earned. For 2021 and 2020, this category includes common stocks of public companies that the Company has the positive intent and ability to hold for an indeterminate amount of time. Such securities are reported at fair value, with unrealized holding gains and losses included in earnings.

 

Securities are evaluated quarterly and more frequently when economic or market conditions warrant such an evaluation to determine whether a decline in their value is other-than-temporary. For debt securities, management considers whether the present value of cash flows expected to be collected is less than the security’s amortized cost basis (the difference defined as the credit loss), the magnitude and duration of the decline, the reasons underlying the decline and the Bank’s intent to sell the security or whether it is more likely than not that the Bank would be required to sell the security before its anticipated recovery in market value, to determine whether the loss in value is other-than-temporary. Once a decline in value is determined to be other-than-temporary, if the Bank does not intend to sell the security, and it is more likely than not that it will not be required to sell the security, before recovery of the security’s amortized cost basis, the charge to earnings is limited to the amount of credit loss. Any remaining difference between fair value and amortized cost (the difference defined as the non-credit portion) is recognized in other comprehensive income, net of applicable taxes. Otherwise, the difference between fair value and the amortized cost is charged to earnings. For equity securities where the fair value has been significantly below cost for one year, the Bank’s policy recognizes an impairment loss unless sufficient evidence is available that the decline is not other-than-temporary and a recovery period can be predicted.

 

Restricted Stock

 

Common stock of the Federal Home Loan Bank (“FHLB”) represents ownership in an institution that is wholly owned by other financial institutions. This equity security is accounted for at cost and classified with other assets. The FHLB of Cincinnati has reported profits for 2021 and 2020, remains in compliance with regulatory capital and liquidity requirements and continues to pay dividends on the stock and make redemptions at the par value. Considering these factors, management concluded that the stock was not impaired on December 31, 2021, or 2020.

 

10
 
 

Mortgage Banking Activities

 

The Bank sells mortgage loans on a servicing retained basis. Servicing rights are initially recorded at fair value, with the income statement effect recorded in gains on sales of loans. The Bank measures servicing assets using the amortization method. Loan servicing rights are amortized in proportion to and throughout estimated net future servicing revenue. The expected period of the estimated net servicing income is partly based on the expected prepayment of the underlying mortgages. The unamortized balance of mortgage servicing rights is included in accrued interest and other assets on the Consolidated Balance Sheet.

 

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of outstanding principal and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Late fees and ancillary fees related to loan servicing are not material. The Bank is servicing loans for others in the amount of $105.9 million and $92.3 million on December 31, 2021, and 2020, respectively.

 

Loans

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances net of the allowance for loan and lease losses. Interest income is recognized, when earned, on the accrual method. The accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions, the borrower’s financial condition is such that the collection of interest is doubtful. Interest received on nonaccrual loans is recorded as income or applied against principal according to management’s judgment as to the collectability of such principal.

 

Loan origination fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loan’s yield. These amounts are amortized over the contractual life of the associated loans.

 

Allowance for Loan and Lease Losses

 

The allowance for loan and lease losses represents the amount that management estimates is adequate to provide for probable loan losses inherent in the loan portfolio. The allowance method is used in providing for loan losses. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. The allowance for loan and lease losses is established through a provision for loan losses charged to operations. The provision is based on management’s periodic evaluation of the adequacy of the allowance for loan and lease losses, which encompasses the overall risk characteristics of the various portfolio segments, experience with losses, the impact of economic conditions on borrowers, and other relevant factors. The estimates used in determining the adequacy of the allowance for loan and lease losses, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to a significant change in the near term.

 

A loan is considered impaired when it is probable the borrower will not repay the loan according to the original contractual terms of the loan agreement. Loans that experience insignificant payment delays, which are defined as 89 days or less, generally are not classified as impaired. A loan is not impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest accrued, at the contractual interest rate for the period of delay. All loans identified as impaired are evaluated independently by management. The Company estimates credit losses on impaired loans based on the present value of expected cash flows or the fair value of the underlying collateral if the loan repayment is expected to come from the sale or operation of such collateral. Impaired loans, or portions thereof, are charged off when a realized loss has occurred. An allowance for loan and lease losses is maintained for estimated losses until such time. Cash receipts on impaired loans are applied first to accrued interest receivable unless otherwise required by the loan terms, except when an impaired loan is also a nonaccrual loan, in which case the portion of the payment related to interest is used to reduce principal.

 

Mortgage loans secured by one-to-four family properties and all consumer loans are large groups of smaller-balance homogeneous loans and are measured for impairment collectively. Management determines the significance of payment delays on a case-by-case basis, considering all circumstances concerning the loan, the creditworthiness and payment history of the borrower, the length of the payment delay, and the amount of shortfall concerning the principal and interest owed.

 

Loans Acquired

 

Loans acquired, including loans that have evidence of deterioration of credit quality since origination and for which it is probable, at acquisition, that the Company will be unable to collect all contractually required payments receivable, are initially recorded at fair value (as determined by the present value of expected future cash flows) with no valuation allowance. Loans are evaluated individually to determine if there is evidence of deterioration of credit quality since origination. The difference between the undiscounted cash flows expected at acquisition and the investment in the loan, or the “accretable yield,” is recognized as interest income on a level-yield method over the life of the loan. Contractually required payments for interest and principal that exceed the undiscounted cash flows expected at acquisition, or the “non-acceptable difference,” are not recognized as a yield adjustment or as a loss accrual or a valuation allowance. Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining estimated life. Decreases in expected cash flows are recognized immediately as impairment. Any valuation allowances on these impaired loans reflect only losses incurred after acquisition.

 

11
 
 

For purchased loans acquired that are not deemed impaired at acquisition, credit discounts representing the principal losses expected over the life of the loan are a component of the initial fair value. Loans are aggregated and accounted for as a pool of loans if the loans being aggregated have common risk characteristics. Subsequent to the purchase date, the methods utilized to estimate the required allowance for credit losses for these loans is similar to originated loans; however, the Company records a provision for loan losses only when the required allowance exceeds any remaining credit discounts. The remaining differences between the purchase price and the unpaid principal balance at the date of acquisition are recorded in interest income over the life of the loans.

 

Premises and Equipment

 

Land is carried at cost. Premises and equipment are stated at cost net of accumulated depreciation. Depreciation is computed on the straight-line method over the assets' estimated useful lives, which range from three to 20 years for furniture, fixtures, and equipment and 3 to 40 years for buildings and leasehold improvements. Expenditures for maintenance and repairs are charged against income as incurred. Costs of significant additions and improvements are capitalized.

 

Leases

 

The Company has operating and financing leases for several branch locations and office space. Generally, the underlying lease agreements do not contain any material residual value guarantees or material restrictive covenants. The Company may also lease specific office equipment under operating leases. Many of our leases include both lease (e.g., minimum rent payments) and non-lease components (e.g., common-area or other maintenance costs). The Company accounts for each element separately based on the standalone price of each component. In addition, there may be operating and financing leases with lease terms of less than one year. Therefore we have elected the practical expedient to exclude these short-term leases from our right-of-use assets and lease liabilities.

 

Most leases include one or more options to renew. The exercise of lease renewal options is typically at the sole discretion of management. It is based on whether the extension options are reasonably certain to be exercised after giving proper consideration to all facts and circumstances of the lease. If management determines that the Company is reasonably sure to exercise the extension option(s), the additional term is included in the calculation of the right-of-use asset and a lease liability.

 

As most of our leases do not provide an implicit rate, we use the fully collateralized FHLB borrowing rate commensurate with the lease terms based on the information available at the lease commencement date in determining the present value of the lease payments.

 

Goodwill

 

The Company accounts for goodwill using either a qualitative assessment or a two-step process for testing the impairment of goodwill on at least an annual basis. Either of these approaches could cause more volatility in the Company’s reported net income because impairment losses, if any, could occur irregularly and in varying amounts. No impairment of goodwill was recognized in any of the periods presented.

 

Intangible Assets

 

Intangible assets include core deposit intangibles, which measure the value of consumer demand and savings deposits acquired in business combinations accounted for as purchases. The core deposit intangibles are being amortized to their estimated residual values over their expected useful lives, commonly ten years. The recoverability of the carrying value of intangible assets is evaluated on an ongoing basis, and permanent declines in value, if any, are charged to expense.

 

Bank-Owned Life Insurance (“BOLI”)

 

The Company owns insurance on the lives of a specific group of key employees. The policies were purchased to help offset the increase in the costs of various fringe benefit plans, including healthcare. The cash surrender value of these policies is included as an asset on the Consolidated Balance Sheet, and any increases in the cash surrender value are recorded as noninterest income on the Consolidated Statement of Income. In the event of the death of an insured individual under these policies, the Company would receive a death benefit, which would be recorded as tax-free noninterest income.

 

Other Real Estate Owned (“OREO”)

 

Real estate properties acquired through foreclosure are initially recorded at fair value at the foreclosure date, establishing a new cost basis. After foreclosure, management periodically performs valuations, and the real estate is carried at the lower of cost or fair value less estimated cost to sell. Revenue and expenses from operations of the properties, gains or losses on sales, and additions to the valuation allowance are included in operating results. The Company is required to disclose the carrying amount of residential real estate loans in the process of foreclosure. At December 31, 2021 and 2020, the Company reported $1.0 million and $734,000, respectively, in residential real estate loans in the process of foreclosure.

 

12
 
 

Income Taxes

 

The Company and its subsidiaries file a consolidated federal income tax return. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

 

Treasury Stock

When shares recognized as equity are repurchased, the amount of the consideration paid, which includes directly attributable costs, is recognized as a deduction from equity. Repurchased shares are classified as treasury shares and are presented in the treasury share reserve. The reserve for the Company’s treasury shares comprises the cost of the Company’s shares held by the Company. As of December 31, 2021, the Company had 1,441,811 of the Company’s shares, which is an increase of 512,449 shares for the twelve months ended December 31, 2021, from the 929,362 shares held as of December 31, 2020.

 

Earnings Per Share

 

The Company provides a dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated utilizing net income as reported in the numerator and average shares outstanding in the denominator. The computation of diluted earnings per share differs in that the dilutive effects of any stock options, warrants, and convertible securities are adjusted in the denominator. Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements.

 

Stock-Based Compensation

 

The Company accounts for stock compensation based on the grant date fair value of all share-based payment awards expected to vest, including employee share options to be recognized as employee compensation expense over the requisite service period.

 

Compensation cost is recognized for restricted stock issued to employees based on the fair value of these awards at the grant date. The market price of the Company’s common shares at the grant date is used to estimate the fair value of restricted stock and stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period, and is recorded in "Salaries and employee benefits" expense. (See Note 14-Employee Benefits). The Company’s restricted stock plan allows for a portion of the value received in cash by the participant upon vesting. Therefore, the Company records the expense as a liability until the shares vest and the split of the payment between shares and cash can be determined. The Company also measures the fair value of the liability each reporting period and adjusts accordingly.

 

Cash Flow Information

 

The Company has defined cash and cash equivalents as those amounts included in the Consolidated Balance Sheet captions as “Cash and due from banks” and “Federal funds sold” with original maturities of less than 90 days.

 

Advertising Costs

 

Advertising costs are expensed as incurred.

 

Reclassification of Comparative Amounts

 

Certain comparative amounts for prior years have been reclassified to conform to current-year presentations. Such reclassifications did not affect net income or retained earnings.

 

Recently Issued Accounting Pronouncements

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the impairment model for most financial assets. This Update is intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur over the remaining life of a financial asset. The income statement will be affected for the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period. With certain exceptions, transition to the new requirements will be through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the guidance is adopted. This Update is effective for SEC filers that are eligible to be smaller reporting companies, non-SEC filers, and all other companies, to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. We expect to recognize a one-time cumulative-effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective but cannot yet determine the magnitude of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements. Management will continue to monitor model output throughout the deferral period.

 

13
 
 

CECL Adoption The Company continues to monitor the opportunity to early adopt ASC Topic 326, which replaces the current incurred loss approach for measuring credit losses with an expected loss model ("CECL"). CECL applies to financial assets subject to credit losses and measured at amortized cost and certain off-balance-sheet credit exposures, which include, but are not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. Expected results of adoption are challenging to foreshadow due to the evolving macroeconomic landscape. Early adoption of CECL is unlikely.

 

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. To simplify the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. In computing the implied fair value of goodwill under Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination. Instead, under the amendments in this Update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The Update is effective for smaller reporting companies and all other entities for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. This Update is not expected to have a significant impact on the Company’s financial statements.

 

In November 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses, to clarify its new credit impairment guidance in ASC 326, based on implementation issues raised by stakeholders. This Update clarified, among other things, that expected recoveries are to be included in the allowance for credit losses for these financial assets; an accounting policy election can be made to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions instead of the prepayment assumptions applicable immediately prior to the restructuring event; and extends the practical expedient to exclude accrued interest receivable from all additional relevant disclosures involving amortized cost basis. For entities that have not yet adopted ASU 2016-13 as of November 26, 2019, the effective dates for ASU 2019-11 are the same as the effective dates and transition requirements in ASU 2016-13. For entities that have adopted ASU 2016-13, ASU 2019-11 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company qualifies as a smaller reporting company and does not expect to early adopt these ASUs.

 

In January 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, March 2020, to provide temporary optional expedients and exceptions to the U.S. GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls “reference rate reform” if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Also, entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform if certain criteria are met, and can make a one-time election to sell and/or reclassify held-to-maturity debt securities that reference an interest rate affected by reference rate reform. The amendments in this ASU are effective for all entities upon issuance through December 31, 2022. It is too early to predict whether a new rate index replacement and the adoption of the ASU will have a material impact on the Company’s financial statements.

 

In August 2021, the FASB issued ASU 2021-06, Presentation of Financial Statements (Topic 205), Financial Services – Depository and Lending (Topic 942), and Financial Services – Investment Companies (Topic 946): Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants (SEC Update), to amend SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Release No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU requires applicable entities to disclose, as of each balance sheet date, in a footnote to the financial statements, the aggregate dollar amount of loans (exclusive of loans to any such persons which in the aggregate do not exceed $60,000 during the latest year) made by the registrant or any of its subsidiaries to directors, executive officers, or principal holders of equity securities of the registrant or any of its significant subsidiaries, or to any associate of such persons. This disclosure need not be furnished when the aggregate amount of such loans at the balance sheet date (or with respect to the latest fiscal year, the maximum amount outstanding during the period) does not exceed five percent of stockholders equity as of that date. This Update does not affect the Company's reported statements of financial condition or results of operations.

 

14
 
 
 

2.

REVENUE RECOGNITION

 

Per ASC Topic 606, management determined that the primary sources of revenue emanate from interest income on loans and investments, along with noninterest revenue resulting from investment security gains, gains on the sale of loans, and BOLI income are not within the scope of ASC 606. These revenue sources cumulatively comprise 90.9% of the Company's total revenue.

 

The main types of noninterest income within the scope of the standard are as follows:

 

Service charges on deposit accounts – The Company has contracts with its deposit customers where fees are charged if the account balance falls below predetermined levels defined as compensating balances. The agreements can be canceled at any time by either the Company or the deposit customer. Revenue from these transactions is recognized monthly as the Company has an unconditional right to the fee consideration. The Company also has transaction fees related to specific customer requests or activities, including overdraft fees, online banking fees, and other transaction fees. All of these fees are attributable to particular performance obligations of the Company where the revenue is recognized at a defined point in time, which is the completion of the requested service/transaction.

 

Gains (losses) on sale of other real estate owned (“OREO”) - Gains and losses are recognized after the property sale when the buyer obtains control of the real estate, and all of the performance obligations of the Company have been satisfied. Evidence of the buyer obtaining control of the asset includes the transfer of the property title, physical possession of the asset, and the buyer securing control of the risks and rewards related to the asset. In situations where the Company agrees to provide financing to facilitate the sale, additional analysis is performed to ensure that the contract for sale identifies the buyer and seller, the asset to be transferred, and the payment terms, that the contract has an actual commercial substance and that amounts due from the buyer are reasonable. In situations where financing terms are not reflective of current market terms, the transaction price is discounted, impacting the gain/loss and the carrying value of the asset. Gains and losses on the sale of OREO are reported in the Consolidated Statement of Income.

 

Revenue from investment services – The Company earns investment services revenue through its servicing partnership with LPL Financial. The performance obligation to investment management customers is satisfied over time, and therefore, revenue is recognized over time.  The Company generally receives trailing investment services revenue in arrears and recognizes the revenue when the monthly statement is received.

 

The following table depicts the disaggregation of revenue derived from contracts with customers to describe the nature, amount, timing, and uncertainty of revenue and cash flows for the years ended December 31,

 

Noninterest Income

 

2021

  

2020

 

(Dollar amounts in thousands)

        
         

Service charges on deposit accounts:

        

Overdraft fees

 $727  $665 

ATM banking fees

  1,377   1,061 

Service charges and other fees

  1,321   813 

Gain (loss) on equity securities (a)

  209   (101)

Earnings on bank-owned life insurance (a)

  546   427 

Gain on sale of loans (a)

  1,240   1,487 

Revenue from investment services (b)

  727   526 

Other income

  1,059   1,112 

Total noninterest income

 $7,206  $5,990 
         

Gain on other real estate owned

 $(43) $(253)

 

(a)

Not within scope of ASC 606

(b)

From services offered by the Company through it's servicing partnership with LPL Financial

 

 

3.

EARNINGS PER SHARE

 

The Company provides a dual presentation of basic and diluted earnings per share. Basic earnings per share is calculated by dividing net income by the average shares outstanding. Diluted earnings per share adds the dilutive effects of stock options and restricted stock to average shares outstanding.

 

15
 
 

The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation for the year ended December 31:

 

  

2021

  

2020

 
         

Weighted-average common shares issued

  7,325,449   7,302,845 
         

Average treasury stock shares

  (1,138,783)  (917,495)
         

Weighted-average common shares and common stock equivalents used to calculate basic earnings per share

  6,186,666   6,385,350 
         

Additional common stock equivalents (stock options and restricted stock) used to calculate diluted earnings per share

  24,410   19,174 
         

Weighted-average common shares and common stock equivalents used to calculate diluted earnings per share

  6,211,076   6,404,524 

 

There were no options to purchase shares of common stock outstanding on December 31, 2021. Also outstanding were 76,933 shares of restricted stock, 53,438 shares of which were anti-dilutive.

 

Options to purchase 12,150 shares of common stock at $8.78 per share were outstanding during the year ended December 31, 2020. All options were dilutive. Also outstanding were 67,634 shares of restricted stock, 67,295 shares of which were anti-dilutive.

 

 

4.

INVESTMENT AND EQUITY SECURITIES

 

The amortized cost, gross gains and losses and fair values of securities available for sale are as follows:

 

  

December 31, 2021

 
      

Gross

  

Gross

     
  

Amortized

  

Unrealized

  

Unrealized

  

Fair

 

(Dollar amounts in thousands)

 

Cost

  

Gains

  

Losses

  

Value

 
                 

Subordinated debt

 $32,300  $356  $(119) $32,537 

Obligations of states and political subdivisions:

                

Taxable

  500   2   -   502 

Tax-exempt

  122,877   4,307   (341)  126,843 

Mortgage-backed securities in government-sponsored entities

  10,140   257   (80)  10,317 

Total

 $165,817  $4,922  $(540) $170,199 

 

16
 
 
  

December 31, 2020

 
      

Gross

  

Gross

     
  

Amortized

  

Unrealized

  

Unrealized

  

Fair

 

(Dollar amounts in thousands)

 

Cost

  

Gains

  

Losses

  

Value

 
                 

Subordinated debt

 $21,050  $254  $(7) $21,297 

Obligations of states and political subdivisions:

                

Taxable

  500   2   -   502 

Tax-exempt

  73,157   4,643   -   77,800 

Mortgage-backed securities in government-sponsored entities

  14,230   536   (5)  14,761 

Total

 $108,937  $5,435  $(12) $114,360 

 

Equity securities totaled $818,000 and $609,000 on December 31, 2021, and 2020, respectively, which incorporates a recognized net gain (loss) on equity investments of $209,000 and ($101,000) for the years ended December 31, 2021, and 2020, respectively. No net gains on sold equity securities were realized from sales during these periods.

 

The amortized cost and fair value of debt securities on December 31, 2021, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

  

Amortized

  

Fair

 

(Dollar amounts in thousands)

 

Cost

  

Value

 
         

Due in one year or less

 $-  $- 

Due after one year through five years

  1,715   1,726 

Due after five years through ten years

  40,962   41,427 

Due after ten years

  123,140   127,046 
         

Total

 $165,817  $170,199 

 

Investment securities with an approximate carrying value of $77.1 million and $71.1 million on December 31, 2021, and 2020, respectively, were pledged to secure deposits and other purposes as required by law.

 

There were no securities sold during the year ended December 31, 2021, or 2020.

 

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

 

  

December 31, 2021

 
  

Less than Twelve Months

  

Twelve Months or Greater

  

Total

 
      

Gross

      

Gross

      

Gross

 
  

Fair

  

Unrealized

  

Fair

  

Unrealized

  

Fair

  

Unrealized

 

(Dollar amounts in thousands)

 

Value

  

Losses

  

Value

  

Losses

  

Value

  

Losses

 
                         

Subordinated debt

 $9,150  $(100) $731  $(19) $9,881  $(119)

Obligations of states and political subdivisions

                        

Tax-exempt

  24,273   (341)  -   -   24,273   (341)

Mortgage-backed securities in government-sponsored entities

 $-  $-  $1,980  $(80) $1,980  $(80)

Total

 $33,423  $(441) $2,711  $(99) $36,134  $(540)

 

17
 
 
  

December 31, 2020

 
  

Less than Twelve Months

  

Twelve Months or Greater

  

Total

 
      

Gross

      

Gross

      

Gross

 
  

Fair

  

Unrealized

  

Fair

  

Unrealized

  

Fair

  

Unrealized

 

(Dollar amounts in thousands)

 

Value

  

Losses

  

Value

  

Losses

  

Value

  

Losses

 
                         

Subordinated debt

 $4,243  $(7) $-  $-  $4,243  $(7)

Mortgage-backed securities in government-sponsored entities

  2,748   (5)  -   -   2,748   (5)

Total

 $6,991  $(12) $-  $-  $6,991  $(12)

 

Every quarter, the Company assesses whether there have been any events or economic circumstances indicating that a security with an unrealized loss has suffered other-than-temporary impairment (“OTTI”). A debt security is considered impaired if the fair value is less than its amortized cost basis at the reporting date. The accounting literature requires the Company to assess whether the unrealized loss is other-than-temporary. For equity securities where the fair value has been significantly below cost for one year, the Company’s policy recognizes an impairment loss unless sufficient evidence is available that the decline is not other-than-temporary and a recovery period can be predicted.

 

The Company has asserted that on December 31, 2021, and 2020, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe it will be required to sell these securities before recovery of their cost basis, which may be at maturity. The Company has concluded that any impairment of its investment securities portfolio outlined in the above table is not other-than-temporary and results from interest rate changes, sector credit rating changes, or company-specific rating changes that are not expected to result in the non-collection of principal and interest during the period.

 

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 80.9% of the total available-for-sale portfolio as of December 31, 2021. No credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of significant unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company evaluates credit losses quarterly. The Company considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

 

 

●

The length of time and the extent to which the fair value has been less than the amortized cost basis.

 

 

●

Changes in the near-term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions.

 

 

●

The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities.

 

 

●

Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation, and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

 

 

5.

LOANS AND RELATED ALLOWANCE FOR LOAN AND LEASE LOSSES

 

The Company’s primary business activity is with loan customers located within its local Northeastern Ohio trade area, eastern Geauga County, and contiguous counties to the north, east, and south. The Company also serves the central Ohio market with offices in Dublin, Sunbury, Powell, Plain City, and Westerville, Ohio. The Northeastern Ohio trade area includes Cuyahoga and Summit County, locations in Beachwood, Twinsburg, and Solon, Ohio. Commercial, residential, and consumer loans are granted. Although the Company has a diversified loan portfolio on December 31, 2021, and 2020, loans outstanding to individuals and businesses depend on the local economic conditions in the Company’s immediate trade area.

 

18
 
 

The following tables summarize the primary segments of the loan portfolio and the allowance for loan and lease losses (in thousands):

 

December 31, 2021

 

Ending Loan Balance by Impairment Evaluation

 
  

Individually

  

Collectively

  

Total Loans

 

Loans:

            

Commercial real estate:

            

Owner occupied

 $731  $110,739  $111,470 

Non-owner occupied

  5,297   278,321   283,618 

Multifamily

  -   31,189   31,189 

Residential real estate

  1,104   238,985   240,089 

Commercial and industrial

  587   148,225   148,812 

Home equity lines of credit

  250   104,105   104,355 

Construction and other

  -   54,148   54,148 

Consumer installment

  -   8,010   8,010 

Total

 $7,969  $973,722  $981,691 

 

December 31, 2020

 

Ending Loan Balance by Impairment Evaluation

 
  

Individually

  

Collectively

  

Total Loans

 

Loans:

            

Commercial real estate:

            

Owner occupied

 $1,565  $101,556  $103,121 

Non-owner occupied

  4,123   305,301   309,424 

Multifamily

  -   39,562   39,562 

Residential real estate

  1,319   232,676   233,995 

Commercial and industrial

  834   231,210   232,044 

Home equity lines of credit

  246   112,297   112,543 

Construction and other

  -   63,573   63,573 

Consumer installment

  -   9,823   9,823 

Total

 $8,087  $1,095,998  $1,104,085 

 

The commercial and industrial loan portfolio as of December 31, 2021, includes $34.1 million in loans issued through the Paycheck Protection Program (“PPP”). Although the SBA guarantees PPP loans if specific criteria are met, minimal risk exists in the portfolio. Therefore, a 0.4% qualitative adjustment, equaling $137,000 is reserved for loss. The commercial and industrial loan portfolio as of December 31, 2020, includes $116.1 million in loans issued through the Paycheck Protection Program (“PPP”). Therefore, a 0.4% qualitative adjustment, equaling $464,000 is reserved for loss.

 

The amounts above include net deferred loan origination fees of $3.6 million and $4.4 million on December 31, 2021, and December 31, 2020, respectively. The net deferred loan origination fees at December 31, 2021, include $1.3 million of unearned deferred fees from PPP loans. The net deferred loan origination fees at December 31, 2020, include $2.7 million of unearned deferred fees from PPP loans.

 

19
 
 

December 31, 2021

 

Ending Allowance Balance by Impairment Evaluation

 
  

Individually Evaluated for Impairment

  

Collectively Evaluated for Impairment

  

Total Allocation

 

Loans:

            

Commercial real estate:

            

Owner occupied

 $10  $1,826  $1,836 

Non-owner occupied

  655   6,776   7,431 

Multifamily

  -   454   454 

Residential real estate

  17   1,723   1,740 

Commercial and industrial

  42   840   882 

Home equity lines of credit

  16   1,436   1,452 

Construction and other

  -   533   533 

Consumer installment

  -   14   14 

Total

 $740  $13,602  $14,342 

 

December 31, 2020

 

Ending Allowance Balance by Impairment Evaluation

 
  

Individually Evaluated for Impairment

  

Collectively Evaluated for Impairment

  

Total Allocation

 

Loans:

            

Commercial real estate:

            

Owner occupied

 $10  $1,332  $1,342 

Non-owner occupied

  371   6,446   6,817 

Multifamily

  -   461   461 

Residential real estate

  20   1,663   1,683 

Commercial and industrial

  48   1,305   1,353 

Home equity lines of credit

  41   1,364   1,405 

Construction and other

  -   378   378 

Consumer installment

  -   20   20 

Total

 $490  $12,969  $13,459 

 

The Company’s loan portfolio is segmented to a level that allows management to monitor risk and performance. The portfolio is segmented into Commercial Real Estate (“CRE”) which is further segmented into Owner Occupied (“CRE OO”), Non-owner Occupied (“CRE NOO”), and Multifamily, Residential Real Estate (“RRE”), Commercial and Industrial (“C&I”), Home Equity Lines of Credit (“HELOC”), Construction and Other (“Construction”), and Consumer Installment Loans. Although PPP loans are included with C&I loans, the nature of PPP loans differs considerably from the rest of the category. The U.S. government fully guarantees loans funded through the PPP program. This guarantee exists at the loans' inception and throughout the loans' lives and was not entered into separately and apart from the loans. The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts. The increases in the allowance for loan loss for the CRE and Construction portfolios, were partially offset by a decrease in the allowance for the C&I portfolio. The increase in the allowance for loan losses for CRE was primarily a result of an increase in specifically impaired loans, coupled with increased exposure to substandard credits. The increase in the allowance for loan losses for the Construction portfolios was a result of slight increases in the historical loss factors applied to the portfolio. The decrease in the allowance for the C&I portfolio was a result of a decrease in outstanding loan balances as a result of PPP loan forgiveness.

 

Management evaluates individual loans in all commercial segments for possible impairment based on guidelines established by the Board of Directors. Loans are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall concerning the principal and interest owed. The Company does not separately evaluate individual consumer and residential mortgage loans for impairment unless such loans are part of a larger relationship that is impaired, or the loan was modified in a troubled debt restructuring.

 

20
 
 

Once the determination has been made that a loan is impaired, the decision of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis. The evaluation of the need and amount of a specific allowance allocation and whether a loan can be removed from impairment status is made quarterly. The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

 

The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary (in thousands):

 

December 31, 2021

 

Impaired Loans

 
      

Unpaid

     
  

Recorded

  Principal  

Related

 
  

Investment

  Balance  

Allowance

 

With no related allowance recorded:

            

Commercial real estate:

            

Non-owner occupied

 $1,547  $1,802   - 

Residential real estate

  820   874   - 

Commercial and industrial

  370   538   - 

Home equity lines of credit

  7   7   - 

Total

 $2,744  $3,221  $- 
             

With an allowance recorded:

            

Commercial real estate:

            

Owner occupied

 $731  $731  $10 

Non-owner occupied

  3,750   4,277   655 

Residential real estate

  284   284   17 

Commercial and industrial

  217   230   42 

Home equity lines of credit

  243   243   16 

Total

 $5,225  $5,765  $740 
             

Total:

            

Commercial real estate:

            

Owner occupied

 $731  $731  $10 

Non-owner occupied

  5,297   6,079   655 

Residential real estate

  1,104   1,158   17 

Commercial and industrial

  587   768   42 

Home equity lines of credit

  250   250   16 

Total

 $7,969  $8,986  $740 

 

21
 
 

December 31, 2020

 

Impaired Loans

 
      

Unpaid

     
  

Recorded

  Principal  

Related

 
  

Investment

  Balance  

Allowance

 

With no related allowance recorded:

            

Commercial real estate:

            

Owner occupied

 $1,118  $1,142  $- 

Non-owner occupied

  801   801   - 

Residential real estate

  941   1,013   - 

Commercial and industrial

  561   1,056   - 

Home equity lines of credit

  80   92   - 

Consumer installment

  -   -   - 

Total

 $3,501  $4,104  $- 
             

With an allowance recorded:

            

Commercial real estate:

            

Owner occupied

 $447  $447  $10 

Non-owner occupied

  3,322   3,596   371 

Residential real estate

  378   378   20 

Commercial and industrial

  273   276   48 

Home equity lines of credit

  166   166   41 

Total

 $4,586  $4,863  $490 
             

Total:

            

Commercial real estate:

            

Owner occupied

 $1,565  $1,589  $10 

Non-owner occupied

  4,123   4,397   371 

Residential real estate

  1,319   1,391   20 

Commercial and industrial

  834   1,332   48 

Home equity lines of credit

  246   258   41 

Consumer installment

  -   -   - 

Total

 $8,087  $8,967  $490 

 

The tables above include troubled debt restructurings totaling $2.6 million and $2.9 million as of December 31, 2021, and 2020, respectively. The amounts allocated within the allowance for losses for troubled debt restructurings were $150,000 and $45,000 on December 31, 2021, and December 31, 2020, respectively.

 

The following table presents the average balance and interest income by class, recognized on impaired loans (in thousands):

 

  

As of December 31, 2021

  

As of December 31, 2020

 
  

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Average

Recorded

Investment

  

Interest

Income

Recognized

 
                 

Commercial real estate:

                

Owner occupied

 $1,334  $53  $2,851  $72 

Non-owner occupied

  5,023   262   8,815   184 

Residential real estate

  1,208   56   1,247   52 

Commercial and industrial

  763   62   1,076   42 

Home equity lines of credit

  245   12   308   8 

Total

 $8,573  $445  $14,297  $358 

 

22
 
 

Troubled Debt Restructuring (“TDR”) describes loans on which the bank has granted concessions for reasons related to the customer’s financial difficulties. Such concessions may include one or more of the following:

 

●

reduction in the interest rate to below-market rates

 

●

extension of repayment requirements beyond standard terms

 

●

reduction of the principal amount owed

 

●

reduction of accrued interest due

 

●

acceptance of other assets in full or partial payment of a debt

 

In each case, the concession is made due to deterioration in the borrower’s financial condition, and the new terms are less stringent than those required on a new loan with similar risk.

 

Additionally, on April 7, 2020, federal banking regulators issued a revised interagency statement that included guidance on their approach for the accounting of loan modifications in light of the economic impact of the COVID-19 pandemic. The guidance interprets current accounting standards and indicates that a lender can conclude that a borrower is not experiencing financial difficulty if short-term modifications are made in response to COVID-19, such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant related to the loans in which the borrower is less than 30 days past due on its contractual payments at the time a modification program is implemented. The agencies confirmed in working with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current before any relief are not TDRs. As of December 31, 2021, there were no loans with Covid-19 related payment modifications. As of December 31, 2020, we modified 11 loans aggregating $24.5 million, consisting of the deferral of principal payments and the extension of the maturity date.

 

The following tables summarize troubled debt restructurings that did not meet the exemption criteria above (in thousands) for the following years ended:

 

  

December 31, 2021

 
  

Number of Contracts

  

Pre-Modification

  

Post-Modification

 

 

 

Term

          Outstanding Recorded  Outstanding Recorded 
Troubled Debt Restructurings Modification  

Other

  

Total

  Investment  Investment 

Commercial real estate:

                    

Non-owner occupied

  1   -   1  $730  $730 

Residential real estate

  1   -   1   96   96 
           $826  $826 

 

  

December 31, 2020

 
  

Number of Contracts

  

Pre-Modification

  

Post-Modification

 

 

 

Term

          Outstanding Recorded  Outstanding Recorded 
Troubled Debt Restructurings Modification  

Other

  

Total

  Investment  Investment 

Commercial and industrial

  2   -   2  $25  $24 

Residential real estate

  1   -   1   114   114 
           $139  $138 

 

There were no subsequent defaults of troubled debt restructurings for the years ended December 31, 2021, or 2020.

 

Management uses a nine-point internal risk-rating system to monitor the credit quality of the overall loan portfolio. The first five categories are considered not criticized and are aggregated as Pass rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in undue and unwarranted credit risk, but not to the point of justifying a Substandard classification.  Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected.  All loans greater than 90 days past due are considered Substandard or Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, based on currently existing facts, conditions, and values, highly questionable and improbable. Any portion of a loan that has been charged off is placed in the Loss category.

 

To help ensure that risk ratings are accurate and reflect borrowers' present and future capacity to repay a loan as agreed, the Company has a structured loan-rating process with several layers of internal and external oversight.  Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death, occurs to raise awareness of a possible credit event.  The Company’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Credit Department performs an annual review of all commercial relationships with loan balances of $750,000 or greater.  Confirmation of the appropriate risk grade is included in the ongoing review.  The Company engages an external consultant to conduct loan reviews on a semiannual basis. Detailed reviews, including resolutions plans, are performed on loans classified as Substandard every quarter.  Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in determining the allowance.

 

23
 
 

The following tables present the classes of the loan portfolio summarized by the aggregate Pass rating and the criticized categories of Special Mention, Substandard, and Doubtful within the internal risk rating system (in thousands):

 

      

Special

          

Total

 

December 31, 2021

 

Pass

  

Mention

  

Substandard

  

Doubtful

  

Loans

 
                     

Commercial real estate:

                    

Owner occupied

 $104,217  $2,400  $4,853  $-  $111,470 

Non-owner occupied

  230,672   3,038   49,908   -   283,618 

Multifamily

  31,189   -   -   -   31,189 

Residential real estate

  237,132   -   2,957   -   240,089 

Commercial and industrial

  143,911   2,748   2,153   -   148,812 

Home equity lines of credit

  103,296   -   1,059   -   104,355 

Construction and other

  53,807   341   -   -   54,148 

Consumer installment

  8,005   -   5   -   8,010 

Total

 $912,229  $8,527  $60,935  $-  $981,691 

 

      

Special

          

Total

 

December 31, 2020

 

Pass

  

Mention

  

Substandard

  

Doubtful

  

Loans

 
                     

Commercial real estate:

                    

Owner occupied

 $93,939  $7,084  $2,098  $-  $103,121 

Non-owner occupied

  258,974   983   49,467   -   309,424 

Multifamily

  39,562   -   -   -   39,562 

Residential real estate

  230,944   265   2,786   -   233,995 

Commercial and industrial

  227,765   1,800   2,479   -   232,044 

Home equity lines of credit

  111,208   -   1,335   -   112,543 

Construction and other

  58,082   -   5,491   -   63,573 

Consumer installment

  9,816   -   7   -   9,823 

Total

 $1,030,290  $10,132  $63,663  $-  $1,104,085 

 

Management further monitors the loan portfolio's performance and credit quality by analyzing the portfolio's age as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the aging categories of loans and nonaccrual loans (in thousands):

 

      

30-59 Days

  

60-89 Days

  

90 Days+

  

Total

  

Total

 

December 31, 2021

 

Current

  

Past Due

  

Past Due

  

Past Due

  

Past Due

  

Loans

 
                         

Commercial real estate:

                        

Owner occupied

 $111,257  $81  $132  $-  $213  $111,470 

Non-owner occupied

  282,365   880   -   373   1,253   283,618 

Multifamily

  31,189   -   -   -   -   31,189 

Residential real estate

  238,483   1,187   -   419   1,606   240,089 

Commercial and industrial

  148,437   112   -   263   375   148,812 

Home equity lines of credit

  104,316   -   39   -   39   104,355 

Construction and other

  54,148   -   -   -   -   54,148 

Consumer installment

  7,799   16   19   176   211   8,010 

Total

 $977,994  $2,276  $190  $1,231  $3,697  $981,691 

 

24
 
 

 

      

30-59 Days

  

60-89 Days

  

90 Days+

  

Total

  

Total

 

December 31, 2020

 

Current

  

Past Due

  

Past Due

  

Past Due

  

Past Due

  

Loans

 
                         

Commercial real estate:

                        

Owner occupied

 $102,587  $418  $-  $116  $534  $103,121 

Non-owner occupied

  305,613   1,844   1,373   594   3,811   309,424 

Multifamily

  39,562   -   -   -   -   39,562 

Residential real estate

  230,996   2,364   95   540   2,999   233,995 

Commercial and industrial

  231,534   260   219   31   510   232,044 

Home equity lines of credit

  112,325   120   -   98   218   112,543 

Construction and other

  63,529   44   -   -   44   63,573 

Consumer installment

  9,424   71   108   220   399   9,823 

Total

 $1,095,570  $5,121  $1,795  $1,599  $8,515  $1,104,085 

 

The following tables present the recorded investment in nonaccrual loans and loans past due over 89 days and still on accrual by class of loans (in thousands):

 

      

90+ Days Past

 

December 31, 2021

 

Nonaccrual

  Due and Accruing 
         

Commercial real estate:

        

Owner occupied

 $81  $- 

Non-owner occupied

  2,442   - 

Residential real estate

  1,577   - 

Commercial and industrial

  456   - 

Home equity lines of credit

  121   - 

Consumer installment

  182   - 

Total

 $4,859  $- 

 

      

90+ Days Past

 

December 31, 2020

 

Nonaccrual

  Due and Accruing 
         

Commercial real estate:

        

Owner occupied

 $458  $- 

Non-owner occupied

  3,758   - 

Residential real estate

  2,487   - 

Commercial and industrial

  509   - 

Home equity lines of credit

  422   - 

Consumer installment

  224   - 

Total

 $7,858  $- 

 

There were no loans past due 90 days or more and still accruing interest on December 31, 2021 or 2020.

 

An allowance for loan and lease losses (“ALLL”) is maintained to absorb losses from the loan portfolio.  The ALLL is based on management’s continuing evaluation of the loan portfolio's risk characteristics and credit quality, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of nonperforming loans.

 

The Company’s methodology for determining the ALLL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other bank regulatory guidance.   The total of the two components represents the Company’s ALLL. Management also performs impairment analysis on TDRs, resulting in specific reserves.

 

25
 
 

Loans that are collectively evaluated for impairment are analyzed, with general allowances being made as appropriate.  For general allowances, historical loss trends are used to estimate losses in the current portfolio.  Other qualitative factors modify these historical loss amounts.

 

The classes described above, which are based on the purpose code assigned to each loan, provide the starting point for the ALLL analysis.  Management tracks the historical net charge-off activity at the purpose code level.  Then, a historical charge-off factor is calculated utilizing the last twelve consecutive historical quarters.

 

Management has identified several additional qualitative factors to supplement the historical charge-off factor. These factors likely cause estimated credit losses associated with the existing loan pools to differ from historical loss experience.  The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are:

 

●

national and local economic trends and conditions;

 

●

levels of and trends in delinquency rates and nonaccrual loans;

 

●

trends in volumes and terms of loans;

 

●

effects of changes in lending policies;

 

●

experience, ability, and depth of lending staff;

 

●

value of underlying collateral;

 

●

and concentrations of credit from a loan type, industry, and/or geographic standpoint.

 

Management reviews the loan portfolio every quarter using a defined, consistently applied process to make appropriate and timely adjustments to the ALLL.  When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALLL.

 

The following tables summarize the ALLL within the primary segments of the loan portfolio and the activity within those segments (in thousands):

 

  

Allowance for Loan and Lease Losses

 
  

Balance

              

Balance

 
  

December 31,

2020

  

Charge-offs

  

Recoveries

  

Provision

  

December 31,

2021

 

Loans:

                    

Commercial real estate:

                    

Owner occupied

 $1,342  $-  $45  $449  $1,836 

Non-owner occupied

  6,817   (313)  138   789   7,431 

Multifamily

  461   -   -   (7)  454 

Residential real estate

  1,683   (27)  27   57   1,740 

Commercial and industrial

  1,353   (1)  194   (664)  882 

Home equity lines of credit

  1,405      56   (9)  1,452 

Construction and other

  378   -   46   109   533 

Consumer installment

  20   (124)  142   (24)  14 

Total

 $13,459  $(465) $648  $700  $14,342 

 

  

Allowance for Loan and Lease Losses

 
  

Balance

              

Balance

 
  

December 31,

2019

  

Charge-offs

  

Recoveries

  

Provision

  

December 31,

2020

 

Loans:

                    

Commercial real estate:

                    

Owner occupied

 $801  $(50) $17  $574  $1,342 

Non-owner occupied

  3,382   (3,022)  74   6,383   6,817 

Multifamily

  340   -   -   121   461 

Residential real estate

  726   (62)  42   977   1,683 

Commercial and industrial

  456   (245)  294   848   1,353 

Home equity lines of credit

  932   (55)  84   444   1,405 

Construction and other

  103   -   157   118   378 

Consumer installment

  28   (405)  22   375   20 

Total

 $6,768  $(3,839) $690  $9,840  $13,459 

 

26
 
 

The provision fluctuations during the year ended December 31, 2021, allocated to:

 

●

non-owner occupied commercial real estate loans are due to exposure to the substandard rate credits related to the hospitality industry.

 

●

commercial and industrial loans are due to a decrease in outstanding balances as PPP loans receive forgiveness.

 

●

owner-occupied are due to an increase in substandard rated credits.

 

The provision fluctuations during the year ended December 31, 2020, allocated to:

 

●

commercial real estate loans are due to large charge-offs from two relationships totaling $3.0 million and additional provisions for hospitality-related relationships.

 

●

commercial and industrial loans are due to several small charge-offs that total $245,000, along with an allocation for the PPP loans of $464,000, along with additional provisions for unexpected losses resulting from the current economic environment.

 

●

residential real estate loans are due to several small charge-offs totaling $62,000 and additional provisions for unforeseen losses resulting from the current economic environment.

consumer installment loans are due to charge-offs in the student loan portfolio totaling $383,000.

 

 

6.

PREMISES AND EQUIPMENT

 

Major classifications of premises and equipment at December 31:

 

(Dollar amounts in thousands)

 

2021

  

2020

 
         

Land and land improvements

 $2,963  $2,963 

Building and leasehold improvements

  16,531   16,239 

Furniture, fixtures, and equipment

  9,596   9,395 

Financing right-of-use assets

  4,491   4,737 

Total premises and equipment

  33,581   33,334 

Less accumulated depreciation and amortization

  16,309   15,001 
         

Total premises and equipment, net

 $17,272  $18,333 

 

Depreciation expense charged to operations was $1.4 million in 2021 and $1.3 million in 2020.

 

 

7.

GOODWILL AND INTANGIBLE ASSETS

 

Goodwill totaled $15.1 million for both years ended December 31, 2021, and 2020. Core deposit intangible carrying amount was $1.4 million and $1.7 million for the years ended December 31, 2021, and 2020, respectively. Core deposit accumulated amortization was $1.7 million and $1.4 million for the years ended December 31, 2021, and 2020. Amortization expense totaled $321,000 and $332,000 in 2021 and 2020, respectively.

 

Core deposit intangible assets are amortized to their estimated residual values over their expected useful lives, commonly ten years. The estimated aggregate future amortization expense for core deposit intangible assets as of December 31, 2021, is as follows:

 

Remaining 2022

 $309 

2023

  296 

2024

  281 

2025

  264 

2026

  253 

Thereafter

  - 

Total

 $1,403 

 

27
 
 

Activity for mortgage servicing rights (“MSR”s) follows:

 

(Dollar amounts in thousands)

 

2021

  

2020

 
         

Beginning of year

 $476  $390 

Additions

  257   276 

Amortized to expense

  (191)  (190)
         

End of year

 $542  $476 

 
 

8.

ACCRUED INTEREST RECEIVABLE AND OTHER ASSETS

 

The components of accrued interest receivable and other assets at the years ended December 31:

 

(Dollar amounts in thousands)

 

2021

  

2020

 
         

Restricted stock

 $4,399  $5,057 

Accrued interest receivable on investment securities

  1,312   854 

Accrued interest receivable on loans

  2,820   4,356 

Deferred tax asset, net

  1,693   1,073 

Operating right-of-use assets

  872   742 

Other

  3,201   1,554 
         

Total

 $14,297  $13,636 

 
 

9.

DEPOSITS

 

Time deposits that meet or exceed the FDIC Insurance limit of $250,000 as of December 31, 2021, and 2020 were $33.4 million and $74.9 million, respectively.

 

Scheduled maturities of all time deposits as of December 31, 2021, are as follows:

 

(Dollar amounts in thousands)

    

2022

 $144,016 

2023

  25,496 

2024

  16,640 

2025

  6,533 

2026

  6,040 

Total

 $198,725 

 

Scheduled maturities of time deposits that meet or exceed the FDIC Insurance limit of $250,000 as of December 31, 2021, are as follows:

 

(Dollar amounts in thousands)

 

Amount

  

Percent of Total

 
         

Within three months

 $7,506   22.46%

Beyond three but within six months

  4,778   14.30%

Beyond six but within twelve months

  10,463   31.31%

Beyond one year

  10,672   31.94%
         

Total

 $33,419   100.00%

 

Deposits of related parties amounted to $29.2 million as of December 31, 2021.

 

28
 
 
 

10.

SHORT-TERM BORROWINGS

 

For the year ended December 31, outstanding balances and related information of short-term borrowings, which includes securities sold under agreements to repurchase and short-term borrowings from other banks, are summarized as follows:

 

(Dollar amounts in thousands)

 

2021

  

2020

 
         

Balance at year-end

  -   - 

Average balance outstanding

  85   22,637 

Maximum month-end balance

  -   62,329 

Weighted-average rate at year-end

  N/A   N/A 

Weighted-average rate during the year

  0.40%  0.35%

 

Average balances outstanding during the year represent daily average balances, and average interest rates represent interest expense divided by the related average balance.

 

The Company maintains a $6.0 million line of credit at an adjustable rate, currently 3.50%, a $10.0 million line of credit at an adjustable rate, currently at 3.33%, and a $4.0 million line of credit at an adjustable rate, currently 3.50%. On December 31, 2021, and 2020, there were no outstanding borrowings under these lines of credit. The additional borrowing capacity on FHLB advances was $417.4 million and $401.7 million on December 31, 2021, and 2020, respectively.

 

 

11.

OTHER BORROWINGS

 

Other borrowings consist of advances from the FHLB and subordinated debt as follows:

 

       

Weighted-

  

Stated interest

         

(Dollar amounts in thousands)

Maturity range

  

average

  

rate range

         

Description

from

  to  

interest rate

  

from

   to   2021   2020 

Finance lease liabilities

10/30/34

 

06/01/40

   2.63%  1.89

%

  3.51

%

 $4,653  $4,839 

PPPLF(a)

01/28/21

 

01/28/21

   0.00%  0.35

%

  0.35

%

  -   3,951 

Junior subordinated debt

12/21/37

 

12/21/37

   1.84%  1.80

%

  1.80

%

  8,248   8,248 
                          

Total

               $12,901  $17,038 

 

(a) PPPLF (Paycheck Protection Program Liquidity Facility) borrowings were used to fund PPP loans. This was paid off in 2021. Maturity range and interest rates are as of December 31, 2020.

 

The scheduled maturities of other borrowings are as follows:

 

(Dollar amounts in thousands)

        
      

Weighted-

 

Year Ending December 31,

 

Amount

  

Average Rate

 

2022

 $265   2.63%

2023

  272   2.63%

2024

  279   2.63%

2025

  286   2.63%

2026

  298   2.63%

Beyond 2025

  11,501   1.97%
         

Total

 $12,901   1.62%

 

Under the terms of a blanket agreement, FHLB borrowings are secured by certain qualifying assets of the Company, which consist principally of first mortgage loans or mortgage-backed securities. Under this credit arrangement, the Company had an available borrowing capacity of approximately $417.4 million on December 31, 2021.

 

29
 
 

The Company formed a special purpose entity (“Entity”) to issue $8.0 million of floating rate, obligated mandatorily redeemable securities, and $248,000 in common securities as part of a pooled offering. The rate adjusts quarterly, equal to LIBOR plus 1.67%. The Entity may redeem them at face value in whole or in part. The Company borrowed the issuance proceeds from the Entity in December 2006 in the form of an $8.3 million note payable, which matures in December 2037, and is included in the other borrowings on the Company’s Consolidated Balance Sheet.

 

As of December 31, 2021, the Company had finance lease liabilities of $4.7 million on the Consolidated Balance Sheet. See Note 15 of the financial statements for more information.

 

In April 2020, the Federal Reserve initiated the PPPLF, which is designed to facilitate lending by financial institutions to small businesses under the PPP provisions of the CARES Act.  Only PPP loans are eligible to serve as collateral for the PPPLF, with each dollar of PPP loans providing one dollar of advance availability. The maturity date of an extension of credit under the PPPLF will equal the maturity date of the pool of PPP loans pledged to secure the extension of credit.  Any principal payments received by the financial institution on the PPP loans, such as PPP loan forgiveness payments from the Small Business Administration or principal payments from the borrower after the initial six-month deferment period, must be used to pay down the PPPLF advance by the same dollar amount, maintaining the dollar-for-dollar advance amount and PPP aggregate loan balance relationship.  The interest rate on PPPLF advances is fixed at 0.35%.

 

No PPPLF advances could be obtained under the CARES Act after September 30, 2020. In 2021, the Company paid off the advance, and there were no outstanding advances under the PPPLF as of December 31, 2021.

 

 

12.

ACCRUED INTEREST PAYABLE AND OTHER LIABILITIES

 

The components of accrued interest payable and other liabilities are as follows at December 31:

 

  

2021

  

2020

 

(Dollar amounts in thousands)

        

Accrued interest payable

 $237  $580 

Accrued directors' benefits

  2,247   1,587 

Accrued salary and benefits expense

  1,631   1,410 

Operating lease liabilities

  878   746 

Other

  1,167   1,608 
         

Total

 $6,160  $5,931 

 
 

13.

INCOME TAXES

 

The provision for federal income taxes for the years ended December 31 consists of:

 

(Dollar amounts in thousands)

 

2021

  

2020

 
         

Current payable

 $4,466  $2,749 

Deferred

  (401)  (1,348)
         

Total provision

 $4,065  $1,401 

 

30
 
 

The tax effects of deductible and taxable temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows at December 31:

 

(Dollar amounts in thousands)

 

2021

  

2020

 
         

Deferred tax assets:

        

Allowance for loan and lease losses

 $3,012  $2,826 

Supplemental retirement plan

  608   482 

Investment security basis adjustment

  18   18 

Nonaccrual interest income

  350   355 

Accrued compensation

  293   244 

Lease liability

  1,161   1,173 

Gross deferred tax assets

  5,442   5,098 
         

Deferred tax liabilities:

        

Premises and equipment

  632   709 

Net unrealized gain on AFS securities

  920   1,139 

Net unrealized gain on equity securities

  85   41 

FHLB stock dividends

  139   139 

Intangibles

  450   414 

Mortgage servicing rights

  114   100 

Deferred origination fees, net

  34   50 

Acquisition fair value adjustments

  249   278 

Right of use assets

  1,126   1,151 

Other

  -   4 

Gross deferred tax liabilities

  3,749   4,025 
         

Net deferred tax assets

 $1,693  $1,073 

 

No valuation allowance was established on December 31, 2021, and 2020, in view of the Company’s tax strategies, coupled with the anticipated future taxable income as evidenced by the Company’s earnings potential.

 

The reconciliation between the federal statutory rate and the Company’s effective consolidated income tax rate for the years ended December 31, is as follows:

 

(Dollar amounts in thousands)

 

2021

  

2020

 
      

% of

      

% of

 
      

Pretax

      

Pretax

 
  

Amount

  

Income

  

Amount

  

Income

 
                 

Provision at statutory rate

 $4,766   21.0

%

 $2,047   21.0

%

Tax-exempt income

  (703)  (3.1

)%

  (669)  (6.9

)%

Other

  2   -

%

  23   0.3

%

                 

Actual tax expense and effective rate

 $4,065   17.9

%

 $1,401   14.4

%

 

ASC 740-10 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.

 

31
 
 

At December 31, 2021 and 2020, the Company had no ASC 740-10 unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase within the next 12 months. The Company recognizes interest and penalties on unrecognized tax benefits as a component of income tax expense.

 

The Company and the Bank are subject to U.S. federal income tax as well as an income tax in the states of Ohio and Florida, and the Bank is subject to a capital-based franchise tax in the state of Ohio. The Company and the Bank are no longer subject to examination by taxing authorities for years before 2018.

 

 

14.

EMPLOYEE BENEFITS

 

Employee Retirement Plan

 

The Bank maintains section 401(k) employee savings and investment plans for all full-time employees and officers of the Bank who are at least 21 years of age. The Bank’s contributions to the plans are discretionary and were based on 50% matching of voluntary contributions up to 6% of compensation for the years ended December 31, 2021, and 2020. Employee contributions are vested at all times, and MBC contributions are fully vested after six years beginning at the second year in 20% increments. Special vesting provisions are in place for legacy Liberty employees with three or more years of service. Contributions for 2021 and 2020 to these plans amounted to $347,000 and $350,000, respectively.

 

Executive Deferred Compensation Plans

 

The Company maintains executive deferred compensation plans to provide post-retirement payments to members of senior management. The plan agreements are noncontributory, defined contribution arrangements that provide supplemental retirement income benefits to several officers, with contributions made solely by the Bank. Accrued executive deferred compensation amounted to $1.9 million and $1.7 million as of December 31, 2021, and 2020, respectively. In addition, during 2021 and 2020, the Company recognized nonqualified deferred compensation expense of $264,000 and $240,000, respectively, to the plans.

 

Stock Option and Restricted Stock Plan

 

In 2007, the Company adopted the 2007 Omnibus Equity Plan (the “2007 Plan”) for granting incentive stock options, nonqualified stock options, and restricted stock to key officers and employees and nonemployee directors. Three hundred twenty thousand shares of common stock were reserved for issuance under the 2007 Plan, which expired ten years from the date of board approval of the plan. No remaining shares are outstanding in incentive stock options awards granted under the 2007 Plan. The per-share exercise price of an option granted is not less than the fair value of a share of common stock on the date the option was granted.

 

In 2017, the Company adopted the 2017 Omnibus Equity Plan (the “2017 Plan”) for granting incentive stock options, nonqualified stock options, restricted stock, and other equity awards to key officers and employees and nonemployee directors of the Company. The Company’s stockholders approved the 2017 Plan at the annual meeting of the stockholders held on May 10, 2017. A total of 448,000 shares of authorized and unissued or issued common stock are reserved for issuance under the 2017 Plan, which expires ten years from the date of board approval of the plan. The per-share exercise price of an option granted will not be less than the fair value of a share of common stock on the date the option is granted. The remaining available shares that can be issued under the 2017 Plan were 386,188 on December 31, 2021.

 

The following table presents share data related to the outstanding options:

 

  

Shares

  

Weighted-

average Exercise

Price Per Share

 
         

Outstanding, January 1, 2021

  12,150  $8.78 

Exercised

  (12,150)  8.78 
         

Outstanding, December 31, 2021

  -  $- 
         

Exercisable, December 31, 2021

  -  $- 

 

The total intrinsic value of outstanding in-the-money exercisable stock options was $166,759 on December 31, 2020.

 

32
 
 

For the years ended December 31, 2021, and 2020, 12,150 and 2,350 options were exercised, resulting in net proceeds to the participant of $21,000 and $18,000 for December 31, 2021, and 2020, respectively.

 

During 2021 and 2020, the Compensation Committee of the Company's Board of Directors granted awards of restricted stock for an aggregate amount of 29,193 and 23,648 shares, respectively, to certain employees of the Bank.  The expense recognized for all outstanding awards was $478,000 and $271,000 for the years ended 2021 and 2020, respectively. The number of restricted stock shares earned or settled will depend on specific conditions and are also subject to service period-based vesting. The award recipient must maintain service with Middlefield Banc Corp. and its affiliates until the third anniversary of the award to satisfy the service condition. In addition, the market condition will be met if the average total shareholder annual return (“TSR”) on Middlefield Banc Corp. stock for the three subsequent years meets target for 2020 and 2021.  The target TSR is 10%, capped at 125% of target, and reduced proportionally between 0% and 10%.

 

The existence of a market condition, TSR, dictates that these awards be marked to market quarterly using a Monte Carlo simulation. They are recorded through the vesting period as a liability since a portion is payable in cash. The liability for these accrued officer benefits was $979,000 and $581,000 for the years ended December 31, 2021, and December 31, 2020, respectively.

 

The Company recognized restricted stock forfeitures in the period they occur.

 

The following table presents the activity during 2021 related to awards of restricted stock:

 

  

Units

  

Weighted-

average Grant

Date Fair Value

Per Unit

 

Nonvested at January 1, 2021

  66,362  $23.52 

Granted

  29,193   22.50 

Vested

  (18,622)  24.02 

Nonvested at December 31, 2021

  76,933  $23.01 

Expected to vest at December 31, 2021

  60,368  $22.56 

 

As of December 31, 2021, there was $557,000 of total unrecognized compensation cost related to nonvested restricted shares granted under the 2017 Plan. The cost is expected to be recognized over a weighted-average period of 1.69 years. The total fair value of shares vested during the years ended December 31, 2021, and 2020 was $447,000, and $208,000, respectively.

 

 

15.

COMMITMENTS

 

In the ordinary course of business, various outstanding commitments and certain contingent liabilities are not reflected in the accompanying consolidated financial statements. These commitments and contingent liabilities represent financial instruments with off-balance-sheet risk. The contract or notional amounts of those instruments reflect the extent of involvement in particular types of financial instruments, which were composed of the following on December 31:

 

(Dollar amounts in thousands)

 

2021

  

2020

 
         

Commitments to extend credit

 $280,379  $255,429 

Standby letters of credit

  586   581 
         

Total

 $280,965  $256,010 

 

These instruments involve, to varying degrees, elements of credit and interest rate risk over the amount recognized in the Consolidated Balance Sheet. The Company’s exposure to credit loss, in the event of nonperformance by the other parties to the financial instruments, is represented by the contractual amounts as disclosed. The Company minimizes its exposure to credit loss under these commitments by subjecting them to credit approval and review procedures and collateral requirements as deemed necessary. Commitments generally have fixed expiration dates within one year of their origination.

 

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These instruments are issued primarily to support bid or performance-related contracts. The coverage period for these instruments is typically one year, with an annual renewal option subject to prior approval by management. Fees earned from the issuance of these letters are recognized over the coverage period. The collateral is typically bank deposit instruments or customer business assets for secured letters of credit.

 

33
 
 

Leasing Commitments

 

The Company leases six of its branch locations and one loan production office. As of December 31, 2021, net assets recorded under leases amounted to $5.4 million and have remaining lease terms of 1 year to 19 years. As of December 31, 2021, finance lease assets included in premises and equipment, net, totaled $4.5 million, and operating lease assets included in accrued interest receivable and other assets on the Consolidated Balance Sheet totaled $872,000. As of December 31, 2021, finance lease obligations included in other borrowings totaled $4.7 million, and operating lease obligations included in accrued interest payable and other liabilities on the Consolidated Balance Sheet totaled $878,000.

 

In December 2021, the Company entered into a new lease agreement for the loan production office located in Mentor, Ohio. The new lease agreement does not exceed 12 months and, as such, is not considered a capitalized lease as of December 31, 2021.

 

Lease costs incurred are as follows for the years ended December 31:

 

  

2021

  

2020

 

Lease Costs:

        

Finance lease cost:

        

Amortization of right-of-use asset

 $313  $286 

Interest Expense

  130   131 

Other

  63   27 

Operating lease cost

  225   213 

Total lease cost

 $731  $657 

 

The following table displays the weighted-average term and discount rates for both operating and finance leases outstanding as of December 31, 2021:
 
  

Operating

  

Finance

 

Weighted-average term (years)

  5.9   14.6 

Weighted-average discount rate

  1.8%  2.6%

 

The following table displays the undiscounted cash flows due related to operating and finance leases as of December 31, 2021, along with a reconciliation to the discounted amount recorded on the December 31, 2021 balance sheet:

 

  

Operating

  

Finance

 

Undiscounted cash flows due within:

        

2022

 $169  $385 

2023

  169   385 

2024

  169   385 

2025

  169   385 

2026

  134   389 

2027 and thereafter

  122   3,726 

Total undiscounted cash flows

  932   5,655 
         

Impact of present value discount

  (54)  (1,002)
         

Amount reported on balance sheet

 $878  $4,653 

 
 

16.

REGULATORY RESTRICTIONS

 

The Company is subject to the regulatory requirements of the Federal Reserve System as a bank holding company. The bank is subject to regulations of the Federal Deposit Insurance Corporation (“FDIC”) and the State of Ohio, Division of Financial Institutions.

 

34
 
 

Cash Requirements

 

The Federal Reserve Bank of Cleveland requires the Company to maintain certain average reserve balances. The reserves requirement was reduced to zero as of December 31, 2020, and 2021 as a response to the FRB’s pandemic-related initiatives.

 

Loans

 

Federal law prevents the Company from borrowing from the Bank unless specific obligations secure the loans. Further, such a secured loan is limited to 10% of the Bank’s common stock and capital surplus.

 

Dividends

 

MBC is subject to dividend restrictions that generally limit the amount of dividends that an Ohio state-chartered bank can pay. Under the Ohio Banking Code, cash dividends may not exceed net profits as defined for that year combined with retained net profits for the two preceding years less any required transfers to surplus. Under this formula, the amount available for payment of dividends for 2021 approximates $7.9 million, plus 2022 profits retained up to the dividend declaration date.

 

 

17.

REGULATORY CAPITAL

 

The Bank and Company are subject to regulatory capital requirements administered by banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in some instances. As a result, failure to meet various capital requirements can initiate regulatory action that could directly affect the financial statements. As of December 31, 2021, the Bank and Company have met all capital adequacy requirements to which they are subject.

 

The prompt corrective action regulations provide five classifications: well-capitalized, adequately capitalized, under-capitalized, significantly undercapitalized, and critically undercapitalized. However, these terms are not used to represent the overall financial condition. If an institution is adequately capitalized, regulatory approval is required before the institution may accept brokered deposits. If an institution is undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.

 

The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

 

The following tables present actual and required capital ratios as of December 31, 2021, and 2020 under the Basel III Capital Rules. Capital levels required to be considered well-capitalized are based upon prompt corrective action regulations, as amended to reflect the Basel III Capital Rules changes.

 

  

As of December 31, 2021

 
      

Tier 1

  

Common

  

Total Risk

 
  

Leverage

  Risk Based  Equity Tier 1  Based 

The Middlefield Banking Company

  9.80%  12.72%  12.72%  13.97%

Middlefield Banc Corp.

  10.02%  12.96%  12.18%  14.21%

Adequately capitalized ratio

  4.00%  6.00%  4.50%  8.00%

Adequately capitalized ratio plus fully phased-in capital conservation buffer

  4.00%  8.50%  7.00%  10.50%

Well-capitalized ratio (Bank only)

  5.00%  8.00%  6.50%  10.00%

 

  

As of December 31, 2020

 
      

Tier 1

  

Common

  

Total Risk

 
  

Leverage

  Risk Based  Equity Tier 1  Based 

The Middlefield Banking Company

  9.45%  11.47%  11.47%  12.68%

Middlefield Banc Corp.

  10.22%  11.68%  10.96%  12.88%

Adequately capitalized ratio

  4.00%  6.00%  4.50%  8.00%

Adequately capitalized ratio plus fully phased-in capital conservation buffer

  4.00%  8.50%  7.00%  10.50%

Well-capitalized ratio (Bank only)

  5.00%  8.00%  6.50%  10.00%

 

35
 
 
 

18.

FAIR VALUE DISCLOSURE MEASUREMENTS

 

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value. The three broad levels defined by U.S. generally accepted accounting principles are as follows:

 

Level I:

Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

 

Level II:

Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.

 

Level III:

Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

 

This hierarchy requires the use of observable market data when available.

 

The following tables present the assets measured on a recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

 

     December 31, 2021    
             

(Dollar amounts in thousands)

 

Level I

  

Level II

  

Level III

  

Total

 
                 

Assets measured on a recurring basis:

                

Subordinated debt

 $-  $20,337  $12,200  $32,537 

Obligations of states and political subdivisions

  -   127,345   -   127,345 

Mortgage-backed securities in government- sponsored entities

  -   10,317   -   10,317 

Total debt securities

  -   157,999   12,200   170,199 

Equity securities in financial institutions

  818   -   -   818 

Total

 $818  $157,999  $12,200  $171,017 

 

      

December 31, 2020

     
                 

(Dollar amounts in thousands)

 

Level I

  

Level II

  

Level III

  

Total

 
                 

Assets measured on a recurring basis:

                

Subordinated debt

 $-  $14,047  $7,250  $21,297 

Obligations of states and political subdivisions

  -   78,302   -   78,302 

Mortgage-backed securities in government-sponsored entities

  -   14,761   -   14,761 

Total debt securities

  -   114,360   -   114,360 

Equity securities in financial institutions

  609   -   -   609 

Total

 $609  $114,360  $-  $114,969 

 

Investment Securities Available for Sale – The Company obtains fair values from an independent pricing service, which represent quoted prices for similar assets, fair values determined by pricing models using a market approach that considers observable market data, such as interest rate volatilities, LIBOR yield curve, credit spreads and prices from market makers and live trading systems (Level II). Level III securities are assets whose fair value cannot be determined by using observable measures. The inputs to the valuation methodology of these securities are unobservable and significant to the fair value measurement. Currently, this category includes certain subordinated debt investments, that are valued based on the discounted cash flow approach assuming a yield curve of similar structured instruments.

 

36
 
 

While the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

 

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique.  Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated.  The estimated fair value amounts have been measured as of their respective period-ends, and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates.  As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different from the amounts reported at each period-end.

 

Equity Securities - Equity securities that are traded on a national securities exchange are valued at their last reported sales price as of the measurement date. Equity securities traded in the over-the-counter (“OTC”) markets, and listed securities for which no sale was reported on that date are generally valued at their last reported “bid” price if held long, and last reported “ask” price if sold short. To the extent equity securities are actively traded and valuation adjustments are not applied, they are categorized in Level I of the fair value hierarchy.

 

The following table presents the fair value reconciliation of Level 3 assets measured at fair value on a recurring basis.

 

  

Subordinated debt

 

Balance as of January 1, 2021

 $7,250 

Purchases, sales, settlements

    

Purchases

  4,000 

Sales

  - 

Settlements

  - 

Transfers into Level 3 (1)

  1,700 

Transfers out of Level 3 (2)

  (750)

Balance as of December 31, 2021

 $12,200 

 

(1) During 2021, these investments were transferred into level III. Transfers between hierarchy levels are based on the availability of sufficient observable inputs to meet Level II versus Level III criteria. The level designation of each financial instrument is reassessed at the end of each period.

 

(2) During 2021, these investments were transferred out of level III.  Transfers between hierarchy levels are based on the availability of sufficient observable inputs to meet Level II versus Level III criteria. The level designation of each financial instrument is reassessed at the end of each period. 

 

The following tables present the assets measured on a non-recurring basis on the Consolidated Balance Sheet at their fair value by level within the fair value hierarchy. Collateral-dependent impaired loans are carried at fair value if they have been charged down to fair value or if a specific valuation allowance has been established. A new cost basis is established when a property is initially recorded in OREO. OREO properties are carried at fair value if a devaluation has been taken to the property’s value after the initial measurement. No such devaluation occurred during the year ended December 31, 2021.

 

      

December 31, 2021

     
                 
  

Level I

  

Level II

  

Level III

  

Total

 

(Dollar amounts in thousands)

                

Assets measured on a non-recurring basis:

                

Impaired loans

 $-  $-  $4,162  $4,162 

 

      

December 31, 2020

     
                 
  

Level I

  

Level II

  

Level III

  

Total

 

(Dollar amounts in thousands)

                

Assets measured on a non-recurring basis:

                

Impaired loans

 $-  $-  $4,111  $4,111 

Other real estate owned

  -   -   6,992   6,992 

 

37
 
 

Impaired Loans – The Company has measured impairment on collateral-dependent impaired loans generally based on the fair value of the loan’s collateral. Fair value is usually determined based upon independent third-party appraisals of the properties. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. Additionally, management estimates expected costs to sell the property, which are also included in the net realizable value. If the fair value of the collateral-dependent loan is less than the carrying amount of the loan, a specific reserve for the loan is made in the allowance for loan losses, or a charge-off is taken to reduce the loan to the fair value of the collateral (less estimated selling costs) and the loan is included in the above table as a Level III measurement. If the fair value of the collateral exceeds the carrying amount of the loan, then the loan is not included in the above table as it is not currently being carried at its fair value. The fair values in the preceding tables include estimated selling costs of $901,000 and $838,000 on December 31, 2021, and 2020, respectively.

 

Other Real Estate Owned (OREO) – OREO is carried at the lower of cost or fair value, which is measured at the date of foreclosure. If the fair value of the collateral exceeds the carrying amount of the loan, no charge-off or adjustment is necessary. Therefore, the loan is not considered to be carried at fair value and is not included in the above table. If the fair value of the collateral is less than the carrying amount of the loan, management will charge the loan down to its estimated realizable value. The fair value of OREO is based on the appraised value of the property, which is generally unadjusted by management and is based on comparable sales for similar properties in the same geographic region as the subject property and is included in the preceding table as a Level II measurement. In some cases, management may adjust the appraised value due to the age of the appraisal, changes in market conditions, or observable deterioration of the property since the appraisal was completed. In these cases, the loans are categorized in the above table as a Level III measurement since these adjustments are considered unobservable inputs. Income and expenses from operations and further declines in the fair value of the collateral after foreclosure are included in net expenses from OREO.

 

The following tables present additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company uses Level III inputs to determine fair value:

 

  

Quantitative Information about Level III Fair Value Measurements

   

(Dollar amounts in thousands)

     

 

  

 

  

 

   
  

Fair Value Estimate

   Valuation Techniques   Unobservable Input  Range (Weighted Average)

December 31, 2021

               

Impaired loans

 $4,162  

Appraisal of collateral (1)

  

Appraisal adjustments (2)

  25.0%to72.2% (36.6%)

 

                
   

Quantitative Information about Level III Fair Value Measurements

   

(Dollar amounts in thousands)

     

 

  

 

  

 

   
  

Fair Value Estimate

  Valuation Techniques  Unobservable Input  Range (Weighted Average)

December 31, 2020

               

Impaired loans

 $

4,111

  

Appraisal of collateral (1)

  

Appraisal adjustments (2)

  

17.6%

to48.5%(22.7%)
                

Other real estate owned

 $

6,992

  

Appraisal of collateral (1)

  

Appraisal adjustments (2)

  

 

19.9%  

 

 

(1)

Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various level III inputs, which are not identifiable, less any associated allowance.

 

(2)

Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.

 

The estimated fair value of the Company’s financial instruments not recorded at fair value on a recurring basis is as follows:

 

  

December 31, 2021

 
  

Carrying

              

Total

 
  

Value

  

Level I

  

Level II

  

Level III

  

Fair Value

 
  

(in thousands)

 

Financial assets:

                    

Loans held for sale

  1,051   -   1,051   -   1,051 

Net loans

  967,349   -   -   961,645   961,645 
                     

Financial liabilities:

                    

Deposits

 $1,166,610  $967,885  $-  $199,503  $1,167,388 

Other borrowings

  12,901   -   -   12,901   12,901 

 

38
 
 
  

December 31, 2020

 
  

Carrying

              

Total

 
  

Value

  

Level I

  

Level II

  

Level III

  

Fair Value

 
  

(in thousands)

 

Financial assets:

                    

Loans held for sale

  878   -   878   -   878 

Net loans

  1,090,626   -   -   1,089,573   1,089,573 
                     

Financial liabilities:

                    

Deposits

 $1,225,200  $929,450  $-  $299,651  $1,229,101 

Other borrowings

  17,038   -   -   15,250   15,250 

 

Included within other borrowings is an $8.3 million note payable, which matures in December 2037.  These borrowings were used to form a special purpose entity (“Entity”) to issue $8.0 million of floating rate, obligated mandatorily redeemable securities.   The rate adjusts quarterly, equal to LIBOR plus 1.67%. The borrowing is a floating rate instrument and any difference between the cost and fair value are insignificant. 

 

In addition to the financial instruments included in the above tables, cash and equivalents, bank-owned life insurance, Federal Home Loan Bank stock, accrued interest receivable, and accrued interest payable, are carried at cost, which approximates the fair value of the instruments.

 

 

19.

ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The following table presents the changes in accumulated other comprehensive income (loss) by component net of tax:

 

  

Unrealized gains/(losses) on

 
  

available-for-sale

 

(Dollars in thousands)

 

securities (a)

 
     

Balance as of December 31, 2019

 $1,842 

Other comprehensive income

  2,442 

Balance at December 31, 2020

 $4,284 
     

Balance as of December 31, 2020

 $4,284 

Other comprehensive income (loss)

  (822)

Balance at December 31, 2021

 $3,462 

 

 

(a)

All amounts are net of tax. Amounts in parentheses indicate debits to accumulated other comprehensive income.

 

No unrealized gains or losses on available-for-sale securities were reclassified out of accumulated other comprehensive income for the years ended December 31, 2021, or 2020.

 

39
 
 
 

20.

PARENT COMPANY

 

Following are condensed financial statements for the Company.

 

CONDENSED BALANCE SHEET

 

(Dollar amounts in thousands)

 

December 31,

 
  

2021

  

2020

 

ASSETS

        

Cash and due from banks

 $805  $1,222 

Equity securities, at fair value

  818   609 

Investment in nonbank subsidiary

  1   1 

Investment in subsidiary bank

  150,588   149,272 

Other assets

  2,381   1,561 
         

TOTAL ASSETS

 $154,593  $152,665 
         

LIABILITIES

        

Trust preferred debt

 $8,248  $8,248 

Other liabilities

  1,010   607 

TOTAL LIABILITIES

  9,258   8,855 
         

STOCKHOLDERS' EQUITY

  145,335   143,810 
         

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

 $154,593  $152,665 

 

40
 
 

CONDENSED STATEMENT OF COMPREHENSIVE INCOME

 

  

Year Ended December 31,

 

(Dollar amounts in thousands)

 

2021

  

2020

 
         

INCOME

        

Dividends from subsidiary bank

 $18,600  $4,700 

Dividends from nonbank subsidiary

  -   1,399 

Gain (loss) on equity securities

  209   (101)

Other

  5   7 
Total income  18,814   6,005 
         

EXPENSES

        

Interest expense

  151   192 

Salaries and employee benefits

  842   465 

Ohio state franchise tax

  1,144   1,082 

Other

  742   796 
Total expenses  2,879   2,535 
         

Income before income tax benefit

  15,935   3,470 
         

Income tax benefit

  (560)  (552)
         

Income before equity in undistributed net income of subsidiaries

  16,495   4,022 
         

Equity in undistributed net income of subsidiaries

  2,138   4,327 
         

NET INCOME

 $18,633  $8,349 
         

Comprehensive income

 $17,811  $10,791 

 

 

41
 
 

CONDENSED STATEMENT OF CASH FLOWS

 

  

Year Ended December 31,

 
(Dollar amounts in thousands) 

2021

  

2020

 
         
OPERATING ACTIVITIES        

Net income

 $18,633  $8,349 

Adjustments to reconcile net income to net cash provided by operating activities:

        

Equity in undistributed net income of

        

Subsidiaries

  (2,138)  (4,327)

Stock-based compensation

  398   144 

(Gain) loss on equity securities

  (209)  101 

Other, net

  (664)  (609)
Net cash provided by operating activities  16,020   3,658 
         
FINANCING ACTIVITIES        

Stock options exercised

  94   12 

Repurchase of treasury shares

  (12,291)  (1,191)

Cash dividends

  (4,240)  (3,834)
Net cash used in financing activities  (16,437)  (5,013)
         
Decrease in cash  (417)  (1,355)
         
CASH AT BEGINNING OF YEAR  1,222   2,577 
         
CASH AT END OF YEAR $805  $1,222 

 

42
 
 
 

21.

SELECTED QUARTERLY FINANCIAL DATA (Unaudited)

 

(Dollar amounts in thousands)

 

Three Months Ended

 
  

March 31,

  

June 30,

  

September 30,

  

December 31,

 
  

2021

  

2021

  

2021

  

2021

 
                 

Total interest and dividend income

 $13,142  $12,936  $13,447  $12,810 

Total interest expense

  1,244   1,049   952   820 
                 

Net interest income

  11,898   11,887   12,495   11,990 

Provision for loan losses

  700   200   -   (200)
                 

Net interest income after

                

provision for loan losses

  11,198   11,687   12,495   12,190 
                 

Total noninterest income

  2,218   1,632   1,821   1,535 

Total noninterest expense

  8,353   7,926   7,938   7,861 
                 

Income before income taxes

  5,063   5,393   6,378   5,864 

Income taxes

  896   968   1,174   1,027 
                 

Net income

 $4,167  $4,425  $5,204  $4,837 
                 

Per share data:

                

Net income

                
Basic $0.65  $0.70  $0.85  $0.81 
Diluted  0.65   0.70   0.85   0.81 

Average shares outstanding:

                
Basic  6,364,132   6,297,071   6,136,648   5,951,838 
Diluted  6,378,493   6,312,230   6,157,181   5,975,333 

 

(Dollar amounts in thousands)

 

Three Months Ended

 
  

March 31,

  

June 30,

  

September 30,

  

December 31,

 
  

2020

  

2020

  

2020

  

2020

 
                 

Total interest and dividend income

 $13,009  $13,155  $13,507  $12,967 

Total interest expense

  2,976   2,430   2,148   1,696 
                 

Net interest income

  10,033   10,725   11,359   11,271 

Provision for loan losses

  2,740   1,000   4,000   2,100 
                 

Net interest income after

                

provision for loan losses

  7,293   9,725   7,359   9,171 
                 

Total noninterest income

  1,074   1,495   1,811   1,610 

Total noninterest expense

  7,252   7,689   7,022   7,825 
                 

Income before income taxes

  1,115   3,531   2,148   2,956 

Income taxes

  74   565   295   467 
                 

Net income

 $1,041  $2,966  $1,853  $2,489 
                 

Per share data:

                

Net income

                
Basic $0.16  $0.47  $0.29  $0.39 
Diluted  0.16   0.46   0.29   0.39 

Average shares outstanding:

                
Basic  6,417,109   6,369,467   6,376,291   6,378,706 
Diluted  6,429,443   6,388,118   6,385,765   6,397,681 

 

43
 
 
 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This information should be read in conjunction with the consolidated financial statements and accompanying notes to the financial statements.

 

This Management’s Discussion and Analysis section of the Annual Report contains forward-looking statements. Forward-looking statements are based upon a variety of estimates and assumptions. The estimates and assumptions involve judgments about a number of things, including future economic, competitive, and financial market conditions and future business decisions. These matters are inherently subject to significant business, economic, and competitive uncertainties, all of which are difficult to predict and many of which are beyond the Company's control. Although the Company believes its estimates and assumptions are reasonable, actual results could vary materially from those shown. Inclusion of forward-looking information does not constitute a representation by the Company or any other person that the indicated results will be achieved. Investors are cautioned not to place undue reliance on forward-looking information.

 

These forward-looking statements may involve significant risks and uncertainties. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results in these forward-looking statements.

 

Overview

 

During 2021, the Company reported net income of $18.6 million, or $3.00 per diluted share, compared with $8.3 million, or $1.30 per diluted share, in 2020. The Company’s net income as a percentage of average assets for 2021 and 2020 was 1.36% and 0.64%, respectively, while the Company’s net income as a percentage of average shareholders’ equity was 12.74% and 5.87%, respectively.

 

Highlights of the Company’s performance in 2021 (on a year-over-year basis unless noted) include the following:

 

 

●

Net income increased 123.2% to $18.6 million
 

●

Net interest margin improved by 25 basis points to 3.79%, compared to 3.54%
 

●

Total noninterest income was up 20.3% to $7.2 million
 

●

Pre-tax, pre-provision for loan losses(1) income increased 19.4% to $23.4 million
 

●

Return on average assets increased to 1.36% from 0.64%
 

●

Return on average equity increased to 12.74% from 5.87%
 

●

Return on average tangible common equity(1) increased to 14.38% from 6.66%
 

●

The efficiency ratio improved to 56.48%, compared to 58.77%
 

●

Strong asset quality with nonperforming loans to total loans of 0.49%
 

●

Middlefield repurchased 512,449 shares of stock in 2021, including 166,346 shares during the fourth quarter of 2021

 

 

(1)

A reconciliation of non-GAAP financial measures can be found in the following tables.

 

Reconciliation of Common Stockholders' Equity to Tangible Common Equity

  

For the Twelve Months Ended

  

(Dollar amounts in thousands)

  

December 31,

   

December 31,

 
   

2021

    

2020

  
                 

Stockholders' Equity (GAAP)

   $ 145,335     $ 143,810  

Less Goodwill and other intangibles

     16,474       16,795  

Tangible Common Equity (Non-GAAP)

   $ 128,861     $ 127,015  
                 

Shares outstanding

     5,888,737       6,379,323  

Tangible book value per share

   $ 21.88     $ 19.91  

 

44
 

 

Reconciliation of Average Equity to Return on Average Tangible Common Equity

  

For the Twelve Months Ended

  
   

December 31,

   

December 31,

 
   

2021

    

2020

  
                 

Average Stockholders' Equity

   $ 146,237     $ 142,241  

Less Average Goodwill and other intangibles

     16,634       16,960  

Average Tangible Common Equity

   $ 129,603     $ 125,281  
                 

Net income

   $ 18,633       8,349  

Return on average tangible common equity (annualized)

     14.38 %     6.66 %

 

Reconciliation of Pre-Tax Pre-Provision Income (PTPP)  

For the Twelve Months Ended

  
   

December 31,

   

December 31,

 
   

2021

    

2020

  
                 

Net income (GAAP)

   $ 18,633     $ 8,349  

Add Income Taxes

     4,065       1,401  

Add Provision for loan losses

     700       9,840  

PTPP (Non-GAAP)

   $ 23,398     $ 19,590  

 

Critical Accounting Policies

 

Allowance for loan and lease losses. Arriving at an appropriate level of allowance for loan and lease losses involves a high degree of judgment. The Company’s allowance for loan and lease losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio.

 

Management uses historical information to assess the adequacy of the allowance for loan and lease losses as well as the prevailing business environment, which is affected by changing economic conditions and various external factors and which may impact the portfolio in ways currently unforeseen. The allowance is increased by provisions for loan losses and recoveries of loans previously charged off and reduced by loans charged off. For a complete discussion of the Company’s methodology of assessing the adequacy of the reserve for loan losses, refer to Note 1 of “Notes to Consolidated Financial Statements” of this Annual Report.

 

Valuation of Securities. Investment securities are classified as held to maturity or available for sale on the date of purchase. Only those securities classified as held to maturity are reported at amortized cost. Available-for-sale securities are reported at fair value with unrealized gains and losses included in accumulated other comprehensive income, net of related deferred income taxes, on the Consolidated Balance Sheet. The majority of the Company’s securities are valued based on prices compiled by third-party vendors using observable market data. However, particular securities are less actively traded and do not always have quoted market prices. The determination of fair value for less actively traded securities, therefore, requires judgment, with such determination requiring benchmarking to similar instruments or analyzing default and recovery rates. Examples include certain collateralized mortgage and debt obligations and high-yield debt securities. Realized securities gains or losses are reported within noninterest income in the Consolidated Statement of Income. The cost of securities sold is based on the specific identification method.

 

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least quarterly and more frequently when economic or market conditions warrant such an evaluation. Investments in debt securities are generally evaluated for OTTI under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320, Investments — Debt and Equity Securities. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by macroeconomic conditions, and whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies or U.S. government-sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

 

45
 

 

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security, or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income or loss. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.

 

Debt securities issued by U.S. government agencies, U.S. government-sponsored enterprises, and state and political subdivisions accounted for 80.9% of the total available-for-sale portfolio as of December 31, 2021, and no credit losses are expected, given the explicit and implicit guarantees provided by the U.S. federal government and the lack of significant unrealized loss positions within the obligations of state and political subdivisions security portfolio. The Company considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

 

 

●

The length of time and the extent to which the fair value has been less than the amortized cost basis.
 

●

Changes in the near-term prospects of the underlying collateral of a security such as changes in default rates, loss severity given default and significant changes in prepayment assumptions.
 

●

The level of cash flows generated from the underlying collateral supporting the principal and interest payments of the debt securities; and,
 

●

Any adverse change to the credit conditions and liquidity of the issuer, taking into consideration the latest information available about the overall financial condition of the issuer, credit ratings, recent legislation and government actions affecting the issuer’s industry and actions taken by the issuer to deal with the present economic climate.

 

Refer to Note 4 in the consolidated financial statements.

 

Income Taxes

 

The Company estimates income tax expense based on amounts expected to be owed to the various tax jurisdictions in which the Company conducts business. Quarterly, management assesses the reasonableness of the Company’s effective tax rate based upon management’s current estimate of the amount and components of net income, tax credits, and the applicable statutory tax rates expected for the entire year. The estimated income tax expense is recorded in the Consolidated Statement of Income.

 

Deferred income tax assets and liabilities are determined using the balance sheet method and are reported in accrued taxes, interest, and expenses in the Consolidated Balance Sheet. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax basis of assets and liabilities and recognizes enacted changes in tax rates and laws. Deferred tax assets are recognized to the extent they exist and are subject to a valuation allowance based on management’s judgment that realization is more likely than not.

 

Accrued taxes represent the net estimated amount due to taxing jurisdictions and are reported in accrued taxes, interest, and expenses in the Consolidated Balance Sheet. The Company evaluates and assesses the relative risks and appropriate tax treatment of transactions and filing positions after considering statutes, regulations, judicial precedent, and other information and maintains tax accruals consistent with management’s evaluation of these relative risks and merits. Changes to the estimate of accrued taxes occur periodically due to changes in tax rates, interpretations of tax laws, the status of examinations being conducted by taxing authorities, and changes to statutory, judicial and regulatory guidance that impact the relative risks of tax positions. When they occur, these changes can affect deferred taxes and accrued taxes as well as the current period’s income tax expense and can be significant to the Company's operating results.

 

Goodwill and Other Intangible Assets

 

Goodwill is the excess of the purchase price over the fair value of the assets acquired in connection with business acquisitions accounted for as purchases. Other intangible assets consist of branch acquisition core deposit premiums. Initially, an assessment of qualitative factors is performed to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after assessing the totality of events or circumstances, we determine it is not more likely than not that the fair value of a reporting unit is less than its carrying value, then performing the two-step impairment test is unnecessary.  However, if we conclude otherwise, we are required to perform the impairment test by calculating the fair value of the reporting unit and comparing it against the reporting unit's carrying amount.  If the fair value is less than the carrying value, an expense may be required to write down the goodwill to the proper carrying value. 

 

Changes in Financial Condition

 

General The Company’s total assets decreased $61.0 million or 4.4% to $1.33 billion on December 31, 2021, from $1.39 billion on December 31, 2020. For the same period, net loans decreased $123.3 million, offset by an increase of $56.0 million in investments and a $7.1 million increase in cash and equivalents. Total liabilities decreased $62.5 million or 5.0%, while stockholders’ equity increased $1.5 million, or 1.1%.

 

46
 

 

Cash and cash equivalents Cash and due from banks and federal funds sold represent cash and cash equivalents, which increased $7.1 million or 6.3% to $119.5 million on December 31, 2021, from $112.4 million on December 31, 2020. Deposits from customers into savings and checking accounts, loan and security repayments, and proceeds from borrowed funds typically increase these accounts. Decreases result from customer withdrawals, new loan originations, security purchases, and repayments of borrowed funds. Cash remains elevated and can be traced to pandemic-related government stimulus. This resulted in increased deposits, as retail and commercial customers keep excess funds in liquid deposit accounts. The increase in cash and cash equivalents since December 31, 2020, is due to the forgiveness of PPP loans, partially offset by a decrease in deposits.

 

Investment securities Management's objective in structuring the portfolio is to maintain a prudent level of liquidity while providing an acceptable rate of return without sacrificing asset quality. The balance of available-for-sale investment securities increased $55.8 million, or 48.8%, compared to 2020. Securities purchased were $68.9 million, and there were no sales of securities for the twelve months ended December 31, 2021.

 

The municipal bond portfolio, which totaled $127.3 million or 74.8% of the Company's total investment portfolio on December 31, 2021, increased $49.0 million due to security purchases in 2021. Periodically, management reviews the entire municipal bond portfolio to assess credit quality. Each security held in this portfolio is evaluated on attributes that have historically influenced default incidences in the municipal market, such as sector, security, impairment filing, timeliness of disclosure, external credit assessment(s), credit spread, state, vintage, and underwriter. These investments have historically proven to have extremely low credit risk.

 

On December 31, 2021, the Company held $32.5 million of subordinated debt in other banks compared to $21.3 million on December 31, 2020. The average yield on this portfolio was 4.79% on December 31, 2021, as compared to 5.19% on December 31, 2020

 

Loans receivable The loans receivable category consists primarily of single-family mortgage loans used to purchase or refinance personal residences located within the Company’s market area, commercial and industrial loans, home equity lines of credit, and commercial real estate loans used to finance properties that are used in the borrowers’ businesses, or to finance investor-owned rental properties, and, to a lesser extent, construction and consumer loans. The portfolio is well dispersed geographically. Net loans decreased $123.3 million or 11.3% to $967.3 million on December 31, 2021, from $1.09 billion on December 31, 2020. The following table summarizes fluctuation within the primary segments of the loan portfolio (dollars in thousands):

 

   

2021

    

2020

    

$ change

    

% change

  
                                 

Commercial real estate:

                                

Owner occupied

   $ 111,470     $ 103,121       8,349       8.1 %

Non-owner occupied

     283,618       309,424       (25,806 )     -8.3 %

Multifamily

     31,189       39,562       (8,373 )     -21.2 %

Residential real estate

     240,089       233,995       6,094       2.6 %

Commercial and industrial

     148,812       232,044       (83,232 )     -35.9 %

Home equity lines of credit

     104,355       112,543       (8,188 )     -7.3 %

Construction and other

     54,148       63,573       (9,425 )     -14.8 %

Consumer installment

     8,010       9,823       (1,813 )     -18.5 %

Total loans

     981,691       1,104,085       (122,394 )     -11.1 %

Less: Allowance for loan and lease losses

     (14,342 )     (13,459 )     (883 )     6.6 %
                                 

Net loans

   $ 967,349     $ 1,090,626       (123,277 )     -11.3 %

 

The decrease in net loans is a result of PPP loan forgiveness. The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law on March 27, 2020. As a qualified SBA lender, we were automatically authorized to originate PPP loans. As of December 31, 2021, we approved 2,097 applications for up to $212.6 million of loans under the PPP. In addition, on December 31, 2021, we processed $178.4 million of PPP loan forgiveness. Throughout 2021, Middlefield has helped customers receive $149.6 million of forgiveness payments under the terms of the program.

 

The product mix in the loan portfolio consists of CRE non-owner occupied loans equaling 28.9% of total loans, residential real estate loans 24.5%, commercial and industrial loans 15.2%, HELOC loans 10.6%, CRE owner-occupied loans 11.3%, construction and other loans 5.5%, CRE multifamily loans 3.2%, and consumer installment loans 0.8%, at December 31, 2021 compared with 28.0%, 21.2%, 21.0%, 10.2%, 9.3%, 5.8%, 3.6%, and 0.1%, respectively, at December 31, 2020.

 

47
 

 

Loans contributed to 91.5% of total interest income in 2021 and 93.1% in 2020. The loan portfolio yield of 4.56% in 2021 was 45 basis points higher than the average yield for total interest-earning assets. Management recognizes that while the loan portfolio holds some of the Company’s highest-yielding assets, it is inherently the riskiest portfolio. Accordingly, management balances credit risk versus return with conservative credit standards. Management has developed and maintains comprehensive underwriting guidelines and a loan review function that monitors credits during and after approval. Management follows additional procedures to obtain current borrower financial information annually throughout the life of the loan obligation.

 

To minimize risks associated with changes in the borrower’s future repayment capacity, the Company generally requires scheduled periodic principal and interest payments on all types of loans and normally requires collateral.

 

The Company expects loan growth to be minimal but will not lower the conservative credit standards to increase loan originations in a slowing economy. The Company remains committed to sound underwriting practices without sacrificing asset quality and avoiding exposure to unnecessary risk that could weaken the portfolio.

 

Since the opening of the PPP, several larger banks have been subject to litigation regarding the process and procedures used in processing applications for the PPP. Middlefield Bank may be exposed to the risk of similar litigation from customers and non-customers that approached the bank regarding PPP loans, regarding the process and procedures used in processing applications for the PPP. If any such litigation is filed against Middlefield Bank and is not resolved in a manner favorable to Middlefield Bank, it may result in significant financial liability or adversely affect Middlefield Bank’s reputation. In addition, litigation can be costly, regardless of the 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.

 

Middlefield 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 Middlefield 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 Middlefield Bank, 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 Middlefield Bank.

 

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. According to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions that have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions that are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management concerning their commercial real estate portfolios and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced growth in its commercial real estate portfolio in recent years. On December 31, 2021, non-owner-occupied commercial real estate loans (including construction, land, and land development loans) represented 255.5% of total risk-based capital. Construction, land, and land development loans represent 36.1% of total risk-based capital. Management has extensive experience in commercial real estate lending and has implemented and continues to maintain heightened risk management procedures and robust underwriting criteria for its commercial real estate portfolio. Loan monitoring practices include but are not limited to periodic stress testing analysis to evaluate changes to cash flows owing to interest rate increases and declines in net operating income.

 

Nevertheless, we may be required to maintain higher levels of capital due to our commercial real estate concentrations, which could require us to obtain additional capital, and may adversely affect shareholder returns. The Company has a comprehensive capital planning policy, including pro forma projections and stress testing. The Board of Directors has established internal minimum targets for regulatory capital ratios that are more than well-capitalized ratios.

 

Other real estate owned (“OREO”). OREO decreased $395,000 from December 31, 2020, to $7.0 million as of December 31, 2021.

 

Restricted stock. The Company’s investment in FHLB’s restricted stock decreased $658,000, or 13.0%, to $4.4 million as of December 31, 2021, compared to $5.1 million as of December 31, 2020.

 

Premises and equipment, net. The Company’s investment in premises and equipment, net, decreased $1.1 million, or 5.8%, to $17.3 million as of December 31, 2021, compared to $18.3 million as of December 31, 2020. This decrease is mainly due to the depreciation of previously capitalized assets.

 

48
 

 

Goodwill and other intangibles. The carrying value of goodwill was $15.1 million on December 31, 2021, and December 31, 2020. During 2020, the Company considered the negative economic impact resulting from the COVID-19 shutdowns to be a triggering event necessitating a mid-cycle analysis for impairment. The Company performed a quantitative analysis of goodwill on March 31, 2020, using multiple approaches. The primary methodology was the discounted cash flow approach while also considering a market approach of comparing to multiples of similar public companies as well as market price with control premiums. The results from each primary method showed the reporting unit's valuation above carrying value on March 31, 2020. A weighted average of the methodologies resulted in a fair value approximately 18% higher than its carrying value.

 

Each of the valuation methods used by the Company requires significant assumptions. Depending on the specific method, assumptions are made regarding growth rates, discount rates for cash flows, control premiums, and selected multiples. Changes to any of the assumptions could result in significantly different results. Based on the analysis performed as of March 31, 2020, the Company determined that goodwill was not impaired.

 

The company also completed a qualitative assessment of goodwill as of September 30, 2021, and 2020 with no resulting goodwill impairment. There have been no triggering events since the goodwill analysis as of September 30, 2021, and therefore, management has determined there is no goodwill impairment as of December 31, 2021.

 

The Company also monitors the ongoing value of core deposit intangibles and mortgage servicing rights (“MSR”). As of December 31, 2021, the Company recorded a decrease in core deposit intangibles of $321,000 to $1.4 million, while MSR increased $66,000 to $542,000.

 

Bank-owned life insurance. BOLI increased by $122,000 to $17.1 million as of December 31, 2021, from $16.9 million at the end of 2020 due to increases in cash surrender value.

 

Deposits. Interest-earning assets are funded generally by both interest-bearing and noninterest-bearing core deposits. Deposits are influenced by changes in interest rates, economic conditions, and competition from other banks. The Company considers various sources when evaluating funding needs, including but not limited to deposits, which represented 98.9% of the Company’s total funding sources on December 31, 2021. The deposit base consists of demand deposits, savings, money market accounts, and time deposits. Total deposits decreased $58.6 million to $1.17 billion on December 31, 2021, from $1.23 billion on December 31, 2020. The following table summarizes fluctuation within the primary segments of the deposit portfolio (in thousands):

 

   

December 31,

   December 31,    

 

                  
   

2021

  

2020

    

$ change

    

% change

  
                                 

Noninterest-bearing demand

   $ 334,171     $ 291,347     $ 42,824       14.7 %

Interest-bearing demand

     196,308       195,722       586       0.3 %

Money market

     177,281       198,493       (21,212 )     -10.7 %

Savings

     260,125       243,888       16,237       6.7 %

Time

     198,725       295,750       (97,025 )     -32.8 %

Total deposits

   $ 1,166,610     $ 1,225,200     $ (58,590 )     -4.8 %

 

Savings, money market deposit and NOW accounts have been stable sources of funds, making up a combined 54.3% of total deposits as of December 31, 2021. Due to the current low-interest-rate environment, the company has experienced an outflow of maturing time deposits to other products. The Company uses specific non-core funding instruments to grow the balance sheet and maintain liquidity. These deposits, either from a broker or a listing service, were $15.1 million on December 31, 2021, compared to $66.9 million on December 31, 2020.

 

Borrowed funds. The Company uses short-term and long-term borrowings as another funding source for asset growth and liquidity needs. These borrowings primarily include advances from the Federal Home Loan Bank of Cincinnati (the “FHLB”), subordinated debt, short-term borrowings from other banks, and federal funds purchased. Other borrowings decreased $4.1 million, or 24.3%, to $12.9 million as of December 31, 2021, from $17.0 million as of December 31, 2020.

 

In July 2017, the United Kingdom FCA, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calculation of LIBOR to the administrator of LIBOR after 2021. Subsequently, in November 2020, the FCA proposed end dates immediately following the December 31, 2021 publication for the one-week and two-month LIBOR settings, and the June 30, 2023 publication for other LIBOR tenors. These announcements indicate that the continuation of LIBOR on the current basis cannot and will not be guaranteed after December 31, 2021 or June 30, 2023, as applicable. The Company formed a special purpose entity to issue $8.0 million of floating rate mandatorily redeemable trust preferred securities (“TruPS”). The rate on the TruPS adjusts quarterly, equal to LIBOR plus 1.67%. The cessation of LIBOR quotes in 2021 and the uncertainty over possible replacement rates for LIBOR will affect our TruPS. The Company expects a consensus as to what rate or rates may become accepted alternatives to LIBOR in 2022.

 

49
 

 

Stockholders’ equity. The Company maintains a capital level that exceeds regulatory requirements as a margin of safety for its depositors and shareholders. All of the capital ratios exceeded the regulatory well-capitalized guidelines. Stockholders’ equity increased $1.5 million, or 1.1%, to $145.3 million on December 31, 2021, from $143.8 million on December 31, 2020. This increase was primarily the result of an increase in retained earnings of $14.4 million, net of an increase in treasury stock of $12.3 million and a decrease in AOCI of $822,000. The change in retained earnings is due to the year-to-date net income offset by dividends paid, the change in treasury stock is due to the Company repurchasing 512,449 of its outstanding shares during the twelve months ended December 31, 2021, and the change in AOCI is due to fair value adjustments of available-for-sale securities.

 

Average Balance Sheet and Yield/Rate Analysis. The following table sets forth, for the periods indicated, information concerning the total dollar amounts of interest income from interest-earning assets and the resultant average yields, the total dollar amounts of interest expense on interest-bearing liabilities and the consequent average costs, net interest income, interest rate spread and the net interest margin earned on average interest-earning assets. For purposes of this table, average balances are calculated using monthly averages, and the average loan balances include nonaccrual loans and exclude the allowance for loan and lease losses, and interest income includes accretion of net deferred loan fees. Yields on tax-exempt securities and loans (tax-exempt for federal income tax purposes) are shown on a fully tax-equivalent basis utilizing a federal tax rate of 21% for the years ended December 31, 2021, 2020, and 2019. Yields and rates have been calculated on an annualized basis utilizing monthly interest amounts.

 

   

For the Twelve Months Ended December 31,

  
   

2021

    

2020

    

2019

  
                                                                         
   

Average

            

Average

    

Average

            

Average

    

Average

            

Average

  

(Dollar amounts in thousands)

  

Balance

    

Interest

    

Yield/Cost

    

Balance

    

Interest

    

Yield/Cost

    

Balance

    

Interest

    

Yield/Cost

  
                                                                         

Interest-earning assets:

                                                                        

Loans receivable (3)

   $ 1,052,351     $ 47,896       4.56 %   $ 1,079,788     $ 49,003       4.55 %   $ 997,744     $ 50,390       5.06 %

Investment securities (3)

     142,705       4,244       3.45 %     109,863       3,381       3.68 %     101,381       3,188       3.77 %

Interest-earning deposits with other banks (4)

     97,417       195       0.20 %     56,222       254       0.45 %     44,943       947       2.11 %

Total interest-earning assets

     1,292,473       52,335       4.11 %     1,245,873       52,638       4.28 %     1,144,068       54,525       4.83 %

Noninterest-earning assets

     78,802                       68,219                       61,596                  

Total assets

   $ 1,371,275                     $ 1,314,092                     $ 1,205,664                  

Interest-bearing liabilities:

                                                                        

Interest-bearing demand deposits

   $ 212,063       274       0.13 %   $ 144,897       445       0.31 %   $ 102,550       374       0.36 %

Money market deposits

     186,009       869       0.47 %     172,587       1,501       0.87 %     167,187       2,438       1.46 %

Savings deposits

     255,267       162       0.06 %     211,151       510       0.24 %     199,515       1,399       0.70 %

Certificates of deposit

     231,662       2,608       1.13 %     347,609       6,506       1.87 %     369,006       8,198       2.22 %

Short-term borrowings

     85       -       0.00 %     22,637       79       0.35 %     14,808       368       2.49 %

Other borrowings

     13,313       152       1.14 %     15,629       209       1.34 %     12,986       363       2.80 %

Total interest-bearing liabilities

     898,399       4,065       0.45 %     914,510       9,250       1.01 %     866,052       13,140       1.52 %

Noninterest-bearing liabilities:

                                                                        

Noninterest-bearing demand deposits

     320,104                       252,615                       199,672                  

Other liabilities

     6,535                       4,726                       4,040                  

Stockholders' equity

     146,237                       142,241                       135,900                  

Total liabilities and stockholders' equity

   $ 1,371,275                     $ 1,314,092                     $ 1,205,664                  

Net interest income

           $ 48,270                     $ 43,388                     $ 41,385          

Interest rate spread (1)

                     3.66 %                     3.27 %                     3.31 %

Net interest margin (2)

                     3.79 %                     3.54 %                     3.68 %

Ratio of average interest-earning assets to average interest-bearing liabilities

                     143.86 %                     136.23 %                     132.10 %

 

(1)

Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(2) 

Net interest margin represents net interest income as a percentage of average interest-earning assets.
(3)

Tax-equivalent adjustments to calculate the yield on tax-exempt securities and loans were $752, $742, and $720, for 2021, 2020, and 2019, respectively.
(4)

Includes dividends received on restricted stock.

 

50
 

 

Interest Rates and Interest Differential

 

   

2021 versus 2020

    

2020 versus 2019

  
                                                 
   

Increase (decrease) due to

    

Increase (decrease) due to

  

(Dollars in thousands)

  

Volume

    

Rate

    

Total

    

Volume

    

Rate

    

Total

  
                                                 

Interest-earning assets:

                                                

Loans receivable

   $ (1,247 )   $ 140     $ (1,107 )   $ 4,154     $ (5,541 )   $ (1,387 )

Investment securities

     1,207       (344 )     863       320       (127 )     193  

Interest-bearing deposits with other banks

     186       (245 )     (59 )     238       (931 )     (693 )

Total interest-earning assets

     146       (449 )     (303 )     4,712       (6,599 )     (1,887 )
                                                 
                                                 

Interest-bearing liabilities:

                                                

Interest-bearing demand deposits

     206       (377 )     (171 )     152       (81 )     71  

Money market deposits

     117       (749 )     (632 )     79       (1,016 )     (937 )

Savings deposits

     107       (455 )     (348 )     82       (971 )     (889 )

Certificates of deposit

     (2,170 )     (1,728 )     (3,898 )     (475 )     (1,217 )     (1,692 )

Short-term borrowings

     (79 )     -       (79 )     195       (484 )     (289 )

Other borrowings

     (31 )     (26 )     (57 )     74       (228 )     (154 )

Total interest-bearing liabilities

     (1,850 )     (3,335 )     (5,185 )     107       (3,997 )     (3,890 )
                                                 
                                                 

Net interest income

   $ 1,996     $ 2,886     $ 4,882     $ 4,605     $ (2,602 )   $ 2,003  

 

The ratio of net income to average shareholders’ equity and average total assets and certain other ratios are as follows for periods ended December 31:

 

(Dollars in thousands)

  

2021

    

2020

    

2019

  
                         

Average total assets

   $ 1,371,275     $ 1,314,092     $ 1,205,664  
                         

Average shareholders' equity

   $ 146,237     $ 142,241     $ 135,900  
                         

Net income

   $ 18,633     $ 8,349     $ 12,711  
                         

Cash dividends declared per share

   $ 0.69     $ 0.60     $ 0.57  
                         

Return on average total assets

     1.36 %     0.64 %     1.05 %
                         

Return on average shareholders' equity

     12.74 %     5.87 %     9.35 %
                         

Dividend payout ratio (1)

     22.76 %     45.92 %     28.99 %
                         

Average shareholders' equity to average assets

     10.66 %     10.82 %     11.27 %

 

(1) Cash dividends declared on common shares divided by net income

 

51
 

 

Allowance for Loan and Lease Losses. The allowance for loan and lease losses (“ALLL”) represents the amount management estimates to be adequate to provide for probable losses inherent in the loan portfolio as of the balance sheet date. Accordingly, all loan losses are charged to the allowance, and all recoveries are credited to it. The ALLL is established through a provision for loan losses charged to operations. The provision is based on management's periodic evaluation of the adequacy of the ALLL, taking into account the overall risk characteristics of the various portfolio segments, the Company's loan loss experience, the impact of economic conditions on borrowers, and other relevant factors. The estimates used to determine the adequacy of the ALLL, including the amounts and timing of future cash flows expected on impaired loans, are particularly susceptible to significant changes in the near term. The total ALLL combines a specific allowance for identified problem loans and a general allowance for homogeneous loan pools.

 

The allowance for loan and lease loss balance as of December 31, 2021, totaled $14.3 million, representing an $883,000 increase from the end of 2020. For 2021, the provision for loan losses was $700,000, which represented a decrease of $9.1 million from the $9.8 million provided during 2020. During 2021, net charge-offs decreased by $3.3 million to $183,000 in net recoveries compared to $3.1 million in net charge-offs in 2020. While the prior period provision was mostly attributable to the pandemic, the lack of provision for this year was impacted by credit quality and loan balance decreases.

 

The specific allowance incorporates the results of measuring impaired loans. The allowance formula is calculated by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined. Loss factors are based on management's determination of the amounts necessary for concentrations and changes in mix and volume of the loan portfolio, and consideration of historical loss experience.

 

The non-specific allowance is determined based upon management's evaluation of existing economic and business conditions affecting the key lending areas of the Company and other conditions, such as new loan products, credit quality trends, collateral values, unique industry conditions within portfolio segments that existed as of the balance sheet date, and the impact of those conditions on the collectability of the loan portfolio. Management reviews these conditions quarterly. The non-specific allowance is subject to a higher degree of uncertainty because it considers risk factors that may not be reflected in the historical loss factors.

 

Although management uses the best information available to determine the adequacy of the ALLL on December 31, 2021, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions, and reductions in income. See Notes 5 for discussions on the impact the COVID-19 pandemic has had on the bank’s ALLL assessment. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review a bank’s ALLL. The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

 

The following table sets forth information concerning the Company's credit ratios for the periods presented:

 

   

For the Years Ended

  
   

December 31,

  

(Dollars in Thousands)

  

2021

    

2020

  

Ratio of allowance for loan and lease losses to loans

     1.46 %     1.22 %

outstanding at end of period

                

Net charge-offs to average loans

     -0.02 %     0.29 %

Nonperforming loans/total loans

     0.49 %     0.71 %

Allowance for loan losses/nonperforming loans

     295.16 %     171.28 %

 

52
 

 

The following table illustrates the net charge-offs to average loans ratio for each loan category for each reported period:

 

   

At December 31,

  
   

2021

     2020  
   

Average Loan Balance

    

Net charge-offs

    

Net charge-offs to average loans

    

Average Loan Balance

    

Net charge-offs

    

Net charge-offs to average loans

  

(Dollars in Thousands)

                                                

Type of Loans:

                                                

Commercial real estate:

                                                

Owner occupied

   $ 108,269     $ 45       0.04

%

   $ 106,258     $ (33 )     -0.03

%

Non-owner occupied

     299,212       (175 )     -0.06       316,233       (2,948 )     -0.93  

Multifamily

     35,696       -       0.00       52,528       -       0.00  

Residential real estate

     239,193       -       0.00       242,392       (20 )     -0.01  

Commercial and industrial

     192,156       193       0.10       166,270       49       0.03  

Home equity lines of credit

     109,433       56               116,229       29       0.02  

Construction and other

     59,395       46       0.08       67,348       157       0.23  

Consumer installment

     8,997       18       0.20       12,530       (383 )     -3.06  
                                                 

Total

   $ 1,052,351       183       0.02     $ 1,079,788       (3,149 )     -0.29  

 

Refer to Note 5 in the consolidated financial statements.

 

The following table illustrates the allocation of the Company's allowance for loan losses for each loan category for each reported period. The allowance allocation to each category is not necessarily indicative of a future loss in a particular category. It does not restrict our use of the allowance to absorb losses in other loan categories.

 

   

At December 31,

  
   

2021

    

2020

  
           

Percent of

            

Percent of

  
           

Loans in Each

            

Loans in Each

  
           

Category to

            

Category to

  
   

Amount

    

Total Loans

    

Amount

    

Total Loans

  

(Dollars in Thousands)

                                
                                 

Type of Loans:

                                

Commercial real estate:

                                

Owner occupied

   $ 1,836       11.35

% $

     1,342       9.34  

Non-owner occupied

     7,431       28.89       6,817       28.03  

Multifamily

     454       3.18       461       3.58  

Residential real estate

     1,740       24.46       1,683       21.19  

Commercial and industrial

     882       15.16       1,353       21.02  

Home equity lines of credit

     1,452       10.63       1,405       10.19  

Construction and other

     533       5.52       378       5.76  

Consumer installment

     14       0.82       20       0.89  
                                 

Total

   $ 14,342       100.0

% $

     13,459       100.0  

 

Nonperforming assets. Nonperforming assets include nonaccrual loans, loans 90 days or more past due, OREO, and repossessed assets. Real estate owned is written down to fair value at its initial recording and continually monitored for changes in fair value. A loan is classified as nonaccrual when, in the opinion of management, there are serious doubts about the collectability of interest and principal. Accrual of interest is discontinued on a loan when management believes that the borrower’s financial condition is such that collection of principal and interest is doubtful after considering economic and business conditions. Payments received on nonaccrual loans are applied against principal until doubt about collectability ceases.

 

53
 

 

Nonperforming loans exclude TDRs that perform according to their terms over a prescribed period. TDRs are those loans which the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to the borrower that the Company would not otherwise consider. The Company has 24 TDRs accruing interest with a balance of $1.7 million as of December 31, 2021, compared to 25 TDRs with a balance of $2.6 million as of December 31, 2020. Nonperforming loans amounted to $4.9 million or 0.49% of total loans and $7.9 million or 0.71% of total loans on December 31, 2021, and December 31, 2020, respectively.

 

A significant factor in determining the appropriateness of the ALLL is the type of collateral that secures the loans. Although this does not insure against all losses, real estate collateral provides substantial recovery, even in a distressed-sale and declining-value environment. The Bank’s objective is to work with the borrower to minimize the debt service burden and reduce the future loss exposure to the Company.

 

Accrual of interest is discontinued on a loan when management believes that the borrower's financial condition is such that collection of interest is doubtful after considering economic and business conditions. Payments received on nonaccrual loans are applied against principal according to management's assessment of collectability.

 

A loan is considered impaired when it is probable the borrower will not repay the loan according to the original contractual terms of the loan agreement, including all troubled debt restructurings. Management has determined that first mortgage loans on one-to-four family properties and all consumer loans represent large groups of smaller-balance, homogeneous loans to be collectively evaluated. Loans that experience insignificant payment delays, defined as 90 days or less, are generally not classified as impaired. A loan is not impaired during a period of delay in payment if the Company expects to collect all amounts due, including interest accrued at the contractual interest rate for the period of delay. Management evaluates all loans identified as impaired individually. The Company estimates credit losses on impaired loans based on the present value of expected cash flows or the fair value of the underlying collateral if loan repayment is expected to come from the sale or operation of the collateral. Impaired loans, or portions thereof, are charged off when it is determined a realized loss has occurred. An allowance for loan and lease loss is maintained for estimated losses until that time.

 

Interest income that would have been recorded had these loans not been placed on nonaccrual status was $204,000 in 2021 and $126,000 in 2020. Management is not aware of any trends or uncertainties related to any loans classified as doubtful or substandard that might have a material effect on earnings, liquidity, or capital resources.

 

Changes in Results of Operations

 

2021 Results Compared to 2020 Results

 

General The Company posted net income of $18.6 million, compared to $8.3 million for the year ended December 31, 2020. On a per-share basis, 2021 earnings were $3.00 per diluted share, representing an increase from the $1.30 per diluted share for the year ended December 31, 2020. The return on average equity for the year ended December 31, 2021, was 12.74%, and the Company’s return on average assets was 1.36%, compared to 5.87% and 0.64%, respectively, for the year ended December 31, 2020.

 

Net interest income Net interest income, the Company’s largest revenue source, is the difference between interest income on earning assets and interest expense paid on liabilities. Net interest income is affected by the changes in interest rates and the composition of interest-earning assets and interest-bearing liabilities. Net interest income increased by $4.9 million in 2021 to $48.3 million compared to $43.4 million for 2020. This increase results from a $5.2 million decrease in interest expense, partially offset by a $303,000 decrease in interest and dividend income. Interest-earning assets averaged $1.29 billion during 2021, a year-over-year increase of $46.6 million from $1.25 billion for 2020. The Company’s average interest-bearing liabilities decreased from $914.5 million in 2020 to $898.4 million in 2021.

 

A key performance indicator, net interest margin, is net interest income as a percentage of total interest-earning assets. For 2021 the net interest margin, measured on a fully taxable-equivalent basis, increased to 3.79%, compared to 3.54% in 2020. The improvement in the net interest margin is attributable to a 56 basis point decrease in the cost of interest-bearing liabilities partially offset by a reduction of 17 basis points in the yield earned on total interest-earning assets for the year ended December 31, 2021.

 

The Company’s net interest margin is subject to fluctuation due to PPP loan forgiveness. As the Company is in an asset-sensitive position, reductions in market interest rates harm margin as the Company’s interest-earning assets reprice faster than its interest-bearing liabilities. Much of our asset sensitivity is due to commercial loans with variable interest rates. Both loan types have floor rates. The benefit of these floors is more evident if the Federal Reserve maintains short-term interest rates at current levels

 

Interest and dividend income Interest and dividend income decreased $303,000 to $52.3 million for 2021, attributable to a $1.1 million decrease in interest and fees on loans, partially offset by a $863,000 increase on investment securities. The decrease in the interest earned on loans resulted from the decrease in the average balance of loans receivable. The average balance of loans receivable decreased by $27.4 million or 2.54% to $1.05 billion for the year ended December 31, 2021, compared to $1.08 billion for the year ended December 31, 2020, which resulted in a $1.2 million decrease to interest income. The loans receivable yield increased to 4.56% for 2021, from 4.55% in 2020, which resulted in a $142,000 increase in interest income.

 

54
 

 

Interest on investment securities increased $863,000 to $4.2 million for 2021, compared to $3.4 million for 2020. The average balance of investment securities increased $32.8 million to $142.7 million for the year ended December 31, 2021, compared to $109.9 million for the year ended December 31, 2020. The investment securities yield decreased 23 basis points to 3.45% for 2021, compared to 3.68% for 2020.

 

Interest expense Interest expense decreased $5.2 million or 56.1% to $4.1 million for 2021, compared with $9.3 million for 2020. This decrease is attributable to a reduction in the average balance of certificates of deposits of $115.9 million, or 33.4%. This decrease is further attributable to the decline in the cost paid on certificates of deposit and money market deposits. The cost of these deposits decreased by 74 and 40 basis points, respectively. The changes in costs were due to declining interest rates on deposit products in response to the unprecedented reduction in the targeted federal funds interest rate and other continuing effects of the COVID-19 pandemic.

 

Provision for loan losses The provision for loan losses is an operating expense recorded to maintain the related balance sheet allowance for loan and lease losses at an amount considered adequate to cover probable losses incurred in the ordinary course of lending. The provision for loan losses for the year ended December 31, 2021, was $700,000, compared to $9.8 million in 2020. The loan loss provision is based upon management's assessment of various factors, including types and amounts of nonperforming loans, historical loss experience, collectability of collateral values and guaranties, pending legal action for collection of loans and related guaranties, and current economic conditions. The loan loss provision reflects management's judgment of the current period cost-of-credit risk inherent in the loan portfolio. Although management believes the loan loss provision has been sufficient to maintain an adequate allowance for loan and lease losses, actual loan losses could exceed the amounts that have been charged to operations. While the prior period provision was primarily attributable to the pandemic, the provision for this period was impacted by credit quality and low loan growth.

 

The ratio of nonperforming loans to total loans was 0.49% on December 31, 2021, decreasing from 0.71% on December 31, 2020. The ratio of the allowance for loan and lease losses to total loans increased to 1.46% of total loans on December 31, 2021, compared to 1.22% on December 31, 2020. The Company remains confident in its conservative and disciplined approach to credit and risk management.

 

With the passage of the PPP, administered by the Small Business Administration (“SBA”), the Company has actively assisted its customers with applications for resources through the program. On December 31, 2021, the Company carried $34.1 million of PPP loans classified as C&I loans for reporting purposes. The U.S. government fully guarantees loans funded through the PPP program. This guarantee exists at the loans' inception and throughout the loans' lives and was not entered into separately and apart from the loans. ASC 326 requires credit enhancements that mitigate credit losses, such as the U.S. government guarantee on PPP loans, to be considered in estimating credit losses. The guarantee is considered “embedded” and, therefore, is considered when estimating credit loss on the PPP loans. Although the loans are fully guaranteed by the U.S. government and absent any specific loss information about any of our PPP loans, the Company does provide a $137,000 qualitative provision for loan losses on its PPP loans on December 31, 2021.

 

Noninterest income Noninterest income increased $1.2 million or 20.3% to $7.2 million for 2021 compared to $6.0 million for 2020. This increase resulted from service charges on deposits accounts, gains on equity securities, and earnings on bank-owned life insurance, which increased $886,000, $310,000, and $119,000, respectively. Service charges on deposit accounts increased partially due to cash management fees relating to cannabis-related deposit business. The increase in the gain on equity securities resulted from the improvement in the stock market year over, and the increase in earnings on bank-owned life insurance is due to a payout on a claim. These increases were offset by a decrease of $247,000 in gain on loan sales, resulting from the decline in demand for residential refinances.

 

Noninterest expense Operating expenses increased $2.3 million, or 7.7% to $32.1 million for 2021 compared to $29.8 million for 2020. The increase resulted from an increase in salaries and employee benefits, data processing costs, advertising expense, and gain on other real estate owned, which increased $1.3 million, $230,000, $187,000, and $183,000, respectively. The salary increase is primarily due to increased profit-sharing expense, restricted stock expense, and increased recognition of deferred PPP costs in the prior year. The change in gains on other real estate owned resulted from an aggregate loss in the previous year.

 

Provision for income taxes The provision for income taxes increased by $2.7 million, or 190.1%, to $4.1 million for 2021 from $1.4 million for 2020. The Company’s effective federal income tax rate in 2021 was 17.9% compared to 14.4% in 2020. The increase in the effective income tax rate year over year was a result of decreases in tax-exempt income.

 

Asset and Liability Management

 

The primary objective of the Company’s asset and liability management function is to maximize net interest income while maintaining an acceptable level of interest rate risk given the Company’s operating environment, capital and liquidity requirements, performance objectives, and overall business focus. The principal determinant of the exposure of the Company’s earnings to interest rate risk is the timing difference between the repricing or maturity of interest-earning assets and the re-pricing or maturity of its interest-bearing liabilities. The Company’s asset and liability management policies are designed to decrease interest rate sensitivity primarily by shortening the maturities of interest-earning assets while at the same time extending the maturities of interest-bearing liabilities. The Company's Board of Directors continues to believe in a strong asset/liability management process to insulate the Company from material and prolonged increases in interest rates.

 

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The Company’s Board of Directors has established an Asset and Liability Management Committee consisting of outside directors and senior management. This committee, which meets quarterly, generally monitors asset and liability management policies and strategies.

 

Liquidity and Capital Resources

 

Liquidity. Liquidity management involves monitoring the ability to meet the cash flow needs of bank customers, such as borrowings or deposit withdrawals and the Company’s financial commitments. The principal sources of liquidity are net income, loan payments, maturing and principal reductions on securities and sales of securities available for sale, federal funds sold, and cash and deposits with banks. Along with its liquid assets, the Company has additional sources of liquidity available to ensure adequate funds are available as needed. These include, but are not limited to, the purchase of federal funds, the ability to borrow funds under line of credit agreements with correspondent banks, a borrowing agreement with the Federal Home Loan Bank of Cincinnati, brokered deposits, and the adjustment of interest rates to obtain deposits. Management believes the Company has the capital adequacy, profitability, and reputation for meeting its customers' current and projected needs.

 

Liquidity is managed based on factors including core deposits as a percentage of total deposits, the degree of funding source diversification, the allocation and amount of deposits among deposit types, the short-term funding sources used to fund assets, the amount of non-deposit funding used to fund assets, the availability of unused funding sources, off-balance sheet obligations, the availability of assets readily converted to cash without undue loss, the amount of cash and liquid securities we hold, and the re-pricing characteristics and maturities of our assets when compared to the re-pricing characteristics of our liabilities and other factors.

 

The Company's liquid assets consist of cash and cash equivalents, including investments in very short-term investments (i.e., federal funds sold), equity securities, and investment securities classified as available for sale. The level of these assets is dependent on the Company's operating, investing, and financing activities during any given period. On December 31, 2021, cash and cash equivalents totaled $119.5 million or 9.0% of total assets, equity securities totaled $818,000 or 0.1% of total assets, and investment securities classified as available for sale totaled $170.2 million or 12.8% of total assets. Management believes that the company's liquidity needs are satisfied by the current balance of cash and cash equivalents, readily available access to traditional funding sources, FHLB advances, junior subordinated debt, brokered deposits, and the portion of the investment and loan portfolios that mature within one year. These sources of funds will enable the Company to meet cash obligations and off-balance sheet commitments as they come due.

 

Operating activities provided net cash of $15.4 million and $15.1 million for 2021 and 2020, respectively, generated principally from net income of $18.6 million and $8.3 million in these respective periods.

 

Investing activities provided net cash of $70.9 million, which consisted primarily of a decrease in loans of $127.3 million and investment repayments and maturities of $11.5 million. This was partially offset by investment purchases of $68.9 million. For the same period ended in 2020, investing activities used net cash of $135.3 million, which consisted primarily of an increase in loans of $127.9 million. Also included in this usage are investment purchases of $24.1 million. Partially offsetting the use are the proceeds from investment repayments and maturities of $18.2 million.

 

Financing activities consist of the solicitation and repayment of customer deposits, borrowings and repayments, and the payment of dividends. During 2021, net cash used by financing activities totaled $79.2 million, principally derived from a decrease in deposits of $58.6 million, and $12.3 million was a result of the repurchase of treasury shares. The Company repurchased 512,449 of its outstanding shares during the twelve months ended December 31, 2021. During 2020, net cash provided by financing activities totaled $197.5 million, principally derived from an increase in deposits of $204.4 million. Partially offsetting the proceeds are decreases in short-term borrowings, net, of $5.1 million and the payment of $3.8 million in cash dividends

 

Management monitors projected liquidity needs and determines the desired level based partly on the Company's commitment to making loans and management's assessment of the Company's ability to generate funds. As a result, the Company anticipates having sufficient liquidity to satisfy estimated short and long-term funding needs.

 

Capital Resources. The Company's primary source of capital is retained earnings. Historically, the Company has generated net retained income to support normal growth and expansion. Management has developed a capital planning policy to ensure regulatory compliance and capital adequacy for future expansion.

 

Registrant's Common Equity and Related Stockholder Matters

 

The Company had approximately 949 stockholders of record as of December 31, 2021. The Company’s common stock is traded and authorized for quotation on NASDAQ under the symbol “MBCN.” The Company currently expects consistency in the payout of future cash dividends.

 

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MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 5), or a combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis by management or employees in the normal course by management or employees in the normal course of performing their assigned functions.

 

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2021. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013). Based on this assessment, management believes that, as of December 31, 2021, the Company’s internal control over financial reporting was effective.

 

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm because section 989G of the Dodd Frank Act exempts smaller reporting companies from the requirement of an attestation by registered public accountants concerning internal controls over financial reporting.

 

 

/s/ Thomas G. Caldwell

By: Thomas G. Caldwell

President and Chief Executive Officer

(Principal Executive Officer)

 

Date: March 15, 2022

 

 

/s/ Donald L. Stacy

By: Donald L. Stacy

Treasurer

(Principal Financial & Accounting Officer)

 

Date: March 15, 2022

 

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