FIRST BANCORP /NC/ Management’s Discussion and Analysis of Consolidated Results of Operations and Financial Condition (form 10-Q)
Overview and Highlights at and for Three Months Ended
We earned net income of$36.6 million , or$1.03 diluted EPS, during the three months endedJune 30, 2022 compared to net income of$29.3 million , or$1.03 diluted EPS, for the three months endedJune 30, 2021 . OnOctober 15, 2021 we acquiredSelect Bancorp, Inc. ("Select") which was headquartered inDunn, North Carolina and which contributed total assets of$1.8 billion , total loans of$1.3 billion , and total deposits of$1.6 billion as of the acquisition date. As such, comparisons for the financial periods presented are impacted by our acquisition of Select.
The main drivers to the increase in net income are presented below. Refer also to additional discussion in the Results of Operations section following.
•Net interest income for the second quarter of 2022 was$78.3 million , a 33.2% increase from the$58.8 million recorded in the second quarter of 2021. The increase in net interest income from the prior year period was driven by higher earning assets related to both the Select acquisition and organic growth, offset somewhat by a reduction in net interest margin ("NIM"). •For the three months endedJune 30, 2022 , we did not record any provision for credit losses based primarily on updated economic forecasts, improving trends, and CECL model assumptions. •Noninterest income declined$4.1 million , or 19.2%, for the three months endedJune 30, 2022 from the prior year period primarily due to a$2.2 million decrease in gains on SBA loan sales, a$1.8 million decrease in mortgage banking income related to lower levels of activity, a$1.5 million decrease in SBA consulting fees due to lower PPP-related revenues, and a$1.3 million decrease in commissions on sales of financial and insurance products due to the sale of substantially all of the assets of our property and casualty insurance agency subsidiary inJune 2021 . Reductions in noninterest income were substantially offset by higher levels of transactions and number of accounts generating service charge income and bankcard revenue. •Noninterest expense increased$8.4 million , or 20.5%, for the quarter endedJune 30, 2022 , as compared to the prior year period driven by higher operating expenses resulting from the Select acquisition. •Income tax expense increased$1.6 million relative to the higher pre-tax income. The effective tax rates were 20.7% and 21.3% for the second quarter of 2022 and 2021, respectively. The lower effective tax rate in the second quarter of 2022 was related to higher tax exempt income in that quarter relative to taxable income. Total assets atJune 30, 2022 amounted to$10.6 billion , a 0.5% increase fromDecember 31, 2021 . The primary balance sheet changes are presented below. Refer also to additional discussion in the Financial Condition section following.
•Total loans amounted to
•Total investment securities decreased$65.2 million fromDecember 31, 2021 to a total of$3.1 billion atJune 30, 2022 , as cash flows were utilized to fund loan growth. •Total deposits amounted to$9.4 billion atJune 30, 2022 , an increase of$235.1 million , or 2.6%, fromDecember 31, 2021 . The high core deposit growth experienced since the onset of the pandemic has started to slow in 2022 and the current growth is primarily attributable to our ongoing growth and retention initiatives.
•We remain well-capitalized by all regulatory standards with a total common equity Tier 1 ratio of 12.90% and total risk-based capital ratio of 15.01%.
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•Accumulated other comprehensive loss increased$224.4 million related to higher unrealized losses on available for sale securities due to increased market rates experienced in the second quarter of 2022.
Overview and Highlights for Six Months Ended
Total net income of$70.6 million , or$1.98 diluted EPS, was reported during the six months endedJune 30, 2022 compared to net income of$57.5 million , or$2.02 diluted EPS, for the six months endedJune 30, 2021 . As noted above, the acquisition of Select was completed in the fourth quarter of 2021 impacting the comparisons with the prior year period. The main drivers to the increase in net income are presented below. Refer also to additional discussion in the Results of Operations section following. •Net interest income for the six months endedJune 30, 2022 was$155.1 million , a 36.1% increase from the$114.0 million recorded in the six months endedJune 30, 2021 . The increase in net interest income from the prior year period was driven by higher earning assets related to both the Select acquisition and organic growth, offset somewhat by a reduction in NIM. •For the six months endedJune 30, 2022 , we recorded a provision for credit losses of$3.5 million based on CECL model assumption updates including updated loss driver analyses normally performed in the first quarter of the year. A reversal of the provision for unfunded commitments of$1.5 million was recorded related to fluctuations in the levels and mix of outstanding loans commitments. No provision for credit losses and a$1.9 million provision for unfunded commitments was required in the comparable period of 2021. •Noninterest income declined$5.5 million , or 13.1%, from the prior year period primarily due to a$5.2 million decrease in mortgage banking income related to lower levels of activity, a$3.5 million decrease in SBA consulting fees due to lower PPP-related revenues, and a$2.6 million decrease in commissions on sales of financial and insurance products due to the sale of substantially all of the assets of our property and casualty insurance agency subsidiary inJune 2021 . Reductions in noninterest income were substantially offset by higher levels of transactions and number of accounts generating service charge income and bankcard revenue. •Noninterest expense increased$19.8 million , or 24.4%, for the six months endedJune 30, 2022 as compared to the same period in the prior year. Included in the six months endedJune 30, 2022 was$4.2 million in merger and acquisition expenses primarily related to computer system conversion costs. The balance of the increase in noninterest expenses was driven by higher operating expenses resulting from the Select acquisition. •Income tax expense increased$2.7 million relative to the higher pre-tax income. The effective tax rates were 20.6% and 21.3% for the six months endedJune 30, 2022 and 2021, respectively. The lower effective tax rate for the six months endedJune 30, 2022 was related to higher tax exempt income in that quarter relative to taxable income.
Impact of COVID-19
Our market areas and local economies continue to show signs of recovery from the
impact of the COVID-19 pandemic, However, the current pandemic is ongoing and
dynamic in nature, and there are many related uncertainties, including, among
other things, its severity and new variants that have and may continue to arise;
its ultimate duration and infection spikes that may occur; its impact on our
customers, employees and vendors; its impact on the financial services and
banking industry; actions that may be taken by governmental authorities and
other third parties in response to the COVID-19 pandemic; and its ongoing impact
on the economy as a whole.
We have not realized significant negative impact on our loan portfolio or asset
quality and all COVID-19 deferral status loans returned to regular payment
schedules in 2021. While the economic pressures and uncertainties arising from
the COVID-19 pandemic have resulted in, and may continue to result in, specific
changes in consumer and business spending and borrowing habits, we have seen
improvements in many industries in which we have loan exposure including
retail/strip shopping centers, hotels/lodging, restaurants, entertainment, and
commercial real estate.
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Critical Accounting Policies and Estimates
The accounting principles we follow and our methods of applying these principles conform with GAAP and with general practices followed by the banking industry. Certain of these principles involve a significant amount of judgment and may involve the use of estimates based on our best assumptions at the time of the estimation. We have identified the accounting policies discussed below as being more sensitive in terms of judgments and estimates taking into account their overall potential impact to our consolidated financial statements.
Allowance for Credit Losses on Loans and Unfunded Commitments
The allowance for credit losses ("ACL") represents management's current estimate
of credit losses for the remaining estimated life of financial instruments. We
perform periodic and systematic detailed reviews of the loan portfolio to
identify trends and to assess the overall collectability of the portfolio. We
believe the accounting estimate related to the ACL is a "critical accounting
estimate" as: (1) changes in it can materially affect the provision for credit
losses and net income; (2) it requires management to predict borrowers'
likelihood or capacity to repay, including evaluation of inherently uncertain
future economic conditions; (3) the value of underlying collateral must be
estimated on collateral-dependent loans; (4) prepayment activity must be
projected to estimate the life of loans that often are shorter than contractual
terms; and (5) it requires estimation of a reasonable and supportable forecast
period for credit losses. Accordingly, this is a highly subjective process and
requires significant judgment since it is difficult to evaluate current and
future economic conditions in relation to an overall credit cycle and estimate
the timing and extent of loss events that are expected to occur prior to end of
a loan's estimated life.
Our ACL is assessed at each balance sheet date and adjustments are recorded in
the provision for credit losses. The ACL is estimated based on loan level
characteristics using historical loss rates, a reasonable and supportable
economic forecast, and assumptions of probability of default and loss given
default. Loan balances considered uncollectible are charged-off against the ACL.
There are many factors affecting the ACL, some of which are quantitative, while
others require qualitative judgment. Although management believes its process
for determining the ACL adequately considers all the potential factors that
could potentially result in credit losses, the process includes subjective
elements and is susceptible to significant change. To the extent actual outcomes
differ from management estimates, additional provision for credit losses could
be required that could adversely affect our earnings or financial position in
future periods.
Purchased credit deteriorated ("PCD") loans represent assets that are acquired
with evidence of more than insignificant credit quality deterioration since
origination as of the acquisition date. At acquisition, an allowance on PCD
assets is booked directly to the ACL. Any subsequent changes in the ACL on PCD
assets is recorded through the provision for credit losses.
We believe that the ACL is adequate to absorb the expected life of loan credit
losses on the portfolio of loans as of the balance sheet date. Actual losses
incurred may differ materially from our estimates.
We estimate expected credit losses on unfunded commitments to extend credit over
the contractual period in which we are exposed to credit risk on the underlying
commitments, unless the obligation is unconditionally cancellable. The allowance
for off-balance sheet credit exposures, which is included in "Other liabilities"
on the Consolidated Balance Sheets, is adjusted for as an increase or decrease
to the provision for unfunded commitments. The estimate includes consideration
of the likelihood that funding will occur and an estimate of expected credit
losses on commitments expected to be funded over its estimated life. The
methodology is based on a loss rate approach that starts with the probability of
funding based on historical experience. Similar to methodology discussed above
related to the loans receivable portfolio, adjustments are made to the
historical losses for current conditions and reasonable and supportable
forecast.
We believe that the accounting for goodwill and other intangible assets also involves a higher degree of judgment than most other significant accounting policies. Accounting Standards Codification 350-10 establishes standards for the amortization of acquired intangible assets, generally over the estimated useful life of the related assets, and impairment assessment of goodwill. AtJune 30, 2022 , we had core deposit and other intangibles of$15.4 million subject to amortization and$364.3 million of goodwill, which is not subject to amortization.
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liabilities assumed.Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset's fair value. At each reporting date between annual goodwill impairment tests, we consider potential indicators of impairment. During 2022 there were no triggers warranting interim impairment assessments and for the 2021 annual assessment, we concluded that it was more likely than not that the fair value exceeded its carrying value. The primary identifiable intangible asset we typically record in connection with a whole bank or bank branch acquisition is the value of the core deposit intangibles which represent the estimated value of the long-term deposit relationships acquired in the transaction. Determining the amount of identifiable intangible assets and their average lives involves multiple assumptions and estimates and is typically determined by performing a discounted cash flow analysis, which involves a combination of any or all of the following assumptions: customer attrition/runoff, alternative funding costs, deposit servicing costs, and discount rates. The core deposit intangibles are amortized over the estimated useful lives of the deposit accounts based on a method that we believe reasonably approximates the anticipated benefit stream from this intangible. The estimated useful lives are periodically reviewed for reasonableness and have generally been estimated to have a life ranging from seven to ten years, with an accelerated rate of amortization. We review identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our policy is that an impairment loss is recognized, equal to the difference between the asset's carrying amount and its fair value, if the sum of the expected undiscounted future cash flows is less than the carrying amount of the asset. Estimating future cash flows involves the use of multiple estimates and assumptions, such as those listed above.
Current Accounting Matters
See Note 2 to the Consolidated Financial Statements for information about recently announced or adopted accounting standards.
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Index RESULTS OF OPERATIONS Net Interest Income Net interest income is our largest source of revenue and is the difference between the interest earned on interest-earning assets (generally loans and investment securities) and the interest expense incurred in connection with interest-bearing liabilities (generally deposits and borrowed funds). Changes in the net interest income are the result of changes in volume and the net interest spread which affects NIM. Volume refers to the average dollar levels of interest-earning assets and interest-bearing liabilities. Net interest spread refers to the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. NIM refers to net interest income divided by average interest-earning assets and is influenced by the level and relative mix of interest-earning assets and interest-bearing liabilities. Net interest income is also influenced by external factors such as local economic conditions, competition for loans and deposits, and market interest rates. Net interest income for the three months endedJune 30, 2022 amounted to$78.3 million , an increase of$19.5 million , or 33.2%, from the$58.8 million recorded in the second quarter of 2021. Net interest income on a tax-equivalent basis for the three months endedJune 30, 2022 amounted to$78.9 million , an increase of$19.7 million , or 33.2%, from the$59.3 million recorded in the second quarter of 2021. For internal purposes, we evaluate our NIM on a tax-equivalent basis by adding the tax benefit realized from tax-exempt loans and securities to reported interest income then dividing by total average earning assets. We believe that analysis of NIM on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest in different periods without taking into account the different mix of taxable versus non-taxable loans and investments that may have existed during those periods.
The following table presents an analysis of net interest income for the three months ended
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Average Balances and Net Interest Income Analysis
For the Three Months Ended
2022 2021
($ in thousands) Interest Interest
Average Average Earned Average Average Earned
Volume Rate or Paid Volume Rate or Paid
Assets
Loans (1) (2) $ 6,149,174 4.24 % $ 65,077 $ 4,679,119 4.48 % $ 52,295
Taxable securities 3,137,383 1.71 % 13,385 2,157,475 1.45 % 7,789
Non-taxable securities 299,982 1.48 % 1,104 131,692 1.45 %
474
Short-term investments, primarily 363,119 0.97 % 881 418,321 0.56 %
581
interest-bearing cash Total interest-earning assets 9,949,658 3.24 % 80,447 7,386,607 3.32 % 61,139 Cash and due from banks 125,545 85,742 Premises and equipment 135,553 123,172 Other assets 305,992 370,260 Total assets$ 10,516,748 $ 7,965,781 Liabilities Interest-bearing checking$ 1,541,768 0.05 %$ 210 $ 1,278,969 0.07 %$ 225 Money market deposits 2,567,138 0.11 % 731 1,776,344 0.18 % 799 Savings deposits 745,496 0.06 % 106 582,081 0.08 % 112 Time deposits >$100,000 525,028 0.29 % 378 526,706 0.52 % 681 Other time deposits 293,421 0.22 % 160 218,463 0.33 % 182 Total interest-bearing deposits 5,672,851 0.11 % 1,585 4,382,563 0.18 % 1,999 Borrowings 67,418 3.52 % 592 61,312 2.49 % 381 Total interest-bearing liabilities 5,740,269 0.15 % 2,177 4,443,875 0.21 %
2,380
Noninterest-bearing checking 3,664,764 2,568,960 Other liabilities 20,638 58,968 Shareholders' equity 1,091,077 893,978 Total liabilities and shareholders' equity$ 10,516,748 $ 7,965,781 Net yield on interest-earning assets and net interest income 3.16 %$ 78,270 3.19 % $
58,759
Net yield on interest-earning assets and net interest income - tax-equivalent (3) 3.18 %$ 78,939 3.22 %$ 59,276 Interest rate spread 3.09 % 3.11 % Average prime rate 3.94 % 3.25 % (1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown. Interest earned includes recognized net loan fees, including late fees, prepayment fees, and deferred loan fee amortization (including deferred PPP fees), in the amounts of$1.3 million , and$2.2 million for three months endedJune 30, 2022 and 2021, respectively. (2) Includes accretion of discount on acquired and SBA loans of$2.3 million and$3.6 million for three months endedJune 30, 2022 and 2021, respectively. (3) Includes tax-equivalent adjustments of$669,000 and$517,000 for three months endedJune 30, 2022 and 2021, respectively, to reflect the tax benefit that we receive related to tax-exempt securities and tax-exempt loans, which carry interest rates lower than similar taxable investments/loans due to their tax exempt status. This amount has been computed assuming a 23% tax rate and is reduced by the related nondeductible portion of interest expense. Page 44
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Overall, as demonstrated in the table above, net interest income grew$19.5 million for the three months endedJune 30, 2022 from the comparable period of the prior year. Higher earning asset volumes, from both organic growth and the Select acquisition, drove the increase. Lower rates on interest-bearing liabilities contributed to higher net interest income while lower yields on interest-earning assets partially offset the increases. •Average loan volumes for the three months endedJune 30, 2022 were$1.5 billion higher than the same period in 2021. Higher volumes were partially offset by lower interest rates on loans related to loans originated during the low market rate environment during 2021, resulting in an increase in loan interest income of$12.8 million . •Higher average volume of$1.1 billion on total securities resulted in an increase of$6.2 million in interest income for the three months endedJune 30, 2022 when compared to the same period in 2021. Also contributing to the increase in interest income was the higher yields on the portfolio as reinvestment rates increased between the periods. •Lower interest rates paid on deposits drove a$0.4 million decrease in deposit interest expense for the three months endedJune 30, 2022 compared to the same period in 2021. Reductions in rates on deposits more than offset the$1.3 billion increase in average volume for total interest-bearing deposits. •The reduction in NIM was in large part the result of general low market rate environment through most of 2021 and the shift of earning asset mix to lower yielding investment securities from loans as excess liquidity was deployed to securities. Net interest income for the six months endedJune 30, 2022 amounted to$155.1 million , an increase of$41.2 million , or 36.1%, from the$114.0 million recorded in the six months endedJune 30, 2021 . Net interest income on a tax-equivalent basis for the six months endedJune 30, 2022 amounted to$156.5 million , an increase of$41.6 million , or 36.2%, from the$115.0 million recorded in the six months endedJune 30, 2021 . For internal purposes, we evaluate our NIM on a tax-equivalent basis by adding the tax benefit realized from tax-exempt loans and securities to reported interest income then dividing by total average earning assets. We believe that analysis of NIM on a tax-equivalent basis is useful and appropriate because it allows a comparison of net interest in different periods without taking into account the different mix of taxable versus non-taxable loans and investments that may have existed during those periods.
The following table presents an analysis of net interest income for the six months ended
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Average Balances and Net Interest Income Analysis
For the Six Months Ended June 30,
2022 2021
Interest Interest
Average Average Earned Average Average Earned
($ in thousands) Volume Rate or Paid Volume Rate or Paid
Assets
Loans (1) (2) $ 6,100,246 4.27 % $ 129,279 $ 4,681,604 4.45 % $ 103,368
Taxable securities 3,066,772 1.75 % 26,595 1,906,549 1.45 % 13,702
Non-taxable securities 294,257 1.47 % 2,152 99,622 1.62 %
797
Short-term investments, primarily 420,671 0.73 % 1,530 456,066 0.57 %
1,281
interest-bearing cash Total interest-earning assets 9,881,946 3.26 %$ 159,556 7,143,841 3.36 % 119,148 Cash and due from banks 120,691 83,486 Premises and equipment 135,768 122,485 Other assets 401,660 373,472 Total assets$ 10,540,065 $ 7,723,284
Liabilities
Interest bearing checking$ 1,558,950 0.06 %$ 434 $ 1,241,662 0.08 %$ 491 Money market deposits 2,586,527 0.12 % 1,584 1,713,714 0.20 % 1,717 Savings deposits 733,769 0.06 % 214 560,550 0.09 % 242 Time deposits >$100,000 553,346 0.29 % 808 540,865 0.57 % 1,539 Other time deposits 295,981 0.22 % 316 221,239 0.36 % 398 Total interest-bearing deposits 5,728,573 0.12 % 3,356 4,278,030 0.21 % 4,387 Borrowings 67,400 3.15 % 1,052 61,356 2.51 % 764 Total interest-bearing liabilities 5,795,973 0.15 % 4,408 4,339,386 0.24 %
5,151
Noninterest bearing checking 3,550,741 2,436,138 Other liabilities 43,098 57,895 Shareholders' equity 1,150,253 889,865 Total liabilities and shareholders' equity$ 10,540,065 $ 7,723,284 Net yield on interest-earning assets and net interest income 3.17 %$ 155,148 3.22 % $
113,997
Net yield on interest-earning assets and net interest income - tax-equivalent (3) 3.19 %$ 156,514 3.24 %$ 114,956 Interest rate spread 3.11 % 3.12 % Average prime rate 3.62 % 3.25 % (1) Average loans include nonaccruing loans, the effect of which is to lower the average rate shown. Interest earned includes recognized net loan fees, including late fees, prepayment fees, and deferred loan fee amortization (including deferred PPP fees), in the amounts of$2.6 million , and$5.6 million for six months endedJune 30, 2022 and 2021, respectively. (2) Includes accretion of discount on acquired and SBA loans of$4.6 million and$5.0 million for six months endedJune 30, 2022 and 2021, respectively. (3) Includes tax-equivalent adjustments of$1.4 million and$1.0 million for six months endedJune 30, 2022 and 2021, respectively, to reflect the tax benefit that we receive related to tax-exempt securities and tax-exempt loans, which carry interest rates lower than similar taxable investments/loans due to their tax exempt status. This amount has been computed assuming a 23% tax rate and is reduced by the related nondeductible portion of interest expense Page 46
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Overall, as demonstrated in the table above, net interest income grew$41.2 million for the six months endedJune 30, 2022 from the comparable period of the prior year. Higher earning asset volumes, from both organic growth and the Select acquisition, and lower rates on interest-bearing liabilities, which were partially offset by lower yields on interest-earning assets, drove the increase. •Average loan volumes for the six months endedJune 30, 2022 were$1.4 billion higher than the same period in 2021. Higher volumes were partially offset by lower interest rates on loans related to the low market rate environment experienced during 2021, resulting in an increase in loan interest income of$25.9 million . •Higher average volume of$1.4 billion on total securities resulted in an increase of$14.2 million in interest income for the six months endedJune 30, 2022 when compared to the same period in 2021. Also contributing to the increase in interest income was the higher yields on the taxable portfolio as reinvestment rates increased between the periods. •Lower interest rates paid on deposits drove a$1.0 million decrease in deposit interest expense for the six months endedJune 30, 2022 compared to the same period in 2021. Reductions in rates on deposits more than offset the$1.5 billion increase in average volume for total interest-bearing deposits. •The reduction in NIM was in large part a result of a general low market rate environment through most of 2021 and the shift of earning asset mix to lower yielding investment securities from loans as excess liquidity was deployed to securities.
Our NIM for all periods benefited from net accretion income, primarily associated with purchase accounting premiums/discounts associated with acquisitions. Presented in the table below is the amount of accretion which increased net interest income in each time period presented.
Three Months Ended June 30, Six Months Ended June 30,
($ in thousands) 2022 2021 2022 2021
Interest income - increased by
accretion of loan discount on acquired
loans $ 1,545 2,913 3,216 3,665
Interest income - increased by
accretion of loan discount on retained
SBA loans 730 718 1,397 1,307
Total interest income impact 2,275 3,631 4,613 4,972
Interest expense - reduced by premium
amortization of deposits 168 11 402 27
Interest expense - increased by
discount accretion of borrowings (53) (44) (126) (88)
Total net interest expense impact 115 (33) 276 (61)
Total impact on net interest income $ 2,390 3,598 4,889 4,911
The decrease in loan discount accretion on purchased loans for both the three
months and the six months ended June 30, 2022 as compared to the same periods in
the prior year is related to accelerated accretion recorded in 2021 on the
payoffs of five former failed-bank loans. Generally the level of loan discount
accretion will decline each year due to the natural paydowns in acquired loan
portfolios. At June 30, 2022 and 2021, unaccreted loan discount on purchased
loans amounted to $14.0 million and $5.3 million , respectively.
In addition to the loan discount accretion recorded on acquired loans, we record
accretion on the discounts associated with the retained unguaranteed portions of
SBA loans sold in the secondary market. The level of SBA loan discount accretion
will vary relative to fluctuations in the SBA loan portfolio. At June 30, 2022
and 2021, unaccreted loan discount on SBA loans amounted to $5.4 million and
$7.0 million , respectively.
Amortization of net deferred loan fees also impacts interest income. During the
six months ended June 30, 2022 , we amortized net deferred PPP fees of
$2.3 million as interest income compared to $5.7 million for the six months
ended June 30, 2021 . At June 30, 2022 , we had $284,000 in remaining deferred PPP
origination fees that will be recognized over the lives of the loans, with
accelerated amortization expected to result from the loan forgiveness process.
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Provision for Credit Losses and Provision for Unfunded Commitments
The provisions for credit losses represents our current estimate of life of loan credit losses in the loan portfolio and unfunded loan commitments. Our estimate of credit losses is determined using a complex model that relies on reasonable and supportable forecasts and historical loss information to determine the balance of the ACL and resulting provision for credit losses. The provision for unfunded commitments represents expected losses on unfunded loan commitments that are expected to result in outstanding loan balances. The allowance for unfunded commitments is included in "Other liabilities" in the Consolidated Balance Sheets. The amount of provision recorded in each period was the amount required such that the total ACL reflected the appropriate balance as determined under CECL. No provision for credit losses was recorded for the three months endedJune 30, 2022 based on improving trends, and$3.5 million was recorded for the six months endedJune 30, 2022 based on updated economic forecasts and updated loss driver analyses normally performed in the first quarter of the year. Also based on the CECL model results and improving asset quality trends, no provision was required for the three and six months endedJune 30, 2021 . No provision for unfunded commitments was recorded for the three months endedJune 30, 2022 , and a reversal provision of$1.5 million was recorded for the six months endedJune 30, 2022 , related primarily to the fluctuations in the levels and mix of outstanding loan commitments. There was$1.9 million provision for unfunded commitments for the three and six months endedJune 30, 2021 .
Additional discussion of our asset quality and credit metrics, which impact our provision for credit losses, is provided in the “Nonperforming Assets” and “Allowance for Credit Losses and Loan Loss Experience” sections below.
Noninterest Income
Our noninterest income amounted to$17.3 million and$21.4 million for the three months endedJune 30, 2022 and 2021, respectively, and$36.5 million and$42.0 million for the six months endedJune 30, 2022 and 2021, respectively. Included in noninterest income was nonrecurring amounts totaling$1.6 million and$1.5 million in other gains for the three months endedJune 30, 2022 and 2021, respectively, and$3.2 million and$ 1.5 million in other gains for the six months endedJune 30, 2022 and 2021, respectively. The following table presents the primary components of noninterest income. For the Three Months Ended June 30, For the Six Months Ended June 30, ($ in thousands) 2022 2021 2022 2021 Service charges on deposit accounts$ 3,700 2,824 7,241 5,557 Other service charges and fees - bankcard interchange income, net 4,812 4,409 9,523 7,933 Other service charges and fees - other 3,070 2,087 5,364 4,085 Fees from presold mortgage loans 454 2,274 1,575 6,818 Commissions from sales of insurance and financial products 1,151 2,466 2,096 4,656 SBA consulting fees 704 2,187 1,484 4,951 SBA loan sale gains 841 2,996 4,102 5,326 Bank-owned life insurance ("BOLI") income 942 614 1,918 1,234 Other gains, net 1,590 1,517 3,212 1,483 Noninterest income$ 17,264 21,374 36,515 42,043 Service charges on deposit accounts increased$0.9 million , or 31%, for the three months endedJune 30, 2022 as compared to the three months endedJune 30, 2021 , and increased$1.7 million for the six months endedJune 30, 2022 compared to the six months endedJune 30, 2021 . The increase was driven by the higher number of new customers and transaction accounts generating fees from both organic growth and the Select acquisition. Other service charges and fees - bankcard interchange income, net represents interchange income from debit and credit card transactions, net of associated interchange expense, and increased$0.4 million , or 9%, for the three months endedJune 30, 2022 as compared to the prior year period, and increased$1.6 million for the six months endedJune 30, 2022 compared to the prior year period. The growth in card usage by our customers is related to the higher volume of outstanding cards giving rise to increased transaction volume as well as customer payment preferences. Because the Company exceeded$10 billion in total assets atDecember 31, 2021 , it is expected that bankcard revenue will be adversely impacted by the Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 limit on debit card interchange fees beginningJuly 1, 2022 . Page 48 --------------------------------------------------------------------------------
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Other service charges and fees - other includes items such as SBA guarantee servicing fees and related servicing rights amortization, ATM charges, wire transfer fees, safety deposit box rentals, fees from sales of personalized checks, and check cashing fees. The increase in this line item for the three months endedJune 30, 2022 compared to the three months endedJune 30, 2021 of$1.0 million , or 47%, and the increase of$1.3 million for the six months endedJune 30, 2022 compared to the prior year period, was primarily due to growth in the number of accounts and related transaction activity, as well as the Bank's deposit base increases. Fees from presold mortgage loans amounted to$0.5 million for the three months endedJune 30, 2022 , a decline of$1.8 million , or 80%, from the same time period in 2021, and a$5.2 million decrease for the six months endedJune 30, 2022 compared to the prior year period. The decrease was due to the general increase in market interest rates and related decline in home mortgage refinancings and new originations during 2022 as compared to the prior year. Commissions from sales of insurance and financial products for the three months endedJune 30, 2022 decreased$1.3 million from the same period in 2021, and decreased$2.6 million for the six months endedJune 30, 2022 compared to the prior year period. The decreases were due to the sale of the majority of the assets of our property and casualty insurance subsidiary inJune 2021 . SBA consulting fees decreased for the three months endedJune 30, 2022 , compared to the same period in 2021 by$1.5 million , or 68%, which was directly related to the wind-down of the PPP loan program and lower related revenues earned in the current period. SBA consulting services decreased$3.5 million for the six months endedJune 30, 2022 compared to the prior year period. SBA loan sale gains decreased$2.2 million , or 72%, for the three months endedJune 30, 2022 compared to the three months endedJune 30, 2021 relating to the timing of sales and the volume of originated loans available to be sold in each period. SBA loan sale gains decreased$1.2 million for the six months endedJune 30, 2022 compared to the prior year period. Other gains, net for the three months and six months endedJune 30, 2022 are primarily related to death benefits realized on BOLI policies. Other gains, net for the comparable periods of 2021 are primarily related to the sale of the the majority of the assets of our property and casualty insurance subsidiary inJune 2021 . Noninterest Expenses Noninterest expenses totaled$49.4 million and$41.0 million for the three months endedJune 30, 2022 and 2021, respectively, and$100.9 million and$81.1 million for the six months endedJune 30, 2022 and 2021, respectively. Included in noninterest expense was nonrecurring merger and acquisition costs totaling$0.7 million and$0.4 million for the three months endedJune 30, 2022 and 2021, respectively. Merger and acquisition costs totaled$4.2 million and$0.4 million for the six months endedJune 30, 2022 and 2021, respectively. The following table presents the primary components of noninterest expense. Page 49 -------------------------------------------------------------------------------- Index For the Three Months Ended June 30, For the Six Months Ended June 30, ($ in thousands) 2022 2021 2022 2021 Salaries$ 23,799 21,187 47,253 41,318 Employee benefits 6,310 4,084 11,888 8,658 Total personnel expense 30,109 25,271 59,141 49,976 Occupancy expense 3,122 2,668 6,506 5,572 Equipment related expenses 1,514 1,053 2,818 2,098 Merger and acquisition expenses 737 411 4,221 411 Amortization of intangible assets 953 845 1,970 1,742 Credit card rewards and other expenses 970 1,116 2,213 2,192 Telephone and data lines 855 740 1,790 1,490 Software costs 1,288 1,502 2,862 2,709 Data processing expense 1,920 1,357 4,022 2,699 Advertising and marketing expense 884 620 1,795 1,230 Foreclosed property gains, net (292) (173) (372) (16) Non-credit losses 488 276 1,090 461 Other operating expenses 6,850 5,299 12,807 10,486 Total$ 49,398 40,985 100,863 81,050 In general, the increase in noninterest expenses was driven by higher operating expenses from personnel, locations, number of accounts, and higher level of activity resulting from the Select acquisition completed in the fourth quarter of 2021. Merger and acquisition expenses amounted to$4.2 million for the six months endedJune 30, 2022 and primarily related to core system conversion costs incurred in the Select acquisition. Total personnel expense increased$4.8 million , or 19%, for the three months endedJune 30, 2022 as compared to the three months endedJune 30, 2021 . Total personnel expense increased$9.2 million for the six months endedJune 30, 2022 compared to the prior year period. The increase for each period was a direct result of the incremental increase in the number of associates from the Select acquisition, combined with regular annual salary increases. Also contributing to the increases were higher insurance claims and costs in the 2022 compared to the prior year. Income Taxes We recorded income tax expense of$9.6 million for the three months endedJune 30, 2022 and$7.9 million for the three months endedJune 30, 2021 . Our effective tax rates declined to 20.7% from 21.3% for the three months endedJune 30, 2022 and 2021, respectively. The lower effective tax rate in the second quarter of 2022 was related to higher tax-exempt income in that quarter relative to taxable income. We recorded income tax expense of$18.2 million and$15.6 million for the six months endedJune 30, 2022 and 2021, respectively. Our effective tax rates declined to 20.6% from 21.3% for the six months endedJune 30, 2022 and 2021, respectively. The lower effective tax rate for the six months endedJune 30, 2022 was related to higher tax-exempt income in the time period relative to taxable income.
FINANCIAL CONDITION
Total assets atJune 30, 2022 amounted to$10.6 billion , a 0.5% increase fromDecember 31, 2021 . Total loans atJune 30, 2022 amounted to$6.2 billion , a 2.7% increase fromDecember 31, 2021 , and total deposits amounted to$9.4 billion , a 2.6% increase fromDecember 31, 2021 . For the six months endedJune 30, 2022 , loans increased$161.5 million , or 2.7%, related primarily to core growth partially offset by forgiveness of PPP loans. We experienced organic growth in most of our loan categories, with commercial real estate and 1-4 family first mortgage categories experiencing the largest growth. The mix of our loan portfolio remained substantially the same atJune 30, 2022 compared toDecember 31, 2021 . The majority of our real estate loans were personal and commercial loans where real estate provides additional security for the Page 50
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loan. Note 4 to the consolidated financial statements presents additional detailed information regarding our mix of loans.
For the six months endedJune 30, 2022 , we continued to experience growth in our deposit base, with total deposits increasing by$235.1 million , or 2.6%, fromDecember 31, 2021 . Deposit growth was primarily in transaction accounts (checking and money market products), which we believe to be related to our ongoing deposit growth initiatives, as well as stimulus funds and changes in customer behaviors remaining from the pandemic. We routinely engage in activities designed to grow and retain deposits, such as (1) emphasizing relationship banking to new and existing customers, where borrowers are encouraged and normally expected to maintain deposit accounts with us, (2) pricing deposits at rate levels that will attract and/or retain deposits, and (3) continually working to identify and introduce new products that will attract customers or enhance our appeal as a primary provider of financial services.
Non-Performing Assets
Nonperforming assets include nonaccrual loans, TDRs, loans past due 90 or more days and still accruing interest, and foreclosed real estate. Non-performing assets are summarized as follows:
$ in thousands June 30, 2022 December 31, 2021 Nonperforming assets Nonaccrual loans$ 28,715 34,696 TDRs - accruing 11,771 13,866 Accruing loans >90 days past due - 1,004 Total nonperforming loans 40,486 49,566 Foreclosed real estate 658 3,071 Total nonperforming assets$ 41,144 52,637 Asset Quality Ratios Nonaccrual loans to total loans 0.46 % 0.57 % Nonperforming loans to total loans 0.65 % 0.82 %
Non-performing assets to total loans and foreclosed properties
0.66 % 0.87 % Nonperforming assets to total assets 0.39 % 0.50 % Allowance for credit losses to nonaccrual loans 202.99 % 158.96 % As shown in the table above, nonperforming assets decreased fromDecember 31, 2021 toJune 30, 2022 , with improvements noted in all categories. AtJune 30, 2022 , total nonaccrual loans amounted to$28.7 million , compared to$34.7 million atDecember 31, 2021 . "Real estate-mortgage-commercial and other" is the largest category of nonaccrual loans, at$11.9 million , or 42%, of total nonaccrual loans, followed by "Commercial, financial, and agricultural" at$11.4 million , or 40%, of total nonaccrual loans. Included in those categories are nonaccrual SBA loans totaling$15.8 million atJune 30, 2022 , or 55%, of total nonaccrual loans, that have$6.2 million in guarantees from the SBA. TDRs are accruing loans for which we have granted concessions to the borrower as a result of the borrower's financial difficulties. AtJune 30, 2022 , total accruing TDRs amounted to$11.8 million , compared to$13.9 million atDecember 31, 2021 , with the decrease being attributed to three large commercial TDRs paying off during the period.
As reflected in Note 4 to the financial statements, total classified loans declined 11.1% to
Total foreclosed real estate amounted to$0.7 million atJune 30, 2022 and$3.1 million atDecember 31, 2021 . Our foreclosed property balances have generally been decreasing as a result of sales activity during the periods and favorable overall asset quality. During the six months endedJune 30, 2022 , we recorded sales of six foreclosed Page 51
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properties partially offset by the addition of one foreclosed property. We believe that the fair values of foreclosed real estate, less estimated costs to sell, equal or exceed their respective carrying values at the dates presented. The following table presents the detail of all of our foreclosed real estate at each period end. ($ in thousands) At June 30, 2022 At December 31, 2021 Vacant land and farmland $ 103 104 1-4 family residential properties 555 1,231 Commercial real estate - 1,736 Total foreclosed real estate $ 658 3,071
Allowance for Credit Losses and Loan Loss Experience
Our ACL is based on the total amount of loan losses that are expected over the remaining life of the loan portfolio. Our estimate of credit losses on loans is determined using a complex model that relies on reasonable and supportable forecasts and historical loss information to determine the balance of the ACL and resulting provision for credit losses. The ACL is measured on a collective pool basis when similar risk characteristics exist based primarily on discounted cash flows computed for each loan in a pool based on its individual characteristics. When we determine that foreclosure is probable or when the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral, expected credit losses are based on the fair value of the collateral at the reporting date, adjusted for selling costs as appropriate. We have reviewed the collateral for our nonperforming assets, including nonaccrual loans, and have included this review among the factors considered in the evaluation of the ACL. We have no foreign loans and few agricultural loans, and do not engage in significant lease financing or highly leveraged transactions. Commercial loans are diversified among a variety of industries. The majority of our real estate loans are primarily personal and commercial loans where real estate provides additional security for the loan. Collateral for virtually all of these loans is located within our principal market area. For the six months endedJune 30, 2022 , we recorded a provision for credit losses of$3.5 million based on our CECL model assumption updates and the recalibration of the model to include the historical loss rates from the Select acquired portfolio. A reversal of the provision for unfunded commitments of$1.5 million was recorded for that period related to fluctuations in the levels and mix of outstanding loans commitments. For the comparable period of 2021, based on our loan portfolio mix and economic forecast updates, no provision for credit losses and a$1.9 million provision for unfunded commitments were required. For the periods indicated, the following table summarizes our balances of loans outstanding, average loans outstanding, ACL, charge-offs and recoveries, and key ratios. Page 52
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Loan Ratios, Loss and Recovery Experience
Twelve Months
Six Months Ended Ended December 31, Six Months Ended
($ in thousands) June 30, 2022 2021 June 30, 2021
Loans outstanding at end of period $ 6,243,170 6,081,715 4,782,064
Average amount of loans outstanding 6,100,246 5,018,391 4,681,604
Allowance for credit losses, at period end 82,181 78,789 65,022
Total charge-offs (2,803) (7,602) (4,448)
Total recoveries 2,695 4,922 2,507
Net charge-offs $ (108) (2,680) (1,941)
Ratios:
Net charge-offs as a percent of average loans
(annualized) 0.00 % 0.05 % 0.08 %
Allowance for credit losses as a percentage of loans at the end of the period
1.32 % 1.30 % 1.36 % Recoveries of loans previously charged-off as a percent of loans charged-off 96.15 % 64.75 % 56.36 % In addition to the ACL on loans, we maintain an allowance for lending-related commitments such as unfunded loan commitments. We estimate expected credit losses associated with these commitments over the contractual period in which we are exposed to credit risk via a contractual obligation to extend credit, unless that obligation is unconditionally cancellable. The allowance for lending-related commitments on off-balance sheet credit exposures is adjusted as a provision for unfunded commitments expense. The estimate includes consideration of the likelihood that funding will occur and an estimate of expected credit losses on commitments expected to be funded over its estimated life. The allowance for unfunded commitments of$12.0 million and$13.5 million atJune 30, 2022 andDecember 31, 2021 , respectively, is classified on the balance sheet within "Other liabilities". We recorded a reversal provision for credit losses on unfunded commitments of$1.5 million during the six months endedJune 30, 2022 primarily relating to the fluctuations in the levels and mix of outstanding loan commitments. We believe the ACL is adequate at each period end presented. It must be emphasized, however, that the determination of the allowances using our procedures and methods rests upon various judgments and assumptions about economic conditions and other factors affecting loans. No assurance can be given that we will not in any particular period sustain loan losses that are sizable in relation to the amounts reserved or that subsequent evaluations of the loan portfolio, in light of conditions and factors then prevailing, will not require significant changes in the ACL or future charges to earnings. See "Critical Accounting Policies - Allowance for Credit Losses on Loans and Unfunded Commitments" in Note 1 to the 2021 Annual Report on Form 10-K filed with theSEC for more information. In addition, various regulatory agencies, as an integral part of their examination process, periodically review our ACL and value of other real estate. Such agencies may require us to recognize adjustments to the allowance or the carrying value of other real estate based on their judgments about information available at the time of their examinations.
Liquidity, Commitments, and Contingencies
Our liquidity is determined by our ability to convert assets to cash or acquire alternative sources of funds to meet the needs of our customers who are withdrawing or borrowing funds, and to maintain required reserve levels, pay expenses and operate the Company on an ongoing basis. Our primary liquidity sources are net income from operations, cash and due from banks, federal funds sold and other short-term investments. Our securities portfolio is comprised almost entirely of readily marketable securities, which could also be sold to provide cash. Since the beginning of the COVID-19 pandemic in early 2020, we have seen our liquidity levels increase, with increases in deposits account balances leading to higher cash and investment securities levels. In addition to internally generated liquidity sources, we have the ability to obtain borrowings under: 1) an approximately$858 million line of credit with the FHLB (of which$1.9 million and$2.0 million were outstanding atJune 30, 2022 andDecember 31, 2021 , respectively); 2) a$150 million federal funds line with a correspondent bank Page 53
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(of which none was outstanding atJune 30, 2022 orDecember 31, 2021 ); and 3) an approximately$169 million line of credit through theFederal Reserve Bank of Richmond's discount window (of which none was outstanding atJune 30, 2022 orDecember 31, 2021 ). Unused and available lines of credit amounted to$1.2 billion atJune 30, 2022 . Our overall liquidity is essentially the same as atDecember 31, 2021 with our liquid assets (cash and securities) as a percentage of our total deposits and borrowings at 30.5% atJune 30, 2022 . We believe our liquidity sources, including unused lines of credit, are at an acceptable level and remain adequate to meet our operating needs in the foreseeable future. The amount and timing of our contractual obligations and commercial commitments has not changed materially sinceDecember 31, 2021 , detail of which is presented in the Contractual Obligations and Other Commercial Commitments table of our 2021 Annual Report on Form 10-K. In addition, we are not involved in any legal proceedings that, in our opinion, could have a material effect on our consolidated financial position.
Off-Balance Sheet Arrangements and Derivative Financial Instruments
Off-balance sheet arrangements include transactions, agreements, or other contractual arrangements pursuant to which we have obligations or provide guarantees on behalf of an unconsolidated entity. We have no off-balance sheet arrangements of this kind other than letters of credit and repayment guarantees associated with our trust preferred securities. Derivative financial instruments include futures, forwards, interest rate swaps, options contracts, and other financial instruments with similar characteristics. We have not engaged in significant derivative activities throughJune 30, 2022 , and have no current plans to do so.
Capital Resources
The Company is regulated by the FRB and is subject to the securities registration and public reporting regulations of theSEC . Our banking subsidiary,First Bank , is also regulated by the FRB and theNorth Carolina Office of the Commissioner of Banks . We must comply with regulatory capital requirements established by the FRB. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on our financial statements. We are not aware of any recommendations of regulatory authorities or otherwise which, if they were to be implemented, would have a material effect on our liquidity, capital resources, or operations. Under Basel III standards and capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Our capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The capital standards require us to maintain minimum ratios of "Common Equity Tier 1" capital to total risk-weighted assets, "Tier 1" capital to total risk-weighted assets, and total capital to risk-weighted assets of 4.50%, 6.00% and 8.00%, respectively. Common Equity Tier 1 capital is comprised of common stock and related surplus, plus retained earnings, and is reduced by goodwill and other intangible assets, net of associated deferred tax liabilities. Tier 1 capital is comprised of Common Equity Tier 1 capital plus Additional Tier 1 Capital, which includes non-cumulative perpetual preferred stock and trust preferred securities. Total capital is comprised of Tier 1 capital plus certain adjustments, the largest of which is our ACL. Risk-weighted assets refer to our on- and off-balance sheet exposures, adjusted for their related risk levels using formulas set forth in FRB regulations. In addition to the risk-based capital requirements described above, we are subject to a leverage capital requirement, which calls for a minimum ratio of Tier 1 capital (as defined above) to quarterly average total assets of 3.00% to 5.00%, depending upon the institution's composite ratings as determined by its regulators. The FRB has not advised us of any requirement specifically applicable to us.
At
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June 30, 2022 December 31, 2021
Risk-based capital ratios:
Common equity Tier 1 to Tier 1 risk weighted assets 12.90 % 12.53 %
Minimum required Common Equity Tier 1 capital 7.00 % 7.00 %
Tier I capital to Tier 1 risk weighted assets 13.76 % 13.42 %
Minimum required Tier 1 capital 8.50 % 8.50 %
Total risk-based capital to Tier II risk weighted assets 15.01 % 14.67 %
Minimum required total risk-based capital 10.50 % 10.50 %
Leverage capital ratio:
Tier 1 capital to quarterly average total assets 9.95 % 9.39 %
Minimum required Tier 1 leverage capital 4.00 % 4.00 %
First Bank is also subject to capital requirements that do not vary materially
from the Company's capital ratios presented above. At June 30, 2022 , First Bank
exceeded the minimum ratios established by the regulatory authorities.
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