The following discussion is intended to assist in understanding the results of
operations and the financial condition of
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains statements concerning the Company's expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute "forward-looking statements" as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, changes in interest rates, general economic conditions, the legislative/regulatory climate, monetary and fiscal policies of the
U.S. Government, including policies of the U.S. Treasury and the Board of Governorsof the Federal Reserve System, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, expansion activities, demand for financial services in the Company's market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements, which speak only as of the date they are made.
Earnings increased 228.6% for the first quarter of 2014 compared to the first quarter of 2013. The first quarter results are highlighted by loan growth, improved margins and lower expenses. The capital position remains solid. During the first quarter, the Company opened a loan production and wealth management office in
Richmond, Virginia. The operations of this office are expected to be neutral to earnings within 15 months and had little impact on earnings in the first quarter of 2014. Core earnings and growth remain as priorities for the Company. Asset quality improved, with nonperforming assets down to 1.77% of total assets as of March 31, 2014.
The portfolio of loans serviced for Fannie Mae grew by
Asset quality improved. OREO balances are down to
$3.5 millionas of March 31, 2014compared to $3.9 millionas of December 31, 2013. During the first quarter of 2014, three OREO properties were sold and three were added through foreclosures. Non-accruing loan balances are down to $2.3 millionas of March 31, 2014as compared to $2.8 millionat December 31, 2013. Annualized net loan charge-offs against the ALL are down to 0.22% of total loans during the first three months of 2014 compared to 0.24% during the first three months of 2013. The net interest margin increased to 3.81% for the first quarter of 2014 compared to 3.40% for the same period in 2013. As this historic low-rate climate continues, loan and investment yields continue to decline, but increased loan balances have mitigated reductions in interest income. From March 31, 2013to March 31, 2014, loan balances grew by $18.9 million. The refinance of a FHLB advance in April, 2013, and scheduled maturities of time deposits in 2013, have reduced both costs of funds and interest expense. The Bank's other FHLB advance will mature in May, 2014, and provide opportunity for further reductions. Maturities of time deposits are typically renewed at lower rates, leave the Bank or transfer to a lower-cost checking or savings account. During the first quarter of 2014, the Company sold a troubled investment for which an impairment loss was recognized in 2013 (refer to Note 4). In addition, during the first quarter of 2014, the Company sold its former Heathsville, Virginia, branch office recognizing a gain of approximately $138 thousand. Finally, the Company's core capital levels and regulatory ratios remain well above what is considered "well capitalized" by the Company's regulators. The Company took no Troubled Asset Relief Program or Small Business Lending Fundinvestments from the U.S. Treasury.
For more information, visit the Company's website at www.baybanks.com. Information contained on the Company's website is not a part of this report.
For the three months ended
March 31, 2014and 2013, net income was $460 thousandand $140 thousand, respectively, an increase of $320 thousandor 228.6% from 2013 to 2014. Diluted earnings per average share for the three months ended March 31, 2014and 2013 were $0.10and $0.03, respectively. Return on average assets was 0.56% for the three months ended March 31, 2014compared to 0.17% for the three months ended March 31, 2013. The annualized return on average equity was 4.90% and 1.53% for the three months ended March 31, 2014and 2013, respectively. 22
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RESULTS OF OPERATIONS
The principal source of earnings for the Company is net interest income. Net interest income is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of interest-earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, the associated yields and rates, and the volume of non-performing assets have an effect on net interest income, the net interest margin, and net income. FOR THE THREE MONTHS ENDED
MARCH 31, 2014COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2013NET INTEREST INCOME Net Interest Income Analysis (unaudited) (Fully taxable equivalent basis) Average Balances, Income and Expense, Yields and Rates (Dollars in Thousands) Three months ended 3/31/2014 Three months ended 3/31/2013 Average Income/ Average Income/ Balance Expense Yield/ Cost Balance Expense Yield/ Cost INTEREST-EARNING ASSETS: Taxable Investments $ 21,794 $ 941.73 % $ 26,734 $ 1241.86 % Tax-Exempt Investments (1) 19,316 148 3.07 % 11,775 85 2.88 % Total Investments 41,110 242 2.36 % 38,509 209 2.17 % Gross Loans (2) 251,676 3,161 5.04 % 235,022 3,154 5.38 % Interest-bearing Deposits 5,930 4 0.29 % 32,658 18 0.23 % Federal Funds Sold 147 - 0.07 % 204 - 0.07 % Total Interest Earning Assets $ 298,863 $ 3,4074.56 % $ 306,393 $ 3,3814.41 % INTEREST-BEARING LIABILITIES: Savings Deposits $ 44,387 $ 170.16 % $ 46,031 $ 300.26 % NOW Deposits 41,817 15 0.15 % 40,997 23 0.23 % Time Deposits => $100,00044,049 201 1.85 % 47,239 260 2.23 % Time Deposits < $100,00050,887 198 1.58 % 58,149 277 1.93 % Money Market Deposit Accounts 27,237 27 0.40 % 27,879 41 0.60 % Total Deposits 208,377 458 0.89 % 220,295 631 1.16 % Federal Funds Purchased 137 - 0.00 % - - 0.00 % Securities Sold Under Repurchase Agreements 7,380 2 0.11 % 6,908 4 0.23 % FHLB Advances 15,000 100 2.70 % 15,000 139 3.76 % Total Interest-Bearing Liabilities $ 230,894 $ 5600.98 % $ 242,203 $ 7741.30 % Net interest income and net interest margin $ 2,8473.81 % $ 2,6073.40 % Non interest-bearing deposits $ 57,192- 0.00 % $ 49,129- 0.00 % Total Cost of funds 0.78 % 1.06 % Net interest spread 3.78 % 3.35 % Notes:
(1) Income and yield assumes a federal tax rate of 34%.
(2) Includes Visa program and nonaccrual loans.
Interest income for the three months ended
March 31, 2014, on a tax-equivalent basis, was $3.4 million, an increase of $26 thousandfrom the first quarter of 2013. Interest expense for the three months ended March 31, 2014, was $560 thousand, a decrease of $214 thousandfrom the first quarter of 2013, due mainly to reductions in both balances and costs of time deposits, but also from the reduced cost of an FHLB advance. Net interest income for the three months ended March 31, 2014, on a tax-equivalent basis, was $2.8 million, an increase of $240 thousandfrom the first quarter of 2013. The annualized net interest margin was 3.81% and 3.40% for the three months ended March 31, 2014and 2013, respectively. The deposit mix continues to improve as lower cost balances in checking accounts have increased while higher cost time deposit balances have declined. Further reductions in the cost of funds are anticipated as time deposits mature and are replaced at lower rates. As long as market rates remain low, this positive trend is expected to continue. The net interest spread, which is the difference between the annualized yield on earning assets and the total cost of funds, increased to 3.78% for the three months ended March 31, 2014, compared to 3.35% for the three months ended March 31, 2013.
Non-interest income for the three months ended
March 31, 2014increased $127 thousand, or 12.9%, compared to the three months ended March 31, 2013. This increase was primarily due a gain of $138 thousandrecognized on the sale of the former branch office in Heathsville, Virginia. VISA-related fees declined by $91 thousanddue to assignment of merchant agreements to a third party, but were offset by increases of $47 thousandfrom bank-owned life insurance and $44 thousandfrom gains on sale of OREO. 23
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For the three months ended
March 31, 2014, non-interest expenses totaled $3.1 million, a decrease of $161 thousand, or 4.9%, compared to the same period in 2013. This decrease is primarily the result of a reduction in salary and benefits of $143due to lower stock compensation costs and lending commissions. Consulting expense increased by $76 thousanddue to accounting services and VISA expense declined by $85 thousanddue to the aforementioned assignment of merchant agreements to a third party.
AVERAGE INTEREST-EARNINGS ASSETS AND AVERAGE INTEREST-BEARING LIABILITIES
Average interest-earning assets decreased 2.5% to
$298.9 millionfor the three months ended March 31, 2014, as compared to $306.4 millionfor the three months ended March 31, 2013, as interest-bearing deposits were redeployed into higher yielding loans and bank-owned life insurance. Average interest-earning assets as a percent of total average assets was 91.3% for the three months ended March 31, 2014as compared to 93.0% for the same period in 2013. The loan portfolio, with $251.7 millionin average balances as of March 31, 2014, is the largest category of interest-earning assets. Average interest-bearing liabilities decreased 4.7% to $230.9 millionfor the three months ended March 31, 2014, as compared to $242.2 millionfor the three months ended March 31, 2013. The largest category of interest-bearing liabilities is time deposits, with combined average balances of $94.9 millionfor the three months ended March 31, 2014, down from $105.4 millionfor the similar period in 2013.
In the first three months of 2014, asset quality improved. Non-performing assets, which include OREO and non-performing loans, declined
$0.8 millionto $5.9 million, or 1.8% of assets. This level also represents 2.3% of loans plus OREO. Non-Performing Assets (Dollars in Thousands) March 31, 2014 December 31, 2013 Loans past due 90 days or more and still accruing $ 8 $ 18 Non-accruing loans 2,324 2,754 Total non-performing loans 2,332 2,772 Other real estate owned 3,538 3,897 Total non-performing assets $ 5,870 $ 6,669 Allowance for loan losses $ 2,950 $ 2,925 Allowance to non-performing loans 126.5 % 105.5 % Non-performing assets to total assets 1.77 % 2.01 % Non-performing loans, which include loans past due 90 days or more and still accruing, plus non-accruing loans, as a percentage of total loans, decreased to 0.9% as of March 31, 2014compared to 1.1% as of December 31, 2013. Non-accruing loans totaled $2.3 millionas of March 31, 2014, down from $2.8 millionat year-end 2013. Loans charged off during the first three months of 2014, net of recoveries, totaled $140 thousandcompared to $142 thousandfor the first three months of 2013. This represents a decline in the annualized net charge-off ratio to 0.22% for the first three months of 2014 compared to 0.24% for the first three months of 2013, reflecting an improvement in asset quality. The majority of the charge-offs were anticipated and specific reserves had been provided for them in the ALL. Management is maintaining an adequate level of the ALL at 1.16% and 1.17% of total loans for March 31, 2014and December 31, 2013, respectively. Classified assets, which include loans with risk rating grades of substandard, doubtful and loss, plus OREO, decreased by $1.7 millionduring the first three months of 2014 to $9.8 million, or 24.55% of Tier 1 capital plus the allowance for loan losses. Risk rating grades are assigned conservatively, causing some homogenous loans, such as residential mortgages, to fall into the pool of adversely risk rated loans and thereby evaluated for impairment, even though they may be performing as agreed and therefore not impaired. As of March 31, 2014, loans valued at $7.9 millionwere considered impaired, whereas $6.7 millionwere considered impaired as of December 31, 2013. Between December 31, 2013and March 31, 2014, five loans were identified as impaired and none were dispensed through foreclosures and charge-offs. Management has reviewed the impaired credits and the underlying collateral and expects no additional losses above those which are specifically reserved in ALL.
Total assets remained relatively flat at
$330.1 millionas of March 31, 2014compared to $331.1 millionat December 31, 2013. Cash and due from banks, which produces no income, decreased to $6.3 millionon March 31, 2014from $6.8 millionat year-end 2013, a result of normal daily fluctuation in deposit transactions. Interest-bearing deposits at other banks, which is mainly the Bank's cash on deposit at the Federal Reserve Bank of Richmond, has declined by $2.0 millionsince year end 2013. 24
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During the three months ended
March 31, 2014, gross loans increased by $2.8 millionor 1.1%, to $253.1 millionfrom $250.3 millionat year-end 2013. The largest components of this increase were $1.0 millionrelated to construction and land development, $1.0 millionrelated to residential revolving and junior mortgages and $0.7 millionrelated to commercial and industrial. The Bank had $3.5 millionof OREO at March 31, 2014and $3.9 millionat December 31, 2013. As of March 31, 2014, OREO consists of 11 residences, 13 lots, two former convenience stores, one former restaurant, one commercial business property and a seafood house. During the first three months of 2014, three properties with a total book value of $197 thousandfrom two borrowers were added through foreclosures, and three properties with a total book value of $556 thousandwere sold. There were no write-downs of OREO properties during the first three months of 2014, compared to $16 thousandfor the same period in 2013. All properties maintained as OREO are valued at the lesser of carrying value or fair value less estimated costs to sell and are actively marketed. In March 2014, the Company sold a former branch in Heathsville, Virginiafor $311 thousandand recognized a gain of $138 thousandon the sale. The branch was included in other assets as of December 31, 2013. As of March 31, 2014, securities available-for-sale at fair value totaled $37.7 millionas compared to $38.5 millionon December 31, 2013. This represents a net decrease of $811 thousandor 2.1% for the three months. The decrease in securities available-for-sale is primarily the result of the sale of a troubled asset with a fair value of $912 thousand. An impairment loss was recognized on this asset in 2013 and therefore, no gain or loss was recognized on the sale of the asset as its carrying value equaled its fair value at the time of sale. As of March 31, 2014, available-for-sale securities represented 11.4% of total assets and 12.6% of earning assets. All securities in the Company's investment portfolio are classified as available-for-sale and marked to market on a monthly basis. These gains or losses, net of tax, are booked as an adjustment to shareholders' equity, and are not realized as an adjustment to earnings until the securities are actually sold or an other than temporary impairment occurs. In the second quarter of 2013, the Company purchased $5.0 millionof bank owned life insurance in order to offset the cost of employee benefits. The bank owned life insurance's fair market value as of March 31, 2014was $5.2 million.
March 31, 2014, securities sold under repurchase agreements decreased $680 thousandto $8.4 millionfrom $9.1 millionat December 31, 2013. This decrease was the result of normal seasonality for these customers.
Liquidity represents an institution's ability to meet present and future financial obligations (such as commitments to fund loans) through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with other banks, federal funds sold and investments and loans maturing within one year. The Company's ability to obtain deposits and purchase funds at favorable rates are major factors for liquidity. Management believes that the Company maintains overall liquidity that is sufficient to satisfy its depositors' requirements and to meet its customers' credit needs. At
March 31, 2014, cash totaled $6.3 million, federal funds sold totaled $333 thousand, interest-bearing deposits totaled $6.9 million, and securities and loans maturing in one year or less totaled $26.0 million. This results in a liquidity ratio as of March 31, 2014of 12.0% as compared to 12.9% as of December 31, 2013. The Company determines this ratio by dividing the sum of cash and cash equivalents, investment securities maturing in one year or less, loans maturing in one year or less and federal funds sold, by total assets. The Bank has a formal liquidity management policy and contingency plan, which includes periodic evaluation of cash flow projections.
In addition, the Company has a line of credit with the FHLB of
Capitalresources represent funds, earned or obtained, over which a financial institution can exercise greater long-term control in comparison with deposits and borrowed funds. The adequacy of the Company's capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company's resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allows management to effectively leverage its capital to maximize return to shareholders. The Company's capital, also known as shareholders' equity, is comprised mainly of outstanding common stock and retained earnings. Capitalcan be increased with securities offerings or through earnings. Several factors impact shareholders' equity, including net income and regulatory capital requirements. The Company's capital resources are also impacted by net unrealized gains or losses on securities. The available-for-sale securities portfolio is marked to market monthly and unrealized gains or losses, net of taxes, are recognized as accumulated other comprehensive income (loss) on the balance sheets and statement of changes in shareholders' equity. Another factor affecting accumulated other comprehensive income (loss) is changes in the market value of the Company's pension and post-retirement benefit plans. The Company's shareholders' equity before accumulated other comprehensive loss was $38.8 millionon March 31, 2014compared to $38.3 millionon December 31, 2013. Accumulated other comprehensive loss decreased $323 thousandbetween December 31, 2013and March 31, 2014, primarily as a result of decreases in unrealized net losses in the investment portfolio. 25
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Book value per share, before accumulated other comprehensive loss, on
March 31, 2014, compared to December 31, 2013, increased to $8.05from $7.96. Book value per share, including accumulated other comprehensive loss, increased to $7.87on March 31, 2014from $7.71on December 31, 2013. No cash dividends were paid for the three-month period ended March 31, 2014, nor for the comparable period ended March 31, 2013. The Bank is subject to minimum regulatory capital ratios as defined by Federal Financial Institutions Examination Councilguidelines. These ratios continue to be well in excess of regulatory minimums. As of March 31, 2014, the Bank maintained Tier 1 capital of $30.9 million, net risk weighted assets of $239.3 million, and Tier 2 capital of $2.9 million. On March 31, 2014, the Tier 1 leverage ratio was 9.57%, the Tier 1 capital to risk weighted assets ratio was 12.92%, and the total capital ratio to risk weighted assets ratio was 14.16%.
OFF BALANCE SHEET COMMITMENTS
In the normal course of business, the Company offers various financial products to its customers to meet their credit and liquidity needs. These instruments may involve elements of liquidity, credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby-letters of credit is represented by the contractual amount of these instruments. Subject to its normal credit standards and risk monitoring procedures, the Company makes contractual commitments to extend credit. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Conditional commitments are issued by the Company in the form of performance stand-by letters of credit, which guarantee the performance of a customer to a third-party. The credit risk of issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.